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Macroeconomics

PGDM : 2016 18
Term 2 (September December, 2016)
(Lecture 05)
Measuring GDP : Expenditure Approach

Presenting the expenditure approach


Y = GDP = C + I + G + X
Y = GDP = the value of total output
C + I + G + NX = aggregate expenditure
Where
C = consumption expenditures
I = investment expenditures
G = government expenditures
X = net exports
Measuring Net Domestic Product (NDP) : Expenditure
Approach

NDP = GDP Depreciation


GDP = C + I + G + X
NDP = C + I + G + X Depreciation
Deducting for depreciation (capital consumption allowance, CCA)
Reduction in the value of capital goods over a one-year period due
to physical wear and tear, and also to obsolescence
Net Investment = I Depreciation
Domestic investment minus an estimate
of the wear and tear on the existing
capital stock
NDP = C + Net I + G + X
Measuring GDP : Income Approach

The sum of all incomewages, interest, rent, and


profitspaid to the four factors of production used
to produce final goods and services in a given
period in a country.
Measuring GDP : Income Approach

Income Approach
Measuring GDP : Income Approach

Income Approach
Measuring GDP : Income Approach

Gross Domestic Income (GDI)


The sum of all incomewages, interest, rent, and profitspaid to the
four factors of production

Labor Income
Wage, Salaries, Supplemental Employee Compensation
Rental Income
Rental Income of Individuals from farms, houses, stores,
Land
Implicit Rent on Owner Occupied Housing
Interest Income
Net interest paid by business
Profits
Proprietorial Income,
Partnership/Corporate Profit (including dividends, retained
earning and direct tax )
Measuring GDP : Income Approach

GDP = GDI + Indirect Business Tax (IBT) +Depreciation (CCA)

CCA: Capital Consumption Allowance

Indirect Business Tax +Depreciation (CCA) = Non-Income Expenses

Indirect Tax includes any kind of sale tax and excise tax

We include this IBT because while measuring GDP using expenditure


approach these taxes have been included as a part of expenditure. Also
you can think of it as the income earned by Government.
Gross National Product (GNP)

It measures the total income earned by citizens of an economy from


engaging in various economic activities, irrespective of whether the
economic activities are carried out within the economic territory or
outside, in a specified period.

GNP = GDP + (Factor Earning from Abroad by Citizens of the


domestic country) (Factor Earning by Foreign Citizens in the
Domestic Country)

GNP = GDP + Net Factor Earning from Abroad (NFEA)


When, NFEA > 0 then GNP > GDP
When, NFEA < 0 then GNP < GDP When,
NEFA = 0 then GNP = GDP
GNP and National Income

National Income (NI) is the sum of all factor earnings from current production of goods and
services. Factor earnings are income from factors of production: land, labor, capital and
entrepreneurial activity. Each rupees of GNP is one rupee of final sales, and if there were no
charges against GNP other than factor income, GNP and National Income (NI) would be equal.

There are in fact some other charges against GNP that causes GNP and national income to
diverge, but the two concepts are still closely related.

The first charge against GNP that is not included in NI is depreciation. The portion of the
capital stock used must be subtracted from final sales before NI is computed.; depreciation
represents a cost of production but not a factor income. With this subtraction we get Net
National Product (NNP)

Since indirect business taxes represent the wedge between buyers and sellers price from NNP
total indirect business taxes such as excise and sales taxes are subtracted to get a measure of
NI.

The adjustment required to go from GNP to NI is the following:


NNP = GNP Depreciation
NI = NNP - IBT
Other Components of National Income Accounting

Personal Income (PI)


The amount of income that households actually receive from all sources before
they pay personal income taxes

PI = NI (Corporate Profit Tax Payments + Undistributed Profit +


Contribution to Social Security Funds) + Transfer Payment (any kind of Social
Security Payment or Business Transfer Payment) + Personal Interest Income
Note that, Personal Interest Income doesnt represent the interest earned from
Corporations since it is already included in the interest income.

