Consider an economy with a widget producer, consumers and a government. The widg
ID: 2441445 • Letter: C
Question
Consider an economy with a widget producer, consumers and a government. The widget producer, produces 100 million widgets which sell at a market price of $5 per widget. 70 million widgets are purchased by consumers, 10 million are sold to the government and the remainder is stored as inventory. The widget producer pays S150 million in wages and S40 million in taxes. Consumers pay $30 million in taxes. The govenment spends all tax revenues to hire workers and purchase widgets as an intermediate good into the production of public infrastructure. The widgets total $50 million and wages total $20 million. Calculate GDP using the product approach, expenditure approach and income approach. 5.Explanation / Answer
The GDP of an economy refers to the market value of all final goods and services produced within an economy at a particular period of time. It can be measured using three main methods:
1. The sum of all the products at each stage of production (intermediate) by all the industries within the economy is known as 'product' or 'value added' or 'output' approach. In this approach, the taxes are added and subsidies are subtracted to know the final value. The general formula to calculate GDP using this approach is:
GDP = Total revenue - Value of intermediate goods
2. The total income generated by the production in the economy in a partulcar period is calculated under the 'income' approach. The taxes on production and on imports are added to the compensation of employees while subsidies and profits are subtracted. The general formula to calculate GDP using this approach is:
GDP = National Income (Compensation of employees + Proprietor's income + Corporate profits + Net interest + Rental Income) + Depreciation + Indirect taxes - Subsidies + Factor Payments to abroad - Factor income from abroad
3. The 'expenditure' approach sums all the expenditures incurred in the production process of an economy during a particular period of time. The general formula to calculate GDP using this approach is:
GDP = Consumption (Personal - Household spending on consumer goods) + Gross domestic investment + Government consumption and investment + Net Exorts (Exports - Imports)
The GDP is calculated using 'Product' approach as:
a. Total Revenue for the producer = Number of widgets produced x Price per widget = 100 x $5 = $500 million
b. Total revenue for government = Taxes from producer + Taxes from consumer - Purchase of widgets from tax income = $40 + $30 - $50 = $20 million
GDP = Total Revenue from the goods = a. + b. = 500+20 = $520 million
The GDP is calculated using 'Income' approach as:
c. Wage income earned after tax = $140 million
d. Profits earned after tax = Total revenue from consumers - Taxes = $350 - $40 = $310 million
e. Interest income earned = $0
f. Taxes = Tax from consumer + Tax from producer = $30 + $40 = $70 million
GDP = Wage income earned after tax +Profits earned after tax + Interest income earned + Taxes = c. + d. + e. + f. = 140 + 310 + 0 + 70 = $520 million
The GDP is calculated using 'Expenditure' approach as:
g. Consumption expenditure = 70 million x $5 = $350 million
h. Investment = Widget inventory stored by the government x Price per widget = 20 million x $5 = $100 million
i. Government Expenditures = Purchase of widgets from tax revenue + Wages = $50 + $20 = $70 million
j. Net Exports = $0
GDP = Consumption expenditure + Investment + Government Expenditures + Net Exports = g. + h. + i. + j. = 350 + 100 + 70 = $520 million