Understanding Intermediate Products and Final Products: Implications for National Income Calculation
It is important for you to understand the meanings of the terms "intermediate products" and "final product."
Intermediate products are some of the final products of a production unit that could serve as raw materials for another production unit. For instance, to a farmer, wheat is considered their final product. However, for a flour mill, wheat is an intermediate product or raw material for their production. The flour mill purchases wheat from the farmer, grinds it, and sells it in the market. The baker then buys flour from the miller, bakes it, and sells the bread to the end consumer.
The farmer's finished product is wheat, with a cost of Rs. 500. The miller buys it, grinds it, and sells it at a cost of Rs. 600. The baker buys it, grinds it, and sells it at a cost of Rs. 800.
When considering the output of all these processes in the national income, there is a chance of a double or triple effect on the national income. The value of wheat, Rs. 500, serves as the intermediate product of the miller. The miller adds a value of Rs. 100 to the intermediate product. The value of flour, Rs. 600, serves as the intermediate product of the baker. The baker adds a value of Rs. 200 to the Rs. 600 product, and the value of bread is Rs. 800.
The total national income of the above production process is Rs. 800, not the sum of the three stages of production, which would be Rs. 500 + Rs. 600 + Rs. 800 = Rs. 1900. There is an element of double counting in the total output of Rs. 1900, once for the value of wheat, Rs. 500, and once for the value of flour, Rs. 600. By ignoring the value of intermediate goods, we can avoid this double counting.
National income is the total value of the final product, which is Rs. 800. In other words, national income is the sum total of value added to a product during the production process. For example, the national income is calculated as the value added by the farmer, Rs. 500, plus the value added by the miller, Rs. 100, plus the value added by the baker, Rs. 200, which equals Rs. 800. It is not the total output of the three processes, which would be Rs. 1900.
Goods purchased for resale are treated as intermediate goods. Electricity, lubricants, packing materials, and other consumables used by the baker and miller are also treated as intermediate goods. Intermediate goods are used as inputs in the production of other goods or services. They can also be treated as partially finished goods. Intermediate goods are either consumed or transformed beyond recognition in the production process.
A clear understanding of the difference between intermediate products and final products is important to accurately calculate the national income.
Final products are products that are intended for consumption or investment, not for resale or further production. They include capital goods such as machines, furniture and fittings, transport vehicles, and household purchases. Sugar purchased for household use is treated as a finished good, whereas sugar purchased by the baker for making biscuits is considered an intermediate product.
You may be wondering whether you can classify capital goods as final products or intermediate goods since these machines are used for further production, and normal wear and tear reduces their value after several years of use. The answer is that we will discuss the provision for depreciation, which takes care of depreciation in the value-added section below.
Value added during the production process is another term you need to understand. Let us consider the example given above. By producing wheat, the farmer adds a value of Rs. 500. This value includes the farmer's effort in tilling the ground, irrigation expenses, labor costs, fertilizers, etc. The miller adds a value of Rs. 100, assuming they have no other expenses. They purchase the wheat for Rs. 500 and sell the flour for Rs. 600. The mill's output is Rs. 600, and the miller's contribution is Rs. 100.
We can calculate the value added by using the following formula:
Value added = Value of output - Value of intermediate cost
= 600 - 500 = Rs. 100
We can refer to the value added by the miller as "Gross Value Added at Market Price," which is Rs. 100.
To fully understand the effects of value added, we need to know about the following terms:
- Gross value added and Net value added
- Market price and Factor Cost.
Gross Value Added and Net Value Added
In the process of production, fixed capital assets such as buildings and machines are essential. However, these assets have a limited lifespan. Machines installed in a factory, for example, may run for a specific period before needing replacement, typically after 10 or 15 years of use. As a result, a certain amount of wear and tear, known as consumption of fixed capital or depreciation, occurs each year. To account for this depreciation, firms establish a provision for depreciation account and allocate an amount equal to the depreciation incurred during the year. Over the course of 10 or 15 years, the funds accumulated in the provision for depreciation account can be utilized to replace the machines.
For instance, let's consider a machine valued at Rs. 10,000 with a lifespan of 10 years. The annual depreciation of the machine would be Rs. 10,000/10 = Rs. 1,000. At the end of the first year, the depreciation would be Rs. 1,000, resulting in a machine value of Rs. 9,000. The firm sets aside a provision of Rs. 1,000 in the provision for depreciation account to account for this depreciation. By the end of the second year, the depreciation would amount to Rs. 1,000, and the machine's value would be Rs. 8,000. An amount of Rs. 1,000 would once again be allocated to the provision for depreciation account to compensate for the consumption of the fixed asset. As the value of the machines decreases, the provision for depreciation increases. After 10 years, the provision for depreciation account would hold Rs. 10,000, which can be used to replace the old machine with a new one. This method compensates for the consumption of fixed capital.
The consumption of fixed assets, or depreciation, can be determined by subtracting the consumption of fixed capital from the gross value added, resulting in the net value added. In other words, if we exclude the consumption of fixed capital from the value added, we obtain the gross value added.
Therefore, Net Value Added = Gross Value Added - Consumption of Fixed Capital or Net Value Added = Gross Value Added - Depreciation.
Differentiating Market Price and Factor Cost
The distinction between market price and factor cost lies in indirect taxes and subsidies.
Net Value Added at Market Price = Net Value Added at Factor Cost + Indirect Taxes - Subsidies or Net Value Added at Factor Cost = Net Value Added at Market Price - Indirect Taxes + Subsidies.
Indirect Taxes: Market price refers to the net amount paid by consumers. A portion of this amount is collected by the government as taxes. This means that the total amount received from consumers is not entirely available for distribution among the factors of production, as a portion is paid in taxes. Taxes imposed by the government are passed on to buyers by sellers.
Subsidies: Subsidies are financial assistance provided by the government to production units to sell products at lower prices. When the government aims to promote the production of certain goods, it offers financial support to producers. Subsidies enable producers to offer products in the market at subsidized prices.
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