Firms in the small country of Oskana produce wooden furniture through a single production chain: a forestry company sells timber to a furniture manufacturer, who sells finished tables to a retailer, who sells the tables to final consumers. There is no other economic activity in…

Answer: ((a)) Value added is the difference between a firm's sales revenue and the cost of the intermediate goods it buys in from other firms; the output method sums value added, rather than gross sales revenue, so that the value of intermediate goods bought and sold between firms is not coun… ((b)) Value added is 40-0=40 for the forestry company, 150-40=110 for the manufacturer and 210-150=60 for the retailer, so GDP by the output method =40+110+60=210, i.e. $210 ((c)) Total gross sales revenue =40+150+210=400, i.e. $400, which overstates GDP because it counts the value of the timber three times over. Once as the forestry company's sale, and again embedded within both the manufacturer's and the retailer's higher sales prices. Part (a): Meaning of value added and why the output method uses it Value added is the difference between the value of a firm's output (its sales revenue) and the cost of the intermediate goods and services it purchases as inputs from other…

AS Level Economics 9708: Calculating GDP by the Output (Value-Added) Method

Stage	Firm	Sales revenue ($)	Cost of purchased inputs ($)
1	Forestry company	40	0
2	Furniture manufacturer	150	40
3	Retailer	210	150

Stage

Firm

Sales revenue ($)

Cost of purchased inputs ($)

Forestry company

Furniture manufacturer

150

Retailer

210

150

Part (a): Meaning of value added and why the output method uses it

Value added is the difference between the value of a firm’s output (its sales revenue) and the cost of the intermediate goods and services it purchases as inputs from other firms:

$\text{Value added} = \text{Sales revenue} - \text{Cost of purchased inputs}$

The output method sums value added, rather than each firm’s total sales revenue, because a firm’s sales revenue already includes the value of the inputs it bought in. Inputs that were themselves already counted as another firm’s output. Summing value added instead means only the extra value personally contributed at each stage is counted, so the same output is never counted more than once.

Part (b): Value added at each stage, and GDP by the output method

Using $\text{Value added} = \text{Sales revenue} - \text{Cost of purchased inputs}$ for each firm:

$\text{Forestry company: } 40 - 0 = 40$

$\text{Furniture manufacturer: } 150 - 40 = 110$

$\text{Retailer: } 210 - 150 = 60$

Summing these gives Oskana’s GDP by the output method:

$GDP = 40 + 110 + 60 = 210$

So Oskana’s GDP is $210, which, in this single production chain, is exactly equal to the final sales price paid by consumers for the tables, since that price already embeds every firm’s contribution along the chain.

Part (c): Gross sales revenue versus GDP

Summing the gross sales revenue of all three firms instead:

$40 + 150 + 210 = 400$

This total of $400 overstates Oskana’s true GDP of $210. The $40 of timber sold by the forestry company is counted once directly, a second time as part of the manufacturer’s $150 sales price (which already includes the cost of the timber it bought), and a third time as part of the retailer’s $210 sales price (which already includes the manufacturer’s price). Summing gross sales revenue therefore counts the same underlying output several times over, whereas summing value added counts it exactly once.

Final answers

(a) Value added $=$ sales revenue $-$ cost of purchased inputs; summing it avoids counting intermediate goods more than once.
(b) Value added: $40, $110, $60. GDP by the output method $=$ $210.
(c) Gross sales revenue summed $=$ $400, which overstates GDP because it counts the timber’s value three times over.