Consider a simple economy consisting of only four firms Firm

Consider a simple economy consisting of only four firms. Firm A, a mining enterprise, extracts iron ore. Firm B, a steelmaker, produces steel sheets. Firm C, a carmaker, makes automobiles while Firm D produces automobile tires.

In 2018, Firm A extracts 50,000 tons of ore, valued at $100 per ton, using previously existing machinery. Firm B produces 10,000 tons of steel sheets, valued at $3,000 per ton, having bought and used all of the ore produced by Firm A. Firm C manufactured 5,000 vehicles and sold them all to households for $25,000 each, having purchased 8,000 tons of steel sheets from Firm B. In addition, Firm C imported 5,000 engines from a foreign subsidiary each valued at $5,000, and purchased 20,000 tires from Firm D for $100 each. Firm D produced 100,000 tires valued at $100 each, but only sold 60,000 tires during 2018. Firm D purchased 2,000 tons of steel sheets from Firm B since all of their tires are steel belted radials.

Calculate GDP in 2018 for this economy using the production (value-added) approach.

Also, calculate GDP in 2018 using the expenditure approach.

Solution

Production (Value Added) Approach

Firm A extracted 50,000 tons of ore at $100 per ton

Value of output = 50,000 * $100 = $5,000,000

Firm A has not purchased any raw material.

Value added = Value of output - Intermediate consumption

Value added = $5,000,000 - $0 = $5,000,000

The value added by Firm A is $5,000,000.

Firm B has produced 10,000 steel sheets valued at $3,000 per ton

Value of output = 10,000 * $3,000 = $30,000,000

Firm B has purchased entire ore produced by Firm A

Intermediate consumption = $5,000,000

Value added = Value of output - Intermediate consumption

Value added = $30,000,000 - $5,000,000 = $25,000,000

The value added by Firm B is $25,000,000

Firm C manufactured 5,000 vehicles for $25,000 each

Value of output = 5,000 * $25,000 = $125,000,000

Firm C purchase 8,000 tons of steel from Firm B. Firm C has imported 5,000 engines for $5,000 each and also purchased 20,000 tires from Firm D at $100 each.

Intermediate consumption = (8,000 * $3,000) + (5,000 * $5,000) + (20,000 * $100)

Intermediate consumption = $24,000,000 + $25,000,000 + $2,000,000 = $51,000,000

Value added = Value of output - Intermediate consumption

Value added = $125,000,000 - $51,000,000 = $74,000,000

The value added by Firm C is $74,000,000

Firm D produced 100,000 tires at $100 each

Value of output = $100 * 100,000 = $10,000,000

Firm D purchased 2,000 tons of steel sheets fro Firm B

Intermediate consumption = 2,000 * $3,000 = $6,000,000

Value added = Value of output - Intermediate consumption

Value added = $10,000,000 - $6,000,000 = $4,000,000

The value added by Firm D is $4,000,000.

Calculate the GDP -

GDP = Value added by Firm A + Value added by Firm B + Value added by Firm C + Value added by Firm D

GDP = $5,000,000 + $25,000,000 + $74,000,000 + $4,000,000 = $108,000,000

The GDP in 2018 using Production (Value Added) approach is $108,000,000.

Expenditure Approach

Household has purchased 5,000 vehicles for $25,000 each

Consumption expenditure = 5,000 * $25,000 = $125,000,000

Firm D has produced 100,000 tires but have sold only 60,000 tires.

So, 40,000 tires would remain in stock which would be taken as investment.

Investment = 40,000 * $100 = $4,000,000

Firm C imported 5,000 engines at $5,000 each

Imports = 5,000 * $5,000 = $25,000,000

Firm D has exported 40,000 tires at $100 each

Exports = 40,000 * $100 = $4,000,000

Net exports = Exports - Imports = $4,000,000 - $25,000,000 = -$21,000,000

Calculate the GDP

GDP = Consumption expenditure + Investment + Net exports

GDP = $125,000,000 + $4,000,000 - $21,000,000 = $108,000,000

The GDP in 2018 by Expenditure approach is $108,000,000.