ECONOMIC AND SOCIAL ISSUES

CHAPTER

MEASUREMENT OF GROWTH: NATIONAL

INCOME AND PER CAPITA INCOME

SUMMARY SHEET

Contents
1 What is the difference between Growth and Development? .............................................................................. 3
2 What is an economy? ........................................................................................................................................... 3
2.1 What are the various sectors of an economy? ............................................................................................. 3
3 Economic Growth: ................................................................................................................................................ 3
4 How can the capacity of an economy be measured? ........................................................................................... 4
4.1 Gross Domestic Product (GDP): .................................................................................................................... 4
4.2 Gross National Product (GNP): ..................................................................................................................... 4
4.3 Net Domestic Product (NDP): ....................................................................................................................... 5
4.4 Net National Product (NNP): ........................................................................................................................ 5
5 Factor Cost: ........................................................................................................................................................... 5
6 Market Price: ........................................................................................................................................................ 5
7 How is the National Income of India calculated? ................................................................................................. 5
8 What is GVA? ........................................................................................................................................................ 6
8.1 What is the GVA at Basic Prices? .................................................................................................................. 6
8.2 How is GDP at Market Price calculated using GVA at Basic Prices? ............................................................. 7
9 Economic Growth Rate ......................................................................................................................................... 7
10 Nominal GDP: ................................................................................................................................................... 7
11 Real GDP: .......................................................................................................................................................... 7
12 Various indicators to measure the change in prices: ....................................................................................... 8
12.1 GDP Deflator: ................................................................................................................................................ 8
13 Methods to estimate National Income: ........................................................................................................... 8
13.1 Product Method: .......................................................................................................................................... 9

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 13.2 Expenditure Method: ................................................................................................................................... 9
13.3 Income Method: .........................................................................................................................................10
14 Other concepts: ..............................................................................................................................................10
14.1 Per Capita Income (PCI): .............................................................................................................................10
14.2 Purchasing Powers Parity (PPP): .................................................................................................................10
14.3 Transfer payments: .....................................................................................................................................11
14.4 Personal Income: ........................................................................................................................................11
14.5 Personal Disposable Income (PDI): .............................................................................................................12
15 India’s GDP by various reports/financial institutions: ....................................................................................12

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1 What is the difference between Growth and Development?
Both growth and development refer to changes over a time period. Both these concepts differ as
follows:

✓ Growth is a Quantitative concept whereas Development is a Qualitative concept.

✓ Growth can be both positive and negative like GDP growth whereas development is always
positive as it shows quality improvement.

✓ Development is basically positive growth in addition to quality.

Let us have a look at a simple example to understand the difference better:

Suppose population of a city grows from 10,000 to 20,000 in a year with no improvement in
supporting infrastructure, then we can say that city has grown but without development.

2 What is an economy?
• The ‘economy’ is the organized system of human activity involved in the production,
consumption, exchange, and distribution of goods and services.
• The economy applies to everyone from individuals to entities such as corporations and
governments.
• The economy of a particular region or country is governed by its culture, laws, history, and
geography, among other factors, and it evolves due to necessity. For this reason, no two
economies are the same.

2.1 What are the various sectors of an economy?

• Human activities which generate income are known as economic activities.
• Economic activities are broadly grouped into primary (directly dependent on environment as
these refer to utilization of earth’s resources such as land, water, vegetation, building
materials and minerals), secondary (they add value to natural resources by transforming raw
materials into valuable products), tertiary activities (they include the services like transport
and communication services, healthcare and education services, trade etc).
• Higher services under tertiary activities are again classified into quaternary and quinary
activities.

3 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 (This is a very simple understanding of economic
growth, we shall be able to understand it better at the end of the chapter).

To conclude if an economy is growing or not, we need to in the first place measure its capacity.

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4 How can the capacity of an economy be measured?
This capacity of an economy can be measured through different indicators. We shall study them one
by one.

