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Macroeconomic Analysis and Policy

Sessions: 2-5
Prof. Biswa Swarup Misra
Dean, XIMB

In these Sessions, we look for the answers to


these questions:

Basic Concepts such - Commodity, Good


and Services

Goods-Intermediate, Capital and Final


Good

Investment- Gross and Net


Consumption versus Investment

What is Circular Flow of Income?


What is Gross Domestic Product (GDP)?

In these Sessions, we look for the answers to


these questions:

Components of GDP
Distinction between GDP and GNP
Nominal versus Real GDP

Implications of Changing the Base year


Indian GDP at 2011-12 base - Concepts
such as GDP at Market Price, GDP at
Factor Cost, GVA at Factor Cost, GVA at
Basic Prices

Income and Expenditure


Gross Domestic Product (GDP) measures
total income of everyone in the economy.

GDP also measures total expenditure on the


economys output of g&s.
For the economy as a whole,
income equals expenditure, because
every rupee of expenditure by a buyer
is a rupee of income for the seller.

The Circular-Flow Diagram


is a simple depiction of the macro economy.
illustrates GDP as spending, revenue,
factor payments, and income.

First, some preliminaries:


Factors of production are inputs like labor, land,
capital, and natural resources.

Factor payments are payments to the factors of


production. (e.g., wages, rent)

FIGURE 1: The Circular-Flow Diagram

Households:
own the factors of production,
sell/rent them to firms for income
buy and consume g&s
Firms

Households

FIGURE 1: The Circular-Flow Diagram

Firms

Households

Firms:
buy/hire factors of production,
use them to produce g&s
sell g&s
6

FIGURE 1: The Circular-Flow Diagram

Revenue (=GDP)
G&S
sold

Markets for
Goods &
Services

Firms
Factors of
production

Wages, rent,
profit (=GDP)

Spending (=GDP)
G&S
bought

Households

Markets for
Factors of
Production

Labor, land,
capital
Income (=GDP)
7

What This Diagram Omits

The government
collects taxes
purchases g&s
The financial system
matches savers supply of funds with
borrowers demand for loans

The foreign sector


trades g&s, financial assets, and currencies
with the countrys residents

Measuring Output
The aggregate measure of income in the economy is
the GDP.
Gross Domestic Product is the market value of the final

goods and services produced in a country during a


given time period - a quarter or a year.

Note: GDP includes only current production and so


does not count the resale of items.
Only final goods are included which means we do not
count raw materials and intermediate goods used
as inputs.

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

Wheat for
self consumption
in Household
Wheat
produced
by Farmer
(INR 50)

Session 2-3

Final
Purchases

Bread produced
-Non-Market activity(Farmer does not pay himself
to produce bread)

MEASURING A NATIONS INCOME

B.S.Misra

10

Wheat for
self consumption
in Household
Wheat
produced
by Farmer
(INR 50)

Session 2-3

Purchased by
Baker (who puts
in effort to transform it to
another good) Value of
effort = INR 50

Final
Purchases

Bread produced
-Non-Market activity(Farmer does not pay himself
to produce bread)

Wheat + Effort
result in output
of bread

MEASURING A NATIONS INCOME

Sale of
bread
(INR 100)

B.S.Misra

Consumption

11

Final
Purchases

Wheat
produced
by Farmer
(INR 50)

Purchased by
Baker (who puts
in effort to transform it to
another good) Value of
effort = INR 50

Wheat + Effort
result in output
of bread

Sale of
bread
(INR 100)

Consumption

If we ask farmer and baker to report their


output and simply add their outputs we would
falsely conclude that INR 150 of output has been
produced in the economy.
What causes the error in counting is that we
have counted wheat which is not a final good.
Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

12

An intermediate good is one that is used


up in the production of other goods
during the same period in which it was
produced.

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

13

An intermediate good is one that is used up in the


production of other goods during the same
period in which it was produced.
Intermediate goods like wheat and oil should not
be double counted when output is computed.

To avoid errors from inclusion of intermediate


goods agents should be asked to report their
sales of final goods to consumers.

Baker
reports
sale of
of final good Farmer reports sale of
of final good

INR 100
INR
0

Total value of final goods = INR 100


14

Final
Purchases

Wheat
produced
by Farmer
(INR 50)

Purchased by
Baker (who puts
in effort to transform it to
another good) Value of
effort = INR 50

Wheat + Effort
result in output
of bread

Sale of
bread
(INR 100)

Consumption

Alternatively agents should report the contribution


each makes to the total output
Value added is the market value of the product of an

agent minus the cost of intermediate inputs purchased.


Value added is arrived at by subtracting costs from the
revenues.
Farmers value added = INR 50
(Assuming he did not pay for any costs)

Bakers value added = INR 50


Total value added = INR 100

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

15

Final
Purchases

Wheat
produced
by Farmer
(INR 50)

Purchased by
Baker (who puts
in effort to transform
it to another good)
Value of effort = INR 50

Wheat + Effort
result in output
of bread

Sale of
bread
Unsold bread
on Shelves
Wheat not
used up

Consumption

Investment
in
Inventory

Suppose farmer does not sell all bread produced or


use up all the wheat purchased from the farmer?
A firms unused raw materials or unsold output is
its inventory.
The change in the stock of inventory in an accounting year is treated as an inventory investment and
is classified as a final good.
MEASURING A NATIONS INCOME

B.S.Misra

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16

Now suppose baker wants to scale up business


and buys new baking racks and a new oven.
These objects are not used up during the accounting
period and are not intermediate goods. Neither are they
sold as final goods by baker.
Objects are called capital goods and economic entity
who purchases them is considered to be final
user of the capital good.
A capital good is a long-lived good that is used in
the production of other goods and services.

