Chapter Objectives – Chapter 3

GNP is a measure of the value of goods and services which the nationals or residents of the
country produce regardless of where they are located.

GDP is the total value of all the final goods and services produced by all the enterprises
within the domestic territory of a country in a particular year.

Personal income is the income received by households and the non-corporate businesses.

Disposable personal income is the amount which is actually available to the households and
to the non-corporate business after they have fulfilled their tax obligations to the government.

Importance of the GDP as one of the most important macroeconomic variables and one of the
best measures to judge an economy’s performance.

Three approaches for calculating the GDP are the output approach, the income approach and
the expenditure approach. 1
 National Income Aggregates

GDP;
Total value of all the final goods and services produced by all the enterprises (both
resident and non-resident) within the domestic territory of a country in a particular
year.

Important Points on GDP:

 Best indicators of judging an economy’s performance.
 Only market prices
 Only the value of currently produced goods and services
 Production of inventories also increases the GDP.
 Intermediate goods: Only the value of the final goods is included.
 For goods which are not sold in the market, imputed values have to be used.
 Nominal GDP: Current prices.
 Real GDP: Constant prices.
2
 GDP is an imperfect measure of economic activity !

Often the value of many goods and services do not get included in the GDP.

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Imputations involved in the calculations of the GDP may not be accurate.

Real GDP is a better measure of economic well being because it is not affected by
a change in the prices.

Real GDP can be calculated either by using base year prices or by using chain-
weighted measures.

GNP = GDP + factor payments from abroad − factor payments to abroad.

NNP = GNP − depreciation

NI = NNP − Indirect business taxes

 Personal Income : Income received by households and the
non-corporate businesses from all sources.

 Personal income = National income (NI) − (Corporate profits + Social security

contributions + Net interest) + (Dividends + Transfers from government to
individuals + Personal interest income)

4
Disposable Personal Income:
Amount which is actually available to the households and to the non-corporate
business after they have fulfilled their tax obligations to the government.

 Disposable
personal income = Personal income − Personal tax and non-
tax payments.

5
Measurement of National Income: Output approach, Income approach
and Expenditure approach.

 (i) Output approach/ Product method/ Value added method.

 Total value of all the final goods and services produced in an economy during a given time
period are estimated in three stages.
 1. Gross Value of Domestic Product:
 Classification of production enterprises according to their activities;
 Primary(agriculture and allied activities);
 Secondary(manufacturing sector);
 Tertiary (Services sector).
Multiply value of output of each sector with respective prices and then sum them up.

2. Estimate
Intermediate Consumption: expenditure on non factor inputs like raw material, electricity,
fuel etc.
Depreciation: Percentage of output or percentage of capital.
6

3. Net Value of domestic product = Gross Value of Domestic Product less Intermediate
Consumption and depreciation
 7

Income approach/ factor income method/ factor

share method

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Total sum of factor payments received during a given period is
estimated.

(i)Employee’s Compensation
(ii)Proprietor Income
(iii)Rental Income
(iv)Corporate Profits
(v)Net Interest
 8

Expenditure approach
Four components—
(i) Private consumption expenditure,

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Durable and non durable good and services
(ii) Investment expenditure,
business fixed investment, residential investment and
inventory investment
(iii) Government purchases,

(iv) Net exports.

Value of goods and services exported to other countries and value of

goods and services imported from other countries
 9

NOTE!

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Transfer payments are not included

NetIncome from abroad is to be added to the

GDP to arrive at the GNI.

Three approaches must yield the same result.

RECENT CONTROVERSY ABOUT
10
THE GDP GROWTH
MEASUREMENT IN INDIA
 
 “India’s GDP growth rate in the post-2011 period has been over-
estimated by an average 2.5%.”
 “Official estimates place annual average GDP growth between

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2011-12 and 2016-17 at about 7 percent. We estimate that actual
growth may have been about 4.5 percent.”
 In his paper Dr. Subramanian has highlighted three potential causes
of overestimation of GDP-

 1.Shift from a volume-based to value-based estimates of Gross

Value Added (GVA) in the manufacturing sector.

