Economic Development- INTRODUCTION TO ECONOMICS & NATIONAL …

Economic Development- INTRODUCTION TO ECONOMICS & NATIONAL INCOME ACCOUNTING

CONTENT

INTRODUCTION TO ECONOMICS 1-5

1. BASICS OF ECONOMICS 2. STRUCTURAL COMPOSITION OF ECONOMY 3. FACTORS OF PRODUCTION 4. TYPES OF GOODS

1 3 4 4

NATIONAL INCOME ACCOUNTING 6-17

1. BASIC CONCEPTS 2. CIRCULAR FLOW OF INCOME 3. GROSS DOMESTIC PRODUCT (GDP) AND GROSS NATIONAL PRODUCT (GNP) 4. MARKET PRICE AND FACTOR COST 5. SOME OTHER BASIC CONCEPTS

6 6 7 9 10 10 10 10 11 11 12 12 13 14 15 15 16 16 16

5.1 NET NATIONAL PRODUCT (NNP) 5.2 PERSONAL INCOME (PI) 5.3 DISPOSABLE INCOME (DI) 5.4 BASE YEAR 5.5 GDP DEFLATOR 5.6 POTENTIAL OUTPUT 5.7 NEW GDP SERIES 5.8 DIFFICULTIES FACED IN ESTIMATING NATIONAL INCOME 5.9 GDP AND WELFARE 5.10 MEASURING DEVELOPMENT 5.11 HUMAN DEVELOPMENT INDEX 5.12 GROSS NATIONAL HAPPINESS (GNH) 5.13 GENDER INEQUALITY INDEX (GII) 5.14 INCLUSIVE DEVELOPMENT INDEX (IDI) 5.15 SOCIAL PROGRESS INDEX (SPI)

Economic Development- INTRODUCTION TO ECONOMICS 1

TOPIC

1 INTRODUCTION TO ECONOMICS

Economics is the science of analyzing the production, distribution and consumption of goods and services. In other words, what choices people make; how and why they make them when making purchases. Scarcity is the basic economic problem that exists because we as humans have unlimited wants that cannot be met by the limited amount of resources our world has. Any good or service that has a non-zero price is considered scarce. It will cost you something to consume that good or service. Without scarcity, there would be no reason to study economics. People would consume everything they could possibly consume and not have to make choices or trade-offs between goods and services. The study of economics can be subcategorized into micro-economics and macro-economics. • Microeconomics is the study of economics at the individual or business level; how individual people or businesses behave given scarcity and government intervention. Microeconomics includes concepts such as supply and demand, price elasticity, quantity demanded and quantity supplied. • Macroeconomics is the study of the performance and structure of the whole economy rather than individual markets. Macroeconomics includes concepts such as inflation, international trade, unemployment, and national consumption and production. There are also schools of economic thought. Two of the most common are Classical and Keynesian. • The Classical view believes that free markets are the best way to allocate resources and the government's role should be limited to that of a fair and strict referee. • In contrast, the Keynesian approach believes that markets don't work well at allocating resources on their own and that governments must step in from time to time and actively reallocates resources efficiently.

1.1 IN TERMS OF THE ROLE OF STATE The most contentious issue that has affected civilized history of mankind is as to how the production process in an economy should be organized. Whether the production should be the sole responsibility of State/Government or should it be left altogether to the private sector? Every society has to answer three questions which determine the type of economic system: • What goods and services should be produced in the country? • How should the goods and services be produced? Should producers use more human labour or more capital (machines) for producing things? • How should the goods and services be distributed among people? Based on the answer of these three questions, the economic systems are classified into 3 categories: 1. Capitalistic Economy The capitalistic form of economy has its origin in the famous work of Adam Smith - Wealth of Nations (1776). He stressed on 'laissez faire' state i.e. non-interference by the government.

The decisions of what to produce, how much to produce and at what price to sell are taken by the market, by the private enterprises in this system with the state having no economic role. • In a capitalist economy, the market determines prices through the laws of supply and demand.

1. BASICS OF ECONOMICS


For example, when demand for coffee increases, a profit-seeking business will boost prices in order to increase its profit. If, at the same time, society's appetite for tea diminishes, growers will face lower prices and aggregate production will decline. In the long run, some suppliers may even exit the business. • If labour is cheaper than capital, more labour-intensive methods of production will be used and vice-versa. • In a capitalist society the goods produced are distributed among people not on the basis of what people need but on the basis of what people can afford and are willing to purchase. This means that a sick person will be able to use the required medicine only if he/she can afford to buy it; if they cannot afford the medicine they will not be able to use it even if they need it urgently. 2. Socialistic Economy or State Economy The socialistic form of economy was rooted in the ideas of historical change proposed by the German philosopher Karl Marx (1818-1883). More specifically, this kind of economic system first came up in the erstwhile USSR after the Bolshevik Revolution (1917) and got its ideal shape in the People's Republic of China (1949). Under a true socialist system, it's the government's role to determine output and pricing levels. The challenge is synchronizing these decisions with the needs of consumers. A socialist society answers the three questions in a totally different manner: • In a socialist society the government decides what goods are to be produced in accordance with the needs of society. It is assumed that the government knows what is good for the people of the country and so the desires of individual consumers are not given much importance. • The government decides how goods are to be produced and how they should be distributed. • In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. Unlike under capitalism, for example, a socialist nation provides free health care to the citizens who need it. Strictly, a socialist society has no private property since everything is owned by the state. There are two versions of the state economy - in erstwhile USSR known as the socialist economy and in pre-1985 China as the communist economy. • Socialistic economy emphasized the collective ownership of the means of production (property and assets) and it also ascribed a large role to the state in running the economy, • Communist economy advocated state ownership of all properties including even labor and absolute power to state in running the economy. 3. Mixed Economy It is an economic system that features characteristics of both capitalism and socialism. A mixed economic system allows a level of private economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims. This type of economic system is less efficient than capitalism, but more efficient than socialism. Mixed economic systems are not laissez-faire systems: the government is involved in planning the use of resources and can exert control over businesses in the private sector. Governments may seek to redistribute wealth by taxing the private sector, and using funds from taxes to promote social objectives. Which model was adopted by the Indian Economy? The leaders of Independent India had to decide the type of economic system most suitable for our nation which would promote the welfare of all rather than a few. Among the different types of economic systems, socialism appealed to Jawaharlal Nehru the most. However, he was not in favour of the kind of socialism established in the former Soviet Union where all the means of production, i.e. all the factories and farms in the country, were owned by the government. There was no private property. It was not possible in a democracy like India for the government to change the ownership pattern of land and other properties of its citizens in the way that it was done in the former Soviet Union. The leaders found the answer in an economic system which, in their view, combined the best features of socialism without its drawbacks. In this view, India would be a socialist society with a strong public sector but also with private property and democracy; the government would plan economy with the private sector being encouraged to be part of the plan effort. So, after Independence, India opted for the Mixed Economy. In the process of organizing the economy, some basic and important infrastructural economic responsibilities were taken up by the State/Governments (centre and state) and rest of the economic activities was left to private enterprise i.e. the market. But once the country started the process of economic reforms in early 1990s, the prevailing state-market mix was redefined and a new form of mixed economy began to be practised. • The redefined mixed economy for India had a declared favour for the market economy. • Many economic roles which were under complete government monopolies were now opened for participation by the