4.1 Gross Domestic Product (GDP):

It is defined as the total market value of all final goods and services produced within the country in a
given period of time- usually a year. In estimating GDP, only final marketable goods and services are
considered. The value of intermediate goods is a part of the final goods and services and so is not
counted separately as it amounts to double counting and exaggerates the value of output.

4.2 Gross National Product (GNP):

In calculating GDP, we are not taking into account the income earned by citizens of India working
abroad. So, we need to find a way to take into account the earnings made by Indians abroad or by
the factors of production owned by Indians. Also we must deduct the earnings of the foreigners who
are working within our domestic economy or the payments to the factors of production owned by
the foreigners. To calculate this GNP is used.

GNP = GDP + Net Factor Income from Abroad

(Net factor income from abroad = Factor income earned by the domestic factors of production
employed in the rest of the world – Factor income earned by the factors of production of the rest of
the world employed in the domestic economy).

Comparison between GDP and GNP:

GDP GNP
GDP shows how much is produced within GNP is a measure of the value of output produced
the boundaries of the country by both the by the "nationals" of a country- both within the
citizens and the foreigners. geographical boundaries and outside.
GDP focuses on where the output is It is a concept where the nationality comes into
produced rather than who produced it, it is a play, irrespective of the geographical location.
geographical concept. GDP measures all the
domestic production, disregarding the
producing entities' nationalities.
In the case of India, whatever is produced
within the boundaries of India will be taken
into account while calculating GDP. For e.g.
the profits earned by the Korean-owned
Hyundai car factory will also be added,
irrespective of the nationality of the owner.

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4.3 Net Domestic Product (NDP):
Net Domestic Product = GDP - depreciation

4.4 Net National Product (NNP):

Net National Product = GNP – Depreciation

Depreciation: The capital gets consumed during the year due to wear and tear. This wear and tear is
called depreciation. E.g. We buy a new car for Rs.5, 00,000. As the years pass by, the car gets used
and needs maintenance. So after say for 5 years, the value of the car does not remain the same.

5 Factor Cost:
Factor costs are the actual production costs at which goods and services are produced by firms and
industries in an economy. They are the cost of all factors of production such as land, labor, capital,
energy, raw materials like steel, etc that are used to produce a given quantity of output in an
economy.

For e.g. A bread is being made in a bakery. The raw material used is wheat (it costs Rs.50), one
person is involved in making it (he charges Rs.10). Now the factor cost of the bread is going to be
Rs.50+Rs.10=Rs.60. (We are ignoring the other charges for simplicity like the rent of the place where
bakery functions, the electricity bill etc).

6 Market Price:
It refers to the actual transacted price and thus includes the indirect taxes (Product Taxes) which a
government levies and the subsidies (Product Subsidies) which the government gives on the
products.

Thus there are two changes we make to the factor cost to arrive at the Market Price. We need to
add the indirect taxes and subtract the subsidies given by the government.

Product Taxes and Product Subsidies:

Product taxes/subsidies depend on quantity produced. Product taxes or subsidies are paid or
received on per unit of product (Eg: tax: GST and import and export duties; subsidies — food,
petroleum and fertilizer subsidies, interest subsidies given to farmers, households, etc).

National Income: We have seen four indicators which are used to measure the capacity of an
economy. Any of these indicators can be considered as National Income of a country.

7 So now how is the National Income of India calculated?

In India, the National Income is calculated by the CSO (The Central Statistics Office) which comes
under the Ministry of Statistics and Programme Implementation (MOSPI).

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Time Periods:

India's GDP is calculated quarterly and annually. The reports are released at a two months gap. For
example, the estimate for the December ended quarter would be released at the end of February.

Changes brought to the calculation of National Income in 2015:

In January 2015, the CSO brought many changes to the way it calculated the GDP.

These changes can be categorized into:

✓ Methodological Changes (Methodology is the science of doing something)

✓ Change in the Base Year
✓ Giving comprehensive coverage to all sectors

Specifically, there are two methodological changes adopted by the CSO in its new estimates and
both are highly interrelated.