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

17

Capital goods and intermediate goods are similar in


that they are both used to produce other
goods.
They are dissimilar in that capital goods are not
used up right away like intermediate
goods.

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

18

Capital goods and intermediate goods are similar in


that they are both used to produce other
goods.
They are dissimilar in that capital goods are not
used up right away like intermediate
goods.
The total quantity of a countrys capital goods
is called its capital stock.
Change in the capital stock from the beginning
of the year to end of the year is denoted
as investment for that year.

If the baker began the year with stock of INR 500 of


ovens and ended the year with stock of INR 800 of
ovens he is considered to have invested INR
300 during the year.
Session 2-3

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19

A capital good is not used up right away but it


dimin- ishes in its material respect and is
used up eventually - it undergoes depreciation.
If in a given year INR 500 of new capital is created and
INR 150 of old capital wears out, then the
capital stock would have increased by INR 350
Gross Investment = INR 500
Depreciation
= INR 150
Net Investment
= INR 350

Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

20

Figure 1.1: Production Processes and the National Income


Wheat for
self consumption
in Household
Wheat
produced
by Farmer
(INR 50)

Purchased by
Baker (who puts
in effort to transform
it to another good)
Value of effort = INR 50

New Oven,
New Baking Racks
(Capital Stock)

Purchased
by Baker so
as to scale
up production

Bread produced
-Non-Market activity(Farmer does not pay himself
to produce bread)

Wheat + Effort
result in output
of bread

Unsold bread
on Shelves
Wheat not
used up

Not used Not sold


up during to others
course of as Final
year
Good
(Gross Investment)

Deterioration of
Capital Good
(Depreciation)

Session 2-3

Sale of
bread

MEASURING A NATIONS INCOME

Net Addition
to
Capital
Stock

B.S.Misra

Final
Purchases

Consumption

Investment
in
Inventory

Net
Investment

21

MEASURING A NATIONS INCOME

B.S.Misra

22

23

Wealth of Nations

America's wealth amounted to almost


$118 trillion in 2008, over ten times its
GDP that year.

For India, wealth was only 7.6 times its


GDP (These amounts are calculated at
the prices prevailing in 2000.)

GDP of US is 14.4 times that of India but


wealth of USA is 19 times that of India.
24

Wealth of Nations

Wealth per person in USA was, however,


lower than that of Japan's, which tops the
league on this measure.

Judged by GDP, Japan's economy is now


smaller than China's.

But according to the UN, Japan was


almost 2.8 times wealthier than China in
2008
25

Wealth of Nations
For all of the countries in the report except Nigeria,
Russia and Saudi Arabia, Human capital forms the
largest share of Wealth.

The UN calculates a population's human capital


based on its average years of schooling, the wage its
workers can command and the number of years
they can expect to work before they retire (or die).

Human capital represents 88% of Britain's wealth


and 75% of America's.

The average Japanese has more human capital than


anyone else.
26

Wealth of Nations
The UN's exercise makes all three kinds of
capital comparable and commensurable.

It also implies that they are substitutable.


A country can lose $100 billion-worth of
pastureland, gain $100 billion-worth of
skills and be no worse off than before.

The framework turns economic


policymaking into an asset-management
problem,
27

Wealth of Nations
A country like Saudi Arabia, for example, depleted
its stock of fossil fuels by $37 billion between
1990 and 2008, while adding to its stock of schoolleavers and university graduates (its human
capital grew by almost $1 trillion).

In some richer countries, however, investments in


human capital appear to have hit diminishing
returns, the report argues.

Perhaps governments should redirect their


investment into natural capital instead, restocking
their forests rather than their libraries.
28

Wealth of Nations
The idea that natural assets are substitutable makes some
environmentalists (including some contributors to the
report) nervous.

Many of the services the environment provides, like clean


water and air, are irreplaceable necessities, they point out.

In theory, however, the undoubted value of these natural


treasures should be reflected in their price, which should
rise steeply as they become more scarce.

A good asset manager will then husband them carefully,


knowing that it will take an ever-increasing amount of
human or physical capital to make up for further losses of
the natural kind.
29

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
Goods are valued at their market prices, so:

GDP measures all goods using the same units


(e.g., dollars in the U.S.), rather than adding
apples to oranges.

Things that dont have a market value are


excluded, e.g., housework you do for yourself.
30

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
Final goods are intended for the end user.
Intermediate goods are used as components
or ingredients in the production of other goods.
GDP only includes final goods, as they already
embody the value of the intermediate goods
used in their production.
31

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes tangible goods
(like DVDs, mountain bikes, soaps)

and intangible services


(dry cleaning, concerts, cell phone service).

32

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
GDP includes currently produced goods,
not goods produced in the past.

33

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
GDP measures the value of production that occurs
within a countrys borders, whether done by its own
citizens or by foreigners located there.

34

Gross Domestic Product (GDP) Is


the market value of all final goods &
services produced within a country
in a given period of time.
usually a year or a quarter (3 months).