private sector. Examples are many - telecommunication, power, roads, oil and natural gas, etc. • At the same time, social sector such as education, health care, drinking water, etc were given extra emphasis by the state. The economic system of India was a mixed economy in pre-1991 years as it is in post-1991 years but the composition of state-market mix has gone for a change. 1.2 IN TERMS OF PER CAPITA INCOME The World Bank classifies economies based on their GNI per capita. The categories are given below: Categorization Per Capita GNI (2020)Low-Income Economy $1,036 or lessLower Middle-Income Economy Between $1,036 and $4045 Upper Middle-Income Economy Between $40466 and $12375 High-Income Economy $12376 or moreLow- and middle-income economies are usually referred to as developing economies, and the Upper Middle Income and the High Income are referred to as Developed Countries. India is categorized in the Lower Middle Income Category. 1.3 IN TERMS OF THE NATURE OF ECONOMY Depending upon the shares of the particular sectors in the total production of an economy and the ratio of the dependent population on them for their livelihood, economies are given different names, such as: Agrarian Economy An economy is called agrarian if the share of its primary sector is 50 per cent or more in the total output (the GDP) of the economy. At the time of independence, India was such an economy. But now it shows the typical symptom of a service economy with primary sector's contribution falling to almost 18 per cent of its total produce while almost 60 per cent of its population depends on the primary sector for its livelihood. Thus, in monetary terms India is no more an agrarian economy. Industrial Economy If the secondary sector contributes 50 per cent or more to the total produce value of an economy, it is an industrial economy. Higher the contribution, higher is the level of industrialization. Most of the developed economies have crossed this phase once the process of industrialization saturated. Service Economy The economy whose 50 per cent or more produce value comes from the tertiary sector is known as the service economy.

The contribution made by the different sectors of the economy, namely the agricultural sector, the industrial sector and the service sector in the GDP of the country makes up the structural composition of the economy. In some countries, growth in agriculture contributes more to the GDP growth, while in some countries the growth in the service sector contributes more to GDP growth. Primary Sector The primary sector involves the extraction of raw materials from the earth. Therefore, this is sometimes known as the Extraction Sector. This extraction results in raw materials and basic foods, such as coal, wood, iron and corn. Secondary Sector The secondary sector involves the transformation of raw materials into finished or manufactured goods. This sector is rightly called the manufacturing sector. Since the manufacturing is done by the industries this sector is also called the industrial sector - bread and biscuits, cakes, automobiles, textiles, etc. Tertiary Sector The service sector is concerned with the intangible aspect of offering services to consumers and business. It involves retail of the manufactured goods. It also provides services, such as insurance and banking. Quaternary Sector The quaternary sector is said to be the intellectual aspect of the economy. It includes education, training, the development of technology and research and development. It is the process which enables entrepreneurs to innovate better manufacturing processes and improve the quality of services offered in the economy. Without this growth of technology and information, economic development would be slow or non-existent. Structural Transformation of an Indian Economy Structural transformation in an economy is usually associated with the changes in sectoral composition of output, employment and changes in the rural - urban composition of output and employment.

2. STRUCTURAL COMPOSITION OF ECONOMY


As a country develops, it undergoes 'structural change'. Usually, with development, the share of agriculture declines and the share of industry become dominant. At higher levels of development, the service sector contributes more to the GDP than the other two sectors. So, in general it follows the below trend as experienced by many developed countries such as US, UK etc. or by developing countries like China etc. Agriculture (Primary Sector) → Industry (Secondary Sector) → Service (Tertiary Sector)

But in the case of India, the structural change is peculiar. • The share of agriculture in Indian GDP fell from > 40% in the early 1960s to around 17% by the end of the 2000s. • It is to be noted that the rate of decline in the agricultural share accelerated as the rate of economic growth increased. • The share of industry as a whole rose from about 20% in 1960 to around 28% in 2009, whereas the share of manufacturing alone disappointingly stayed at around 15% during the entire period, again a sign of sluggish structural transformation. • By 1990 the share of the service sector was 40.59 per cent, more than that of agriculture or industry, like what we find in developed nations. This phenomenon of growing share of the service sector was accelerated in the post 1991 period. • Presently, service sector has emerged as the largest and fastest growing sector of the economy with around more than fifty percent contribution to the GDP (at current prices) in 2015 as per Economic Survey 2015-16. • The distinctive feature of India's growth has been the increasing contribution of service sector to GDP growth. (Also referred as Growing Tertiarization of Indian Economy)

It is an economic term to describe the inputs that are used in the production of goods or services in the attempt to make an economic profit. The factors of production include land, labor, capital and entrepreneurship. Land • Land is the economic resource encompassing natural resources found within a nation's economy. • This resource includes timber, land, fisheries, farms and other similar natural resources. • Land is usually a limited resource for many economies. Example: India has 15% of the global population but only 2.4% of the global land. Labour • Labor represents the human capital available to transform raw or national resources into consumer goods. • Human capital includes all able-bodied individuals capable of working in the nation's economy and providing various services to other individuals or businesses. • This factor of production is a flexible resource as workers can be allocated to different areas of the economy for producing consumer goods or services. • Human capital can also be improved through training or educating workers Capital • Capital has two economic definitions as a factor of production. • Capital can represent the monetary resources companies use to purchase natural resources, land and other capital goods. • Capital also represents the major physical assets individuals and companies use when producing goods or services. These assets include buildings, production facilities, equipment, vehicles and other similar items. Entrepreneurship • Entrepreneurship is considered a factor of production because economic resources can exist in an economy and not be transformed into consumer goods. • Entrepreneurs usually have an idea for creating a valuable good or service and assume the risk involved with transforming economic resources into consumer products.

