a.

value of baker's production = Rs 200

b. value of intermediate goods (inputs; in this case wheat) used by baker = Rs 50
c. value added by baker= a—b =Rs 200—50= Rs 150
Though 5: Total value added in this ‘two economic agent model’ = value added by farmer + value
added by baker = Rs 100 + Rs 150= Rs 250
Thought 6: it is very important to subtract the value of intermediate goods used from the final value
of goods produced while calculating ‘value added’.
Value of Wheat in BUNDLE2 has been incorporated as value added by farmer.
Same wheat in BUNDLE2 is intermediate goods (input) for baker.
Value of wheat BUNDLE2 must be counted only once and that is why it was important to
subtract Rs 50 from Rs 200 in Thought4.
KEY DEFINITION
Gross Domestic Product (GDP): GDP is the total value of al finished goods produced in the country in
one financial year. It doesn't matter if it is produced by citizens or foreigners. If they are located within
the country's boundaries, their productions included in GDP. To avoid double-counting, GDP includes
the final value of the product, but not the parts (or intermediate goods} that go into it. For example,
an Indian footwear manufacturer uses laces and other materials made in India. Only the value of the
shoe gets counted; the shoelace does not.
Value Added method of calculating national income: Method of calculating the national income by
measuring the aggregate sum of gross value added of all the firms in an economy over a period of time.
Concept Check
Q. Gross Domestic Product is the sum of the market value of the
(a) intermediate goods.
(b} final goods and services.
(c) manufactured goods.
CONCEPT NOTE MEASUREMENT OF GROWTH, NATIONAL INCOME AND PE

(d) inferior goods and services.

(e} normal goods and services.
Answer: B
Concept Check
Q. Which of the following is/are not considered while calaulating the Gross Domestic Product (GDP)
ofa country?
371 WWW.EDUTAP.CO.IN HELLO@EDUTAP.CO.IN
 ( ‘a} Purchase of vegetables by a restaurant
( 'b) Ice cream used by the households
( ‘c} Plant and machinery used in a factory
(d)'d) Garments purchased by consumers
{e)ce) None of the above
Answer: A
Concept Check
If a timber mart sells Rs 1,000 of timber to a carpenter and the carpenter uses the timber to build
furniture which he sells for Rs 5,000, the contribution to GDP is Rs 6,000.
Answer: False
In this section we have seen the “ jue added’ approach towards the estimation of GDP, wherein we
simply sum up the value added by different agents. In the next section we wil just flip the approach.
Rather than ad ing up the value of final goods and services being produced by the firms, we will be adding
up the expenditure done by various economic agents for the purchase of final goods and services
produced in the economy in a given time period. Don’t you think that both these approaches should lead
us to the same figure? After al the value of goods and services produced by the firms is same as what you
and | pay for purchasing those goods services!
3.2 Expenditure Method
The expenditure method is a system for calculating gross domestic product (GDP) that combines
consumption, investment, government spending, and net exports.
It is the most common way to estimate GDP. It says everything that the private sector, including
consumers and private firms, and government spend within the borders of a particular country, must add
MEASUREMENT OF GROWTH, NATIONAL INCOME AND PE

up to the total value of al finished goods and services produced over a certain period of time.
The GDP under this method is calculated by summing up al of the expenditures made on final goods and
services.
There are four main aggregate expenditures that go into calculating GDP:
Consumption by households
a
2
3
g
i
 Let us suppose that there are only two kinds of producers in the economy. They are the wheat
producers (or the farmers) and the bread makers (the bakers). The wheat producers grow wheat and
they do not need any input other than human labour. They sel a part of the wheat to the bakers. The
bakers do not need any other raw materials besides wheat to produce bread
Let us suppose that in a year the total value of wheat that the farmers have produced is Rs 100. Out
of this they have sold Rs 50 worth of wheat tothe bakers. The bakers have used this amount of wheat
completely during the year and have produced Rs 200 worth of bread. What is the value of total
production in the economy? If we follow the simple way of aggregating the values of production of
the sectors, we would add Rs 200 (value of production of the bakers) to Rs 100 (value of production
of farmers). The result will be Rs 300.
A little reflection will tell us that the value of aggregate production is not Rs 300. The farmers had
produced Rs 100 worth of wheat for which it did not need assistance of any inputs. Therefore the
entire Rs 100is rightfully the contribution of the farmers. But the same is not true for the bakers. The
bakers had to buy Rs 50 worth of wheat to produce their bread. The Rs 200 worth of bread that they
have produced is not entirely their own contribution. To calculate the net contribution of the bakers,
we need to subtract the value of the wheat that they have bought from the farmers. If we do not do
this we shall commit the mistake of ‘double counting’. This is because Rs 50 worth of wheat will be
counted twice. First it will be counted as part of the output produced by the farmers. Second time, it
wil be counted as the imputed value of wheat in the bread produced by the bakers
Therefore, the net contribution made by the bakers is, Rs 200— Rs 50 = Rs 150. Hence, aggregate
value of goods produced by this simple economy is Rs 100 (net contribution by the farmers} + Rs 150
(net contribution by the bakers} = Rs 250.
The term that is used to denote the net contribution made by a firm is called its value added. We
have seen that the raw materials that a firm buys from another firm which are completely used up in
the process of production are ¢: intermediate goods’. Therefore, the value added of a firm is,
value of production of the firm — value of intermediate goods used by the firm.
MEASUREMENT OF GROWTH, NATIONAL INCOME AND PE

