Module 1: Introduction and NIA

INTRODUCTION

 Economics is the study of how goods and services are produced,

distributed and consumed in a society.
 Economics studies how individuals, firms, government, and other
organisations within our society make choices and how these
choices determine society’s use of its resources.
 The activities which involve profit, loss, livelihood, occupation, wage,
employment, etc. all are economic activities.
 The focus of this discipline is betterment of human life.

Economics and economy

The relation between economics and the economy is that of theory and
practice.
 While the former is a discipline studying economic behaviour of
human beings, the latter is a still-frame picture of it.
 Economics will come out with theories of market, employment, etc.
and an economy is the real picture of the things which emerge after
the follow-up to the same theories in certain areas.
 Economy is economics at play in a certain region. This region is best
defined today as a country, a nation.

Challenges of the Economies

 The main challenge of any economy is to fulfil the needs of its
population-basic as well as other goods and services.
 As an economy achieves success in supplying one set of goods and
services to its population, the population starts demanding another
set of goods and services which are of a higher order- a never ending
phenomenon.
 Standard of living of one set of population varies from another
depending upon the successes of the extent they have been able to
fulfil the needs of their population. There are two aspects of this
challenge.
 First, the availability of the goods and services required by the
population
 Second, the presence of the supply network.

In the arena of distribution network, we have three historically existing

models—state, market and state–market mix.

Almost all economies of the world today follow one or the other kinds of
distribution system. As the socio-economic composition of the population

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of an economy changes the mixture of the goods and services to be

supplied by the state and the market get redefined in the economies from
time to time.

Macroeconomics
Macroeconomics deals with the aggregate economic variables of an
economy. It also takes into account various interlinkages which may exist
between the different sectors of an economy. This is what distinguishes it
from microeconomics; which mostly examines the functioning of the
particular sectors of the economy, assuming that the rest of the economy
remains the same.

 Macroeconomics emerged as a separate subject in the 1930s due to

Keynes. The Great Depression, which dealt a blow to the economies of
developed countries, had provided Keynes with the inspiration
 Macroeconomics sees an economy as a combination of four sectors,
namely households, firms, government and external sector.
 The basic questions of the study of macroeconomics are the broad
economic questions that concern all citizens – Aggregate Output,
prices, employment, growth rates etc,.
 All these broad economic indicators, in the different production
units of an economy, bear close relationship to each other.

In microeconomics, individual ‘economic agents’ and the nature of the

motivations that drive them become important.
 Microeconomics is a study of individual markets of demand and
supply and the ‘players’, or the decisionmakers, are also individuals
(buyers or sellers, even companies) who are seen as trying to
maximise their profits (as producers or sellers) and their personal
satisfaction or welfare levels (as consumers).
 Even a large company is ‘micro’ in the sense that it had to act in the
interest of its own shareholders which is not necessarily the interest
of the country as a whole.

Economic Agents
By economic units or economic agents, we mean those individuals or
institutions which take economic decisions.
 They can be consumers who decide what and how much to consume.
 They may be producers of goods and services who decide what and
how much to produce.

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 They may be entities like the government, corporation, banks which

also take different economic decisions like how much to spend, what
interest rate to charge on the credits, how much to tax, etc.

Macroeconomics tries to address situations facing the economy as a

whole. Macroeconomics has deep roots in microeconomics because it has
to study the aggregate effects of the forces of demand and supply in the
markets.

Who are the macroeconomic decision makers (or ‘players’)?

Macroeconomic policies are pursued by the State itself or statutory
bodies like the Reserve Bank of India (RBI), Securities and Exchange
Board of India (SEBI) and similar institutions.

What do the macroeconomic decision-makers try to do?

They often have to go beyond economic objectives and try to direct the
deployment of economic resources for such public needs such as price
control, employment generation etc. Such activities are not aimed at
serving individual self-interests. They are pursued for the welfare of the
country and its people as a whole.

Types of economic systems

Every society has to answer three questions
 What goods and services should be produced in the country?
o Public goods or private goods or common goods
 How should the goods and services be produced?
o Use more human labour or more capital (machines)
 Whom should the goods and services be provided to/distributed to?
o To everyone alike or based on some parameter like
performance/purchasing power

Market Economy Or Capitalism

Origin in the famous work of Adam Smith—Wealth of Nations (1776),
raised voice against the heavy-handed government regulation of
commerce and industry of the time which did not allow the economy to
tap its full economic worth and reach the level of wellbeing.
 Stressed ‘division of labour’
 An environment of ‘laissez faire’ (non interference by the
government)
 Proposed that the ‘invisible hand’ of the ‘market forces’ (price
mechanism and Demand/Supply) will bring a state of equilibrium to

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the economy and a general well-being to the countrymen with

competition as the main tool.
 Only those consumer goods will be produced that are in demand, i.e.,
goods that can be sold profitably either in the domestic or in the
foreign markets.
 If labour is cheaper than capital, more labour intensive methods of
production will be used and vice-versa.
 Goods produced are distributed on the basis of purchasing power of
people rather than their needs.

Such a society did not appeal to Jawaharlal Nehru, for it meant that
majority of people of the country would be left behind without the chance
to improve their quality of life.

State Economy
Rooted in the ideas of the German philosopher Karl Marx. We see two
versions of the state economy—in erstwhile USSR known as the socialist
economy and in pre-1985 China as the communist economy.
 This kind of economic system first came up in the erstwhile USSR
after the Bolshevik Revolution (1917) and got its ideal shape in the
People’s Republic of China (1949).
 While socialistic economy emphasised the collective ownership of
the means of production (property and assets) and it also ascribed a
large role to the state in running the economy, communist economy
advocated state ownership of all properties including even labour
and absolute power to state in running the economy.
 Though for Marx, Socialism was a transitional stage to Communism,
it never did happen in reality.
 The socialist and communist economies used to criticise capitalistic
economics of being based on exploitation.
 Here the government decides what goods are to be produced in
accordance with the needs of society and not purchasing power.
 The desires of individual consumers are not given much importance-
govt knows better.
 The government decides how goods are to be produced and how
they should be distributed.

