Macro Sessions 2-5 GDP.pdf

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Sessions: 2

-

5Prof. Biswa

Swarup

Misra

Dean, XIMB

Macroeconomic Analysis and Policy



1

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)?



2

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 - Conceptssuch as GDP at Market Price, GDP at

Factor Cost, GVA at Factor Cost, GVA at

Basic Prices



3

Income and Expenditure

Gross Domestic Product (GDP) measures

total income of everyone in the economy.

GDP also measures total expenditure on the

economy’s output of g&s.

For the economy as a whole,

income equals expend i ture , because

every rupee of expenditure by a buyer

is a rupee of income for the seller.



4

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)



5

FIGURE 1: The Circular-Flow Diagram

Households:

own the factors of production,sell/rent them to firms for income

buy and consume g&s

HouseholdsFirms



6


HouseholdsFirms

Firms:

buy/hire factors of production,use them to produce g&s

sell g&s



7


Markets forFactors ofProduction

HouseholdsFirms

Income (=GDP)Wages, rent,profit (=GDP)

Factors of

production

Labor, land,

capital

Spending (=GDP)

G & Sbought

G & Ssold

Revenue (=GDP)Markets for

Goods &Services



8

What This Diagram Omits

The government

• collects taxes• purchases g&s

The financial system

• matches savers’ supply of funds withborrowers’ demand for loans

The foreign sector

• trades g&s, financial assets, and currencieswith the country’s residents



9Session 2-3 MEASURING A NATION’S INCOME B.S.Misra

Measuring Output

The aggregate measure of income in the economy isthe GDP.

Gross Domestic Product is the market value of the finalgoods and services produced in a country during a

given time period - a quarter or a year.

Note: GDP includes only current production and sodoes not count the resale of items.

Only final goods are included which means we do notcount raw materials and intermediate goods usedas inputs.




FinalPurchasesBread producedWheat for

-Non-Market activity-self consumption(Farmer does not pay himself

in Household to produce bread)Wheat

producedby Farmer(INR 50)




FinalPurchasesBread producedWheat for

-Non-Market activity-self consumption(Farmer does not pay himself

in Household to produce bread) Sale of Wheatbread Consumptionproduced Wheat + Effort

Purchased by (INR 100)by Farmer result in outputBaker (who puts of bread(INR 50)

in effort to transform it toanother good) Value ofeffort = INR 50




FinalPurchases

Sale of Wheatbread Consumptionproduced Wheat + Effort



If we ask farmer and baker to report theiroutput and simply add their outputs we wouldfalsely conclude that INR 150 of output has beenproduced in the economy.

What causes the error in counting is that wehave counted wheat which is not a final good.




An intermediate good is one that is usedup in the production of other goodsduring the same period in which it wasproduced.



14

An intermediate good is one that is used up in theproduction of other goods during the sameperiod in which it was produced.

Intermediate goods like wheat and oil should notbe double counted when output is computed.

To avoid errors from inclusion of intermediategoods agents should be asked to report theirsales of final goods to consumers.

Baker reports sale of INR 100of final good Farmer reports sale of INR 0of final good

Total value of final goods = INR 100




FinalPurchases




Alternatively agents should report the contributioneach 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 therevenues.

Farmer’s value added = INR 50(Assuming he did not pay for any costs)

Baker’s value added = INR 50 Total value added = INR 100



16MEASURING A NATION’S INCOME B.S.Misra

FinalPurchases


Purchased byby Farmer result in outputBaker (who puts of bread(INR 50)

Unsold breadin effort to transformon Shelves Investmentit to another good)

inValue of effort = INR 50Wheat not Inventory

used up

Suppose farmer does not sell all bread produced oruse up all the wheat purchased from the farmer?

A firm’s unused raw materials or unsold output isits inventory.

The change in the stock of inventory in an account-ing year is treated as an inventory investment and

e10is classified as a final good.




Now suppose baker wants to scale up businessand buys new baking racks and a new oven.

These objects are not used up during the accountingperiod and are not intermediate goods. Neither are theysold as final goods by baker.

Objects are called capital goods and economic entitywho purchases them is considered to be finaluser of the capital good.

A capital good is a long-lived good that is used inthe production of other goods and services.




Capital goods and intermediate goods are similar in

that they are both used to produce othergoods. They are dissimilar in that capital goods are not

used up right away like intermediategoods.




Capital goods and intermediate goods are similar in

that they are both used to produce othergoods. They are dissimilar in that capital goods are not

used up right away like intermediategoods.

