Question

Assume an economy with two firms. Firm A produces wheat and firm B produces bread. In a given year, firm A produces 50,000 bushels of wheat, sells 20,000 bushels to firm B at $3 per bushel, exports 25,000 bushels at $3 per bushel, and stores 5,000 bushels as inventory. Firm A pays $50,000 in wages to consumers. Firm B produces 50,000 loaves of bread, and sells all of it to domestic consumers at $2 per loaf. Firm B pays consumers $20,000 in wages. In addition to the 50,000 loaves of bread consumers buy from firm B, consumers import and consume 15,000 loaves of bread, and they pay $1 per loaf for this imported bread. Calculate gross domestic product for the year using (a) the product approach, (b) the expen- diture approach, and (c) the income approach.

Answer 1

Product approach

Firm A produces 50,000 bushels of $150,000

wheat at $3/bushel)

Firm B produces 50,000 loaves of bread at $40,000

$2 per loaf $100,000; pays $60,000 to firm A

For 20,000 bushels of wheat, i.e. intermediate

input. Thus value added will be $40,000.

GDP 190,000

Expenditure approach

Buy 50,000 loaves of domestically 100,000

produced bread at $2/loaf

Buy 15,000 loaves of imported bread at $1/loaf 15,000

Consumption spending 115,000

Investment (Firm A adds 5,000 bushels of 15,000

wheat at $3/bushel)

Exports (Firm A exports 25,000 bushels 75,000

of wheat at $3/b)

Import (Consumers import 15,000 15,000

loaves of bread at $1/loaf)

Net exports (Exports - Imports) 60,000

Government spending 0

GDP 190,000

Income approach

Wages (Firm A 50,000 + Firm B 20,000) 70,000

Firm A’s profits (produces $150,000 of

wheat & pays $50,000 in wages) 100,000

Firm B’s profits (Produces $100,000 of 20,000

bread and pays $20,000 in wages and pays

$60,000 to Firm A for wheat. Profits 100,000

- 20,000 - 60,000)

Total profit income (100,000 + 20,000) 120,000

GDP 190,000