SESSION 4

Reading
1. This set of slides
2. From the text material :
Chapter 2 – page 42-45, 49-51
Other Aggregate Measures of Output
 GDP at market price

GDP at market price

Fin. = Σ of revenue from all sources
Inst. = C+I+G+X-M

Govt.
I

G
Firms
House-
hold
C M

X Rest of
the
world
GDP at factor costs

Σ Value added of all sectors

= Σ all factor costs of final goods
production
= GDP at factor costs

Firms

GDP at market price [∑PiQi] and GDP at factor costs [∑VA] may be
different if there are some transfers made between the firms and the
government.
GDP at factor costs
= GDP at market price - indirect taxes + subsidies

Govt.

Firms

Transactions between the

firm and government that
directly affect prices-
1. Indirect taxes
2. subsidies
GDP is evaluated at market price. It diverges from the true cost of production
due to the presence of indirect taxes and subsidies.
True cost = sum of all factor costs

If there are taxes, market price > cost

GDP over-estimates the value of national output.
If there are subsidies, market price < cost
GDP under-estimates the value of national output.

GDP at factor costs

= GDP at market prices – [ Indirect taxes – Subsidies]
 Households aggregate income
(or disposable income)

Govt.
govt. transfers (TR) Firms
Net Int. payment on govt. bonds (NIPGB)

taxes
House-
hold Rest of
net income from abroad the
world
GDP at market price [∑PiQi] and Aggregate income received by
the Household [∑Income for all households] may be different if
there are some transfers made
(i) between the households and the government
(ii) And between the households and the rest of the world
 Disposable income
Disposable income
= income left to the public for consumption and savings.
= GDP at factor costs + net income from abroad + govt. transfers (TR) + net
Interest payment on government bonds (NIPGB) – direct taxes

Disposable income is either consumed or saved. So…

DI = Consumption spending ‘C’ + Personal savings ‘S’

Public: household and firms

S = Households savings and firms retained earnings saved in financial
institutions. Firms save too. But the larger share of this savings comes from
households.
C = Consumption. This mainly constitutes of household consumption, also
incudes firms’ purchase of consumption goods. Households’ share is
commonly much larger.
Exercise
Consider a closed economy with a single telephone company, Call’s
yours’. The residents of the country make 2 million phone calls per year
at a rate of 3/- per call.

One day a new phone company Cheap-calls enters the market and
charges only 2/- per call. All residents immediately switch to Cheap-calls.
They still make 2 million calls.

Cheap calls proud of their achievement posts billboards stating. “Our

country has increased its national savings by 2 million per year by
switching to Cheap calls.”

How true is the statement?

Exercise
For each of the transactions below, what is the contribution to
current year’s GDP? Explain the effects on product, income
and expenditure account.

• A home maker enters workforce taking a job that will pay

20,000/- per month. The home maker must pay 8000/- per
month for a professional child care service.

• You have won a 300,000/- prize from the central

government lottery.

• A Japanese company begins a subsidiary operation in India

to assemble automobiles with imported auto parts from
Japan. The production is marketed from Japan.
Exercise
A country grows wheat and grapes and makes bread and wine. Its costs and
revenue in 2017 are shown in the table below.
Flour Bread Grapes Wine
Labor cost 400 100 200 300
Supplies 100 550 150 200
Profit 50 250 50 350
Sales 550 900 400 850
All flour is used to make bread: the 550 of supplies for bread is flour
produced that year. Some grapes (200) are used to make wine, and some
grapes (200) are sold directly to consumers.

a) What is the country GDP for 2017 measured by the product method?
b) What is the country’s GDP measured by the value added method?
GDP as measured by the value GDP measured as total value of
added approach: final products

Value added= Value of final products

Sales - supplies Sales – supplies
Flour 450 Flour All used as input
Bread 350 Bread 900
Grapes 250 Grapes 200 (rest 200 as input)
Wine 650 Wine 850
Total 1700 Total 1950

GDP calculated by VA approach is less by 250.

This is because all sector uses some input supplies. (100 in flour and 150 in grapes)
But the source of those input supplies is not given. If we could consider the VA in
those input sectors also, then this difference would not exist.
Exercise
Read the table below showing the GDP and its various components for two
consecutive periods. Assume that taxes constitute only income taxes collected
from the households. Government makes no ‘transfers’, subsidy or interest
payments to the public. Net factor income from abroad = 0. Growth rate for
period 2 is 10%.
Fill in the blank spaces.

GDP C S T I G X M
Pd 1 8000 4000 3000 1000 2500 2000 3000 2000
Pd 2 ? 3800 3200 ? 2500 2000 ? 500
Real and Nominal Income
• A distinction between real and nominal income is essential, as price keeps
changing.

• Real income : income measured in terms of quantities of

goods and services

• Nominal income: income measured in current prices

• Say the economy produces only 1 good,
, pizza.

