Definitions:

• Subsidies: are government expenses that are generally extended to business firms, farmers among other groups to defray their production costs or to reduce prices for consumers. Subsidies are also called negative taxes because they impose expenses on government budgets instead of contributing revenues.

Indirect Taxes: are government revenues that result from taxes that are not received directly from the earned incomes of households, businesses etc. Thus sales taxes, highway tolls, excise taxes etc are forms of indirect taxes as opposed to direct taxes that are extracted from earned incomes.

Market prices: are the prices at which goods and services are sold in various markets to households and firms. Thus GDP@ market price for example refers to the total final output of all final goods and services produced within the national frontiers of a country by its citizens and the foreign residents who reside within those frontiers that are sold at market prices in various markets.

Factor costs: are the actual production costs at which goods and services are 

produced by the firms and industries in an economy. Factor costs are really the costs of all the factors of production such as labor , capital, energy, raw materials like steel etc that are used to produce a given quantity of output in an economy. Factor costs are also called factor gate costs since all the costs that are incurred to produce a given quantity of goods and services take place behind the factory gate ie within the walls of the firms, plants etc in an economy. Thus the term GDP@ factor cost refers to the total final output of all final goods and services produced within the national frontiers of a country by its citizens and the foreign residents who reside within those frontiers that are assessed at production or factor cost prior to leaving their respective factory gates for various markets where they are bought and sold..

Capital Consumption Allowances or Depreciation of Capital Stock or Depreciation Costs:

are the total or aggregate costs of the wear and tear or depreciation of the capital stock iemachinery, tools, plants, roads, power grids, buildings, bus fleet, trains, railways etc within an economy usually within a given year. Another name for the CCAs is the depreciation of capital stock or its depreciation costs.

Some Important National Income Accounting Concepts

• NDP = GDP – Capital Consumption AllowancesThe equation above means that Net Domestic Product or NDP is equal to the difference between GDP and Capital Consumption Allowances or (CCAs)

• NNP =GNP – CCAsThe equation above means that Net National Product or NNP is equal to the difference (‐) between the GNP and CCAs

PS.It is very important to note that the NDP and NNP for a country are two very different concepts. To calculate the NDP Macroeconomists subtract the CCAs from the GDP. However to calculate the NNP Macroeconomists subtract the CCAs in an economy from the GNP in that economy.

• Per Capita NDP =NDP\Population• Per Capita NNP =NNP\Population

Now to calculate the following indices:• NDP@ market price• NDP@ factor cost• NNP@ market price• NNP@ factor cost• Per Capita NDP@ market price• Per Capita NDP@ factor cost• Per Capita NNP@ market price• Per Capita NNP@ factor cost

• NDP@ market price =GDP@ market price – CCAs• NDP@ factor cost =GDP@ factor cost – CCAs• NNP@ market price =GNP@ market price – CCAs• NNP@ factor cost =GNP@ factor cost – CCAs• Per Capita NDP@ market price = NDP@ market 

price/Population• Per Capita NDP@ factor cost = NDP@ factor cost/Population• Per Capita NNP@ market price = NNP@ market 

price/Population• Per Capita NNP@ factor cost = NNP@ factor cost/Population

PS. It is very important to note that the NDP@ market price and the NNP@ market price for a country are two very different concepts. Conversely it should also be noted that the NDP@ factor cost and the NNP@ factor cost for a country are two very different concepts. It is equally true that the NNP@ market price and the NNP@factor cost are two different concepts. Likewise the NDP@ market price and the NDP@ factor cost are two different concepts for an economy.

The calculation of each of the concepts NDP@ market price, NDP@ factor cost, NNP@ market price, NNP@ factor cost, Per Capita NDP@ market price, Per Capita NDP@ factor cost, Per capita NNP@ market price etc are given in the above formulas or equations.

Now let’s calculate the following macroeconomic aggregates:

• GDP@ market price• GDP@ factor cost• GNP@ market price• GNP@ factor cost

• What is GDP@ market price?GDP@ market price =GDP@ factor cost –Subsidies + Indirect Taxes

• What is GDP@ factor cost?GDP@ factor cost =GDP@ market price + Subsidies ‐Indirect Taxes

• What is GNP@ market price?GNP@ market price =GNP@ factor cost –Subsidies + Indirect Taxes

• What is GNP@ factor cost?GNP@ factor cost =GNP@ market price + Subsidies ‐ Indirect Taxes

PS. As in the previous cases students should take keen note that the GDP@ market price and the GDP @factor cost are not the same macroeconomic aggregates. Likewise students should note that the GNP@ market price and the GNP@ factor cost are not the same concepts for an economy. Similarly the GDP@ market price and the GNP@ market price are not identical concepts while the GDP@ factor cost and the GNP@ factor cost are two distinct aggregates despite their similar calculations.

