Session 3 - Tracking The Economy's Performance

Tracking the Economy’s
Performance
Session 3
An Outline
Limitations
of GDP
Real versus
Nominal
Measuring GDP
Economic
Activity:
GDP
Prof. Amaresh Samantaraya 2
Measuring Economic Activity -
GDP
Concept, Measurement & Issues

Standard of living
Improvement of standard of living – major goal in all human endeavour
In terms of pleasure or joy derived from consumption of goods and

services
Access to nutritious food, better health care, comfort of using bigger

house, automobile, air-condition, holiday, etc. – better standard of living

Rich versus Poor
Rich country citizens enjoy better standard of living
Vast number of poor country citizens even do not have access to basic needs
Per capita income or Per capita GDP – major barometer
Analyzing cross-country and intertemporal variation in per capita GDP is an interesting

exercise

Per capita GDP
GDP per Head
=GDP/Population
Challenge: Measurement of GDP

GDP - Concept
Key Indicator • Measuring the SIZE of

economic activity
• Total Volume of Production

Proxy for • Total Income Generated
• Total Expenditure Incurred

GDP - Definition
the market values of

Sum
all final goods and services
of
produced within a country
in a given period of time
Example: Bread
Wheat grains Wheat Flour Bread
• Farmer produces • Miller produces • Baker produces

wheat grains wheat flour bread
• Uses seeds, • Uses wheat • Uses wheat flour,
fertilizer, water grains, machines milk, sugar,
and labour, etc. in the mill, stove, labour, etc.
as input electricity, labour, as input
etc. as input

Final Good versus Intermediate Goods
• Final good used for consumption directly
Distinction • Intermediate is used as an input for production

of final goods/other intermediate goods
Depends on • Wheat flour is an intermediate good if it is used

by baker to produce bread
the context • Wheat flour is a final good if used by a

household to make chapati for self-consumption

Question
Why to exclude
intermediate goods from
calculation of GDP?
To avoid double counting - Example: Bread
Wheat grains Wheat Flour Bread
• If the farmer has • Say, miller used 70 • Say, baker used 20

produced 100 kgs of kgs of wheat grain kgs of wheat flour to
wheat, and market to produce 70 kgs of produce 100 packs
price is Rs.30 per kg wheat flour, priced at of bread, each priced
• Market value of Rs.50 per kg at Rs.25
wheat is Rs. 3,000 • Market value of • Market value of
wheat flour is bread is Rs.2,500
Rs.3,500

Note
Total market value of

Total market value Total market value of
intermediate goods
(9000) final goods (5900)
(3100)
• Wheat grains: 3000 • Wheat grains: 900 • Wheat grains: 2100
• Wheat flour: 3500 • Wheat flour: 2500 • Wheat flour: 1000
• Bread: 2500 • Bread: 2500 • Bread: Nil

Group Task
Explain calculation of market value of final goods and
intermediate goods at various stages for following final goods
Readymade
Car Fruit juice Software
garment

Question 2
How to establish that total output

(production) of final goods=total
income generated=total
expenditure in an economy?
Circular Flow of Income
2 types of • Households own factors of production (services) and
sell that to the producers in return of factor income
agents • Firms use factor services from households for

producing goods and services and sell produced goods
• Households sell factor services to firms in the FACTOR

2 markets MARKET in return of factor income
• Firms sell goods and services in the PRODUCT
MARKET in return of payment for market value

Circular Flow – a 2-sector model
Factor
Market
Households Firms
Product
Market

Circular Flow
Circular flow in clockwise direction –REAL - factors services and goods &
services
Simultaneously, a circular flow in anti-clockwise direction – NOMINAL –

factor income and payments for goods & services
Total Expenditure on Goods & Services = Total Factor Income = Total

Value of final goods & services

Calculation of GDP – Expenditure Approach
Consumption Expenditure
Investment
(spending on capital goods, housing & inventories)
Government expenditure
(government consumption expenditure & gross investment)
Net exports