Unlike under capitalism, for example, a socialist nation provides free

health care to all its citizens. Strictly, a socialist society has no private
property since everything is owned by the state. In Cuba and China, for
example, most of the economic activities are governed by the socialistic
principles.

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Mixed Economy
The belief in the self-correcting quality of the market and the ‘invisible
hand’ of Adam Smith got a major setback in early 20th century during the
Great Depression (1929).
 The impact of the depression spread from the USA to the other
economies of western Europe escalating large scale unemployment,
downfall in demand and economic activities and lockouts in
industrial enterprises.
 A new approach came to the fore in the famous work, The General
Theory of Employment, Interest and Money by John Maynard Keynes
(1883–1946) questioning the laissez faire and the invisible hand.
Conceded that it brings equilibrium only upon strangulating the
poor.
 He suggested that prices and wages of the labour are not flexible
enough to provide employment to all. It means there will be some
people unemployed when the economy will be at its full potential.
 Ultimately, a fall in demand will be imminent resulting in recession
and if unchecked, in depression which happened in 1929.

Almost everything the people required was supplied by the private

enterprises via the market which was ultimately an unidimensional
movement of money and wealth (from the mass of people to the few who
controlled the production and supply chain) and the masses were going
through the process of pauperisation(the process of making a person or
group very poor; impoverishment.) every day, thereby weakening their
purchasing power. In the end, it affected overall demand and culminated in
the Great Depression.

Keynes suggested strong government intervention in the economy. To get

the economy out of the depression, he suggested an increase in the
government expenditures, discretionary fiscal policy (fiscal deficit, lower
interest rates, cheap money supply, etc.) to boost the demand of goods
and services as this was the reason behind the depression.

As Keynesian policies were followed, the concerned economies were

successfully pulled out of the Great Depression.
 He suggested the capitalistic order to assimilate the goals of the
socialistic economy.
 The essential goods and services which were till date being
purchased by the people as ‘private goods' were soon made available
by the state ‘free-of-cost’ giving people more spare money to create

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demand for the goods and services which were part of the market-
this part of spending by the governments came to be called as social
sector.

Suggestions and experiments

Suggestion for socialist economies
Prof. Oscar Lange praised the state economy for many of its good things
but also suggested inclusion of some of the good things of the capitalistic
economy.
 He advised the state economies to adopt ‘market socialism’ (the term
was coined by him). His suggestions were out rightly rejected by the
state economies as such compromises in socialistic economic order
were blasphemous at that time (this was ultimately a suggestion
towards democracy from dictatorship).
 Democracies are flexible thus they were able to go for an experiment
which paid them in coming times. But as the socialist and communist
political systems had been stubborn by nature, they did not go for
any experiment and thus started moving towards their economic
decay.

Market experiment in socialist/communist world

It was the communist China under the leadership of Mao Tse Tung where
the first opinion came against the total state economic control. And the
ultimate example of the state economy (i.e., China) started its preparation
towards a limited market economy under the political design of
dictatorship. In 1985, China announced its ‘open door policy’, the first
experiment in ‘market socialism’.

On the other hand, the efforts towards market socialism in the Soviet
Union, fuelled by the lofty ideas of ‘glasnost’ (openness) and ‘prestroika’
(restructuring), resulted in the very disintegration of the nation-state.
 Basically, for smooth transition to market socialism some
prerequisites were required to be put in place beforehand. China
was well ahead doing this homework since Mao’s time (specially
since 1975 onwards) which emerged as a real winner—the ideal
type example of state economy getting smoothly (!) metamorphosed
into giant market economy.

World after 1990s

The world by the late 1980s was having neither a pure example of
capitalistic economy nor a pure example of state economy.

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 Post WW II, many colonies adopted mixed-economic model. The

leaderships are now considered visionary, for the World bank since
1990, accepted the goodness and the need of ‘state intervention’ in
the economy, which earlier were ardent votaries of free market
economics.
 The economic system of India was a mixed economy in pre-1991
years as it is in post-1991 years but the composition of state-market
mix has gone for a change. In future, as the socio-economic and
political factors will be changing, India will be redefining its mixed
economy, accordingly.
 Today, once the World Trade Organisation (WTO) has taken over the
world economy, the brand of the mixed economy it advocates, is
more inclined towards the free market economy. But it does not
propagate to make the state an economic non-entity i.e., it leaves
scope, for greater state intervention in the required areas if need be.

Sectors/structure of the economy

Economic activities have two parts — market activities and non-market
activities. Market activities involve remuneration to anyone who
performs i.e., activity performed for pay or profit. These include
production of goods or services including government service. Non-
market activities are the production for self-consumption. These can be
consumption and processing of primary product and own account
production of fixed assets. Women are not paid for their service delivered
in the family. The household work done by women is not recognised in
the National Income.

Primary sector
 When we produce a good by exploiting natural resources, it is an
activity of the primary sector. This is because it forms the base for all
other products that we subsequently make.
 Since most of the natural products we get are from agriculture, dairy,
fishing, forestry, this sector is also called agriculture and related
sector.
 Mining and Quarrying is included too

Secondary sector
 The secondary sector covers activities in which natural products are
changed into other forms through ways of manufacturing that we
associate with industrial activity.

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 Since this sector gradually became associated with the different

kinds of industries that came up, it is also called as industrial sector.

Tertiary sector
 These are activities that help in the development of the primary and
secondary sectors. These activities, by themselves, do not produce a
good but they are an aid or a support for the production process.
 Since these activities generate services rather than goods, the
tertiary sector is also called the service sector.
 Service sector also includes some essential services that may not
directly help in the production of goods. For example, we require
teachers, doctors etc.

Comparing the Three Sectors

The value of final goods and services produced in each sector during a
particular year provides the total production of the sector for that year.
And the sum of production in the three sectors gives what is called the
Gross Domestic Product (GDP) of a country. It is the value of all final
goods and services produced within a country during a particular year.
GDP shows how big the economy is.

