Measures of GDP: Value Added and Final Demand

INTRODUCTION

Gross Domestic Product, GDP, is defined as the total market value of all final goods and services produced within a region in a given period of time (usually a quarter or year). GDP is the sum of value added at every stage of production (the intermediate stages) for all final goods and services produced within a region in a given period of time. In other words, GDP is the wealth created by industry activity. 

GDP can be measured multiple ways. Conceptually, all measurement approaches are tracking the exact same thing, though some differences can arise based on data sources, timing, and mathematical techniques used. In IMPLAN, GDP can be viewed from the National Income or National Expenditure perspective. The National Income Approach measures GDP as the sum of income generated by production, which is equivalent to total Value Added in IMPLAN. The National Expenditure Approach measures GDP as the sum of expenditures by final users, which is equivalent to total Final Demand in IMPLAN. 

NATIONAL INCOME APPROACH

The National Income approach sums the incomes generated by production. This includes the following:

  • Compensation of employees (wages, salaries, benefits, payroll taxes, etc.)
  • Proprietor income (the income earned by sole proprietors and unincorporated businesses)
  • Rental income (income from property ownership)
  • Corporate profits
  • Net interest (paid by business)
  • Taxes on production and imports (sales tax, property tax, custom duties, and other taxes and fees) less government subsidies (TOPI)
  • Net business transfer payments (net payments by businesses to persons, government, and the rest of the world, for which no current services are performed)
  • Surplus of government enterprises

Incomes generated by production are referred to as Value Added at each stage of production, where Value Added is defined as total Output (also known as value of production) less the value of Intermediate Inputs into the production process. This can be calculated either by subtracting input costs from the final Output of each Industry or by summing each Industry’s payments made the components of Value Added (VA): Labor Income (LI), Other Property Income (OPI), and Taxes on Production and Imports (TOPI).

If you’d like to report the contribution to GDP estimated by your IMPLAN Analysis, simply report total Value Added from your Results. 

NATIONAL EXPENDITURE APPROACH

The National Expenditure approach adds up the value of purchases made by final users, called Final Demand. Final Demand expenditures consist of:

  • Personal consumption expenditures: spending by households on non-fixed-capital items
  • General government final consumption: spending by government institutions on non-fixed-capital items, excluding transfer payments1
  • Gross domestic fixed capital formation: the value of houses and other durables formed during the year plus increases in stocks and works in progress (i.e., net additions to inventory)
  • Net Exports: exports represent items that are produced in the region and sold to purchasers outside the region; imports are subtracted from this value to arrive at a net value.
  • From this sum, institutional sales must be subtracted since they are accounted for elsewhere in GDP. For example, a government institution might provide hospital services to a household. Government then has extra income and extra spending (e.g., buying more stethoscopes). The sale/purchase of hospital services cannot increase both personal consumption expenditures and government final consumption.

RELATIONSHIP BETWEEN VALUE ADDED & FINAL DEMAND

In general macroeconomic terms, both GDP and Final Demand (FD) share the same equation: GDP or FD = total consumption spending (C) + gross private investments (I) + total government expenditures (G) + net exports (X-M). In compact form:

[1]   FD = C + I + G + (X-M)

Find Total Final Demand for your Region in the Region Overview:

final_demand.png

Note that total Output by Industry (O) is:

Total Output = Final Demand + Intermediate Output

Final demand includes production consumed by households and other institutions.1 Intermediate Output (IO) includes production consumed by other Industries as one of their inputs into their production, also known as Intermediate Inputs (II)

So, we now have another equation in compact form:

[2]   O = FD + IO

Output can also be measured as an Industry’s cost of production; the sum of Value Added and Intermediate Inputs (II). One could ask each business how much raw materials and services they purchased (II), how much did they pay employees, how much did they pay in taxes, and how much was left over as profit. 

Total Output = Total Outlay = sum of an industry’s inputs = 

Intermediate Inputs + Value Added 

[3]    O = II + VA

Where,

[4]    II = Intermediate Outlay + Institutional Outlay + Intermediate Imports

Note that VA consists of Labor Income (LI), Other Property Income (OPI), and Taxes on Production and Imports net of subsidies (TOPI):

[5]   VA = LI + OPI + TOPI

If we substitute the right-hand side of equation O = II + VA into the left-hand side of equation O = FD + IO, we get the following:

 II + VA = FD + IO

For all Industries in a Region as whole, Intermediate Outlay is equivalent to Intermediate Output. Intermediate Outlay are Industry purchases from other Industries of Intermediate Inputs, whereas Intermediate Output are Industry sales to other industries for Intermediate Inputs.  This is two ways of looking at all Industry to Industry transactions for Intermediate Inputs. Note for each individual Industry, Intermediate Output and Intermediate Outlay won’t be equivalent because each Industry won’t necessarily buy the same amount from other Industries as it sells to other Industries. 

