I came across this example somewhere on the internet: (I\'ve changed the words a

Question

I came across this example somewhere on the internet: (I've changed the words a bit to make it more clear)

“There are three ways to calculate GNP (or Y). Here is an example. Suppose I bought $5 worth of flour from A, then made a cake with it which I later sold for $15.

Method #1: The consumer purchases that were made is all that counts here, so since one purchase was made, of $15, GNP is $15

(this is the GNP = C + I + G + (x-m) formula)

Method #2: We add the income that was generated in the sale to the consumer: $3 (wage) + $1(interest for my loan of $5) + $2 (rent) + $ 9 (gross profit including the original input cost of $5) Total: $15

Method #3: We look at the value that was added: A made $5 on the flour, and I made $10 on the cake. Total: $15
(This is sales plus change in stock minus purchases)

This story I did not find in my book; I came across it somewhere on the internet

In my book it says that the second method does NOT give you GNP. It says that only when you add the amount paid in taxes does the second method give you GNP.

My book mentions the first and third method, and agrees that those methods give you GNP.

Should I trust my book on this? Thank you

Explanation / Answer

For most intents and purposes, the three methods are equivalent. In your example, the expenditure approach (C+I+G+NX), the factor income approach (Wages+Rents+Interest+Profits), and the value-added approach obviously yield the same answer, as they will in probably any question that you get from your teacher. However, in real life, not all the money that a business gets goes to factor payments—some goes to taxes. Thus, in real life, GNP=Wages+Rents+Interest+Profits+Net indirect Taxes+Some other adjustments. Usually though, you won't have to worry about that in a principles of macroeconomics class—questions will usually be like the one that you listed, where the three methods are perfectly equivalent. Incidentally, make sure you don't get GDP and GNP confused. GDP is the market value of all final goods and services produced within a geographical region. GNP is the market value of all final goods and services produced by citizens of a particular region, regardless of their physical location. C+I+G+NX gets you GDP, not GNP. On the other hand, the factor income approach might get you GNP or GDP, depending on whether you're looking at the factor income of citizens or of members of a geographical region.

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