Historical Change in Sectors

 Generally, it has been noted from the histories of many, now
developed, countries that at initial stages of development, primary
sector was the most important sector of economic activity.
 As the methods of farming changed and agriculture sector began to
prosper, it produced much more food than before. Many people
could now take up other activities. Buying and selling activities
increased many times.
 Over a long time (more than hundred years), and especially because
new methods of manufacturing were introduced, factories came up
and started expanding. Those people who had earlier worked on
farms now began to work in factories in large numbers. People
began to use many more goods that were produced in factories at
cheap rates. Secondary sector gradually became the most important
in total production and employment.
 In the past 100 years, there has been a further shift from secondary
to tertiary sector in developed countries. The service sector has
become the most important in terms of total production. Most of the
working people are also employed in the service sector. This is the
general pattern observed in developed countries.

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Primary, Secondary And Tertiary Sectors In India

While production in all the three sectors has increased, it has increased
the most in the tertiary sector. As a result, the tertiary sector has emerged
as the largest producing sector in India replacing the primary sector. But
by 1990 the share of the service sector was 40.59 per cent, more than
that of agriculture or industry, like what we find in developed nations.
This phenomenon of growing share of the service sector was accelerated
in the post 1991 period

Why is the tertiary sector becoming so important in India? There could be

several reasons.
 First, demand for basic services is high, thanks to huge population.
 Second, the development of agriculture and industry.
 Third, as income levels rise, certain sections of people start
demanding many more services
 Fourth, over the past decade or so, certain new services such as
those based on information and communication technology have
become important and essential.

However, all of the service sector is not growing equally well. Service
sector in India employs many different kinds of people. At one end there
are a limited number of services that employ highly skilled and educated
workers.

At the other end, there are a very large number of workers engaged in
services such as small shopkeepers, repair persons, transport persons,
etc. These people barely manage to earn a living and yet they perform
these services because no alternative opportunities for work are available
to them. Hence, only a part of this sector is growing in importance.

Where are most of the people employed?

A remarkable fact about India is that while there has been a change in the
share of the three sectors in GDP, a similar shift has not taken place in
employment. The primary sector continues to be the largest employer. It
is because not enough jobs were created in the secondary and tertiary
sectors. Even though industrial output or the production of goods went
up. The same applies to tertiary sector as well.

As a result, more than half of the workers in the country are working in
the primary sector, mainly in agriculture, producing only a quarter of the
GDP. What it means is that there are more people in agriculture than is
necessary. So, even if you move a few people out, production will not be

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affected. In other words, workers in agricultural sector are

underemployed.

Disguised unemployment: everyone is working, none remains idle, but in

actual fact their labour effort gets divided. Each one is doing some work but
no one is fully employed. This is the situation of underemployment, where
people are apparently working but all of them are made to work less than
their potential. This kind of underemployment is hidden in contrast to
someone who does not have a job and is clearly visible as unemployed.

DIVISION OF SECTORS AS ORGANISED AND UNORGANISED

Organised sector: enterprises or places of work where
 the terms of employment are regular
 people have assured work
 registered by the government and have to follow its rules and
regulations which are given in various laws such as the Factories Act,
Minimum Wages Act, Payment of Gratuity Act, Shops and
Establishments Act etc.
 Offers jobs that are most sought after
 Employment opportunities here are expanding at a very slow pace

Unorganised sector:
 small and scattered units
 Largely outside the control of the government.
 There are rules and regulations but these are not followed.
 Jobs here are low-paid and often not regular.
 There is no provision for overtime, paid leave, holidays, leave due to
sickness etc.
 Employment is not secure.
 A lot also depends on the whims of the employer.

It is also common to find many organised sector enterprises in the

unorganised sector. They adopt such strategies to evade taxes and refuse
to follow laws that protect labourers. As a result, a large number of
workers are forced to enter the unorganised sector jobs, which pay a very
low salary.

Sectors In Terms Of Ownership: Public And Private Sectors

Ownership: In the public sector, the government owns most of the assets
and provides all the services. In the private sector, ownership of assets
and delivery of services is in the hands of private individuals or
companies.

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Motive: Activities in the private sector are guided by the motive to earn
profits. The purpose of the public sector is not just to earn profits.

Governments raise money through taxes and other ways to meet

expenses on the services rendered by it. Modern day governments spend
on a whole range of activities.

There are several things needed by the society as a whole but which the
private sector will not provide at a reasonable cost. Some of these need
spending large sums of money, which is beyond the capacity of the
private sector.

Also, collecting money from thousands of people who use these facilities
is not easy. Even if they do provide these things they would charge a high
rate for their use. Examples are construction of roads, bridges, railways,
harbours, generating electricity, providing irrigation through dams etc.
Thus, governments have to undertake such heavy spending and ensure
that these facilities are available for everyone.

There are some activities, which the government has to support. The
private sector may not continue their production or business unless
government encourages it. For example, selling electricity at the cost of
generation may push up the costs of production of industries. Many units,
especially small-scale units, might have to shut down. Government here
steps in by producing and supplying electricity at rates which these
industries can afford. Government has to bear part of the cost.

Similarly, the government in India buys wheat and rice from farmers at a
‘fair price’. This it stores in its godowns and sells at a lower price to
consumers through ration shops. In this way, the government supports
both farmers and consumers.

There are a large number of activities which are the primary

responsibility of the government. The government must spend on these.
Providing health and education facilities for all is one example.

Types of economies
Depending upon the shares of the particular sectors in the total
production of an economy and the ratio of the dependent population on
them for their livelihood, economies are given different names, such as:

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(i) Agrarian Economy

The share of its primary sector is 50 per cent or more in the total output
(the GDP) of the economy.
 At the time of independence, India was such an economy. But now it
shows the typical symptom of a service economy
 With primary sector’s contribution falling below 20%, almost 43%
per cent of its population depends on the primary sector for its
livelihood.
Thus, in monetary terms India is no more an agrarian economy, the
dependency ratio makes it so—India being the first such example in the
economic history of the world.

(ii) Industrial Economy

If the secondary sector contributes 50 per cent or more to the total
produce value of an economy, it is an industrial economy.
 Higher the contribution, higher is the level of industrialisation.