✓ GDP of the country is to be estimated in terms of Market Price.

Gross Value Added (GVA) from different sectors will be calculated at basic prices.

8 What is GVA?
• GVA provides the rupee value of the amount of goods and services that have been
produced, less the cost of all inputs and raw materials while producing these goods and
services. There can be GVA for a firm, industry, sector or the entire economy.
• To calculate the GVA for an entire economy, we need to add the GVA of all the sectors of
the economy.

The relation between GDP and GVA:

GVA + Taxes on Products – Subsidies on Products = GDP

8.1 What is the GVA at Basic Prices?

Basic Prices:

Factor Cost + Production Tax – Production Subsidies = Basic Prices

Production Tax and Subsidy:

• Production taxes/subsidies are independent of the quantity (volume) of production.
• It is often imposed even if the products are not produced (Eg: tax —land revenues, stamps
fees, registration fees tax on the profession)
• Production subsidies — subsidies to Railways, input subsidies to farmers, subsidies to the
village and small industries, administrative subsidies to corporations or cooperatives, etc).

So, GVA at basic prices = GVA at factor cost + (Production taxes less Production subsidies)
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8.2 How is GDP at Market Price calculated using GVA at Basic Prices?
GDP at market prices = GVA at basic prices + Product taxes - Product subsidies

What were the other changes?

Change in the Base Year: We shall be seeing the concept of Base Year and the change made in the
subsequent sections.

Giving comprehensive coverage to all the sectors:

The coverage has been enhanced with greater representation of manufacturing and financial
sectors and this became a notable change that caused an upward revision of GDP for few years.
Comprehensive coverage of the financial sector including that of stock brokers, coverage of
activities of local bodies etc marks a deviation that seems to have caused the increase in GDP
figures.

9 Economic Growth Rate

• An economic growth rate is a measure of economic growth from one period to another in
percentage terms.
• In India we measure Economic Growth Rate by measuring the rate of change of GDP from
one year to another.

Here, it is important to understand that GDP can be calculated at:

a. Current prices (Nominal GDP)
b. Constant prices (Real GDP)

10 Nominal GDP:
Nominal GDP refers to the current year production of final goods and services valued at current
year prices.

11 Real GDP:
If this measure is adjusted for inflation; it is expressed in real terms.

Real GDP refers to the current year production of goods and services valued at base year prices.
Base year prices are constant prices.

Base Year:

• It is a specific year against which the economic growth is measured.

• It is allocated a value of 100 in an index.
• The estimates at the prevailing prices of the current year are termed as "at current prices",
while those prepared at base year prices are termed "at constant prices".

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 • A base year has to be a normal year without large fluctuations in production, trade and
prices of commodities in general.

New Base Year 2011-12:

The Ministry of Statistics & Programme Implementation has released the new series of national
accounts, revising the base year from 2004-05 to 2011-12.

12 Various indicators to measure the change in prices:

12.1 GDP Deflator:

• Notice that the ratio of nominal GDP to real GDP gives us an idea of how the prices have
moved from the base year (the year whose prices are being used to calculate the real GDP)
to the current year.
• In the calculation of real and nominal GDP of the current year, the volume of production is
fixed.
• Therefore, if these measures differ it is only due to change in the price level between the
base year and the current year.
• The ratio of nominal to real GDP is a well-known index of prices. This is called GDP Deflator.

Why is it better to measure Growth at CONSTANT PRICES rather than at CURRENT PRICES?

A growing Nominal GDP might reflect a rise in inflation as opposed to growth in the amount of
goods and services produced. Measurement at CONSTANT PRICES cancels the effect of INFLATION
(Price Rise).

