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MEASURING MACROECONOMIC
AGGREGATES
Lecture 2
September 13 2017

THE CIRCULAR FLOW


• We can measure the value of all goods
and services produced (GDP) by either
working on the lower loop:
expenditures on goods and services at
market values. This is called the
expenditure method.
• Or, equivalently, we can measure the
value of all goods and services
produced by looking at the upper
loop: incomes earned from the
provision of productive services by
factors of production. This is called the
income method, calculated at factor
costs.
• Equivalence of the income flow and
expenditure flow, both measure GDP
• The equivalence is best understood by
realizing that each transaction is
somebody’s income and someone
else’s expenditure

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Unit
• There are many goods and services and
many different inputs firms buy, so to
add “apples and oranges” we need a
common unit, prices in some currency,
for example rupees

MEASURING GDP
• Gross domestic product GDP is the total value of all
final goods and services produced in an economy in
a period of time (one year)
• If current rupee prices are used, we get the nominal
(money value) of GDP at current prices
• If we use some benchmark prices (base year) then
we get GDP at constant prices of the base year: for
instance if the base year is 1995, we will say that we
have measured GDP for 2010-11 at 1995 prices

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SOME ISSUES TO REMEMBER

• Final output: goods and services purchased


for final use
• Imputed values: housing services is an
example. If one pays rent then it is counted
as income for the landlord. If one stays in
one’s own house then a market rent is added
to the income of the owner and then
subtracted as expenditure. Goods and
services without market prices ought to have
imputed value, but not all are counted.
Example: the popular feminist argument that
homemakers services are not valued

SOME ISSUES TO REMEMBER


• Used goods sold: GDP measures currently
produced goods. Used goods are therefore
transfers of assets that were previously
produced
• Inventories: if there is unsold stock from
current production then it is treated as if the
firm buys it (and later sells it) the buying is
treated as investment, the later selling as
disinvestment.
• Nothing happens if the unsold stock is
thrown away or simply rots (if perishable)
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SOME ISSUES TO REMEMBER


• Selling a two year old car this year does not
add to GDP (even if it was lying idle for the
last two years) remember inventory
investment and disinvestment
• If you sell your car to a used car dealer, and
he sells it for a higher price, his income from
the car (the value added service he provided)
is added to GDP. Not the value of the car

SOME ISSUES TO REMEMBER

• Selling a stock or bond does not add to GDP,


however, the broker’s commission does
• Insurance payments, welfare payments,
pensions are all deemed to be transfers and
hence do not get added in GDP – these
payments are not against the provision of
current services
• Any service cost of transferring these
however, will get added
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SOME ISSUES TO REMEMBER


• Unpaid services are not counted
• Unreported activities and incomes should,
but cannot be counted; illegal activities such
as narcotics trade, undisclosed cash incomes
(to avoid taxes)
• The nominal value of GDP can change if
either output changes, or prices change, or
more realistically they both do. Economic
performance has more to do with real output
rather than prices
• How to measure output? Real as well as
nominal GDP
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Value Added
• Intermediate products: inputs purchased by
business on which value is added for further
sales: buy textiles, make and sell, say ‘kurtas’
• We should avoid counting the value of the
material of the kurta, and also the value of the
kurta (which includes the value of the material)
• We need to avoid double or triple counting. We
need to take final goods and services only
• To avoid this there is an alternative way: ‘value
added’ method
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SOME ISSUES TO REMEMBER


• An example of the value added method

• Business Cost Sales Value added


Farm (Corn) 0 100 100
Mill (Flour) 100 140 40
Baker (Bread) 140 200 60
Store (Package) 200 220 20

TOTAL 440 660 220


Final value is equal to the total value added: 220

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THE PRODUCT APPROACH

• Value added is obtained by deducting


the value of all purchased inputs (from
other firms) from the value of sales
• This is another way of arriving at GDP

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THE EXPENDITURE APPROACH

• Economists and policy makers are not only


interested in the total production but also in the
allocation of expenditure between alternative
uses. The national income accounts identity
divides total expenditure into four broad heads:
consumption C, investment I, government
expenditures G, and net exports NX.

