IN THIS CHAPTER
► Economic Growth and Economic Development.
► Definition and features of GDP, NDP, GNP, NNP etc.
► Methods of GDP calculation.
► Costs and Prices of GDP.
► New GDP series-2015.
► Human Development Index (HDI).
► Gross National Happiness (GNH).
► World Happiness Report.
Economic Growth and Economic Development
- Economic Growth: Economic growth is an increase in the capacity of an economy to produce goods and services, compared from one period of time to another.
- Economic development means an improvement in the overall quality of life and living standards of the people.
Difference between Economic Growth and Economic Development
Measuring Economic Growth
- It is imperative for every modern country to measure its economic growth. It will help a country to compare it’s growth rates with that of previous years as well as with the growth rates of other countries and to take steps necessary to improve the economic activities.
- Economists use many different methods to measure how fast an economy is growing. The most common way to measure the economy is Gross Domestic Product or GDP.
- The idea of the Gross Domestic Product was introduced by US economist Simon Kuznets in 1934.
Gross Domestic Product –GDP
- Definition: GDP is the total monetary value of all final goods and services produced within the geographical boundaries of a country in a given year.
- While calculating GDP, only those goods and services which have a fixed monetary value are taken in to account. Goods and services which do not have a monetary value affixed to them are not included in the GDP calculations.
For example: Goods and services produced free of cost as social service, work done by women at home like taking care of children, household chores etc which is known as ‘Care economy’ are not included in GDP estimates.
- While estimating GDP only the value of final goods and services are included (Final goods refer to those goods which are used either for consumption or for investment. Intermediate goods refer to those goods which are used either for resale or for further production). Goods that go into making other goods- intermediate /input goods are counted only once when the final product is valued. Otherwise it becomes double counting.
Intermediate Vs Final Goods
- Only newly produced goods are included in GDP. Transactions in existing goods such as second hand cars (resale) are not included, as they do not involve production of new goods.
- Transfer payments (One-way payment of money for which no good or service is received in exchange) such as pensions, scholarships, subsidies etc are excluded from GDP calculations because there is no production of any goods or services in exchange of such payments.
- Remittances (Money sent home from emigrants working abroad) are also not included in the GDP. This is because, in GDP estimations, only those goods and services produced within a country are included.
- ‘Where’ the production takes place is the most important criteria in GDP and not ‘Who’ produces it.
For example – an Indian company –Tata motors produces cars and USA Company Ford also produces cars in India. Since both these companies produce cars within India – their product will be considered for calculation of GDP of India. Similarly – Tata motors producing Car in Gujarat is counted in India’s GDP. But, Tata motors producing Car in UK is not counted in India’s GDP
Approaches of GDP calculation
Methods of GDP calculation
- The Expenditure Approach: The expenditure approach, also known as the spending approach, calculates spending by the different groups that participate in the economy.
- This approach can be calculated using the following formula:
GDP = C + I + G + NX
(C=consumption; G=government spending; I=Investment; and NX=net exports)
- Consumption refers to private consumption expenditures or consumer spending. Consumers spend money to acquire goods and services, such as groceries and haircuts etc. Government spending represents government consumption expenditure and gross investment. Governments spend money on equipment, infrastructure, and payroll. Government spending may become more important relative to other components of a country's GDP when consumer spending and business investment both decline sharply. (This may occur in the wake of a recession). Investment refers to private domestic investment or capital expenditures. Businesses spend money in order to invest in their business activities. For example, a business may buy machinery. Business investment is a critical component of GDP since it increases the productive capacity of an economy and boosts employment levels. Net exports refers to a calculation that involves subtracting total exports from total imports (NX = Exports - Imports).
- The Income Approach: The income approach calculates the income earned by all the factors of production in an economy, including the wages paid to labor, the rent earned by land, the return on capital in the form of interest, and corporate profits.
