4.4: Measuring GDP

Nominal GDP is measured using market prices and a specific time period. It is not possible to add up the final physical outputs of many different businesses and arrive at a meaningful result. Instead, because we have a 'money economy', we let current market prices determine the money values of these different outputs. Then the total market value can be found by adding up the money values. Nominal GDP is the market value at current prices of all final goods and services.

Furthermore, the outputs of goods and services occur over time, not all at once. They flow over time and must be measured relative to time. GDP measured over three-month and one-year time periods are reported as quarterly GDP and annual GDP. Annual nominal GDP for any year is the value of the final goods and services produced in that year at the prices of that year.

Final goods and services: goods and services are purchased by the ultimate users.

In Canada, Statistics Canada uses the Canadian System of National Accounts (CSNA) to measure GDP. This framework is based on the circular flow concept we have discussed, but is applied to the complexity of the actual economy.

Although earlier in this chapter we defined and discussed real GDP, measured at prices of a base year national accounting measures nominal GDP at current prices. The CSNA produces three measurements of nominal GDP:

1. Output-based GDP is the sum of value added (output less the cost of goods and services purchased from other business) by all industries in Canada;
2. Income-based GDP records the earnings generated by the production of goods and services; and
3. Expenditure-based GDP is equal to expenditure on final goods and services produced.

Nominal GDP: the output of final goods and services, the money incomes generated by the production of that output, and expenditure on the sale of that output in a specific time period.

These three alternative measures of GDP provide importantly different perspectives on the level of national economic activity. The output and income measures describe the supply side of the economy in terms of goods and services produced, and cost of production. The expenditure measure of GDP describes the demand side of the economy.

Output-based GDP

To measure output in the economy, and the contribution of particular businesses or industries to that output, we use the value-added approach to GDP. Value added measures the net output of each industry. To find the value added (net output) of a particular business or industry, the costs of the goods and services purchased from other businesses and industries are deducted from the value of the final product. National, or all-industry GDP, is then the sum of GDP by industry.

Value added: the difference between the market value of the output of the business and the cost of inputs purchased from other businesses.

This method recognizes that businesses buy inputs to production from other businesses as well as from households. Automakers like General Motors and Honda buy parts and components like tires and windshields from other businesses, and include the costs of those inputs in the prices of the finished cars they sell. They also buy services like accounting, advertising, and transportation from service producers. Similarly, pizza makers buy cheese and pepperoni from cheese factories and meat processors. If we were to add up the outputs of auto parts manufacturers, cheese makers, meat processors, pizza makers, General Motors, and Honda in our measurement of nominal GDP, we would overstate GDP by double counting. The cheese would be counted once at the cheese factory and again in the pizza. The same applies to the tires and windshields of the new cars. To avoid double counting, we use value added, the increase in the value of goods and services as measured by the difference between market value of output and the cost of intermediate inputs bought from other businesses. Or we could count only the outputs sold to final users. Notice that total GDP by our definition measures the output of final goods and services.

Intermediate inputs: services, materials, and components purchased from other businesses and used in the production of final goods.

Consider a simple example. A coffee shop sells 100 cups of coffee an hour at a price, before tax, of $1.50. To make 100 cups of coffee the shop uses 2 kilos of ground coffee costing $10.00 per kilo, 25 litres of pure spring water costing $0.40 a litre, and electricity and dairy products costing, in total $20. The coffee shop's sales per hour are $150 using inputs costing $50. Its value added is . As we will see shortly, this value added, or $100, covers the labour costs, rent, interest expenses, and management costs of the business, for producing 100 cups of coffee an hour.

