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Lecture 28

ECON 2400 Lecture 28: Lesson 28

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York University
ECON 2400
prof Antone

Lesson 28 An Example with Inventory Investment and An Example with International Trade An Example with Inventory Investment One component of investment expenditures is inventory investment, which consists of any goods that are produced during the current period but are not consumed. Stocks of inventories consist of inventories of finished goods (e.g., automobiles that are stored on the lot), goods in process (e.g., automobiles still on the assembly line), and raw materials. Suppose in our running example that everything is identical to the above, except that the coconut producer produces 13 million coconuts instead of 10 million, and that the extra 3 million coconuts are not sold but are stored as inventory. In terms of the valueadded approach, GDP is the total value of coconuts produced, which is now 26 million, plus the value of restaurant food produced, 30 million, minus the value of intermediate goods used up in the production of restaurant food, 12 million, plus value added by the government, 5.5 million, for total GDP of 49.5 million. Note that we value the coconut inventory at the market price of coconuts in the example. In practice, this need not be the case; sometimes the book value of inventories carried by firms is not the same as market value, though sound economics says it should be. Now, for the expenditure approach, C = 38 million, NX = 0, and G = 5.5 million as before, but now I = 6 million, so GDP = C + I + G + NX = 49.5 million. It may seem odd that the inventory investment of 6 million is counted as expenditure, because this does not appear to be expenditure on a final good or service. The convention, however, is to treat the inventory investment here as if the coconut producer bought 6 million in coconuts from itself. Finally, in terms of the income approach, wage income to consumers is 14.5 million, interest income to consumers is 0.5 million, taxes are 4.5 million, as before, and total profits after taxes for the two producers are now 30 million, for total GDP of 49.5 million. Here, we add the 6 million in inventories to the coconut producers profits, because this is an addition to the firms assets. An Example with International Trade To show what can happen when international trade in goods comes into the picture, we take our original example and alter it slightly.
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