The economy of Kraftwerk

Question One

a) Gross Domestic Product (GDP) refers to the worth of goods that are produced in an

economy over a specified period. Three basic approaches to calculating GDP and

each of the three approaches are formulated to best estimate the monetary value of

final goods and services were produced in a country over a period. The three

approaches, or methods to calculating GDP are, expenditure method, value-added

method and income method.

The key difference between the approaches is that of their initiation. The expenditure

approach calculates GDP by adding private consumption expenditure(C), investment

(I), government expenditure (G) and net exports (NX or X-M), net exports being

calculated by deducting imports from exports.

Expenditure method of GDP

Since the only consumption expenditure is that of direct sales to consumers by Sue’s

superstore, which is worth $128m, the value of C will be $128m.

The investment value is only that of Sue’s unsold inventories, which amount to $32m.

The value of Government expenditure will be derived from the purchase of musical

instruments from Sue’s Supertore which amounts to $96m.

Exports are calculated by combining the value of exports from each firm. Timmy’s

Forestry exports $96m, Gab’s Guitar Factory exports $96m. The total amount of

exports will be 96m +96m = $192m.

Timmy’s Forestry has no imports so none will be calculated, Gab’s Guitar Factory has

imports of $32m of electrical components and Sue’s superstore has imports of $32m

for assorted goods. The total imports would thus amount to 32m +32m = $64m.

The formula for calculation of GDP according to expenditure methods would be

GDP = C + I + G + (X-M)

We replace the known variables with their corresponding values.

GDP= 128m + 32m + 96m + (192m – 64m)

The GDP would amount to $384m from expenditure method.

Value-added Approach

The value-added approach to calculate GDP observes the value of inputs against the

value of outputs to look at the overall production in the economy. To calculate GDP

from the value-added approach all the input costs and output prices will be calculated

to be used in the formula.

The output prices will be calculated as follows for each producer. Timmy’s Forestry

produced goods worth $128m, Gab’s Guitar Gactory produced and sold goods worth

$192m and Sue’s Superstore sold goods worth $256m. The total worth of outputs

amount to 128m + 192m + 256m = $576m.

Timmy’s forestry has no input costs so none will be accounted for, Gab’s Guitar

Factory has input costs $32m from imports and $32m from Timmy and Sue’s

superstore imports $32m in assorted goods and bought $96m worth of goods from

Gab. The total input costs would thus amount to 32m + 32m + 32m + 96m = $192m.

Therefore, the formula would be applied as follows:

Value-added = (total value of outputs) – (total input costs)

Value-added = 576m – 192m

Value-added= $384m

Income Approach

Income approach calculates GDP by adding labor income, rental income, interest

income, profits, indirect business taxes and depreciation. As the case of

 Kraftwerkdoes not have any indirect business taxes or depreciation figures, the GDP

will be calculated from the National Income.

Wages: Timmy pays 16m, Gab pays 32m and Sue pays 48m, so total wages equal to

96m

Rent: Timmy pays 16m, Gab pays 16m and Sue pays 32m, totalling rent of 64m.

There are no interest payments, so none are included.

Profit:

Timmy. Profit= 128 – (16 + 16) = 96m

Gab. Profit= 192 – (32 + 32 + 32 + 16) = 80m

Sue. Profit= 256 – (32 + 96 + 48 + 32) = 48m

Overall Profit = 96 + 80 + 48 = 224m

GDP = Profit + Wages + Rent

GDP = 224 + 96 + 64

GDP = $384m

b) Firstly, The GDP that was calculated was nominal and not real, as it did not

accountfor inflation rate. This means that even though people have more money the

prices have also gone up with the same rate, which negates the purpose of growth.

Secondly, the government expenditure was only done on musical instruments for its

schools, which are merit goods, and no expenditure was made on public goods.

Thirdly, GDP fails to account for income inequality which means that the majority of

population may have experienced no growth and the growth of GDP might only

portray a minority.

Question Two
 a) 0.8 is assumed to be denoting marginal propensity to consume, whereas Y denotes the

equilibrium level of real GDP. A denotes the Autonomous expenditure, which will be

calculated by adding C,I,G and NX. M will denote the unknown value of multiplier.

M = 1/(1-0.8).

M= 5

Y = M(A)

A = 300 + 200 + 200 – 100

A = 600

Y= M(A)

Y= 5(600)

Y = 3000billion

b) The multiplier as calculated above, is 5.

c) If the potential GDP is 3500 billion and the current GDP is 3000 billion, the economy

is 500 billion below its full employment output.

d) The government should increase its spending by 100 billion in order to reach full

employment output.

e) Increased government expenditures are likely to show a higher increase in GDP than

the initial amount spent because the government expenditures in time are turned in to

other factors that are used in the calculation of GDP. For example, Government

expenditure on infrastructure is likely to encourage more economic activity which

will also increase investment of the economy.