Item Type of Expenditure Comment
Buying a new mobile phone Consumption
Buying an used mobile phone in OLX Not counted in GDP Already counted in the
year it was produced
Buying a new flat Investment
Renting a flat Consumption
A mobile phone produced in 2020 but not Investment Inventory

sold in the same year
Purchasing of equities of Reliance Not counted Ownership transferred
Industries (not IPO) only
Purchase Prof.
ofAmaresh
equities
Samantaraya
under IPO Not counted Investment when20proceeds
used to install a factory
Income Approach
Wages & Salaries earned by workers
Interest earned on capital investments
Rent earned on land and property
Profits earned by firms

Value-added Approach
Farmer: Wheat grains (Value added = 3,000 – 0 = 3,000)
Assume input cost=0 Output value=3,000
Miller: Wheat flour (Value Added = 5,000 – 3,000 = 2,000)
Input cost = 3,000 Output Value=5,000
Baker: Bread (Value Added = 12,500 – 5,000 = 7,500)
Input Cost = 5,000 Output Value = 12,500

Real versus Nominal GDP

Issue
Market value of a cars produced in a year is a product of
number of cars and unit price of car
Accordingly, GDP is sum of product of quantity of goods

and services produced and their respective price
GDP = σ 𝑄𝑖𝑃𝑖

Issue
Using the same for comparison of GDP over the years becomes erroneous
It is because this GDP does not purely account for variation in quantity of production of goods &
services
Comparison of GDP across the years requires isolating the effect of changing prices
Concept of Real GDP serves this purpose

Nominal GDP versus Real GDP
Nominal • Quantity produced are multiplied by current prices in

each year
GDP • Over the years, it represents variation in quantity
produced as also changing prices
Real • Quantity produced in various years are multiplied by

price of the base year (constant prices)
GDP • Over the years, it reflects variation in quantity of
output only (and not prices)

Nominal GDP versus Real GDP
Year Quantity of Unit Price Nominal GDP Real GDP
Apple of Apple
2011 100 10 1000 1000
(100*10) (100*10)
2012 112 11 1232 1120
(112*11) (112*10)
2013 108 15 1620 1080
(108*15) (108*10)
2014 120 17 2040 1200
(120*17) (120*10)
2015 125 20 2500 1250
(125*20) (125*10)
GDP Deflator
GDP deflator is a proxy for current prices w.r.t. base prices
GDP Deflator = (GDPcurrent / GDPconstant)*100
GDP Deflator = (σ 𝑄𝑖𝑃𝑖current / σ 𝑄𝑖𝑃𝑖constant)*100

GDP Deflator - India
Year GDP-Current GDP-Constant GDP Deflator
2020-21 19745670 13512740 146.1
2019-20 20351013 14569268 139.7
2018-19 18886957 14003316 134.9
2017-18 17090042 13144582 130.0
2016-17 15391669 12308193 125.1
2015-16 13771874 11369493 121.1
2014-15 12467959 10527674 118.4
2013-14 11233522 9801370 114.6
2012-13 9944013 9213017 107.9
2011-12 8736329 8736329 100.0
2010-11 7634472 8301235 92.0
2009-10 6366407 7651078 83.2
2008-09 5514152 7093403 77.7
2007-08 4898662 6881007 71.2
2006-07 4254629 6391375 66.6
2005-06
Prof. Amaresh Samantaraya 3632125 5914614 61.4 32
2004-05 3186332 5480380 58.1

Economic Growth
Percentage change in GDP of the current year over the previous year
Economic Growth=[(GDPt – GDPt-1)/GDPt-1]*100
If GDP2020=210 crore, GDP2019=200 crore, g=5%
Higher economic growth over a long period significantly improves SoL

GDP and Economic growth – India
9.0 15060000
14060000
8.0
13060000
12060000
7.0
11060000
6.0 10060000
9060000
5.0
8060000
7060000
4.0
6060000
3.0 5060000
2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20
Growth GDP

GDP and Per capita GDP
GDP is a proxy for overall income or production in an economy
But it does not reflect available income or goods to an individual citizen
Per capita GDP or Income is a better indicator for individual standard of living

