1.

Measurement of Growth
Saturday, November 14, 2020 9:01 PM

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

✓ Growth is a Quantitative concept whereas Development is a Qualitative(Quality) concept.

✓ Growth can be both positive and negative like GDP growth

✓ Like increased in the height or weight of a person.

✓ Development is all about how human being can access quality of life like Quality education, health, and environment.
Development is always positive as it shows quality improvement.

2 What is an economy?
 The ‘economy’ is the organized system of human activity involved in the production, consumption, exchange and distribution
of goods and services.
 The economy applies to everyone from individuals to entities such as corporations and governments.

1. What are the various sectors of an economy?

 Human activities which generate income are known as economic activities.
 Economic activities are broadly grouped into primary sector (directly dependent on environment as utilization of
earth’s resources such as land, water, vegetation, building materials and minerals) Hunting, fishing, forestry, agriculture
people engaged into this called Red collarworkers. secondary sector(they add value to natural resources by
transforming raw materials into products) people engaged into this called blue collar, tertiary sector( include
Production and Exchange services like transport and communication services, healthcare and education services, trade
etc.) people engaged into this called White collar.

1 Economic Growth:

Economic growth is an increase in the capacity of an economy to produce goods and services, compared from one period of
time to another .

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 Now that we have understood what *an Economy and' Economic growth' is ,let us differentiate between
Economic Growth and Development with a simple example:

* At the start of the lesson we have discussed about the difference between Growth and
Development. Now let us apply that understanding in terms of Economic Growth and
Development,

* Since we have not gone into the understanding of the various terms related to economic growth,
we shall keep it simple by referring it as National Income.

* Now, suppose we have a country X, It has shown remarkable increase in its National Income when
compared to the previous year, This is an example of Economic Growth*

* But when we have a closer look at the social indicators of the country, that is how is it performing
in the social sectors like Health, Education etc. we find that the country has massive poverty,
unemployment, high crime rate, low level of nutritional status. Now we can conclude that the
country X has grown but NOT developed as one would have expecte

2 How can the capacity of an economy be measured?

This capacity of an economy can be measured through different indicators. We shall study them one by one.
1. Gross Domestic Product (GDP):
The total market value of all final goods and services produced within the country in a given period of time- a year called GDP
In estimating GDP, only final marketable goods and services are considered.
The value of intermediate goods is a part of the final goods and services and so is not counted separately to avoid double
counting.

Intermediate goods- the raw materials that a firm buys from another firm which are completely
Used in the process of production are called 'intermediate goods.

Let us take an example to understand this: We will take a very hypothetical example, where there is only one farmer and a
tyre manufacturer. Suppose, a company manufactures tyres, Now that company needs rubber as a raw material. The company
buys rubber from a farmer for Rs.500 and uses that to manufacture one tyre. The final cost of the tyre comes to Rs.1000, Now if
we calculate the GDP: We see two products here, one is the rubber and the other is the tyre When we calculate the cost of
both, we get our GDP as Rs, 500 + Rs.1000 = Rs.1500.

A little reflection will tell us that the value of aggregate production is not Rs 1500. The farmer had
produced Rs 500 worth of rubber for which it did not need assistance of any inputs. Therefore the entire Rs 500 is rightfully the
contribution of the farmer. But the same is not true for the tyre manufacturer. The manufacturer had to buy Rs 500 worth of
rubber to produce his tyre. The Rs 1000 worth of tyre that he has produced is not entirely his own contribution.
To calculate the net contribution of the manufacturer, we need to subtract the value of the rubber that he has bought from the
farmer. If we do not do this we shall commit the mistake of 'double counting'. This is because Rs 500 worth of rubber will be
counted twice. First it will be counted as part of the output produced by the farmer. Second time, it will be counted as the input
value of rubber in the tyre produced by the manufacturer.
Therefore, the net contribution made by the tyre manufacturer is, Rs 1000 - Rs 500 = Rs 500, Hence, aggregate value of goods
produced by this simple economy is Rs 500 (net contribution by the farmer) + Rs 500 (net contribution by the tyre
manufacturer) = Rs 1000.

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 2. Gross National Product (GNP):
In calculating GDP, we don’t take into account the income earned by citizens of India working abroad.
We must deduct the earnings of the foreigners who are working within our domestic economy or the payments to the factors
of production owned by the foreigners. To calculate this GNP is used.