• Y = C+I+G+NX (Very standard notation used in


all textbooks)
• NX = X-M (Exports less imports)
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THE EXPENDITURE APPROACH

• The expenditure approach is the bottom half of


the circular flow
• Consumption: households and individuals
receive income and spend them on domestic, as
well as, foreign goods and services, and pay
taxes. They also save what is not consumed
• It is the largest and most important of the flows,
the most obvious way income received is
returned to firms
• We aggregate all kinds of goods: durable goods,
non durable goods and services
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THE EXPENDITURE APPROACH

• The portion of income saved leaves the circular


flow and enters financial markets
• Investment: it is the business spending on
equipment (business fixed investment), structures
(residential fixed investment) and inventories (can
be negative)
• Investment is for future use
• Depreciation is the erosion of the value of assets in
creating output: the wear and tear
• Net investment=gross investment less depreciation
(depreciation is sometimes called capital
consumption allowance, CCA)
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THE EXPENDITURE APPROACH

• Government expenditures: government


makes payments for buying and using goods
and services as well as equipments and
structures
• Taxes are either spent or returned to
individuals as transfers
• If the government runs a deficit then it must
borrow from financial markets to close the
gap

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THE EXPENDITURE APPROACH

• Net exports: exports are foreigners’ demand


for our goods and hence contributes to our
income
• Imports are subtracted from spending by
consumers, investors and government, as
they are a leakage from the domestic
economy, contributing to income for other
countries
• Net exports is exports minus imports

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OTHER MEASURES OF INCOME


• Gross national product GNP: it is the aggregate output
produced by businesses and citizens of a country
(economy)
• To compute this measure, net foreign factor income is
added to GDP
• Net foreign factor income is factor income earned
abroad by Indians less the factor income earned by non-
Indians in India (domestically)
– “Income attributable to factor services rendered by the normal
residents of the country to the rest of the world, less factor
services rendered to them by the rest of the world.”
• NNP is GNP less depreciation
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THE INCOME APPROACH

• National income NI: the income approach is


the top half of the circular flow, calculating
income in terms of factor costs
• NI is the total income earned by citizens and
businesses in one country in one year
• NI = NNP – indirect business taxes (e.g. sales
tax, excise, vat, customs duties): difference
between what a buyer pays and what a firm
actually receives

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OTHER MEASURES OF INCOME


• NI consists of incomes earned by factors
of production
• Employee compensation, salaries and
fringe benefits,
• Rental income: including imputed rent,
• Net interest: interest paid by businesses
less what they receive, plus interest
earned from foreigners
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Some more terms


• Proprietors’ income: from
unincorporated business
• Profits: corporate profits
• Income and expenditures must be equal
once indirect taxes have been adjusted
for
• Profit is the balancing term
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THE CIRCULAR FLOW ONCE


AGAIN
Wages, rents, interest,
profits

Factor services
FIRMS
HOUSEHOLDS Goods

Government

Financial markets
Personal consumption

Other countries

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WHAT DO WE KNOW SO FAR?


• GDP is total production (output): value of goods
and services produced by businesses, less
purchased inputs and intermediate goods from
other businesses – market value added
• GDP is total expenditure by ultimate (final)
purchasers of goods and services
• GDP is total income received by the producers
of output
• Should they be equal?
• Yes, barring unreported or misreported data

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AN EXAMPLE TO SHOW THE EQUIVALENCE

• Consider just two business firms in a simple


economy: Tomato Incorporated that makes
tomatoes and sells them to the consuming
households as well as to Ketchup
Incorporated
• The following annual data for the two firms
T-inc and K-inc are given to you

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ALL FIGURES IN Rs. HUNDREDS

• T-INC • K-INC
*Wages paid to *Wages paid to
its employees Rs.15000 its employees Rs.10000
*Taxes paid *Taxes paid
to government Rs.5000
to government Rs.2000
* Sales Revenue
*Tomatoes bought
Total Rs.35000
* From tomatoes sold from T-inc Rs.25000
to households Rs.10000 *Sales Revenue
From tomatoes Total Rs.40000
sold to K-inc Rs.25000

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COMPUTING GDP BY THE PRODUCT


APPROACH
• Since T-inc does not buy • T-INC • K-INC

anything from other firms, *Wages paid to


its employees Rs.15000
*Wages paid to
its employees
its value added is the value *Taxes paid Rs.10000
of total sales of tomatoes to government Rs.5000 *Taxes paid
to the public and to K-inc, * Sales Revenue to government
which is Rs.10000 + Total Rs.35000 Rs.2000
Rs.25000 * From tomatoes sold *Tomatoes bought
• For K-inc, value added is to households
Rs.10000 from T-inc
total sales Rs.40000 less From tomatoes Rs.25000
the value of purchased sold to K-inc Rs.25000 *Sales Revenue
inputs (tomatoes from T- Total
inc) worth Rs.25000. So Rs.40000
value added is Rs.15000
(Rs.40000 – Rs.25000)
• GDP is Rs.35000 +
Rs.15000 = Rs.50000

