Examkin

Question

Difficulty: HardDifficulties and Problems in National Income Accounting

An economy comprises three interconnected firms operating within a single production year:

- Firm P extracts raw iron ore valued at $15 million\$15\text{ million}. It sells $10 million\$10\text{ million} worth of ore to Firm Q and exports the remaining $5 million\$5\text{ million} directly to foreign buyers.
- Firm Q processes the $10 million\$10\text{ million} ore to produce steel valued at $28 million\$28\text{ million}. It sells $20 million\$20\text{ million} worth of steel to Firm R and retains $8 million\$8\text{ million} of steel as capital inventory additions.
- Firm R manufactures motor vehicles valued at $50 million\$50\text{ million}, utilizing the $20 million\$20\text{ million} steel purchased from Firm Q along with $5 million\$5\text{ million} worth of imported engine components.

To avoid double counting and correctly account for intermediate inputs, what is the total contribution of these production activities to the nation's Gross Domestic Product (GDP)?

  1. $58 million\$58\text{ million}Answer
  2. B
    $93 million\$93\text{ million}
  3. C
    $63 million\$63\text{ million}
  4. D
    $50 million\$50\text{ million}

Answer

The total contribution to Gross Domestic Product (GDP) is $58 million\$58\text{ million}.
The value-added method measures national output by taking the gross value of each firm's output and subtracting the cost of intermediate goods and services purchased from other suppliers (including foreign imports). Firm P generates $15 million\$15\text{ million} in value added. Firm Q produces $28 million\$28\text{ million} in total steel from $10 million\$10\text{ million} in ore inputs, generating $18 million\$18\text{ million} in value added. Firm R produces $50 million\$50\text{ million} in vehicles using $20 million\$20\text{ million} in domestic steel and $5 million\$5\text{ million} in imported parts, generating $25 million\$25\text{ million} in domestic value added. The sum of domestic value added is $15m+$18m+$25m=$58 million\$15\text{m} + \$18\text{m} + \$25\text{m} = \$58\text{ million}. Alternatively, summing final goods directly (exported ore $5m\$5\text{m} + steel inventory additions $8m\$8\text{m} + final vehicles $50m\$50\text{m} minus imports $5m\$5\text{m}) also yields $58 million\$58\text{ million}.

Step-by-Step Solution

1
Calculate the value added by Firm P
Value Added (P) = Total Output ($15m\$15\text{m}) - Intermediate Inputs ($0m\$0\text{m}) = $15 million\$15\text{ million}.
Firm P extracts raw ore without purchasing intermediate inputs from other domestic producers.
2
Calculate the value added by Firm Q
Value Added (Q) = Total Steel Output ($28m\$28\text{m}) - Intermediate Ore Inputs ($10m\$10\text{m}) = $18 million\$18\text{ million}.
Firm Q uses $10 million\$10\text{ million} of iron ore as intermediate input to produce $28 million\$28\text{ million} worth of steel.
3
Calculate the value added by Firm R
Value Added (R) = Total Vehicle Output ($50m\$50\text{m}) - Domestic Steel Input ($20m\$20\text{m}) - Imported Engine Input ($5m\$5\text{m}) = $25 million\$25\text{ million}.
Imports must be deducted alongside domestic intermediate goods because imported components are not part of domestic value added.
4
Sum the value added across all firms to find total GDP contribution
Total GDP = Value Added (P) + Value Added (Q) + Value Added (R) = $15m+$18m+$25m=$58 million\$15\text{m} + \$18\text{m} + \$25\text{m} = \$58\text{ million}.
The value-added approach ensures that every intermediate product is counted exactly once.

Key Concept

Value Added Method and Double Counting Prevention
Estimated Time:2m 30s
Rate this question

Topics

Difficulties and Problems in National Income Accounting

More questions from this topic