Economics 102 Discussion Handout Week 5 Spring 2018

Transcription

1 Economics 102 Discussion Handout Week 5 Spring 2018 GDP: Definition and Calculations Gross Domestic Product (GDP) is the market value of all goods and services produced within a country over a given time period, typically a year. - GDP is measured in market value, not quantities - GDP includes on final goods, not intermediate goods o A final good is purchased by the final user and is not used in the production of any other good or service o An intermediate good is used as an input for another good or service - GDP only includes production in the current time period/year - GDP only includes production within the border of the country Some historical perspective: GDP in the past two millenniums (A.D. 1 A.D. 2017) Calculating GDP: The Price-Quantity Method In this method we take the market value of all final goods and services produced in an economy and multiply them by their market value. This formula can be represented by the following: n GDP = P i Q i Calculating GDP: The Expenditures Approach In this method we calculate GDP by summing the expenditures on final goods and services in an economy. The formula used here is: Y = C + I + G + NX i=1

2 - C = Consumption Spending - I = Investment Spending. Includes purchase of durable/capital goods by firms, purchase of new homes, and changes in inventory over a year - G = Government Spending. Only includes purchases of goods and services by the government, and not transfers of wealth - NX = Net Exports = Exports Imports Calculating GDP: The Value Added Approach In this approach you add the value added by each good in the economy Value Added = Price of final good Price of intermediate goods Calculating GDP: The Income Approach In this method we add up the income paid to all the factors of production GDP = Wages + Interest + Rent + Profit - Note that these approaches should all yield the same value of GDP Question 1. Suppose you are given the following information about the economy of Grantland. In 2014 Grantland had rent payments of $10 billion, interest payments of $20 billion, consumption spending on goods and services of $120 billion, investment spending on goods and services of $40 billion, wages of $100 billion, and net exports of $20 billion. You also know that in Grantland in 2014 that profits were equal to three times the level of government spending on goods and services. Given this information, calculate the level of GDP in Grantland in Show how you found your answer. In your calculations you will also need to find the value of profits and government spending on goods and services. Show how you found your answers to each of these values. Answer: Let s start by organizing the data we have: Using the factor payments approach to measuring GDP: GDP = wages + interest + rent + profits GDP = profits GDP = profits Using this approach we have two unknowns and will therefore be unable to solve this equation Using the expenditure approach to measuring GDP: GDP = C + I + G + (X M) GDP = G + 20 GDP = G

3 Using this approach we have two unknowns and will therefore be unable to solve this equation We do know that both measures should give us the same value for GDP: thus, profits = G But, we still have two unknowns and will therefore be unable to solve this equation In the prompt we are also told that profits are 3 times the level of government spending: we can write this in equation form as Profits = 3G Now, use this information to solve for profits, G, and GDP: G = G 2G = 50 G = $25 billion Profits = 3G = 3($25 billion) = $75 billion GDP = profits = = $205 billion Or, GDP = G = = $205 billion [Note: that you should be getting the same value for GDP using either method.]

4 Question 2. Use the following information to answer this question. Suppose there are three firms in the economy: firm A produces the inputs that are used by firm B. Firm B produces the inputs that are used by Firm C. Assume that all of firm A s product is purchased by firm B and that all of firm B s product is purchased by firm C. Firm C is the only firm that produces a final good or service in this economy. You are provided the following information about these three firms. a. Fill in the missing entries in the above table. Answer: Since the value of sales by firm B is equal to $21,000 and firm B only sells to firm C we can conclude that the cost of intermediate goods for firm C is equal to $21,000. Since total wages are equal to $12,000 and we know wage payments for firm A and firm B it is a simple matter to calculate wage payments to firm C: 12,000 = wage payments by firm C. Wage payments by firm C = $5,500. Since we know the value of sales for firm A we use this information to find the interest payment for firm A. Once we have that interest payment we can calculate the total amount of interest paid in this economy. We can calculate rent paid by firm B by noting that total expenditure is equal to the sum of the cost of intermediate goods + wages + interest payments + rent + profit. Once you have rent paid by firm B you can then easily calculate rent paid by firm C. Profit for firm C is also easily calculated. The rest of the entries should be fairly straight forward at this point.

5 b. What is the value of aggregate spending on domestically produced final goods and services in this economy? c. What is the value of total payments to factors of production in this economy? d. What is the value of total production in this economy using the value added approach?