There is one firm in an economy. It sells $100 worth of donuts to foreigners and

Question

There is one firm in an economy. It sells $100 worth of donuts to foreigners and $400 worth of donuts to domestic consumers. It imports $50 worth of sugar and an industrial oven that costs $100. The firm pays $300 to workers and $20 in interest. The rest of the firm’s value added is profit and is paid out to the firm’s owners as dividends. There is no government in this economy.

The interviewer is not finished. She wants to check your understanding of how imports and exports affect GDP. Your (aged over 21) friend (who lives in the US) purchases a $100 bottle of wine from France.

(a) How would this wine purchase show up in the GDP accounts (i.e. which terms in theequationY =C+I+G+NX changeandbyhowmuch)? (6points)

(b) Would persuading your friend not to spend this $100 on the wine (or anything else) lead to an increase in US GDP? Why or why not? (4 points)

Explanation / Answer

Solution: a. The wine purchase from france worth $100 will show up in the term NX and NX will decrease by $100 as import.

b. Since Y=C+I+G+NX does not contain a term for saving, saving of $100 will not contribute to GDP. Of course saving may increase GDP if the leakage in the form of saving is injected back into the system in the form of investment.

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