Value Added Method or Product Method

Product or value added method is a way of computing the national income of a country. This system is also known as output or inventory method. This method calculates national income by adding value to a product at every stage of its production.

What is the National Income?

National income stands for the total value of goods and services produced by a country in a financial year. It portrays the net result of every economic activity of that country during this period and its value in terms of money. The progress of a nation can be determined by its growth of the national income.

There are three ways to calculate national income. These are –

  1. Product Method or Value Added Method

  2. Income Method 

  3. Expenditure Method

Product Method or Value Added Method

This method denotes the value added by various enterprises at every level, starting from production to the final sale. This method focuses on calculating this added value to products to determine the national income of a country. It is determined by finding the distinction between the value of output and value of intermediate consumption. The value added method formula is –

Value Added or Value Addition = Value of Output - Intermediate Consumption

Here, the value of output stands for the market value of goods produced by an enterprise during a financial year. Intermediate consumption stands for the value of non-factor inputs like the value of raw materials. Here is an example to clarify this point further, a baker buys flour worth Rs.100 from a miller and then converts that flour into bread worth Rs.120.

  • Here, flour is an intermediate good valued at Rs.100, and its value is regarded as ‘intermediate consumption’.

  • Bread, an output product valued Rs.120, is regarded as ‘value of output’.

  • Therefore, the difference of Rs.20 is the ‘value-added’ and it is the net value added to the economy by the baker.

Here is a more comprehensive example of this method explained in this following table.

Producers

Stages of Production

Selling Price

Cost Price

Value Added

Farmers

Wheat

80

0

80

Millers

Flour

100

80

20

Baker

Bread

120

100

20

Total


300

180

120

The value added method includes the contribution of each stage of production into the calculation. Thus, it eliminates the possibility of double counting.

Steps of the Value-Added Method

  1. Identifying and classifying production units: The first step is to recognise every production units and then categorise them into three sectors, primary, secondary and tertiary. 

  2. Calculate GDP at market price: To arrive at this figure, first add Gross Value Added at Market Price (GVAMP) of every sector and the total sum will represent the Gross Domestic Product at Market Price (GDPMP). Therefore, GVAMP=GDPMP.

  3. Calculate Domestic Income: To calculate the domestic income or Net Domestic Product at Factor Cost (NDPFC), net direct taxes and depreciation should be subtracted from GDPMP. The product method formula applicable here is NDPFC=GDPMP – depreciation - net direct taxes.

  4. Add Net Factor Income from Abroad (NFIA) to NDPFC: Finally, NFIA is added with NDPFC to get the final figure of national income. Therefore, National Income at Factor Cost (NNPFC) = NDPFC + NFIA.

Precautions to be Taken in This Calculation

  1. Intermediate goods must not be added in the National Income as these are already accounted for in the valuation of final products. If included again, it will result in double counting.

  2. Dealings (sale and purchase) of second hands goods should not be included in this calculation. These goods had been included in the financial year in which they were produced, and they are not counted as a part of current flow manufactured products and services. However, any brokerage fee or commission paid on any sale or purchase of such products are to be included in this calculation as a productive service.

  3. Self-consumption services, i.e. domestic services like services of a housewife are not to be included in this calculation as it is challenging to figure out the market value of such work. These are produced and consumed within a household, and they do not enter the market. Therefore, these are regarded as non-market transactions. However, paid services like maids, drivers, etc. should be mentioned in this calculation.

  4. On the other hand, self-consumption goods should be counted in national income calculations because they contribute to the output of a financial year. However, their value is to be estimated as these products are never sold in the open market.

  5. The estimated value of houses owned by individuals should be included. The reason being, owners who live in their own homes are enjoying similar housing services like people who live in rented places. Hence, the value of such services is estimated as per the market rate. This estimation is known as imputed rent.

  6. Any changes in the inventory must be included in this calculation. Net increase in inventory stocks is involved in national income calculation as a part of capital formation.

National income and its methods of calculation are a vital chapter of economics. Value added method is one of the three ways which has been discussed here. Thus, students who want to know about the other two ways can visit the official website of Vedantu.

FAQ (Frequently Asked Questions)

1. Explain the Methods of Measuring National Income

Ans. – There are three methods of measuring national income of a country. These are valued-added method, income method and expenditure method.

2. What is the Value/Product Added Method Formula?

Ans. – The formula behind the product method of measuring national income is: Value Added or Value Addition = Value of Output - Intermediate Consumption.

3. What is Double Counting?

Ans. – Double counting is calculating the value of output more than once in various stages of production. It mainly occurs when the cost of intermediate goods are added along with the value of final products.

4. Which Elements Should be Subtracted From the Output Value of a Product?

Ans. – The elements that must be subtracted from the output value of a product are the value of raw materials, capital and net indirect tax.