The total quantity of a country’s capital goodsis called its capital stock.

Change in the capital stock from the beginningof the year to end of the year is denotedas investment for that year.

If the baker began the year with stock of INR 500 ofovens and ended the year with stock of INR 800 ofovens he is considered to have invested INR300 during the year.




A capital good is not used up right away but it

dimin- ishes in its material respect and isused 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 thecapital stock would have increased by INR 350

Gross Investment = INR 500

Depreciation = INR 150

Net Investment = INR 350




Figure 1.1: Production Processes and the National IncomeFinal

PurchasesBread producedWheat for -Non-Market activity-self consumption(Farmer does not pay himself

in Household to produce bread) Sale of Wheatbread Consumptionproduced Wheat + Effort

Purchased byby Farmer result in outputBaker (who puts of bread(INR 50)

Unsold breadin effort to transformon Shelves Investmentit to another good)

inValue of effort = INR 50Wheat not Inventory

used up

Not used Not soldPurchasedNew Oven, up during to others

by Baker soNew Baking Racks course of as Finalas to scale(Capital Stock) year Good

up production (Gross Investment) Net AdditionNet

toInvestment

CapitalDeterioration of Stock

Capital Good(Depreciation)



22MEASURING A NATION’S INCOME B.S.Misra



23



24

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 itsGDP (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.



25

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 nowsmaller than China's.

But according to the UN, Japan wasalmost 2.8 times wealthier than China in

2008



26

Wealth of Nations

For all of the countries in the report except Nigeria,

Russia and Saudi Arabia, Human capital forms thelargest 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.



27

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 ofpastureland, gain $100 billion-worth of

skills and be no worse off than before.

The framework turns economicpolicymaking into an “asset -management

problem”,



28

Wealth of Nations

A country like Saudi Arabia, for example, depleted

its stock of fossil fuels by $37 billion between1990 and 2008, while adding to its stock of school-

leavers 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.



29

Wealth of Nations

The idea that natural assets are substitutable makes some

environmentalists (including some contributors to thereport) 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.



30

…the market value of all final goods &

services produced within a country

in a given period of time.

Gross Domestic Product (GDP) Is…

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 don’t have a market value are

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



31





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.



32





GDP includes tangible goods

(like DVDs, mountain bikes, soaps)

and intangible services

(dry cleaning, concerts, cell phone service).



33





GDP includes currently produced goods,

not goods produced in the past.



34





GDP measures the value of production that occurs

within a country’s borders, whether done by its own

citizens or by foreigners located there.



35





usually a year or a quarter (3 months).



36

National Income Accounting

National income accounts: an accounting

framework used in measuring current economicactivity

Three alternative approaches give the samemeasurements

• Product approach: the amount of outputproduced

• Income approach: the incomes generated by

production• Expenditure approach: the amount of spendingby purchasers



37


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



38


Why are the three approaches equivalent?

• They must be, by definition

• Any output produced (product approach) ispurchased by someone (expenditure approach)

and results in income to someone (incomeapproach)

• The fundamental identity of national incomeaccounting:

total production = total income = total expenditure



39

Exercise:

• A farmer grows a kilo of wheatand sells it to a miller for Rs10.00.

• The miller turns the wheat into flourand sells it to a baker for Rs.30.00.

• The baker uses the flour to make a loaf ofbread and sells it to an engineer for Rs.60.00.

• The engineer eats the bread.

Compute & comparevalue added at each stage of production

and GDP



40

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



41

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.



42

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 notmean the purchase of financial

assets like stocks and bonds.



43

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



44

Stocks vs. Flows

A flow is a quantity measured per unit of time.

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

Flow Stock

A stock is aquantity measured

at a point in time.

E.g .,“The U.S. capital stock

was $26 trillion on

January 1, 2006.”



45

Stocks vs. Flows - examples

the govt budget deficitthe govt debt

# of new college

graduates this year

# of people with

college degrees

a person’s

annual savinga person’s wealth

f low stock



46

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



47

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.



48

Net Exports (NX)

NX = exports – imports

Exports represent foreign spending on the

economy’s 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

Share of different components in India’s GDP



49

Share of different components in India s GDP

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

C 59

G 11

I 38

NX -9



50

U.S. GDP and Its Components, 2005

–2,444

7,950

7,072

29,460

$ 42,035

per capita

–5.8

18.9

16.8

70.1

100.0

% of GDP

–726

2,360

2,100

8,746

$12,480

billions

NX

G

I

C

Y



51

U.S. GDP and Its Components, 2013

GDP % of GDP

Y 16768.1

C 11484 68I 2648 16

G 3144 19

NX -508 -3

E i

1



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 year’s 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

E i

1

:



Exercise 1:

Answers

A. Abhinav spends Rs. 200 to buy his friend dinnerat 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

:



Exercise 1:

Answers

C. Ipsita spends Rs.1200 on a computer to use in herbusiness. She got last year’s 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



55

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.

