1. Discussion Session 6

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

3. Measuring Production Spending Approach Income Approach Production Approach

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

5. 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

6. 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)

7. 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

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

9. 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

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

11. 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

12. Question 1 c. The farmer sells corn overseas.

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

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

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

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

17. 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

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

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

20. Question 1 g. The farmer buys a newly constructed house

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

22. 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

23. 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

24. 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.

25. Question 3

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

27. 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 = +

28. 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.

29. 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

30. 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

31. 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

32. 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%

33. 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.

34. 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.