Cross-country comparison
• GDP of different countries are expressed in respective local currency
• Indian GDP in Rupee, France GDP in Euro, Bhutan GDP in Ngultrum, etc.
• To compare GDP or per capita GDP across countries, we need to convert
GDP measured in local currency to a common currency like say US $
• The exchange rate to be used for conversion
a) Market exchange rate
b) PPP exchange rate
GDP and Per Capita GDP (US $) - 2020
Country GDP (tn) Per capita GDP Per capita GDP
(PPP)
US 17.7 53,749 60,236
China 11.8 8,405 16,411
Singapore 0.32 56,349 93,397
India 2.7 1,961 6,118
Norway 0.49 90,885 63,586
Limitations of GDP

GDP - an important indicator in a
macroeconomic toolbox
Powerful and versatile way of measuring size of the economy
Helps comparing how much output different countries produce
Helps in assessing how rapidly or slowly an economy is growing

Not a perfect measure to assess economic
wellbeing
Per capita GDP is an average - it does not capture income distribution
Need to be supplemented by other socioeconomic indicators
Consumption distribution, IMR, HDI, Life expectancy, etc.

Can money buy you happiness?
• Beyond material consumerism, psychological or spiritual aspects
are fundamental for overall satisfaction and happiness in life
• Drive for lucrative job and luxurious life style may have their own
cost in terms of health hazards, spending quality time with family,
etc.

Issues on Computation of GDP
Home production
Underground economy
Negative externalities – environmental

cost

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Tracking the Economy’s

Prof. Amaresh Samantaraya 3

In terms of pleasure or joy derived from consumption of goods and

Access to nutritious food, better health care, comfort of using bigger

Prof. Amaresh Samantaraya 4

Per capita income or Per capita GDP – major barometer

Analyzing cross-country and intertemporal variation in per capita GDP is an interesting

Prof. Amaresh Samantaraya 5

GDP per Head

Challenge: Measurement of GDP

Prof. Amaresh Samantaraya 6

Key Indicator • Measuring the SIZE of

• Total Volume of Production

Prof. Amaresh Samantaraya 7

the market values of

• Farmer produces • Miller produces • Baker produces

Prof. Amaresh Samantaraya 9

Distinction • Intermediate is used as an input for production

Depends on • Wheat flour is an intermediate good if it is used

the context • Wheat flour is a final good if used by a

Prof. Amaresh Samantaraya 10

• If the farmer has • Say, miller used 70 • Say, baker used 20

Prof. Amaresh Samantaraya 12

Total market value of

Prof. Amaresh Samantaraya 13

Prof. Amaresh Samantaraya 14

How to establish that total output

agents • Firms use factor services from households for

• Households sell factor services to firms in the FACTOR

Prof. Amaresh Samantaraya 16

Prof. Amaresh Samantaraya 17

Simultaneously, a circular flow in anti-clockwise direction – NOMINAL –

Total Expenditure on Goods & Services = Total Factor Income = Total

Prof. Amaresh Samantaraya 18

Prof. Amaresh Samantaraya 19

Buying a new mobile phone Consumption

Renting a flat Consumption

A mobile phone produced in 2020 but not Investment Inventory

Interest earned on capital investments

Rent earned on land and property

Profits earned by firms

Prof. Amaresh Samantaraya 21

Assume input cost=0 Output value=3,000

Miller: Wheat flour (Value Added = 5,000 – 3,000 = 2,000)

Input cost = 3,000 Output Value=5,000

Baker: Bread (Value Added = 12,500 – 5,000 = 7,500)

Input Cost = 5,000 Output Value = 12,500

Prof. Amaresh Samantaraya 25

Accordingly, GDP is sum of product of quantity of goods

Prof. Amaresh Samantaraya 26

Concept of Real GDP serves this purpose

Prof. Amaresh Samantaraya 27

Nominal • Quantity produced are multiplied by current prices in

Real • Quantity produced in various years are multiplied by

Prof. Amaresh Samantaraya 28

GDP Deflator = (GDPcurrent / GDPconstant)*100

GDP Deflator = (σ 𝑄𝑖𝑃𝑖current / σ 𝑄𝑖𝑃𝑖constant)*100

Prof. Amaresh Samantaraya 31

2004-05 3186332 5480380 58.1

Economic Growth=[(GDPt – GDPt-1)/GDPt-1]*100

If GDP2020=210 crore, GDP2019=200 crore, g=5%

Higher economic growth over a long period significantly improves SoL

Prof. Amaresh Samantaraya 33