 2. Deflating the services by manufacturing deflators

 3. Proxying informal by formal activity
 11

1. Shift from a volume-based to value-based estimates of Gross Value

Added (GVA) in the manufacturing sector.
Prior to 2011, to calculate the manufacturing GVA, data of ASI (Annual Survey of Industries) and IIP (Index of
Industrial Production) were used.
These data were volume-based estimates.

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After 2011, data of financial accounts prepared by Ministry of Corporate Affairs are being used, which are mainly value
based estimates (quantity multiplied by price).
Serious consequence:
If the nominal values are not properly deflated to get the real figures. The problem is more serious in case of
manufacturing sector whose major input is petroleum and the price of this input is very fluctuating in the world market.
So, when we move from a volume-based to value-based estimates of GVA while calculating GDP growth, we have to
ensure that proper deflation method is applied to convert the nominal figures into real figures. Dr. Subramanian suggests
that in such cases a method of “double deflation” is most suitable to avoid any mis-estimation. “Double deflation” refers
to the mechanism where input values are deflated by input prices and output values are deflated by output prices while
calculating the real GVA growth.
But the new methodology that started in 2011 did not follow the double deflation procedure rather it followed a single
deflation procedure in which both input and output values were deflated by output price. In the manufacturing sector the
price of the major input – petroleum – had been declining in the post-2011 period. So, the input prices were
considerable lower than the output prices. If the input costs were deflated by the larger output prices rather than the
lower input prices, the single deflation method is bound to lead to an over-estimation of GVA.

However, this proposition by Dr. Subramanian has been challenged by the former Chief Statistician Pranab Sen. Pranab
Sen in his counter-argument justified the methodological shift from the volume-based method to value-based method on
the ground that, GDP by definition is a nominal measure and most of the developed countries used value based
estimates, while the developing nations use volume-based estimates for GDP growth.
 Solution: 12

 Dr. Subramanian suggests that in such cases a method of “double

deflation” is most suitable to avoid any mis-estimation. “Double
deflation” refers to the mechanism where input values are deflated by
input prices and output values are deflated by output prices while
calculating the real GVA growth.

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 But the new methodology that started in 2011 did not follow the double
deflation procedure rather it followed a single deflation procedure in
which both input and output values were deflated by output price.
 In the manufacturing sector the price of the major input – petroleum –
had been declining in the post-2011 period. So, the input prices were
considerable lower than the output prices. If the input costs were
deflated by the larger output prices rather than the lower input prices,
the single deflation method is bound to lead to an over-estimation of
GVA.
.
 
 However, this proposition by Dr.13Subramanian has been
challenged by the former Chief Statistician Pranab Sen. Pranab
Sen in his counter-argument justified the methodological shift
from the volume-based method to value-based method on the
ground that, GDP by definition is a nominal measure and most of
the developed countries used value based estimates, while the

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developing nations use volume-based estimates for GDP growth
 The reason is that, GDP growth can take place because of three
reasons –
 Growth in volume (which we can equate with Marx’s absolute
surplus value production concept)
 Growth in productivity or technological efficiency (which we can
equate with Marx’s relative surplus value production concept).
 Improvement in product quality.
w
 14

 The volume based estimate as proposed by Dr.

Subramanian, can capture only the first factor, but not the
other two factors.
 But GDP can increase due to the other two factors also.
 So, according to Pranab Sen it is wrong to claim that GDP

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growth has been overestimated by 2.5% in the post-2011
period.
 Rather it would be more appropriate to say that while 4.5%
of GDP growth is due to volume growth as calculated by
Subramanian, rest 2.5% of GDP growth is due to either
quality growth or efficiency growth.
 
 15

Bone of Contention:

Should a developing nation like India should stick to the previous volume-based
method or whether it should shift to a value-based method.

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According to Subramanian the value-based estimates would give faulty picture of
GDP growth in the post recession period and would misdirect the development
policies.
Pranab Sen on the other hand argues that the volume based GDP estimate seriously
undermines the role of quality.

For example
Suppose previously a very low quality rice of Rs.20 per kg was produced in
an amount of 40 kg, but now a very high quality Basmati Rice of Rs. 100 per kg is
produces in an amount of 40 kg. The volume growth is then zero but the value
growth is quite high, which Subramanian’s measurement would miss.
16

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Macroeconomics: Theory and Policy by Vanita Agarwal