Table 4.2 Outputs of selected industries in GDP, Canada 2016 (percent shares)

All industries	100.0
Goods producing industries	29.5
Service producing industries	70.5
Agriculture, forestry, fishing, etc.	1.7
Mining, oil and gas extraction	8.2
Construction	7.0
Manufacturing	10.4
Wholesale and retail trade	11.2
Transportation	4.5
Finance, insurance and real estate	20.3
Professional, scientific and management	8.6
Health and social assistance	6.7
Educational	5.2
Public administration	6.4
All other	9.8

Source: Statistics Canada, CANSIM Table 379-0031 and author's calculations

Table 4.2 shows the industrial structure of output in Canada in 2016, based on the percentage shares of selected industries in Canadian GDP. Industry outputs are measured by value added. The data illustrate the importance of service-producing industries to economic activity in Canada. This industrial structure is typical of today's high-income economies and raises many interesting questions about the relationship between economic structure, performance, and growth. However, when our main interest is in the total level of economic activity rather than its industrial structure, the expenditure-based and income-based measures of GDP are used.

Expenditure-based GDP and income-based GDP

In the national accounts, expenditure based GDP and income based GDP are equal by definition. Table 4.3 provides an example using the actual accounts for Canada in 2016Q4. Expenditure categories and their shares in total expenditure are recorded in the left hand side of Table 4.3. Income categories and indirect taxes shares and their shares are recorded on the right-hand side.

Table 4.3 Canadian National Accounts 2016Q4
($ billions at current prices and seasonally adjusted at annual rates and % GDP)

Expenditure Measures			Incomes Measures
At market price	$	%	By income source	$	%
C by households	1,196.1	57.8	Employee compensation	1,066.0	51.5
I by business	455.3	22.0	Gross operating surplus	530.7	25.7
G by government	435.8	21.1	Gross mixed income	242.0	11.7
X exports	654.1	31.6	Net indirect taxes	228.2	11.0
IM imports	–672.7	–32.5
Statistical discrepancy	–0.8	0.0	Statistical discrepancy	0.8	0.0
GDP at market price	2,067.8	100.0	GDP at market price	2,067.8	100.0

Source: Statistics Canada, CANSIM Tables 380-0063 and 380-0064

Expenditure-based nominal GDP adds up the market value of all the final goods and services bought in a given time period, say one year. The national accounts classify this final expenditure into five main categories: Consumption, investment, government expenditure, exports, and imports.

For expenditure, the national accounts classification system is essential for our study of macroeconomic activity for two reasons. First, the classification scheme covers final expenditure in the economy completely; nothing is omitted. Second, the categories represent expenditure decisions made for different reasons in different parts of the economy and the percentage share or importance of each in final expenditure. Understanding expenditure decisions is critical to the work that lies ahead. Defining the expenditure categories is the first step.

Applying a name to each expenditure category in the table and using the notation attached gives:

or

(4.6)

For macroeconomic theory and models, this expenditure GDP is the foundation of theory of aggregate demand introduced in Chapter 5 and developed in detail in later chapters.

Income-based GDP adds up the factor costs of production of all goods and services plus the net in direct taxes included in market price. The national accounts classifications of factor incomes correspond to labour income, corporate profit, unincorporated business income plus investment income, and depreciation. The table also shows the percentage share of each category in GDP and thus the relative importance of each in income or cost respectively. The income categories are: Employment compensation (W), gross operating surplus (corporate profit) (GCS), gross mixed income (unincorporated business income plus investment income) (GMI) and net indirect taxes (). (The allowance for depreciation of capital is included in GCS and GMI.) Then GDP at market price is:

(4.7)

This income based GDP measures total cost of production. The first three components W, GCS and GMI are factor costs of production including the depreciation of capital equipment used in production. Net indirect tax is the revenue generated by taxes applied to goods and services and included in final price. An aggregate supply function for the economy involves these costs of production in relation to total output. Aggregate expenditure at market prices is the revenue that producers receive to cover these costs.

To construct a macroeconomic theory and model of the economy we must explain the linkages, feedbacks and interactions among the elements of the economy defined by national accounting conventions. These linkages, feedbacks and interactions are the important relationships that work together to explain how this economic system determines GDP, business cycle fluctuations in GDP, inflation, and employment.