Question

Consider an economy with a corn producer, some consumers, and a government. In a given year, the corn producer grows 30 million bushels of corn and the market price for corn is $5 per bushel. Of the 30 million bushels produced, 20 million are sold to consumers, 5 million are stored in inventory, and 5 million are sold to the government to feed the army. The corn producer pays $60 million in wages to consumers and $20 million in taxes to the government. Consumers pay $10 million in taxes to the government, receive $10 million in interest on the government debt, and receive $5 million in Social Security payments from the government. The profits of the corn producer are distributed to consumers. Calculate GDP using the product approach, the expenditure approach, and the income approach. Calculate private disposable income, private sector saving, national saving, and the government deficit. Is the government budget in deficit or surplus?

Answer 1

GDP using product approach:

There are no intermediate goods inputs. The corn producer grows 30 million bushels of corn. Each bushel of corn is worth $5.

GDP = 30 million * $5 = $150 million

GDP = $150 million

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GDP using expenditure approach:

i) Consumers buy 20 million bushels of corn

Consumption = 20 million * 5 = $100 million

Consumption (C) = $100 million

ii) Corn producer adds 5 million bushels to inventory

Investment = 5 million * $5 = $25 million

Investment (I) = $25 million

iii) Government buys 5 million bushels of corn

Government spending = 5 million * $5 = $25 million

Government spending (G) = $25 million

GDP = C + I + G

GDP = $100 + $25 + $25

GDP = $150 million

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GDP using income approach:

Wage income is $60 million, paid by the corn producer. Corn producer’s revenue equals $150, including the value of its addition to inventory. Additions to inventory are treated as purchasing one owns output. The corn producer’s costs include wages of $60 million and taxes of $20 million.

Profit income = $150 million - $60 million - $20 million = $70 million

Government income = Taxes paid by the corn producer = $20 million

GDP = $60 million + $70 million + $20 million = $150 million

GDP = $150 million

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Private disposable income:

Private disposable income = GDP + Net factor payments + Government transfers + Interest on the government debt - Total taxes

Private disposable income = $150 million + 0 + $5 million + $10 million - $30 million

Private disposable income = $135 million

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Private savings:

Private savings = Private disposable income - Consumption

Private savings = $135 million - $100 million = $35 million

Private savings = $35 million

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Government savings:

Government savings = Government tax income - Transfer payments - Interest on the government debt - Government spending

Government savings = $30 million - $5 million - $10 million - $5 million = $10 million

Government savings = $10 million

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National savings:

National savings = Private savings + Government savings

National savings = $35 million + $10 million = $45 million

National savings = $45 million

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Government budget surplus = Government savings = $10 million

Since the budget surplus is positive, the government budget is in surplus.

Government deficit = (-) $10 million

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