(iii) Service Economy

The economy whose 50 per cent or more produce value comes from the
tertiary sector is known as the service economy.
 First lot of such economies in the world were the early industrialised
economies.
 The tertiary sector provides livelihood to the largest number of
people in such economies.

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ROLE OF THE STATE

Three possible roles for the State/Government in the economy:

(i) Regulator of the economic system (where the state takes important
economic decisions, announces the required kind of economic policies,
takes the sole responsibility to get them implemented and controlling and
punishing those who don’t oblige to those economic decisions).

(ii) As a producer and/or supplier of the ‘private goods and services’

(these include all those goods and services which constitute the part of
market and which will be distributed among the people according to the
principles of the market mechanism. Here the state earns profit as a
private enterprise).

(iii) As a producer and/or supplier of the ‘public goods’ or the ‘social

goods’ (these include the goods and services which look essential from
the social justice and well-being perspective for the people. Education,
healthcare, sanitation, drinking water, nutrition, caring for the
handicapped and old etc. come under this category. These goods which
are generally distributed free of cost at times might reach the
beneficiaries at the subsidised prices. The loss incurred by the state in
this way is paid out of the public exchequer which means that the whole
economy pays for the cause of a few people).

A timely shuffle
A timely shuffling of state’s role in the economy as per the socioeconomic
and political needs of the economy is required. We may understand the
moot question via Keynes for whom the political problem of mankind is
to combine three things:
(i) Economic efficiency,
(ii) Social justice, and
(iii) Individual liberty.

These challenges could only be faced properly once the state and the
market both are given a balanced role in an economy—the balance to be
defined by its present conditions and the direction of the future desire of
the economy. Striking the right balance between the roles of the state
and market in the economies came to be known as the process of
economic reforms in the post-WTO world.

Basically, the WB study, the East Asian Miracle (1993) recognises the
above-given shift of one kind of mixed economy to the another kind of
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mixed economy—in the case of the Malaysian, Thai and S. Korean

economies—taking place since the mid-1960s. Experts believe that this
shift could not take place in time in India. And once it started (1991–92) it
was too late and this choice was not voluntary but obligatory. The East
Asian economies had gone for the same kind of reform process but by
their choice.

Income determination and circular flow of

income
The basic objective of macroeconomics is to develop theoretical tools,
called models, which attempt to provide theoretical explanation to
questions such as what causes periods of slow growth or recessions in
the economy, or increment in the price level, or a rise in unemployment.

It is difficult to account for all the variables at the same time. Thus, when
we concentrate on the determination of a particular variable, we must
hold the values of all other variables constant.

We apply the same method in the analysis of the macroeconomic system

for the determination of National Income under the assumption of fixed
price of final goods and constant rate of interest in the economy.

Circular flow of goods and services

There may fundamentally be four kinds of contributions that can be made
during the production of goods and services
a. contribution made by human labour, remuneration for which is
called wage
b. contribution made by capital, remuneration for which is called
interest
c. contribution made by entrepreneurship, remuneration of which is
profit
d. contribution made by fixed natural resources (called ‘land’),
remuneration for which is called rent.

Year after year we can imagine the aggregate income of the economy
going through the two sectors, firms and households, in a circular way.
When the income is being spent on the goods and services produced by
the firms, it takes the form of aggregate expenditure received by the
firms.

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Since the same amount of money, representing the aggregate value of

goods and services, is moving in a circular way, if we want to estimate the
aggregate value of goods and services produced during a year we can
measure the annual value of the flows at any of the dotted lines indicated
in the diagram.

1. EXPENDITURE METHOD
We can measure the uppermost flow by measuring the aggregate value of
spending that the firms receive for the final goods and services which
they produce. This method will be called the expenditure method.

GDP Expenditure Examples

Method
(C) Consumption of  Purchasing new car, mobiles, computer etc.
final goods and Both India made & (Imported) foreign made
services are counted.
 If existing house, its ‘notional rent’ is counted
(i.e. even if you did not rent the property.)
 IGNORE purchase of second hand goods,
because we are only measuring ‘new’ things
“MADE in India” in present year.
 IGNORE if new house is not counted here, it’s
counted in (I)

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(I) Investments  Purchase of tangible capital assets like New

House, Land, Building, Factory, Truck,
Machinery.
 Purchase of intangible capital assets like IPR /
Patents, Computer Software etc.
 Purchase of raw material & intermediate goods,
wages to workers for production.

IGNORE savings in bank, shares and bonds etc.

(because it’d have been given to entrepreneur
as ‘Capital’ to buy above things).
(G) Government  Salaries to employees, Procurement of
Purchases computer, stationery, fans, tube lights, vehicles
etc.
 IGNORE Government’s scholarship, subsidy etc.
‘Transfer Payments’. They’re counted in “C”
(Private) consumption by the respective
beneficiaries.
(X-M) Export  Export is added because it means a foreigner
MINUS Imports must have bought goods/services “MADE in
India” so it’s part of India’s GDP.
 Whereas, Import is subtracted because some
Indians must have Consumed (C) foreign
products that were not “MADE in India”, So if
you do not subtract the ‘Import(M)’, it will give
wrong estimation of India’s GDP.
Total = GDP The GDP thus arrived is called GDP at Current
Market Price. When we adjust it with inflation
against base year 2011 → GDP at Constant
Market Price

Calculation methodology
Textbook formula CSO’s formula
(C) Consumption of (+) Private Final Consumption
final goods and services Expenditure(PFCE)
(I) Investments (+) Gross Fixed Capital Formation (GFCF)+
Change in Stocks (CIS)

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(G) Govt Purchases (+) Government Final Consumption

Expenditure (GFCE)
(X-M) Export (+) Net Export of Goods & Services.
MINUS Imports
(+) Discrepancies
Total = C+I+G+X-M Total = GDP @Current Market Price

PRODUCT METHOD
If we measure the flow at B by measuring the aggregate value of final
goods and services produced by all the firms, it will be called product
method.