Answers



56

Answers

a. When an earthquake destroys property, wealth

is affected, not income (or GDP). However, if a

significant amount of the capital stock isdestroyed, 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 activitywill 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 notcurrently produced. Therefore GDP will not be

affected.

A



57

Answers

c. The sale of existing stock holdings is a transfer

of wealth and, as such, does not affect GDP. Anyfees 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 arespent, will consumption increase.)



58

Related Measures of GDP

Gross National Product



59

GDP has a territorial dimension

Gross National Product (GNP) is the total

value of output produced and incomereceived in a year by the nationals of acountry - citizenship dimension

GNP = GDP + Net Factor Income Earnedfrom Abroad

While GDP indicates productive capacity ofan economy, GNP is a crude indicator for

living standard.

If a country has more non-resident inflowsits GNP will be higher than GDP.

For a closed economy GDP = GNP.

GDP vs GNP



60

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 GNPbut not in Indian GDP because they do not

represent production taking place within India

Net Factor Income from Abroad



61

Net Factor Income from Abroad

Net factor income from abroad consists of three

components1)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 bythe fee it receives from Saudi Government is

counted in India’s GNP but not in India’s

GDP

NFIA



62

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 thoseemployees 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 thenational income of the employer country.

Net compensation of employees, as it is defined, can

be a positive or a negative value.

Who is a Resident?



63

Residents include both individuals and institutions.

Tourists or commercial travelers of a given country

traveling abroad are treated as residents of theirhome countries.

The official diplomatic and consular representativesof a given country including members of officialmissions and members of the armed forces stationedabroad are considered extra territorial by the countryin which they are located and as residents of thegiven country.

The factor incomes generated by such residents aredomestic product of the resident country.

Factor incomes of locally recruited staff of foreigndiplomatic military establishments are included infactor incomes from abroad.

Net Income from Property and



64

p y

Entrepreneurship from Abroad

Net income from property andEntrepreneurship from abroad is the

difference between the income received by

way of interest, rent, dividend and profit bythe 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.

Net Retained Earnings of Resident



65

Companies Abroad

Retained earning refers to the undistributed profit of

the companies.

Resident companies abroad (i.e., companies belongingto 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 residentcompanies located abroad and retained earnings ofnon-resident companies located within the domesticterritory of the country.

GDP and GNP



66

G a d G

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.

Some Concepts



67

p

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 thatare sold at market prices in various markets.

Subsidies: are government expenses that are generally

extended to business firms, farmers among other groupsto defray their production costs or to reduce prices for

consumers.

Some Concepts



68

Some Concepts

Subsidies are also called negative taxes because

they impose expenses on government budgetsinstead of contributing revenues.

Indirect Taxes: are government revenues that

result from taxes that are not received directlyfrom 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.

National Income Relations



69


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

Payments to Factors of Production



70

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 beneficiaryfrom 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.

GDP at Market Price and Factor Cost



71

The market value of the goods and services willinclude the indirect taxes like excise duties,customs, sales tax etc., levied by the governmenton goods and services.

Similarly, the price paid by the consumer will notinclude any subsidy which the government pays tothe producer.

Hence, the market value of final expenditure wouldexceed the total obtained at factor cost by theamount of indirect taxes reduced by the value ofsubsidies.

Domestic or national product can, therefore, bemeasured either at market prices or at factor costone differing from the other by the amount of netindirect taxes (indirect taxes less subsidies)




72


Macroeconomic aggregates @ market prices

whether GDP, GNP, NDP or NNP or Per capitaGDP, Per capita GNP, Per capita NDP or Per

capita NNP include indirect taxes and exclude

subsidies.

Conversely all the above aggregates @ factorcosts 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




National Income GNPMP

Relationships

NNP GDP GNPFC

MP MP

NDP NNP GDP

MP FC FC

Depreciation

Net Indirect Taxes NDPFC

Net Income from Abroad

National Income vs. Personal Income



74

NI measures the income individuals receive for doingproductive work.

PI measures all income actually received byindividuals.

