This is one of the methods for calculating GNP. The money value of final goods and services produced at current prices during a year is taken into account. This is one of the ways to avoid double counting.
The difference between the value of material outputs and input at each stage of production is called the value added. If all such differences are added up for all industries in the economy, we arrive at the GNP by value added.
The formula for computing value added GNP is as under.
GNP by Value Added = Gross Value added + Net Income Overseas.
Let us consider an illustration to know clearly of this method.
Illustration 3:
The below given tablet (2) represents various sectors which yields national income and their corresponding productivities along with their transitional purchases, you have to ascertain the following.
- Calculate Gross Domestic Product,
- Net Domestic Product and
- Value Added GDP.
- The transactions relating to these are as follows – Tablet (1)
Tablet (1)
Items |
Value in $ |
Income Earned from Leasing |
10 |
Earned Profits |
15 |
Administrative Expenses |
50 |
Net interest |
5 |
Depreciation |
8 |
Indirect Taxes |
7 |
Tablet
(2)
Sector |
Total Productivity in units |
Transitional Inputs |
A |
B |
C |
Farming |
100 |
50 |
Production |
250 |
125 |
Rest of others |
150 |
75 |
Total |
500 |
250 |
Solution
(iii) GDP by Value Added
Sector |
Total Productivity in units |
Transitional Inputs |
Value Added |
A |
B |
C |
D = (B – C) |
Farming |
100 |
50 |
50 |
Production |
250 |
125 |
125 |
Rest of others |
150 |
75 |
75 |
Total |
500 |
250 |
250 |
Hence the value added approach of GDP has been computed.
Now let us compute the Gross Domestic Product
(i) Gross Domestic Product
Items |
Value in $ (Millions) |
Income Earned from Leasing |
10 |
Earned Profits |
15 |
Administrative Expenses |
50 |
Net interest |
5 |
Indirect Taxes |
5 |
Depreciation |
10 |
Gross Domestic Product |
95 |
(iii) Net Domestic Product
Items |
Value in $ (Millions) |
Market Value of Productivity Less: Cost of Transitional Purchases Gross Value Added Less: Depreciation Net Value Added or Domestic Product at Market Price Less: Indirect Taxes Value Added Factor cost |
500 250 250 10 240 5 235 |
Points to be Noted
- The total value added equals the value of gross national product of the economy. Of which, value added, the major portion goes in the form of administrative expenses, leased income, profits and interest. A small portion goes to government in the form of indirect taxes and the remaining amount for depreciation.
- Thus we find that the total gross value added of an economy is greater than the Gross Domestic Product. If depreciation is deducted from the gross value added, we obtain, net value added to about $240 millions.
- This is nothing but Net Domestic Product at market prices. Again, if indirect taxes $5 millions are deducted from the net domestic product of the market, of $240 millions, we obtain, $235 millions as value added factor cost.
Its Importance
The value added method for measuring national income is more realistic than the product and income methods for the reason that it avoids the problem of double counting by excluding the value of intermediate products.
Thus this method establishes the importance of intermediate products in the national economy. Next to it, by studying the national income accounts relating to value added the contribution of each production sector to the value of the GNP can be found out. For instance, it can tell us whether agriculture is contributing more, or the share of manufacturing is dropping or the tertiary sector is enhancing in the present year when compared to some previous years.
Third this method is highly useful for the reason that “it provides a means of checking the GNP estimates obtained by summing the various types of commodity purchases.”
Conclusion
From the modern point of view, Simon Kuznets has defined national income as “the net output commodities and services flowing during the year from the country’s productive system in the hands of the ultimate consumer.” Conversely, in one of the reports of United Nations, national income has been defined on the basis of the systems of estimating national income, as net national product, as addition to the shares of different factors and as net national expenditure in the country in a year’s time. In practice, while estimating national income, any of the definitions may be adopted for the reason that the same national income would be derived, if different items were correctly included in the estimate.
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- Break Even Analysis
- Concept of Factor Cost
- Contribution Margin, Limitations of Break Even Analysis
- Criticism, Clark's Product Exhaustion Theorem
- Distributive Shares: The Product Exhaustion Theorem
- Inequality of Income, Effects of Inequality
- Interest, Gross and Pure Interest
- Investment Analysis and Social Cost Benefit
- Measurement of Inequality, Lorenz Curve
- Meaning of Minimum Wages, Benefits of Minimum Wages
- National Income Meaning and Measurement
- Net Present Value Method, Internal Rate of Return Method
- Price Level, Social Prestige, Conditions of Work
- Profit, Gross Profit and Net Profit
- Rent, Meaning of Economic Rent
- Time Preference Theory
- Theories of Distribution
- Theories of Profit, Rent Theory of Profit
- Quasi Rent, Distinction Between Rent and Quasi Rent
