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.