13 Methods to estimate National Income:

1. OUTPUT METHOD/PRODUCT METHOD
2. EXPENDITURE METHOD
3. INCOME METHOD

Circular Flow of Income:

Before, explaining each one in detail, let us consider a simple economy (without a government,
external trade or any savings)

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 • Here we have individuals working for the firms (Business), they receive their wages from the
firms in exchange of their services.
• In this simplified economy, there is only one way in which the individuals (households) may
dispose off their earnings – by spending their entire income on the goods and services
produced by the domestic firms.
• In other words, factors of production use their remunerations to buy the goods and services
which they assisted in producing.
• The aggregate consumption by the households of the economy is equal to the aggregate
expenditure on goods and services produced by the firms in the economy.
• The entire income of the economy, therefore, comes back to the producers in the form of
sales revenue.

13.1 Product Method:

• In this method, national income is measured as a flow of goods and services. We calculate
money value of all final goods and services produced in an economy during a year. Final
goods here refer to those goods which are directly consumed and not used in further
production process.
• Goods which are further used in production process are called intermediate goods. In the
value of final goods, value of intermediate goods is already included therefore we do not
count value of intermediate goods in national income otherwise there will be double
counting of value of goods.
• The money value is calculated at market prices so sum-total is the GDP at market prices.

13.2 Expenditure Method:

In this method, national income is measured as a flow of expenditure. GDP is sum-total of private
consumption expenditure. Government consumption expenditure, gross capital formation
(Government and private) and net exports (Export-Import).

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13.3 Income Method:
• Under this method, national income is measured as a flow of factor incomes. There are
generally four factors of production labour, capital, land and entrepreneurship. Labour gets
wages and salaries, capital gets interest, land gets rent and entrepreneurship gets profit as
their remuneration.
• Besides, there are some self-employed persons who employ their own labour and capital
such as doctors, advocates, CAs, etc. Their income is called mixed income. The sum-total of
all these factor incomes is called NDP at factor costs.
• The three methods must yield the same results because the total expenditure on goods and
services (Gross National Expenditure) must be equal to the value of goods and services
produced (Gross National product) which must be equal to the total income paid to factors
that produced these goods and services.

14 Other concepts:
There are few other concepts that need to be understood.

14.1 Per Capita Income (PCI):

Per Capita Income = National Income/Population

14.2 Purchasing Powers Parity (PPP):

• There are two ways to measure GDP (total income of a country) of different countries and
compare them.
• One way, called GDP at exchange rate, is when the currencies of all countries are converted
into USD (United States Dollar).
• The second way is GDP (PPP) or GDP at Purchasing Power Parity (PPP).

Now let us differentiate these two:

When we say that we convert the price of one currency in terms of another currency, we are
referring to the market exchange rate (Nominal).

Now this would tell us the income or the GDP of a country in terms of another currency.

Let us consider a hypothetical example:

1 US Dollar = 65 Indian Rupees

Now the GDP of India is Rs.1300, so the Indian GDP in terms of Market Exchange Rate would be
$20.

What it means?

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 • It means if a person has Rs.1300 in his hands and would like to go to US for a trip, then on
exchanging the Indian Rupees with dollars, he would get $20 in his/her hands.
• But this Market Exchange Rate does not tell us anything about the purchasing power of the
currencies.
• We cannot compare how much one needs to spend to buy similar products in both the
countries.

To assess this, we calculate the GDP of a country in terms of PPP (Purchasing Power Parity).

What is it?

• Let us take a hypothetical example, suppose there is only one product being manufactured in
both US and India – Pen.
• Now to buy a pen in US we need 1$. In India, with the same one dollar which is equal to
Rs.65, we can buy 5 pens.
• This means in India one pen can be purchased with Rs.13 and in US one pen can be
purchased with 1$.
• So, PPP exchange rate is Rs.13/$.
• Using this exchange rate we can see that India’s GDP in terms of PPP exchange rate is
(1300/13) = $100.

Let us take one more example and show how comparison helps?

Suppose, you buy a pen in US which costs say $2. Now, in Germany, people buy the same pen for
say $4 (here we have converted the currency of Germany to US dollars for comparison).
Thus, for every $1.00 spent on the pen in the US, it takes $2 to obtain the same pen in Germany.

