Question

Consider a simple example economy where there are two goods, coconuts and restaurant meals (coconut-based). There are two firms. A coconut producer collects and sells 10 million coconuts at $2.00 each. The firm pays $5 million in wages, $0.5 million in interest on an old loan, and $1.5 million in taxes to the government. We also know that 4 million coconuts are sold to the public for consumption, and 6 million coconuts are sold to the restaurant firm, which uses them to prepare meals. The restaurant sells $30 million in meals. The restaurant pays $4 million in wages and the government $3 million in taxes. The government supplies security and accounting services and employs only labor, and government workers are paid $5.5 million, collected in taxed by the government. Finally, consumers pay $1 million in taxes to the government in addition to the taxes paid by the two firms.
Required:
a. Compute GDP for this simple economy using the product approach.
b. Compute GDP for this simple economy using the expenditure approach.
c. Compute GDP for this simple economy using the income approach.
d. Now, suppose that the coconut producer cannot sell 1 million coconuts during the course of the year. These are collected coconuts that are not sold to the public (assume that sales to the other firm, the restaurant, remain the same).
e. How does this new piece of information affect your calculations in the expenditure approach? Explain.

Answer 1

A) Product Approach

GDP = Value added of all industries

Value added = revenue - intermediate costs

Value added coconut producer = $20,000,000 (it does not have intermediate costs)

Value added restaurant = $30,000,000 - $12,000,000 (cost of coconuts)

                                        = $18,000,000

Value added government = $5,500,000 (collected in taxes, $3 million from the restaurant, $1.5 million from the coconut producer, and $1 million from consumers).

GDP = $20,000,000 + $18,000,000 + $5,500,000

        = $43,000,000

B) Expenditure Approach

GDP = Consumption + Investment + Government Spending + Net Exports

Consumption = $8,000,000 in coconuts + $30,000,000 in meals

                       = $38,000,000

Investment = $0

Government Spending = $5,500,000 in government wages

Net Exports = $0 (it is a closed-economy)

GDP = $38,000,000 + $0 + $5,500,000 + $0

       = $43,500,000

C) Income Approach

Wages = $14,500,000

Corporate Profits  = $24,000,000

Interest income = $500,000

Taxes = $4,500,000

GDP = $43,500,000

e. How does this new piece of information affect your calculations in the expenditure approach? Explain.

GDP under the expenditure approach, would rise by the value of the unsold coconuts ($1 million) as long as the coconuts were harvested in the given year. This is because inventory produced in the given year, is part of that year's GDP.