Finally students should take careful note that all the above macroeconomic aggregates @ market prices whether GDP, GNP, NDP or NNP or Per capita GDP, Per capita GNP, Per capita NDP or Per capita NNP include indirect taxes and exclude subsidies. Conversely all the above aggregates @ factor costs whether GDP, GNP, NDP or NNP or Per capita GDP, Per capita GNP, Per capita NDP or Per capita NNP include subsidies and excludes indirect taxes.

MacroeconomicsSurta Mehta

Xcellon Institute

National income per person or per capita income is often used as an indicator of people’s standard of living or welfare. However, many development economists have criticized that GNP as a measure of welfare has many limitations. hey argued that human well-being does not depend on national income alone. As measures of GNP exclude poverty, literacy, public health, gender equity, and many human issues of well-being, they developed other measures of welfare such as the Human Development Index (HDI).

Some rich countries in terms of national income are poor in human development. Similarly, poor countries in terms national income have performed well in human development. In the case of India, though the GDP is growing faster, its performance in terms of HDI is far below than that of many countries.

National income is a measure of the total value of the goods and services (output) produced by an economy over a period of time (normally a year). It is also a measure of the income flown from production, and/or the sum total of all the spending involved for the production of output. The following are some of the notable definitions.

Alfred Marshal :“The labour and capital of the country acting

on its natural resources produce annually a certain net aggregate of commodities, material and immaterial, including services of all kinds… This is the net annual income or revenue of the country, or the national dividend.”

Irving Fisher:“The national dividend or income consists

solely of services as received by ultimate consumers, whether from their material or from their human environment.”

National Income Committee of India,:“ National income estimate measures the

volume of commodities and services turned out during a given period counted without duplication.”

Paul A. Samuelson:“ Gross national product (GNP) is the most

comprehensive measure of a nation’s total output of goods and services. It is the sum of the dollar (money) value of consumption, gross investment, government purchase of goods and services and net exports”.

Though there are some variations among these definitions, the basic idea is very clear –national income is simply the income of the whole nation. The basic concepts will help to understand it more precisely.

Gross National Product (GNP) is the total value of output (goods and services) produced and income received in a year by domestic residents of a country. It includes profits earned from capital invested abroad.

Gross Domestic Product (GDP) is the total value of output (goods and services) produced by the factors of production located within the country’s boundary in a year. The factors of production may be owned by any one –citizens or foreigners.

GNP – Net income earned from abroad = GDPThus, GDP measures income from where it is

earned rather than who owns the factors of production.

Net National Product (NNP) is arrived at by making some adjustment, with regard to depreciation, in GNP. As noted above, GNP is the total value of output produced and income received in a year by domestic residents of a country. Over this one year period, the available plant and machinery (capital) will wear and tear and get condemned. Such decline in the capital assets due to wear and tear is measured as ‘capital depreciation’.

NNP is arrived at by deducting value of such depreciation from GNP.

That is GNP – Depreciation = NNP

Net domestic product (NDP) is also arrived from GDP by making adjustment with regard to depreciation in the same way described above.

(NDP is calculated by deducting depreciation from GDP).

GDP – Depreciation = NDP

Per capita income (or) output per person is an indicator to show the living standards of people in a country. If real PCI increases, it is considered to be an improvement in the overall living standard of people.

PCI is arrived at by dividing the GDP by the size of population. It is also arrived by making some adjustment with GDP.

PCI = GDP/size of population

While GDP indicates productive capacity of an economy, GNP is a crude indicator for living standard. The significance of the distinction between GNP and GDP depends on the nature of a particular economy. For instance, if a country has more non-resident inflows and produces a considerable portion of its output by multinational corporations (i.e. with the help of external factors of production), its GNP will be higher than GDP. Otherwise the distinction will be negligible.

Many countries have foreign firms. In the case of US Ford Motors in Chennai, the income from the car factory would be counted as Indian GDP and not as US GDP. But the amount of profit the company sends to US will be added to their GNP. Similarly, our GNP can be arrived by adding to our GDP the net factor income receipts from abroad for the factor inputs owned by Indians. That is, the non-resident Indians income will be added to GDP to arrive at our GNP.

The concepts of national income discussed above can be measured either at ‘current price’ or at ‘constant price’. The measure based on current price uses the ongoing market prices to compute the value of output. It is quite possible that the current price may always be higher than real value due to many factors like taxes and inflation (or rising prices). Hence, national income arrived at ‘current price’ includes such influences as inflation and taxes.

With inflation as a common feature in almost all the economies, it is necessary to measure the national income after deducting any such increase in the value of any output or income. National income at ‘constant price’ measures the national income after making necessary adjustment to eliminate the effect of inflation. Thus it is based on unchanged price of output. As the national income at ‘constant price’ is computed based on the real worth of the purchasing power of income, it is also called as ‘real national income’ or national income in ‘real’ terms.

A national income measure serves various purposes regarding economy, production, trade, consumption, policy formulation, etc. The following are some such needs.