- The Production (Output) Approach: The production approach is the reverse of the expenditure approach. Instead of measuring the input costs that contribute to economic activity, the production approach estimates the total value of economic output and deducts the cost of intermediate goods that are consumed in the process. Whereas the expenditure approach projects forward from costs, the production approach looks backward from the vantage point of a state of completed economic activity.
Cost and Price of GDP
- While calculating the GDP the issues related to ‘cost’ and ‘Price’ needs to be decided.
- Basically, there are two sets of costs and prices, and an economy has to decide at which of the two costs and two prices it will calculate its GDP.
- Cost: Income of an economy, i.e., value of the goods and services produced can be calculated at either ‘factor cost’ or the ‘market cost’.
- GDP at Factor Cost (FC): Basically, factor cost is the input cost incurred by the producer in the process of producing something (such as cost of raw materials, wages and salaries, rent, power, interest on loans etc).
- So, factor cost= Labor (Wages) + Land (Rent) + Capital (Interest) + Entrepreneurship (Profit). This is nothing but price of the commodity from the producer’s side.
- When GDP is estimated by taking in to account the costs incurred by the producer, it is known as GDP at Factor cost.
Example: Let’s say to produce ‘xyz” the producer spent Rs 50 (wages) + Rs 50 (rent) + Rs 50 (interests) + Rs 50(profit), than the factor cost of ‘xyz’ will be Rs 200.
- GDP at Market Cost (MC): Market cost is the cost of goods and services prevailing in the market.
- After the production of goods and services, when they reach the market, government levies indirect taxes (Such as excise duty, service tax etc) on them.
- So, when indirect taxes are added to the factor cost, we get market cost of goods and services.
- When GDP is calculated by taking in to account the costs of goods and services prevailing in the market, it is known as GDP at market cost.
- GDP at Market cost = Factor cost + indirect taxes – Subsidies.
Subsidies are given by the government to reduce the prices of goods and services)
Let’s take an example,
If the factor cost of product ‘xyz’ is Rs 200 and indirect taxes is Rs 20 and subsidy given by the government to reduce its price is Rs 10, than
The market cost of ‘xyz’ will be 200 + 20 – 10 = 210 Rs.
- If we add indirect taxes and subtract subsidies from GDP at factor cost, we get GDP at market cost. And from GDP at market cost, if we subtract indirect taxes and add subsidies, we will get GDP at factor cost.
GDP at factor cost + Indirect taxes - subsidies = GDP at market cost
GDP at market cost - Indirect taxes + subsidies = GDP at factor cost
- India officially used to calculate its GDP at factor cost (the data at market cost was also released which was used for other purposes by the government). Since January, 2015, the CSO has switched over to calculating Indian GDP at market cost.
- Price: Income can be derived from two prices- ‘Current prices’ and ‘Constant prices’.
- GDP at Current prices: When the value of goods and services produced in a country is calculated by taking in to account their current prices, it is called as GDP at current prices.
- Current price is the most recent price at which goods and services are sold.
For Example, in 2020, if 100 soaps are produced and the price of each soap is Rs 10, than the GDP at current price will be 100 x 10= 1000 Rs.
- Current prices does not exclude the impact of inflation while calculating GDP. And hence, it does not reflect the actual health of an economy. Therefore, it is called as Nominal GDP.
Example: Let’s consider soaps produced in two years- 2010 and 2020. In 2010, the number of soaps produced was 150 and each soap was priced at Rs 5 each. And in 2020, the number of soaps produced was 100 and each soap was priced at Rs 10 each.
At current prices, the value of goods produced in 2010 will be 150 x 5 = Rs 750.
The Value of goods produced in 2020 will be 100 x 10 = Rs 1000.
- It can be seen from the above example that even though more goods were produced in 2010, when calculated in current prices, the GDP of 2020 appears more (even though lesser goods were produced) because of inflation.
- Nominal GDP is therefore GDP without adjusting to inflation.
- GDP at Constant prices: In order to exclude the impact of inflation and to get a realistic picture of growth in an economy, GDP is calculated at constant prices.
