Thursday, August 7, 2014

"Gross Output" does not include all transactions

Output is output. Spending is spending.

In a recent post David Beckworth incorrectly identified the data on his graph:
The figure below shows total dollar spending in the United States as measured by nominal gross output (it includes all transactions, not just the final ones used in GDP).

It is important to measure total spending. I absolutely agree with David Beckworth on that. But his graph does not show total spending.

Beckworth is in error when he says gross output "includes all transactions, not just the final ones used in GDP". He would have been correct if he had said "includes all final transactions, not just the final ones used in GDP."

Just one extra word.

You know, I wouldn't be surprised if David Beckworth originally had it right. When he says "... not just the final ones used in GDP" I think he is comparing final transactions in GDP to some other set of final transactions. I think you can see it in what's left of his sentence. Maybe he took out a final to simplify the story. It is a story that demands simplification. I can vouch for that.

So... What is "final" spending?

If you are a business that buys something in order to sell it, your purchase is NOT final spending. If you sell the thing to a customer who plans to sell it to someone else, it is NOT final spending when your customer buys it. If you sell the thing to a customer who plans to eat it or drive it or otherwise use it up -- to consume it, in other words -- your customer's purchase IS final spending.

Two Measures of Final Spending

Suppose in the process of making your product, your fastidious office staff goes through a ton of pencils and paper keeping track of things. That ton of paper and pencils is consumed by your staff. Your guys used it up. It was final spending when you bought that ton of pencils.1

There are two measures of final spending: gross, and net. Gross output includes the output your business created and the ton of pencils you bought and used to produce it. Net output doesn't count output that is used up in the production process, like your ton of pencils.

Nomenclature: Gross output is called gross output. Net output, unfortunately, is called Gross Domestic Product.

GDP is net final spending, not total spending.

Gross output is gross final spending. Not total spending.

Suppose we look at the output of just one product. Call it a "thingy". It sells for $5.

Suppose there are five steps in the production process and, at each step, there is $1 of value added. Company 1 sells it for $1 to company 2. Company 2 sells it for $2 to company 3. Company 3 sells it for $3 to company 4. Company 4 sells it for $4 to company 5. And company 5 sells the final product for $5 to a final customer.

There is 1+2+3+4 = $10 of preliminary spending in the first four steps of the production process. And then there is the final purchase, the $5 purchase by a consumer. In our little economy, for each five-dollar thingy we make, there is $10 of preliminary spending and $5 of final spending, and total spending of $15.

Suppose we make 2 thingies in a year. The production process generates $20 of preliminary spending. Final spending adds up to $10. Total spending, final plus non-final, is $30.

If consumers buy both thingies, all $10 of the final spending is counted as Net Final spending, or GDP. If a producer buys one of the thingies and uses it up in the production process, it counts in Gross Final but not Net Final spending, and not GDP.

If a consumer buys one thingy and a producer buys and consumes the other, only $5 of the final spending is counted in GDP. But both count in Gross Output, no matter who buys and consumes the thingies. Gross output is $10, but GDP is only $5.

Total spending is still $30.

Gross Output is a bigger number than GDP. But total spending is bigger yet. Gross Output is not the same as total spending.


1. I had this wrong in my posts tagged "Gross Domestic Spending". In those posts I assumed that GDP included all of final spending, and that all intermediate spending is non-final. Looking into it more, it seems maybe half of intermediate spending is final and half non-final. We end up with three numbers that are approximately equal: (1) GDP, (2) Other Final Spending, and (3) Non-Final spending.


The Arthurian said...

I just found some stuff on NGO -- Nominal Gross Output.

NGDP 3% per year; NGO much less!

and links listed there, and

Beyond GDP: Gross Output Gains Prominence

The Arthurian said...

Also, FRED has some "gross output" data series.