Consider an economy that has an aggregate capital stock of 200
billion which depreciates at the rate of 8 percent per year.
Suppose that each unit of capital stock produces 0.15 units of
output. What is the level of income produced in this economy?
The correct answer is 14 billion. Since the economy produces 1.5
units of aggregate output for every 10 units of aggregate capital
stock, the level of output will be 30 billion. Depreciation
will equal 8 percent of the capital stock, or 16 billion.
Income equals output minus depreciation, or 14 billion.
You had to remember three things to get the correct answer here.
- That the economy's output is the flow of returns off its stock
of capital---the ratio of returns to stock is 1.5/10.
- That depreciation is the amount of the capital stock that wears
out during the year---in this case, some 8 percent of it.
- That income is the amount of output left after depreciation
has been allowed for---it is the amount that could be consumed
and still keep the capital stock intact.
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