B] Value added method of measuring national income.
Value added method is also known as Production method. In order to avoid double counting, value -added approach is used.
This method is used to measure national income at the different phases of the process of production of each enterprise during a year. In fact this method measures the contribution of each enterprise in the flow of goods and services in the economy.
According to this approach value- added in each stage of production process is taken separately and added to get the final value of the commodity.
Meaning of value added
i) Value added is “the increase in the value of goods or services as a result of the production process”
ii) Value added = value of production – value of intermediate goods
iii) Value added is “the difference between the cost of materials purchased by a firm and the price for which it sells those goods that were purchased by that firm”.
iv) Value added is the difference between the value of final outputs and inputs at each stage of production
The same approach can be used to estimate national income from the three main wealth-generating sectors of the economy
(a) Primary (agricultural) sector
(b) Secondary (industrial) sector and
(c) Tertiary (service sector.
For computing national income, the values added by the above three sectors at each stage is worked out. The value of output at each enterprise is found by multiplying the physical output with the market prices of the goods produced.
This measure of GDP adds together the value of output produced by each of the productive sectors in the economy using the concept of value added.
The same approach is also used to calculate net income contributed to national income from international trade.
Thus GNP is obtained as the sum total of the values added in all the different stages of production process, till the final output reaches the consumer, to meet their final demand.
While considering this approach we should deduct indirect taxes and include subsidies.
Whether we adopt the final goods method or the value-added method, if proper adjustments are made, the result will be the same.
This can be explained with the help of the following examples
Examples
1]
i) Say you buy a pizza from Dominos at a price of Rs 325. This is the retail price and will count as consumption.
The pizza has many ingredients at different stages of the supply chain – for example tomato growers, dough, mushroom farmers and also the value created by Dominos as they put the pizza together and deliver to the consumer.
ii) Some products have a low value-added, for example cheap tee-shirts that you might find in a supermarket for little more than Rs 100.
These are low cost, high volume, low priced products.
iii) Other goods and services are such that lots of value can be added as we move from sourcing the raw materials through to the final product. Examples include designer jewellery, perfumes, meals in expensive restaurants and sports cars. And also the increasingly lucrative computer games industry.
2]
| Firm | Sale | To | Price | Value added |
| A | Produces & sells raw materials | Firm B | Rs 2000 | Rs 2000 |
| B | Manufactures & sells finished product | Firm C | Rs 4000 | Rs 2000 |
| C | Sells finished product to | Households | Rs 5000 | Rs 1000 |
|
TOTAL VALUE ADDED |
Rs 5000 | |||
What is total ‘GDP’ here?
Rs 2000+ Rs 4000+ Rs 5000 = Rs 11000? Definitely no! This would be double counting.
You should consider only the value added ie Rs 2000+ Rs 2000+ Rs 1000= Rs 5000.
OR only the value of the final product sold to households ie Rs 5000.
3]
| Producer/seller | Produces & sells | @ Rs | Value (Original/Added) | |
| Farmer | (100 kg)Wheat | 2000 | 2000 | Original value |
| Flour mill owner | flour | 2500 | 500 | value added |
| Baker | breads, cookies and biscuits | 3500 | 1000 | value added |
|
TOTAL VALUE ADDED |
3500 | |||
What is total ‘GDP’ here?
Rs 2000+ Rs 2500+ Rs 3500 = Rs 8000? Definitely no! This would be double counting.
You should consider only the value added ie Rs 2000+ Rs 500+ Rs 1000= Rs 3500.
OR only the value of the final product sold to households ie Rs 3500.
Not all of the wheat goes into Baker’s oven. Some of it will go in making beer, some in a normal household for making roti and so on.
One has to track the value added in each different line.
4] We use seed to produce wheat, wheat to produce flour, and flour to produce bread. In order to produce Rs 5000 worth of bread (the final product). For this we need Rs 3500 worth of flour, which require Rs 2500 worth of wheat, which require Rs 1000 worth of seed.
The value added in each process is illustrated below:
| Product produced & sold | @ Rs | Value added = |
| Seed | Rs1000 |
1000 – 0000 = 1000 |
| Wheat | Rs 2500 |
2500 – 1000 = 1500 |
| Flour | Rs 3500 |
3500 – 2500 = 1000 |
| Bread (Final product) | Rs 5000 |
5000 – 3500 = 1500 |
|
TOTAL VALUE ADDED |
Rs 5000 |
|
The sum of value added is the value of the final product, bread in the above example. Therefore, value added approach is the same as counting only the value of the final products.
To avoid double counting, either the value of final output or the sum of value added should be taken in the estimation of GNP.
Precautions
1. Danger of double counting :-
We can avoid from this danger by the following ways :
i) We should add up the value of those goods which have reached to the final shape and are available for consumption, ie consider only the value of final goods and services.
ii) Value of intermediate goods: Value of intermediate goods is ignored while calculating in the national income.
(iii) Second method is that we should calculate only the added value of a particular commodity at every stage.
2. Production for self consumption-
The production of goods for self consumption should be should be valued at the prevailing market prices.. As part of the production, though has been by the producer, but it has been produced. This value is estimated by guess work.eg self consumption by farmers.
Similarly imputed rental value of the self-occupied house is included in the national income.
3. Indirect taxes and subsidies
Indirect taxes included in the market prices are to be deducted and subsidies given by the government on certain products should be added for accurate measurement of national income.
4. Changes in price level
While evaluating output, changes in the price level between different years must be taken into account.
5. Value of exports and imports
Value of exports should be added and value of imports should be deducted.
6. Depreciation allowances :-
The depreciation allowance, for depreciation of capital assets should be deducted
Similarly stock appreciation, if any, must be deducted from value added.
This is necessary as there is no real increase in output
(7) Sale price of second-hand goods:
Sale price of second-hand assets should be ignored as it is not a part of current production. Their values were included in the year when they were produced.
(8) Value addition in particular year: While calculating national income, the values of goods added in the current year in question are added up. The values which had previously been added to the stocks of raw material and goods have to be ignored
The output method is widely used in developing countries. However, it is less reliable because of the margin of error.
In India, this method is applied to agriculture, mining and manufacturers including handicrafts. But it is not applied for transport, commerce and communication sectors in India.