Gross Domestic Product-Measurement

The Gross Domestic Product (GDP) which is the value of all the goods and services produced within a country’s geographical boundary can be measured in three ways. The methods are product (output), income and expenditure methods. The methods should produce the same figure. 

The product or output method
This method involves the addition of the value of the output of all the firms operating in different industries in a particular country over a given period. The problem with this method of calculating the GDP is that there could be overstatement due to double counting. There is, usually, more than one stage involved before a product is completely made. It starts from the extraction of raw materials (primary stage) to the conversion to a finished product (secondary state) and product distribution (tertiary stage). And the output of a firm in one stage of production is the input of a firm in another stage. Adding up the values of the output in all the stages without making any adjustment will overstate the GDP. For example, the output of the primary sector is sold to the secondary sector. The output of the secondary sector, therefore, will include the cost of purchases from the primary sector. Likewise, the output in the tertiary sector will include the cost of purchases from the secondary sector. The cost of purchasing raw materials or components has to be deducted from the sales revenue to ascertain the true value created in each stage of production. This is known as value added.

Value added is the difference between the sales revenue and the cost of materials and components. The values added in all the industries in the economy are added together in order to arrive at the Gross Value Added (GVA). The GVA is equivalent to GDP at basic prices. The GDP at basic prices does not account for taxes and subsidies. And because GDP is normally measured at market prices, an adjustment has to be made to GVA or GDP at basic prices. GDP at market prices is obtained by adding taxes and subtracting subsidies from GDP at basic prices.

In Table 1 below, the value added in each stage of production is obtained by deducting the cost of materials and components from the sales value of output. The total value added to the GDP is $80 billion, i.e. the addition of value added in the three stages of production. The same result can be obtained by using the final sales value of the finished product which is $80 billion value by the chocolate retailer.

Table 1: Numerical example of value-added method

The income method
Another method is summing up all the incomes paid to the factors of engaged in the production of goods and services in the economy. These incomes are rents, wages, salaries, interests and profits. The sum of all the values added should be equal to the sum of incomes paid to productive resources of land, labour, capital and enterprise. This is because the output of a firm is valued by considering all payments incurred in the production which are payments made to the factors of production.

Transfer payments are excluded when calculating GDP by the income method. These payments are not made for productive purposes, e.g. welfare benefits or pensions. Besides, the incomes added are incomes before income taxes and subsidies that are adjusted for. Taxes are added and subsidies are subtracted in order to get the GDP at market prices. 

The expenditure method
This method involves totalling the spending on domestic goods and services. These are already at market prices.  The GDP is given as:

C + I + G + (X-M)

C stands for consumption, i.e. spending by households on goods and services.
I stands for investment, i.e. purchase of capital goods by businesses or firms.
G stands for government spending.
X-M is net exports, i.e. exports minus imports.
X stands for export of goods and services.
M stands for import of goods and services.