GDP - IV

Other Useful fundas

• Calculating National Income From GDP

GDP calculated from the above methods is GDP at factor cost (i.e factory cost, tht means factory main us prepared products ka kya value hain)

GDP at market price = GDP at factor cost + net indirect taxes - subsidies

GNP (Gross National Product) at market price = GDP at mp + net factor income from abroad

NNP at mp = GNP at mp - Consumption of fixed capital ( depreciation)

NNP at factor cost = NNP at mp - net indirect taxes + subsidies = NATIONAL INCOME

where,net factor income from abroad is the income attributable to factor services rendered by the normal residents of the country to the rest of the world less factor services rendered to them by the rest of the world.

Note :- In India, the difference between NI and GDP in terms of value is very insignificant. As such , at time they are taken the same.

Per Capita Income = National Income / Population

GDP - III

• INCOME METHOD

For every rupee's worth of goods and services produced, a rupee's income is generated. Hence the GDP calculated under VA method and income method gives similar results.

The income method measures GDP from the side of the payments made to the primary factors of production for their productive services in an accounting year. The primary factors of production are:

i. Land

ii. Labour

iii. Capital

iv. Enterprise

The respective factor payments made to the above factors are:

i. Rent ( for land)

ii. Wages ( for labour)

iii. Interest ( for capital)

iv. Profits ( for enterprise i.e entrepreneur / govt. in case of PSU)

Along with these 4 , the mixed income of self emplyed people is also added. (as told earlier, they are the doctors, barbers, etc...... who do not come under the other 4 categories)

Few precautions which need to be taken under Income Method are :-

i. Transfer payments ( i.e voluntary like donations, use wiki ) are not included.

ii. Illegal incomes should not be include; as these might lead to double counting.

iii. Windfall gains like lotteries should not be included.

iv. Corporation Tax is a part of Profits. While calculating national income, profits before deduction of corporation tax have to be included. While doing so , corporation tax should not be included separately. Similarly, wages includes the income tax to be paid by workers. Hence, similarly the taxes should not be included separately (infact even these taxes are transfers; forced transfers in economic terms)

v. Death duties, gift tax, wealth tax, and tax on widfall gains are paid from wealth or past savings of the tax payers. Since they are not paid from the current income of the tax payers, they are not a part of national income.

vi. If a person rcvs. money by selling his second hand goods, the sale proceeds are not income since he has not rendered any productive service. Only there is a change of ownership of the second hand goods sold and purchased. This transaction has not contributed anything to the current flow of goods and services.Similarly, thousands of rupees are rcvd by persons who sell bonds and shares ( both old and new ones). in the market. The money reciepts are not income since there is no corresponding production of goods and services and income generation.

Hence GDP in Income Method = Wages + Rent + Interes + Profit + income of self employed

• EXPENDITURE METHOD

(The doubts this method should clear is .... imports wala doubt, cost price sale price ka koi doubt tha i guess, and many more)

Will explain each item one by one after the formula;

GDP by exp. method = Private final consumption expenditure + govt. final consumption expenditure + gross fixed capital formation + change in stocks + net exports.

Now we know private and govt. expenditure kya hain ... We require two types of data to calculate this -

a> total volume of sales in the market

b> retail prices.

By multiplying the volume of final sales with the retail prices of the durable, semi durable and non durable goods and services to the consumer households we get private final consumption expenditure in the domestic market. NOW this expenditure includes the direct purchases in the domestic market by non resident households. Therefore, their share of expenditure has to be deducted from the pvt. final con. exp. Also resident households make direct purchases abroad. These direct purchases have to be added to the pvt. final cons. exp.

The second item is govt.'s final con. exp. It consists of the compensation of govt employess and net purchases of goods and ser. by the govt. By multiplying the total volume of sales to the govt. by the enterprises with the retail prices, g.f.c.e is obtained. To this we have to add purcahes from abroad.

Also production for self consumption will be added to GDP by multiplying the price of the produce with the produce (by the self emplyed).

Now, Gross fixed capital formation includes total expenditure on construction ( steel, bricks, wood, etc) and machinery and equipments.

As regards expenditure on physical change in stocks with the producers, the physical change has to be multiplied with the market prices.

Finally Net exports ...... In open economies, govt. and consumer households of one country make direct purchases in the domestic market of some other country. These purchases are exports from the side of the selling country and import frm the side of the purchaser. Direct purchase of goods and services by foreigners is only a part of the total exports of goods and services of a country. For eg take India, we export tea, coffee, jute, cotton , etc. these are called merchandising exports. We also export services like shipping, insurance , banking, air transport, etc. When foreigners use our ships for transporting goods and passengers , our ships export shipping services. Similarly Indian insurance companies export insurance services when foreigners pay insurance premium for goods and passengers moving frm one country to another. All these exports of goods and services are provided by the producers of the domestic territory of the country.