1. To measure the size of the economy and level of country’s economic performance.

2. To trace the trend or speed of the economic growth in relation to previous year(s) as well as to other countries.

3. To know the structure and composition of the national income in terms of various sectors and the periodical variations in them.

4. To make projection about the future development trend of the Economy.

5. To help government formulate suitable development plans and policies to increase growth rates.

6. To fix various development targets for different sectors of the economy on the basis of the earlier performance.

7. To help business firms in forecasting future demand for their products.

8. To make international comparison of people’s living standards.

The most important point to be noted for the computation of national income is that income (Y) received is equal to the consumption expenditure (C) made by the consumers, i.e. Y=C.

This simple circular flow model is explained without the other components of national income namely savings or investment (I), public expenditure by government (G) and expenditure on net exports (X-M). If we include all the above components of national income Y= C will become Y = C + I + G + (X-M)

Thus national income is the aggregate summation of income or expenditure made through these four components, consumers (C), investors (I), government (G) and foreign trade (Exports [X] – Imports [M] )

There are three different methods of calculating national income.

They are1. Product or Output Method2. Income Method3. Expenditure Method

As noted above, GDP is the measure of an economy’s total output. It is also used as a measure of total income and total expenditure in that economy. Figure 4.1 clearly shows that factor incomes received by the public is being spent to buy the output of goods and services produced.

Hence, income is equal to expenditure and expenditure is equal to the value of output produced in the economy.

Income = expenditure = outputY = E = O

In the output or product method, the measures of GDP are calculated by adding the total value of the output (of goods and services) produced by all activities during any time period, such as a year. The major challenge of this method is the problem of double-counting.

The output of many businesses is the inputs of some other businesses.

For example, the output of the tyre industry is the input of racing bike industry.

Counting the final output of both industries will result in double-counting of the value of tyre. This problem can be avoided by including only the value added at each stage of production or by adding only the final value of output produced.

In the income method, the measures of GDP are calculated by adding all the income earned by various factors of production which are engaged in the production of output.

The various incomes included to compute the gross national income are:Wages and salariesIncome of self-employedProfits and dividends of business corporationsInterestRentSurplus of government enterprisesNet flow of income from abroad

In the expenditure method, the measures of GDP are calculated by adding all the expenditures made in the economy. The essential components of expenditure are:

C = consumption expendituresI = domestic investmentG = government expendituresX = exports of goods and servicesM = imports of goods and servicesNR = net income receipts from assets abroadThe sum of all these aggregate expenditure provides us

the measure of national income.GDP = E = C + I + G + (X-M)where E is aggregate expenditure.

All the above three methods must yield the same results because the total expenditures on output must by definition be equal to the value of the output produced which must be equal to the total income paid to the factors that produced these goods and services. However, in practice, there will be minor differences between these results due to changes in inventory levels and timing discrepancies. The following are some of the national income identities.

NNP = GNP - DepreciationNNI = NNP -Indirect taxesPI = NNI - Retained earnings, corporate taxes and

intereston public debtPDI = PI - Personal taxes.Where, GNP = Gross National ProductNNP = Net National ProductNNI = Net National IncomePI = Personal IncomePDI = Personal Disposable Income

The measurement of national income encounters many problems. The problem of double-counting has already bee noted. Though there are some corrective measures, it is difficult to eliminate double-counting altogether. And there are many such problems and the following are some of them.

Black MoneyIn countries where level of illegal activities, illegal

businesses and the level of corruption are very high, the circulation of black money is so high, it has created a ‘parallel economy’. It means unreported economy which is equivalent to the size of officially estimated size of the economy. GDP does not take into account the ‘parallel economy’ as the transactions of black money are not registered. In India, black money is all-pervasive, affecting not only the economy but also the society at large. The black economy as percentage of GDP is estimated to have grown from about 3 percent in the mid-fifties to 40 per cent by 1995-96.

Non-MonetizationIn most of the rural economy, considerable portion of

transactions occurs informally and they are called as non-monetized economy. The presence of such non-monetary economy in developing countries keeps the GDP estimates at lower level than the actual.

Growing Service SectorIn recent years, the service sector is growing faster than

that of the agricultural and industrial sectors. Many new services like business process outsourcing (BPO) have come up. However, value addition in legal consultancy, health services, financial and business services and the service sector as a whole is not based on accurate reporting and hence underestimated in national income measures

Household ServicesThe national income analysis ignores domestic work, and

housekeeping and social services. Most of such valuable work rendered by our women at home does not enter our national accounting.

Social ServicesIt ignores volunteer and unpaid social services. For

example, the wonderful services of Mother Teresa is invaluable for millions of poor, destitute, orphans and the diseased but at the same time not included in our GDP.

Environmental CostNational income estimation does not distinguish between

environmental-friendly and environmental-hazardous industries. The cost of polluting industries is not i l d d i h i

After independence, a regular national accounts system was initiated in the mid-sixties. Indian system of national account statistics (NAS) follows the United Nation’s (UN) system of national accounts (1968). Based on the National Income Committee’s recommendation (1954), the Central Statistical Organisation (CSO)has been making continuous efforts to improve the quality of these statistics. Shifting the base year to revise the series is one such effort.

