As we suggest in the text, in order to estimate GDP the government needs to know how much of the economy’s new investment is really incremental and how much just replaces worn out stock. But how does the government figure this out? For some products, the calculation is relatively simple. Depreciation is mostly physical, and we can get some data on when those goods fall apart and are no longer useful. But many other goods, particularly in the high tech area, depreciate not so much from physical wear and tear but because they become obsolete. How is the depreciation of these goods determined? A paper by four Federal Reserve Board economists takes us through the calculation of depreciation rates for personal computers. Using data on prices and model characteristics for more than 10,000 transactions involving used personal computers, these researchers were able to determine the depreciation rate of personal computers by type. Their results indicated that computers lose roughly half their value with each additional year of use. Most of this depreciation comes from the inability of older models to match the functionality of the newer models. So depreciation comes not so much because the machines cannot do what they always did, but because expectations for what a computer needs to be able to do change over time as new machines enter the workplace.

Interestingly, the estimates of these economists made their way into the depreciation schedules used by the government in constructing the NIPA accounts, showing us the practical importance of macroeconomics.

CRITICAL THINKING

If a computer is initially worth $1,000 and loses half of its value per year, what is its value after three years of depreciation? How much depreciation takes place in the third year?