Similarly India imports services of foreign nations. These import are part a part of the domestic product of foreign countries. Hence, we have to deduct the value of imports of goods and services from the value of exports to arrive at net exports.

Note :- As in the case of income method; similar precautions need to be taken here also....... expenditure on IG are not to be included (as already explained in detail), exp. on old shares and bonds not included, on second hand goods not included, on transfer payments not included, etc.

GDP -II

It is the money value of final goods and services produced in the domestic territory ( indian embassies in foreign land is also a domestic ter. for india ) of a country in an accounting year.

• End - use classification of Goods and Services

i > Consumer goods (CG) - Durable goods like cars, tv , ac . Similar goods purchased by the govt. for military purposes are a part of final consumption of the govt. Non-durable goods and services like paper, pen, pencils, soaps, oil, etc.

ii > INTERMEDIATE GOODS (IG) - Durable goods mentioned above and other durable goods like trucks , buildings, airfields, aircraft, etc. meant primarily for military purposes by the govt. are intermediate goods. Non - durable goods mentioned above used by the three producing sectors of the economy for producing goods and services are intermediate goods.

iii > Capital goods (KG) - All durable goods like trucks, cars, machines etc used to produce goods and services for sale in the market are a part of capital goods. Stocks of raw materials, semi finished goods lying with the producers at the end of an accounting yr. are also a part of capital goods. Capital goods are defined as all goods produced for use in future productive processes.

These examples will help a lot .....

a> a car purchased by a consumer for house use is a CG ; a car purchased by govt for military pupose is a IG and a car purchased by a taxi driver is a KG.

b> pencil purchased by anarchy to write XAT is a CG and the same used by XLRI to set the paper is an IG.

Note :- Intermediate cons. of the govt. is part of its final cons. Therefore , all the IG are also final consumer goods as far as the govt is concerned.

Now we come back to the three methods.

• VALUE ADDED METHOD

Each producing enterprise sells goods and services in the market and the value of its output is equal to the sum of sales and change in stocks. As far as this enterprise is concerned, sales are treated as final sales or sale of final goods and services.

For example -(the main idea which confused evryone) say a farmer produces two tons of wheat and sells it in the market to a flour mill. As far as the farmer is concerned, the sale of wheat is a final sale, and he gets Rs. 500 (say). Let us suppose that he has not used any fertilizer or hired any labourer. In that case , Rs. 500 is entirely the value of his contribution. But the purchase of wheat by the flour mill is for internediate consumption (it is an IG ) . It converts wheat into flour and sells it at Rs. 700 to a baker. The flour mill treats the flour as final product, but the baker uses it at the intermediate input and manufactures bread. The baker sells the bread to shopkeeper at Rs. 900. For the baker, the bread is a final good, but it is an inter. input for the shop keeper. Now suppose the shop keeper sells it for Rs. 1000 (the bread).

Thus the value of production as far as the farmer, miller, baker and shopkeeper is 500 + 700 + 900 + 1000 = 3100. Every producer treats the commodity he sells as final. He is not wrong in thinking so, as he is not concerned to which use the comm. is going to be put. BUT we know that the value of flour contains the value of hweat, value of bread contains the value of wheat and the value of services by miller. Finally, the value of bread sold by the shop keeper contains the value of wheat , the value of services of the miller and baker. Now the value of wheat is counted 4 times, miller 3 times and baker 2 times. This leads to double counting. And thus leads to the over estimation of the value of goods and services.

To avoid this problem we have to take the value of final goods and services ( recall the definition of GDP !!) And as i have already mentioned that there are three classification of goods, CG, IG, KG. Hence there are three uses for any commodity, final consumption, intermediate consumption and capital formation. From this it is clear that there are only two final uses; final consumption and capital formation Thus we need to calculate the value of goods and services going into these two. The best way to do so is to find the Value Added ( VA ) at each stage of production and then add it.

Thus in our example .....

Farmers VA = 500 ( as assumed that no inter. consumption)

Miller's VA = 700 - 500 = 200

Baker's VA = 900 - 700 = 200

Shop keeper's VA = 1000 - 900 = 100

Hence the total VA = 500 + 200 + 200 + 100 = 1000 --- > which is equal to ??? hmmm the price of the bread !!! ( coincidence ??.... nahi boss ).

Thus we subtract depreciation from the (gross) VA of all the producing enterprises in a sector ( thus making it net VA) and we get the GDP of the economy.