- For calculating GDP at constant prices, the prices of goods and services in a constant year i.e., Base year are considered and not their current prices.
- Using constant prices enables us to measure the actual change in output (and not just an increase due to the effects of inflation).
Example: Let’s take 2011- 12 as base year. The price of soap was Rs 7 in
In 2010, soaps produced were 150, so GDP at constant prices will be-
150 x 7 = Rs. 1,050
In 2020, soaps produced were 100, so GDP at constant prices will be –
100 x 7 = Rs 700
- The above example shows that constant prices depict the real growth in an economy by excluding the impact of inflation. Therefore, GDP at constant prices is called as Real GDP.
- The base year used in India is 2011-12.
- GDP Deflator: The GDP deflator, also called implicit price deflator, is a measure of inflation. GDP price deflator measures the difference between real GDP and nominal GDP.
- The formula to find the GDP deflator = (nominal GDP ÷ real GDP) x 100
Shortcomings of GDP
Using GDP for measuring economic prosperity of a country has several limitations such as:
- GDP is a measure of growth and not progress: GDP indicates growth that is quantitative. Qualitative aspects such as development, progress and well being are not taken in to account.
- GDP dose not capture black money: Thus, parallel economy poses a serious hurdle to accurate GDP estimates.
- GDP does not cover barter system: Even today, in rural areas, considerable portion of transaction of goods and services occur through barter system. GDP does not cover it.
- Does not cover informal/unorganized sector: Quite a large portion of the economy is in the informal sector- small and marginal farmers, landless laborers, street vendors etc. The value of goods and services produced in the informal sector is outside official GDP estimates.
- Care Economy is not included: GDP estimates do not include ‘care economy’ –domestic work and housekeeping.
- Social works are ignored: Voluntary and charitable works are not included in GDP estimates as they are unpaid.
- Environmental costs and other negative externalities are neglected: GDP estimates do not indicate whether the output causes environmental pollution or any other negative externality. What matters is output and its market value.
- Poverty and inequality is not indicated in GDP estimates.
Central Statistics office (CSO)
- The GDP estimation in India is undertaken by the Central Statistics office or CSO.
- The Central Statistics Office (CSO) is a governmental agency under the Ministry of Statistics and Programme Implementation responsible for co-ordination of statistical activities in India, and evolving and maintaining statistical standards.
- Its activities include National Income Accounting, conduct of Annual Survey of Industries, Economic Censuses and its follow up surveys, compilation of Index of Industrial Production, as well as Consumer Price Indices for Urban Non-Manual Employees, Human Development Statistics, Gender Statistics, imparting training in Official Statistics etc.
- It was established in 1951 and is headquartered in New Delhi.
Revised GDP series
The Central statistics Office released a new and revised GDP series in January, 2015.
Various changes made in the new GDP series are as follows:
- Changing the Base Year: The Base year has been changed from 2004-05 to 2011-12. This was done in accordance with the recommendation of National Statistical Commission, which had advised to revise the base year of all economic indices every five year.
- Replacing Factor Costs with Market Costs: Earlier GDP was measured in terms of factor cost at constant prices. This has been changed from 2015 onwards, GDP at market cost and at constant prices will be considered as India’s GDP.
- GVA at Basic prices: Sector wise estimates of the economy will be given at Gross Value added (GVA) at basic prices instead of factor cost. Earlier, India was measuring GVA using ‘factor cost’ now GVA will be measured using Basic prices.
What is Gross Value Added?
Gross value added (GVA), is defined as the value of output minus the value of intermediate consumption. It helps to measure the contribution made by an individual producer, industry or sector.
The relationship between GVA at Factor Cost and GVA at Basic Prices and GDP at market prices and GVA at basic prices is shown below:
GVA at basic prices = factor cost + (Production taxes - Production subsidies)
Production taxes and production subsidies are paid and received by the producer and are independent of the volume of actual production.