Final Goods Any good or service purchased by the consumer (Individual or Enterprise) can be for final use or for use in further production. An item that is meant for final use and will not pass through any more stages of production or transformations is called a final good. Why do we call this a final good? • Once it has been sold, it passes out of the active economic flow. • It will not undergo any further transformation at the hands of any producer.

4. TYPES OF GOODS

3. FACTORS OF PRODUCTION


• It may, however, undergo transformation by the action of the ultimate purchaser. In fact, many such final goods are transformed during their consumption. Example: The tea leaves purchased by the consumer are not consumed in that form - they are used to make drinkable tea which is consumed. Similarly, most of the items that enter our kitchen are transformed through the process of cooking. But cooking at home is not an economic activity even though the product involved undergoes transformation. Home cooked food is not sold to the market. However if the same cooking or tea brewing was done in a restaurant where the cooked product would be sold to the customers, then the same items such as tea leaves would cease to be final goods and would be counted as inputs to which economic addition takes place. Thus, it is not in the nature of the good but in the economic nature of its use that a good becomes a final good. Final Goods can be distinguished between Consumption Goods and Capital Goods.

Consumer Goods Capital Goods • These goods are consumed to satisfy current wants of consumers directly. • For example, food, shirt, shoes, cigarettes, pen, TV set, and radio, etc. are all consumer goods. • Similarly, services rendered to consumers by hotels, retailers, barbers, etc. are consumer services. • Consumption goods sustain the basic objective of an economy, i.e., to sustain the consumption of entire population of the economy. • Consumer goods are further classified into durable and non-durable goods. • Durable goods are those which can be used in consumption again and again over a considerable period of time, e.g., chair, car, fridge, shoes, TV set. • Non-durable goods are like single use goods which are used up by consumers in a single act of consumption, e.g., milk, fruits, matches, cigarettes, coal, etc.

• There are the goods that are of durable character which are used in the production process. • While they make production of other commodities feasible, they themselves don't get transformed in the production process. • These goods form a part of capital, one of the crucial factors of production in which a productive enterprise has invested. • They gradually undergo wear and tear, and thus are repaired or gradually replaced over time.

Intermediate Goods Of the total production taking place in the economy a large number of products don't end up in final consumption and are not capital goods either. Such goods may be used by other producers as material inputs. Examples are steel sheets used for making automobiles and copper used for making utensils. These are intermediate goods, mostly used as raw material or inputs for production of other commodities. These are not final goods.

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Economic Development- NATIONAL INCOME ACCOUNTING 6

TOPIC

2 NATIONAL INCOME ACCOUNTING

Economic growth Economic growth is the change - increase or decrease in the value of goods and services produced by an economy. If it is positive, it means an increase in the output and the income of a country. It is generally shown as the increase in percentage terms of real gross domestic product (GDP adjusted to inflation) or real GDP. Measuring Growth Measures of national income and output are used in economics to estimate the value of goods and services produced in an economy. Common measures are Gross National Product (GNP) and Gross Domestic Product (GDP). National Income National Income is the money value of all final goods and services produced in an economy during a financial year. At the level of an economy, value of final goods and services is equal to the total income of all factors of production via labor, capital, land and entrepreneurship. There are different measures of national income like Gross National Product (GNP), Net National Product (NNP), Gross Domestic Product (GDP), Net Domestic Product (NDP), etc.

The firms will produce goods and services and pay remunerations to the factors of production. These remunerations will once again be used to buy the goods and services. Hence year after year we can imagine the aggregate income of the economy going through the two sectors, firms and households, in a circular way. This is represented in the Figure below. • When the income is being spent on the goods and services produced by the firms, it takes the form of aggregate expenditure received by the firms. Since the value of expenditure must be equal to the value of goods and services, we can equivalently measure the aggregate income by "calculating the aggregate value of goods and services produced by the firms". • When the aggregate revenue received by the firms is paid out to the factors of production, it takes the form of aggregate income.

In the above figure: • The uppermost arrow going from the households to the firms represents spending the households undertake to buy goods and services produced by the firms. • The second arrow going from the firms to the households is the counterpart of the arrow above. It stands for goods and services which are flowing from the firms to the households. In other words, this flow is what the households are getting from the firms, for which they are making the expenditures. In short, the two arrows on the top represent the goods and services market - the arrow above represents the flow of payments for the goods and services, the arrow below represents the flow of goods and services. The two arrows at the bottom of the diagram similarly represent the factors of production market. • The third arrow going from the households to the firms symbolizes the services that the households are rendering to the firms. Using these services the firms are manufacturing the output. • The lowermost arrow, going from the firms to the households, represents the payments made by the firms to the households for the services provided by the latter.

