Summary

Economics Class 25

A BRIEF OVERVIEW OF THE PREVIOUS CLASS (05:08 PM)

PRODUCTION METHOD (05:09 PM)

GVA Method
GVA= Value of output- Intermediate consumption
value of output= Sales + Inventory

FC= factor cost= WIPR= cost of factors of production

Basic Prices= FC+ Production taxes- Production subsidy

Basic prices= FC+ Net Production taxes

GDP at MP= GVA at Basic prices + Net product taxes.

GVA at FC= CE+MI+OS
GVA at BP= GVA at FC+ net production taxes
GDP at MP= GVA at BP + Net Product taxes
NDP at MP= GVA at BP + Net product taxes- Depreciation

Production taxes= Independent of production volume. Tata manufactures some cars, and the Tax paid on the land revenue is independent of no. of cars produced.
Product taxes- Dependent on production volume such as Excise duty and GST
Production subsidy- Independent of production volume- Subsidy to farmers, cooperatives, textiles, and Railways.
Production method
It has two approaches-
a) Final product approach
b) Value-added approach
Final product approach
This approach calculates national Income from the output side i.e. We measure the value of all that is produced in the domestic economy.
It is estimated by multiplying the gross product with market prices to arrive at GDP at Market Prices.
GDP at Market Price= P* Q + P*S
P= market price
Q= Quantity of goods
S= Quantity of services
Value-added approach
It measures the contribution of each producing unit to the domestic economy avoiding any possibility of double counting.
NVA at FC, Net value added at Factor cost= Gross Output- Intermediate consumption- Depreciation
Steps involved in the calculation
1) Identify all the producing units in the domestic economy and classify them into three sectors as Primary, secondary, and Tertiary.
2) Primary sector produces goods by exploiting Natural Resources, Fishing, Mining, etc. The secondary sector produces manufacturing goods by transforming one type of commodity into another type of Commodity like construction, or electricity generation. The tertiary sector renders services like education, medicine, banking, etc.
3) Estimate Net value added at factor cost by each producing unit by deducting intermittent consumption, depreciation, and net indirect taxes from the value of output
4) Estimate the net value added of each sector (Primary, Secondary, Tertiary) by summing up the net value added at the Factor cost of all producing units in each sector
5) Compute domestic income (NDP at FC) by adding up the NVA at FC of all the three sectors
6) Estimate Net factor income from Abroad which is added to domestic income for deriving NNP at FC
Precautions- Items Included
It includes imputed rent of the owner-occupied houses.
Value of own account production by enterprises, Government, and households. [* For own consumption]
Only value-added and not the value of output by production units should be included to avoid double counting.
Do not include the sale of second-hand goods as they are not fresh production activities, however, brokerage or commission paid to facilitate the sale is included as it is a fresh production activity
Precautions- Items excluded
Sale and purchase of second-hand goods
Sale of bonds by a company- this is merely a financial transaction that does not contribute directly to the flow of goods and services.

GVA AT BASIC PRICES (05:51 PM)

In 2015 it was decided by CSO that the sector-wise estimates of GVA at basic prices will be released instead of factor cost.
The concept of GVA at basic prices is different from GVA at factor cost or market prices.
GVA at basic prices = GVA at factor cost + net production taxes.
Where net production taxes = production taxes minus production subsidies
Production taxes and production subsidies are independent of the volume of production whereas product taxes and product subsidies are paid or received based on per unit of product.
Examples of production tax include- land revenue, stamp, registration fees, etc.
Production subsidies include - subsidies to railways, input subsidies to farmers, fixed amounts of subsidies to cooperatives, etc.
While product taxes include taxes like GST, customs, etc and product subsidies include food subsidies, fertilizer subsidies, etc.
GDP at market prices = GVA at basic prices + product taxes-product subsidies.

EXPENDITURE METHOD (05:58 PM)

It measures the final expenditure on GDP at Market Prices during a period of time.
Since all domestically produced goods and services are purchased for final use either by consumers for consumption or by producers for investment, therefore, we take some of the final expenditure on consumption and investment to arrive at GDP at Market Prices.
The final expenditure is the expenditure made on the purchase of domestically produced goods and services for final use.
By deducting depreciation and Net indirect taxes from GDP at Market Prices and adding to NFIA, we arrive at NNP at Factor cost.
Steps involved in the calculation
Identification of economic units incurring the final expenditure. Examples are- Household or consuming sector, Firm or producing sector, and government sector.
Classifying the final aggregate expenditure into the following components
a) Private final consumption expenditure
b) Government final consumption expenditure
c) Gross fixed capital formation
d) Change in stock or Inventory investment
e) Net exports- [* A foreigner coming to India and purchasing a shirt then it is called an export. ]

GDP at MP= C (domestic/Household consumption)+ G (Government consumption)+ I (Investment by private sector)+ X(export)
Investment= GFCF (Investment into physical assets such as machinery, infrastructure)+ Inventory investment (Change in stock)
GDP at MP= (C- C_I)+ (G-G_I)+ (I-I_I)+ X
GDP at MP= C+ G+I+X -(C_I+ G_I+I_I)
GDP at MP= C+ G+ I+ X-M
X-M= Net exports= N_x