GNP = GDP + Net Factor Income from Abroad

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

Factors of production:
The factors of production are resources that are the building blocks of the economy; they are people use to produce goods and
services. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship.

Factor Income:
Factor income is income received from the factors of production- land, labor, capital and
entrepreneurship. Income generated from the use of land is called rent, income generated from labor is called wages, income
generated from capital is called interest and the income generated from entrepreneurship is called profit.
Comparison between GDP and GNP:

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

For open economy:

if it is an open economy with great levels of foreign investment (FDI) and lesser levels of outbound FDI, its GDP is
likely to be larger than GNP.

For closed economy:

If it is a dosed economy where nobody leaves its shores (land at the edge of a sea), nobody invests abroad, nobody comes in
and nobody invests in the country, its GDP will be equal to GNP

3.
Net Domestic Product (NDP):
Net Domestic Product = GDP - depreciation

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 4. Net National Product (NNP):
Net National Product = GNP – Depreciation

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

4 Market Price:
It refers to the actual transacted price and thus includes the indirect taxes (Product Taxes) which a government levies and the
subsidies (Product Subsidies) which the government gives on the products.
Thus there are two changes we make to the factor cost to arrive at the Market Price. We need to add the indirect taxes and
subtract the subsidies given by the government.

 Once a product is produced and it leaves the factory gate, Market Price comes into play during
The billing process, where the indirect taxes levied by the government are added and this is the
Final cost the consumer has to pay for the product.

 Subsidies are subtracted because it reduces the cost of production and thus the consumer has to pay less.

Concept Check:
Let us take a very hypothetical example. Suppose, the cost of making a product is Rs.1000. The indirect tax levied on it by
the government is 10%. Let us suppose the government grants a subsidy of Rs.150 on the product. Now, what is its Factor
cost and Market Price (in Rs)?
a ) 1000, 950
b) 950, 1000
c) 1100, 950
d) 850, 950

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 d) 850, 950
Answer: a) 1000, 950
Thus in two ways, if we explain, it is:

1. Market Price=Factor Cost + Indirect Taxes - Subsidies Here , the cost of making the product is Rs.1000, this is our factor
cost. 10% tax is levied which is Rs.100 {10% of 1000). The value of subsidy granted is Rs.150. So, the market price is going to
be 1000+100-150=950.

2. Similarly, we can find Factor Cost

Factor Cost = Market price –Indirect Taxes + Subsidies

National Income: We have seen four indicators which are used to measure the capacity of an economy.

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

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

Ministry of Finance uses GDP numbers (at Current Prices) to peg Fiscal targets

Time Periods:

India's GDP is calculated quarterly and annually. The reports are released at a two months gap. For example, the estimate for
the December ended quarter would be released at the end of February.
Changes brought to the calculation of National Income in 2015:

In January 2015, the CSO brought many changes to the way it calculated the GDP. These changes can be categorized into:
✓ Methodological Changes (Methodology is the science of doing something)
✓ Change in the Base Year
✓ Giving comprehensive coverage to all sectors
Specifically, there are two methodological changes adopted by the CSO in its new estimates and both are highly interrelated.
✓ GDP of the country is to be estimated in terms of Market Price.
Gross Value Added (GVA) from different sectors will be calculated at basic prices.

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

The relation between GDP and GVA:

GVA + Taxes on Products – Subsidies on Products = GDP

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8.01 Why is GVA calculated?

* GVA and GDP give a picture of economic activity from producer's (supply side) and consumers
(demand side) perspective respectively, because GVA is the net receipt of the producers and GDP
is the expenditure incurred by the consumers.
* Both these measures need not match and there could be a sharp divergence due to net indirect
taxes (NIT = Indirect Taxes- Subsidies), which are counted in GDP calculation (GDP is the sum of

GVA and NIT).

* GVA provides a better measure of economic activity because GDP can record a sharp increase
just on account of increased tax collections due to better compliance /coverage and not
necessarily due to increase in output.

* GVA is a better reflection of the productivity of the producers as it excludes the indirect taxes,
which could distort the production process.
* A sector-wise breakdown provided by the GVA measure can better help policymakers to decide
which sectors need incentives/stimulus or vice-versa.

1. What is the GVA at Basic Prices?

Basic Prices:

Production Tax and Subsidy:

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

3.

What were the other changes?