2. CIRCULAR FLOW OF INCOME

1. BASIC CONCEPTS


3.1 GROSS DOMESTIC PRODUCT (GDP) Gross Domestic Product (GDP) is the value of all the final marketable goods and services taking place within the domestic economy during a year. It will be better to understand the terms used in the concept, • 'Gross' means 'total' means to Mathematics; • 'Domestic' means all the economic activities done inside the boundary of the nation/country and by its own capital; • 'Product' is word to define 'goods and services' together; and • 'Final' means the stage of a product after which there is no known chance of value addition in it. (Read about the characteristics of Final goods and services in the first chapter) Domestic Territory What domestic (economic) territory includes? • Territory lying within the political frontiers of a country. It includes territorial waters also. • Ships and aircrafts owned and operated by the residents between two or more countries. For Instance, Indian ships moving between UK and Pakistan regularly or passenger planes operated by Air India between Russia and Japan are parts of domestic territory of India. • Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters or engaged in extraction in areas where the country has exclusive rights of operation. For example, fishing boats operated by Indian fishermen in the international waters of the Indian Ocean will be considered as a part of domestic territory of India. • Embassies, consulates and military establishments of the country located abroad. To illustrate, Indian embassies in Russia, America and other countries will form parts of domestic territory of India. Similarly, embassies of other countries like Japan, Russia, America located in India are parts of domestic territories of their own countries and not of India. What domestic territory does not include: • Territorial enclaves (like embassies) used/administered by foreign governments. • International organizations which are physically located within geographical boundaries of a country. Their offices form part of international territory. Resident (Normal Resident) of a Country National income has also been defined as "Sum total of factor incomes earned by the normal residents of a country during a year." Thus, like domestic territory, normal resident has a special meaning and importance in national accounting. A resident is said to be a person (or institution) who ordinarily resides in a country and whose centre of economic interest lies in that country. He is called a normal resident since he normally lives in the country of his economic interest. The period of stay should be at least one year or more. Thus, (i) staying for more than a year and (ii) having economic interest [e.g. earning, spending, accumulation) are the two normal conditions for becoming a normal resident. Following points need to be noted: • Normal residents cover both individuals and institutions. • Normal residents Include both citizens and non-citizens, i.e., foreigners who reside in a country for more than a year and have economic interest in that country. • International bodies like World Bank, World Health Organization or International Monetary Fund are not considered residents of the country in which these organizations operate but are treated as residents of international territory. However, the staffs of these bodies are treated as normal residents of the country in which the international body operates. For example, international body like World Health Organization located in India is not normal resident of India but Americans working in its office for more than a year will be treated as normal residents of India. • Local employees working in foreign embassies located in their country are treated as normal residents. For example, Indians working in US embassy located in India are residents of India. • Workers from across the border who cross border in the morning to work in the other country (like Indians who work in Nepal) and return in the evening are not residents of the country where they work. Normal residents of India include • Citizens (and institutions) of India, • Citizens of other countries (i.e., non-citizens) who normally reside in India for more than a year and whose centre of economic interest lies in India, • Citizens of India working in (a) international bodies like I.M.F. (b) foreign bodies like banks, enterprises operating in India and (c) foreign embassies located in India.

3. GROSS DOMESTIC PRODUCT (GDP) AND GROSS NATIONAL PRODUCT (GNP)


Nominal GDP (GDP at Current Price) When GDP of a given year is estimated on the basis of price of the same year, it is called nominal GDP i.e. Nominal GDP refers to the current year production of final goods and services valued at current year prices. Real GDP (GDP at Constant Price) When GDP of a given year is estimated on the basis of price of Base Year, it is called real GDP i.e. Real GDP refers to the current-year production of goods and service valued at base year prices. Base year prices are constant price. Which is better: Nominal GDP or Real GDP? Real GDP is better as compared to Nominal GDP because of following reasons: • Real GDP helps in determining the effect of increased production of goods and services as it is affected by change in physical output only. On the other hand, Nominal GDP can increase even without any increase in physical output as it is affected by change in prices also. • Real GDP is a better measure to make periodic comparison in the physical output of goods and services over different years. • Real GDP facilitates international comparison of economic performance across the countries. Therefore, Real GDP is better than Nominal GDP as it truly reflects the growth of an Economy. Some important points about the GDP: • In estimating GDP, only final marketable goods and services are considered. When it is compared to the base year figure, the real growth levels are seen. • Gains from resale are excluded but the services provided by the agents are counted. That is, when a used car or house is sold, no new goods are being produced. But the real estate or the auto agent makes some money though commission which adds to the service economy. Similarly, transfer payments (pensions, scholarships etc) are excluded as there is income received but no good or service produced in return. • Not all goods and services from productive activities enter into market transactions. Hence, imputations are made for these non-marketed but productive activities: for example, imputed rental for owner-occupied housing. • The value of intermediate goods are a part of the final goods and services and so are not counted separately as it

amounts to double counting and exaggerates the value of the output. • Transfer payment refers to payments made by government to individuals for which there no economic activity is produced in return by these individuals. Examples of transfer are scholarship, pension. Thus, they are also not included in the calculation of GDP.

3.2 GROSS NATIONAL PRODUCT (GNP) Gross National Product (GNP) is a broad measure of a nation's total economic activity. GNP is the value of all finished goods and services produced in a country in one year by its nationals.

Net Factor Income from Abroad: Factor Income earned by the domestic factors of production employed in the rest of the world - Factor Income earned by the factors of production of the rest of the world employed in the domestic economy. What does Net Factor Income from Abroad stand for? The sum of factor incomes such as wages and salaries (i. e. compensation of employees), rent, interest and profits generated within the domestic territory of a country in a year is called Domestic Factor Income. It includes factor incomes generated both by residents and non-residents working in the domestic territory of a country. For example, non-residents (i.e., foreigners) work in the domestic territory of India and earn wages and salary. Thus, foreign individuals and companies from the USA, Great Britain and other countries have acquired property such as factories, offices, buildings, places and have also acquired financial assets such as bonds and shares of Indian companies. This generates incomes in the form of rent and interest to them. In addition to this, foreign residents - individuals and companies - have set up industrial plants and factories producing goods and services from which they earn profits. On the other hand, Indians go abroad and work in the territories of other countries and earn wages and salaries. Likewise, some Indian individuals and corporate companies have acquired assets such as buildings, factories, commercial space, and have also invested in bonds, bank deposits of foreign countries and thus receive rent and interest. Some Indian companies have set up factories abroad and earn profits. Now, the net factor income from abroad is the difference between factor income received from abroad by normal residents of India for rendering factor services in other countries on the one hand and the factor incomes paid to the foreign residents for factor services rendered by them in the domestic territory of India on the other. It should however be noted that net factor income from abroad should not be confused with income from net exports which are a part of both gross national product (GNP) and gross domestic product (GDP). Net exports equal total


exports minus imports. Gross exports are the total value of domestically produced goods and services sold to foreign buyers in a year and are therefore a part of Gross Domestic Product (GDP) and not a factor income from abroad. On the other hand, imports are the value of imported goods and services purchased by the domestic buyers. Therefore, imports do not form a part of GDP or GNP. In national income accounting, we subtract the value of imports from the value of exports to arrive at net exports which are a part of GDP and therefore also of GNP. Thus, earnings from net exports are quite distinct from net factor income from abroad. Example - GNP versus GDP: • Honda manufactures cars in the U.S., but is incorporated in Japan. The cars it produces in the U.S. are added to U.S. GDP, but not U.S. GNP as these cars use domestic factors of production (labour and resources), but are produced by a foreign nation. Conversely, the values are added to Japan's GNP, but not Japan's GDP. GDP shows how much is produced within the boundaries of the country by both the citizens and the foreigners. GDP focuses on where the output is produced rather than who produced it - it is a geographical concept. GDP measures all domestic production, disregarding the producing entities nationalities. . In contrast, GNP is a measure of the value of the output produced by the "nationals" of a country both within the geographical boundaries and outside. That is all the output that the Indian citizens produce in a given year both within India and all other countries makes up the GNP of India. GDP and GNP Case-I GDP is essentially about where production takes place. GNP is about who produces. If it is an open economy with great levels of foreign investment (FDI) and lesser levels of outbound FDI, its GDP is likely to be larger than GNP. Case-II If it is an open economy but more of its nationals tend to move economic activity abroad or earn more from investing abroad compared with non-nationals doing business and earning incomes within its borders, its GNP will be larger than GDP. Case-III If it is a closed economy where nobody leaves its shores, nobody invests abroad, nobody comes in and nobody invests in the country its GDP will be equal to GNP.

