Supply Chains and "Value Added" (1)

While we're discussing reproductive consumption…

Since we’ve been looking at reproductive and unproductive consumption, now seems like a good time to write something about supply chains, and discuss the idea of “value added”. I don’t normally talk about value, because it’s subjective, and the One Lesson¹ is all about understanding what we can know for sure without any subjectivity, but it can be useful to think about it in an informal way.

Making final products in stages

Think about a product you own: maybe a phone, tablet or computer; maybe a chair you’re sitting on; maybe a loaf of bread.

Ask yourself how many people were involved in making it. It’s very rare for someone to go out into nature, acquire all the materials needed to make a final product², and then do all the production themselves. Most products are made in stages, with lots of intermediate goods (and services).

To take a familiar example from this blog, when Alice makes tables, she’s unlikely to start off by growing and then cutting down a tree. Instead she relies on other people to make intermediate goods which are more useful for her when making tables, such as wooden planks. So someone else might specialise in producing trees: planting them, letting them grow, then cutting them down. Then a saw mill might buy the trees, and cut them into a variety of more useful shapes and sizes. Next, Alice can buy planks of wood from the saw mill to turn into tables. Finally, someone may buy a table from Alice to use as a dining table.

(Some of) the intermediate and final products involved in making a table

Notice how the intermediate goods (tree and planks) are produced (transactions 1 and 3), sold to the next person along (transactions 2 and 4), and then consumed reproductively³ (transactions 3 and 5) to make a new product, closer to what Dom actually wants.

This sequence of products being produced and passed on to someone to consume reproductively in making their own product is what’s known as a supply chain. At each stage, a producer adds some “value” on to what’s already been produced (represented by people being prepared to pay more for the goods produced further along the chain). Over the entire supply chain, different people add value in their own specialised way, and we hopefully end up with a product which meets people’s needs and wants extremely well.

Here’s a nice animation showing how extremely intricate supply chains are involved in making something so apparently simple and cheap that we barely notice it: a pencil.

Next time we’ll look at VAT — value added tax. This is charged by many governments to firms all along the supply chain, wherever any value is added.

1. The One Lesson of this blog is this:
To understand economics, look at how each decision or action affects each person’s Raw Net Worth (RNW).
Someone’s raw net worth (RNW) is what they own plus what they’re owed minus what they owe (i.e. their assets minus their liabilities). It is a “heterogeneous” sum/difference, which just means that things of different types are added and subtracted, not monetary “values” which have been assigned to them. If the idea is new to you, this article explains it with examples.

2. A final product is one to be consumed for someone’s personal benefit, rather than consumed in the process of making another product. See this article for details.

3. We can see that they’re being consumed reproductively, because they’re part of a transaction in which something else is being produced.