Application Exercise 6c: Determining the value of production
- The value-added method of production will yield a total value-added of $100,000 calculated as follows: $10,000 added by the writer, plus $40,000 added by the publisher, plus $50,000 added by the bookseller. The final market value approach is simply the $100,000 in total sales that is recorded by the bookseller.
- The total value of production is a $100,000. This $100,000 also represents the total net income earned by each of the 3 economic agents involved in the production of the eBooks ($10,000 by the writer, $40,000 by the publisher and $50,000 by the bookseller. The total value of expenditure is also $100,000 which is ultimately represented by expenditure of $100,000 by consumers (i.e. when purchasing the e-book from the bookseller).
- The total value of production now becomes $120,000. However, this is nominal production (i.e. not real) because it has occurred purely as a result of higher prices. The total real value of production remains at $100,000 because the volume of books produced (10,000 copies) remains unchanged. The rate of economic growth is zero because there is been no change in the real value of production between both periods.
- The economy is no better off in the 2nd year because there is no change in the real value of production income and expenditure. While it might appear that the bookseller is better off because she is able to receive an additional $2 per book (i.e. her income increases by 20%), she is no better off because she will need to pay an extra 20% for goods and services that she purchases. [In this very simplified example, it unrealistically assumes that the e-books are the only form of production taking place in the economy.]
- If this occurs, then inflation is the only result which means that nominal GDP continues to rise with real GDP is unaffected in the short term. However, an economy that continues to experience an increase in nominal GDP due to inflation will inevitably experience a reduction in real GDP over time given that international competitiveness declines and fewer e-books will be sold.