Gross National Product: Intermediate Products and Value Added

Intermediate Products and Value Added In measuring GNP it's important to exclude the market value of production that is not for final use to avoid overestimating aggregate production. Intermediate products are those produced by business firms for resale by other firms or for use as materials or services that will be included in the value of resold goods. For example, steel purchased by General Motors from the US Corporation is not considered part of the final product of the economy because the steel will be used by General Motors as an input in the production of automobiles. If the value of the steel and the value of the automobile it is used in are both counted in GNP, the value of the steel will be counted twice. In effect, the value of the steel is already included in the value of the automobile. The steel sold for use in automobile bodies is an intermediate rather than a final product. During the process of production, business firms add worth to the intermediate products they purchase from other firms. Value added is the extra worth that a business firm adds to intermediate products measured by the difference between the market value of what it sells and the market value of intermediate products purchased over a period. Value added comes from inputs such as labor, capital, land, and entrepreneurial expertise. Firms combine these inputs with intermediate products they purchase from other firms. An automobile producer buys steel, glass, tires, and other parts from other firms and uses its workers, capital, and managerial expertise to produce a vehicle. Naturally the vehicle is worth more than the intermediate products that the car maker purchased from other firms. The sum of the value of intermediate products and value added at each stage of production is equal to the market value of the products. Total value added in a nation is the difference between the market value of all products of business firms and the market value of all intermediate products. The market value of all products includes the value of both final and intermediate products. Therefore, when the value of intermediate products is subtracted from this sum, the result is the market value of the nation's final products. Because the market value of final products is GNP, it follows that GNP can be viewed as total value added in a nation over the year. A simple example about the production of jeans will show you how value added is computed at each stage of production and how it is related to the receipts and payments of a business firm. 1. To make a pair of jeans available in product markets, cotton is first grown by farmers. If you assume that farmers produce cotton without purchasing any materials or services from other firms, the value added by farmers equals the market value of their sales of cotton. (The value of the intermediate products is zero.) Suppose annual sales of the cotton to be used in producing jeans are $1 million. The value of these sales must be fully accounted for by the sum of profit and costs incurred by the farmer. Because the farmers are not purchasing anything from other firms, the value of wages paid to workers, rent paid to land and equipment owners, and interest paid to lenders are the only costs reflected in the $1 million sales receipts. Therefore any part of the $1 million not accounted for by these costs is the profit. The value added of the farmer represents the income generated by the sale of cotton. 2. Next weavers who convert the cotton to cloth purchase the cotton from the farmers. The weavers' only intermediate purchase is that of the $1 million worth of cotton they obtain from farmers. After the cotton is processed into cloth, the weavers sell the cloth for $2 million to a manufacturer of jeans. The value added by the weavers is therefore the $2 million in sales less the $1 million purchase of cotton. The logic of the concept of value added should be clear to you now. Value added at each stage of production is the difference between the value of the product at that stage and the cost of products purchased from other firms for use as inputs. The value added by the weavers represents the worth they have added to the cotton by processing it into cloth. This worth must reflect the value of the inputs not purchased from other firms that are used to process the cotton into cloth. 3. The manufacturers of blue jeans sell the product they produce with the cloth to consumers who wear the jeans. Assume that the only intermediate purchase made by the blue jean manufacturer is the $2 million purchase of cloth. If the total market value of the jeans produced by the manufacturer is $4 million, then the value added at this final stage of production is $4 million less $2 million, which equals $2 million. Once again the $2 million value added by the blue jean maker must equal the sum of incomes of workers and other input owners whose resources are used to produce the blue jeans, plus the manufacturer's profit. The table in Box 1 shows how we arrived at total value added. Line 1 shows the sales transactions of farmers. It shows that the farmers have no intermediate purchases and that their value added is therefore equal to their sales revenue. Line 2 shows that value added by the weavers is $1 million per year. This $1 million value added must be fully accounted for by the weavers' labor costs and any costs other than purchases of cotton. Any difference between the weavers' costs and value added represents their annual profits. Line 3 shows the value added by the manufacturers. The sum of product sales, including those of intermediate products, is $7 million, which is obtained by adding the numbers in Column 1. The sum of the market value of all intermediate purchases is $3 million, obtained by summing the dollar values of sales in Column 2. The sum of value added is $4 million (Column 3). The sum of the value added associated with the production of jeans at its various stages exactly equals the market value of the final product sold by the jean makers to consumers. To summarize, GNP can be viewed as the sum of value added in all transactions involving new production in a nation over a year. Value added also equals the sum of payments to the owners of all resources used to produce the goods and services included in GNP and the profit of business firms, because value added at each stage represents the sum of payments to labor, capital, land, and all other inputs. When value added goes up in a nation, so will income.