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I know that the term Economic Value Added is an internal measure that executives use to measure the financial performance of a company, say, executing a project. However, I'm doing some research in Complex Systems, and I'm interested in the term "value" as it relates to the economic system as a whole.

I came up with a definition of adding "value" as any activity that creates or increases the consumer or producer surplus. I'm now struggling to see how this definition related to the standard definition of Economic Value Added. What are the pros and cons of my definition as against the standard EVA term? Why isn't the definition that I'm using the standard definition, at least in economics?

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The standard (finance) definition of EVA is only related to the producer's side of the market. Broadly speaking, it is defined as profits minus the cost of capital.

This is closely related to the concept of producer's surplus in microeconomics which is defined as profits (P) minus fixed costs (FC). In micro-economics, fixed costs most of the time refers to the cost of capital, capital being the fixed factor of production (and labour the variable factor of production).

Producer's surplus (PS) is defined as total revenues (TR) minus variable cost (VC, cost of using labour, in an easy model VK=w*L, with w=wage; L=labourinput). Profits are, of course, total revenues minus total costs (TC), with total cost equalling fixed plus variable costs.

So, it is easy to show from these two definitions that PS really looks like the finance EVA, because, as I said, FC can be seen as the cost of capital, the fixed factor of production.

PS=TO-VC

W=TO-VC-FC

<=> W = PS - FC <=> PS = W + FC

Therefore, the PS (or, for the finance guys: EVA) is only measuring value that is created (surplus) for the producer. Just add consumper surplus (CS) to the PS and you get the total surplus of an exchange. Two remarks: 1) to get the CS you need to measure utility, CS = Utility of the goods bought - price paid for the goods. Unfortunately, this is quite impossible to measure. 2) I use "exchange" since surplus is only created when a seller sells his stuff to a buyer. CS refers to the surplus of total utility derived from the consumption of the goods above the price paid for the goods, PS refers to the benefit of producing (and selling) goods above the situation of not producing. This interpretation is equivalent to PS = TO-VC. When the producer produces and sells his product, he has profits TR-VC-FC. When he doesn't produce, but disposes of the production capacity (the capital), his profits are -FC (no revenues and no variable cost, but having the production capacity at his disposal means he has to bear the cost of capital, the FC). The producer will be producing when is PS is positive, that is, when producing creates a surplus (more profits than if he would not produce).

Notice how I prefer to use surplus (instead of added value) to adress this kind of measure for the value of an activity. This is because, in economics there is the concept of added value, which may be closer to what you're looking for. It is defined as outputs - intermediate inputs (net outputs), and thus measures the value that the producer 'adds' to his inputs when producing. It can be easily measured and is, in fact, GDP.

To sum up, these all the measures discussed:

  • EVA, the finance equivalent of PS;

  • total surplus = PS + CS, but with CS being unmeasurable;

  • GDP, or value added.

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At the risk of merely adding confusion, I will mention that there is much discussion of theory of "value" in Marxist literature, which obviously will be outside standard economics.

Marx separated "use value," "exchange value," and "surplus value." All of which he attempted to connect to the classical assumption of "labor value." He wanted to demonstrate across the entire macroeconomic system how "surplus value" (roughly, profit) is derived from "labor time," not some magically "added value." While every commodity will combine "use value" (roughly, utility) and "exchange value" (roughly, price) the two can rise or fall independently.

Thus he was attempting to burden economics with some concept of human "value" beyond price traceable through the entire production cycle, a burden the marginalists happily tossed off. Marx was trying to avoid the kind of purely quantitative paradoxes we now have, where forest fires, wars, and hurricanes, "add to GDP growth" and other measures of "value."

I trust a "real economist" will address your question more adequately. It seems to me that "added value" is often tossed around loosely. And I'm not sure from your description how you determine some constant measure of "surplus" across the consumer and producer sides or how it is correlated consistently with some measure of "value." Anyway, hope you get a better answer.

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    $\begingroup$ This is a very good comment, but unfortunately it is not an answer. $\endgroup$ – Giskard Nov 1 '15 at 16:21
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    $\begingroup$ "...where forest fires, wars, and hurricanes, 'add to GDP growth'" a serious economist today would be well aware to avoid the broken window fallacy. $\endgroup$ – Kitsune Cavalry Nov 1 '15 at 16:39
  • $\begingroup$ While I would never masquerade as a "economist," serious or otherwise, I don't think I was applying a "broken window" argument as justification, nor did I think "broken window fallacy" is inarguable. I was only pointing out the problems of defining "value" quantitatively across consumer, producer and other platforms. And while we might argue that the increased production from, e.g., a war washes out in the end, the "end" can be endlessly deferred and displaced. Besides, I thought the GDP phenomenon was a real problem, not a "windows" justification. Perhaps I misunderstand. $\endgroup$ – Nelson Alexander Nov 1 '15 at 17:31

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