The CSO revised its national accounts series by shifting the base year to 1970-71. With improved data base and extended coverage, the CSO revised its series again by shifting the base year to 1980-81, and then to 1993-94. Recently CSO has revised its series within six year period by shifting the base to 1999-2000.

Trends in National IncomeAs noted already, national income is a rough

indicator to measure the economic growth performance of a country. The outcome of India’s development effort can be seen, to some extent, in terms of the size, growth and the composition of our national income.

Table 4.1 provides the trend of the GDP growth from the year 1950 to 2005. The size of the national income at constant prices has increased by about 15 percent during this period. The growth rate of national income has increased from 3.5 percent during 1950-80 to 5.6 percent during 1980-2005.

Table 4.1 also gives the trend of per capita income. The size of the per capita income at constant prices has recorded only five fold increase from 1950 to 2005. The growth rate of per capita income during the same period has increased from 1.4 percent to 3.6 percent. The per capita income is not the correct indicator for the living standards of people. The actual income of the people would have deviated well above or below than that of the per capita income. Some measure of poverty and income inequality would help us to understand the actual distribution of the i th hi d

National income is derived from many sectors. We generally classify them into three major sectors namely primary, (agriculture), secondary (manufacturing) and tertiary (services). During the initial stage of development, share of primary sector in the national income will be high. But this will decline during the course of development and share of industry will be greater. At very high level of development, the share of service sector in the national income will be more.

Note : Figures upto 1990-91 are based on 1993-94 series. From2000-01 onwards, figures are based on the new series with 1999-2000 asthe base year.

The sectoral composition of national income presented in Table 4.2 confirms such general pattern but partially. The share of primary sector has declined from 59 per cent to 24 percent. However, the industrial sector has not grown to the expected level. Instead, the service sector has almost reached more than half (52 %) of our national income. The growth rates of these three sectors presented in Table 4.3 also show similar trend.

We have compared the growth performance of India since independence to date. How has India performed with other countries of the world?

Table 4.4 provides such a comparison of per capita income with reference to some select countries. The performance of India in terms of the per capita dollars in 2001 in relation to high and middle income countries of the world is far below. With a per capita dollar of 460, India has just managed to be marginally above the average per capita income of (430) very poor countries in the world.

slide 0

MACROECONOMICSSurta Mehta

XCELLON INSTITUTE School of Business

AHMEDABAD

LEARNING OBJECTIVES

In this chapter, you will learn about:

Gross Domestic Product (GDP)

the Consumer Price Index (CPI)

the Unemployment Rate

GROSS DOMESTIC PRODUCT

Two definitions:

1. Total expenditure on domestically-produced final goods and services

2. Total income earned by domestically-located factors of production

Expenditure equals income because every dollar spent by a buyer becomes income to the seller.

THE CIRCULAR FLOW

Households Firms

Goods

Labor

Expenditure ($)

Income ($)

GROSS DOMESTIC PRODUCT: EXPENDITURE AND INCOME

One Limitation:Measurement of income and expenditure is imperfect.

Difference in GDP and Gross Domestic Income (GDI) is called the “Statistical Discrepancy.”

VALUE ADDEDdefinition:

A firm’s value added is the value of its output

minus the value of the intermediate goods the firm used to produce that output.

EXERCISE

A farmer grows a kg of wheat and sells it to a miller for Rs.10.00. The miller turns the wheat into flour and sells it to a baker for Rs. 30.00. The baker uses the flour to make a loaf of bread and sells it to an engineer for Rs. 60.00. The engineer eats the bread.

Computevalue added at each stage of productionGDP

FINAL GOODS, VALUE ADDED, ANDGDP

GDP = value of final goods produced = sum of value added at all stages

of production

The value of the final goods already includes the value of the intermediate goods, so including intermediate goods in GDP would be double-counting.

THE EXPENDITURE COMPONENTS OF GDPconsumption, C

investment, I

government spending, G

net exports, NX

An important identity:Y = C + I + G + NX

aggregate expenditure

value of total output

CONSUMPTION (C)

• durable goodslast a long time ex: cars, home appliances

• non-durable goodslast a short time ex: food, clothing

• serviceswork done for consumers ex: dry cleaning, air travel.

def: the value of all goods and services bought by households. Includes:

U.S. CONSUMPTION, 2008

42.6

20.8

7.2

70.5%

6,069.6

2,965.1

1,023.2

$ 10,057.9

Services

Nondurables

Durables

Consumption

% of GDP$ billions

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ASSIGNMENT TO BE DONE

Data on Consumption, India

INVESTMENT (I)

def1: spending on [the factor of production] capital.def2: spending on goods bought for future use.Includes:

business fixed investmentspending on plant and equipment that firms will use to produce other goods & servicesresidential fixed investmentspending on housing units by consumers and landlordsinventory investmentthe change in the value of all firms’ inventories

U.S. INVESTMENT, 2008

–0.3

3.4

10.9

14.0%

–47.0

487.7

1,552.8

$1,993.5

Inventory

Residential

Business fixed

Investment

% of GDP$ billions

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ASSIGNMENT TO BE DONE

Data on Investment, India

INVESTMENT VS. CAPITAL

Capital is one of the factors of production. At any given moment, the economy has a certain overall stock of capital.

