Measuring Total Output and Income
6.1 Measuring Total Output
Final Goods and Value Added
GDP is the total value of all final goods and services produced during a particular period valued at prices in that period. That is not the same as the total value of all goods and services produced during a period. This distinction gives us another method of estimating GDP in terms of output.
Suppose, for example, that a logger cuts some trees and sells the logs to a sawmill. The mill makes lumber and sells it to a construction firm, which builds a house. The market price for the lumber includes the value of the logs; the price of the house includes the value of the lumber. If we try to estimate GDP by adding the value of the logs, the lumber, and the house, we would be counting the lumber twice and the logs three times. This problem is called "double counting," and the economists who compute GDP seek to avoid it.
In the case of logs used for lumber and lumber produced for a house, GDP would include the value of the house. The lumber and the logs would not be counted as additional production because they are intermediate goods that were produced for use in building the house.
Another approach to estimating the value of final production is to estimate for each stage of production the value added, the amount by which the value of a firm's output, exceeds the value of the goods and services the firm purchases from other firms. Table 6.1 "Final Value and Value Added" illustrates the use of value added in the production of a house.
Table 6.1 Final Value and Value Added
| Good | Produced by | Purchased by | Price | Value Added |
|---|---|---|---|---|
| Logs | Logger | Sawmill | $12,000 | $12,000 |
| Lumber | Sawmill | Construction firm | $25,000 | $13,000 |
| House | Construction firm | Household | $125,000 | $100,000 |
| Final Value | $125,000 | |||
| Sum of Values Added | $125,000 |
If we sum the value added at each stage of the production of a good or service, we get the final value of the item. The example shown here involves the construction of a house, which is produced from lumber that is, in turn, produced from logs.
Suppose the logs produced by the logger are sold for $12,000 to a mill, and that the mill sells the lumber it produces from these logs for $25,000 to a construction firm. The construction firm uses the lumber to build a house, which it sells to a household for $125,000. (To simplify the example, we will ignore inputs other than lumber that are used to build the house.) The value of the final product, the house, is $125,000. The value added at each stage of production is estimated as follows:
- The logger adds $12,000 by cutting the logs.
- The mill adds $13,000 ($25,000 − $12,000) by cutting the logs into lumber.
- The construction firm adds $100,000 ($125,000 − $25,000) by using the lumber to build a house.
The sum of values added at each stage ($12,000 + $13,000 + $100,000) equals the final value of the house, $125,000.
The value of an economy's output in any period can thus be estimated in either of two ways. The values of final goods and services produced can be added directly, or the values added at each stage in the production process can be added. The Commerce Department uses both approaches in its estimate of the nation's GDP.