Taking a sum of all Industries in a Region can be:

[6] Total II + Total Industry VA 

= Total Industry FD + Total IO

Intermediate Outlay is just one component of II for each Industry. II can also come from imports and other Institutions, Intermediate Imports and Institutional Outlay respectively. 

Substituting II for equation [4] in equation [6], the Total Intermediate Outlay portion of Total II and Total IO cancel out, and the equation simplifies to:

Total Industry VA + Total Institutional Outlay + Total Intermediate Imports  = Total Industry FD 

Or,

Total Industry VA = Total Industry FD - Total Institutional Outlay - Total Intermediate Imports

Because Total Industry VA is the Total VA for the Region and Total Industry FD minus Total Institutional Outlay and Total Intermediate Imports is the total FD for the Region, we conclude that,

Total Region VA = Total Region FD

In a balanced Social Accounting Matrix (SAM) model like IMPLAN, total value added = total final demand for a given Region. Shown through the equations above, the data also confirms it is true that Final Demand is equal to Value Added in a given Region

As shown above, the sum of Value Added for every Industry in an economy produces the total GDP for the Region. Summing Value Added follows the National Income Approach for calculating GDP. IMPLAN is designed such that all components of Value Added are internalized in the IMPLAN Industries: hence Industries 535-546 are not private Industry producers or government enterprises. Income earned by government employees are represented by Industries 539-546, but these Industries do not include other institutional government expenditures, which are exogenous to the IMPLAN Industries as IMPLAN does not make assumptions about how government revenue is spent. Find the data points that make up the Region Details data in:

Industry Accounts

                            > Reports

                                       > Industry Output/Outlay Summary

output_outlay.png

  • Total Outlay equals the sum of Intermediate Outlay, Institutional Outlay, Intermediate Imports, and Value Added 
    • Total Outlay = II + VA
    • Total Outlay = Total Output 
  • The sum of Intermediate Outlay, Institutional Outlay and Intermediate Imports columns produces Intermediate Inputs (formerly called Intermediate Expenditures)
  • Valued Added
  • Total Output equals the sum of Intermediate Output and Final Demand
    • Total Output = FD + IO
  • Intermediate Output
  • Final Demand

One can also use equations [1] and [5] from above to relate the components of FD and VA as follows:

 C + G + I + X – M = LI + OPI + TOPI

WHAT GDP EXCLUDES

Note that GDP is only concerned with new and domestic production; therefore, it excludes the value of used goods and Output produced in another country that is owned by domestic factors of production (including the latter yields Gross National Product). 

Not all productive activity is included in GDP. For example, unpaid work (such as that performed in the home or by volunteers) and black-market activities are not included because they are difficult to measure and value accurately and may be illegal. That means, for example, that a baker who produces a loaf of bread for a customer would contribute to GDP, but would not contribute to GDP if he baked the same loaf for his family (although the ingredients he purchased would be counted).2

GDP takes no account of the wear and tear on the machinery, buildings, etc. (i.e., capital stock) that are used in producing the Output. If this depletion of the capital stock, called depreciation, is subtracted from GDP we get net domestic product.3

Furthermore, GDP is not a measure of the overall standard of living or well-being of a country. Although changes in the Output of goods and services per person (GDP per capita) are often used as a measure of whether the average citizen in a country is better or worse off, it does not capture things that are often deemed important to general well-being. So, for example, increased Output may come at the cost of environmental damage or other externalities such as noise or light pollution. It might involve the reduction of leisure time or the depletion of nonrenewable natural resources. The quality of life may also depend on the distribution of GDP among the residents of a country, not just the overall level.

 


1Institutions in IMPLAN include: households, federal, state and local government institutions, capital, inventory and trade. Government enterprises are Industries, not Institutions in IMPLAN.

2Savings and investment are the same thing in accounting. Savings are defined as the money left in the business after all costs and profits have been paid/distributed. If these savings are not invested in something concrete, it can still be considered an investment in cash.

3http://www.imf.org/external/pubs/ft/fandd/basics/gdp.htm