Question

Assume an economy with two manufacturers: a parts and components manufacturer and a tablet manufacturer. Suppose that parts and components manufacturing does not require any intermediate inputs. In a given year, the parts and components manufacturer produces 50,000 units of parts and components, of which 45,000 units were sold to the tablet manufacturer at $100 per unit and the remaining units were stored as inventory. In the same year, the tablet manufacturer produces 25,000 tablets and sells all of them to consumers at $800 per unit. Compute GDP of this economy for the year using the product and expenditure approaches. Do the two approaches yield the same GDP?

Answer 1

Let's first calculate the GDP by using the product method or also commonly known as value added method. In this method we add the value of added to the product at different stages of the production.

The component manufacturer produces 50,000 units parts and components and he willing to sell each part to a tablet manufacturer at a prrice of $100 per unit. So the component manufacturer has added the value of $100 to 50,000 units and the value added will be,

Value added by component manufacturer,

= 50000 × 100 = $5,000,000 or $5million

Now the component manufacturer sellers the 45,000 units to the tablet manufacturer and then the tablet manufacturer using the components produces 25,000 units of tablet and sells it a price of $800 a unit. So the value added by tablet manufacturer will be calculated as,

Value added by the tablet manufacturer,

= 25,000 × 800 - 45,000 × 100

= 20,000,000 - 4,500,000

= $15,500,000

So the value added by the tablet manufacturer is $15,500,000.

GDP by the product method will the sum of the values added by the component manufacturer and tablet manufacturer.

GDP = 5,000,000 + 15,500,000

GDP = $20,500,000

So the GDP by product method is $20.5 million.

Let's calculate the GDP by expenditure method. In this method we calculated the total expenditure made by the people on the purchase of the final product, keep the word final product in mind. Because if we start including the expenditure on intermediate product then we will be counting the value of product twice so in expenditure method we only include the expenditure made on the final product.

For the component manufacturer the final product is the parts and components that they kept in inventory since it wasn't sold to tablet manufacturer. So the component manufacturer keeps 5,000 units of components worth $100 each so the total expenditure by the component manufacturer will be,

Expenditure by the components manufacturer,

= 100 × 5,000

= $500,000.

So the expenditure made by the components manufacturer on the purchase of inventory is $0.5 million

Now let's calculate the expenditure made by people on the sells of tablet. The tablet manufacturer sells 25,000 units of tablets to people at a price of $800 each and it is the final product since people buy tablets for their purpose of use.

So the total expenditure made by the people on the purchase on tablet,

= 25,000 × 800

= $20,000,000

So the expenditure made by the people on the purchase of tablets is $2 million.

The GDP by the expenditure method will the sum of the expenditures made on the final product.

GDP by expenditure method,

= 500,000 + 20,000,000

= $20,500,000.

So the GDP by the expenditure method is $20.5 million

So the GDP by the product method and expenditure method is same as $20.5 million.