To calculate GDP as the value added in production, we need to sum all value
added (value of output less input costs) for each company. Value added in the
bread company is $150; in the cheese company, $80; and in the pizza company,
$215 ($300 –$50 –$35). The total value added in production is $445
To calculate GDP as spending on final goods and services, we need to sum the
value of bread, cheese, and pizzas sold as final goods. GDP equals $445 because
the bread company sells $100 worth as final goods, the cheese company sells $45
worth as final goods, and all $300 worth of pizzas are final goods.
To calculate GDP as factor income, we need to sum factor income (labor and
profits) for each firm. For the bread company, factor income is $150: labor earns
$50 and profit is $100. For the cheese company, factor income is $80: labor earns
$50 and profit is $30. For the pizza company, factor income is $215: labor earns
$75 and profit is $140 ($300 –$75 –$50 –$35). As factor income, GDP equals
$445 ($150 +$80 +$215).
a.This is an example of the effect of shoe leather costs, a net cost of inflation to the economy. Workers spend
valuable resources going to the bank more frequently, firms spend valuable resources (such as bookkeepers’ time) in
paying workers more frequently, and banks spend more resources in processing the greater volume of transactions.
b.This is an example of unit-of-account costs. A dollar when Lanwei spends it on a work related expense is worth
more than a dollar she receives much later in reimbursement from her company. Because she is less willing to travel
for her job, there is a net cost to the economy of her forgone output.
c.This is an example of inflation creating winners and losers. As the inflation rate creeps up unexpectedly, the real
value of the funds that Hector pays to the mortgage company falls. So Hector is better off as inflation increases, and
the lender of