September 20, 2018 

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LAFFER CURVE: The graphical inverted-U relation between tax rates and total tax collections by government. Developed by economist Arthur Laffer, the Laffer curve formed a key theoretical foundation for supply-side economics of President Reagan during the 1980s. It is based on the notion that government collects zero revenue if the tax rate is 0% and if the tax rate is 100%. At a 100% tax rate no one has the incentive to work, produce, and earn income, so there is no income to tax. As such, the optimum tax rate, in which government revenue is maximized, lies somewhere between 0% and 100%. This generates a curve shaped like and inverted U, rising from zero to a peak, then falling back to zero. If the economy is operating to the right of the peak, then government revenue can be increased by decreasing the tax rate. This was used to justify supply-side economic policies during the Reagan Administration, especially the Economic Recovery Tax Act of 1981 (Kemp-Roth Act).

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The increase in the value of a good at each stage of the production process. The "value" part of this phrase means the ability of a good to satisfy wants and needs either directly as a consumption good or indirectly as a capital good. The "added" part means that resources have transformed the good in the course of production, to make it more valuable. A good that provides greater satisfaction has greater value.
The act of production is essentially the process of transforming raw materials and natural resources that have relatively little value into goods and services that have greater value. Gross domestic product, among other things, measures the value added by resources in the course of production.

Production and Income

This notion of value added is fundamental to the measurement of gross domestic product. Gross domestic product, as a measure of current production, identifies the value added to raw materials and natural resources as they are transformed into final goods and services during a given time period. For example, a Hot Momma Fudge Bananarama Ice Cream Shoppe transforms ice cream, hot fudge, bananas, almond sprinkles, whipped cream, and maraschino cherries into a highly valued Hot Momma Fudge Bananarama Ice Cream Sundae.

Value added is also important for the income generated by productive factors in the transformation of raw materials and natural resources into final goods. The income received by owners of the factors of production (labor, capital, land, and entrepreneurship) corresponds with the value added by the particular factor. In other words, workers who add greater value to a final good generally receive higher incomes.

For example, Harold "Hair Doo" Dueterman, the superstar baseball player for the Shady Valley Primadonnas, receives a greater income than Edgar Millbottom, a taco-making employee of Waldo's TexMex Taco World, because the value of the baseball entertainment produced by Hair Doo is greater than the value of the tacos produced by Edgar.

Adding Stuffed Value

To examine this value added concept more closely, consider the production of a relatively simple product like Wacky Willy Stuffed Amigos. Stuffed Amigos begins with the three primary material inputs or intermediate goods: fabric, thread, and stuffing. The fabric is 100 percent cotton, produced by OmniTextiles. The thread is a cotton-polyester blends, produced by MegaThread. And the stuffing is a gelatinous substance produced using soybean extract, graphite, and recycled newspapers by a firm called Ooze, Inc.

In addition to these intermediate goods, The Wacky Willy Company also uses the four basic factors of production. Labor includes a staff of 300 employees. Capital includes the Wacky Willy factory and equipment. Land includes the land on which the factory rests. Entrepreneurship includes the founder and president of The Wacky Willy Company, William J. Wackowski.

These factors of production are responsible for adding value to the intermediate goods. The Wacky Willy Company buys the fabric, thread, and gelatinous substance as intermediate products, which it then transforms into more valuable Stuffed Amigos.

Stuffed Amigo Production

Production InputValue

Intermediate Goods$4.00

Total Value$14.95

Value Added$10.95

The table to the right presents a breakdown of the revenue received by The Wacky Willy Company for the sale of one Stuffed Amigo and the cost incurred in its production. The sales price is $14.95. This is the revenue collected by The Wacky Willy Company. More notably this is the value placed on this product by the buyer. And most important of all, this value is included as part of gross domestic product.

The production of the Stuffed Amigo is divided into five categories. One is the cost of purchasing intermediate goods (fabric, thread, and stuffing). The next three is the cost of using the factors of production (labor, capital, and land). The last item listed is profit, the difference between the revenue received and the total cost. More on profit later.

The cost of acquiring the three intermediate goods is $4. This $4 is the value of these intermediate goods when purchased from OmniTextiles (fabric), MegaThread (thread), and Ooze, Inc. (gelatinous stuffing). The function of The Wacky Willy Company is to add value to these intermediate goods, which they do by transforming these material inputs into a highly valued Stuffed Amigo.

In particular, the value added by The Wacky Willy Company is $10.95, the difference between the $4 worth of intermediate goods and the $14.95 price for the final good. This value is added by the factors of production. How much value added by each factor can be determined by noting its "cost." Labor adds $5 worth of value, capital adds $3 of value, and the land adds $0.50 of value. These cost items are also the income received by the owners of each factor.

But what about the profit? The profit is actually the value added by the entrepreneur, William J. Wackowski, the person who undertook the risk of starting The Wacky Willy Company to produce Stuffed Amigos. The $2.45 of profit is the income he receives in compensation for the value added by his entrepreneurship.


Recommended Citation:

VALUE ADDED, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: September 20, 2018].

Check Out These Related Terms...

     | final goods | intermediate goods | double counting | in-kind payments | current production | underground economy |

Or For A Little Background...

     | value | gross domestic product | gross domestic product, ins and outs | production | production cost | National Income and Product Accounts |

And For Further Study...

     | gross domestic product, welfare | gross domestic product, expenditures | gross domestic product, income | net domestic product | national income | personal income | disposable income | gross national product | real gross domestic product | circular flow | business cycles | Bureau of Economic Analysis | derived demand | marginal productivity theory |

Related Websites (Will Open in New Window)...

     | Bureau of Economic Analysis |

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