Market price refers to the actual transacted price and it includes indirect taxes (not direct taxes) - custom duty, excise duty, sales tax, service tax etc. Factor cost refers to the actual cost of the various factors of production and it includes government grants and subsidies but it excludes indirect taxes. They are really the costs of all the factors of production such as land, labor, capital, energy, raw materials like steel etc that are used to produce a given quantity of-output in an economy. They are also called Factor Gate Costs (farm gate, firm gate and factory gate) since all the costs that are incurred to produce a given quantity of goods and services take place behind the factory gate i.e. within the walls of the firms, plants etc in an economy. Relationship between Market Price

and Factor Cost METHODS OF ESTIMATING GDP/GNP

(DISCUSSED IN THE CLASS) 1. Income Method: Wages (W) + Interests (I) + Rent (R) + Profits (P) 2. Expenditure Method: Consumption (C) + Investments (I) + Government Purchases (G) + Net Exports (X) 3. Production Method: Gross Value Added

4. MARKET PRICE AND FACTOR COST


5.1 NET NATIONAL PRODUCT (NNP) In the production of gross national product of a year, we consume or use up some fixed capital i.e. equipment, machinery, etc. The capital goods, like machinery, wear out or fall in value as a result of its consumption or use in the production process. This consumption of fixed capital or fall in the value of fixed capital due to wear and tear is called depreciation. When charges for depreciation are deducted from the gross national product we get net national product. Clearly, it means the market value of all final goods and services after providing for depreciation. Characteristics of Depreciation The depreciation charged on fixed assets has the following features: • Depreciation is always a fall in the value of asset. • This fall is always gradual. • The fall is of permanent character and it cannot be recouped afterwards. • The depreciation is a continuous process and it does not matter whether the asset was put to use during the period or not. • Depreciation is always on fixed assets and not on current or floating assets. • Depreciation is the fall in the book value of the asset and not in market or exchange value. • Depreciation is the result of the use of assets, passage of time and obsolescence. National Income at factor cost which is also simply called national income means the sum of a incomes earned by resource suppliers for their contribution of land, labour, capital and entrepreneurial ability which go into the year's net production. In other words, national income (or national income at factor cost) shows how much it costs society in terms of economic resources to produce net output. It is really the national income at factor cost for which we use the term National Income (NI).

5.2 PERSONAL INCOME (PI) Personal Income is the sum of all incomes actually received by all individuals or households during a given year. • First, let us note that out of NI which is earned by the firms and government enterprises, a part of profit is not distributed among the factors of production. This is called Undistributed Profits (UPs). We have to deduct UP from NI to arrive at

PI, since UP does not accrue to the households. • Similarly, Corporate Tax which is imposed on the earnings made by the firms will also have to be deducted from the NI since it does not accrue to the households. • On the other hand, the households do receive interest payments from private firms or the government on past loans advanced by them. And households may have to pay interests to the firms and government as well, in case they had borrowed money from either. So, we have to deduct the net interests paid by the households to the firms and government. • The households receive transfer payments from government and firms (pensions, scholarships, prizes for example) which have to be added to calculate the Personal Income of the households.

5.3 DISPOSABLE INCOME (DI) Even whole of the incomes which are actually received by the people are not available to them for consumption. This is because governments levy some personal taxes such as income tax, personal property taxes. Therefore, after a part of personal income is paid to government in the form of personal taxes like income tax, personal property taxes, etc. and in the form of Non-Tax payments (such as fines), what remains of personal income is called disposable income. Therefore,

Disposable Income = Personal Income - Personal Taxes - Non-Tax Payments Disposable Income can either be either consumed or saved. Hence, Disposable Income = Consumption + Saving

National Disposable Income and Private Income Apart from these categories of aggregate macroeconomic variables, in India, a few other aggregate income categories are also used in National Income Accounting.

5. SOME OTHER BASIC CONCEPTS


• National Disposable Income = Net National Product at market prices + other current transfers from the rest of the world. The idea behind National Disposable Income is that it gives an idea of what is the maximum amount of goods and services the domestic economy has at its disposal. Current transfers from the rest of the world include items such as gifts, aids, etc. • Private Income = Factor income from net domestic product accruing to the private sector + National debt interest + Net factor income from abroad + Current transfers from government + Other net transfers from the rest of the world.

NFIA : Net Factor Income from Abroad D : Depreciation ID : Indirect Taxes Sub : Subsidies PTP : Personal Tax Payments UP : Undistributed Profits NIH : Net Interest Payments by households CT : Corporate Taxes TrH : Transfers received by the Households NP : Non-tax Payments

5.4 BASE YEAR For examining the performance of the economy in real terms through the measurement of Gross Domestic Product (GDP), national income, consumption expenditure, capital formation etc. estimates are prepared at the prices of selected year known as base year. Base year is a specific year from which the economic growth is measured. It is allocated the value of 100 in an index. The estimates at the prevailing prices of the current year are termed as "at current prices", while those prepared at base year prices are termed "at constant prices". The comparison of the two estimates gives the measure of real growth. It means the production of the current year is valued at base year prices so that the real growth is worked out by deducting the impact of inflation or deflation. That is, the increase in the value of the GDP due to inflation is excluded and the 'real increase' is found out. The base year of the national accounts is changed periodically to take into account the structural changes which take place in the economy and to depict a true picture of the economy through measures like GDP. Recently, Base Year of the calculating National Income have been shifted from 2004 - 05 to 2011 - 12. Normally, when the base year of national accounts statistics is changed, there is some change in the levels of GDP estimates. This happens due to widening the coverage. A base year has to be a normal year without large fluctuations in production, trade and prices of commodities in general. Reliable price data should be available for it. It should be as recent as possible. The National Statistical Commission wants that base year should be revised every five years. 5.5 GDP DEFLATOR GDP deflator measures the ratio of nominal (or current price) GDP to the real (or chain volume) measure of GDP. The formula used to calculate the deflator is:

The nominal GDP of a given year is computed using that year's prices, while the real GDP of that year is computed using the base year's prices. The formula implies that dividing the nominal GDP by the GDP deflator and multiplying it by 100 will give the real GDP, hence "deflating" the nominal GDP into a real measure. • A price deflator of 200 means that the current year price of this computing power is twice its base year price - price inflation. • A price deflator of 50 means that the current year price is half the base year price - price deflation.