Disposable Personal Income (DPI)


Personal income after personal income taxes have been paid
DPI = PI Income Taxes
Summary

GDP to DPI : Expenditure Approach


GDP = C +I + G + NX
NDP = GDP Depreciation = (C+I+G+NX) - Depreciation
GNP = GDP + Net Factor Earning from Abroad (NFEA)
= (C+I+G+NX) + Net Factor Earning from Abroad (NFEA)
NNP = GNP Depreciation = (C+I+G+NX +NFEA) Depreciation
NI = NNP IBT = (C+I+G+NX +NFEA) Depreciation IBT
PI = NI - (Undistributed Profit + Contribution to Social Security Funds) + Transfer
Payment (any kind of Social Security Benefit)
= (C+I+G+NX +NFEA) Depreciation IBT - (Undistributed Profit + Contribution to
Social Security Funds) + Transfer Payment (any kind of Social Security Benefit)
DPI = PI Personal Taxes = (C+I+G+NX +NFEA) Depreciation IBT
(Undistributed Profit + Contribution to Social Security Funds) + Transfer Payment
(any kind of Social Security Benefit) Personal Taxes
Summary

GDP to DPI : Income Approach

GDI = w + i + r + profit
GDP = GDI + IBT + Depreciation = (w + i + r + profit )+ IBT + Depreciation
NDP = GDP Depreciation = (w + i + r + profit + IBT) - Depreciation
GNP = GDP + Net Factor Earning from Abroad (NFEA)
= (w + i + r + profit ) + IBT + Depreciation + Net Factor Earning from Abroad
(NFEA)
NNP = GNP Depreciation = (w + i + r + profit +NFEA + IBT + Depreciation) Depreciation
NI = NNP IBT = (w + i + r + profit +NFEA + IBT + Depreciation) Depreciation IBT
PI = NI - (Undistributed Profit + Contribution to Social Security Funds) + Transfer Payment
(any kind of Social Security Benefit)
= (w + i + r + profit +NFEA + IBT + Depreciation) Depreciation IBT - (Undistributed
Profit + Contribution to Social Security Funds) + Transfer Payment (any kind of Social
Security Benefit)
Example

Gross Domestic Product - Country X ( The spending Side) ( in million $)

Consumption 4923.4
Durables 606.5
Nondurables 1485.2
Services 2831.7
Investment 1067.5
Fixed investment 1029.3
Nonresidential 739.9
Residential 289.4
Inventory Investment 38.1
Government Purchases 1358.5
Net Exports -101.7
Exports 804.5
Imports 906.2
Gross Domestic Product 7247.7
Final sales 7207.6

Note: Final sales in GDP less inventory investment. Details in the table may not add to
totals because of rounding.
Source: Economic Survey of India, 2012-13
Notes
1. Any kind of transfer payment by Government is not part of Government Expenditure (G) component since it
does not involve any production of goods and services. However, while measuring GDP using expenditure
approach this transfer payment is reflected in GDP through Private Consumption Expenditure (C) component
of the household. Similarly, Government funds this kind of transfer payment through collecting Tax Revenues
and Contribution of individuals to social security benefits. Therefore while measuring GDP using it is not
needed to enter this transfer payment as separate income component. All the income components are gross
item and thus includes transfer payments. So, adding transfer payment leads to double counting.

2. Any kind of financial transaction like bond purchase or stock purchase are not included in GDP while
measuring through Expenditure approach since the value of bond or stock is included in the value of final
goods and services through investment expenditure (I) component. You can argue that any earning through
financial transaction is reflected in the consumption expenditure. It is true. At the same time, GDP measured
using Income approach includes these financial transactions through interest income. Also, profit includes
any kind of dividend earned by individual. Depreciation is also accounted for since while measuring profit
the firm includes depreciation as a part of cost. This is why we add Depreciation to GDI to get a measure of
GDP.

3. While measuring PI, Transfer Payments (Social Security Benefit and Other) is added to National Income. It
seems to be a double counting since Transfer Payment is already added to GDP through Consumption
Expenditure (Expenditure Approach) or the different components of GDI (Income Approach). But, it should
also be noted that we are also subtracting Profit Tax and Contribution to Social Security Benefit (think about
provident fund contribution). These two items are the source of transfer payments by Government.
Measuring GDP through Production: Value added

GDP can also be computed by adding up production of goods and services in


different industries. As we observed on the spending side, we must avoid counting
the same items more than once. Many industries specialize in the production of
intermediate goods that are used in the production of other goods. If we want each
industrys production to include the contribution of those industries to total GDP,
then we want to take the production of intermediate goods into account.

