- Consider an economy with a coconut producer, a restaurant, and a government. The coconut producer produces 10 million coconuts, which are sold for $2 each, generating a revenue of $20 million. The coconut producer pays wages of $5 million to its workers, $0.5 million interest on a loan to some consumers, and $ 1.5 million in taxes to the government. The restaurant buys 6 million coconuts, and the remaining 4 million coconuts are directly bought and consumed by consumers. The restaurant uses coconuts to produce meals that generate a revenue of $30 million. The restaurant pays its workers $4 million in wages, and the government $3 million in taxes. Consumers work for the coconuts producer, restaurant and the government, earning a total of $14.5 million in labour income ($9 million in wages from the private sector, and $5.5 million from the government). They also earn $24 million in after-tax profits (dividends) from the producers, in addition to the interest income of $0.5 million dollars from the coconut producer. Consumers pay the government $1 million in taxes. The government collects a total of $5.5 million dollars in taxes ($4.5 million from the producers, and $1 million from the consumers). All of the tax revenues are used to pay wages to the Armed Forces for National Defense.

(a) Calculate the GDP in this economy using the income approach.

(b) The government is more generous to its Armed Forces even though the threat by foreign invaders is the same as before. In particular, it pays $6.5m instead of $5.5m to its soldiers. In order to balance its budget, the government taxes the coconut producers by $2m (instead of $1.5m), and taxes the restaurant by $3.5m (instead of $3m). Calculate the GDP using the income approach. Compare the GDP in this case to that in (5a). Do you see a problem with the GDP calculation? Explain.

(c) What can you say about the welfare of the consumers in (5b) relative to that in (5a)?