Discussion Session 6

Outline Measuring Production Spending Allocation Model Growth Accounting Formula Quantity Equation of Money

Measuring Production Spending Approach Income Approach Production Approach

Measuring Production Spending Approach (Expenditure approach) Y= C + I + G + X

Measuring Production Income Approach Y = Labor Income (wages, salaries and fringe benefits) + Capital Income (profits, rental payments, and interest payment) + Depreciation + Tax – Subsidy + Net income of foreigners

Measuring Production Production Approach: Sum of the value added by each of the manufacturers. (value of a firm’s production less the value of the intermediate goods used in the production)

Question 1 Which components of GDP (spending approach) will be affected by each of the following transactions involving a farmer in the United States, and why? a.The farmer buys a used tractor from a friend, to be used for his farming business b.The farmer has a mechanic replace one of the tractor parts with a new one. c.The farmer sells corn overseas. d.The farmer uses some of the corn to make cornbread for his family. e.The farmer receives a subsidy from the government. f.The farmer buy a new four-wheel-drive vehicle to use on vacation g.The farmer buys a newly constructed house

Question 1 a.The farmer buys a used tractor from a friend, to be used for his farming business

Question 1 a.The farmer buys a used tractor from a friend, to be used for his farming business There is no change in GDP, because the tractor is a used good

Question 1 b. The farmer has a mechanic replace one of the tractor parts with a new one.

Question 1 b. The farmer has a mechanic replace one of the tractor parts with a new one. Investment will increase by the cost of the tractor part and mechanic service, so GDP increases

Question 1 c. The farmer sells corn overseas.

Question 1 c. The farmer sells corn overseas. Net export will increase, because the farmer is exporting corn. GDP increases

Question 1 d. The farmer uses some of the corn to make cornbread for his family.

Question 1 d. The farmer uses some of the corn to make cornbread for his family. Home production is not included in GDP

Question 1 e. The farmer receives a subsidy from the government.

Question 1 e. The farmer receives a subsidy from the government. This is a transfer from the government to the farmer; it does not count towards GDP

Question 1 f. The farmer buy a new four-wheel-drive vehicle to use on vacation

Question 1 f. The farmer buy a new four-wheel-drive vehicle to use on vacation This is counted towards Consumption. GDP increases

Question 1 g. The farmer buys a newly constructed house

Question 1 g. The farmer buys a newly constructed house This is counted towards Investment (Residential Investment). GDP increases

Measuring Production Question 2: Given the data, calculate Investment, Net Exports, and GDP –using spending approach Components of SpendingValue (billion of US$) Consumption$140 Business Fixed and Residential Investment$27 Inventory Stocks at the end of 2007$10 Inventory stock at the end of 2008$5 Government Purchases$65 Exports$21 Imports$17

Spending Allocation Model Y=C+I+G+X Dividing both sides by Y, 1= C/Y + I/Y + G/Y+ X/Y Which says that the sum of shares of spending in GDP must equal one

Question 3 Suppose the government introduces a new tax policy that encourages investment. Using diagrams, showing what will happen to real interest rate. What will happen to the spending shares of GDP in the long run.

Question 3

Production function Production function with technology: Y = F(L, K, T) whereT = technology Y = GDP K = capital input L = labor input

Growth Accounting Formula The growth accounting formula states that Growth rate of productivity Growth rate of capital per hour of work Growth rate of technology = +

Question 4 In country A, capital per hour of work from 1950 to 1973 grew by 3 % per year and output per hour of work grew by about 3% per year. Suppose that from 1973 to 1991, capital per hour of work did not grow at all and output per hour of work grew by about 1 % per year. How much of the slow down in productivity (output per hour of work) growth was due to technological change? Explain.

Question 4 In country A, capital per hour of work from 1950 to 1973 grew by 3 % per year and output per hour of work grew by about 3% per year. Suppose that from 1973 to 1991, capital per hour of work did not grow at all and output per hour of work grew by about 1 % per year. How much of the slow down in productivity (output per hour of work) growth was due to technological change? Explain. 2% decline in productivity growth 3% decline in growth rate of capital per hour of work

Question 4 In country A, capital per hour of work from 1950 to 1973 grew by 3 % per year and output per hour of work grew by about 3% per year. Suppose that from 1973 to 1991, capital per hour of work did not grow at all and output per hour of work grew by about 1 % per year. How much of the slow down in productivity (output per hour of work) growth was due to technological change? Explain. 2% decline in productivity growth 3% decline in growth rate of capital per hour of work -- But only one-third of the capital growth rate impacts productivity 1% decline in productivity growth can be explained by decline in growth rate of capita per hour of work The other 1% is explained by slowdown in technology growth

Quantity Equation of Money MV = PY M is money supply P is the price level (sometimes called the GDP deflator) V is the velocity (a measure of how quickly money is turned over in the economy) Y is real GDP

Question 5—The Fed and Money Supply If the Federal Reserve increases the money supply in the U.S. by 10% in 2014, while real GDP increases by only 2%; what will be the long run effect on prices? MV = PY Money growth + velocity growth = inflation + real GDP growth Inflation = money growth + velocity growth- real GDP growth = 10% + v% -2% = 8% + v% If velocity doesn’t change, inflation would be 8%

Question Suppose personal income tax rates are cut. Using a diagram, show what will happen to real interest rates. What will happen to the spending shares of GDP in the long run.

Question Suppose personal income tax rates are cut. Using a diagram, show what will happen to real interest rates. What will happen to the spending shares of GDP in the long run. The C/Y* shifts right; this shifts NG/Y* right also. Interest rates will rise. I/Y*and X/Y* shares will fall.