Consider the economy of the country of “Apple Island”. There are two firms in th
ID: 1169769 • Letter: C
Question
Consider the economy of the country of “Apple Island”. There are two firms in this economy, “Apple Co.” and “Squashed Apple Co.” Apple Co. grows apples on its apple farm, employing workers. It sells $50 of apples to Squashed Apple Co. and $40 of apples to consumers for the consumers to eat. It also keeps $10 of apples in inventory. Apple Co. pays $70 wages to its workers and keeps the remainder as profits. Squashed Apple Co. owns a special flat rock that allows it to squash the apples that it buys from Apple Co. into a flattened apple pancake that the consumers seem to like. It buys $50 of apples from Apple Co., squashes them, and then sells $100 of squashed apples to consumers. Squashed Apple Co. pays $10 in wages to its workers, keeping the remainder in profits.
(a) (30 marks) Calculate GDP in this economy using 3 methods: expenditure method, income method and value-added method.
(b) (5 marks) Does “Squashed Apple Co.” use only labour to produce its squashed apples, or labour and capital? Explain.
Explanation / Answer
Lets understand the information provided to us first
Apple Company
-------------
Input
------
Wages = $70
Output
-------
Revenues from Squashed Apple Co. = $50
Revenues from Consumers = $40
Inventory = $10
Squashed Apple Company
----------------------
Input
-----
Labor = $10
Raw material = $50 (purchased from Apple Co.)
Output
------
Revenues from Consumers = $100
(a) Calculating the GDP
------------------------
(i) Expenditure Method
GDP = C + I + G + NX
where, C = total consumption
I = investment
G = Government spending
Nx = net exports
In our case,
C = $40 (consumption of raw apples sold by Apple Co.) + $100 (consumption of pancake sold by Squashed Apple Co.) = $140
I = 0
G = 0
NX = 0
GDP = $140 + 0 + 0 + 0 = $140
(ii) Income Method
GDP = Labor Income + Rental Income + Interst Income + Profits
In our case
Labor Income = $70 (wages paid by Apple Co.) + $10 (wages paid by Squashed Apple Co.) = $80
Rental Income = 0
Interest Income = 0
Profits = ($50+$40) (revenue earned by Apple Co.) - $70 (wages paid) + $100 (revenues earned by Squashed Apple Co.) - $50 (cost of raw material paid by Squashed Apple Co.) - $10 (cost of labor paid by Squashed Apple Co.) = $90-$70+$100-$60 = $60
So, GDP = $80 + 0 + 0 + $60 = $140
(iii) Value-Added Method
GDP = Value of sold (final) goods - cost of intermediate goods to produce the sold goods
For Apple Co.
Value of (final) sold goods = $40+$50 = $90
Cost of intermediate goods = $0
For Squashed Apple Co.
Value of (final) sold goods = $100
Cost of intermediate goods = $50
Therefore GDP = $90 - $0 + $100 - $50 = $140
Please note that the GDP calculated using all the three approaches is same, which is $140
(b) Squashed Apple Co. uses both labor and capital to produce its squashed apples. The capital used is the special flat rock that allows it squash the apples. Since the cost of procuring this rock is not provided, we have not inclded it in the calculations.