35

National Income Accounting


National income accounts: an accounting

framework used in measuring current economic


activity

Three alternative approaches give the same

measurements
Product approach: the amount of output
produced
Income approach: the incomes generated by
production
Expenditure approach: the amount of spending
by purchasers
36

National Income Accounting


The Bakery example shows that all three
approaches are equal
Important concept in product approach:
value added = value of output minus value of
inputs purchased from other producers

37

National Income Accounting


Why are the three approaches equivalent?
They must be, by definition
Any output produced (product approach) is

purchased by someone (expenditure approach)


and results in income to someone (income
approach)
The fundamental identity of national income
accounting:

total production = total income = total expenditure

38

Exercise:
A farmer grows a kilo of wheat

and sells it to a miller for Rs10.00.


The miller turns the wheat into flour
and sells it to a baker for Rs.30.00.
The baker uses the flour to make a loaf of
bread and sells it to an engineer for Rs.60.00.
The engineer eats the bread.

Compute & compare


value added at each stage of production
and GDP
39

The Components of GDP


Recall: GDP is total spending.
Four components:

Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
These components add up to GDP (denoted Y):
Y = C + I + G + NX
40

Consumption (C)
is total spending by households on g&s.
Note on housing costs:
For renters, consumption includes rent
payments.

For homeowners, consumption includes


the imputed rental value of the house,
but not the purchase price or mortgage
payments.

41

Investment (I)
is total spending on goods that will be used in the
future to produce more goods.

includes spending on
capital equipment (e.g., machines, tools)
structures (factories, office buildings, houses)
inventories (goods produced but not yet sold)
Note: Investment does not
mean the purchase of financial
assets like stocks and bonds.
42

Investment vs. Capital


Note: Investment is spending on new capital.
Example (assumes no depreciation):

1/1/2007:
economy has $500b worth of capital
during 2007:
investment = $60b
1/1/2008:
economy will have $560b worth of capital

43

Stocks vs. Flows


Flow

Stock

A stock is a
quantity measured
at a point in time.
E.g.,
The U.S. capital stock
was $26 trillion on
January 1, 2006.

A flow is a quantity measured per unit of time.


E.g., U.S. investment was $2.5 trillion during 2006.
44

Stocks vs. Flows - examples

stock

flow

a persons wealth

a persons
annual saving

# of people with
college degrees

# of new college
graduates this year

the govt debt

the govt budget deficit

45

Now you try:


Stock or flow?

the balance on your credit card statement


how much you study economics outside of class
the size of your compact disc collection
the inflation rate
the unemployment rate

46

Government Purchases (G)


is all spending on the g&s purchased by govt
at the federal, state, and local levels.

G excludes transfer payments, such as


Social Security or unemployment insurance
benefits.
These payments represent transfers of income,
not purchases of g&s.

47

Net Exports (NX)


NX = exports imports
Exports represent foreign spending on the
economys g&s.

Imports are the portions of C, I, and G


that are spent on g&s produced abroad.

Adding up all the components of GDP gives:


Y = C + I + G + NX

48

Share of different components in Indias GDP


in 2011-12 at 2004-05 base (%)

C
G
I
NX

59
11
38
-9
49

U.S. GDP and Its Components, 2005


billions

% of GDP

per capita

$12,480

100.0

$ 42,035

8,746

70.1

29,460

2,100

16.8

7,072

2,360

18.9

7,950

NX

726

5.8

2,444

50

U.S. GDP and Its Components, 2013


GDP
Y

16768.1

11484

2648

3144

NX

-508

% of GDP
68
16
19
-3

51

Exercise 1:

GDP and its components


In each of the following cases, determine how much GDP and each of
its components is affected (if at all).
A. Abhinav spends Rs.200 to buy his friend dinner
at Mayfair, the finest restaurant in Bhubaneswar.
B. Aditi spends Rs.1800 on a new laptop to use in his business. The
laptop was built in China.

C. Ispsita spends Rs.1200 on a computer to use in her business. She


got last years model on sale for a great price from a local
manufacturer.
D. Tata Motors builds Rs.500 million worth of cars,
but consumers only buy Rs.470 million worth of them.

52

Exercise 1:

Answers
A. Abhinav spends Rs. 200 to buy his friend dinner

at Mayfair.
Consumption and GDP rise by Rs. 200.
B. Aditi spends Rs.1800 on a new laptop to use in his

business. The laptop was built in China.


Investment rises by Rs.1800, net exports fall
by Rs.1800, GDP is unchanged.

53

Exercise 1:

Answers
C. Ipsita spends Rs.1200 on a computer to use in her
business. She got last years model on sale for a great
price from a local manufacturer.
Current GDP and investment do not change, because the
computer was built last year.
D. Tata Motors builds Rs.500 million worth of cars, but
consumers only buy Rs.470 million of them.
Consumption rises by Rs.470 million,
inventory investment rises by Rs.30 million,
and GDP rises by Rs.500 million.

54

How will the following events


affect GDP and why?
a. An earthquake destroys part of Rajasthan.
b. You sell your old macroeconomics textbook
to another student.
c. You sell your holdings of Infosys stock.

d. A retired worker gets an increase in Pension


benefits.

55

Answers
a. When an earthquake destroys property, wealth
is affected, not income (or GDP). However, if a
significant amount of the capital stock is
destroyed, then less can be produced in the time
period under study, leading to a decrease in GDP.
On the other hand, the rebuilding of destroyed
property means that increased economic activity
will take place, leading to an increase in GDP.
b. The sale of your old textbook will not constitute
an official market transaction. In addition, the
textbook has already been used and is not
currently produced. Therefore GDP will not be
affected.
56

Answers
c. The sale of existing stock holdings is a transfer
of wealth and, as such, does not affect GDP. Any
fees that you may have to pay your broker for his
or her services, however, constitute payment for
services rendered. GDP will increase by that
amount.

d.