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

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 Giving comprehensive coverage to all the sectors:

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

7 Economic Growth Rate

 An Economic growth rate is a measure of economic growth from one period to another period
 In India we measure Economic Growth Rate by GDP from one year to another.

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

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

Inflation:
Inflation is defined as a situation where there is sustained, unchecked increase in the general price level and a fail in the
purchasing power of money. Thus, inflation is a condition of price rise. The increase in price can be due to increased demand or
reduced supply and there can be other factors also.

Real GDP refers to the current year production of goods and services valued at base year prices. Base year prices are constant
prices.
We can explain this concept with a simple example.

Let us consider that there are two products being produced in an economy: breads and shirts. Year 2011-12: 20 breads, 30
shirts at the rate of Rs.15 per bread and Rs.150 per shirt were produced.
GDP for 2011-12: 20*15+30*150=Rs.4800
Year 2016-17: Let us assume the same quantity has been produced, i.e.20 breads and 30 shirts but at
Rs.25 per bread and Rs.200 per shirt,
We will calculate the real GDP and Nominal GDP for 2016-17.
Nominal GDP for 2016-17: 20*25+30*200=Rs, 6500.
Real GDP for 2016-17: 20*15+30*150=Rs.4800 (here the prices of 2011-12 are being used since we are
Taking 2011-12 as base year).
Here we see that Real GDP for 2016-17 is same as GDP for 2011-12.
This is because the quantity of goods produced has remained the same.
Thus, to actually see whether the production has increased or not, we need to refer to real GDP.

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10 Various indicators to measure the change in prices:

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

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

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

Other common Price indices are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI).
Consumer Price India (CPI)
• CPI {Rural, Urban, Combined) is released by the Central Statistics Office (CSO) in the Ministry of
Statistics and Programme implementation.
• In India, RBI uses CPI (combined) released by CSO for inflation targeting purpose.

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 • In India, RBI uses CPI (combined) released by CSO for inflation targeting purpose.
• Base Year: Base year for CPI {Rural, Urban, Combined) is 2011-12 (In exams if there are two
Separate options 2011, 2012; the correct option is 2012. It has to be chosen as the base year).
• Number of Items: The number of items in CPI basket include 448 in rural and 460 in urban.

The items in CPI are divided into 6 main groups as follows:

The six broad categories are:
Food and Beverages
Pan, Tobacco and Intoxicants
Clothing and Footwear
Housing
Fuel and Light
Miscellaneous
Now, while calculating the CPI (Rural), the component of 'Housing' has no weightage.

The weightage for CPI (Combined) is as follows:

Food and Beverages: 45.86%
Pan, Tobacco and Intoxicants: 238%
Clothing and Footwear: 6.53%
Housing: 10.07%
Fuel and Light: 6.84%
Miscellaneous: 2832%Wholesale Price Index:

• Wholesale Price Index (WPI) is computed by the Office of the Economic Adviser in Ministry of
Commerce & Industry, Government of India.
• It was earlier released on weekly basis for Primary Articles and Fuel Group. However, since 2012,
This practice has been discontinued. Currently, WPI is released monthly.
• The current base year for WPI is 2011-12 (earlier it was 2004-05).
• Humber of Items: Earlier, there were 676 items in WPI.
• The number of items covered in the new series of the WPI has increased from 676 to 697.
Overall, 199 new items have been added and 146 old items have been dropped.
• These items are divided into three broad categories:
(1) Primary Articles
(2) Fuel & power and
(3] Manufactured Products, It does not include services.
• Under the new series of WPI, weight of manufactured items has decreased to 64.2 per cent from
64.9 per cent in old series. Similarly, the weight of fuel and power has decreased to 13.1 per
Cent from 14.9 per cent. On the other hand, the weight of primary items has increased to 22.6
Per cent from 20.1percent

11 Methods to estimate National Income:

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

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 Circular Flow of Income:

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

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

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

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

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

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

1. Per Capita Income (PCI):

Per Capita Income or the average income measures the average income earned per person in a given area
(city, region, country, etc.,) in a specified year.

It is calculated by dividing the area's total income by its total population.

Per Capita Income = National Income/Population

Real Per Capita Income is obtained after adjusting nominal per capita income for inflation.

GDP Vs Per Capita Income:

* Economic Growth is measured on the basis of expansion of GDP, However, there are instances
when the Rate of population growth is higher than the Rate of increase in GDP. In such instances,GDP
increases while per capita income decreases. Thus, we can say that per capita income is
considered a better indicator of economic growth.