Investment is spending on new capital.

INVESTMENT VS. CAPITAL

Example (assumes no depreciation): – 1/1/2009:

economy has $500b worth of capital

– during 2009:investment = $60b

– 1/1/2010: economy will have $560b worth of capital

STOCKS VS. FLOWS

A flow is a quantity measured per unit of time. E.g., “U.S. investment was $2.5 trillion during 2009.”

Flow StockA stock is a quantity measured at a point in time.

E.g., “The U.S. capital stock was $26 trillion on January 1, 2009.”

STOCKS VS. FLOWS - EXAMPLES

the govt budget deficitthe govt debt

# of new college graduates this year

# of people with college degrees

a person’s annual savinga person’s wealth

flowstock

NOW YOU TRY: STOCK OR FLOW?the balance on my credit card statementhow much you study economics outside of classthe size of your compact disc collectionthe inflation ratethe unemployment rate

GOVERNMENT SPENDING (G)G includes all government spending on goods and services.G excludes transfer payments (e.g. unemployment insurance payments), because they do not represent spending on goods and services.

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'In economics, a transfer payment (or government transfer or simply transfer) is a redistribution of income in the market system. These payments are considered to be non-exhaustive because they do not directly absorb resources or create output. Examples of certain transfer payments include welfare (financial aid), social security, and government subsidies for certain businesses (firms).'

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SUBSIDIES AND TRANSFER PAYMENTS

Forms of subsidiesA cash payment to producers/ consumers is an easily recognizable form of a subsidy. However, it also has many invisible forms. Thus, it may be hidden in reduced tax-liability, low interest government loans or government equity participation. If the government procures goods, such as food grains, at higher than market prices or if it sells as lower than market prices, subsidies are implied.

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SUBSIDIES AND TRANSFER PAYMENTS

Transfers and SubsidiesTransfers which are straight income supplements need to be distinguished from subsidies. An unconditional transfer to an individual would augment his income and would be distributed over the entire range of his expenditures. A subsidy however refers to a specific good, the relative price of which has been lowered because of the subsidy with a view to changing the consumption/ allocation decisions in favour of the subsidised goods. Even when subsidy is hundred percent, i.e. the good is supplied free of cost, it should be distinguished from an income-transfer (of an equivalent amount) which need not be spent exclusively on the subsidised good.

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SUBSIDIES AND TRANSFER PAYMENTS

Transfers may be preferred to subsidies on the ground that

i) any given expenditure of State funds will increase welfare more if it is given as an income-transfer rather than via subsidising the price of some commodities, and ii) transfer payments can be better targeted at a specific income groups as compared to free or subsidised goods.

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SUBSIDIES AND TRANSFERSTransfers to individuals are income supplements and may be distinguished from price subsidies.

Transfers which are straight income supplements need to be distinguished from subsidies.

An unconditional transfer to an individual would augment his income and would be distributed over the entire range of his expenditures.

A subsidy, however, refers to a specific good, the relative price of which has been lowered because of the subsidy with a view to changing the consumption/allocation decisions in favour of the subsidised good.

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SUBSIDIES AND TRANSFERSIn this sense, transfers and subsidies can be considered respective obverses of direct and indirect taxes. Even when subsidy is hundred percent, i.e., the good is supplied free of cost, it should be distinguished from an income-transfer (of an equivalent amount).

Transfer payments can be better targeted at specific income groups as compared to free or subsidised goods.

Price subsidies focus on the consumption levels of specific goods (e. g., education, health, and food).

However, subsidised prices also have associated income effects leading to an increase in the consumption of other (non-subsidised) goods.

U.S. GOVERNMENT SPENDING, 2008

- Federal

20.2%$2,882.4Govt spending

- State & local

Defense

7.5

12.7

5.2

2.4

1,071.9

1,810.4

734.9

337.0Non-defense

% of GDP$ billions

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ASSIGNMENT TO BE DONE

India Government Spending

NET EXPORTS: NX = EX – IM def: the value of total exports (EX) minus the value of total imports (IM)

-8%

-4%

0%

4%

8%

12%

16%

20%

1950 1960 1970 1980 1990 2000 2010

NXexportsimports

AN IMPORTANT IDENTITY

Y = C + I + G + NXwhere Y = GDP = the value of total outputC + I + G + NX = aggregate expenditure

A QUESTION FOR YOU:Suppose a firm

produces $10 million worth of final goods

but only sells $9 million worth.

