Question

Last year, a small nation with abundant forests cut down \(\$ 200\) worth of trees. It then turned \(\$ 100\) worth of trees into \(\$ 150\) worth of lumber. It used \(\$ 100\) worth of that lumber to produce \(\$ 250\) worth of bookshelves. Assuming the country produces no other outputs, and there are no other inputs used in producing trees, lumber, and bookshelves, what is this nation's GDP? In other words, what is the value of the final goods the nation produced including trees, lumber and bookshelves?

Short answer

The nation's GDP, considering only the value of final goods (lumber and bookshelves), is \(\$ 300\).

Step-by-step solution

Understand the GDP concept

GDP (Gross Domestic Product) is the total monetary value of all final goods and services produced within a country over a specific period, usually a year. To calculate GDP, we need to focus only on the value of final goods and services to avoid double counting of intermediate goods like raw materials or components that are used in the production of final goods.

Determine the value of trees

The problem states that the nation cut down \(\$ 200\) worth of trees. In this case, the trees serve as a natural resource and not a final good. No further value-added happens if these trees are not processed into lumber or any other product. Therefore, the value of trees does not contribute to the nation's GDP in this case.

Determine the value of lumber

Assuming the lumber results only from the value addition after cutting trees, the nation turns \(\$ 100\) worth of trees into \(\$ 150\) worth of lumber. Here, the value added is by processing the trees into lumber which is given by: \[Value\,added = Final\,value \,-\, Initial\,value = \$ 150 - \$ 100 = \$ 50\] However, not all the lumber is used as a final good because \(\$ 100\) worth of it is used to produce bookshelves. So, only \(\$ 50\) worth of lumber is considered final goods in this case.

Determine the value of bookshelves

The lumber worth \(\$ 100\) is used to produce \(\$ 250\) worth of bookshelves. Again, we can determine the value added in this production process: \[Value\,added = Final\,value \,-\, Initial\,value = \$ 250 - \$ 100 = \$ 150\] Since these bookshelves are final goods (they will not be processed further), they should be included in the nation's GDP.

Calculate the nation's GDP

Now we can add the value of final goods, which includes the final lumber and the bookshelves, to calculate the nation's GDP: \[GDP = Value\,of\,lumber + Value\,of\,bookshelves = \$ 50 + \$ 250 = \$ 300\] So, this small nation's GDP is \(\$ 300\).

Key concepts

Economic Output

Economic output refers to the total value of all goods and services produced by an economy over a specific period. Think of it as the sum of everything a country creates, from cars to haircuts. It's a snapshot of a country's economic activity. To ensure we're not overestimating this activity, only the final outputs are counted, meaning goods that are ready for sale to the end user and not intermediate goods that will be used in the production of other items.

For example, if we take the raw materials that are made into parts, then assembled into a computer, and then sold to consumers, only the value of the finished computer is counted in the economy's overall output. Raw materials and parts, being intermediate goods, are part of the production process, but their individual values are not counted separately in the total economic output.

Value Added

Value added is the difference between the cost of inputs and the price for which the finished goods or services are sold. It represents the additional value created at each stage of production. To put it simply, it's the extra worth added to raw materials at each step until the final product is complete.

Returning to our earlier example, when trees are turned into lumber, the lumber has more value than the standing trees. This increase in value is the 'value added' by the process of transformation. The economic measure of this added value helps us understand how much each stage of production contributes to the overall value of the final product.

Final Goods and Services

Final goods and services are the end products of production processes, which are purchased for consumption, investment, government use, or export. These are what consumers directly use and are usually counted once in GDP calculations to prevent double-counting.

In our example of the small nation with its trees, lumber, and bookshelves, only the lumber that consumers might use directly and the bookshelves sold to customers are considered final goods. The trees are not considered a final good until they are transformed into something like lumber or paper that end users can use.

GDP Calculation

To calculate GDP, one needs to add up the value of all final goods and services produced within a country's borders over a given time period. It’s important to emphasize that GDP includes only the final products sold for use and does not count the intermediate goods used to produce these final products.

The calculation of GDP can be approached from three different angles—production (output), expenditure, and income. However, regardless of the approach, the final number should theoretically be the same. In the case of our example, only the final lumber and the bookshelves are counted into GDP, giving a clear-cut measure of the nation’s economic production.

National Income Accounting

National income accounting is a system used by governments to measure the overall economic activity of a country. It involves the tracking and tallying of all the income generated by the nation's economy. This includes GDP as well as other measures like net national product (NNP), national income (NI), and disposable income.

In the broader context, these accounts help policymakers assess the health of the economy, set monetary policy, and make decisions regarding taxation and spending. In the context of GDP, national income accounting helps in verifying that the sum of all individual incomes matches the value of goods and services produced—ensuring the GDP figure accurately reflects the economic strength of the nation.