(For difference between the GDP Deflator and Other Indices of Inflation read the chapter Inflation.)


5.6 POTENTIAL OUTPUT Potential output basically means the level of output that an economy can attain without stroking inflation or deflation. The International Monetary Fund (IMF) in its latest World Economic Outlook (April 2015) described it thus: "Potential output is defined as the level of output consistent with stable inflation (no inflationary or deflationary pressure)." It further explained that the difference between potential and actual output is referred as output gap. So, if the output is below potential, it means that available factors of production such as labour and capital are not being fully utilized. Just as GDP can rise or fall, the output gap can go in two directions: positive and negative. Neither is ideal. • A positive output gap occurs when actual output is more than full - capacity output. This happens when demand is very high and to meet that demand, factories and workers operate far above their most efficient capacity. All else equal, if the output gap is positive over time, so that actual output is greater than potential output, prices will begin to rise in response to demand pressure in key markets. • A negative output gap occurs when actual output is less than what an economy could produce at full capacity. A negative gap means that there is spare capacity, or slack, in the economy due to weak demand. Similarly, if actual output falls below potential output over time, prices will begin to fall to reflect weak demand. An output gap suggests that an economy is running at an inefficient rate - either overworking or under-working its resources. Therefore, it is important for policy makers to know the potential output the economy can produce to be able to take more informed decisions. It is important to know what the level of potential output is as it tells you where you are in the business cycle and, therefore, how to position policy, said Michael D. Patra, executive director, Reserve Bank of India (RBI), in a post policy conference call with analysts after the release of the first bi-monthly policy statement for the financial year 2015-16. However, it is not easy to determine potential output. "Estimating potential output from historical data is difficult even in the best of times. It has become much more complex in the aftermath of the global financial crisis when potential output across the world is likely to have fallen, led by decline in productivity," noted The Monetary Policy Report (April 2015) of the RBI. Things in India have become even more complicated after the revision of gross domestic product data. According to the IMF, globally, the potential output has declined in recent years. "In advanced economies, this decline started as far back as the early 2000s and worsened with the global financial crisis. In emerging market economies, in contrast, it began only after the crisis," said the World Economic Outlook. Aging population is a big factor behind decline in potential output in both emerging markets and advanced economies. Besides, in emerging markets, weaker investment and lower productivity growth are also contributing to the decline. 5.7 NEW GDP SERIES The current base year revision follows the revision undertaken in January 2010. The following are the major changes incorporated in the just-concluded base-year revision: 1. Headline growth rate will now be measured by GDP at constant market prices, which will henceforth be referred to as 'GDP', as is the practice internationally. Earlier, growth was measured in terms of growth rate in GDP at factor cost at constant prices. 2. Sector-wise estimates of gross value added (GVA) will now be given at basic prices instead of factor cost. The

relationship between GVA at factor cost, GVA, at basic prices, and GDP (at market prices) is given below:

Where, CE: Compensation of Employees; MI: Mixed Income; OS: Operating Surplus; CFC: consumption of fixed capital) Production taxes or production subsidies are paid or received with relation to production and are independent of the volume of actual production. • Some examples of production taxes are land revenues, stamps and registration fees and tax on profession. • Some production subsidies are subsidies to Railways, input subsidies to farmers, subsidies to village and small industries, administrative subsidies to corporations or cooperatives, etc.


Product taxes or subsidies are paid or received on per unit of product. • Some examples of product taxes are excise tax, sales tax, service tax and import and export duties. • Product subsidies include food, petroleum and fertilizer subsidies, interest subsidies given to farmers, households, etc. through banks, and subsidies for providing insurance to households at lower rates). 3. Comprehensive coverage of the corporate sector both in manufacturing and services by incorporation of annual accounts of companies as filed with the Ministry of Corporate Affairs (MCA) under their e-governance initiative, MCA21. Use of MCA21 database for manufacturing companies has helped account for activities other than manufacturing undertaken by these companies. 4. Comprehensive coverage of the financial sector by inclusion of information from the accounts of stock brokers, stock exchanges, asset management companies, mutual funds and pension funds, and the regulatory bodies including the Securities and Exchange Board of India (SEBI), Pension Fund Regulatory and Development Authority (PFRDA) and Insurance Regulatory and Development Authority (IRDA). 5. Improved coverage of activities of local bodies and autonomous institutions, covering around 60 percent of the grants/transfers provided to these institutions. Owing to these changes, estimates of GVA both at aggregate and sectoral levels have undergone changes. The sector-wise shares in aggregate GVA have undergone significant revision especially in the case of manufacturing and services. Changes have also been observed in the growth rates in GVAs of individual sectors and contribution of each sector to overall GVA due to use of sales tax and service tax data for estimation in the years 2012-13 and 2013-14. Caution needs to be exercised while comparing estimates and growth rates from the earlier series to the new series. 5.8 DIFFICULTIES FACED IN ESTIMATING NATIONAL INCOME Underestimation of National Income: The measurement of national income encounters many problems: 1. Black Money Illegal activities like smuggling and unreported incomes due to tax evasion and corruption are outside die GDP estimates. Thus, parallel economy poses a serious 'hurdle to accurate GDP estimates. GDP does not take into account the 'parallel economy' as the transactions of black money are not registered. 2. Non-Monetization In most of the rural economy, considerable portion of transactions occurs informally and they are called as non-monetized economy- the barter economy. The presence of such non monetary economy in developing countries keeps the GDP estimates at lower level than the actual. 3. Household Services The national income accounts do not include the care economy-domestic work and housekeeping. Most of such valuable work rendered by our women at home does not enter our national accounting. 4. Social Services It ignores voluntary and charitable work as it is unpaid. 5. Environmental Cost National income estimation does not account for the environmental costs incurred in the production of goods. • For example, the land and water degradation accompanying the Green revolution in India. • Similarly, the climate change that is caused by the use of fossil fuels. However, in recent years, green GDP is being calculated where the environmental costs is deducted from the GDP value and the Green GDP is arrived at. Problems in the calculation of National Income What should we include in the National Income? Ideally we should include all goods and services produced in the course of the year, but there are some services which are not calculated in terms of money, e.g., services of housewives. • Lack of Adequate Data: The lack of adequate statistical data makes the task of estimation of national income more acute and difficult. • Non-availability of Reliable Information: The reason of illiteracy, most producers has no idea of the quantity and value of their output and do not follow the practice of keeping regular accounts. • Choice of Method: The selection of method while calculating National Income is also an important task. The wrong method leads to poor results. • Lack of Differentiation in Economic Functioning: In all the countries the occupational specialization is still incomplete so that there is a lack of differentiation in economic functioning. An individual may receive income partly from farm ownership and partly from manual work in industry in the slack season.