Yr 2000 Yr 2001
Real income 50 pizzas 45 pizzas
Price 100 200
Nominal income 5000 9000

• Nominal income has increased despite fall in real output.

• Hence nominal GDP may over or under estimate real output.
 • Say the economy produces 2 goods,, pizzas and books.

Yr 2000 Yr 2001
Pizzas 30 20
Price of pizzas 100 200
Books 4 7
Price of books 500 400

• Is the economy growing?

• … if value of output shows a rise, when calculated at constant prices.

• Growth rate = [GDP (2001) – GDP (2000)] / GDP (2000)

All calculated at constant prices.
Change in the base year and implication on Growth rate

GDP growth rate of 2013-14 measured at 2010-11 as base year appears to

be more than when measured at 2004-5 as base year.
What could be the reason?

• GDP of 2013 at 2010 prices = A(13).Pa(10) + B(13).Pb(10)

• GDP of 2012 at 2010 prices = A(12).Pa(10) + B(12).Pb(10)

• Growth rate of 2013 calculated with 2010 as base year = G(10)

= [ [A(13).Pa(10) + B(13).Pb(10)] – [A(12).Pa(10) + B(12).Pb(10)] ]/
[A(12).Pa(10) + B(12).Pb(10)]

• Growth rate of 2013 calculated with 2004 as base year = G(04)

= [ [A(13).Pa(04) + B(13).Pb(04)] – [A(12).Pa(04) + B(12).Pb(04)] ]/
[A(12).Pa(04) + B(12).Pb(04)]
Say Pa(10) = Pa(04)(1+α) and Pb(10) = Pb(04)(1+β)

G(10) > G(04)

 [B(13) – B(12)]/ B(12) . (β- α) > [A(13) – A(12)]/ A(12) . (β- α)

 Gb > Ga and β > α
 B sector grew faster than A between 2012 and 2013
and B’s price increased faster than A’s between 2004 and 2010

Or Gb < Ga and β < α

 A sector grew faster than B between 2012 and 2013
and A’s price increased faster than B’s between 2004 and 2010

Steel, Wheat and E commerce were growth sectors in 2012 -2013.

What explains 7% GDP growth despite Modi’s demonetisation drive?

• http://www.livemint.com/Politics/7zBUW4O2OlqqeCcPvgVOdL/What-
explains-7-GDP-growth-despite-Modis-demonetisation-dr.html

• http://www.hindustantimes.com/business-news/five-reasons-why-
economists-doubt-india-s-gdp-numbers/story-
MU65A1dutqylWJ2OevIGXM.html
 • Inflation rate is measured by - GDP Deflator
,
Yr 2000 Yr 2001
Pizzas 30 20
Price of pizzas 100 200
Books 4 7
Price of books 500 400

• GDP deflator
= [GDP of 2001 at 2001 prices / GDP of 2001 at 2000 prices] * 100
= [nominal GDP / real GDP] * 100

Base Year – 2000

GDP calculated at base year prices is also called real income or real GDP.
• Includes all goods that are included in the GDP

• Published – on an annual basis.

• Usually not considered for stating inflation rate as it is not published

frequently enough.
• There are other measures of inflation , namely
,
• Whole sale Price Index (WPI)

• Consumer Price Index (CPI)

1. CPI for rural workers
2. CPI for urban workers
3. Combined CPI

http://mospi.nic.in/Mospi_New/site/PressRelease.aspx - for CPI

http://www.eaindustry.nic.in/home.asp - for WPI
 WPI Index of average wholesale prices

• Includes all commodities (final and intermediate – raw materials, semi

finished goods) that are sold in the wholesale market.
• Excludes services as those cannot be sold in the wholesale market.
• Wholesale prices of the products are considered.

• The base year is changed every 10 years approximately.

• Published at all India level (aggregated). Also for groups and sub groups and
individual commodities. This makes it easy to pin down the source of
inflation.
• Published on a monthly basis.

• Used for stating inflation rates.

CPI Index of average retail prices

• Includes all commodities (also imported goods, services) that are sold in the
retail market.
• Excludes capital goods, raw materials, intermediate goods.
• Retail market prices are considered.

• Published at all India level (aggregated), state levels and at selected

industrial centers.
• Weights of each item is fixed on the basis of a comprehensive survey of
households.
• Published on a monthly basis.
• CPI (urban),CPI (rural) and CPI (combined).
• Used for stating inflation rates in the cost of living. Used for wage revisions in
response to inflation.
 • To calculate CPI and WPI, Laspayre index
, is used.

Laspayre Index
= [Expenditure at 2001 prices and 2000 quantities]* 100
Expenditure at 2000 prices and 2000 quantities

Note : both expenditures are measured in base year quantities.

Inflation rate

= [price index in year t – price index in year t-1]

price index in year t-1
Inflation measured from WPI is higher than inflation measured from CPI.

What could be the reason?

WPI
GDP deflator
CPI
Food price
inflation