Economics (McConnell) AP Edition, 19th Edition

Chapter 29: Aggregate Demand and Aggregate Supply (+ Appendix)

Worked Problems

Problem 29.1 - Productivity and costs

Problem:

Suppose the relationship between an economy's aggregate inputs and its output can be represented by the following table, in which inputs and real GDP are expressed in billions:

Inputs

 

Real GDP

100

 

$400

105

 

420

110

 

440

115

 

460

  1. What is the productivity level in this economy?
  2. Suppose each input costs $5. What is the per-unit production cost at each level of output?
  3. Suppose productivity increases by 10% with no change in input prices. Calculate the new per-unit production cost.
  4. Alternatively, suppose input prices increase by 10% with no change in productivity. Calculate the new per-unit production cost.
  5. True or false: "An equal percentage increase in productivity and input prices will have no impact on per-unit production costs."

Answer:

  1. Productivity is measured as the ratio of total real output to total inputs. In this example, productivity is 400/100 = 4.
  2. Production cost is measured as the price of each input times its price. Per-unit production cost is this amount divided by total output, or real GDP. In this example, per-unit production cost at each level of output is $1.25. $1.25 = ($5 x 100)/$400 = ($5 x 105)/$420 =($5 x 110)/$440 =($5 x 115)/$460.
  3. The new productivity level is 1.1 x 4 = 4.4, a 10% increase over its previous level. This means that 100 billion units of inputs could produce 100 x $4.4 = $440 billion of real GDP. The new per-unit production cost is ($5 x 100)/$440 = $1.14, a drop of 10%.
  4. Each input would now cost 1.1 x $5 = $5.50. Per-unit production cost is ($5.50 x 100)/$400 = $1.375, an increase of 10% over its previous value of $1.25.
  5. True. Per-unit production cost is the ratio of total input cost to total output. If both numerator and denominator increase in proportion, the ratio is unchanged. In this example, the per-unit production cost following a 10% increase in both productivity and input prices would be ($5.50 x 100)/$440 = $1.25, the same as before.
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