An economy has two firms. Firm A uses no raw material and produces cotton worth Rs 80: it sells Rs 50 of it to firm B and Rs 30 to households. Firm B uses up the cotton and sells cloth worth Rs 220 to households. Firm A pays Rs 30 as wages. Firm B pays Rs 90 as wages, Rs 20 as rent and Rs 10 as interest. All the rest of each firm's value added is profit. What are the total profits in the economy?
Answer & explanation
Correct answer: option 4
The correct answer is Option (4) → Rs 100
Given:
Cotton produced by A = Rs 80, of which Rs 50 to B and Rs 30 to households
A uses no raw material
Wages paid by A = Rs 30
Cloth sold by B = Rs 220
Cotton used by B = Rs 50
Wages paid by B = Rs 90
Rent paid by B = Rs 20
Interest paid by B = Rs 10
A firm’s value added is paid out as wages, rent, interest and profits. So profit = value added − the other factor payments.
Value added of A = 80 − 0 = 80
Profit of A = 80 − 30 = 50
Value added of B = 220 − 50 = 170
Profit of B = 170 − 90 − 20 − 10 = 50
Total profits = 50 + 50 = Rs 100
Only the Rs 50 of cotton sold to B is an intermediate good; the Rs 30 sold to households is a final good. Rs 70 treats all of A’s cotton as intermediate.
NCERT (2026-27): “2.2.1 The Product or Value Added Method … The term that is used to denote the net contribution made by a firm is called its value added. We have seen that the raw materials that a firm buys from another firm which are completely used up in the process of production are called ‘intermediate goods’. Therefore the value added of a firm is, value of production of the firm – value of intermediate goods used by the firm. The value added of a firm is distributed among its four factors of production, namely, labour, capital, entrepreneurship and land. Therefore wages, interest, profits and rents paid out by the firm must add up to the value added of the firm. Value added is a flow variable.” |