Individuals receive other income that they do notdirectly earn- Welfare payments, food stamps etc

also interest payments from government andindividuals

In NI accounting, individuals are attributed incomethat they do not actually receive-Undistributed

corporate profits(retained earnings)employee’scontribution to social security.

Personal income is national income plus transferpayments from government minus amountsattributed but not received.

GDP to Disposable Income

G D i P d PLUS



75

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.

Exercise-1



76

Exercise-1

Using the following data, calculate the GDP and NDP.

Calculate under closed and open economy.

Gross Investment $46

Exports 9 Consumption 180

Government Purchases 84

Consumption of Fixed Capital 52 Imports 12

Solution-1



77

Solution 1

Under Open Economy

GDP = C + I + G + NX

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

= $307

NDP = GDP – Consumption of Fixed Capital

= $307 - $52

= $255

Solution-1



78

Solution 1

Under Closed Economy

GDP = C + I + G

= $180 + $46 + $84

= $310

NDP = GDP – Consumption of Fixed Capital

= $310 - $52

= $258

Exercise-2



79

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 70Interest 40 Imports 30Corporate Profit 70 Proprietor’s Income 55Government Purchases 150 Income Tax 100Depreciation 40 Income Earned but not received 60Rent 20 Income Received but not earned 70

Gross Private Domestic Investment 50 Factor Incomes to Overseas 25Compensation of Employees 420 Exports 50Factor Incomes from Overseas 30

Solution-2



80

Solution 2

2. Expenditure Approach

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=715-40-70=605

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

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.

Solution-2



81

Solution 2

National Income = Employees Compensation (Wages andSalaries) + Corporate Profits + Sole Proprietor’s Income +Net Interest Income + Rental Income

= $ 4 2 0 + 7 0 + 5 5 + 4 0 + 2 0

= $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

Solution-2



82

Solution 2

Income Approach

GDP = National Income + Depreciation + Indirect BusinessTaxes + Net Factors Payments (factors incomes/paymentsto 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 isnegative, therefore GDP<GNP.

Exercise-3



83

Exercise 3

The following information is given:

Personal Consumption Expenditures $500 Indirect Business Taxes 105Interest 40 Imports 30Corporate Profit 85 Proprietor’s Income 50Government Purchases 150 Income Tax 120

Depreciation 45 Income Earned but not received 80Rent 25 Income Received but not earned 90Gross Private Domestic Investment 70 Factor Incomes to Overseas 50Compensation of Employees 400 Exports 80Factor Incomes from Overseas 30

Using the following information, calculate the GDP (using theexpenditure approach), NDP, National Income, Personal Income,

Disposable Income, GNP, and NNP. Which economic indicator is

higher, GDP or GNP? Why?

Solution-3



84

Solution 3 Expenditure Approach

G D P = C + I + G + N X

= $500 + 70 + 150 + (80-30)

= $770

NDP = GDP – Depreciation

= $770 - $45

= $725

National Income = Employees Compensation (Wages and

Salaries) + Corporate Profits + Sole Proprietor’s Income +Net Interest Income + Rental Income

= $ 4 0 0 + 8 5 + 5 0 + 4 0 + 2 5

= $600

Solution-3



85

Personal Income = National Income – Income earned but not received + Income received but not earned

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

Personal Disposable Income = Personal Income – IncomeTax

= $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 ispositive, therefore GDP>GNP.

Other Measures of Total Production and Total



86

Income

Measures of Total Production

and Total Income, 2007

Other Measures of Total Production and Total

I



87

Income

The Division of Income

The Division of Income

We can measure GDP in terms of total expenditure or as the total income received byhouseholds.

The largest component of income received by households is wages, which are about threetimes as large as the profits received by sole proprietors and the profits received bycorporations combined.

Real versus Nominal GDP



88

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.

EXAMPLE 2 :



89

Compute nominal GDP in each year:

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

2004: Rs.12 x 600 + Rs.3 x 1200 = Rs.10,800

Pizza Ice Cream

year P Q P Q

2002 Rs.10 400 Rs.2.00 1000

2003 Rs.11 500 Rs.2.50 1100

2004 Rs.12 600 Rs.3.00 1200

37.5%

Increase:

30.9%

EXAMPLE 2 :



90

Compute real GDP in each year,

using 2002 as the base year:

Pizza Ice Cream

year P Q P Q 2002 Rs.10 400 Rs.2.00 1000

2003 Rs.11 500 Rs.2.50 1100

2004 Rs.12 600 Rs.3.00 1200

20.0%

Increase:

