Chapter 10, Problem 3CYU

To determine

Why the approach used in calculating total value added was incorrect?

Explanation of Solution

GDP is the value of final goods and services produced in a nation in a given financial year. The calculation of GDP doesn’t include the value of intermediate goods.

In the given figure, the price of a car includes the costs of intermediate goods such as steel (worth $4800) and iron ore (worth $4200). If the calculation of GDP includes the value of intermediate goods and the value of final goods, then it will generate a double counting problem, which means estimating the value of a single product twice in the calculation of GDP.

Value of intermediate products:

As given in the figure,

  $\begin{array}{c}\text{Cost of ore = \$4,200}\\ \text{Cost of steel = \$4,800}\\ \text{Cost of motors = \$12,500}\\ \text{Total value added = }\$4200+\$4800+\$12500\\ =\$21500\end{array}$

Thus, it would be incorrect to calculate the total value added as $30,500 as it represents the worth of both the final good (a car) and the intermediate good (steel).