Transfer payments that do not arise from


productive activity are not counted in GDP. Thus
GDP will not be affected when pension benefits
are paid. (Only later, when these payments are
spent, will consumption increase.)

57

Related Measures of GDP

58

Gross National Product

GDP has a territorial dimension


Gross National Product (GNP) is the total
value of output produced and income
received in a year by the nationals of a
country - citizenship dimension

GNP = GDP + Net Factor Income Earned


from Abroad

While GDP indicates productive capacity of


an economy, GNP is a crude indicator for
living standard.

If a country has more non-resident inflows


its GNP will be higher than GDP.

For a closed economy GDP = GNP.

59

GDP vs GNP
GDP - market value of all final goods &
services produced within a country in a
given period of time

GNP- market value of all final goods & services


produced by domestic factors of production
in a given period of time

When India labour and capital are used abroad,


they produce output and earn income. This
output and income are included in Indian GNP
but not in Indian GDP because they do not
represent production taking place within India
60

Net Factor Income from Abroad


Net factor income from abroad consists of three
components

1)Net compensation of employees,


2)Net income from property and
Entrepreneurship

and

3)Net retained earnings of resident companies


abroad.
Value of roads built by a Indian construction
company in Saudi Arabia, as measured by
the fee it receives from Saudi Government is
counted in Indias GNP but not in Indias
GDP
61

NFIA
Net compensation of employees receivable from
abroad is equal to the difference between
compensation of employees received by resident
employees who are living or employed abroad
temporarily and compensation of foreign nationals
working temporarily in the domestic economy.

The clause temporary resident applies to those


employees who stay abroad for less than one year.

In case they stay for one year or more in a foreign


country they would be treated as normal residents of
that country and their income would be a part of the
national income of the employer country.

Net compensation of employees, as it is defined, can


be a positive or a negative value.
62

Who is a Resident?

Residents include both individuals and institutions.


Tourists or commercial travelers of a given country
traveling abroad are treated as residents of their
home countries.

The official diplomatic and consular representatives

of a given country including members of official


missions and members of the armed forces stationed
abroad are considered extra territorial by the country
in which they are located and as residents of the
given country.

The factor incomes generated by such residents are


domestic product of the resident country.

Factor incomes of locally recruited staff of foreign


diplomatic military establishments are included in
factor incomes from abroad.

63

Net Income from Property and


Entrepreneurship from Abroad

Net income from property and


Entrepreneurship from abroad is the
difference between the income received by
way of interest, rent, dividend and profit by
the resident producers of a country and
payments of similar type made to the rest of
the world.

This also includes net interest received by the


government on foreign loans.
64

Net Retained Earnings of Resident


Companies Abroad
Retained earning refers to the undistributed profit of
the companies.

Resident companies abroad (i.e., companies belonging


to one country and working in the domestic territory
of some other country) retain a part of their profits.

Likewise, foreign companies and their branches retain


a part of their profits without distributing it.

The difference between retained earnings of resident


companies located abroad and retained earnings of
non-resident companies located within the domestic
territory of the country.

65

GDP and GNP


In the case of US Ford Motors in Chennai, the
income from the car factory would be counted as
Indian GDP and not as US GDP.

But the amount of profit the company sends to US


will be added to their GNP.

Similarly, our GNP can be arrived by adding to our


GDP the net factor income receipts (Wages and
Profits) from abroad for the factor inputs owned
by Indians.

That is, the non-resident Indians income will be


added to GDP to arrive at our GNP.
66

Some Concepts
Market prices: The prices at which goods and services
are sold in various markets to households and firms.

Thus GDP@ market price refers to the total final output


of all final goods and services produced within the
national frontiers of a country by its citizens and the
foreign residents who reside within those frontiers that
are sold at market prices in various markets.

Subsidies: are government expenses that are generally


extended to business firms, farmers among other groups
to defray their production costs or to reduce prices for
consumers.
67

Some Concepts
Subsidies are also called negative taxes because
they impose expenses on government budgets
instead of contributing revenues.

Indirect Taxes: are government revenues that


result from taxes that are not received directly
from the earned incomes of households,
businesses etc.

Thus sales taxes, highway tolls, excise taxes etc are


forms of indirect taxes as opposed to direct taxes
that are extracted from earned incomes.
68

National Income Relations


GNP Depreciation = NNP
GDP Depreciation = NDP
Per Capita NDP =NDP/Population
Per Capita NNP =NNP/Population
GDP@ factor cost =GDP@ market price +
Subsidies -Indirect Taxes

GNP@ factor cost =GNP@ market price +


Subsidies - Indirect Taxes

69

Payments to Factors of Production

GNPFC = GNPMP + S IT
IT is paid to government and not to factors of
Production

Subsidies are paid by the Government to the


producer
If the payment is made directly to the beneficiary
from the government it is known as a cash
transfer
Similarly,

NNPFC = NNPMP + S IT
NNPFC is otherwise known as National Income and

refers to the payment to all factors of production


consisting of wages, rent, interest and profit.
70

GDP at Market Price and Factor Cost

The market value of the goods and services will

include the indirect taxes like excise duties,


customs, sales tax etc., levied by the government
on goods and services.

Similarly, the price paid by the consumer will not

include any subsidy which the government pays to


the producer.

Hence, the market value of final expenditure would


exceed the total obtained at factor cost by the
amount of indirect taxes reduced by the value of
subsidies.