16.7%

Rs.10 Rs.2.00

2002: Rs.10 x 400 + Rs.2 x 1000 = Rs.6,000

2003: Rs.10 x 500 + Rs.2 x 1100 = Rs.7,200

2004: Rs.10 x 600 + Rs.2 x 1200 = Rs.8,400

EXAMPLE 2 :



91

In each year,

nominal GDP is measured using the (then)current prices.

real GDP is measured using constant pricesfrom the base year (2002 in this example).

year

Nominal

GDP

Real

GDP2002 Rs.6000 Rs.6000

2003 Rs.8250 Rs.7200

2004 Rs.10,800 Rs.8400

EXAMPLE 2 :



92

The change in nominal GDP reflects both prices and

quantities.

year

Nominal

GDP

Real

GDP

2002 Rs.6000 Rs.6000

2003 Rs.8250 Rs.7200

2004 Rs.10,800 Rs.8400

20.0%

16.7%

37.5%

30.9%

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 co rrected fo r in f lat ion.

Real GDP versus Nominal GDP



93

Real GDP versus Nominal GDP

Comparing Real GDP and Nominal GDP

Nominal GDP and

Real GDP, 1990 –2007

Nominal and Real GDP in the U.S.,

1965

2005



94

1965-2005

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1965 1970 1975 1980 1985 1990 1995 2000 2005

Billions

Real GDP(base year

2000)

Nominal

GDP

The GDP Deflator



95

The GDP Deflator

The GDP deflator is a measure of the overall

level of prices.

Definition:

One way to measure the economy’s inflation

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

GDP deflator = 100 x nominal GDPreal GDP

EXAMPLE 3 :



96

Compute the GDP deflator in each year:

year

Nominal

GDP

Real

GDP

GDP

Deflator 2002 Rs.6000 Rs.6000

2003 Rs.8250 Rs.7200

2004 Rs.10,800 Rs.8400

2002: 100 x (6000/6000) = 100.0

100.0

2003: 100 x (8250/7200) = 114.6

114.6

2004: 100 x (10,800/8400) = 128.6

128.6

14.6%

12.2%

Exercise

2

:

C i GDP



Computing GDP

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

2004 (base yr) 2005 2006P Q P Q P Q

good A Rs.30 900 Rs.31 1,000 Rs.36 1050

good B Rs.100 192 Rs.102 200 Rs.100 205

Exercise

2

:

A



Answers

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

2004 (base yr) 2005 2006P Q P Q P Q

good A Rs.30 900 Rs.31 1,000 Rs.36 1050

good B Rs.100 192 Rs.102 200 Rs.100 205

Exercise

2

:

A



Answers

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.52,000GDP deflator = 100 x (Nom GDP)/(Real GDP)

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

99

2004 (base yr) 2005 2006P Q P Q P Q

good A Rs.30 900 Rs.31 1,000 Rs.36 1050

good B Rs.100 192 Rs.102 200 Rs.100 205

Rebasing-Case Study of Nigeria



100

Yemi Kale, Nigeria’s statistician-general on April 6,

2014 revised Nigeria’s GDP in 2013 from 42.4 trillionnaira to 80.2 trillion naira ($510 billion), an 89%

increase.

The revision means Nigeria leapfrogs South Africa to

be Africa’s largest economy.

It rises to 24th in the list of the world’s big economies,

behind Poland and Norway and ahead of Belgium and

Taiwan.

The upgrade is the outcome of a process known as

“rebasing”.

GDP i i ll d b f h h

Rebasing-Case Study of Nigeria



101

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.

Nigeria’s 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 fast-growing industries such as mobile telecoms and film-

making that have sprung up since then.

What Has Changed in the Nigerian Economy

Telecoms industry accounts for more than a quarter of



102

Telecoms industry accounts for more than a quarter of

the upgrade in GDP.

- In 1990 the state telephone company had just a fewhundred thousand fixed-line customers. There are nowaround 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 sector’s 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 industry’s size is estimated at around 1.4% of

GDP.

Other Improvements in GDP Estimates

Th ld GDP fi b d l l ti t f



103

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 increasedtenfold to around 850,000 establishments, including

many small ones.

The informal shops that account for the bulk of retailand wholesale trade are now part of the GDP picture.

Indeed after telecoms, trading makes up the biggest

share of the revision.

What the New GDP Figures Suggest A near-doubling of GDP is a hefty change.



104

A near doubling of GDP is a hefty change.

