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.

1.Compute GDP for this simple economy using the product approach.

2.Compute GDP for this simple economy using the expenditure approach.

3.Compute GDP for this simple economy using the income approach.

4.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).

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

Answer 1

1) GDP using product Approach ; Market value of all goods and services produced

= Cocunut + Restaurant meal

= 10million * $2 + ($30 million - 6 million * $2) As 6 million coconuts are sold to restaurant as raw materials so to avoid double counting.

= $20 million + $30 million - $12 million

= $38 million

2) Expenditure Approach : Consumption + Investment + GovernmentExpenditure + Net Exports

= 4 million * $2 + $30million + $5.5 million

= $8 million + $30 million + $5.5 million

= $43.5 million

3) Income Approach : Wages + Rent + Interest + Profit

= $5 million + $0.5 million + $1.5 million +$3 million + $4 million + $1 million

= $15 million

4&5) In the expenditure approach, consumption by bublic is also a component. As the consumption reduces by 1 million at a price of $2, amounting to $2 million. Thus the GDP by expenditure approach reduces by $2 million.

So new GDP would be $43.5 - $2 million

= $41.5 million