3. (30 points) Consider an economy that produces only two goods: oil and gasolin
ID: 1132417 • Letter: 3
Question
3. (30 points)
Consider an economy that produces only two goods: oil and gasoline. In this economy, the technology of producing gasoline involves using oil as an input. Olive’s Oil is the only company that produces Oil, while George’s Gasoline is the only producer gasoline. The relevant revenue and cost information for each of the two firms in the economy is given below:
Georges’s
Revenue from selling gasoline: $4,800,000
Cost of buying fresh oil from Olive: 1,300,000
Interest on funds borrowed to buy refinery: 900,000
Wages paid to employees 1,200,000
Taxes 500,000
Olive’s
Revenue from oil: $1,300,000
Rent on land (including mineral rights) 400,000
Wages to employees 500,000
Taxes 300,000
Calculate nominal GDP using (a) the expenditure approach (b) the production (value added) approach, and (c) the income approach. (Hint: the three approaches give the same number for the Nominal GDP).
Explanation / Answer
a) Expenditure approach:
Final expenditure on gasoline is $4.8 million.
Total expenditure = $8.8 million on gasoline sold by George to consumers + $0 of oil sold to final consumers = $4.8 million
b) Production approach:
Value added - Olive= $1.3 m
Value added - George= 4.8 m- 1.3 m= $3.5 million
Aggregate= $1.3+$3.5 million= $4.8 million
c) Income approach: .
Labor income= $1.2 million+$.5 million= $1.7 million
Interest income= $.9 million
George’s profits= $4.8 -$1.3-$.9-$1.2-$.5= $.9 million
Olive’s profits= $1.3-$.4-$.5-$.3= $.1 million
Total profits= $.9 m+$.1 m= $1 m
Land owner income= $.4 m
Taxes= $.5+$.3= .8 m
Aggregate income= $1.7+$.9+$1+$.4+$.8= $4.8 million
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