• Double Counting: Double counting is also an important problem while calculating national income. If the value of all goods and services totaled, the total will overtake the national output, because some goods are currently consumed being used in the making of others. The best way to avoid this error is to calculate only the value of those goods and services that enter into final consumption 5.9 GDP AND WELFARE Can the GDP of a country be taken as an index of the welfare of the people of that country? If a person has more income he or she can buy more goods and services and his or her material well-being improves. So it may seem reasonable to treat his or her income level as his or her level of well-being. GDP is the sum total of value of goods and services created within the geographical boundary of a country in a particular year. It gets distributed among the people as incomes (except for retained earnings). So we may be tempted to treat higher level of GDP of a country as an index of greater well-being of the people of that country (to account for price changes, we may take the value of real GDP instead of nominal GDP). But there are at reasons why this may not be correct. 1. Distribution of GDP - how uniform is it? If the GDP of the country is rising, the welfare may not rise as a consequence. This is because the rise in GDP may be concentrated in the hands of very few individuals or firms. For the rest, the income may in fact have fallen. In such a case the welfare of the entire country cannot be said to have increased. If we relate welfare improvement in the country to the percentage of people who are better off, then surely GDP is not a good index. 2. Non - Monetary Exchanges Many activities in an economy are not evaluated in monetary terms. • For example, the domestic services women perform at home are not paid for. • The exchanges which take place in the informal sector without the help of money are called barter exchanges. • In barter exchanges goods (or services) are directly exchanged against each other. But since money is not being used here, these exchanges are not registered as part of economic activity. In developing countries, where many remote regions are underdeveloped, these kinds of exchanges do take place, but they are generally not counted in the GDPs of these countries. This is a case of underestimation of GDP. Hence GDP calculated in the standard manner may not give us a clear indication of the productive activity and well-being of a country. 3. Externalities Externalities refer to the benefits (or harms) a firm or an individual causes to another for which they are not paid (or penalised). Externalities do not have any market in which they can be bought and sold. For example, let us suppose there is an oil refinery which refines crude petroleum and sells it in the market. The output of the refinery is the amount of oil it refines. We can estimate the value added of the refinery by deducting the value of intermediate goods used by the refinery (crude oil in this case) from the value of its output. The value added of the refinery will be counted as part of the GDP of the economy. But in carrying out the production the refinery may also be polluting the nearby river. This may cause harm to the people who use the water of the river. Hence their well being will fall. Pollution may also kill fish or other organisms of the river on which fish survive. As a result the fishermen of the river may be losing their livelihood. Such harmful effects that the refinery is inflicting on others, for which it will not bear any cost, are called externalities. In this case, the GDP is not taking into account such negative externalities. Therefore, if we take GDP as a measure of welfare of the economy we shall be overestimating the actual welfare. This was an example of negative externality. There can be cases of positive externalities as well. In such cases GDP will underestimate the actual welfare of the economy. 4. Standard of living GDP does not value intangibles like leisure, quality of life etc. Quality of life is determined by many other things than economic goods. The major disadvantage of using GDP as an indicator of standard of living is that it is not, strictly speaking, a measure of standard of living. For instance, in an extreme example, a country which exported 100 percent of its production would still have a high GDP, but a very poor standard of living. The argument in favour of using GDP is not that it is a good indicator of standard of living; but rather that (all other things being equal) standard of living tends to increase when GDP per capita increases. This makes GDP a proxy for standard of living, rather than a direct measure of it.


5.10 MEASURING DEVELOPMENT ECONOMIC GROWTH VS ECONOMIC DEVELOPMENT Economic Growth is a narrower concept than economic development. • It is an increase in a country's real level of national output which can be caused by an increase in the quality of resources (by education etc.), increase in the quantity of resources & improvements in technology or in another way an increase in the value of goods and services produced by every sector of the economy. • Economic Growth can be measured by an increase in a country's GDP (gross domestic product). Economic development is a normative concept i.e. it applies in the context of people's sense of morality (right and wrong, good and bad). The definition of economic development given by Michael Todaro is an increase in living

