Measuring GDP: Output and Value-added Approach

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Economics Mafia
Published at : 24 Dec 2020
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Transcript:

1 Looking at the Circular Flow of Income,

1 We see that stuff just gets transformed in different stages.

1 Firms use factors of production from households,

1 Perform some magic,

1 And Tada! You get goods and services

1 These are sold back to households.

1 Households pay for these stuff too,

1 Which reflects the value of these goods.



2 So this arrow, the National Expenditure,

3 And this arrow, the National Output.

4 Should be roughly equivalent.

5 Because when firms sell goods to households,

6 It's just goods transformed into money



7 Hey, where does all this money on spending come from?

8 It comes from income made by the households.

9 So this arrow, the national income,

10 also equals to national expenditure.

11 We see that National Income = National Expenditure = National Output.

They are just in different stages of the Circular Flow of Income.



12 So how do we measure GDP?

13 We can measure the total output, the total final goods and services.

14 Why only final goods and services?

15 Take the production of sandwiches for example.

16 First, we need labor

17 to harvest wheat,

18 then wheat goes into the production of flour.

19 Flour goes into the production of bread,

20 And bread goes into the production of sandwiches.

21 We then sell the sandwich at $5.

22 Tada! GDP equals to $5.

23 This $5 already includes the value of labor, flour, wheat and bread

24 that went into the production of sandwich.

24 We don't have to add these things again.

25 See, if you add the value of these things,

25 On top of the sandwich,

(1 + 2 + 3 + 4 + 5 = 15 )

26 It's $15, way higher than $5.

27 Because you've double-counted, and it's wrong.



28 Alternatively, we can use the value-added approach

28 We measure the additional value that is created in every stage of production.

We start from zero.

Labor doesn't require any other input.

So labor itself is pure value.

Using this labor, we grow wheat.

Wheat is sold at $2. What is the additional value created?

Remember we got to minus the cost of production which is labor.

So $2 - $1 = $1

$1 of additional value created.

Using wheat, we make flour.

Flour is sold at $3.

What is the additional value created?

We got to minus the cost of production which is wheat.

$3 - $2 = $1

$1 of additional value created.



Do the same for the rest

Bread adds value to flour.

And sandwich adds value to bread.

Add up all the additional value created by each stage of production,

We get $5 as well. Wow!



29 You see, Output approach and value-added approach are quite similar.

29 In value-added approach, you add up all the additional value

30 Which is just the value of the final output.



31 Hey, that's not the only way to measure GDP…

31 If you like this video, remember to like and subscribe.

32 Next up: measuring GDP: Expenditure and Income Approach.

_____________________________________________________



How do we measure the size of the economy? We can calculate the total output produced.

Why do we only count FINAL goods and services towards gross domestic product (GDP)? What's double-counting? What is the difference between intermediate goods and final goods?

Important definitions:
Gross Domestic Product or GDP is the total value of all final goods and services produced within the borders of a country during a given period.

Use flashcards to remember these definitions:
http://www.memrise.com/course/461808/economics-101/
Measuring GDPGross Domestic ProductGDP

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