Value added of a firm is, value of production of the firm – value of

intermediate goods used by the firm. The value added of a firm is
distributed among its four factors of production, namely, labour, capital,
entrepreneurship and land. Therefore wages, interest, profits and rents
paid out by the firm must add up to the value added of the firm. Value
added(net contribution) is a flow variable.

Production method is also known as Value Added method (GVA)

Mining Engine Tractor Total

Company Company Company →
→ →
A) Total Steel: 1 Engine: 5 Tractor: 10 1+5+10=16
Production → lakh lakh lakh lakh. Value of
Final Goods
produced by
firms
B) 00 1 lakh 5 lakh 0+1+5= 6 lakh
Intermediate (suppose (Steel (Engine Value of
Goods → ore dug purchased) purchased) Intermediate
from Goods used by
free land!) firms
Value Added 1 lakh → 4 lakh → 5 lakh → GVA =16 – 6 =
(A-B)= 1+4+5 =10

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Here, GVA = Value of final MINUS intermediate = (16-6) = 10 lakh.

Alternatively, GVA = Value added at each stage = 1 + 4 + 5 = 10 lakh. The
amount thus derived is called GVA (at basic price).

From GVA to GDP

GVA at Basic price: (Suppose a country only produces LPG ₹ 600
cylinders)
Indirect Taxes: CGST + SGST (Earlier, Excise + VAT) (+) ₹
100
But Petroleum ministry is also giving subsidy on the (-) ₹ 200
purchase of LPG cylinders under PAHAL scheme
GDP at Current Market Price ₹ 500
= GVA (+) Indirect Taxes (-) Subsidies
When we adjust Current Prices with inflation against base year 2011, we
get GVA / GDP Constant Prices

GVA at Basic Prices → Add indirect taxes minus subsidies = GDP at Market
Price.

 While GVA gives a picture of economy from the producers' side or

supply side, the GDP model gives the picture from the consumers' /
demand side perspective. (Because it considers Indirect taxes and
subsidies).

 Therefore, from 2018-April, RBI decided to use GDP instead of GVA

to measure the economic activities for its policy making & big data
analytics.

INCOME METHOD
Measuring the sum total of all factor payments will be called income
method.

This method follows the simple idea that whatever is “MADE in India”, its
revenues must have been distributed among the factors of production. So,
 GDP = Wages to labourers (W) + Interest on Capital to Lenders (I) +
Profits to Entrepreneur / Owners of the firm (P) + Rent on land (R).
 The GDP thus arrived is called GDP at Current Factor Cost

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CSO methodology
Theoretical CSO’s Income formula
Wages Compensation (i.e. Employees salary + Employer’s
contribution to his Social Security Account e.g. EPFO /
ESIC).
(+) Interest (+) Operating Surplus, Mixed Income. (Because in a
family run farm / enterprise it is difficult to separate
(+) Profit income and profit, unlike a corporate balance sheet)

(+) Rent (+) Consumption of fixed assets during production

Total= “GDP Here total is called “GVA @Factor Cost”
@Factor Cost”

GVA at Factor Cost

add production level (+) Professional Tax, Stamp Duty, Land
taxes i.e. taxes Revenue
“independent of
volume”
Subtract production (-) Farmer interest subvention because it is
level subsidies i.e. given irrespective of whether he produces
subsidies 100kg or 1000 kg; similarly, Govt paying EPFO
“independent of contribution on behalf of
volume” industrialist etc.
Answer= GVA at Basic Prices
add Product Taxes i.e. (+) Excise / VAT / GST / Custom Duty- Because
taxes “dependent of their absolute figures will vary as per the
volume / value quantum of production
of product”
Subtract Product Level (-) LPG Pahal subsidy that depends on number
subsidies i.e. subsidies of cylinders purchased, MSP that depends on
“dependent of amount of grains procured etc.
volume”

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Answer= GDP at Current Market Price (MP). When we

adjust it with inflation against base year
2011 → GDP at Constant Market Price.

GDP Discrepancy
Theoretically, the GDP calculated by production method should equal to
GDP by expenditure method.
 However, in real life, GDP (production ) ≠ GDP (expenditure );
because factory production data is systematically captured by
Government machinery such as Corporate Affairs ministry’s MCA-21
portal, CSO’s Annual Survey of Industries (ASI) etc.
 But, all of the final private consumption may not be captured in the
official statistics due to unreported transactions (e.g. due to black
money etc.)
 As a result, mismatch / ‘discrepancy’ will be observed in GDP
(expenditure) figures, and mentioned in the official CSO report.
 Therefore, GDP (Production Method GVA) is considered more
accurate method among the three methods (Production,
Expenditure, Income).
 So, while CSO computes data using all 3 methods, but official GDP &
growth figures are presented based on the ‘Production GVA’
method.

National income measures

National income measures
Gross Domestic Product
 measures the aggregate production of final goods and services
taking place within the domestic economy during a year.
 But the whole of it may not accrue to the citizens of the country.
 For example, a citizen of India working in Saudi Arabia may be
earning her wage and it will be included in the Saudi Arabian GDP.
But legally speaking, she is an Indian.

GNP
 ≡ GDP + Net factor income from abroad
 Net factor income=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
 IGNORE transfer incomes such as remittances gifts, donations,
charities, fines.
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 IGNORE the incomes from second hand goods.

NNP
 A part of the capital gets consumed during the year due to wear and
tear. This wear and tear is called depreciation.
 Naturally, depreciation does not become part of anybody’s income.
 If we deduct depreciation from GNP the measure of aggregate
income that we obtain is called Net National Product (NNP).
 Thus NNP ≡ GNP – Depreciation

Market prices vs factor cost

 It is to be noted that all these variables are evaluated at market
prices.
 But market price includes indirect taxes.
 When indirect taxes are imposed on goods and services, their prices
go up. Indirect taxes accrue to the government.
 We have to deduct them from NNP evaluated at market prices in
order to calculate that part of NNP which actually accrues to the
factors of production.
 Similarly, there may be subsidies granted by the government on the
prices of some commodities (in India petrol is heavily taxed by the
government, whereas cooking gas is subsidised). So we need to add
subsidies to the NNP evaluated at market prices.

