Question

The table below shows a series of market transactions in the life of an automobile. Transaction Time Frame Cost Parts sold to car maker Fall 2017 $13,000 in parts Factory labor leads to assembled car Winter 2017 $11,000 in labor Dealer buys car Spring 2018 $28,000 for the car Dealer sells car to customer Summer 2018 $33,000 for the car Describe two different ways that these transactions could contribute to gross domestic product (GDP) for the years 2017 and 2018. Which way is used in practice?  

Answer 1

The two methods that can be used to calculate gross domestic product (GDP) for the years 2017 and 2018 are as follows:

1. Expenditure Approach : This sums the value of final expenditure (except the intermediate consumption) on the goods or services produced during a year within a country's boundary. Here the final expenditure occurs when the Customer buys the Car from the dealer.

So, the GDP will be the value of the transaction i.e. $33,000.

2. Output Approach or Value Added Approach : This sums the value of all goods and services produced during one year within a country's boundary or say the sums of the value added at each stage of production.

Here it goes like this:

The part maker sells the parts to the manufacturer for $13,000. Assuming he did not buy any material for this, Value added at this stage is $13,000.

Manufacturer buys the parts for $13,000 and sells the car for $28,000. So value added at this stage is =28,000-13,000= $15,000

Finally, dealer buys the car for $28,000 and sells it for $33,000. So, the value added is $5,000.

Summing value added at all the three stages we get = 13,000+15,000+5,000= $33,000.

This is same as what we got from Expenditure Approach.

In practice, Expenditure Approach is used because Value Added Approach is not efficient and not even feasible to calculate in the real world.