Production and Distribution


Review Questions

1. What explains GDP?

 

 Factors of production (capital, labor) and technology.

 
2. What is productivity? Labor productivity is output per unit of labor.  Total factor productivity is output per average unit of all factors of production.

 
3. What explains variations in labor productivity?

 

 Variations in the capital-labor ratio and variations in total factor productivity.

 
4. What explains variations in total factor productivity?

 

 Technology, the degree of competition, the legal and regulatory environment, political stability, education, etc.

 
5. What determines how total output gets divided?

 

 Factors of production get paid their marginal products.

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Answers to Selected Textbook Problems

Mankiw, Macroeconomics, fourth edition, chapter 3, problems and applications

1. Factors of production get paid their margnial products, which depend on the capital-labor ratio and total factor productivity.
a. The capital-labor ratio falls, raising the rental rate of capital and lowering the wage rate.
b. The capital-labor ratio falls, raising the rental rate of capital and lowering the wage rate.
c.

 Total factor productivity rises.  For fixed amounts of capital and labor, this raises both the rental rate of capital and the wage rate of labor.
3.




 This is a fairly sophisticated question, possibly moreso than the author intended, and a good grasp of microeconomics is required to answer it.  To keep things simple, assume that their are only two goods in the economy, wheat and haircuts (the latter of which is actually a service).  Also assume that there are only two types of workers, farmers and barbers.  Finally, assume that all workers (who are also the consumers) have the same preferences about the mix of wheat and haircuts that they consume.  It is most logical to answer the questions in the following order rather than in the order shown in the text.
f.

 Assuming that both wheat and haircuts are normal goods, increased productivity in the wheat sector causes the output of wheat to rise, lowering the relative price of wheat (and therefore raising the relative price of haircuts).
a-b.

 

 The marginal productivity of labor in the wheat sector rises.  If the real wage of farmers were measured only in units of their own output good, their real wage would clearly rise.  But if their real wage is measured in baskets of wheat and haircuts in the proportions that they actually consume, then their real wage could fall if the relative price of wheat declines enough.
c-d.

 

 The marginal productivity of barbers is unchanged.  If their real wage were measured only in units of their own output good, the real wage would remain unchanged.  But if their real wage is measured in baskets of wheat and haircuts in the proportions that they acually consume, then their real wage clearly rises because the relative price of haircuts goes up.
e.

 

 If workers can move freely between the two sectors, then in equilibrium they must earn the same wage in either sector, measured in terms of baskets of wheat and haircuts in the proportions that they actually consume.   If this were not the case, workers would migrate from the sector with the low real wage to the sector with the high real wage.
g. This means that both types of workers benefit equally from the increase in productivity in agriculture.

Additional comments:
i.







 Without more information, we cannot say which way labor will actually move.  If the income elasticity of demand for haircuts is sufficiently high or the price elasticity is sufficiently low (or some combination of the two), the net effect of the technological improvement in agriculture is to increase the quantity of haircuts demanded.  Because the productivity of barbers has not increased, more barbers are needed to produce the additional haircuts (i.e., the demand for barbers increases).  If the income elasticity of demand for haircuts is sufficiently low or the price elasticity is sufficiently high, the quantity of haircuts demanded falls, reducing the number of barbers.  (Note that the weighted average of the income elasticities for the two goods, where each is weighted by the share of the good in total expenditure, must equal 1.0.  Thus, a high income elasticity of demand for haircuts implies a low income elasticity of demand for wheat.)
ii.





 

 Suppose that workers cannot move freely between sectors.  In fact, suppose they cannot move at all.  Then the wages of the two types of workers need not be equal.  By the reasoning in the answers to parts (c) and (d) above, the real wage of barbers, measured in baskets of wheat and haircuts, must increase.  Thus, technological improvement in agriculture clearly maket barbers better off.  But if the income and price elasticities of demand for wheat are both sufficiently low, then the increased output of wheat causes a large drop in the relative price of wheat.  In this case, it is possible for the real wage of farmers, measured in baskets of wheat and haircuts, to drop, meaning that technological progress in agriculture has reduced the demand for farmers and thus their wages.  (Remember that a low income elasticity of demand for wheat means a high income elasticity of demand for haircuts, which was one of the conditions tending to increase the demand for barbers.)

4.
National saving equals private saving plus public (i.e., government) saving.   In a closed economy (which we assume to be the case here) national saving equals domestic investment.
a. Public saving increases by $100.
b. Disposable income falls by $100.   Consumption falls by $60.  Thus, private saving falls by $40.
c.
 National saving increases by $60, which is equal to the fall in consumption.  (This is not a coincidence)
d.
 Investment increases by $60.

5.

 
The upward shift in the consumption function leads to more consumption and less saving at any level of disposable income. Given the investment demand curve, the reduction in saving implies a higher interest rate. The higher interest rate implies a lower quantity of investment.  (Note the distinction between shifts of curves and movements along curves.)

6.
a.
Private saving = (Y-T) - C = (5000 - 1000) - [250 + .75(5000 - 1000)] = 750
Public saving = T - G = 0
National saving = 750
b. I = 1000 - 50r = 750 = S, implying r = 5 percent.
c. Private saving is still equal to 750.   Public saving equals -250, implying national saving of 500.
d.
 r = 10 percent.

7.
Use the numerical example in question 6 above to find the answer.  Suppose that G = T = 1400 and compare the solution with the original case where G = T = 1000.
Private saving = (Y-T) - C = (5000 - 1400) - [250 + .75(5000 - 1400)] = 650
Public saving is still zero, implying national saving (and investment) of 650.   Solving for the interest rate gives r = 7 percent.
Yes, the answer does depend on the marginal propensity to consume.  Note that increasing taxes by 400 lowers private saving by 100, which is (1-MPC) times the increase in taxes.  If the MPC = 1, then an increase in taxes has no effect on private saving. In this case, equal increases in taxes and government purchases have no effect on saving, investment, or the interest rate.

9.
If consumption depends negatively on the interest rate, the effects of fiscal policy would be weaker but would still go in the same direction as in the case where consumption does not depend on the interest rate.