Does this violate the expenditure = output identity?

WHY OUTPUT = EXPENDITUREUnsold output goes into inventory, and is counted as “inventory investment”……whether the inventory buildup was intentional or not.

In effect, we are assuming that firms purchase their unsold output.

GDP: AN IMPORTANT AND VERSATILE CONCEPT

We have now seen that GDP measurestotal incometotal outputtotal expenditurethe sum of value-added at all stages in the production of final goods

GNP VS. GDP

Gross National Product (GNP):total income earned by the nation’s factors of production, regardless of where located

Gross Domestic Product (GDP):total income earned by domestically-located factors of production, regardless of nationality.

(GNP – GDP) = (factor payments from abroad) – (factor payments to abroad)

GNP VS. GDP FOR INDIA

Factor payments from abroad include things like 1) wages earned by Indian citizens working abroad 2) profits earned by Indian -owned businesses located abroad 3) income (interest, dividends, rent, etc) generated from the foreign assets owned by Indian citizensFactor payments to abroad include things like 1) wages earned by foreign workers in India 2) profits earned by foreign-owned businesses located in India3) income (interest, dividends, rent, etc) that foreigners earn on Indian assets

DISCUSSION QUESTION:

In India, which would you want

to be bigger, GDP or GNP?

Why?

slide 37

GDP can be contrasted with gross national product (GNP) or gross national income (GNI). The difference is that GDP defines its scope according to location, while GNP defines its scope according to ownership. GDP is product produced within a country's borders; GNP is product produced by enterprises owned by a country's citizens.

slide 38

GNP may be much less than GDP if much of the income from a country’s production flows to foreign persons or firms.

For example, in 1994 Chile’s GNP was 5 percent smaller than its GDP. If a country’s citizens or firms hold large amounts of the stocks and bonds of other countries’ firms or governments, and receive income from them, GNP may be greater than GDP.

In Saudi Arabia, for instance, GNP exceeded GDP by 7 percent in 1994. For most countries, however, these statistical indicators differ insignificantly.(source: The World Bank Group) Thus, for most countries GDP and GNP are not much different. (as we mentioned in the class on Thursday...)

GNP VS. GDP IN SELECT COUNTRIES, 2007

Country GNP GDP GNP – GDP (% of GDP)

Philippines $157,087 $144,062 9.0%

Japan $4,530,191 $4,384,255 3.3%

China $3,229,841 $3,205,507 0.8%

United States $13,827,201 $13,751,400 0.6%

Canada $1,318,304 $1,329,885 –0.9%

South Africa $274,141 $283,007 –3.1%

New Zealand $125,936 $135,667 –7.2%

Peru $98,625 $107,297 –8.1%

slide 40

ASSIGNMENT TO BE DONE

India – GDP and GNP

OTHER MEASURES OF INCOME

Personal Income = National Income - Indirect Business Taxes - Corporate Profits - Social Insurance Contributions - Net Interest + Dividends + Government Transfers to Individuals + Personal Interest Income

Disposable Personal Income = Personal Income -Personal Tax and Nontax Payments

Disposable Personal Income is what households and noncorporate businesses have to spend (or save).

For more information, please, refer to the PPT titled NI earlier.

REAL VS. NOMINAL GDP

GDP is the value of all final goods and services produced. Nominal GDP measures these values using current prices. Real GDP measures these values using the prices (constants) of a base year.

USEFUL LINKS – INDIAUseful links for CPIhttp://labourbureau.nic.in/indexes.htmhttp://labourbureau.nic.in/indnum.htmhttp://labourbureau.nic.in/HNSpecial%20Art%20CPI%20IW%20NS%202006.htm

Useful links for WPIhttp://www.mospi.gov.in/manual_compilation_index.htmhttp://eaindustry.nic.in/

http://eaindustry.nic.in/report/fin4.htmhttp://eaindustry.nic.in/pib.htm

Useful Glossary http://www-personal.umich.edu/~alandear/glossary/

Macroeconomic data on India: http://www.rbi.org.in/scripts/AnnualPublications.aspx?head=Handbook+of+Statistics+on+Indian+Economy

REAL GDP CONTROLS FOR INFLATION

Changes in nominal GDP can be due to:changes in prices changes in quantities of output produced

Changes in real GDP can only be due to changes in quantities,because real GDP is constructed using constant base-year prices.

REAL VS. NOMINAL GDP

GDPt= P

itQ

iti=1

n

∑

RGDPt= P

iBQ

iti=1

n

∑

NOW YOU TRY: REAL & NOMINAL GDP

Compute nominal GDP in each year.

Compute real GDP in each year using 2006 as the base year.

