Value Added, Inventory and NDP in a Village Economy
A village economy has three production units: a farmer, a flour mill and a bakery. The farmer grows wheat worth ₹1,20,000. Of this, wheat worth ₹1,00,000 is sold to the flour mill and ₹20,000 is kept by the farmer for home consumption. The mill produces flour worth ₹1,80,000, but sells only ₹1,50,000 worth to the bakery; the remaining ₹30,000 is unsold and added to the mill's inventory. The bakery uses the flour to produce bread worth ₹2,70,000 and sells all of it to households. There are no other producers and no imports. Depreciation in the economy is ₹15,000, indirect taxes are ₹20,000 and subsidies are ₹5,000. A student computes GDP by adding the three outputs (₹1,20,000 + ₹1,80,000 + ₹2,70,000 = ₹5,70,000) and is surprised that this is much larger than total household spending on bread. You are asked to reconcile the production, expenditure and income approaches and to derive NDP at factor cost.
1. Compute GDP at market prices by the value-added method and by the final expenditure method. Explain why adding the three outputs overstates GDP.
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Value added:
Farmer: output ₹1,20,000, no intermediate input, so value added = ₹1,20,000.
Mill: output ₹1,80,000 minus wheat bought from farmer ₹1,00,000 = ₹80,000.
Bakery: output ₹2,70,000 minus flour bought from mill ₹1,50,000 = ₹1,20,000.
GDP at market prices = 1,20,000 + 80,000 + 1,20,000 = ₹3,20,000.
Final expenditure: bread bought by households ₹2,70,000 + wheat kept for home consumption ₹20,000 + unsold flour added to inventory ₹30,000 = ₹3,20,000.
Adding outputs gives ₹5,70,000 because wheat and flour appear twice: wheat is counted in the farmer's output and again inside the mill's output; flour is counted in the mill's output and again inside the bakery's output. Value added or final expenditure avoids this double counting.
2. Derive NDP at factor cost from GDP at market prices using the depreciation, indirect tax and subsidy figures.
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Start from GDP at market prices = ₹3,20,000.
Subtract depreciation to get NDP at market prices:
3,20,000 − 15,000 = ₹3,05,000.
Then adjust for indirect taxes and subsidies:
NDP at factor cost = NDP at market prices − indirect taxes + subsidies
= 3,05,000 − 20,000 + 5,000
= ₹2,90,000.
The logic is that market prices include indirect taxes but not subsidies as a cost of production; factor cost measures income accruing to factors of production. Depreciation is subtracted because it is replacement of capital, not net income.
3. How is the mill's unsold inventory treated in the accounts? What would happen to GDP and to the expenditure total if the ₹30,000 inventory were ignored?
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Unsold flour is still output produced during the year. In the production approach it is part of the mill's output and value added: the mill's value added stays ₹80,000 even though only ₹1,50,000 of flour was sold. In the expenditure approach it appears as inventory investment of ₹30,000, which is a component of final expenditure.
If the inventory were ignored, the mill's output would be treated as only ₹1,50,000. Its value added would be 1,50,000 − 1,00,000 = ₹50,000, and GDP would be 1,20,000 + 50,000 + 1,20,000 = ₹2,90,000.
The expenditure total would also fall to bread ₹2,70,000 + home-consumed wheat ₹20,000 = ₹2,90,000. GDP would be understated by ₹30,000. Counting inventory keeps the production and expenditure measures consistent: goods produced but not sold are still part of current output.