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COMPUTING GDP BY THE EXPENDITURE


APPROACH
• GDP will be the total • T-INC • K-INC
*Wages paid to *Wages paid to
expenditure on its employees Rs.15000 its employees
tomatoes and on *Taxes paid Rs.10000
to government Rs.5000
tomato ketchup by all * Sales Revenue
*Taxes paid
to government
buyers Total Rs.35000 Rs.2000
• Public buys Rs.10000 * From tomatoes sold
to households
*Tomatoes bought
tomatoes from T-inc, Rs.10000 from T-inc
Rs.25000
and Rs.40000 ketchup From tomatoes
sold to K-inc Rs.25000 *Sales Revenue
from K-inc Total Rs.40000
• So GDP is Rs.10000 +
Rs.40000 = Rs.50000

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COMPUTING GDP BY THE INCOME APPROACH


• Profits earned by T-inc is • T-INC • K-INC
revenue less wage costs: *Wages paid to *Wages paid to
Rs.35000 – Rs.15000 = its employees Rs.15000
Rs.20000 (before tax) *Taxes paid
its employees
Rs.10000
• Profits earned by K-inc is to government Rs.5000 *Taxes paid
revenue less costs * Sales Revenue
(tomatoes purchased and Total Rs.35000
to government
wages paid): Rs.40000 – * From tomatoes sold
Rs.2000
(Rs.25000 + Rs.10000) = to households
*Tomatoes bought
Rs.5000 (before tax) Rs.10000 from T-inc
• Total Income is total profits From tomatoes Rs.25000
plus total wages: (Rs.20000 sold to K-inc Rs.25000 *Sales Revenue
+ Rs.5000) + (Rs.15000 + Total
Rs.10000) = Rs.50000 Rs.40000
• (Note we would have got
the same result with after-
tax profits but then adding
total taxes)

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WHY ARE THE ALTERNATIVE APPROACHES


EQUIVALENT?

• Observe that the market value of goods


and services produced in a year must be
(by definition) what buyers must spend
to purchase them – so the product
approach (market values) and the
expenditure approach must yield the
same result

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Expenditure & Income Approach


• Next, note what the buyer spends must be
what the seller receives.
• These receipts must be the total income
generated by the business – distributed as
wages and salaries, paid to suppliers, earned
residually as profits, and taxes paid as per
law.
• Hence the expenditure approach and the
income approach must yield the same result

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Three Approaches
• It follows from above that since the
product approach and the income
approach are both equal to the
expenditure approach, they themselves
must be equal to each other
• Hence all three yield the same result

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OTHER MEASURES OF INCOME

• Personal income (PI) = NI


– Corporate profits
- Social insurance contributions
- Net interest
+ Dividends
+ Government transfers to individuals
+ Personal interest income
• Disposable personal income= PI – direct
individual taxes plus non tax payments to
government
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USES OF SAVING
• When households and firms save in an
economy the flow gets used up in
alternative ways
• Firms borrow to fund investment
projects
• Government taxes out part of it for its
own spending needs

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SAVING –
PRIVATE and GOVERNMENT
• Private saving is private disposable
income less consumption, taxes being T
• Sprivate = (Y – T – C)
• Sgovernment = (T – G)
• National Saving is the sum of the two,
equal to: (Y – C – G)

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Saving-Investment (Contd..)
• We can substitute C+I+G+NX for Y
• So for the national economy, S = (C+I+G+NX) – C – G
• S = I + NX
• Sprivate = I + NX – Sgovernment
• Sprivate = I + NX – (T – G)
• This gives us a very useful identity. We will use the
notation S as private saving in an economy with
government),
• Sprivate = S
• S = I + NX + (G – T)
• (S – I) = (X – M) + (G – T)
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Saving-Investment (Contd..)
• Or, we can re-write the identity as
• (S-I) + (T-G) = (X-M)
• If net exports are negative (imports are more than exports) then
either in the private sector I is more than S, or the government
sector must be dissaving { (T-G) must be negative}
• If we have a trade surplus then (S-I) and/or (T-G) must be
positive
• If the trade balance (X-M) is positive, then (say for India) we
must be lending to foreigners or buying foreign stocks or land or
other assets
• Remember, if NX is measured to include net factor payments
from abroad, then the associated Y measures GNP. If not, Y
measures GDP
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Which Measure of I or Y?
• If I measures net investment (net of
depreciation), rather than gross
investment, then Y is NNP or NDP
depending on how one measures NX

