4.2 Value Added Approach

Another approach to estimating the value of final production is to estimate the value added for each stage of production. This will be the amount by which the value of a firm’s output exceeds the value of the goods and services the firm purchases from other firms. Fig 4.8 “Final Value and Value Added” illustrates the use of value added in the production of a house.

If we sum the value added at each stage of the production of a good or service, we get the final value of the item. The example shown here involves the construction of a house, which is produced from lumber that is, in turn, produced from logs.

Suppose the logs produced by the logger are sold for $12,000 to a mill and that the mill sells the lumber it produces from these logs for $25,000 to a construction firm. The construction firm uses the lumber to build a house, which it sells to a household for $400,000. (To simplify the example, we will ignore inputs other than lumber used to build the house.) The value of the final product, the house, is $400,000. The value added at each stage of production is estimated as follows:

1. The logger adds $12,000 by cutting the logs.
2. The mill adds $13,000 ($25,000 − $12,000) by cutting the logs into lumber.
3. The construction firm adds $375,000 ($400,000 − $25,000) to build a house using the lumber.

The sum of values added at each stage ($12,000 + $13,000 + $375,000) equals the final value of the house, $400,000.

The value of an economy’s output in any period can thus be estimated in either of two ways. The values of final goods and services produced can be added directly, or the values added at each stage in the production process can be added. Statistics Canada, the national statistical organization that provides key information on Canada’s economy, society, and the environment, uses both approaches in its estimate of the nation’s GDP.