Problem of Double Counting: Meaning and Ways for Avoiding!
Double counting means counting of the value of the same product (or expenditure) more than once. How?
According to output method (an alternative method to value added method) of calculating national income, value of only final goods and services produced by all the production units of a country during a year should be counted. In other words, value of intermediate goods which enter into final goods (e.g., paper used in printing of books, raw cotton used in garments, wheat used in making bread, etc.) should not be taken into account.
But in actual practice, while taking value of final goods, value of intermediate goods also gets included because every producer treats the commodity he sells as final product irrespective of whether it is used as intermediate or final good. For instance, while taking value of final goods like cycles, the value of tyres, tubes, frames, bells, etc. (intermediate goods) used in manufacturing these cycles also gets included inadvertently
In this way certain items are counted more than once resulting in over-estimation of national product to the extent of the value of intermediate goods included. This is called the problem of double counting which means counting value of the same commodity more than once.
This can be explained further with the help of an example. Let us for the sake of convenience and understanding, presume that in an economy, there are only four production units (or firms) engaged in production of garments (ready-made clothes like shirts, pants, etc.).
Firm A produces raw cotton, assuming though unrealistically that it uses no intermediate inputs and sells it for Rs 1,000 to firm B. Firm B converts it into cotton yarn and sells it for Rs 1,500 to firm C. Firm C manufactures cotton cloth and sells it for Rs 2,200 to firm D. Firm D produces garments and sells them for Rs 3,500 to final consumers.
The total value of all these transactions or gross output is Rs 8,200 (= 1,000 + 1,500 + 2,200 4- 3,500) in which raw cotton has been counted four times, cotton yarn three times and cotton cloth two times. On the contrary, value of final goods (garments) which the economy has produced is t 3,500. Thus, while calculating national income, if we take into account Rs 8,200 (value of final as well as intermediate goods), it will be a case of double counting and duplication.
Actually only Rs 3,500 should be counted since the economy has produced final goods worth Rs 3,500 and not worth Rs 8,200. It is, therefore, essential that the element of double counting erupting in final product approach should be avoided. The problem of double counting is solved by Value added approach according to which chances of double counting are automatically eliminated.
(b) How to avoid Double Counting:
Theoretically, we may say that there may be two alternative ways of avoiding double counting, namely, (i) final product approach and (ii) value added approach. But in actual practice, double counting still occurs unintentionally in final product approach because every producer treats the product he sells as a final product though the same might have been used by the buyer as an intermediate product.
Therefore this problem is perfectly solved by value added method. According to this method, instead of taking value of final products, value added by each firm at each stage of production is included.
In other words, cost of intermediate goods or raw material used by a firm in making a product is excluded and only the value added at each stage of production by every producing enterprise (firm) is included. The value added is found out by subtracting the value of inputs (intermediate goods which enter into final goods) from the value of output (final goods) of a firm.
In the above example, value added by each firm will be as follows:
Clearly, value added by all the four firms is Rs 3,500 comprising Rs 1,000 by A + Rs 500 by B + Rs 700 by C + Rs 1,300 by D. There is no scope for double counting in this method. Thus, to avoid double counting, the value added method, also known as industry of origin method, is used in computation of national income. It is worth mentioning that total value added is equal to value of final product.
In the above example, total value added is Rs 3,500 and the value of final product (final garments sold to consumers) is also Rs 3,500. (That is why in production method there can be two approaches. Final product approach and Value added approach.) Mind, in the above example, depreciation and net indirect taxes are assumed as zero with the result that value added is in fact net value added at FC.