20.1 National Output and Value Added
Central topic of macroeconomics is the overall level of economic activity
(aggregate output and the income that is generated by its production).
Production occurs in stages: Some firms produce outputs that are used as
inputs by other firms, and these other firms, in turn, produce outputs that are
used as inputs by yet other firms.
Double counting: counting up the value of output that becomes part of
another output and so on and so forth.
The problem of double counting can be solved by distinguishing two types of
o Intermediate goods: all outputs that are used as inputs by other
producers in a further stage of production.
o Final goods: goods that are not used as inputs by other firms but are
produced to be sold for consumption, investment, government, or
exports during the period under consideration.
It is generally extremely difficult to distinguish final from intermediate
To avoid double counting, economists use the concept of value added.
o Value added: the value of a firm’s output minus the value of the inputs
that it purchases from other firms.
Value added is the correct measure of each firm’s contribution to total output
– the amount of market value that is produced by that firm.
The firm’s value added is the net value of its output.
The sum of all values added in an economy is a measure of the economy’s
20.2 National Income Accounting: The Basics
The measure of national income and national product derive from an
accounting system called the National Income and Expenditure Accounts
o Produced by Stats Canada.
The accounts have a logical structure of the circular flow of income.
The value of domestic output is equal to the value of the expenditure on that
output and is also equal to the total income claims generated by producing
National income = national product.
The circular flow of income suggests three different ways of measuring
o Value added o Expenditure
Add up the total flow of expenditure on final domestic output.
Add up the total flow of income generated by the flow of
Gross domestic product (GDP): the total value of goods/services produced in
the economy during a given period.
o Value added
When this method is used, it is called the GDP by value added.
When this method is used, it is called the GDP on the
When this method is used, it is called the GDP on the income
The conventions of double-entry bookkeeping require that all value
produced must be accounted for by a claim that someone has to that value.
o Income side = expenditure side.
GDP for a given year is calculated from the expenditure side by adding up the
expenditures needed to purchase the final output produced in that year.
Total expenditure on final output is the sum of four broad categories of
Includes expenditure on all goods and services sold to their
final users during the year (households).
o I.e. haircuts, dental car, legal advice etc.
o I.e. fresh vegetables, clothing, cut flowers etc.
o I.e. cars, TVs, air conditioners etc.
(in picture) Semi-durable goods
Actual measured consumption expenditure is denoted by the
symbol C a
Expenditure on the production of goods not for present
o Stocks of raw materials, goods in process, and
finished goods held by firms to mitigate the
effect of short-term fluctuations in production or
sales. Allows firms to meet orders despite
fluctuations in the rate of production.
o The accumulation of inventories during a given
year counts as positive investment for that year
because it represents goods produced but not
used for current consumption.
o These goods are included in the national income
accounts at market value (includes costs
incurred in producing them and the profit made
by the selling of them).
o Decumulation: the drawing down of inventories.
Counts as disinvestment (- investment)
because it represents a reduction in the
stock of finished goods that are available
to be sold.
o Manufactured aids to production, such as tools,
machines, and factory buildings.
o Capital stock: the economy’s total quantity of
o [Business] Fixed investment: the creation of new
plant and equipment.
o A house or an apartment building is a durable
asset that yields its utility over a long period of
o Thus, the building of a new house is counted as
investment expenditure rather than as
o Only when a new house is built does it appear as
residential investment in the national accounts.
These goods are called investment goods.
The total investment that occurs in the economy is called gross
Gross investment is divided into:
o The amount of investment required to replace
that part of the capital stock lost through the
process of depreciation.
Depreciation: the amount by which the
capital stock is depleted through the
o Net investment = gross investment –
depreciation. o If net investment is > 0, the economy’s capital
stock is growing (vice-versa).
All investment goods are part of the nation’s total current
output, and their production creates income whether they’re
part of replacement/net investment.
Actual total investment expenditure is denoted by the symbol
o Government purchases
When governments provide goods/services that households
want, such as street-cleaning and firefighting, they are adding
to the sum of valuable output in the economy.
National income statisticians include all government purchases
of goods and services as part of national income.
Government purchases: all government expenditure on
currently produced goods and services, exclusive of
government transfer payments.
o Represented by the symbol G.
Government output is typically valued at cost rather than at
I.e. what is the market value of the law courts? Easier to
record the costs incurred by the government to provide
o If, for example, one civil servant can do what two
used to do and the extra worker moves to the
private sector, the government’s measured
contribution to national income will fall, yet
production hasn’t changed (vice-versa).
Only government purchases of currently produced goods and
services are included as part of GDP.
Transfer payment: a payment to an individual or institution
not made in exchange for a good or service.
I.e. welfare payment, EI, payments through CPP etc.
o Net exports
Imports: the value of all domestically produced goods and
services purchased from firms, households, or governments in
Exports: the value of all goods and services sold to firms,
households, and governments in other countries.
A country’s national income is the total value of final goods
produced in that country.
To arrive at total expenditure on Canadian products, we need
to subtract from total Canadian expenditure any expenditure
The value of actual imports is given the symbol IM a All goods and services that are produced in Canada and sold to
foreigners must be counted as part of Canadian production and
They are produced in Canada, and they create incomes
for the Canadian residents who produce them.
To arrive at the total value of expenditure on Canadian output,
it is necessary to add the value of Canadian exports of goods
The value of actual exports is given the symbol Xa.
Net exports: the value of total exports minus the value of total
Represented by the symbol NX . a
o GDP measured from the expenditure side is equal to:
GDP = C a I a G +a(X –aIM ) a
GDP from the income side involves adding up factor incomes and other
claims on the value of output until all of the value is accounted for.
o Factor incomes