Domestic or national product can, therefore, be

measured either at market prices or at factor cost


one differing from the other by the amount of net
indirect taxes (indirect taxes less subsidies)
71

National Income Relations


Macroeconomic aggregates @ market prices
whether GDP, GNP, NDP or NNP or Per capita
GDP, Per capita GNP, Per capita NDP or Per
capita NNP include indirect taxes and exclude
subsidies.

Conversely all the above aggregates @ factor


costs whether GDP, GNP, NDP or NNP or Per
capita GDP, Per capita GNP, Per capita NDP or
Per capita NNP include subsidies and excludes
indirect taxes

National Income = NNP at Factor Cost


72

National Income
Relationships
NNPMP

GNPMP

GDPMP

GNP

NNP

GDP

FC

NDP
MP

FC

FC

Depreciation
Net Indirect Taxes

NDP

FC

Net Income from Abroad


Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

73

National Income vs. Personal Income

NI measures the income individuals receive for doing


productive work.

PI measures all income actually received by


individuals.

Individuals receive other income that they do not

directly earn- Welfare payments, food stamps etc


also interest payments from government and
individuals

In NI accounting, individuals are attributed income


that they do not actually receive-Undistributed
corporate profits(retained earnings)employees
contribution to social security.

Personal income is national income plus transfer


payments from government minus amounts
attributed but not received.

74

GDP to Disposable Income


Gross Domestic Product, PLUS
Net foreign factor income, EQUALS
Gross National Product, LESS
Depreciation, EQUALS
Net national product, LESS
Indirect business taxes and statistical discrepancy, EQUALS
National income, LESS
IENR(Undistributed Corporate Profits), PLUS
IRNE(Transfer Payments), EQUALS
Personal Income, LESS
Income taxes, EQUALS
Disposable income.
75

Exercise-1
Using the following data, calculate the GDP and NDP.
Calculate under closed and open economy.

Gross Investment

$46

Exports
Consumption

Government Purchases
Consumption of Fixed Capital

84

Imports

12

180
52

76

Solution-1
Under Open Economy
GDP
= C + I + G + NX

= $180 + $46 + $84 + ($9 - $12)

NDP

= GDP Consumption of Fixed Capital

= $307 - $52

= $255

= $307

77

Solution-1
Under Closed Economy

GDP = C + I + G

= $180 + $46 + $84


= $310
NDP = GDP Consumption of Fixed Capital

= $310 - $52

= $258

78

Exercise-2
Using the following data, derive GDP, NDP, National
Income, Personal Income, Personal Disposal Income, GNP,
and NNP. Which economic indicator is higher, GDP or GNP?
Why?
Personal Consumption Expenditures $490 Indirect Business Taxes
70
Interest
40 Imports
30
Corporate Profit
70 Proprietors Income
55
Government Purchases
150 Income Tax
100
Depreciation
40 Income Earned but not received
60
Rent
20 Income Received but not earned
70
Gross Private Domestic Investment 50 Factor Incomes to Overseas
25
Compensation of Employees
420 Exports
50
Factor Incomes from Overseas
30

79

Solution-2

2. Expenditure Approach

PI=NI+IRNE-IENR=605+70-60=615

GDP = C + I + G + NX= $490 + 50 + 150 + (50-30)= $710

GDP@ factor cost =GDP@ market price + S - IT=710-70=640


GNP@MP=GDP@MP+NFIA=710+(30-25)=715
NI=NNP@FC=NNP@MP+S-IT=(GNP@MP-DEP)+S-IT=715-4070=605
PDI=PI-IT=615-100=515
NNP=GNP-DEP=715-40=675
NDP= GDP Depreciation= $710 - $40= $670

Since the NFIA is positive GNP>GDP.

80

Solution-2
National Income = Employees Compensation (Wages and
Salaries) + Corporate Profits + Sole Proprietors Income +
Net Interest Income + Rental Income

= $420 + 70 + 55 + 40 + 20
= $605
Personal Income = National Income Income earned but
not received + Income received but not earned

= $605 - $60 + $70 = $615


Personal Disposable Income = Personal Income Income Tax

= $605 - $100
= $515
81

Solution-2
Income Approach
GDP = National Income + Depreciation + Indirect Business

Taxes + Net Factors Payments (factors incomes/payments


to overseas factor incomes/payments from overseas)

= $605 + $40 + $70 + ($25 - $30)

= $710
GNP = GDP Net Factor Payments to the rest of the world
= $710 ($25 - $30) = $715

Since the net factor payments to the rest of the world is


negative, therefore GDP<GNP.

82

Exercise-3
The following information is given:
Personal Consumption Expenditures
Interest
Corporate Profit
Government Purchases
Depreciation
Rent
Gross Private Domestic Investment
Compensation of Employees
Factor Incomes from Overseas

$500
40
85
150
45
25
70
400
30

Indirect Business Taxes


Imports
Proprietors Income
Income Tax
Income Earned but not received
Income Received but not earned
Factor Incomes to Overseas
Exports

105
30
50
120
80
90
50
80

Using the following information, calculate the GDP (using the


expenditure approach), NDP, National Income, Personal Income,
Disposable Income, GNP, and NNP. Which economic indicator is
higher, GDP or GNP? Why?
83

Solution-3

Expenditure Approach
GDP = C + I + G + NX
= $500 + 70 + 150 + (80-30)

= $770
NDP

= GDP Depreciation

= $770 - $45
= $725
National Income = Employees Compensation (Wages and
Salaries) + Corporate Profits + Sole Proprietors Income +
Net Interest Income + Rental Income

= $400 + 85 + 50 + 40 + 25
= $600

84

Solution-3
Personal Income = National Income Income earned but
not received + Income received but not earned

= $600 - $80 + $90= $610


Personal Disposable Income = Personal Income Income
Tax

= $610 - $120 = $490


GNP= GDP Net Factor Payments to the rest of the world=
$770 ($50 - $30)= $750

GDP = NI + IBT + CCA + NFP

= $600 + $105 + $45 + 20 = $770


Since the net factor payments to the rest of the world is
positive, therefore GDP>GNP.