National income
The measure that we obtain by doing so is called Net National Product at
factor cost or National Income.
Thus, NNP at factor cost ≡ National Income (NI )
≡ NNP at market prices –(Indirect taxes – Subsidies)
≡ NNP at market prices – Net indirect taxes
Where Net indirect taxes ≡ Indirect taxes –
Subsidies

NNP (Factor Cost) is the National Income of India, says NCERT

Class12.

Per Capita Income = NNP ÷ population of India

Per Capita Income 2016 2017 2018-19

(Est)
Population in Crores 129 131 >133

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At ₹ Current Prices 1,04,659 1,14,958 >1,26,000

At ₹ Constant Prices 82,931 87,623 > 92,000
(@BaseYear2011)

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Personal Income (PI)

First, let us note that 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). We have
to deduct UP from NI to arrive at PI, since UP does not accrue to the
households.

 Similarly, 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.
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 On the other hand, 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.

 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.

Thus, Personal Income (PI)

≡ NI – Undistributed profits – Net interest payments made by
households – Corporate tax + Transfer payments to the
households from the government and firms.
Personal disposable income
However, 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. Thus

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

tax payments.

National Disposable Income and Private Income

Apart from these categories of aggregate macroeconomic variables, in
India, a few other aggregate income categories are also used in National
Income accounting

National Disposable Income

= Net National Product at market prices + Other current transfers
from the rest of the world

The idea behind National Disposable Income is that it gives an idea of

what is the maximum amount of goods and services the domestic
economy has at its disposal. Current transfers from the rest of the world
include items such as gifts, aids, etc.

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Gross OECD defines it as GDP + NET receipts from abroad

National (wages,
Income interest, profit, rent) plus net taxes & subsidies
(GNI) receivable from
abroad.
 Here, ‘Wages and salaries’ from abroad = ‘Guest
workers who reside abroad for less than 12 months
and whose centre of economic interest remains in
their home country.
 The technical difference between GNP and GNI=not
IMP
National = NNP + Other Current Transfers from rest of the world
disposable (remittances, gift, donations etc.)
income
National Disposable Income gives an idea of what is the
maximum amount of goods and services the domestic
economy has at its disposal.

GDP & PER CAPITA INCOME→ CRITICISM / LIMITATIONS

1. Provides only quantitative picture and does not consider the
qualitative aspects / negative externalities e.g. More coal based
thermal power production= more GDP, disregarding how much
pollution it created.
2. Ignores non-marketed activities e.g. domestic work done by mother.
3. Ignores the Opportunity Cost e.g. A child labour produced ₹ 50000
rupees worth firecracker annually = added in GDP. But, child
labourer could not pursue education ELSE he could have become a
doctor/engineer and produced ₹ 5,00,000 worth of annual goods
and services - such angles are not considered in computing GDP.
4. Ignores inequality of income among people.

Growth vs Development
Economic Growth Economic Development
It measures the increase in the It measures whether economic growth
production of goods and has resulted in improving the quality
services in a country. of life & the socioeconomic structure of
the country
Quantitative measurement: Qualitative measurements such as
gross Domestic Product (GDP), UNDP’s HDI (Human Development

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Consumption, Government Index), life expectancy, gender- related

Spending, Investment, Net indices, infant mortality, literacy etc.
Exports.
NNP divided by total It’ll focus on ‘Inequality of income
population = per capita income. distribution’ e.g. obtained through
World Bank Gini coefficient or Oxfam
NGO’s Inequality report.

Nominal vs Real GDP (Base Year)

GOODS AND PRICES
One implicit assumption in all this discussion is that the prices of goods
and services do not change during the period of our study. If prices
change, then there may be difficulties in comparing GDPs.

If we measure the GDP of a country in two consecutive years and see that
the figure for GDP of the latter year is twice that of the previous year, we
may conclude that the volume of production of the country has doubled.
But it is possible that only prices of all goods and services have doubled
between the two years whereas the production has remained constant.

Therefore, in order to compare the GDP figures (and other

macroeconomic variables) of different countries or to compare the GDP
figures of the same country at different points of time, we cannot rely on
GDPs evaluated at current market prices.

Nominal and real GDPs

For comparison we take the help of real GDP. Real GDP is calculated in a
way such that the goods and services are evaluated at some constant set
of prices (or constant prices). Since these prices remain fixed, if the Real
GDP changes we can be sure that it is the volume of production which is
undergoing changes. Nominal GDP, on the other hand, is simply the value
of GDP at the current prevailing prices.

For example, suppose a country only produces bread. In the year 2000 it
had produced 100 units of bread, price was Rs 10 per bread. GDP at
current price was Rs 1,000. In 2001 the same country produced 110 units
of bread at price Rs 15 per bread. Therefore nominal GDP in 2001 was Rs
1,650 (=110 × Rs 15). Real GDP in 2001 calculated at the price of the year
2000 (2000 will be called the base year) will be 110 × Rs 10 = Rs 1,100.

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GDP @ PPP
This is about the calculation of GDP based on the comparison of value of
the same basket of goods and Services in two different economies. This
gives us a picture of whether the Cost of Living is higher or lower as
compared to another country.

Illustration:
Suppose the basket of G&S is made up of Apples, Health, Cars etc

The value of this basket in the US = $10,000

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If you want to buy the same basket in India, you have to pay in Rupees.
Let's assume that 1$= Rs.70.

The value of the same basket in India = Rs. 7,00,000 ( $10000)

In such a scenario, we say that the currencies are at PPP (Purchasing

Power Parity)

If the same basket in India is available for Rs. 4,90,000, it would mean
that you have spend only $7000. Relatively, Indian CoL is lesser and thus
G&S are cheaper.

Now, if India's GDP is just Rs.4,90,000 ($7000) in nominal terms, then in

PPP terms it is $10000 (Rs. 700000). It means the India is able to provide
G&S worth $10k at just $7k.