The concept of value added was developed to prevent double counting and to
attribute to each industry a part of GDP. The value added by a firm is the difference
between the revenue the firm earns by selling its products and the amount it pays
for the products of other firms it uses as intermediate goods. It is a measure of the
value that is added to each product by firms at each stages of production. For
Toyota, for example, value added is the revenue from selling cars less the amount it
pays for steel, glass, and the other inputs it buys. For a car dealer, value added is
the revenue from selling cars less the wholesale cost of the cars. Wages ,rents,
interest, and profits are what make up value added at each firm.
Measuring GDP through Production ( Value Added)

GDP is the sum of the value added by all the firms located in in an economy. If a
firm sales a final product, the sale appears in that firms value added but does not
appear anywhere else.. On the other hand, if a firm sells its output as an input for
another firm, that sale appears negatively in the other firms value added. Products
sold by one firm to another are called intermediate products. When the two firms
are added together in the process of computing GDP, sales of intermediate products
wash out. When a firm imports a product, the transaction appears negatively in that
firms value added, but does not appear positively in the value added .

Near the bottom of the list is a small item called statistical discrepancy. Although
the value added computation of GDP should give the same answer as total
spending, in practice there are measurement errors that cause a slight discrepancy
between the two.
Measuring GDP through Production ( Value Added)

Value added by Industry : Country x ( in million $)

Agriculture 110.3
Mining 89
Construction 201.4
Manufacturing 924.6
Transportation and utilities 494.5
Wholesale and retail trade 827.6
Finance, insurance and real estate 893.4
Services 889.9
Government 584.2
Statistical discrepancy 7.3
GDP 4979.3
Source: Economic Survey of India, 2012-13
Source: Economic Survey of India, 2012-13
Problem : 01

Find out GDP using Expenditure


Approach (all figures are in Billions)
Problem : 02

Find out GDP using Income


Approach (all figures are in Billions)
Problem : 03

a. Find out GDP and NDP using Expenditure Approach (all figures are in
Billions)
b. Find out NI using Income Approach (all figures are in Billions)
Distinguishing Between Nominal and Real Values

Nominal Values
Measurements in terms of the actual market prices at which
goods are sold; expressed in current Rs., also called money
values
Real Values
Measurements after adjustments have been made for
changes in the average of prices between years; expressed
in constant Rs.
Constant Rs.
Rs. expressed in terms of real purchasing power
Real GDP vs. Nominal GDP

It is important to distinguish between real and nominal measures of


national income and output. When we add up money values of outputs,
expenditures, or incomes, we end up with what are called nominal values.
Suppose that we found that a measure of nominal GDP had risen by 70 per
cent between 2008 and 2015. If we wanted to compare real GDP in 2013
with that in 2005, we would need to determine how much of that 70 per
cent nominal increase was

due to increase in the general level of prices and

how much was due to increase in quantities of goods and services produced.

Although there are many possible ways of doing this, the basic principle is
always the same. It is to compute the value of output, expenditure and
income in each period by using a common set of base period prices. When
this is done, we speak of real output , expenditure or income as being
measured in constant Rs. or say 2008-09 prices.
Real GDP vs. Nominal GDP

GDP (R) = GDP at constant market price


= Price in base year x Output in current year

GDP (N) = GDP at current Market Prices


= (Price in current Year x Output in Current year

Suppose, there are n goods and services are produced in year t. Therefore,
n
GDP ( N ) t pit qit
i 1
n
GDP ( R ) t piB qit
i 1
GDP Deflator (GD) and Inflation Rate

GDP Deflator reflects the change in the general price level of


goods and services.
n t
pi qit
GDP ( N ) t
GD n
t i 1
100 100;
t

i
GDP ( R )
p B
q t
i
i 1
n t 1 t 1
pi qi t 1
and GD i n1 100
t 1 GDP ( N )
100
t 1

i
t 1 GDP ( R )
p B
qi
i 1
This is known as Paasche' s Price Index
GDt 1 GDt
Inflation Rate t
100
GD
GDP Deflator (GD) : An Implicit Price Index

