I have a doubt in national income value added method I will tell you by example see I produced 5 kg wheat so national income is amount of wheat and I gave 3 kg wheat to my teacher as fees assuming no depreciation by value added method national income will be 8kg but it should be 5kg


1 Answer 1

  1. You are not using value added method above since you are just discussing quantities of goods not their value, unless you want to assume wheat is an unit of account. If you want to use wheat as a unit of account output can be higher than just the amount of wheat in the economy, because you are using wheat just as a measuring stick.

  2. Let us assume for simplicity that 1kg of wheat = \$1:

The national identity for closed economy is given by:

$$Y = C+I+G$$

where $Y$ is income $C$ consumption, $I$ investment which is equal to private and public savings*, and $G$ government spending, which in your case is zero so we have just:

$$Y = C+I $$

Now you say you earned \$5 producing wheat, spent \$3 on consumption (school fees), and saved \$2. So your ($i=1$) personal income $Y_{1}= 5$, your personal consumption $C_1 = 3$ and your personal saving/investment $I_1=2$.

So so far we have:

$$Y_1=C_1+I_1 \implies 5= 3+2$$

Next, by spending \$3 on your school fees your teacher (i=2) got income of \$3, this income can be only spent or saved, since you do not mention any consumption of your teacher I will just assume by default that he saved it all so for your teacher we have:

$$Y_2= C_2+I_2 \implies 3= 0+3$$

Now for whole economy we just sum all consumption, investment and income for all individuals and we have:

$$Y_1+Y_2 = C_1 + C_2 + I_1 + I_2 \implies 5+3 = 3+0+2+3 \implies 8=8$$

So it does work.

  1. If you want to use wheat as an unit of account, then you have to use it just as a measuring stick.

So here we would have your income is $Y_1= 5kw$ where $kw$ is wheat based commodity money where 1kg of wheat is unit of account, you spend $C_1=3kw$ on consumption of education and save $I_1=2kw$, now by consuming $3kw$ your teacher has $Y_2=3kw$ and assuming again its all saved we have $I_2=3kw$

Hence again we have:

$$Y_1+Y_2 = C_1 + C_2 + I_1+I_2 \\ 5kw + 3kw = 3kw + 0kw +2kw + 3kw \\ 8kw = 8kw$$

Hence the value added here would be 8kw, however, that does not mean there is physically 8 kg of wheat, here you just use kg of wheat as a currency, your tutor rendered you a service that is worth to you 3 kg of wheat, that service is not nothing, that service is part of value added, if that service would have no value to you, you would never purchase it.

* Note: if $G=0\implies S=I$ where $S$ is saving. See Blanchard et al Macroeconomic pp 52.

  • $\begingroup$ Oh thanks a lot it it helped me so much I have a doubt my teacher said that the amount paid by business firm to a lawyer for hiring his services is intermediate consumption but I want to know the reason why it is intermediate consumption $\endgroup$
    – Neev Garg
    Jul 12, 2021 at 16:07
  • $\begingroup$ @NeevGarg if this helped you consider accepting the answer. That is because it is business to business transaction, final consumption is always business to consumer not to other business $\endgroup$
    – 1muflon1
    Jul 12, 2021 at 16:09

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