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TEST-8 EXPLANATION PDF

October 6th, 2019

Lesson 2
Growth & Development
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Measurement of Growth ......................................... 3 GDP in the Phase of Distribution or Income

Different Types of Goods ..................................... 3 Method............................................................ 13

What are ‘Goods’? ............................................ 3 Important Macroeconomic Identities ................ 13

Classification of Goods ..................................... 3 Gross National Product ................................... 13

Economic Goods and Free Goods ........................ 3 Net National Product ...................................... 13
Consumer Goods and Producer Goods ................ 3 Distinction between Net National Product at
Market Price and Net National Product at
Single Use and Durable Use Goods ...................... 3
Factor Cost ...................................................... 14
Private goods and public goods ........................... 3
Personal Income and Personal Disposable
Intermediate Goods ............................................. 4
Income............................................................. 15
Distinction between Goods and Services ......... 4
Nominal GDP and Real GDP ............................... 16
Circular Flow of Income in a Simple Economy ..... 5
Nominal GDP ................................................... 16
Revisiting the ‘Two Sector Model’ .................... 5
Real GDP .......................................................... 16
Product or Value Added Method of Calculating
Why is Calculating Real GDP Important? ........ 17
National Income ................................................... 6
Difference Between Nominal GDP and Real
Concept of Value Added ................................... 6
GDP.................................................................. 17
Concept of Depreciation, Gross Investment And
Meaning ............................................................. 17
Net Investment ................................................. 8
Calculation ......................................................... 17
Concept of Depreciation, Gross Value Added
and Net Value Added ........................................ 8 Price Change Effect ............................................ 17
Value .................................................................. 17
Concept of Gross Value Added And Gross
Domestic Product ............................................. 9 Usage ................................................................. 17

Expenditure Method of Calculating National Complexity ......................................................... 17

Income ............................................................... 10 Analysis of Economic Growth ............................ 17
Revisiting the Farmer-Baker Two-Sector Model Comparison across countries............................. 17
........................................................................ 10 GDP Deflator, Consumer Price Index, Wholesale
Expenditure Method – Salient Points ............. 10 Price Index .......................................................... 18
Consumption by households..............................10 GDP Deflator ................................................... 18
Investment by businesses ..................................10 Consumer Price Index ..................................... 18
Government spending on goods and services ...11 Wholesale Price Index ..................................... 19
Income Method of Calculating National Income12 Difference Between CPI and GDP Deflator ..... 19
Comparison of The Three Methods of Estimating GDP & Welfare ................................................... 19
GDP – Product Method, Expenditure Method and
Limitations of GDP .......................................... 19
Income Method ................................................. 12
Quality of Life..................................................... 19
GDP in the Phase of Production or the Value
Added Method................................................ 12 Non-market transactions ................................... 19

GDP in the Phase of Disposition or the Income Inequality .............................................. 19

Expenditure Method....................................... 12 Sustainability...................................................... 19

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Economic Bads ...................................................20

Depreciation of Capital ......................................20
Real GDP per capita............................................20
Other Important Indicators ............................ 20
The Human Development Index (HDI) ...............20
The Genuine Progress Indicator (GPI) ................20
The Happy Planet Index (HPI) ............................20
Factor Cost, Basic Prices and Market Prices ...... 21
Summary ............................................................ 22
Gross Domestic Product at Market Prices (GDPMP)
............................................................................22
GDP at Factor Cost (GDPFC) ................................22
Net Domestic Product at Market Prices (NDPMP)
............................................................................22
NDP at Factor Cost (NDPFC) ................................22
Gross National Product at Market Prices (GNPMP)
............................................................................22
GNP at Factor Cost (GNPFC) ................................22
Net National Product at Market Prices (NNPMP) 22
NNP at Factor Cost (NNPFC) OR National Income
(NI)......................................................................22
MCQs for Practice .................................................. 23

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▪ Example: machinery, tools, raw materials, seeds,

MEASUREMENT OF manure and tractor etc are all example of
GROWTH producer goods.

SINGLE USE AND DURABLE USE GOODS

DIFFERENT TYPES OF GOODS
SINGLE USE GOODS
WHAT ARE ‘GOODS’? ▪ Single use goods are those goods, which can be
used only once. They are finished in one use
A commodity, or a physical, tangible item that itself.
satisfies some human want or need, or something ▪ Example: bread, butter, egg, milk etc are the
that people find useful or desirable and make an single use consumer goods as they are
effort to acquire it. consumed immediately and once and for all.
▪ Similarly, single use producer goods are
CLASSIFICATION OF GOODS exhausted in one production process. Example:
ECONOMIC GOODS AND FREE GOODS
coal, raw material, seeds, manure etc.