Gross Fixed capital
It Indicates expenses incurred during the purchase of fixed assets.
Gross fixed capital can be further categorized into two types
a) Gross business fixed investment- It includes investments towards long-term assets such as machinery, production facility, infrastructure
b) Gross residential construction investments- These are expenses incurred by businesses for constructing residential units upon receiving tenders.
Investment also includes Inventory investment. These are investments made toward the acquisition of raw materials, semi-finished or Finished goods. These are considered as items that can not be utilized for current consumption.
Inventory investment is determined by calculating the closing stock balance and the opening stock balance at the end of each year (Closing stock- Opening stock).
Precautions
To avoid double counting, expenditure on all intermediate goods and services is excluded. For example- The purchase of vegetables by restaurants, expenses on electricity by a factory, etc are not included.
Government expenditure on all transfer payments such as scholarships, Unemployment allowances, Old age pensions, etc is excluded because no productive service is rendered by recipients in exchange.
Expenditure on the purchase of shares, bonds, etc is excluded because it is not a payment for goods or services which are currently produced. It shows the transfer of property from one person to another.
Similarly, gifts from abroad are also not included.

PERSONAL INCOME AND NATIONAL INCOME (06:46 PM)

Personal income of household= Productive income + Non- productive income i.e. transfer payment (This is not included in National income but part of Personal income)
Profit= Dividends, Undistributed profits, or Retained earnings, Corporate tax
Undistributed profits, Retained earnings, or the aspect of corporate tax are part of national income but they are not part of Personal income.
Net interest paid is also not part of Personal income
National income- Undistributed profits, or Retained earnings- corporate tax- Net interest paid+ Transfer payments= Personal income
From this personal income, one has to pay Direct taxes, Fees and the remaining is called Personal disposable income

Personal Income(PI)	National Income(NI)
It includes both factor income and transfer receipts/payment	Transfer receipts or payments are not included under national income
Undistributed profit of companies and corporate taxes are not part of personal income	Undistributed profits of companies and corporate taxes are included in NI
Interest on the national debt is included in the PI	Interest in the national debt is not part of the National Income

Interest paid by the bank to its depositors is part of National Income.
Personal Income (07:12 PM)
It is the income of the household including factor income and transfer payments
Personal Disposable Income
Income that remains with the individual or Household after the deduction of direct taxes levied on their income and property.
Personal Disposable Income= Personal Income(PI) - Direct taxes - Miscellaneous fees and fines paid by the Households
Per capita income(PCI)
It indicates the average income per person earned in a given area at a particular period of time.
For a nation, nominal Per Capita Income is NNP at current Prices/Total population
Real PCI is then computed by adjusting inflation with the Nominal PCI.
Internationally, PCI may be compared between countries based on Purchasing Power parity(PPP) method.
The PPP method compares economic productivity and the standard of living between countries.
It compares different countries' currencies through a basket of goods approach where the prices of goods are compared.

NOMINAL EXCHANGE RATE (07:54 PM)

It is the value of foreign currency expressed in terms of domestic currency. For example- the value of one dollar expressed in terms of the Indian rupee is Rs 70.
NER means how many rupees somebody will get when he sells one dollar in the exchange market i.e. NER depends on Market forces of demand and supply.
PPP exchange rate
Let us consider an example where an ice cream is costing 35â¹ rupees in India and the same ice cream can be purchased at 1$ in the US.
The PPP exchange rate in the above case is arrived at by comparing prices of ice creams in both countries that is 1$=35â¹ is the PPP exchange rate which can also be written as â¹35 per $, which implies whatever rupees 35 can purchase in India, the same items can be purchased in the US for 1$ that is Purchasing power of â¹35 in India is equal to purchasing power of 1$ in the US.
PPP exchange rate = Domestic price/ Foreign price that is here â¹35/1$
The trade competitiveness of a country is decided by real Exchange rates.
Trade competitiveness ∝ NER

Trade competitiveness ∝ Foreign price

Trade competitiveness ∝ 1/ domestic price
India's trade competitiveness = Price of ice cream in the US * Nominal exchange rate/ price of ice cream in India
India's trade competitiveness= Nominal exchange rate/( Price of ice cream in India/Price of ice cream in the US)
India's trade comepetitveness= Nominal exchange rate/PPP exchange rate
India's trade comeptitiveness= The real Exchange rate.
Note- When RER= 1, then there will be no trade.
Note- If RER>1, then India's trade will be competitive, and India will export to the USA [* At NER- 1$= 70rs, and at PPP, 1$= 35rs]
Note- If RER<1, then India's trade will be uncompetitive and the USA will export to India, or India will import from the USA. [*At NER- 1$= 17.5 rs, & at PPP, 1$= 35rs ]

The topic for the next class:- Changes made in GDP calculation, Potential GDP, etc.