Lecture 2- 4

1. Analyze the national income concepts (briefly)

2. We can distinguish between GDP and GNP.
3. Internationally look at GDP. This can be further understood as GDP at
constant vs. current factor cost and GDP at constant vs. current market
prices
4. Which are the relevant GDP concepts that are used for various
measurements?

The headline growth rate is measured by GDP at constant market prices as

of Jan 2015.

(Earlier. When looking at rate of growth of GDP, we looked at GDP at

constant Factor cost; however, international comparisons were usually at
GDP at constant market prices.)

When analyzing all other concepts, such as Saving/GDP ratio, Invt/GDP

ratio , Fiscal Deficit/GDP ratio etc.- the concept used is GDP at current
market prices.
5. Look at the kind of composition of supply side GDP i.e. economic activity
based classification of GDP. It shows a service-based kind of growth
model. What are its implications for the economy: Lack of markets for
service sector; Also, what about inputs for the economy? Implications on
cost and price both. It would affect profits from both cost and sales
(revenue) side.
6. Look at the composition of expenditure side GDP( expenditure based
classification of GDP). It is a consumption-led growth. What happens when
it is consn led-growth? Impact on invt. Invt includes GDFCF, inventories
and valuables. What happens when G goes up? It crowds out investment
i.e. the large scale of public borrowings leads to increase in interest costs
and hence there is a reduction in private investment. Also, what is the
impact of the large exposure to the external sector on GDP? Any
fluctuations wd impact our GDP- open economy concept. Net Exports refer
to difference between exports of goods and non -factor services and
imports of goods and non factor services.

(Good read:
http://www.arthapedia.in/index.php?title=GDP_/_National_Accounts_Revised_S
eries_with_2011-12_as_base_year)

7. We need to understand the national income identity, and its implications.

Y=C+I (AD)
Y=C+S (AS)

In a four-sector model,
Y=C+I+G+NX……………………………………… (1)
Yd=C+S OR C=Yd-S
Also, by definition, Yd=Y+Tr-Ta

Hence, C= Y+Tr-Ta-S --------------------------------(2)

Substituting (2) in (1),

Y= Y+Tr-Ta-S+ I+G+ NX

S-I= (G+Tr-Ta) + NX

If S=I, then G+Tr-Ta = Public savings/Budget Deficit will be equal to –NX (i.e. M-
X)= Current Account Deficit

OR in other words,
S- (Ta- G-Tr) –(M-X)= I

That is, the sum total of private, public and external savings= Invt.

If domestic savings falls short of the required invt, the country will run a CAD.

8. Next, what determines the rate of growth, g:

g= Savings rate/ ICOR ratio
= Invt rate/ICOR ratio

( OPTIONAL READ- ICOR is the abbreviation of Incremental capital output

ratio.
It is the ratio given by incremental output (Y) resulting from incremental
addition to the stock of capital (K).
ICOR indicates the amount of additional capital required to generate
additional GDP or National Income (Y).
To represent symbolically, v = ICOR = ΔK/ΔY where Δ stands for incremental
change.
Now we also know that ΔK is nothing but Investment (I) during a period
because it is through investment that the capital stock to produce additional
output is made available. So , ΔK = I.

We also know that (in the ex post sense) in a closed economy Investment
equals Savings (S).

So, I = S.

but Saving depend on the level of income ( a percentage of income is saved)

and this is represented by the equation S= s.Y where s is the saving rate.
Noe let us see what we have:
v= ΔK/ΔY = I/ΔY= S/ΔY= sY/ΔY

by transposing we get ΔY/Y= s/v

ΔY/Y is nothing but the rate of growth of GDP or Income.

The final equation says that this growth rate equals s/ v or savings rate divided
by the ICOR.

The higher the ICOR, the lower is the rate of growth of GDP or the economy.
The lower the ICOR the higher will be the economy's growth rate measured by
the rate of growth of GDP or income.

This is so simple intuitively: given the savings rate, the lower the additional
capital required to produce an additional unit of GDP, higher will be the
additional GDP generated from the given investment and hence higher the
growth rate. This is a simplistic version of the Harrod Domar growth model.)

a) Look at the GDP growth rates, Invt rates and work out the ICORs. What do
you notice- the ICOR has dropped. Why? What is its implication?
b) Given the relationship between growth, invt and ICOR, as also S and I, how
will the S-I gap be bridged? Through higher CAD.
Note, every year, the S-I difference is nothing but CAD.

So, as our savings rates falls and I falls lesser, what is the implication for growth?-
To sustain higher growth, we shall have to incur high CAD with its repercussions.

9. What is output gap? Difference between actual and potential output.

When actual output> potential output- implies an expansionary phase;
actual output < potential output- refers to a contractionary phase.
10. What is the observed pattern of output gaps? Find the average of the peaks
over the period 1950-1 to 2017-18 What does this average of the peaks
imply? One measure of the potential output. There could be other measures
of potential output as well. That itself has been revised in the last few years.
11. How do you relate the large output gap seen over a long period of time, vs.
the shorter output gap over a shorter period, say a year. This shows the
difference between structural vs. cyclical factors. The larger output gap is
on account of structural factors. Such structural factors are largely
irrelevant for advanced economies, which emphasise cyclical factors and
cycles of activity. But these are what are more relevant for less developed
countries.
12. Characteristics of Business cycles- read from Text Book