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Revenue$1,000CostsWages and salaries$700Rent on land$50Rental fee for tractor$100Seed, fertilizer$100Pesticides, irrigation$50Suppose that, because of flooding in Kansas, wheat prices increase suddenly and revenues rise to $1,100, but the prices of intermediate inputs do not change. What happens to value added and profits in this case?

Question

Revenue1,000CostsWagesandsalaries1,000CostsWages and salaries700Rent on land50Rentalfeefortractor50Rental fee for tractor100Seed, fertilizer100Pesticides,irrigation100Pesticides, irrigation50Suppose that, because of flooding in Kansas, wheat prices increase suddenly and revenues rise to $1,100, but the prices of intermediate inputs do not change. What happens to value added and profits in this case?

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Solution

The value added is calculated by subtracting the cost of intermediate goods from the total revenue. In the initial scenario, the total costs are 700(wagesandsalaries)+700 (wages and salaries) + 50 (rent on land) + 100(rentalfeefortractor)+100 (rental fee for tractor) + 100 (seed, fertilizer) + 50(pesticides,irrigation)=50 (pesticides, irrigation) = 1,000. The initial revenue is 1,000,sotheinitialvalueaddedis1,000, so the initial value added is 1,000 - 1,000=1,000 = 0.

The profit is calculated by subtracting the total costs from the total revenue. In the initial scenario, the profit is 1,000(revenue)−1,000 (revenue) - 1,000 (costs) = $0.

When the revenue increases to 1,100duetotheincreaseinwheatprices,andthecostsremainthesame,thenewvalueaddedis1,100 due to the increase in wheat prices, and the costs remain the same, the new value added is 1,100 (new revenue) - 1,000(costs)=1,000 (costs) = 100.

The new profit is also 1,100(newrevenue)−1,100 (new revenue) - 1,000 (costs) = $100.

So, in this case, both the value added and the profits increase by $100.

This problem has been solved

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