Economics is the study of how people, businesses, societies, or nations deal with the scarcity of resources.
The economy is the practical implementation of economics. For example, the Indian economy, and the US economy and we never use the terms Indian economics or USA economics.
Households provide people and businessmen to the corporates and in return, it provides goods and services back to them, with the help of money paid by the corporates to these people, they demand various goods and services.
| Factors of Production | Factors of Income |
| Land | Rent |
| Labour | Wages |
| Entrepreneur | Profit |
| Capital | Interest |
When the economy deals with Society, it is called ‘Macro-economics’
When the economy deals with Individuals, it is called ‘Micro-economics’
GDP and GNP
The term GDP was given by Simon Kuznets
Gross domestic product(GDP): Gross domestic product means the total amount of goods produced and services provided in a country in a given period of time and it doesn’t matter who made it, but it has to be within the boundary .
In India GDP is calculated by the National Statistics Office (NSO) which works under the Ministry of Statistics and programme implementation (MoSPI).
Gross National Product (GNP): The total amount of goods produced and services provided by the nationals of the country in a given period of time is called Gross National Product (GNP).
GNP = GDP– Earnings of foreigners in India + Earnings of Indians outside India.
i.e. GNP = GDP + Net factor income from Abroad. Where, Net factor income from Abroad = Earnings of Indians outside India – Earnings of foreigners in India.
- GDP at the current price is called Nominal GDP.
- GDP at a constant market price is called Real GDP.
Terms related to GDP
- Base Year: It is the year whose prices are being used to calculate the real Gross Domestic Product (GDP).
- Basic Price: It is the price at which factor cost is adjusted with production taxes and production subsidy.
- Market Price: It is the price under which the Basic price is added with the product tax and product subsidies (at which consumers purchase the product).
- Factor Cost: It is the cost that includes the cost of production of Land, Labour, Capital, and Entrepreneur.
- Depreciation: It is a part of the capital that gets consumed during the year due to wear and tear. It does not become part of anybody’s income.
- Gross: It indicates that the products are counted regardless of their subsequent use. When depreciation is deducted from the Gross value then it becomes the Net amount.
- Net Domestic Product at Market Prices (NDP) = Gross Domestic Product (GDP) – Depreciation.
Which year should be considered as Base Year?
- It has to be nearby (not very old) and should be a normal/stable year (no major ups and downs, no new reforms, no war or economic crisis) in that year.
- A revision in the base year is essential for better policy-making. It is meant to track structural changes in an economy and improve or update macroeconomic indicators that reflect the economic performance of a country.
- India has now subscribed to
- The System of National Accounts (SNA) 2008 was evolved by the United Nations (to maintain a similar pattern while calculating in different countries for better comparison).
- The International Monetary Fund’s (IMF) Special Data Dissemination Standard (SDDS).
- India used to change the Base year every ten years from 1949 till 1980-81, but after that, India started changing the Base year every five years.
- This practice was broken in 2009-10 because that year was not considered a normal year as it succeeded in the global slowdown of 2008. Hence, the next Base year was fixed for 2011-12.
- Next time the revision in the Base year was supposed to happen in 2019-20 due to covid but it didn’t happen and India is still using 2011-12 as the Base year.
Nominal and Real GDP
- Real growth means when the growth in the country only shows an increase in quantity and to know the real growth in the country the prices for both years need to be concerned.
- Nominal growth means an increase in quantity as well as an increase in prices. Under nominal growth, we are supposed to take the current year price and current year quantity for both the year concerned to know the growth in the country.
- Real growth rate provides the actual picture of the country that shows how well the country is doing.
- The main purpose of calculating real GDP in the country is to provide the information about real growth rate while on the other hand, the size of the country is provided with the help of the nominal GDP of the country.
- As per the current nominal GDP of a country India is the fifth largest country at a global level.
The problem of Double Counting
- GDP is defined as the current value of all final goods and services produced in a nation in a year.
- But what are the Final Goods?
- Individuals who calculate GDP must avoid the mistake of double counting, which is counting output more than once as it travels through the stages of production.
- For Example: What would happen if government statisticians first counted the value of tires produced by a tire manufacturing company and then counted the value of a new car sold by an automaker that contains those tires? The value of the tires would have been counted twice because the price of the car includes the value of the tires.
