Question

Consider the country of Smelterland. There are 2 businesses: (1) the Smelterland Steelworks; and (2) the Smelterland Autoworks. The Steelworks produces $1000 of steel, all of which is sold to the Autoworks. A key input for manufacturing the steel is labor, which the Steelworks hires at a total cost of $700. The Autoworks combines the $1000 of steel and $1500 of its own labor to produce: (1) $2000 of large sport utility vehicles (SUVs), which are bought by domestic consumers; (2) $500 of tanks, which are bought by the Smelterland Army; (3) $500 of small SUVs, which are sold to foreign consumers; and (4) $500 of steel smelting equipment, which is sold to the Steelworks. a) (4 pts.) What is Smelterland’s GDP? b) (12 pts.) What are consumption (C), investment (I), net exports (NX) and government spending (G)?

Answer 1

Solution:

As Smelterland Steelworks give away all of its output or production to Smelterland Autoworks, this steel of $1000 is just an intermediary good and is not counted in gross domestic product (GDP) calculation (GDP includes value of all and only final goods and services). So, for GDP we consider only what Smelterland autoworks has produced.

Now, given the information, we can see that:

1. Consumer spending (which is the amount sold to direct household consumers) = $2000

2. Investment (that is equipment or any such investment helping in production, other than labor) = $500 (for smelting equipment)

3. A nation's army is under the government, and so any spending on the army is government spending itself. So, G = $500

4. Net exports = exports - imports. Small SUVs for foreign consumers is simply export of Smelterland, so exports = $500. With no information on imports, we assume it to be 0. So, net exports = 500 - 0 = $500.

5. GDP using the expenditure method = consumption spending + investment spending + government spending + net exports

GDP = C + I + G + NX

GDP = 2000 + 500 + 500 + 500 = $3500.