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Concept of Intermediate Product and Final Product in economics

Updated on November 11, 2013

Intermediate Product and Final Product

It is important for you to understand the meaning of the terms "intermediate products" and "final product".

Intermediate products:
Some of the final products of a production unit could be the raw materials for another production unit. For example, to a farmer, wheat is his final product. But for the flour mill, wheat is the intermediate product or raw material for his production. Flour mill buy wheat from the farmer and grind it and sell it in the market. The baker buys flour from the miller and bake it and sell the bread to the end consumer.

Farmer's finished product is wheat and the cost of it is Rs. 500
Millers buys it and grind it and sell it at the cost of Rs. 600
Baker buys it and grind it and sell it at the cost of Rs. 800

If you take the output of all the process into account of national income there is chances of double or triple effect in the national income. Value of wheat Rs. 500 is the intermediate product of the miller. Miller added value of Rs. 100 to the intermediate product. Value of flour is Rs. 600 is the intermediate product of baker. Baker added value of Rs. 200 to the Rs. 600 product and the value of bread is Rs. 800

Total national income of the above production process is Rs. 800
Not the total of 3 stages of production i.e. Rs.500+Rs.600+Rs. 800=Rs.1900
There is an element of double counting in the total output of Rs. 1900. once the value of wheat Rs. 500 and 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 final product = Rs. 800
In other words National income is the sum total of value added to a product during the production process. i.e.
National income = Value added by farmer Rs. 500 + Value added by the miller Rs. 100 + Value added by the baker Rs. 200 = Rs. 800 and not the total output of three process i.e. 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. It can also be treated as partially finished goods. Intermediate goods are either consumed or changed beyond recognition in the production process.

Clear understanding or difference between the intermediate product and final product is important to calculate the national income accurately.

Final Products
: are product which are meant for consumption or for investment and Not for resale or further production. It includes the capital goods like machines, furniture and fittings, transport vehicles and household purchases etc. Sugar purchased for household use is treated as finished goods. At the same time sugar purchased by the baker for making biscuits is an intermediate product.

You may be wondering whether you can treat capital goods as final product or intermediate goods since these machines use for further production and the normal wear and tear will reduce the value of machine after using it for many years? The answer is that we will discuss about provision for depreciation which will take care of depreciation in the value added section below.

Value added during the production


Another term you need to understand is: What is value added during the production process. Let us look at the example given above. By producing wheat farmer added value of Rs. 500 It includes his effort of tilling the ground, irrigation expenses, labour cost and fertilizers etc. Value added by the miller is Rs. 100 if we assume that he hand no other expenses. He bought the wheat at Rs. 500 and sold the flour at Rs. 600. Output of the mill is Rs. 600 Contribution of the miller is Rs. 100

Then 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 call the value added by the miller as "Gross Value Added at Market Price" i.e. Rs. 100

To understand fully the effects of Value added, we need to know about the following terms:

  1. Gross value added and Net value added
  2. Market price and Factor Cost.

Gross value added and Net value added

Production requires use of fixed capital assets like building, machines etc. The life of a building or a machine is limited. Machines installed in a factory may run for a period of time. You need to replace it after 10 or 15 years of its use. That means there is a certain amount wear and tear occurs every year. This type of normal wear and tear is called consumption of fixed capital or depreciation. To make good of this depreciation firms open an account called provision for depreciation and set apart an amount equal to the depreciation happened during the year. After 10 or 15 years the machines can be replace by using the money set apart for provision for depreciation.

For example, the value of a machine is Rs. 10000 and the life of the machine is 10 years.

The depreciation of the machine is =10000/10 = Rs. 1000

At the end of the first year the depreciation would be 1000 and the value of the Machine would be Rs. 9000

A provision for depreciation Rs. 1000 will be set apart by the firm to compensate the depreciation under the head "provision for depreciation account"

At the end of second year the value of depreciation would be Rs. 1000 and the value of the machine would be Rs.8000

To compensate the consumption of fixed asset (or depreciation) an amount of Rs. 1000 would be set apart in the "provision for depreciation account". As the value of the machines decrease the provision for depreciation increase. At the end of the 10th year provision for depreciation account will have Rs. 10000/- This is the the value of the machine. Using this amount old machine can be replaced with a new one. Consumption of fixed capital is compensated in this way.

Consumption of fixed asset is the difference between gross value added and net value added. If we deduct the consumption of fixed capital (depreciation) from the gross value added is the net value added. In other words, if we do not deduct the consumption of fixed capital from the value added, the figure is the gross value added.

Therefore, Net Value added = Gross Value added - Consumption of fixed capital
or Net Value Added = Gross value added - Depreciation.

Market price and factor Cost.

The difference between market price and factor cost is indirect tax and subsides.

Net Value added at Market Price = Net value added at factor cost + indirect taxes - Subsides.
or
Net Value Added at factor cost = Net value added at Market price - Indirect taxes + subsides.

Indirect Tax
Market price is the net amount paid by the consumer. A part of this amount goes to the Government in the for of government tax. It means the entire amount received from the consumer is not available to distribute among the factors of production. A portion of this amount goes to Government as tax. Taxes by the government is shifted to the buyer by the sellers.

Subsides
Subsides are the financial help given by the government to the production units for selling the products at a lower price. If government wants to encourage the production of certain goods, they provide financial support to such producers. Subsidies help the producers to bring the product in the market with a subsidized price.

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