GDP data
12000

10000

8000
US $ Billion

6000

4000

2000

0
1970

1992

2012
1960
1962
1964
1966
1968

1972
1974
1976
1978
1980
1982
1984
1986
1988
1990

1994
1996
1998
2000
2002
2004
2006
2008
2010

2014
2016
2018

WORLD BANK DATA

Nominal GDP PPP (GDP)

New GDP numbers

There are variations in the ways to calculate GDP and it is the
introduction of these new calculation methodologies that has caused a
spike in India’s recent GDP growth rate, leading to quite a lot of confusion
and debate.

Earlier, India’s GDP growth rate for the year ending in March 2014 was
marked at 4.7%, but with the new calculation methods it has now been
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revised to be 6.9%. And for the fiscal year ending in March 2015, the
earlier estimated GDP that was marked at 5.5% has now increased to
7.4%.

How did they arrive at the new numbers?

The changes in the GDP calculation were devised by India’s statisticians
working for the Central Statistics Office (CSO) that is under the Ministry
of Statistics & Programme Implementation (MOSPI)

There are three important changes made in the calculation of the GDP:
o Changing the base year
o Replacing factor costs with market prices
o Widening of the data pool

Changing the Base Year:

Choosing a base year is the first step while counting the ‘real’ GDP. A real
GDP growth rate removes any effects that have arisen due to inflation to
give us a truer picture of economic reality. For the revised GDP
calculations the Indian statisticians have changed the base year from
2004-05 to 2011-12.

This change alone has played an important part in shooting up the GDP
and related numbers. The change in base year is not an unusual
phenomena as base year is regularly updated.

Replacing Factor Costs with Market Prices:

There are two ways to calculate GDP and those are calculating via factor
costs or calculating via market prices. Until the recent revisions India had
used factor costs for calculating GDP but now we have shifted towards
market prices. Factor costs means the cost of production that the
producers or service providers have incurred after removing the effect of
indirect taxes and subsidies.

But by the recent changes we have now shifted towards calculating the
GDP by measuring the Gross Value Added (GVA) at market prices. Market
prices mean the actual expenditure incurred by consumers. These will
also include any subsidies such as food and petrol that are provided to
the consumer.

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The shift from factor costs to market prices indicates that India is slowly
conforming to international norms as most countries use market prices
for calculating the GDP.

Widening of Data Pool

In statistics, the larger the sample, the more accurate the extrapolations
are, generally speaking. Previous data was sampled from Annual Survey
of Industries (ASI), which comprised of about two lakh factories. The new
database draws from the five lakh odd companies registered with the
Ministry of Corporate Affairs (MCA21). While the earlier data gave only a
factory-level picture, the new data looks at the enterprise level.

Does this reflect reality?

A sudden spike in GDP or GDP growth rate has to be understood without
resorting to extreme opinions. It doesn’t mean that our economy has
overtaken China’s economy in a fortnight and it also doesn’t mean that
these numbers are fully misleading. The revisions are not abnormal or
unusual practices and can be reasonably argued.

Back-series Controversy
The (new) GDP-data re-produced for 2005-2011 is called “Backseries”
data.

2018- November: NITI released back-series data, showing UPA/Congress

Raj GDP growth was pathetic.

Critiques alleging “Methodology is wrong, and MoSPI/CSO should have

released the report. NITI Ayog should not have released it on their behalf.
So, it’s all Modi’s manipulated data just to show his growth figures are
higher.

Average Growth rate Base year 2004 Base year 2011

UPA-1 era (2004-09) 8.1% ~ 6.7% (using
Backseries)
UPA-2 era (2009-14) 7.0% ~ 6.7% (using
Backseries)
Modi-era (2014-2018*) N/A ~ 7.4%

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The new back series data diverges quite sharply from the estimates made
in a draft report released by the National Statistical Commission, which
showed that growth during the UPA years crossed 9% on at least four
occasions, and even hit 10.78% in 2010-11.

This report pegged the average GDP growth during UPA-I at about 8.4%
and UPA-II at 7.7%. The government, however, was quick to clarify that
this was just a draft report that used only one of the many methods on
offer to estimate the back series, and that it was not the final number.

Changing base years to 2017 & 18

2018-Feb: MoSPI declared that it’ll ‘initiate’ steps to change base years:

Indicator Present Base year Proposed New Base Year

GDP & IIP 2011-12 2017-18
CPI 2012 2018-19

This is proposed to ‘accommodate’ the changes take place in the

economic scenario of the country (e.g. GST, Demonetization, RERA)

Growth Deflator
The ratio of Nominal and Real GDPs is called ‘GDP deflator’, it presents a
picture of inflation like CPI and WPI but, unlike CPI & WPI it’s not based
on a fixed basket of commodities.

𝐺𝐺𝐺 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 = Nominal GDP at Current Prices/Real GDP at Constant

Prices (BaseYear 2011) × 100
CSO Release in 2019-Feb 2016 2017-18 2018-19 (est)
→ ₹ crores
A) Nominal GDP @Current 153,62,386 170,95,005 190,10,164
Basic Prices in crores
[Production GVA Method]
Nominal Growth Rate *** 11.3% 11.7 %
@Current Prices (against growth growth
Previous Year) than 2016! than 2017!
B) Real GDP @Constant 122,98,327 131,79,857 140,77,586
Prices (BaseYear2011)

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Real Growth Rate @Constant *** 7.2% 6.8% growth

Prices (against Previous growth than
Year) than 2016 2017
GDP Deflator = {A÷B} x 100 124 129 135

Growth Rate
Growth Rate (%) = {GDP (Present year - Last Year) / Last Year} x 100

GDP growth Rates

20
15
10
5
0
-5
-10
-15
-20
-25
-30
2020-
2012- 2013- 2014- 2015- 2016- 2017- 2018- 2019-
21
13 14 15 16 17 18 19 20
(Q1)
GDP constant Prices (2011-
5.46 6.39 7.41 8 8.17 7.17 6.1 4.2 -23.9
12)
GDP current Prices 13.82 12.97 10.99 10.46 11.55 11.28 11.2 7.5 -22.6

GDP constant Prices (2011-12) GDP current Prices

How to improve?
Savings It’s the Income excess of Consumption. Subdivided into
Private Savings [by households & business firm] and
Public Savings by Govt organizations.
Investment It's the domestic Savings + NET foreign money WHICH
IS put in Real (physical) Assets like machines, tools,
buildings, office spaces, storehouses, roads, bridges,
airports
GFCF Gross Fixed Capital Formation Rate = INVESTMENT –
DISPOSAL of assets (liquidation, condemnation).

