This method is used to measure national income in different phases of production in the circular flow. It shows the contribution (value added) of each producing unit in the production process.

Every individual enterprise adds certain value to the products, which it purchases from some other firm as intermediate goods. When value added by each and every individual firm is summed up, we get the value of national income.

Concept of value added – Value added refers to the addition of value to the raw material (intermediate goods) by a firm by virtue of its productive activities. It is the contribution of an enterprise to the current flow of goods and services. It is calculated as the difference between value of output and value of intermediate consumption.

Value added = Value of output – Intermediate consumption

Example of concept of value addition :
Suppose a baker needs only flour to produce bread. He purchases flour as input worth Rs. 500 from the miller and then by virtue of its productive activities converts the flour into bread and sells the bread for Rs. 700. In this, flour is an input (intermediate good) and its value of Rs. 500 is termed as value of ‘intermediate consumption’. Bread is the output and its value of Rs. 700 is termed as ‘value of output’. Difference between the value of output and intermediate consumption is termed as ‘value added’. It means, that the baker has added a value of Rs.200 to the total flow of final goods and services in the economy.