85

Other Measures of Total Production and Total


Income
Measures of Total Production
and Total Income, 2007

86

Other Measures of Total Production and Total


Income
The Division of Income
The Division of Income

We can measure GDP in terms of total expenditure or as the total income received by
households.
The largest component of income received by households is wages, which are about three
times as large as the profits received by sole proprietors and the profits received by
corporations combined.

87

Real versus Nominal GDP


Inflation can distort economic variables like GDP,
so we have two versions of GDP:
One is corrected for inflation, the other is not.

Nominal GDP values output using current prices.


It is not corrected for inflation.

Real GDP values output using the prices of


a base year. Real GDP is corrected for inflation.

88

EXAMPLE 2 :
Pizza

Ice Cream

year

2002

Rs.10

400

Rs.2.00

1000

2003

Rs.11

500

Rs.2.50

1100

2004

Rs.12

600

Rs.3.00

1200

Compute nominal GDP in each year:

Increase:

2002:

Rs.10 x 400 + Rs.2 x 1000

= Rs.6,000

2003:

Rs.11 x 500 + Rs.2.50 x 1100

= Rs.8,250

37.5%

2004:

Rs.12 x 600 + Rs.3 x 1200

= Rs.10,800

30.9%
89

EXAMPLE 2 :
Pizza

Ice Cream

year

2002

Rs.10
Rs.10

400

Rs.2.00
Rs.2.00

1000

2003

Rs.11

500

Rs.2.50

1100

2004

Rs.12

600

Rs.3.00

1200

Compute real GDP in each year,


using 2002 as the base year:

Increase:
2002: Rs.10 x 400 + Rs.2 x 1000 = Rs.6,000
20.0%
2003: Rs.10 x 500 + Rs.2 x 1100 = Rs.7,200
16.7%
2004: Rs.10 x 600 + Rs.2 x 1200 = Rs.8,400
90

EXAMPLE 2 :
year
2002

Nominal
GDP
Rs.6000

Real
GDP
Rs.6000

2003

Rs.8250

Rs.7200

2004

Rs.10,800

Rs.8400

In each year,
nominal GDP is measured using the (then)
current prices.
real GDP is measured using constant prices
from the base year (2002 in this example).
91

EXAMPLE 2 :
year
2002

Nominal
GDP
Rs.6000

2003

Rs.8250

2004

Rs.10,800

Real
GDP
Rs.6000
37.5%
30.9%

Rs.7200

20.0%

Rs.8400

16.7%

The change in nominal GDP reflects both prices and


quantities.

The change in real GDP is the amount that


GDP would change if prices were constant
(i.e., if zero inflation).
Hence, real GDP is corrected for inflation.
92

Real GDP versus Nominal GDP


Comparing Real GDP and Nominal GDP

Nominal GDP and


Real GDP, 19902007

93

Nominal and Real GDP in the U.S.,


1965-2005
Billions
$12,000
$10,000

Real GDP
$8,000

(base year
2000)

$6,000
$4,000

Nominal
GDP

$2,000
$0
1965

1970

1975

1980

1985

1990

1995

2000

2005
94

The GDP Deflator


The GDP deflator is a measure of the overall
level of prices.

Definition:
nominal GDP
GDP deflator = 100 x
real GDP

One way to measure the economys inflation


rate is to compute the percentage increase in
the GDP deflator from one year to the next.
95

EXAMPLE 3 :

2002

Rs.6000

Rs.6000

GDP
Deflator
100.0

2003

Rs.8250

Rs.7200

114.6

Rs.8400

128.6

year

2004

Nominal
GDP

Rs.10,800

Real
GDP

14.6%
12.2%

Compute the GDP deflator in each year:


2002:

100 x (6000/6000) =

100.0

2003:

100 x (8250/7200) =

114.6

2004:

100 x (10,800/8400) =

128.6
96

2:
Computing GDP
Exercise

2004 (base yr)


P
good A
good B

2005
P

2006
Q

Rs.30

900

Rs.31

1,000

Rs.36

1050

Rs.100

192

Rs.102

200

Rs.100

205

Use the above data to solve these problems:


A. Compute nominal GDP in 2004.
B. Compute real GDP in 2005.

C. Compute the GDP deflator in 2006.


97

2:
Answers
Exercise

2004 (base yr)


P
good A
good B

2005
P

2006
Q

Rs.30

900

Rs.31

1,000

Rs.36

1050

Rs.100

192

Rs.102

200

Rs.100

205

A. Compute nominal GDP in 2004.

Rs.30 x 900 + Rs.100 x 192 = Rs.46,200


B. Compute real GDP in 2005.

Rs.30 x 1000 + Rs.100 x 200 = Rs.50,000


98

2:
Answers
Exercise

2004 (base yr)


P
good A
good B

2005
P

2006
Q

Rs.30

900

Rs.31

1,000

Rs.36

1050

Rs.100

192

Rs.102

200

Rs.100

205

C. Compute the GDP deflator in 2006.


Nom GDP = Rs.36 x 1050 + Rs.100 x 205 = Rs.58,300
Real GDP = Rs.30 x 1050 + Rs.100 x 205 = Rs.52,000

GDP deflator = 100 x (Nom GDP)/(Real GDP)


= 100 x (Rs.58,300)/(Rs.52,000) = 112.1
99

Rebasing-Case Study of Nigeria


Yemi Kale, Nigerias statistician-general on April 6,
2014 revised Nigerias GDP in 2013 from 42.4 trillion
naira to 80.2 trillion naira ($510 billion), an 89%
increase.