2006 2007 2008

P Q P Q P Q

good A $30 900 $31 1,000 $36 1,050

good B $100 192 $102 200 $100 205

NOW YOU TRY: ANSWERS

nominal GDP multiply Ps & Qs from same year2006: $46,200 = $30 × 900 + $100 × 192 2007: $51,400 2008: $58,300

real GDP multiply each year’s Qs by 2006 Ps2006: $46,2002007: $50,000 2008: $52,000 = $30 × 1050 + $100 × 205

U.S. NOMINAL AND REAL GDP,1960-2009

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

$16,000

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

(bill

ions

)

Nominal GDP

Real GDP(in 2000 dollars)

slide 49

ASSIGNMENT TO BE DONE

India – nominal and real GDP

GDP DEFLATORThe inflation rate is the percentage increase in the overall level of prices.One measure of the price level is the GDP Deflator, defined as

Nominal GDPGDP deflator = 100

Real GDP×

NOW YOU TRY:GDP DEFLATOR AND INFLATION RATE

Use your previous answers to compute the GDP deflator in each year. Use GDP deflator to compute the inflation rate from 2006 to 2007, and from 2007 to 2008.

Nom. GDP Real GDP GDP deflator

Inflationrate

2006 $46,200 $46,200 n.a.

2007 51,400 50,000

2008 58,300 52,000

NOW YOU TRY: ANSWERS

Nominal GDP Real GDP GDP

deflatorInflation

rate

2006 $46,200 $46,200 100.0 n.a.

2007 51,400 50,000 102.8 2.8%

2008 58,300 52,000 112.1 9.3%

UNDERSTANDING THE GDP DEFLATORExample with 3 goods

For good i = 1, 2, 3

Pit = the market price of good i in month t

Qit = the quantity of good i produced in month t

NGDPt = Nominal GDP in month t

RGDPt = Real GDP in month t

UNDERSTANDING THE GDP DEFLATORt

t

NGDPGDP deflator

RGDP= ×100 1t 1t 2t 2t 3t 3t

t

P Q P Q P QRGDP

+ += ×100

1t 2t 3t1t 2t 3t

t t t

Q Q QP P P

RGDP RGDP RGDP

⎡ ⎤⎛ ⎞ ⎛ ⎞ ⎛ ⎞= × + +⎢ ⎥⎜ ⎟ ⎜ ⎟ ⎜ ⎟

⎢ ⎥⎝ ⎠ ⎝ ⎠ ⎝ ⎠⎣ ⎦100

The GDP deflator is a weighted sum of prices.

The weight on each price reflects that good’s relative importance in GDP.

Note that the weights change over time.

WORKING WITH PERCENTAGE CHANGES

EX: If your hourly wage rises 5% and you work 7% more hours,

then your wage income rises approximately 12%.

USEFUL TRICK #1 For any variables X and Y,

the percentage change in (X ×Y )≈ the percentage change in X+ the percentage change in Y

WORKING WITH PERCENTAGE CHANGES

EX: GDP deflator = 100×NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%, then the inflation rate is approximately 5%.

USEFUL TRICK #2

the percentage change in (X/Y )≈ the percentage change in X− the percentage change in Y

MEASURING ECONOMIC GROWTH

A problem arises when using fixed base-year weights: Growth will vary depending on base year chosen.Rapidly growing sectors with declining relative prices will be weighted “too much” as base year becomes further and further in the past. Opposite for slowly growing sectors.

CONSUMER PRICE INDEX (CPI)A measure of the overall level of prices

Published by the Labour Bureau in India.

Used to track changes in the typical household’s cost of livingadjust many contracts for inflation allow comparisons of currency figures from different years

HOW IS CPI CALCULATED

1. Survey consumers to determine composition of the typical consumer’s “basket” of goods.

2. Every month, collect data on prices of all items in the basket; compute cost of basket

3. CPI in any month equals

Cost of basket in that month100

Cost of basket in base period×

EXERCISE: COMPUTE THE CPI

The basket contains 20 pizzas and 10 compact discs.

prices:pizza CDs

2000 $10 $152001 $11 $152002 $12 $162003 $13 $15

For each year, computethe cost of the basketthe CPI (use 2000 as the base year)the inflation rate from the preceding year

ANSWERS:cost of inflationbasket CPI rate

2000 $350 100.0 n.a.2001 370 105.7 5.7%2002 400 114.3 8.1%2003 410 117.1 2.5%

THE COMPOSITION OF THE CPI’S “BASKET”USA

16.2%

40.0%

4.5%

17.6%5.8% 5.9%

2.8%

2.5%

4.8%

Food and bev.

Housing

Apparel

Transportation

Medical care

Recreation

Education

Communication

Other goods andservices

UNDERSTANDING THE CPIExample with 3 goods

For good i = 1, 2, 3

Ci = the amount of good i in the CPI’s basket

Pit = the price of good i in month t

Et = the cost of the CPI basket in month t

Eb = cost of the basket in the base period

UNDERSTANDING THE CPIt

b

ECPI in month

E= ×100t 1t 1 2t 2 3t 3

b

P C + P C + P CE

= ×100

31 21t 2t 3t

b b b

CC CP P P

E E E

⎡ ⎤⎛ ⎞ ⎛ ⎞ ⎛ ⎞= × + +⎢ ⎥⎜ ⎟ ⎜ ⎟ ⎜ ⎟

⎢ ⎥⎝ ⎠ ⎝ ⎠ ⎝ ⎠⎣ ⎦100

The CPI is a weighted sum of prices.