Examples of production taxes are land revenues, stamps and registration fees and tax on profession. Examples of production subsidies include, input subsidies to farmers, subsidies to village and small industries, administrative subsidies to corporations or cooperatives, etc
GDP at market prices = GVA at basic prices + Product taxes -Product subsidies
Product taxes and product subsidies are paid and received 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.
- Widening of Data Pool: In statistics, if the sample is larger, the more accurate the outcome will be. Previous data was sampled from Annual Survey of Industries (ASI), which comprised of about two lakh factories. The new database draws from the five lakh odd companies registered with the Ministry of Corporate Affairs under its e-governance initiative known as- MCA21.
While the earlier data gave only a factory-level picture, the new data looks at the enterprise level.
Net Domestic Product (NDP)
- Net domestic product (NDP) is an annual measure of the economic output of a nation that is calculated by subtracting depreciation from the Gross Domestic Product (GDP).
NDP = GDP – Depreciation
- Depreciation = Capital assets (e.g. Machinery, building etc) used to produce goods and services, undergo ‘wear’ and ‘tear’ in the process of production. The monetary value of the assets decreases over time due to use, wear and tear or obsolescence. This decrease in the value of capital assets is known as depreciation.
- Every asset (except human beings) undergoes depreciation. Government (Ministry of commerce and industry) announces the rates by which assets depreciate For example, a residential house in India has 1 % depreciation rate per annum, an electric fan has depreciation rate of 10 % per annum etc.
- While calculating GDP, the impact of depreciation is not taken in to account, which is done in NDP.
- NDP of an economy has to be always lower than its GDP for the same year, since there is no way to cut the depreciation to zero.
- NDP is not used to compare the economies of the world because different rate of depreciation is set by different countries.
Gross National Product (GNP)
- Gross National Product (GNP) is the total value of goods and services produced by the people of a country in a given year. It is not territory specific.
Gross National Product (GNP)
- Gross National Product (GNP) of a country is measured by adding its GDP with its ‘factor income from abroad’.( Factor income is the income that is derived from the factors of production like land, labour , capital and organization)
- Factor income from abroad = Residents of a country earn income not only within the domestic territory of a country but outside it also. Income from outside can be earned mainly in following ways:
(i) Income from work: Income is earned by working in other countries earning thereby wages and salaries.
(ii) Income from property and entrepreneur ship: Income from abroad is also earned by owning property (Like buildings, shops, factories, financial assets like bonds and shares) in foreign countries. Also, profit is earned for undertaking entrepreneurial activities of producing goods and services.
(iii) Retained earnings of resident companies abroad.
GNP = GDP + Net Factor Income from Abroad (NFIA)
Net Factor Income from Abroad of India = Factor income earned from abroad by Indians – Factor income earned by foreigners in India.
- The GNP of India is lower than its GDP because India’s net factor income from abroad has always been negative (due to more outflow of money than incoming). That means the factor income earned by foreigners in India is more than factor income earned by Indians from abroad.
- While calculating GNP, ‘Who’ produces goods and services becomes more important than ‘where’ it was produced.
Example: Many Indian citizen works in USA. They produce goods and services. Those goods and services are included in USA’s GDP but the salary/wages earned by those Indian’s will be included in India’s GNP.
Similarly, USA car company, Ford produces cars in India. The value of the cars produced by Ford in India will be added in India’s GDP but the profits earned by Ford Company in India will be included in in USA’s GNP.
Net National Product (NNP)
Net National Product = GNP – Depreciation
Net National Product (NNP) at factor cost is considered as ‘National Income’ of India.
Per Capita Income
- Per capita means per person. It is a Latin term that translates to "by the head."
- Per capita income or average income measures the average income earned per person in a country in a specified year. It is calculated by dividing the country’s total income by its total population.
- Per Capital Income = National Income divided by the population.
Net National Product at factor cost divided by the population.
- Let’s say, The National Income of a country is 1000 and there are 10 people in that country. The per capita income of that country will be, 1000 / 10 = 100.