The revision means Nigeria leapfrogs South Africa to


be Africas largest economy.

It rises to 24th in the list of the worlds big economies,


behind Poland and Norway and ahead of Belgium and
Taiwan.

The upgrade is the outcome of a process known as


rebasing.
100

Rebasing-Case Study of Nigeria


GDP is typically measured by reference to the shape
of the economy in a base year.

The weight each sector gets depends on its


importance to the economy in the base year.

As time passes the figures become less and less


accurate.

Nigerias old GDP data relied on a dated snapshot of


its economy in 1990. The new figures (which have
2010 as the base year) give due weight to fastgrowing industries such as mobile telecoms and filmmaking that have sprung up since then.
101

What Has Changed in the Nigerian Economy


Telecoms industry accounts for more than a quarter of
the upgrade in GDP.
- In 1990 the state telephone company had just a few
hundred thousand fixed-line customers. There are now
around 115m mobile-phone lines in use in Nigeria.

Manufacturing has assumed greater importance.


Factories that have opened since 1990 are being
counted.
- As a result the sectors share of the economy has grown
from less than 2% of GDP to nearly 7%.

Film-making had not shown up at all in the old figures;


now the industrys size is estimated at around 1.4% of
GDP.
102

Other Improvements in GDP Estimates

The old GDP figures were based solely on estimates of


output. The new ones are reconciled with separate
surveys of spending and income.

Perhaps the greatest advance is the inclusion of the


activity of small businesses. The sample of firms
from which the GDP data are calculated has increased
tenfold to around 850,000 establishments, including
many small ones.

The informal shops that account for the bulk of retail


and wholesale trade are now part of the GDP picture.
Indeed after telecoms, trading makes up the biggest
share of the revision.
103

What the New GDP Figures Suggest

A near-doubling of GDP is a hefty change.

- Other African countries have also bumped


their numbers up a lot by shifting the base
year, but not by quite as much.

The IMF advises that the base year should be


updated at least every five years.

- Nigeria had left it much longer and as a result


the revision is especially dramatic.

However, Nigerians are no richer than they were


before the GDP figures were revised.

- The majority of its 170m-plus people live on


less than $1.25 a day.
104

Implications of Rebasing

Why are poverty and unemployment high


when the economy is doing well as shown
by rebased GDP?

The rebasing exercise has revealed that the key


determinant of the expanding output/GDP growth
has been the dominance of capital-intensive rather
than labour-intensive activities.

This suggests that increasing adoption of


technology is leading to an expansion of output
without the need to employ more labour.

Rebasing does not change the challenges of


poverty or unemployment but rather measures the
economy more accurately so that policy can be
105
designed to address them.

What the New GDP Figures Suggest


Even so the new figures show that Nigeria is much
more than just an oil enclave.

The weight of the oil and gas industry, at 14% of


GDP, is less than half what was previously thought.

There are more factories. Service industries are


booming.

Nigeria now looks like an economy to be taken


seriously.

106

Indian GDP at a New Base

107

Indian GDP - Base Year

Current/New Series Base Year 201112


Previous series base years

1948-49 (1956) 1960-61 (1967) 1970-71


(1978)
1980-81 (1988) 1993-94 (1999) 19992000 (2006) 2004-05 (2010)

Choice of base years

Previously population census years


Currently, the NSS employmentunemployment survey years
108

108

SNA
The compilation practices of Indias NAS have
always broadly followed the United Nations System
of National Accounts (SNA).

The UN SNA underwent periodic changes in 1968,


1993 and 2008.

The presentation of accounts in Indias NAS in


recent years has generally conformed to the
standards set in SNA 1968, but the compilation
practices in regard to sector-wise data were
changed to cover some of the recommendations of
SNA 1993 to the extent that data is available.
109

109

GDP of India at 2011-12 base


GDP for the base year 2011-12 is estimated as Rs.
88.3 lakh crore.

Nominal GDP or GDP at current prices for the year


2012-13 is estimated as Rs. 99.9 lakh crore while that
for the year 2013-14 is estimated as Rs. 113.5 lakh
crore, exhibiting a growth of 13.1 percent and 13.6
percent during the years 2012-13 and 2013-14
respectively.

Real GDP or GDP at constant (2011-12) prices stands


at Rs.92.8 lakh crore and Rs.99.2 lakh crore,
respectively for the years 2012-13 and 2013-14,
showing growth of 5.1 percent during 2012-13, and
6.9 percent during 2013-14.
MEASURING A NATIONS INCOME

B.S.Misra

110

SNA

The comprehensive revisions in the methodology of


compilation and classification systems in the 201112 base have involved some radical departures that
were proposed by SNA 1993 and the latest SNA
2008 in defining gross domestic product (GDP),.