ECONOMIC GOODS DURABLE USE GOODS

▪ Economic goods are those goods (manmade or ▪ Durable use goods are those goods, which can be
free gifts of nature) whose demand is more than used again and again for a long period of time.
supply (i.e. they are scarce). They command a There are durable use consumer goods as well as
price and they can be bought in the market. durable use producer goods.
▪ Example: toothpaste, soap, shaving cream, ▪ Durable use consumer goods are cloth,
footwear, bread, machines, buses, table, chair, furniture, television, scooter etc. that can be
books, fans, television etc. used by consumer again and again.
▪ Durable use producer goods are used in
FREE GOODS production again and again for example,
▪ We can define free goods as goods which
machines, tools, tractors and implements etc.
possess utility but which are not scarce.
This does not mean that repeated use of these
▪ Free goods are free gifts of nature. They are
goods does not make any difference to them.
available in abundance i.e. in unlimited quantity
▪ In fact, the value of these goods gets depreciated
and the supply is much more than the demand.
after continuous use.
▪ Example: Sand, clean air, water etc.
PRIVATE GOODS AND PUBLIC GOODS
CONSUMER GOODS AND PRODUCER GOODS
PRIVATE GOODS
CONSUMER GOODS ▪ All goods that are privately owned and are
▪ Consumer goods are those goods, which satisfy
exclusively enjoyed by individuals are called
the want of consumers directly. They are goods,
private goods. For example, all the goods owned
which are used for consumption.
by you are private goods.
▪ Example: bread, fruits, milk, clothes etc.
▪ Examples: watch, pen, scooter, books, table,
PRODUCER GOODS chair, bed, clothes etc. If you own a factory then
▪ Producer goods are those goods, which satisfy its building, machinery; tools etc are your private
the want of consumers indirectly. As they help goods.
in producing other goods, they are known as
PUBLIC GOODS:
producer goods.
▪ Public goods are those goods, which are owned
and enjoyed by the society as a whole. They are
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available to all people in a society without any INTERMEDIATE GOODS VERSUS CONSUMER
AND CAPITAL GOODS
discrimination, i.e. no one is denied from the
▪ Intermediate goods can be used in production,
consumption of public goods.
but they can also be consumer goods. How it is
▪ Both government and private entrepreneurs
classified depends on who buys it.
may produce public goods, but it is usually the
▪ If a consumer buys a bag of sugar to use at
former.
home, it is a consumer good (final good). But if a
▪ Example: roads, bridges, park, town hall etc. are
manufacturer purchases sugar to use during the
all collectively owned.
production of another product, it becomes an
▪ Economists refer to public goods as "non-
intermediate good.
rivalrous" and "non-excludable," and most such
▪ Capital goods, on the other hand, are assets that
goods are both.
are used in the production of consumer goods.
▪ Their non-rivalry refers to the fact that the goods
Key thing to note about capital goods is that they
don't dwindle in supply as people consume
don’t transform, or change shape in the
them; a country's defenses, for example, do not
production process.
run out or diminish as its population grows.
▪ Non-excludability means just that; the good is DISTINCTION BETWEEN GOODS AND
available to all and cannot be withheld, even SERVICES
from people who do not contribute to its public
funding. ▪ Goods are tangible in nature i.e. they can be
▪ That characteristic, in turn, leads to what is called seen and touched. Services are non-tangible in
the free-rider problem with public goods. Since nature i.e. they can neither be seen nor be
you need not contribute to the provision of a touched.
public good to benefit from it, some people will ▪ There is a time gap between production and
inevitably choose to use the good and yet shirk consumption of goods as they are produced first
the public responsibility to help pay for it. and consumed later. There is no time gap
between the production and consumption of
INTERMEDIATE GOODS services. That is why they are produced and
Intermediate Goods – What are they? How are they consumed simultaneously.
different from Consumer Goods and Capital Goods? ▪ Goods can be stored and utilized when required.
Are they factored in calculating Gross Domestic Services cannot be stored.
Product? ▪ Goods can be transferred from one place to
WHAT ARE INTERMEDIATE GOODS? another. Transfer of service is not possible.
▪ An intermediate good is a product used to
produce a final good or finished product—also
referred to as a consumer good.
▪ Intermediate goods are vital to the production
process, which is why they are also called
producer goods. Industries sell these goods to
each other for resale or to produce other goods.
▪ These goods are also called semi-finished
products because they are used as inputs to
become part of the finished product. When they
are used in the production process, they are
transformed into another state.