The weight on each price reflects that good’s relative importance in the CPI’s basket.

Note that the weights remain fixed over time.

UNDERSTANDING THE CPI

CPI =

Et

EB

=Q

iBP

iti=1

n

∑

QiBP

iBi=1

n

∑

=Q

iBP

iBP

it/ P

iB⎡⎣ ⎤⎦

i=1

n

∑

QiBP

iBi=1

n

∑

UNDERSTANDING THE CPI

The CPI is a weighted average of prices relative to their value in the base period.

The weight on each “price relative” reflects that good’s relative importance in the CPI’s

basket. Note that the weights remain fixed over time.

REASONS WHYTHE CPI MAY OVERSTATE INFLATION

Substitution bias: The CPI uses fixed weights, so it cannot reflect consumers’ ability to substitute toward goods whose relative prices have fallen.

Introduction of new goods: The introduction of new goods makes consumers better off and, in effect, increases the real value of the dollar. But it does not reduce the CPI, because the CPI uses fixed weights.

Unmeasured changes in quality: Quality improvements increase the value of the dollar, but are often not fully measured.

CPI VS. GDP DEFLATOR

prices of capital goods• included in GDP deflator (if produced domestically)

• excluded from CPI

prices of imported consumer goods• included in CPI• excluded from GDP deflator

the basket of goods• CPI: fixed• GDP deflator: changes every year

TWO MEASURES OF INFLATION IN THE U.S.

0%

5%

10%

15%

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Per

cent

age

chan

ge

from

12

mon

ths

earli

er

CPI

GDP deflator

CATEGORIES OF THE POPULATION

employedworking at a paid job

unemployednot employed but looking for a job

labor force the amount of labor available for producing goods and services; all employed plus unemployed persons

not in the labor forcenot employed, not looking for work.

TWO IMPORTANT LABOR FORCE CONCEPTS

unemployment rate percentage of the labor force that is unemployed

labor force participation rate the fraction of the adult population that ‘participates’ in the labor force

NOW YOU TRY: COMPUTING LABOR STATISTICS

U.S. adult population by group, May 2009Number employed = 140.57 millionNumber unemployed = 14.51 millionAdult population = 235.45 million

Use the above data to calculatethe labor forcethe number of people not in the labor forcethe labor force participation ratethe unemployment rate

NOW YOU TRY: ANSWERS

data: E = 140.57, U = 14.51, POP = 235.45

labor forceL = E +U = 140.57 + 14.51 = 155.08

not in labor forceNILF = POP – L = 235.45 – 155.08 = 80.37

unemployment rateU/L x 100% = (14.51/155.08) x 100% = 9.4%

labor force participation rateL/POP x 100% = (155.08/ 235.45) x 100% = 65.9%

EXERCISE: COMPUTE PERCENTAGECHANGES IN LABOR FORCE STATISTICS

Suppose the population increases by 1%the labor force increases by 3%the number of unemployed persons increases by 2%

Compute the percentage changes in

the labor force participation rate:

the unemployment rate:

2%−1%

NOW YOU TRY: ANSWERS

LFPR = L/POP

L increases 3%, POP increases 1%, soLFPR increases 3% – 1% = 2%

U rate = U/L

U increases 2%, L increases 3%, soU-rate increases 2% – 3% = –1%

Note: the changes in LFPR and U-rate are shown as percent of their initial values, not in percentage points! E.g., if initial value of LFPR is 60.0%, a 2% increase would bring it to 61.2%, because 2% of 60 equals 1.2.

Employed workers help produce GDP, while unemployed workers do not. So one would expect a negative relationship between unemployment and real GDP.

This relationship is clear in the data…

Okun’s Law

OKUN’S LAW

19511984

1999

2000

1993

1982

1975

Change in unemployment rate

10

-3 -2 -1 0 1 2 43

8

6

4

2

0

-2

Percentage change in real GDP

Okun’s Law states that a one-percent decrease in unemployment is associated with two percentage points of additional growth in real GDP

CHAPTER SUMMARY

1. Gross Domestic Product (GDP) measures both total income and total expenditure on the economy’s output of goods & services.

2. Nominal GDP values output at current prices; real GDP values output at constant prices. Changes in output affect both measures, but changes in prices only affect nominal GDP.

3. GDP is the sum of consumption, investment, government purchases, and net exports.

CHAPTER SUMMARY

4. The overall level of prices can be measured by either

the Consumer Price Index (CPI), the price of a fixed basket of goods purchased by the typical consumerthe GDP deflator, the ratio of nominal to real GDP

5. The unemployment rate is the fraction of the labor force that is not employed. When unemployment rises, the growth rate of real GDP falls.