This radical departure indicated above, takes


three forms:

(i) The concept of gross value added (GVA) at


factor cost is not a concept to be explicitly used in
the SNA; it is a measure of income and not output
with observable sector of prices.
111

SNA
(ii) GDP at market prices is the GDP in

SNA, as transactions are valued at the actual


price agreed upon by the transactors - at
market prices This is now the headline
GDP as opposed to GDP at Factor Cost
previously

(iii) The SNA introduces an intermediary

concept called GVA at basic prices covering


value added at factor cost plus indirect taxes
on production net of production subsidies.

Though these recommendations were made in

SNA 1993, these were not been implemented


112 now.
112
in India for over two decades, until

GVA at Basic Prices


The concept of GVA at basic prices was
introduced by the SNA 1993 and carried
forward in an identical fashion in SNA 2008.

In the entire SNA system, the basic output


aggregate is GDP measured at purchasers
prices.

These purchasers values include indirect


taxes net of subsidies.

It is in the classification of indirect taxes (net


of subsidies) that distinguishes the SNA 1993
and SNA 2008 from the SNA 1968.
113

113

GVA at Basic Prices


The two former SNAs classify indirect taxes (net of
subsidies) into two categories:

(i) indirect taxes on production (net of subsidies on


production) and (ii) indirect taxes on products (net
of subsidies on products).

The SNA 1968 made no such distinction, and


covered all indirect taxes under one bracket,
whether levied on units of commodities such as
excise duties, sales taxes, and customs duties are,
or on production activities involving the
employment of land, labour and the use of fixed
assets or on general business activities attracting
business licence fees, transaction (e g, stamp)
114
duties, and real estate taxes.

GVA at Basic Prices

GVA at basic prices includes the


contribution of factors of production
(land, labour, capital, and
entrepreneurship) in the production
process and the amount appropriated by
the government in the form of taxes on
production (net of subsidies on
production).

These taxes on production are said to be


taxes levied on some aspect of a
business or the other.

115

GVA at Basic Prices


In the Indian NAS, some examples of
taxes on production specified are: land
revenue, stamps and registration fees,
and profession taxes.

Subsidies on production are: subsidies to


the railways, input subsidies to farmers,
subsidies to village and small industries,
administrative subsidies to corporations or
cooperatives, etc.

116

GDP at Basic Prices


Thus, the basic price receivable by the
producer from the purchaser for a good or
service covers both factor cost and the
taxes on production (net of subsidies on
production), which are incurred before the
product is ready for sale; it is thereafter
that indirect taxes on products are levied
(except valued added tax, VAT).

117

118

119

120

National Accounts Formulae as per 2011-12 Base

1. GVA at basic prices = CE + OS/MI + CFC +


Production taxes less Production subsidies

2. GVA at factor cost (earlier referred to as GDP at


factor cost) = GVA at basic prices Production taxes
less Production subsidies

3. GDP = GVA at basic prices + Product taxes Product subsidies

4. NDP/NNI = GDP/GNI - CFC


5. GNI = GDP + Net primary income from ROW
(Receipts less payments)

6. Primary Incomes = CE + Property and


Entrepreneurial Income
121

National Accounts Formulae as per 2011-12 Base


7. NNDI =NNI + other current transfers from
ROW, net (Receipts less payments)

8. GNDI = NNDI + CFC = GNI + other current


transfers from ROW, net (Receipts less payments)

9. Gross Capital Formation= Gross Savings+ Net


Capital Inflow from ROW

10. GCF = GFCF + CIS + Valuables + Errors and


Omissions

11. Gross Disposable Income of Govt. = GFCE +


Gross Saving of GG

12. Gross Disposable Income of Households =


GNDI GDI of Govt. Gross Savings of All
Corporations
122

Acronyms used in the Formulae


GDP: Gross Domestic Product

GVA: Gross Value Added


GNI: Gross National Income

NDP: Net Domestic Product


NNI: Net National Income

GNDI: Gross National Disposable Income


PFCE: Private Final Consumption Expenditure

123

Acronyms used in the Formulae

GFCE: Government Final Consumption


Expenditure

CFC: Consumption of Fixed Capital


GFCF: Gross Fixed Capital Formation

CIS: Changes in Stock


CE: Compensation of Employees

OS: Operating Surplus


MI: Mixed Income

ROW: Rest of the World


124

GDP in 2012 base

GDP at factor cost=GVA at factor


cost=payment to all factors of production
excluding government. In this concept we
dont use any form of tax or subsidies for
adjustment

GVA at basic price= GVA at factor cost +


production tax-production subsidy.

GDP at market price=Payment to factors of


production + production tax+ product taxproduction subsidy-product subsidy

=payment to all factors of production


including government

125

GDP in 2012 base


Before the product is sold to the consumer, the
distributor or wholesaler purchases the product
from the producer.

The producer charges the distributor not only the


payment to factors of production but also the
amount paid to government on production like
license fee, land revenue, stamp duty and
registration fees .

The retailer while sells the product to the


consumer the retailer also collects sales tax
126

GDP in 2012 base


Production taxes or subsidies are paid or
received with relation to production and are
independent of the volume of actual production.
Some examples are:

Production Taxes - Land Revenues, Stamps and


Registration fees and Tax on profession

Production Subsidies - Subsidies to Railways,


Input subsidies to farmers, Subsidies to village
and small industries, Administrative subsidies to
corporations or cooperatives, etc.
127

GDP in 2012 base


Product taxes or subsidies are paid or received
on per unit of product. Some examples are:

Product Taxes: Excise Tax, Sales tax, Service


Tax and Import and Export duties

Product Subsidies: Food, Petroleum and


fertilizer subsidies, Interest subsidies given to
farmers, households etc. through banks,
Subsidies for providing insurance to households
at lower rates

128

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