KEY DEFINITION
Value added: Net contribution made by a firm in the process of production. It is defined as, Value of
production — Value of intermediate goods used.
Double Counting: The act of including the value of intermediate goods more than once in the value of
gross domestic product. Because the value, or price, of final goods includes the cost, or value, of al
CONCEPT NOTE
 intermediate goods used, including market transactions for intermediate separately in the
measurement of gross domestic product would lead to double counting.
* The value added of afirm is distributed among its four factors of production, namely, labour, capital,
entrepreneurship and land. Therefore wages, interest, profits and rents paid out by the firm must add
up to the value added of the firm.
Table summari ing above explanation (all values in Rupees)
Total
100 200
Production
Intermediate
0 50.
Goods Used
Value Added 100 200-50 = 150
If we sum the gross value added of all the firms of the economy in a year, we get a measure of the
value of aggregate amount of goods and services produced in the economy ina year (just as we had
done in the wheat-bread example). Such an estimate is called Gross Domestic Product (GDP). Thus,
GDP = Sum total of gross value added of all the firms in the economy.
If there are N firms in the economy, each assigned with a ser I number from 1 to N, then
Oo GDP =GVAi + GVA2+..... + GVAN
Therefore, GDP = GVA\
Let us de-jargonise (simplify) Product or Value Added Method of Calculating National Income:
"Thought 1: There are two economic agents — a farmer and a baker. Farmer produces wheat and
baker bakes bread.
MEASUREMENT OF GROWTH, NATIONAL INCOME AND PE

= Thought2: Farmer grows wheat worth Rs 100. Assume that farmer uses no input. Therefore,
a. value of farmer’s production = Rs 100
b. value of intermediate goods (inputs) used by farmer = 0
c. value added by farmer = ab = 100-0= Rs 100
"Thought3: Farmer consumes wheat worth Rs 50 himself (let us cali this BUNDLE 1) and sells
remaining wheat worth Rs 50 to the baker (let us call this BUNDLE 2).
"Thought4: Using the wheat purchased from farmer as input, baker produces bread worth Rs 200.
Therefore,
36[P a QUERY? 207241
CONCEPT NOTE
 Let us suppose that there are only two kinds of producers in the economy. They are the wheat
producers (or the farmers) and the bread makers (the bakers). The wheat producers grow wheat and
they do not need any input other than human labour. They sell a part of the wheat to the bakers. The
bakers do not need any other raw materials besides wheat to produce bread
Let us suppose that in a year the total value of wheat that the farmers have produced is Rs 100. Out
of this they have sold Rs 50 worth of wheat tothe bakers. The bakers have used this amount of wheat
completely during the year and have produced Rs 200 worth of bread. What is the value of total
production in the economy? If we follow the simple way of aggregating the values of production of
the sectors, we would add Rs 200 (value of production of the bakers) to Rs 100 (value of production
of farmers). The result will be Rs 300.
A little reflection will tell us that the value of aggregate production is not Rs 300. The farmers had
produced Rs 100 worth of wheat for which it did not need assistance of any inputs. Therefore the
entire Rs 100is rightfully the contribution of the farmers. But the same is not true for the bakers. The
bakers had to buy Rs 50 worth of wheat to produce their bread. The Rs 200 worth of bread that they
have produced is not entirely their own contribution. To calculate the net contribution of the bakers,
we need to subtract the value of the wheat that they have bought from the farmers. If we do not do
this we shall commit the mistake of ‘double counting’. This is because Rs 50 worth of wheat will be
counted twice. First it will be counted as part of the output produced by the farmers. Second time, it
wil be counted as the imputed value of wheat in the bread produced by the bakers
Therefore, the net contribution made by the bakers is, Rs 200 — Rs 50 = Rs 150. Hence, aggregate
value of goods produced by this simple economy is Rs 100 (net contribution by the farmers} + Rs 150
(net contribution by the bakers} = Rs 250.
The term that is used to denote the net contribution made by a firm is called its value added. We
have seen that the raw materials that a firm buys from another firm which are completely used up in
the process of production are called ‘intermediate goods’. Therefore, the value added of a firm is,
value of production of the firm — value of intermediate goods used by the firm.
MEASUREMENT OF GROWTH, NATIONAL INCOME AND PE

KEY DEFINITION
Value added: Net contribution made by a firm in the process of production. It is defined as, Value of
production — Value of intermediate goods used.
Double Counting: The act of including the value of intermediate goods more than once in the value of
gross domestic product. Because the value, or price, of final goods includes the cost, or value, of all
E
bi
g
8