Suppose there are only two firms in an economy: Cowhide, Inc. produces leather and sells it to Couches, Inc., which produces and sells leather furniture. With each $1,000 worth of leather that it buys from Cowhide, Inc., Couches, Inc. produces a couch and sells it for $2,600. Neither firm had any inventory at the beginning of 2015. During that year, Cowhide produced enough leather for 25 couches. Couches, Inc. bought 80% of that leather for $20,000 and promised to buy the remaining 20% for $5,000 in 2016. Couches, Inc. produced 20 couches during 2015 and sold each one during that year for $2,600. What was the economy's GDP for 2015?

$57,000

Explanation:

The calculation for GDP only takes into account the final, market value, of finished goods and services. The value of intermediate goods (those that are transformed into other goods during the year) is not taken into account.

In this case, we have 20 couches that were finished and sold for $2,600. They are part of GDP under their market value. Their total contribution to GDP is:

20 couches x $2,600 = $52,000

Cowhide, Inc. produced 25 units of leather, each worth $1,000. 20 of them were bought by Couches, Inc. and transformed into couches. As a result, those 20 units are not counted on GDP.

The remaining 5 units of leather are part of GDP because they are finished goods which have not been transformed into anythign else. Even if Couches, Inc. has promised to buy those 5 units of leather, it would only do so in 2016, and a promise is not necessarily a certainty.

The contribution of the 5 units of leather to GDP is:

5 units of leather x $1,000 = $5,000

Finally, we add up the two figures to obtain total GDP:

GDP = $52,000 + $5,000

        = $57,000