Question

Which component of GDP will be affected by each of the following transactions involving the Ford Motor Company? If you believe that a transaction will affect none of the components of GDP, briefly explain why. a. You purchase a new Ford Escape hybrid from a Ford dealer. b. You purchase a 2013 Ford Escape hybrid from a friend. c. Ford purchases door handles for the Escape from an auto parts manufacturer in Indiana. d. Ford produces 1,000 Escapes in a factory in Missouri and ships them to a car dealer in Shanghai, China. e. Ford purchases new machine tools to use in its Missouri Escape factory. f. The state of Missouri builds a new highway to help improve access to the Ford Escape plant.

Short answer

a. Consumption is affected. b. No components of GDP are affected. c. No components of GDP are affected. d. Net exports are affected. e. Investment is affected. f. Government spending is affected.

Step-by-step solution

Analyzing Transaction A

In this transaction, a new car is being purchased from a dealer. Thus this transaction is part of consumption (C) since it is an expenditure made by households on a good. So, GDP would increase.

Analyzing Transaction B

When buying a used car, GDP is not affected. This is because used cars are not counted in GDP as GDP measures the value of new production. Hence, this transaction will not affect any component of GDP.

Analyzing Transaction C

In this scenario, Ford is spending money on intermediate goods (the door handles), which are goods used in the production of other goods. Intermediate goods are not counted in GDP as their value is already embodied in the final good. Therefore, this transaction does not affect any component of GDP.

Analyzing Transaction D

When Ford produces cars and ships them overseas, it increases net exports (NX), since these cars are being sold outside of the United States. So, this transaction would increase GDP.

Analyzing Transaction E

Ford's purchase of new tools for its factory will be considered a business investment (I) since firms invest in machinery for production. This transaction would, therefore, increase the GDP.

Analyzing Transaction F

The construction of a new highway by the Missouri government is a government purchase (G). It is part of the government spending on goods and services produced in the country. So, this improves the GDP.

Key concepts

Consumption

When we talk about consumption in the context of GDP, we're referring to the total value of all goods and services bought by households. This includes durable goods like cars and appliances, non-durable goods such as food and clothing, and services like healthcare and entertainment. The purchase of a new Ford Escape hybrid from a dealer, as mentioned in transaction A, is a perfect example of consumption. It reflects the spending power of individuals and is a direct contribution to the economy's overall health.

Understanding consumption is key because it typically makes up the largest portion of GDP in economies like the United States. It is an indicator of the economic wellbeing of a society. High levels of consumption can signal a healthy economy where people feel confident to spend money, while low levels may indicate economic distress or saving behavior.

Net Exports

Net exports, part of the GDP equation, is calculated by subtracting total value of imports from the total value of exports. If a country exports more than it imports, it has a positive net export figure, and vice versa. In the context of transaction D, when Ford ships cars to China, these vehicles are counted as exports. An increase in the quantity of exports boosts the net export value and, consecutively, the GDP.

For students and other learners, it is crucial to understand that net exports reflect a country's position in global trade. A high net export value can signify a competitive, production-based economy, while a negative value could indicate a high reliance on imported goods.

Business Investment

Business investment is all about purchases that businesses make to produce goods and services. This includes investments in machinery, equipment, and facilities that contribute to production capacity. Ford's action of buying new machine tools for its factory, as mentioned in transaction E, falls into this category. Such investments are vital signs of business confidence, as companies are willing to spend capital to increase efficiency or expand operations.

Investments made by businesses play a critical role in GDP as they drive future productivity and economic growth. Moreover, they often come with a multiplier effect, where an increase in investment leads to a greater overall increase in GDP through additional spending and employment.

Government Purchases

Government purchases reflect the total expenditure by government entities on goods and services, which includes spending on public projects such as infrastructure. When the state of Missouri constructs a new highway (transaction F), this is a government expenditure that contributes to the GDP. Infrastructure projects like highways not only directly increase GDP; they can also have long-term benefits in terms of spurring economic development and improving efficiency.

Understanding government spending is crucial for grasping its role in the economy. Through fiscal policy, government spending can help stabilize an economy during downturns and also create job opportunities, ultimately affecting the nation's economic output.

Intermediate Goods

Intermediate goods are the materials or products that are used in the production process to produce other goods. In terms of GDP calculation, these are not directly included because their value is already captured within the final product — it's a way to avoid double-counting. Ford's purchase of door handles for its cars (transaction C) is an example. These door handles are intermediate goods and are only counted in GDP when the final product, the completed Ford Escape, is sold.

It's essential for learners to recognize that while intermediate goods don't show up as a separate GDP component, they are crucial to the production process. The investment in and production of intermediate goods are indicative of a healthy industrial sector and can give insights into the production chain's complexity.