Value added

Value added refers to the additional value created at a particular stage of production or through image and marketing. In modern neoclassical economics, especially in macroeconomics, it refers to the contribution of the factors of production, i.e., land, labor, and capital goods, to raising the value of a product and corresponds to the incomes received by the owners of these factors. The factors of production provide "services" which raise the unit price of a product (X) relative to the cost per unit of intermediate goods used up in the production of X.

For example, making apples into apple juice increases the value or price beyond that of the unprocessed apples. Organic has more value or price than produce that is not produced organically. In this case, value is added because the identity of the product is preserved--it is not simply an apple, it is an organic apple. Another example of value added in this way is fair-trade coffee. There can also be a value added to a product when the market for the product increases, giving the producer an added value for the product due to the greater demand. Renewable energy produced on farmland is another source of added value, such as converting manure to methane for fuel.

Method of calculation

Economists use the value-added method as a way to avoid double counting, i.e., the counting of the same input twice. The sum of the value added in each of the different stages of production equals the value of the final product, the product that drops out of the production process and is thus not incorporated in some new product. Final products include consumer goods and fixed capital equipment. A numerical example further explains this concept below.

Example calculation

To understand the concept of value added, take the example of three simple stages of production:

1000 Yen of miso soup is produced by a chef using pots, pans, and a stove, converting 500 Yen tofu and other ingredients. The chef and his or her tools are the "factors of production," while the tofu (and the other ingredients, ignored here) are the intermediate goods used up and converted into part of the soup.
The tofu used was converted using 200 Yen of soy beans. The soy beans are the raw material used up and converted into the tofu.
The soy beans were grown and harvested during the year. Assume, for simplicity, that the 200 Yen measures the value added in that sector. These beans are thus assumed to be simply results of the services of the factors of production.

If we simply add up the results of the three stages, we get a total of 1900 Yen. But this counts the tofu twice, first by itself and then as part of the miso soup. The soy beans are counted three times, in all three stages. This is double counting.

On the other hand, we can get an accurate estimate of the final product by using the value-added method:

The value added in the first process is 1000 Yen (the soup) minus 500 Yen (the tofu), equalling 500 Yen.
the value-added in the second process is 500 Yen (the tofu) minus 200 Yen (the soy beans), equalling 300 Yen.
the value added in the third process is, by assumption, 200 Yen.

The sum of these three is 1000 Yen, which is the same as the value of the final product, the miso soup.

National Accounts

In national accounts such as the United Nations System of National Accounts (UNSNA) or the NIPA's, gross value added is obtained by deducting intermediate consumption from gross output. Thus gross value added is equal to net output. Net value added is obtained by deducting consumption of fixed capital (or depreciation charges) from gross value added. Net value added therefore equals gross wages, pre-tax profits net of depreciation, and indirect taxes less subsidies.

Marxian interpretation

Karl Marx's concept of the value product is similar to the national accounting concept of net national product, or net value added. It is equal to the sum of labor-compensation (variable capital) and surplus-value (pre-tax profit income). The argument is that the labour force produces a new value equivalent to its own wage-cost, plus a surplus-value.

Neoclassical economics regards the incomes constituting added value as the reward for services rendered. In his critique of political economy Marx saw them as results of production under conditions of capitalist exploitation.

A difference between Marxian theory and conventional national accounts concerns the interpretation of the distinction between new value created, transfers of value and conserved value, and of the definition of "production".

For example, Marxian theory regards the "imputed rental value of owner-occupied housing" which is included in GDP as a fictitious entry; if the housing is owner-occupied, this housing cannot also yield real income from its market-based rental value at the same time.

In the 1993 manual of the United Nations System of National Accounts (UNSNA), the concept of "imputed rental value of owner occupied housing" is explained as follows:

"6.89. Heads of household who own the dwellings which the households occupy are formally treated as owners of unincorporated enterprises that produce housing services consumed by those same households. As well-organized markets for rented housing exist in most countries, the output of own-account housing services can be valued using the prices of the same kinds of services sold on the market in line with the general valuation rules adopted for goods or services produced on own account. In other words, the output of the housing services produced by owner-occupiers is valued at the estimated rental that a tenant would pay for the same accommodation, taking into account factors such as location, neighbourhood amenities, etc. as well as the size and quality of the dwelling itself. The same figure is recorded under household final consumption expenditures."

Marxian economists object to this accounting procedure on the ground that the monetary imputation made refers to a flow of income which does not exist, because most home owners do not rent out their homes if they are living in them. Of course, it is possible that (1) some owner-occupiers may rent part of their house to tenants or that (2) informal prostitution occurs within households, but even so, no argument has yet been given that this income constitutes part of the value of production or of value-added, rather than being a transfer of revenue.

If, for example, it is argued that "the moon is made of green cheese" then this statement might be true in a poetic sense, but in fact the moon is not made of green cheese. Similarly, if house X is really owned and occupied by person Y, Y cannot be said to rent out X, except within some theoretical re-interpretation. At most one might be able to prove, that X has a mortgage, and pays interest to a financial institution on the loan.

The issue has some significance in modern times because of:

the large capital gains made in the housing sector. Thus, the argument is made that, although capital gains should not be taxed, house owners should nevertheless be taxed on the basis of an imputed market-based rental value of their homes. This could then possibly influence home owners to put more money in corporate stocks, as an alternative investment, adding to the buoyancy of capital markets.

the increase in the proportion of homes which are privately owned rather than rented in OECD countries, which has the statistical effect of raising GDP totals and GDP growth rates. For example, in the USA, the imputed rent represented about 5.9% of GDP in 1970, as against 9.8% in 2004, because home ownership rose from about 43% to 69% of all households. If the imputed rent is removed from GDP, GDP growth rates are often significantly reduced. Thus, the imputed rent can mask the real level of output produced to some extent.

Value added tax

Value added tax (VAT) is a sales tax on value added. It works by being charged on the sale price of goods and services whether purchased by intermediate or final consumers; however intermediate parties can reclaim VAT paid on their inputs, thus ensuring that the net VAT they pay is in effect based on the value added at that particular stage of the process.

References

Edgar Z. Palmer, The meaning and measurement of the national income, and of other social accounting aggregates.

M. Yanovsky, Anatomy of Social Accounting Systems.

Anwar Shaikh & Ahmet Ertugrul Tonak, Measuring the Wealth of Nations. CUP.