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National Income and AD/AS Analysis: Question 6

Syllabus 4.1

Multiple choice AS 1 mark

A country's national statisticians measure Gross Domestic Product (GDP) using the output method, which adds together the contribution made by every firm in the economy, from raw-material producers through to final retailers.

To avoid counting the same output more than once as it passes through several stages of production, which of the following must the statisticians do?

Choose an answer to check it, then compare with the worked solution below.
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Worked solution

Step 1: Identify the problem the output method must avoid

Producing a single final good, such as a chair, typically passes through several firms: a forestry company sells logs to a furniture manufacturer, who sells finished chairs to a retailer, who sells to the final consumer. If statisticians simply added up every firm’s total sales revenue, the value of the logs would be counted once when the forestry company sells them, again when the manufacturer’s higher sales price (which already includes the cost of those logs) is added, and again when the retailer’s price (which already includes the manufacturer’s price) is added. This is double counting.

Step 2: Check option A

Option A describes summing the value added created at each stage. That is, the difference between a firm’s sales revenue and the cost of the intermediate goods it bought in from other firms. Since each firm’s value added measures only the extra value it personally contributed, summing value added across every stage of production gives exactly the value of the final output once, with no double counting. This matches option A.

Step 3: Rule out options B, C and D

  • Option B: summing gross sales revenue is precisely the double-counting problem described above, not a solution to it.
  • Option C: counting only intermediate sales, while ignoring the value added at the final stage, would understate GDP and still misses the point. Value added must be summed at every stage, including the last one.
  • Option D: there is no rule involving multiplying by the number of firms in a production chain; this would produce an arbitrary and meaningless figure.

Final answer

Option A, the output method avoids double counting by summing the value added created at each stage of production, not the gross sales revenue of every firm involved.