Hence GDP in VA method = Gross VA - depreciation = Net VA

Note :- the funda of gross VA and net VA ..... just remember that while going from anything gross to anything net ... we subtract consumption of fixed capital (i.e depreciation) from gross to get net.

Rendezvous With GDP - I (Chango bhai's article)

• Introduction ( very important )

Production and sale of goods and services (including goods meant for self-consumption) and the generation of income that accompanies these activities are processes that go on continuously. Production gives rise to income, income gives rise to demand for goods and services; and demand in turn gives rise to expenditure; again, expenditure leads to further production. The circular flow of production, income and expenditure represents three related phases, namely production, distribution and disposition.

We can look at GDP as a flow of goods and services produced, as a flow of incomes, or as a flow of expenditure on goods and services. To measure GDP at each of the 3 phases, we require data and method.

If we want to measure it at the phase of production , we have to find out the sum of net values added by all the producing enterprises (including the government) of the country. If we want to measure it at the phase of income distributed, we have to find out the total income generated in the production of goods and services. Finally, if we want to measure it at the phase of disposition, we have to know the sum of expenditures of the three spending units in the economy ; govt. ( G ) , consumer households ( C ) and producing enterprises ( I ).

Thus we have three methods of measuring GDP ( or National Income *more on this later* )

i > Value Added Method

ii> Income Method

iii> Expenditure method

• Basic Economic Activities

The basic forms of economic activities are Production, Consumption and Capital Formation. Capital Formation is also called accumulation or adding to the stocks of wealth.

A> Production - It is the provision of goods and services. It consists of the following

i. all the goods and services which are sold in the market with a view to earn profit. In other words, the commodities are sold at a price to cover costs ( Costs include profit as well, since profit is a cost). Industries and self employed workers like doctors, tailors, etc. produce commodities for sale in the market.

ii. goods and services not sold in the mkt. but provided free or at a nominal charge. Most of the govt. services rendered like defence, law, public health, street light, etc ( the ones in which we have already seen the free rider problem exists .... economics ; man evrythng is related to evrythng ..... keep reading ). Some other services here are hospitals, services by NGO, etc. All these come under "other goods and services"

iii. Produced goods which fail to reach the market and hence are not sold.

iv. Own account production of fixed assets by govt. , business enterprises, etc. such as houses, wells.

Note : Domestic services like cooking, nursing children etc are excluded from production . These activities are definitely economic in the sense that their production requires the use of scarce resources , still the statisticians ignore it due to inability of exact calculations. Also "Leisure Time" activities such as gardening are excluded from production.

B > Consumption - Using up of goods and services to satisfy human needs and wants is defined as consumption. There is no time gap between production and consumption, they take place simultaneously. For eg: the moment a doctor attends a patient, his service are consumed by the patient. The only exception is houses as they are treated as capital goods and they continue to produce housing services for a no. of yrs.

C > Capital Formation - In any growing economy, the entire production in an accounting year is not consumed. Production is normally higher than consumption ( and thus we have "inventory" , about which arun uncle spoke .... which are added to "change in stock" in GDP by expenditure method ; dealt with later ) . Thus the surplus of production over consumption in an accounting yr is known as capital formation. For developing countries like India , CF is very imp. as it determines the rate of growth of the economy. CF consists broadly of:

i. Construction of new assets like buildings, roads, bridges and transport equipments.

ii. Production of machinery and equipments.

iii. Increase in stock of raw materials, semi-finished goods and finished goods during an accounting year.

• Inter-Relation between the three

Production determines consumption and capital formation. An increase in the quantity of production of goods and ser. increases the level of consumption or capital formation or both. They in turn increase production. A higher level of consumption, improves the living std. of workers and this in turn increases their efficiency and productivity. This would increase the level of production. Similarly, capital formation directly determines the rate of growth of production. They act and react upon one another and keep the economy growing.

Why India survives high fiscal deficits

For years, the World Bank, IMF and Indian observers (including me) have warned that India’s fiscal deficit is too high and will soon lead to disaster. So too did Martin Wolf and Ed Luce in a recent article in The Financial Times.

Yet disaster has stubbornly refused to arrive for so long that it seems a case of crying wolf. How droll, a Wolf crying wolf.

When oil prices shot up during the 1991 Gulf war, it proved the last straw for an Indian economy burdened by a 10% combined fiscal deficit for the Centre and states. Today, another Gulf war has raised oil prices, and India’s fiscal deficit is back to 10% of GDP after dipping briefly in the mid-1990s. But today India has a current account surplus, forex reserves of $75 billion, low inflation and low interest rates.

Now, fiscal deficits of even 5% of GDP have bankrupted countries like Argentina. How does India survive, indeed thrive? What makes India different from other countries, and even from the India of 1991? The main reason is the flood of invisibles in the 1990s. That makes India really different.