GDP Deflator reflects the change in the general price level of


goods and services through the changes in GDP of an economy.
n t
pi qit
GDP ( N ) t
GD n
t i 1
100 100;
t

i
GDP ( R )
p B
q t
i
i 1
n t 1 t 1
pi qi t 1
and GD i n1 100
t 1 GDP ( N )
100
t 1

i
t 1 GDP ( R )
p B
qi
i 1
This is known as Paasche' s Price Index
GDt 1 GDt
Inflation Rate t
100
GD
Example: Correcting GDP for Price Index Changes
Problem : 04
Consumer Price Index(CPI)

CPI is a measure of overall cost of goods and services bought by a typical


consumer. In India different CPIs are reported such as
CPI for Industrial Workers
CPI for Agricultural Laborers
CPI for Rural Consumers
CPI for Urban Consumers
State Wise CPI

Also see the PDF file titled National Price Indices and Inflation During 2012
for a detailed discussion of CPI in India.
Consumer Price Index(CPI) and Inflation Rate

n t B
pi qi
CPI n
t i 1 100
Current Value of the Basket (in year t )
100;

i i
Value of the Basket in the BaseYear
p B
q B

i 1
n t 1 B
pi qi
t 1 i 1 Current Value of the Basket (in year t 1)
and CPI n 100 100

pi qi
B B Value of the Basket in the BaseYear
i 1
CPI t 1 CPI t
Inflation Rate t
100
CPI
Assignment: Identify the Items
included in Indias CPI basket
Weighting Diagram: CPI
02 August 2008 General: AV 44
Wholesale Price Index
For long, point-to-point changes in the wholesale price index (WPI) were considered the headline
inflation rate.

The WPI is a weighted average of the prices of most goods produced in the economy, with
the weights being their shares in domestic output and
their prices those prevailing in wholesale markets.

It is closer to a producer price index (used in USA), reflecting more what producers charge their
immediate buyers, rather than the prices that prevail at the end of the trading chain, in retail
markets. Internationally consumer price indices rather than producer price indices are the
standard for measuring inflation, since they reflect the prices that ordinary citizens face and pay.
India does have multiple consumer price indices (for industrial workers, non-manual employees
and agricultural/rural laborers) used to assess the increase in the prices paid by these sections for
the commodity bundles they consume. However, inflation measured by the WPI was treated as
the measure of headline inflation.

Source: What defines headline inflation?


C.P. Chandrasekhar
The Hindu, July 28, 2013
Explaining the difference between CPI and WPI inflation
Rate (C. P. Chandrasekhar, The Hindu, July, 28, 2013

Early in 2012, the Central Statistical Organization of the government of India released a new, national,
monthly, consumer price index (CPI), with separate indices for rural and urban areas and covering a set of
final consumption goods, weighted by their share in the consumption basket and with their prices collected
from retail markets. The release was supposed to mark the transition to the use by the government and the
central bank of this new index rather than the wholesale price index (WPI) to compute the headline inflation
rate. Given that, it is surprising that barely a year and a half since annual point-to-point inflation rates have
been calculated based on this index (which was first released for January 2011, making January 2012 the
first month for which we have an annual rate), the government and the media have returned to focusing on
WPI-based inflation.

This does indeed make a difference. As Chart 1 shows, trends in the month-on-month annual inflation rate
differ substantially, depending on the index used to compute that rate. When measured using the WPI,
inflation was running at 7-8 per cent between January 2012 and February 2013, and has since fallen to less
than 5 per cent. However, when measured using the national CPI, it had risen from 7.7 per cent to 10.9 per
cent between January 2012 and February 2013, and has since fluctuated between 9 and 10 per cent.

The reason for this significant difference partly lies in the substantial difference in rates of inflation across
commodity groups as measured by the WPI. While Minerals, Fuel and Manufactures have registered
significant declines in month-on-month inflation rates (Chart 2), and helped hold aggregate WPI-based
inflation steady, inflation in Primary articles, especially non-Food primary articles, has remained high and
even risen sharply during the early part of the period. Since many of these primary goods are likely to be
consumed by the ordinary citizen and, therefore, feature in the CPI with a large weight, that index shows
inflation to be much higher.