Question

Suppose an economist conducts a growth accounting exercise on a country and finds that for a period of time, that output is growing at a rate of 5 per cent on an annual basis. The growth accounting procedure suggests that 2.1 per cent is due to labour growth, 0.6 per cent is due to capital growth and the remaining 2.3 per cent is due to growth in total factor productivity.

Now, suppose that errors exist in measuring capital stock. Further, suppose the statistician tells us that there is a 2 per cent rise in capital stock, but in reality, there was actually a 5 per cent rise.

Explain how the actual contributions of capital, labour and productivity to output growth vary from our estimates?

Does the measurement error imply we underestimate or overestimate the role of productivity in explaining growth when we used the incorrect measure of capital stock?

Answer 1

SOLUTION:

* We know that the output growth is made up of labor growth, captial growth and productivity growth.

* In this case there was an underestimation of growth in capital. In reality captial growth is higher than what was taken by the economist.

* Assuming that the output growth and labor growth were measure correctly, it would mean that productivity growth was over-estimated and in reality it is lower than what the economist took it to be.

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