GDP - Final Output

The output of an economy, if restricted to the process of production, is the part of the output that reaches the final consumers. In measuring the output of the total economy, all the intermediate transactions occurring within the factory park are discarded. Although they are essential for the working of the economy, they in themselves do not meet the needs of the final consumers in the economy. A nations output, GDP, can be measured from the production side as total production minus intermediate inputs; from the expenditure side by looking at the use of the output; as well as from the income side.

Total Total output, or total value added, can be measured as final output from all businesses less intermediate imports going into the production process. This is achieved by considering how each business or enterprise adds value to the inputs it receives, so that the output of the business is measured in terms of the value added by means of its production activities.

For a single enterprise, value added by production activity is measured as gross output less inputs from other businesses less inputs from abroad.

Summing up the value added by all enterprises, the domestic intermediate transactions between businesses cancel out. For the total economy, value added from the production side is measured as gross output less inputs from abroad (imports).

Example: This small example shows how domestic intermediate transactions between businesses cancel out when summing up value added for the total economy.

A farmer produces grain worth $500. The value of his intermediate input, seeds, which is imported, is $100. So his value added is $400.

The miller buys the grain from the farmer, worth $500. The miller produces and sells flour worth $700 using the grain as intermediate inputs. Thus his value added is $200.

Total value added for the economy can either be found as value added, farmer: $400 + value added, miller: $200 = total value added: $600; or as final output in the economy - flour: $700 less imported intermediate inputs - seeds: $100 = total value added: $600.

Since output by industry (or institutional sector) is measured at basic (or producers) prices, value added by industry (or institutional sector) will be defined at basic (or producers) prices. However, GDP is a measure defined at purchasers (market) prices only. Therefore, to go from total value added at basic (or producers) prices to GDP at purchaser's prices, taxes less subsidies on products have to be added.

Final domestic output can be used for the purpose of final consumption, fixed investment, and exports. However, final output coming from domestic enterprises includes a contribution from intermediate imports going into the production process and final expenditure includes expenditure on imports. Both imports for intermediate as well as final use must be excluded to measure domestic production. It follows that GDP can be measured from the expenditure side as the sum of consumption, fixed investment and net exports.

The third approach to measuring GDP is by looking at the incomes generated through the process of production. The incomes generated through this process are wages and salaries paid to labor as well as gross operating surplus (profits) paid to the owners of the capital used in the process of production. This is the income approach to measuring GDP.

Example: This example shows how measuring GDP form the output, the expenditure and the income sides give identical estimates of GDP.

On an island lived a farmer, a miller and a baker. The farmer grew corn and sold it to the miller, who ground the corn and sold the flour to the baker. He in turn used the flour to bake the bread and sold the bread in his shop.

In one year, the transactions between the three were as follows.
The farmer grew and sold 400 pesos worth of corn to the miller.
He paid his son 100 pesos wages and kept the rest.
He bought 300 loaves of bread to eat for 450 pesos.
The miller bought 400 pesos worth of corn and sold the flour for 800 pesos to the baker. He also bought 300 loaves for 450 pesos.
The baker bought 800 pesos worth of flour, baked it, and sold 1000 loaves for 1500 pesos. He and his family consumed 400 loaves of the total sold, valued at 600 pesos.

It would give a misleading picture if we measured the level of the economy by simply adding together all the production in the island, 400 + 800 + 1500 = 2700 pesos, as this would be double-counting things like the value of the corn - once as the farmer sold it to the miller, then again included in the value of the flour sold on to the baker, and yet again in the value of the loaves sold to the consumers. Corn is an intermediate product, and is only of interest and value to the consumer in as far as it adds to the value of the final output, the bread.
To illustrate the double counting, consider the case where the farmer does not take the corn to the miller himself, but hires someone to take it for him. This introduces an extra activity of the transport from farm to mill by having the farmer sell the corn to the carrier for 300 pesos, and she in turn selling it on to the miller for 400 pesos. Obviously there is no real increase in economic output measured in terms of goods available for final consumption, and yet by adding together all production, we would appear to have added 300 pesos worth of output to the economy.

Measuring only the value added at each stage of the production processes avoids this double counting. The value added at each stage of the process is given by sales less costs.
Farming on the farm: 400 less 0 = 400 pesos
Milling at the mill: 800 less 400 = 400 pesos
Baking at the bakery: 1500 less 800 = 700 pesos
Total value added over all activities = 1500 pesos

Now introducing the carrier transporting the corn as a separate economic activity, the picture changes as follows :
Farming on the farm: 300 less 0 = 300 pesos
Transporting the corn: 400 less 300 = 100 pesos
Milling at the mill: 800 less 400 = 400 pesos
Baking at the bakery: 1500 less 800 = 700 pesos
Total value added over all activities = 1500 pesos

So the value added summed over all activities is unchanged.

The final output going to consumers measured through what each consumer spent was:
450 + 450 + 600 = Total final output = 1500 pesos

Measuring GDP from the expenditure side gives the same result as measuring it from the output side.
The incomes generated through the process of production:
Farmer: = 300 pesos
Farmer's boy: = 100 pesos
Miller: = 400 pesos
Baker: = 700 pesos
Total incomes = 1500 pesos

So, it can be seen from this simple example that total value added through the production process equals the sum of the incomes generated, which is in turn equals total final expenditure.