• If I is gross investment, then Y measures


GDP or GNP

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REAL AND NOMINAL GDP


• Take two years: 2000 and 2005. The nominal
GDPs for a country are given. How to
compare the change in numbers of, say,
computers and pizzas segregated from the
price change that may have taken place?
• Important to do this segregation so that we
can focus on the actual quantities of goods
and services available to people living in that
economy

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REAL AND NOMINAL GDP


– AN EXAMPLE
• 2000 2005 Y to Y %∆
• Quantity
• Computers 5 10 +100
• Pizzas 200 250 +25
• Price
• Computers 50000 25000 -50
• Pizzas 200 240 +20
• Values
• Computers 250000 250000 0
• Pizzas 40000 60000 +50
• TOTAL (Nominal Y) 290000 310000 +6.9

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REAL GDP WITH BASE YEAR 2000


• Current Q Base P Value
• Year 2000
• Computers 5 50000 250000
Pizzas 200 200 40000
• TOTAL 290000

• Year 2005
• Computers 10 50000 500000
• Pizzas 250 200 50000
• TOTAL 550000
• % growth in real GDP (550000 – 290000)/290000
• = 89.6%

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REAL GDP WITH BASE YEAR 2005


• Current Q Base P Value
• Year 2000
• Computers 5 25000 125000
Pizzas 200 240 48000
• TOTAL 173000

• Year 2005
• Computers 10 25000 250000
• Pizzas 250 240 60000
• TOTAL 310000
• % growth in real GDP (310000 – 173000)/173000
• = 79.2%
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THE IMPLICIT DEFLATOR


• Nominal GDP = Real GDP X GDP deflator
• Nominal GDP measures the current rupee value of the
output of the economy
• Real GDP measures output valued at constant prices
• The GDP deflator measures the price of output relative
to its price in the base year
• In the example worked out in the earlier slides
• Nominal GDP for 2005 was 310000
• Real GDP for 2005 (at 2000) prices was 550000
• The GDP deflator will be 310000/550000 = 0.56
• Can you interpret this result?

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CPI AND GDP DEFLATOR


• Consumer price index CPI is measured in terms of a
basket of goods as preferred by consumers in terms of
their spending, whereas the deflator measures all
things produced
• There is a distinct difference
• If a good is not produced currently and its stock prices
shoot up, CPI tags it, but not the deflator. The CPI may
overstate the hardship of the consumer as the
consumer has the right to substitute
• The deflator is sensitive to new goods produced,
whereas the CPI is for a fixed basket of goods

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MEASURING UNEMPLOYMENT
• Unemployment Rate =
Number of Unemployed X 100
Labour Force
• Labour Force = Number employed + Number
unemployed
• Labour force participation rate =
Labour Force X 100
Adult Population

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A NUMERICAL EXAMPLE
• Consider the following data for a • Compute:
hypothetical economy: • GDP
• Private Consumption C = 150
• GNP
• Net Private Investment = 30
• Government Purchases = 30 • NNP
• Net Exports = -10 • Exports
• Government Budget Surplus = 10 • Private saving
• Net Factor Income from abroad = 10 • Government saving
• Imports = 20 • National Saving
• Depreciation = 20 • Verify that (S-I) = (G-T) + (X-M)

• GDP = C + Gross I + G + NX
= 150 +(Net I +Depreciation) +G +NX
= 150 + (30+20) +30 -10
= 220
• GNP = GDP + Net Factor Payments From abroad
= 220 + 10 = 230
• NNP = GNP – Depreciation = 230 – 20 =210
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Solution
• Exports X - Imports M = • Sgovernment = BS = T – G =
NX 10
• So, X – 20 = -10
• X=10
• Hence total national
• Private Saving S = Y – C –
savings:
T • = 30 +10 = 40
• We take Y as GDP, and • Verify (S-I) = (G-T) + (X-
note taxes T must be
Budget Surplus plus G M)
• So T=10+30 = 40 • 30-50 = (30 – 40) + (-10)
• S = 220 – 150 – 40 = 30 • -20 = -10 - 10 = - 20

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National Accounts Statistics in India

http://www.mospi.gov.in/
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ADVANCE RELEASE CALENDAR OF VARIOUS RELEASES ON