standards, improvement in self-esteem needs and freedom from oppression as well as a greater choice. • The most accurate method of measuring development is the Human Development Index which takes into account the literacy rates & life expectancy which affects productivity and could lead to Economic Growth. • It also leads to the creation of more opportunities in the sectors of education, healthcare, employment and the conservation of the environment. • It implies an increase in the per capita income of every citizen. Economic Growth does not take into account the size of the informal economy. The informal economy is also known as the black economy which is unrecorded economic activity. Development alleviates people from low standards of living into proper employment with suitable shelter. Economic Growth does not take into account the depletion of natural resources which might lead to pollution, congestion & disease. Development however is concerned with sustainability which means meeting the needs of the present without compromising future needs. Economic growth is a necessary but not sufficient condition of economic development. 5.11 HUMAN DEVELOPMENT INDEX The dilemma was solved once the United Nations Development Program (UNDP) published its first Human Development Report (HDR) in 1990. The report had a human development index (HDI) which was the first attempt to define and measure the levels of development. The 'index' was a product of selected team of leading scholars, development practitioners and members of the Human Development Report office of the UNDP. The first such team which developed the HDI was led by Mahbub Ul Haq and Inge Kaul. The term 'human development' is a corollary of 'development' in the index. The HDI went on to select three broad parameters and allotted them an equal weightage on the scale of one and measured the development of the countries included in the report. The three parameters are as given below: • Standard of living: to be indicated by the real per capita income adjusted for the differing purchasing power parity (PPP). • Knowledge: to be measured by indicators related to the level of education: Educational attainment among the adults (given 2/3rd weightage). School enrolment (given 1/3rd weightage). • Life Expectancy: to be calculated at the time of birth. The UNDP ranked the economies in accordance of their achievements on the above given three parameters on the scale of one (i.e. 0.000-1.000). As per their achievements the countries were broadly classified into three categories with a range of points on the index: • High Human Development Countries: 0.800 - 1.000 points on the index. • Medium Human Development Countries: 0.500 - 0.799 points on the index. • Low Human Development Countries: 0.000 - 0.499 points on the index. \ India has slipped from the 130th rank to 131st among the 188 countries on the human development index according to the latest UNDP's Human Development Report (2016)."India's HDI score improved from 0.615 to 0.624 in 2015, which puts the country in the Medium Human Development Category though its rank fell. In Emerging Economies like the BRICS where India's rank is the lowest. China's rank is at 90th, Brazil 79th, Russia 49th and South Africa 119th. Even among SAARC members, India's Human Development Index (HDI) rank is lower than Sri Lanka and Maldives and a little higher than Bhutan, Bangladesh, Pakistan, Afghanistan and Nepal.

5.12 GROSS NATIONAL HAPPINESS (GNH) Happiness is a normative concept as well as a state of mind. Therefore its idea might vary from one economy to the other. Gross National Happiness Bhutan, a small Himalayan kingdom and an economic non-entity developed a new concept of development in early 1970s - the Gross National Happiness (GNH). Without rejecting the idea of human development propounded by the UNDP, the kingdom has been officially following the targets set by the GNH. Bhutan has been following up the GNH since 1972 which has the following parameters to attain happiness/ development:


• Higher real per capita income. • Good Governance. • Environmental Protection. • Cultural Promotion (i.e. inculcation of ethical and spiritual values in life without which, it says, progress may become a curse rather than a blessing). Comparison between the GNH and HDI • At the level of real per capita income, the GNH and the HDI are the same. • Though the HDI is silent on the issue of 'good governance', today it should be considered as being promoted around the world once the World Bank came with its report on it in 1995 and enforced it upon the member states. • On the issue of protecting environment though the HDI didn't say anything directly the World Bank and the UNO had already accepted the immediacy of sustainable development by then and by early 1990s there was a separate UN Convention on the matter. • It means the basic difference between the GNH and the HDI looks at the level of assimilating the ethical and spiritual aspects into our (UNDP's) idea of development. 5.13 GENDER INEQUALITY INDEX (GII) Gender inequality remains a major barrier to human development. Girls and women have made major strides since 1990, but they have not yet gained gender equity. The disadvantages facing women and girls are a major source of inequality. All too often, women and girls are discriminated against in health, education, political representation, labour market, etc - with negative repercussions for development of their capabilities and their freedom of choice. The GII measures gender inequalities in three important aspects of human development: • Reproductive Health measured by maternal mortality ratio and adolescent birth rates; • Empowerment measured by proportion of parliamentary seats occupied by females and proportion of adult females and males aged 25 years and older with at least some secondary education; and • Economic status expressed as labour market participation and measured by labour force participation rate of female and male populations aged 15 years and older. Countries with high gender inequality also experience more unequal distribution of human development. India is ranked 125 of 159 countries in the Gender Inequality Index (GII). The ratio of maternal mortality is 174 against every 100,000 live births. Only 12.2 per cent of Parliament seats are held by women. 26.8 per cent of women above the age of 15 years are part of India's labour force — compared to 79.1 per cent men. 5.14 INCLUSIVE DEVELOPMENT INDEX (IDI) The Inclusive Development Index (IDI) is an annual assessment of 103 countries' economic performance that measures how countries perform on eleven dimensions of economic progress in addition to GDP. It has 3 pillars: • Growth and development; • Inclusion and; • Intergenerational equity - sustainable stewardship of natural and financial resources. The IDI is a project of the World Economic Forum's System Initiative on the Future of Economic Progress, which aims to inform and enable sustained and inclusive economic progress through deepened public-private cooperation through thought leadership and analysis, strategic dialogue and concrete cooperation, including by accelerating social impact through corporate action. This Inclusive Development Index has been developed as a new metric of national economic performance as an alternative to GDP. India has been ranked 62 out of 74 emerging economies on a metric focused on the living standards of people and future-proofing of economies by the WEF. Pakistan has been ranked 47, Sri Lanka is at 40, and Nepal at 22; Uganda (59) and Mali (60) are also higher on the index than India. 5.15 SOCIAL PROGRESS INDEX (SPI) The Social Progress Index is an aggregate index of social and environmental indicators that capture three dimensions of social progress - Basic Human Needs, Foundations of Wellbeing, and Opportunity. It includes data from 128 countries on 50 indicators and partial results from additional 61 countries. It includes 98% of the world population. The index is published by the non-profit Social Progress Imperative, and is based on the writings of Amartya Sen, Douglass North, and Joseph Stieglitz. India has been ranked 93rd out of 128 countries in the 2017 Social Progress Index (SPI).


SOCIAL PROGRESS INDEXBasic Human Needs Foundations of Wellbeing Opportunity Nutrition And Basic Medical Care Do people have enough food to eat and are they receiving basic medical care?

Access to Basic KnowledgeDo people have the educational foundations to improve their lives?

Personal Rights Are people free of restrictions on their rights?

Water and Sanitation Can people drink water and keep themselves clean without getting sick?

Access to Info & CommutationsCan people freely access ideas and information from anywhere in the world?

Personal Freedom and ChoiceAre people free of restrictions on their personal decisions?

Shelter Do people have adequate housing with basic utilities?

Health and Wellness Tolerance and InclusionDo people live long and healthy lives? Is no one excluded from the opportunity to be a contributed member of society? Personal Safety Environmental Quality Access to Advanced EducationAre people able to feel safe? Is this society using its resources so they will be available to future generations? Do people have the opportunity to achieve high levels of education?

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