Question

Briefly describe the production approach to measuring a country’s Gross Domestic Product. Include in your description a definition of “value added” and explain the role of value added in calculating GDP under the production approach

Answer 1

GDP refers to the money value of all goods and services that are produced within the country during specified period of time. GDP is calculated on annual basis as well as on quarterly basis. Higher GDP reflects increase in national output, higher economic growth, more employment and better standard of living. GDP act as a tool for Investors, Businesses, government for investment and strategic decision making.

GDP by Production or output approach - In value added method, also known as production method, measures the output of all sectors (Manufacturing, construction, Primary), in form of value added in each part of production process. Value added refers to the addition of value to the raw material (intermediate goods) by a firm, by virtue of its productive activities.

GDP by value added method = Value of Production - value of intermediate goods.  

For example, farmer sell wheat flour to breakmaker at 10 $ , the breadmaker add other ingredients amounts to 20$ to make bread. He sold the bread to customer at 50 $. Here we will include 50 $ as final output instead of adding all the figures amounting to 80 $. Only value of final goods are included in national output.

Do remember that , here we do not include sale and purchase of second hand goods

Let us summarise the concepts of valued added:

(i) Value of output = Sales + change in stock (Output is always at MP. Output implies gross output)

(ii) Value added = Value of output-Value of intermediate goods

= Gross product = Gross value added at MP

(iii) NVA at MP = GVA at MP – Depreciation

(iv) NVA at FC = NVA at MP-Net indirect taxes

= Sum of factor incomes

The sum of net value added in various economic activities is known as GDP at factor cost. GDP at factor cost plus indirect taxes less subsidies is GDP at Market price. GDP at Market price theoretically should be equal to GDP calculated based on the expenditure approach. However, discrepancies do arise because there are instances where the price that a consumer may pay for a good or service is not completely reflected in the amount received by the producer and the tax and subsidy adjustments mentioned above may not adequately adjust for the variation in payment and receipt.