Question Three

a) In order to make housing more affordable to average wage earners, the government

would need to create policies that would cause a downward shift in the demand curve.
 The government is unable to influence the supply of properties as the supply of

housing would be constant and the curve would be parallel to the y-axis. Cutting

down tax concessions on property are likely to increase the prices of housing in the

short run but in the long run once the demand curve shifts downward the price

equilibrium would be set lower than before.

b) It is one of the goals of the government to keep the unemployment rate at a minimum,

but one of the biggest problems the economy faces is the negative relation between

inflation and employment rate. If the government puts its efforts in reducing

unemployment rate to 0 then it becomes highly likely for the economy to face a high

demand-pull inflation which would negate the effect of economic growth. While the

government strives towards keeping both factors at a minimum, this can only be

achieved by keeping them at minimum as reaching 0 is likely to adversely affect the

economy.

c) Cyclical unemployment is reliant upon the business cycle within the economy. For

example, if the economy experiences a fall in demand for its housing industry it is

likely for the construction industry to also temporarily fire its employees as a result of

low business cycle. This may convert to structural unemployment as the businesses

restructure themselves in response to the demand trends of the market. An employee

who was temporarily fired as a result of business cycle being low in the construction

industry may become permanently and structurally unemployed as a result of the

organization changing its policies of recruiting temporary employees due to the fall in

demand.

Question Four

a) Population growth is one of the most important factors that considered when it comes

to the decision of classifying one as a developing country. Developing countries often

 face high population growth due to illiteracy and many other factors. There can be

many advantages and disadvantages for an economy experiencing high population

growth.

Advantages

1. High population growth means that a larger workforce will be available in the

long run. Africa’s population is likely to be doubled by 2050 reaching up to 2

billion, meaning it will have 20% of the world’s population and one of the largest

work forces on the planet (Fengler, 2010).

2. Population growth leads to higher urbanization, which leads to economic

growthand specialization(Easterlin, 1967).

Disadvantages

1. Increased population leads to the rsources being further divided between

individuals, which leads to inefficiency of resources being utilized as well as

corruption. One example can be that of Nigeria where corruption is high due to

population(Fox, & Dyson, 2015).

2. Due to high population growth in the past and now having been regulated after

government intervention China is experiencing aging population (Lozeau, 2007).

b) While India has quite a significant growth rate compared to many other developing

economies, there are still many economic issues that its government needs to address

in order for the economy to be classified among developed nations. From 1983 till

2013, India reached averaged the unemployment rate of 7.32% and further declined to

4.90% during 2014("India Unemployment Rate | 1983-2017 | Data | Chart | Calendar |

Forecast", 2017). India has a high population, recorded of up to 1,293 million as of

2015("India Economy - GDP, Inflation, CPI and Interest Rate", 2017). However, the

government is taking strong actions by educating the residents in order increase

awareness regarding the disadvantages of high number of individuals present in a

household.

The country is also experiencing a growth in its GDP per capita since the last decade,

having 1610 USD as of 2015("India Economy - GDP, Inflation, CPI and Interest

Rate", 2017). The economic growth rate of India has also been increasing, showing

increase in economic growth 6.7% to 7.9% in the period 2011-2015 for the country,

which is a good prospect for the economy("India Economy - GDP, Inflation, CPI and

Interest Rate", 2017). The economy of India has also been able to have a good impact

on its inflation rate which has declined from 8.5 during 2011 to 4.9 during

2015("India Economy - GDP, Inflation, CPI and Interest Rate", 2017). However, the

currency of the Indian Ruppee has declined in comparison to U.S Dollar, showing a

rising exchange rate from 50.88 in 2011 to 66.25 in 2015.

References

Easterlin, R. (1967). Effects of Population Growth on the Economic Development of

Developing Countries.

Fengler, W. (2010). Can rapid population growth be good for economic

development?. Africa Can End Poverty. Retrieved 26 May 2017, from

http://blogs.worldbank.org/africacan/can-rapid-population-growth-be-good-for-

economic-development

Fox, S., & Dyson, T. (2015). Is population growth good or bad for economic

development? - IGC Blog. IGC. Retrieved 26 May 2017, from

http://www.theigc.org/blog/is-population-growth-good-or-bad-for-economic-

development/
India Economy - GDP, Inflation, CPI and Interest Rate. (2017). FocusEconomics |

Economic Forecasts from the World's Leading Economists. Retrieved 26 May 2017,

from http://www.focus-economics.com/countries/india

India Unemployment Rate | 1983-2017 | Data | Chart | Calendar | Forecast.

(2017). Tradingeconomics.com. Retrieved 26 May 2017, from

https://tradingeconomics.com/india/unemployment-rate

Lozeau, B. (2007). The Effects of Population Growth on Economic Performances in

China and India.