Value Added Method of Measuring National Income

Value Added Method of Measuring National Income –

Value Added Method is also called Output Method or Production Method. In this method, the economy is divided into different industrial sectors such as agriculture, mining, construction, communication, transport, manufacturing, trade and commerce and other services. Then the net value added at factor cost (NVAFC) by each producing enterprise as well as by each industry or sector is estimated.

Measuring net value added at factor cost (NVAFC) by each industry requires to find out the value of output.

To find out the estimated value of various goods and services we have to multiply the quantity of goods and services produced by a particular enterprise by their market prices. This value (the quantity of goods and services multiplied by their market prices) is also called value of output.

After adding up the value of output of all producing enterprises in a given industry or sector we can obtain the value of output of that industry or sector. A major part of output of an enterprise is sold in the market (which is known as sales) and the remaining part is added to the inventories (stock of goods).

Value of output of an enterprise = Sales + Change in Stocks

Gross Value Added at Market Prices (GVAMP) –

Gross value added measures the contribution of the value of output of a product produced during a year.

The value of output is estimated by multiplying the quantity of output with the market prices. So, the gross value added is obtained by deducting the value of intermediate consumption.

Gross Value Added at Market Prices (GVAMP) = Value of Output – Intermediate Consumption

A firm disposes of its value added at market prices (GVAMP) among three items –

1. Making depreciation provision for consumption of fixed capital during the year

2. Making payments of indirect taxes (such as excise duty, import duty, sales tax)

3. Making factor payments such as wages, interest and profits to the factor of production whose services have been used for the production of goods.

Net Value Added at Market Prices (NVAMP) –

When from the gross value added at market prices we deduct depreciation on account of consumption of fixed capital during the production process of a good during the year, we get net Value Added at Market Prices (NVAMP).

NVAMP = GVAMP – Depreciation

Net Value Added at Factor Cost (NVAFC) –

When the adjustment is made in net value added at market prices (NVAMP) for the payment of net indirect taxes, we get Net Value Added at Factor Cost (NVAFC).

This is because after the subtraction of depreciation and net indirect taxes what remains is used for making payments to factors of production (such as wages to labour, interest on capital borrowed, rent for land/building and profits to entrepreneur.

In simple words, NVAFC measures the value of factor cost a firm has to incur.

Adding up the net value added at factor cost (NVAFC) by all producing enterprises of an industry or sector gives us the net value added at factor cost of each industry or sector.

After adding up net value added at factor cost by all industries or sectors we get the net domestic product at factor cost (NDPFC).

When we add the net factor income from abroad to the net domestic product we get the net national product at factor cost (NNPFC) which is also called National Income.

NI = NNPFC = NDPFC + Net factor income from abroad

This method can be used where there exists a census of production for the year. But in many countries, the data of production of only important industries are known. So, this method is used along with other methods to get the national income.

The great advantage of this method is that it shows the relative importance of the different sectors of the economy by providing their respective contributions to the national income.

Precautions –

1. Imputed rent values of self occupied houses should be included in the value of output. These values can be easily estimated from prevailing values in the market.

2. Sale and purchase of second hand goods should not be included in measuring the value of output of a year because their values were counted in the year of their production. But the commission or brokerage earned in their sale and purchase has to included because this is a new service rendered in the current year.

3. Value of production for self consumption are to be included while measuring national income. These values should be valued at the prevailing market prices.

4. Value of services of housewives are not included because it is very hard to find out the value of their services.

5. Value of intermediate goods must not be counted while measuring value added because this will cause double counting problem.