- Other African countries have also bumped

their numbers up a lot by shifting the baseyear, 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 werebefore the GDP figures were revised.

- The majority of its 170m-plus people live onless than $1.25 a day.

Implications of Rebasing Why are poverty and unemployment “high”



105

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

designed to address them.

What the New GDP Figures Suggest



106

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 arebooming.

Nigeria now looks like an economy to be taken

seriously.



107

Indian GDP at a New Base

Indian GDP

-

Base Year



108108

Current/New Series Base Year 2011-

12 Previous series base years

1948-49 (1956) 1960-61 (1967) 1970-71(1978)

1980-81 (1988) 1993-94 (1999) 1999-

2000 (2006) 2004-05 (2010)

Choice of base years

Previously population census years Currently, the NSS employment-

unemployment survey years

SNA



109

The compilation practices of India’s NAS have

always broadly followed the United Nations Systemof National Accounts (SNA).

The UN SNA underwent periodic changes in 1968,1993 and 2008.

The presentation of accounts in India’s NAS inrecent years has generally conformed to thestandards set in SNA 1968, but the compilation

practices in regard to sector-wise data werechanged to cover some of the recommendations ofSNA 1993 to the extent that data is available.

109

GDP of India at 2011-12 base



110

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 2013-14respectively.

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 NATION’S INCOME B.S.Misra

The comprehensive revisions in the methodology of

SNA



111

The comprehensive revisions in the methodology of

compilation and classification systems in the 2011-

12 base have involved some radical departures thatwere proposed by SNA 1993 and the latest SNA

2008 in defining gross domestic product (GDP),.

This radical departure indicated above, takesthree forms:

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

factor cost is not a concept to be explicitly used inthe SNA; it is a measure of income and not outputwith observable sector of prices.

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



112

(ii) GDP at market prices is the GDP inSNA, as transactions are valued at the actual

price agreed upon by the transactors - atmarket prices – This is now the headlineGDP as opposed to GDP at Factor Costpreviously

(iii) The SNA introduces an intermediaryconcept called GVA at basic prices coveringvalue added at factor cost plus indirect taxes

on production net of production subsidies.

Though these recommendations were made inSNA 1993, these were not been implemented

in India for over two decades, until now.112

GVA at Basic Prices The concept of GVA at basic prices was



113

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 (netof subsidies) that distinguishes the SNA 1993

and SNA 2008 from the SNA 1968.

113

GVA at Basic Prices The two former SNAs classify indirect taxes (net of



114

The two former SNAs classify indirect taxes (net of

subsidies) into two categories:

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

of subsidies on products).

The SNA 1968 made no such distinction, andcovered 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 theemployment of land, labour and the use of fixed

assets or on general business activities attracting

business licence fees, transaction (e g, stamp)

duties and real estate taxes.

GVA at Basic Prices GVA at basic prices includes the



115

GVA at basic prices includes the

contribution of factors of production

(land, labour, capital, andentrepreneurship) in the production

process and the amount appropriated by

the government in the form of taxes onproduction (net of subsidies on

production).

These taxes on production are said to be

taxes levied on some aspect of a

business or the other.

GVA at Basic Prices



116

In the Indian NAS, some examples of

taxes on production specified are: landrevenue, 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.

GDP at Basic Prices



117

Thus, the basic price receivable by the

producer from the purchaser for a good orservice 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 thereafterthat indirect taxes on products are levied

(except valued added tax, VAT).



118



119



120

National Accounts Formulae as per 2011-12 Base

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



121

G a ba p O /

Production taxes less Production subsidies

2. GVA at factor cost (earlier referred to as GDP atfactor cost) = GVA at basic prices – Production taxes

less Production subsidies

3. GDP = Σ 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

7. NNDI =NNI + other current transfers from

National Accounts Formulae as per 2011-12 Base



122

ROW, net (Receipts less payments)

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

Acronyms used in the Formulae



123

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

Acronyms used in the Formulae



124

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

GDP in 2012 base GDP at factor cost=GVA at factor



125

cost=payment to all factors of production

excluding government. In this concept wedon’t 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 tax-

production subsidy-product subsidy

=payment to all factors of production

including government

GDP in 2012 base



126

Before the product is sold to the consumer, the

distributor or wholesaler purchases the productfrom 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

GDP in 2012 base



127

Production taxes or subsidies are paid or

received with relation to production and areindependent 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.

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 andfertilizer subsidies, Interest subsidies given to

farmers, households etc. through banks,

Subsidies for providing insurance to households

at lower rates

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