High fiscal deficits typically cause three problems — a balance of payments crisis, high interest rates (because of crowding out) and high inflation (with currency depreciation being a key contributor). India suffered all three problems in 1991.

The big difference now lies not in the invisible hand of Adam Smith but in trade invisibles. Net invisibles have shot up from under $2 billion a year in the 1980s to $11.7 billion in 200-01 and $14.0 billion in 2001-02. They totalled $8.6 billion in the first half of 2002-03, and I expect the inflow to be a whopping $19-20 billion for the full year, over 4% of GDP.

A closer look at invisibles shows that miscellaneous services amounted to $14.7 billion in 2001-02, of which software accounted for $7.2 billion. In the first half of 2002-03, miscellaneous services yielded $9.2 billion of which software exports were $4.1 billion. We need more information on what the other miscellaneous services are. Remittances from Indians abroad were $12.19 billion in 2001-02, and accelerated to $7.3 billion in the first half of 2002-03. Possibly this includes some panic remittance of accumulated savings by Indians in the Gulf in anticipation of war.

The influx has more than offset the impact of a high fiscal deficit. Such deficits typically cause a balance of payments problem, high interest rates through crowding out, and high inflation because of currency depreciation. Let us examine each of these three in India’s current context. India’s high fiscal deficit has indeed created a huge trade deficit as conventionally measured. India’s merchandise trade deficits in the 1990s have been 3 to 4% of GDP, often higher than the 3.2% that emptied India’s forex reserves in 1991. But an influx of net invisibles of 4% of GDP has converted a record trade deficit into a current account surplus. Instead of a crisis we have equanimity.

Next, consider the impact of the fiscal deficit on interest rates. A high deficit should crowd out private investment and so raise interest rates. This is exactly what happened in the investment boom of the mid-1990s, when corporate bond rates soared to over 20%. This was unsustainable, led to uncompetitive production, and was followed by an investment bust that cooled interest rates. These were then pushed down even further by the flood of invisibles. The flood greatly increased money supply, despite the RBI’s sterilisation efforts. The Economic Survey says that forex reserves now exceed 100% of currency. The inflow of invisibles has been augmented by FDI and FII investment. The net effect is that corporates today can float 5-year bonds at 7%, the lowest rate for decades. Reliance, which once borrowed abroad to save on interest costs, now finds Indian borrowing cheaper. As Surjit Bhalla has remarked, globalisation has forced down Indian interest rates via invisibles.

What about inflation? Typically, high fiscal deficits drive down the real effective exchange rate. Currency depreciation plus high interest rates typically cause high inflation. But in India invisibles have kept the rupee steady, and steady import prices have meant low inflation. As India opens up, domestic inflation is increasingly determined by global inflation. Many people think the rupee was weak in the late 1990s because it depreciated against the dollar. In fact other currencies depreciated even more, and India’s real effective exchange rate was pretty steady. Ever since the Asian financial crisis, global inflation has been modest. So too has Indian inflation.

Can the situation suddenly change? Maybe, but I see no sign of it. Mckinsey expects India’s software exports to boom from $9.5 billion last year to $58 billion by 2008.

In sum, the fiscal deficit should not be criticised for threatening an imminent crisis. Rather, it should be criticised for funnelling precious resources (invisibles) to finance the fiscal deficit instead of accelerating GDP growth. That is a less stringent criticism, but a more accurate one.

An article by M.S.Swaminathan

Summary for Questions of 5th December:-

• What is the Fiscal Deficit? The fiscal deficit is the difference between the government's total expenditure and its total receipts (excluding borrowing). The elements of the fiscal deficit are (a) the revenue deficit, which is the difference between the government’s current (or revenue) expenditure and total current receipts (that is, excluding borrowing) and (b) capital expenditure. The fiscal deficit can be financed by borrowing from the Reserve Bank of India (which is also called deficit financing or money creation) and market borrowing (from the money market, that is, mainly from banks).
• Nominal GDP Growth vs. Real GDP GrowthGDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example: Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year 2000 prices. Since we're using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced $110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at $105B if year 2000 prices are used.

Then:

Year 2000 Nominal GDP = $100B, Real GDP = $100B

Year 2001 Nominal GDP = $110B, Real GDP = $105B

Nominal GDP Growth Rate = 10%

Real GDP Growth Rate = 5%

Similar is the case for Interest. General rates as we understand are nominal rates interest (Quoted by Banks) but we adjust the inflation, then remaining part is the real interest rates.

I am creating this blog for the preparation of GD/PI.

It will contain all the excerpts of the ongoing discussion on Pagalguy.

Let's rawk this world!!!!!