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not save, they do not pay taxes to the government

CIRCULAR FLOW OF INCOME IN A – since there is no government, and neither do they
SIMPLE ECONOMY buy imported goods since there is no external trade
in this simple economy.
REVISITING THE ‘TWO SECTOR
MODEL’ In other words, factors of production use their
remunerations to buy the goods and services which
Let us revisit the ‘Two Sector Model’ that we had they assisted in producing. The entire income of the
discussed in the previous lesson. economy, therefore, comes back to the producers
in the form of sales revenue.

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.

In the next period the firms will once again produce

goods and services and pay remunerations to the
factors of production. These remunerations will once
again be used to buy the goods and services. Hence
year after year we can imagine the aggregate
income of the economy going through the two
sectors, firms and households, in a circular way.

Since the value of expenditure must be equal to the

In the above model, households receive their
value of goods and services, we can equivalently
payments from firms for productive activities they
measure the aggregate income by “calculating the
perform for the latter. As we have mentioned
aggregate value of goods and services produced by
before, there may fundamentally be four kinds of
the firms”. When the aggregate revenue received by
contributions that can be made by households
the firms is paid out to the factors of production it
during the production of goods and services:
takes the form of aggregate income.
(a) Contribution of human labour, remuneration for
Since the same amount of money, representing the
which is called wage.
aggregate value of goods and services, is moving in a
(b) Contribution of capital, remuneration for which
circular way, if we want to estimate the aggregate
is called interest.
value of goods and services produced during a year
(c) Contribution of entrepreneurship, remuneration
(which is nothing but Gross Domestic Product) we
for which is profit.
can measure the annual value of the flows at any of
(d) Contribution of fixed natural resources (called
the dotted lines indicated in the diagram.
‘land’), remuneration for which is called rent.
We can measure the uppermost flow (at point A) by
In this simplified economy, there is only one way in
measuring the aggregate value of spending that the
which the households may dispose off their earnings
firms receive for the final goods and services which
– by spending their entire income on the goods and
they produce. This method will be called the
services produced by the domestic firms.
expenditure method.
The other channels of disposing their income are
closed: we have assumed that the households do
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If we measure the flow at point B by measuring the

aggregate value of final goods and services
PRODUCT OR VALUE ADDED
produced by all the firms, it will be called product METHOD OF CALCULATING
method. NATIONAL INCOME
At point C, measuring the sum total of all factor KEY DEFINITION:
payments will be called income method.
Value added: Net contribution made by a firm in
KEY DEFINITION: the process of production. It is defined as, Value of
production – Value of intermediate goods used.
Gross Domestic Product (GDP): GDP is the total
monetary or market value of all the finished goods Product method of calculating national income:
and services produced within a country's borders Method of calculating the national income by
in a specific time period. GDP provides an measuring the aggregate value of production
economic snapshot of a country, used to estimate taking place in an economy over a period of time.
the size of an economy and growth rate. It can be
calculated in three ways, using expenditures,
production, or incomes. CONCEPT OF VALUE ADDED

In product method we calculate the aggregate

Simplified
annual value of goods and services produced (if a
GDP is the total value of all finished goods
year is the unit of time).
produced in the country in one financial year. It
doesn't matter if it is produced by citizens or
Let us suppose that there are only two kinds of
foreigners. If they are located within the country's
producers in the economy. They are the wheat
boundaries, their production is included in GDP.
producers (or the farmers) and the bread makers
To avoid double-counting, GDP includes the final
(the bakers). The wheat producers grow wheat and
value of the product, but not the parts (or
they do not need any input other than human
intermediate goods) that go into it. For example,
labour. They sell a part of the wheat to the bakers.
an Indian footwear manufacturer uses laces and
The bakers do not need any other raw materials
other materials made in India. Only the value of
besides wheat to produce bread.
the shoe gets counted; the shoelace does not.
Let us suppose that in a year the total value of wheat
Gross National Income (GNI): GNI is the total
that the farmers have produced is Rs 100. Out of this
amount of money earned by a nation's people and
they have sold Rs 50 worth of wheat to the bakers.
businesses. It is used to measure and track a
The bakers have used this amount of wheat
nation's wealth from year to year. The number
completely during the year and have produced Rs
includes the nation's gross domestic product plus
200 worth of bread. What is the value of total
the income it receives from overseas sources.
production in the economy? If we follow the simple
way of aggregating the values of production of the
sectors, we would add Rs 200 (value of production
of the bakers) to Rs 100 (value of production of
farmers). The result will be Rs 300.