Thus, GFCF shows the net increase in physical assets. It

IGNORES depreciation, and land purchases

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Capital It is the amount of capital needed to produce one unit of

Output output. It depends
Ratio on factors such as technological progress, prices of
capital goods /
machinery. In India, High Capital Ratio is among the
reasons for subdued
growth rates.

Survey and Budget Observations on Growth

ES19: GDP HARMED DURING ECONOMIC POLICY UNCERTAINTY
Economic Policy Uncertainty Index (EPU) index Started in 2016, by three
US-based economists—Scott Ross Baker, Nick Bloom and Steven J. Davis.
 They capture countries’ newspapers’ headlines related to economic
policy uncertainty, and then rank the nation accordingly.
 2011-12: economic policy uncertainty was the highest in India - 2G
Scam, Coal allocation scam, Subprime Crisis, Global Financial Crisis.
 During this time, the government did not take the corporate friendly
reform decisions or reverted its original decisions fearing the media
scrutiny, judicial scrutiny, protest by the labour unions.
 2013: again increased Due to Taper-tantrum and its impact on
weakening the rupee and exit of FPIs.
 2016-17: increased due to Demonetisation, GST. But during this
stage it was not as bad as the uncertainty during 2011-12.

From 2014 onwards India’s EPU has declined although in a zigzag

manner with occasional spikes during Demonetization - GST etc. Whereas
Global EPU has increased in zigzag manner- due to the Policies pursued
by Donald Trump, BREXIT, Iran, N.Korea, OPEC, Trade war between USA
and China etc.

 During high EPU, domestic investors hold up their decision to invest

into financial market. They prefer to invest in gold (=large BOP), land
/ real estate (=Black money). FPI inflows decline during are volatility
of exchange rate.
 However, the relationship between FDI growth and volatility of
exchange rate is weak. Because Foreign Direct Investors are entering
a market for long term. They look at multiple factors beyond just the
exchange rate. They look at taxation, monetary policy, consumer
sentiment etc. all which are reflected by EPU.

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 Low growth of FPI, FDI = Corporates are deprived of the new capital
from the domestic and foreign investors → it affect the factory
expansion, job creation and GDP growth.

ES19: How to reduce Economic Policy Uncertainty

Reducing economic policy uncertainty is critical for both domestic
investment and foreign investment.
1. Make Policies predictable
 From which date Bharat Stage emission norms will become
effective?
 From which date GAAR or E-Way Bill will become effective?
 2019-Budget proposed to hike surcharge on the income tax of
super-rich, then due to a backlash by foreign investors, it was
reverted.

2. Keep consistency in promises

 Monetary policy Committee keeping “Calibrated Tightening”. Means
in the next meeting they would either ‘hold', or 'increase' repo rate.
No chance of cutting the repo rate. Yet, they cut the repo rate.
 Government should avoid changing the goalposts and deadlines of
Fiscal Responsibility and Budget Management Act. Then consistency
becomes hard to find and harder to follow.

3. Policy implementations must be monitored

 The actual implementation of policy occurs at the lower levels,
where ambiguity gets created and it compounds the economic policy
uncertainty. Therefore, staff should be trained and implementation
processes should be certified (by NITI etc) before implementing
policy.
 Poorly drafted laws full of ambiguities, amendments, clarifications
and exemptions = endless litigation. E.g. Provisions related to Capital
Gains Tax in the Income Tax Act 1961: Vodafone-Hutch case.

4. Respect boundaries
 Judiciary, legislature and executive should respect each other's
boundaries. Executive and legislature should not create a vacuum
which could encourage Judicial Overreach such as firecracker ban, or
no selling of liquor on highway hotels, which may create new
challenges in economy.

BUDGET-2019: $5 TRILLION ECONOMY

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Year India’s GDP in trillion $ (Current Prices)

2014-15 1.85
2018-19 2.70
2024-25 5 trillion targeted.
 For this, India must have real GDP growth rate of 8% per year.

ES 20: Wealth Creation

Several levers for furthering wealth creation:
1. Entrepreneurship at the grassroots - new firm creation

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2. Promote “pro-business” policies - unleashing competitive markets to

generate wealth as against “pro-crony” policies
3. Integrate “Assemble in India” into “Make In India” to focus on
labour-intensive exports and thereby create jobs at large scale
4. Efficiently scale up the banking sector -- match the size of the Indian
economy
5. Healthy shadow banking sector
6. Privatisation to foster efficiency.

With all the above -- India’s GDP growth estimates can be trusted.

NSO = CSO + NSSO

The Ministry of Statistics and Programme Implementation has decided to
merge the Central Statistics Office (CSO) and the National Sample Survey
Office (NSSO) into National Statistical Office (NSO) in a major
restructuring move.

Stated purpose: To streamline and strengthen the present nodal function

of MOSPI with respect to Indian official statistics system and bring in
more synergy by integrating its administrative functions within the
ministry."

About the order

The Statistical Wing, comprising the NSO with constituents as the CSO
and the NSSO, to be an integral part of the main ministry.
 NSO would be headed by Secretary, Statistics and Programme
Implementation, with various divisions reporting to the Secretary
through Director Generals (DGs).
 The CSO headed by a DG brings out macro economic data like
economic (GDP) growth data, industrial production and inflation.
 The NSSO conducts large-scale surveys and brings out reports on
health, education, household expenditure and other social and
economic indicators. The NSSO and the CSO were functioning
independently.

The Data Processing Division (DPD) of the present NSSO would be

renamed Data Quality Assurance Division (DQAD) and have the
responsibility to bring out quality improvements in survey data, as well in
data of non-survey source like Economic Census and administrative
statistics (provided by various department or bodies).

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Stocks and Flows

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