Question

A Farmer produces $200,000 in wheat and pays wages to her workers of $120,000. A Miller buys all $200,000 of wheat from the farmer and turns it into $300,000 worth of flour. The Miller pays $40,000 in wages, sells $50,000 of flour to households and sells the remainder to a baker. The baker buys $250,000 in flour from the Miller, pays $100,000 in wages to workers and sells $500,000 worth of bread to the public. Briefly discuss the three approached to calculating GDP and calculate GDP for this example using each of these approaches.

Answer 1

GDP is the market value of all goods and services produced in an economy. There are three approaches to calculate GDP :

• Product Approach : Value added to all the product and services through the various sectors, like primary, secondary and tertiary.
• Income Approach : It is the sum of the factor incomes earned by all the factors of production. It can be mentioned as : Wages (labor) + Rent (Land) + Interest (Capital) + Profit (Entrepreneur)
• Expenditure Approach : It is the sum of all the expenditure incurred by various entities. It can be mentioned as : Consumption + Government expenditure + Investment + Net Exports Exports - Imports)

Calculation of GDP for the Example

Product Approach (Value addition at each level) = $50000 (Flour sold to households) + $500000 (Bread sold to Public)

= $550000

Income Approach = $120000 (Wages paid by farmer) + $40000 (Wages paid by miller) + $100000 (Wages paid by Baker) + $80000 (Profit earned by Farmer)+ $60000 (Profit earned by miller)+ $150000 (Profit earned by baker)

= $550000

Expenditure Approach = $500000 (Consumption of Bread) + $50000 (Consumption of flour by households)

= $550000