Consider a simple economy consisting of only four firms. Firm A, a mining enterprise, extracts iron ore. Firm B, a Steelmaker, produces steel sheets. Firm C, a carmaker, makes automobile while Firm D produces automobile tires.
In 2016, firm A extracts 50,000 tons of ores, valued at $200 per ton, using previously existing machinery. Firm B produces 10,000 tons of steel sheets, valued at $3000 per ton, having bought and used all of the ore produced by Firm A. Firm C manufactured 5000 vehicles and sold them all to households for 20,000 each, having purchased 8000 tons of steel sheets from Firm B. In addition, Firm C imported 5000 engines from a foreign subsidiary, each valued at $5000, and purchased 20,000 tires from Firm D for $100 each. Firm D produced 100,000 tires valued at $100 each, but only sold 60,000 tires during 2016. Firm D purchased 2000 tons of steel sheets from Firm B since all of their tires are steel belted radials.
Calculate GDP in 2016 for this economy using the production approach (valu added). Also, calculate GDP in 2016 using the expenditure approach.
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To calculate GDP using the production approach, we need to find the value added at each stage of production. Value added is calculated by subtracting the cost of intermediate goods from the total value of output.
1. Firm A (Mining enterprise):
Value added = Total value of output - Cost of intermediate goods
Value added = (50,000 tons) * ($200/ton) - 0 (no intermediate goods)
Value added = $10,000,000
2. Firm B (Steelmaker):
Value added = Total value of output - Cost of intermediate goods
Value added = (10,000 tons) * ($3,000/ton) - ($200/ton * 50,000 tons)
Value added = $30,000,000 - $10,000,000
Value added = $20,000,000
3. Firm C (Carmaker):
Value added = Total value of output - Cost of intermediate goods
Value added from vehicles = (5000 vehicles) * ($20,000/vehicle) - ($3,000/ton * 10,000 tons)
Value added from engines = (5000 engines) * ($5000/engine) - 0 (no intermediate goods)
Value added = $100,000,000 - $30,000,000
Value added = $70,000,000
4. Firm D (Tire Manufacturer):
Value added = Total value of output - Cost of intermediate goods
Value added from tires = (60,000 tires) * ($100/tire) - 0 (no intermediate goods)
Value added = $6,000,000 - 0
Value added = $6,000,000
GDP using the production approach = Sum of value added at each stage of production
GDP = $10,000,000 + $20,000,000 + $70,000,000 + $6,000,000
GDP = $106,000,000
To calculate GDP using the expenditure approach, we need to sum up the final expenditures on goods and services.
1. Firm C (Carmaker):
Household expenditure on vehicles = (5000 vehicles) * ($20,000/vehicle)
Expenditure on imported engines = (5000 engines) * ($5000/engine)
Total expenditure on Firm C's output = Household expenditure on vehicles + Expenditure on imported engines
Total expenditure on Firm C's output = $100,000,000 + $25,000,000
Total expenditure on Firm C's output = $125,000,000
2. Firm D (Tire Manufacturer):
Expenditure on Firm D's output = (60,000 tires) * ($100/tire)
Expenditure on Firm D's output = $6,000,000
GDP using the expenditure approach = Sum of final expenditures on goods and services
GDP = Total expenditure on Firm C's output + Expenditure on Firm D's output
GDP = $125,000,000 + $6,000,000
GDP = $131,000,000
So, the GDP in 2016 for this economy is $106,000,000 using the production approach and $131,000,000 using the expenditure approach.
To calculate GDP using the production approach, we need to sum up the value-added by each firm in the economy.
1. Firm A: Since this is a mining enterprise, its value-added is equal to the value of the iron ore it extracted. This can be calculated as:
Value-Added by Firm A = 50,000 tons x $200/ton = $10,000,000
2. Firm B: The steel sheets produced by Firm B consist of input from Firm A's iron ore. Therefore, the value-added by Firm B is the difference between the value of its output (steel sheets) and the cost of inputs it purchased from Firm A (iron ore). This can be calculated as:
Total Output by Firm B = 10,000 tons x $3000/ton = $30,000,000
Cost of Inputs purchased from Firm A = 10,000 tons x $200/ton = $2,000,000
Value-Added by Firm B = Total Output - Cost of Inputs = $30,000,000 - $2,000,000 = $28,000,000
3. Firm C: The automobiles manufactured by Firm C consist of inputs from both Firm B (steel sheets) and the foreign subsidiary (engines). The value-added by Firm C is the difference between the value of its output (automobiles) and the cost of inputs it purchased from Firm B (steel sheets) and the foreign subsidiary (engines). This can be calculated as:
Total Output by Firm C = 5,000 vehicles x $20,000/vehicle = $100,000,000
Cost of Steel Sheets purchased from Firm B = 8,000 tons x $3,000/ton = $24,000,000
Cost of Engines imported from foreign subsidiary = 5,000 engines x $5,000/engine = $25,000,000
Value-Added by Firm C = Total Output - Cost of Inputs = $100,000,000 - ($24,000,000 + $25,000,000) = $51,000,000
4. Firm D: The tires produced by Firm D have inputs from Firm B (steel sheets). The value-added by Firm D is the difference between the value of its output (tires) and the cost of inputs it purchased from Firm B (steel sheets). This can be calculated as:
Total Output by Firm D = 60,000 tires x $100/tire = $6,000,000
Cost of Steel Sheets purchased from Firm B = 2,000 tons x $3,000/ton = $6,000,000
Value-Added by Firm D = Total Output - Cost of Inputs = $6,000,000 - $6,000,000 = $0
Now, let's calculate GDP using the production approach by summing up the value-added by each firm:
GDP = Value-Added by Firm A + Value-Added by Firm B + Value-Added by Firm C + Value-Added by Firm D
= $10,000,000 + $28,000,000 + $51,000,000 + $0
= $89,000,000
To calculate GDP using the expenditure approach, we sum up the expenditures on final goods and services in the economy.
1. Firm C's automobiles sold to households = 5,000 vehicles x $20,000/vehicle = $100,000,000
2. Firm D's tires sold = 60,000 tires x $100/tire = $6,000,000
GDP using the expenditure approach is the sum of these expenditures:
GDP = Household Expenditures (Consumption) + Expenditures on Tires (Investment)
= $100,000,000 (Consumption) + $6,000,000 (Investment)
= $106,000,000
Therefore, the GDP in 2016 for this economy is $89,000,000 using the production approach and $106,000,000 using the expenditure approach.