Discuss the value-added method of measuring national income of a country.
Definition:
Under the value-added method, the sum of the market value of each good or service produced in a given year is the national income. But there is a risk of double counting while measuring national income this way. To compensate for this error, only the value of final product can be added to obtain a correct and accurate national income. Therefore, the amount of surplus value created at each level of production is added during the calculation of national income. This is called value-added method.
Example:
Let’s assume, Bread is the finished product in a bakery. There are four stages in making this bread. At the first stage, farmers produce wheat. Flour is made at the second stage in the wheat factory. In the third stage, different mixtures are made with flour and at the last stage bread is made.
| Level of Production | Cost of Material | Selling Price | Value-Added |
|---|---|---|---|
| Wheat | 0 | 10 | 10 |
| Flour | 10 | 15 | 5 |
| Flour Mix | 15 | 20 | 5 |
| Bread | 20 | 25 | 5 |
| Total | 45 | 70 | 25 |
As seen from the above table, the value added from different stages of making bread is 70 – 45 = Rs. 25. From the value added, the factory owner will pay the workers’ wages, house rent, interest on loan capital and finally make profit. This method is accurate as it avoids double counting. Because once the price of bread is Rs. 25, the price of bread flour and flour mix can also be calculated. In that case the national income in double counting : 25 + 20 + 15 = Rs. 60, but the real national income is Rs. 25.
However, the following caveats must be observed while measuring national income under Value-Added Method :
1. Semi-finished goods shall not be counted in the measure of national income.
2. The product should be a finished product.
3. To avoid double counting, the sum of value additions should be used.
4. Indirect tax should be excluded.
5. The price of goods used for consumption must be added to the market price.
6. National income should be calculated at base year prices.
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