Long Questions: The Aggregate Economy and GDP measures of "free" goods (20 points)

You are being interviewed for a position at a large technology/social media company. The interviewer

would like to see how you think about the contributions of the company to the aggregate U.S.

economy and has prepared the following case study for you. Here is the relevant background:

The digital economy has made free goods and services ubiquitous (think about Facebook,

Youtube, Google). Consider the following example economy. In the economy there is

an online content creator: Viral-Videos; an advertising company: Sterling Cooper; and

a manufacturing company: Widgeco.

Consider the following three different scenarios to see how the presence of free goods are considered

in current GDP estimates and how that might introduce a bias into standard measurements. Your

interviewer also provides you with the following tips:

It might be useful to review some of the concepts used to compute GDP. Refer to the lecture

slides and notes of week 1. The Bureau of Economic Analysis also provides a primer on

measuring GDP you may find useful, available here:

www.bea.gov/sites/default/files/methodologies/nipa_primer.pdf

For additional details (and more in depth analysis of the measurement of free goods), refer

to: Nakamura, Samuels, Soloveichik (2017). The paper is available here:

www.bea.gov/system/files/papers/WP2017-9.pdf

1. (5 points) -- Suppose Viral-Videos sells $400 of entertaining online videos directly to consumers

via a subscription service1; Sterling Cooper sells $200 of advertising services to Widgeco

(it makes catchy images featuring Widgeco products and places them on billboards around

town) and Widgeco sells $1000 of widgets to consumers. Complete the table below. (Be sure

to explain/show all calculations! )

Company Value-Added

Viral-Videos ----------

Sterling Cooper -------------

Widgeco -----------

GDP ----------

2. (5 points) Suppose now Viral-Videos sells just $200 of videos directly to consumers via its

subscription service. It also produces a further set of videos of the same quality as those on

its subscription service. It posts them online where consumers can view them for free. They

are viewed the same number of times as those on its subscription service. However, it attaches

advertisements to these videos. The advertisements are made by Sterling Cooper and are

for Widgeco products. Viral-Videos charges Sterling Cooper $200 for the right to place the

advertisements it makes in its videos. Sterling Cooper charges Widgeco $400 for its services

in making and placing the adverisements. Widgeco sells $1000 of widgets to consumers.

Complete the table below. (Be sure to explain/show all calculations! )

Company Value-Added

Viral-Videos ----------

Sterling Cooper -------------

Widgeco -----------

GDP ----------

3. (5 points) Suppose lastly that Viral-Videos goes bustthat is, bankrupt. Online videos are

now produced by a guy called Chris in his spare time. Chris uploads the videos to a new

online site, called TokTik, that is owned and managed by Sterling Cooper. Anyone can watch

videos on TokTik without paying a fee. Sterling Cooper makes videos advertising Widgeco's

product and embeds them on the site and in videos Chris posts. It sells this service for $400

to Widgeco. Widgeco sells $1000 of widgets to consumers. Complete the table below. (Be

sure to explain/show all calculations! )

Company Value-Added

Chris +Sterling Cooper -------------

Widgeco -----------

GDP ----------

4. (5 points) What are the free goods in these economies? Should they be included in GDP

measurement? How could their value be measured in either economy 2 or 3?

Answer: