Count each unit of current production once.
The same current production can be measured by value added, final expenditure and the income generated in producing it, using consistent accounting boundaries and valuation adjustments. Counting both an intermediate input and the final product at their full selling prices double counts the input. Actual output not sold can be recorded as inventory investment, so the accounting identity does not mean firms sold exactly the amount they planned. Domestic output and the income generated domestically should not be casually equated with residents' gross national income, which also reflects net primary income from abroad.
- Value added
- Value added is the value of a producer's output minus the purchased intermediate inputs used to make it. Grain used in bread is an intermediate input; the bread bought for household consumption is a final product.
- One production, three views
- On a consistent accounting basis, production creates value added, final expenditure buys that output, and producing it generates incomes. Count the final product or sum value added, without counting the input again.
- Actual versus planned
- Inventories are stocks of goods held for later use or sale. Newly produced unsold output can count as inventory investment in the accounts even when firms did not intend to accumulate it.
Apply the idea
Domestic and national
Domestic output is production within the economy. Gross national income (GNI) also accounts for residents' primary income received from abroad, such as wages or investment income, minus the corresponding income paid abroad. Detailed indicator comparisons follow in Living Standards.
Accounting adjustments
Real accounts adjust consistently for items such as depreciation, the loss in capital value through use or age, and taxes less subsidies. The bread example sets these complications aside so the three measures can be compared directly.
Worked example: Count the grain and bread once
In a simple domestic economy without taxes or depreciation, a farmer sells grain for $40 to a baker. The baker sells bread to households for $100. The farmer uses no purchased intermediate inputs and all the bread is sold.
- The farmer adds $40 because there are no purchased intermediate inputs. The baker adds $100 - $40 = $60 after subtracting the grain. Total value added is $100, not $140.
- Final household spending on the bread is $100. Counting the grain sale again would double count an intermediate input.
- The $100 value added is distributed as the factor incomes and profits generated in these activities under the stated simplified accounting assumptions.
- If $10 of bread were produced but not sold, actual expenditure accounting would include inventory investment. Unexpected stock accumulation could still prompt a later production cut.
Watch out for this
Output equals expenditure, so unwanted stocks and disequilibrium are impossible.
Actual expenditure includes changes in inventories. Planned purchases can differ from production, causing unplanned stock changes and adjustment.
Check your understanding
In the farmer-baker example, how much value is added in total?
- $100.
- $140.
- $60.