Consider JK Rowling’s first Harry Potter book. I want to understand in this post how the production of this product enters the national “gross domestic product” calculation.
So far we have discussed extensively where we think prices mostly come from in the world as it mostly is. On the whole, or let’s say at a first order of importance, the price for a certain product can be thought of as gradually forming in such a way that the supply of this product equals the demand of this product. In a competitive such situation, such as the global market for cocoa beans, or apples, or wheat, or some other agricultural product or natural resource, then such prices will typically lead to something close to a Pareto-efficient (this does not mean fair) allocation of these products. In a not so competitive market, that all firms try to be in, if possible, firms have some power over the price they choose for their product. This power will typically lead to higher (than efficient) prices and a lower (than efficient) supply of this product. There are a lot of interesting other special phenomena in special markets, some of which you will learn about in your future micro courses.
In any case, it is through their “market prices” (which we now at least somewhat know how to think about) that products that are created in an economy enter the so-called gross domestic product (GDP) calculation.
So how does for instance the production of the first Harry Potter book enter this GDP calculation? To fix ideas let me give you some fictional and arbitrary but not completely implausible numbers about the first Harry Potter book. Let us be in the UK and let us say that the first Harry Potter book was in its first year initially sold in a hard cover for £ 20 a book and sold to 1 million readers, and then in soft cover for £ 10 a book to a further 9 million readers. Let us say that JK Rowling receives 80% of this revenue. The publisher takes the remaining 20%. From this the publisher pays £ 1 per hard cover book and £ 0,50 per soft cover book to the paper company. Of this amount half stays with the paper company as salaries to its employees and profits to its shareholders, the other half goes to the owner of the wood that the paper company acquires to make the paper out of. The publisher pays £ 1 million to an advertising company that makes and places adverts for this book. Half of this amount goes to TV, Radio, other media, and half stays as salaries and profits with the advertising company. This is still all hugely simplified. In reality there are many more “inputs” into the production of even such a simple thing as a book. Water is needed for paper-making, so are certain wood-cutting and other machines, which in turn have lots of different inputs; in the printing process, there is obviously ink as well as printing machines, which again need many inputs by themselves. But you get the idea.
So, how does all this enter GDP? How would you do it?
Well, there are at least three answers and all give you the same amount. The easiest way is to simply calculate 20 times 1 million plus 10 times 9 million, which is equal to £ 110 million, the “market value” of the final product, the book, as it is sold to the consumers of this final product.
Another, equivalent way to compute how this all enters GDP, is to add up all value added contributions in each stage of the production process of the first 10 million copies of the first Harry Potter book. So first someone grew trees that were then sold to the paper company for the value added of £ 2,75 million. Then the paper company added another £ 2,75 million of value by turning wood into paper. A further £ 500.000 of value was added by the media companies for running ads for the book, and another £ 500.000 by the advertising company for composing these ads. The publisher then added a value of £ 15,5 million for organizing this all, and finally J K Rowling added a value of £ 88 million for filling the pages with her story. If you add all this up you get the same amount of £ 110 million total “market value” of this first Harry Potter book.
Finally, there is a third way to compute how the first 10 million copies of the first Harry Potter book enter the GDP calculations. This last one is based on the simple truth that whenever something “costs” something the money actually goes to some person. If you buy wood, the money you use it to pay for it is not given to the tree or hidden in the place the tree grew, at least not usually. The money is given to the person who grew the tree (or at least the one who felled and sold it). All “costs” are really salaries or profits for people. This means we can compute how the first 10 million copies of the first Harry Potter book enter the GDP calculations by adding up all the income or profits people received in the process. Given the simplification of the Harry Potter book production that I made here, this would mean the following. J K Rowling received an income of £ 88 million, the publisher paid out salaries or profits of £ 15,5 million, half a million in salaries or profits were paid out by both the advertising company as well as the various media companies, £ 2,75 million were paid out in salaries or profits by the paper company, a final £ 2,75 million goes to the tree farmer. In total you again get the same amount of £ 110 million total “market value” of this first Harry Potter book.