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Chapter 25

ECON 295 Chapter 25: Chapter 25.docx

Course Code
ECON 295
Kenneth Ragan

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Chapter 25
I) Accounting for Changes in GDP
To illustrate the difference between short-term and long-term changes in economic activity is
the behaviour of real GDP over time.
The value of potential GDP is estimated by combining three pieces of information: the
amount of available factors of production, an estimate of these factors normal rates of
utilisation and an estimate of each factor’s productivity.
When studying long-run trends in GDP, economists focus on the change in potential output.
When studying short-term fluctuations, economists focus on the change in the output gap.
Now let’s break down any change in GDP into its component parts.
GDP = F * ( GDP / F )
GDP = F * ( Fe / F ) * ( GDP /Fe )
With F, the economy’s factor supply: it is the total amount of all factors of production that
the economy currently possesses.
With Fe / F, the factor utilization rate: it is the fraction of the total supply of factors that is
actually used or employed at any time.
With GDP / Fe, a simple measure of productivity because it shows the amount of output
(GDP) per unit of input employed (Fe).
A) The Long-Run: Factor Supply
Labour: The economy’s supply of labour can increase for two main reasons. First,
population can increase. Second, there can be an increase in the fraction of the
population that chooses to seek employment. But no matter how the economy’s
supply of labour increases, these changes are mostly long-term.
Capital: The economy’s supply of physical goods increases for one reason. Firms
that choose to purchase such investment goods today are accumulating physical
capital that will be used to produce output in the future. The economy’s stock of
capital goods changes only very gradually.
B) The Long-Run: Productivity
The economy’s level of productivity (GDP / Fe) is a measure of the average amount of
output that is produced per unit of input. Productivity growth is an important source of long-
term in per capita income. Thus it grows substantially over periods of many years.
C) The Short-Run: Factor Utilization
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