NATIONAL ACCOUNTS STATISTICS DURING 2017

QUARTERLY ESTIMATES OF GDP Date


Q3 of 2016-17 (Oct – Dec, 2016) 28.02.2017
Q4 of 2016-17 (Jan – Mar, 2017) 31.05.2017
Q1 of 2017-18 (Apr – June, 2017) 31.08.2017
Q2 of 2017-18 (Jul – Sept, 2017) 30.11.2017

ANNUAL ESTIMATES OF GDP


First Advance Estimates for 2016-17 06.01.2017
First revised Estimates for 2015-16 with
31.01.2017
Base Year 2011-12
Second Advance Estimates for 2016-17 28.02.2017
Provisional Estimates for 2016-17 31.05.2017

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Statement 1.1: Key aggregates of national accounts


(at constant (2011-12) prices) (Rs. Crore)
Item 2014-15 2015-16 % Change
Domestic Product
1 GVA (Gross Value Added) at basic prices 9719023 10490514 7.9
2 Taxes on Products including import duties 1095011 1164463 6.3
3 Less Subsidies on Products 277050 273975 -1.1
4 GDP (1+2-3) 10536984 11381002 8.0
5 CFC (Consumption of Fixed Capital) 1180724 1264193 7.1
6 NDP(4-5) 9356260 10116809 8.1
Final Expenditure
7 PFCE (Private Final Consumption Expenditure) 5902386 6262373 6.1
(C-private)
8 GFCE (Govt Final Consumption Expenditure) (G- 1073894 1109725 3.3
Govt)
9 GCF (Gross Capital Formation) (I) 3741235 4023585 7.5
9.1 GFCF (Gross Fixed Capital Formation 3302173 3518446 6.5
9.2 CIS (Change in Stock) 270613 274447 1.4
9.3 VALUABLES 187957 180274 -4.1
10 Exports of goods and services 2512176 2378687 -5.3
11 Less Imports of goods and services 2667658 2510753 -5.9
12 Discrepancies -44556 167803
13 GDP 10536984 11381002 8.0 49

GVA and Sectoral GVA

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Expenditure on GDP

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Private Final Consumption Expenditure: PFCE ; Government Final Consumption


Expenditure: GFCE; Gross Fixed Capital Formation: GFCF; Change in Stocks: CIS 52

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Change of Base Year in NAS

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QUARTERLY ESTIMATES OF FINAL EXPENDITURES OF GDP FOR OCTOBER-


DECEMBER (Q3) OF 2015-16
(at current prices)

Item 2015-16 (Rs. Crore) 2015-16


Q1 Q2 Q3 Q1 Q2 Q3
1. Private Final Consumption
Expenditure (PFCE) 1904600 1935528 2070448 60.1 59.6 59.5

2. Government Final Consumption


Expenditure (GFCE) 368327 431193 354407 11.6 13.3 10.2
3. Gross Fixed Capital Formation
(GFCF) 979234 990348 969324 30.9 30.5 27.8
4. Change in Stocks(CIS) 57900 57874 55494 1.8 1.8 1.6
5. Valuables 51030 50813 50862 1.6 1.6 1.5
6. Exports 665962 681820 670023 21 21 19.2
7. Less Imports 761832 796865 754756 24 24.5 21.7
8. Discrepancies -95561 -101299 65250 -3.0 -3.1 1.9
GDP 3169658 3249412 3481052 100 100 100

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Improved Coverage
• Corporate Sector
– In the 2004-05 series, the Private Corporate Sector in 2004-05 series was being covered using
the RBI Study on Company Finances, with financial results of around 2500 companies.
– In the new series, comprehensive coverage of Corporate Sector has been ensured in mining,
manufacturing and services by incorporation of annual accounts of companies as filed with the
Ministry of Corporate Affairs (MCA) and Accounts of about 5 lakh companies have been
analysed and incorporated for 2011-12 and 2012-13.
• Financial Corporations
– Financial corporations in the private sector, other than banking and insurance, in the earlier
series was limited to a few mutual funds and estimates for the Non-Government Non-Banking
Finance Companies as compiled by RBI.
– In the new series, the coverage of financial sector has been expanded by including stock
brokers, stock exchanges, asset management companies, mutual funds and pension funds, as
well as the regulatory bodies, SEBI, PFRDA and IRDA.
• Local bodies and autonomous institutions
– Earlier, estimates for local bodies and autonomous institutions were prepared on the basis of
information received for seven autonomous institutions and local bodies of four States – Delhi,
Himachal Pradesh, Meghalaya and Uttar Pradesh.
– In the new series, there has been an improved coverage of local bodies and autonomous
institutions, covering around 60% of the grants/transfers provided to these institutions.
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Thank
You

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