• Even Per Capita Income has its own drawback. It does not tell about the distribution of income in
a nation.

• There might be a situation where in a country, a section of a population maybe earning very well
than the rest of the sections. Because of this, we shall observe that the total income of the country
will be more and when we divide it with the population, we shall get high per capita income.

• So we are seeing here that the 'Capita Per Income' also does not capture the inequality that exists
in our country.

• So, in a way it captures the economic growth of a nation but not the economic development.

2. Purchasing Powers Parity (PPP):

 There are two ways to measure GDP (total income of a country) of different countries and compare
them.
 One way, called GDP at exchange rate, is when the currencies of all countries are converted into USD

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  One way, called GDP at exchange rate, is when the currencies of all countries are converted into USD
(United States Dollar).
 The second way is GDP (PPP) or GDP at Purchasing Power Parity (PPP).

Now let us differentiate these two:

When we say that we convert the price of one currency in terms of another currency, we are referring to the
market exchange rate (Nominal).
Now this would tell us the income or the GDP of a country in terms of another currency.

Let us consider a hypothetical example:

1 US Dollar = 65 Indian Rupees

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

What it means?
2 It means if a person has Rs.1300 in his hands and would like to go to US for a trip, then on exchanging the Indian
Rupees with dollars, he would get $20 in his/her hands.
3 But this Market Exchange Rate does not tell us anything about the purchasing power of the currencies.
4 We cannot compare how much one needs to spend to buy similar products in both the countries.
To assess this, we calculate the GDP of a country in terms of PPP (Purchasing Power Parity). What is it?
5 Let us take a hypothetical example, suppose there is only one product being manufactured in both US and India –
Pen.
6 Now to buy a pen in US we need 1$. In India, with the same one dollar which is equal to Rs.65, we can buy 5 pens.
7 This means in India one pen can be purchased with Rs.13 and in US one pen can be purchased with 1$.
8 So, PPP exchange rate is Rs.13/$.
9 Using this exchange rate we can see that India’s GDP in terms of PPP exchange rate is (1300/13) = $100.

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

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

What is the conclusion?

We see that, in Germany, the cost of living is higher when compared to the US and this means that the
purchasing power of the people in Germany is less than that of people in US.
In our examples, we have taken just one product for comparison, to calculate the GDP at PPP, a basket of goods
is selected and the prices of it are used to calculate the GDP of a nation at PPP.

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

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

Nl: National Income

Undistributed profits:
Out of Nl, 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).

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

Corporate Tax: Corporate Tax, which is imposed on the earnings made by the firms, will also have to be deducted
from the NI, since it does not accrue to the households.
Transfer Payments: The households receive transfer payments from government and firms (pensions,
scholarship, prizes, for example) which have to be added to calculate the Personal Income of the households.

5. Personal Disposable Income (PDI):

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

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

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

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

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

S.No Name of Headquarter Report Frequency of Examples (These are only examples: Date
the of the (released if the Report need not be memorized, only the latest
Organizatio Organization any) data before the exam is relevant)
n
1 World Bank Washington Global Two For 2018-19 – it is 7.3% and for 2019-
D.C, United Economic editions in a 20, t is 7.5% respectively.
States Prospects year: Here when we say 2018-19, it is FY
Report January and 2019 and it is from 1st April, 2018 to 31st March
June 2019.

2 International Washingto World Prepared two times in a year For 2018 it is 7.4% and for 2019
Monetary Fund n D.C, Economic and updated twice in a year it is 7.8%.
(IMF) United Outlook Here when we say for 2018 – it
States is referring to the calendar year
2018, that is from 1st January
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 2018, that is from 1st January
2018 to 31st December 2018.
3 United Nations New World Released once every year at
York Economic the starting and updated in
city, New Situation and the mid of the year
York, Prospects
United
States
4 Asian Manila, Asian Published every year in
Development Philippines Developmen March/April with an update
Bank t Outlook published in September
and brief supplements
published in
July and
December
5 Central -
Statistics Office
(CSO)
6 Department of - Economic Released every year
Economic Survey of
Affairs, Ministry India
of Finance
7 Reserve Bank of Mumbai Bi-monthly After every two months
India monetary
policy review
8 Fitch Ratings New York Need to
City, USA keep a check
9 Moody’s New York Need to
Investor City, USA keep a check

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

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