- To avoid this problem, which would overstate the size of the economy, government statisticians count just the value of final goods and services in the chain of production that is sold for consumption, investment, government, and trade purposes.
- Intermediate goods, which are goods that go into the production of other goods, are excluded from GDP calculation. This means that in the example above only the value of the car would be counted.
- The problem of double counting can be solved either by calculating the value of the final output or by taking the value added by each firm.
Methods of GDP Calculation
- Expenditure Method
- Production Method (Output method or Value added method)
- Income Method
1. Expenditure Method
- In a country, income earned is either spent on consumer goods and services or saved and invested.
- In this method, total national expenditure incurred in a particular year is taken into consideration to compute GDP.
As per the expenditure method, the GDP will be as follows:
GDP= C+I+G+(X-M)
➢ ‘C’ stands for gross private consumption expenditure
➢ ‘I’ stands for gross private investment or capital formation
➢ ‘G’ stands for Government expenditure
➢ ‘X’ stands for export
➢ ‘M’ stands for import.
➢ X-M stands for Net Exports
2. Production Method
- This is also called the ‘Output method’ or ‘Value added method’.
- Under this method, Gross Value Added (GVA) or GDP is computed, which is nothing but the difference between the value of output and intermediate consumption of all the three sectors, i.e. Primary sector, Secondary sector, and Tertiary sector.
- Production Method: GVA or GDP Value of Output of all three sectors – Intermediate consumption of all three sectors.
- It can be written as: Value Added = Value of Output – Value of (non-factor) Inputs
3. Income Method
- This follows from the simple idea that the revenues earned by all the firms put together must be distributed among the factors of production such as salaries, wages, profits, interest earnings, and rents.
- GVA at Basic Price = CE (Compensation to employee) + OS (Operating System) + MI (Mixed Income) + CFC (Consumption of Fixed Capital) + Production Taxes – Subsidies
- GDP at Market Price: GVA at Basic Price + Product Tax – Product Subsidies.
- Let W be the wages and salaries received by all the households in a particular year. Similarly, P, In and R are the gross profits, interest, and rents respectively received by all the households in a particular year.
- Therefore, GDP is given by, GDP: W+P+In+R
Calculation of GDP in India
- In India, currently, expenditure and production methods are used to calculate GDP.
- Developed countries like Germany, and Canada use income methods to calculate GDP.
- India has a large number of people working in the informal sector, which makes it difficult to calculate GDP in the Income method.
Purchasing Power Parity (PPP)
- In order to compare the absolute purchasing power of the currencies of the various nations, purchasing power parity, or PPP, is a measurement of the cost of particular goods in various countries.
- The price of a basket of goods at one location divided by the price of the same basket of goods at a different location is effectively what makes up the PPP ratio. Because of tariffs and other transaction costs, the PPP inflation and exchange rate may be different from the market exchange rate.
- For example: A maid in the USA will get around 500$ (i.e. 140000 rs) but in India she gets only around Rs. 15000.
- In GDP at PPP China is the first largest country of the world followed by the USA and India.
- PPP conversion factor is the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market as the US dollar would buy in the United States.
- GDP comparisons using PPP are generally considered more useful than those using Nominal GDP when accessing the domestic market of a state because PPP takes into account the relative cost of local goods and services of the country, rather than using International market exchange rates.
- For Example: As per International monetary fund calculations in 2022, if in the USA someone wants to buy something for 1 dollar on an average, but in India we have to pay around rupees 24.1 For the same thing on an average. That means the exchange rate is 1 dollar equal to 24.1 you need to increase the GDP by 3.36 times (81 divided by 24.10). That means if India’s nominal GDP in 2022 is 3.46 trillion US dollar, then in terms of PPP it will be 3.46 trillion dollars X 3.36 = 11.66 trillion US dollars.
- The contribution of Agriculture to India’s GDP is 18.8%.
- The contribution of Manufacturing sector to India’s GDP is 28.2%.
- The contribution of the Service sector to India’s GDP is 53%.
Important Points
- India is the Fifth largest economy of the world in Nominal GDP.
- But in GDP per capita India is the 139th richest country in the world.
- But in GDP at Purchasing power parity (PPP) India is the 3rd largest country of the world.
- GDP at PPP is calculated not by the government of India, but by agencies of the world like IMF, UN and CIA (Central Investigation Agency of USA).