What is the conclusion?

We see that, in Germany, the cost of living is higher when compared to the US and this means that
the purchasing power of the people in Germany is less than that of people in US.

In our examples, we have taken just one product for comparison, to calculate the GDP at PPP, a
basket of goods is selected and the prices of it are used to calculate the GDP of a nation at PPP.

14.3 Transfer payments:

It refers to payments made by government to individuals for which there is no economic activity in
return by these individuals. Examples include pensions, scholarships, etc.

14.4 Personal Income:

Personal Income (PI) ≡ NI – Undistributed profits – Net interest payments made by households –
Corporate tax + Transfer payments to the households from the government and firms.

NI: National Income

Undistributed profits: Out of NI, which is earned by the firms and government enterprises, a part of
profit is not distributed among the factors of production. This is called Undistributed Profits (UP).

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Net interest payments made by households: The households do receive interest payments from
private firms or the government on past loans advanced by them. And households may have to pay
interests to the firms and the government as well, in case they had borrowed money from either. So
we have to deduct the net interests paid by the households to the firms and government.

Corporate Tax: Corporate Tax, which is imposed on the earnings made by the firms, will also have to
be deducted from the NI, since it does not accrue to the households.

Transfer Payments: The households receive transfer payments from government and firms
(pensions, scholarship, prizes, for example) which have to be added to calculate the Personal
Income of the households.

14.5 Personal Disposable Income (PDI):

Even PI is not the income over which the households have complete say. They have to pay taxes
from PI. If we deduct the Personal Tax Payments (income tax, for example) and Non-tax Payments
(such as fines) from PI, we obtain what is known as the Personal Disposable Income.

Personal Disposable Income is the part of the aggregate income which belongs to the households.
They may decide to consume a part of it and save the rest.

Personal Disposable Income (PDI) ≡ PI – Personal tax payments – Non-tax payments.

15 India’s GDP by various reports/financial institutions:

We have given below a list of institutions that releases the GDP estimates of India at frequent
intervals (We have mentioned the frequency of all these reports). These estimates are very
important, and the students need to keep themselves updated by referring the ESI in news
monthly current affairs document released by EduTap every month.

S.No Name of the Headquarter Report Frequency of Examples

Organization of the (released if the Report (These are only
Organization any) examples: Date
need not be
memorized, only
the latest data
before the exam is
relevant)
1 World Bank Washington Global Two editions For 2018-19 – it is
D.C, United Economic in a year: 7.3% and for 2019-
States Prospects January and 20, t is 7.5%
Report June respectively.
Here when we say
2018-19, it is FY
2019 and it is from
1st April, 2018 to 31st
March 2019.
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2 International Washington World Prepared two For 2018 it is 7.4%
Monetary D.C, United Economic times in a year and for 2019 it is
Fund (IMF) States Outlook and updated 7.8%.
twice in a year Here when we say
for 2018 – it is
referring to the
calendar year 2018,
that is from 1st
January 2018 to 31st
December 2018.
3 United New York World Released once
Nations city, New Economic every year at
York, United Situation and the starting
States Prospects and updated in
the mid of the
year
4 Asian Manila, Asian Published
Development Philippines Development every year in
Bank Outlook March/April
with an update
published in
September
and brief
supplements
published in
July and
December
5 Central -
Statistics
Office (CSO)
6 Department - Economic Released every
of Economic Survey of year
Affairs, India
Ministry of
Finance
7 Reserve Bank Mumbai Bi-monthly After every
of India monetary two months
policy review
8 Fitch Ratings New York Need to keep
City, USA a check
9 Moody’s New York Need to keep
Investor City, USA a check

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 Service
10 India Ratings Corporate Need to keep
and Research headquarters: a check
(Ind-Ra) Mumbai
11 S&P Global New York, Need to keep
Ratings United States a check
12 HSBC London, UK Need to keep
a check

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