A little reflection will tell us that the value of

aggregate production is not Rs 300. The farmers had
produced Rs 100 worth of wheat for which it did not
need assistance of any inputs. Therefore the entire
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Rs 100 is rightfully the contribution of the farmers. Let us de-jargonise (simplify) Product or Value
But the same is not true for the bakers. The bakers Added Method of Calculating National Income:
had to buy Rs 50 worth of wheat to produce their ▪ Thought 1: There are two economic agents – a
bread. The Rs 200 worth of bread that they have farmer and a baker. Farmer produces wheat and
produced is not entirely their own contribution. To baker bakes bread.
calculate the net contribution of the bakers, we ▪ Thought 2: Farmer grows wheat worth Rs 100.
need to subtract the value of the wheat that they Assume that farmer uses no input. Therefore,
have bought from the farmers. If we do not do this a. value of farmer’s production = Rs 100
we shall commit the mistake of ‘double counting’. b. value of intermediate goods (inputs) used by
This is because Rs 50 worth of wheat will be counted farmer = 0
twice. First it will be counted as part of the output c. value added by farmer = a – b = 100 – 0 = Rs
produced by the farmers. Second time, it will be 100
counted as the imputed value of wheat in the bread ▪ Thought 3: Farmer consumes wheat worth Rs 50
produced by the bakers. himself (let us call this BUNDLE 1) and sells
remaining wheat worth Rs 50 to the baker (let us
Therefore, the net contribution made by the bakers call this BUNDLE 2).
is, Rs 200 – Rs 50 = Rs 150. Hence, aggregate value ▪ Thought 4: Using the wheat purchased from
of goods produced by this simple economy is Rs 100 farmer as input, baker produces bread worth Rs
(net contribution by the farmers) + Rs 150 (net 200. Therefore,
contribution by the bakers) = Rs 250. a. value of baker’s production = Rs 200
b. value of intermediate goods (inputs; in this
The term that is used to denote the net contribution case wheat) used by baker = Rs 50
made by a firm is called its value added. We have c. value added by baker = a – b = Rs 200 – 50 =
seen that the raw materials that a firm buys from Rs 150
another firm which are completely used up in the ▪ Though 5: Total value added in this ‘two
process of production are called ‘intermediate economic agent model’ = value added by farmer
goods’. Therefore, the value added of a firm is, value + value added by baker = Rs 100 + Rs 150 = Rs 250
of production of the firm – value of intermediate ▪ Thought 6: It is very important to subtract the
goods used by the firm. value of intermediate goods used from the final
value of goods produced while calculating ‘value
The value added of a firm is distributed among its added’.
four factors of production, namely, labour, capital, o Value of Wheat in BUNDLE 2 has been
entrepreneurship and land. Therefore wages, incorporated as value added by farmer.
interest, profits and rents paid out by the firm must o Same wheat in BUNDLE 2 is intermediate
add up to the value added of the firm. goods (input) for baker.
o Value of wheat BUNDLE 2 must be counted
Table summarising above explanation (all values in only once and that is why it was important to
Rupees) subtract Rs 50 from Rs 200 in Thought 4.
Farmer Baker
Total 100 200
Production
Intermediate 0 50
Goods Used
Value Added 100 200-50 = 150

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CONCEPT OF DEPRECIATION, GROSS regular wear and tear of capital, is called

INVESTMENT AND NET INVESTMENT depreciation.

KEY DEFINITIONS: So new addition to capital stock in an economy is

measured by net investment or new capital
Final goods: Those goods which do not undergo formation, which is expressed as
any further transformation in the production
process. Net Investment = Gross investment – Depreciation

Capital goods: Goods which are bought not for KEY DEFINITION
meeting immediate need of the consumer but for
producing other goods. Stocks: Those variables which are defined at a
point of time. (Example: Number of machines that
Depreciation: Wear and tear or depletion which a baker has at a given point of time)
capital stock undergoes over a period of time.
Flows: Variables which are defined over a period
Gross investment: Addition to the stock of capital of time. (Example: Bread production per annum)
which also includes replacement for the wear and
tear which the previously installed capital stock
undergoes. CONCEPT OF DEPRECIATION, GROSS
VALUE ADDED AND NET VALUE
Net investment: Addition to capital stock; unlike ADDED
gross investment, it does not include the
replacement for the depletion of capital stock. We have discussed the concept of value addition. In
the process of making consumer goods (for
That part of our final output that comprises of example, bread), value addition can be observed
capital goods constitutes gross investment of an (remember the farmer-baker model?).
economy. These may be machines, tools and
implements; buildings, office spaces, storehouses or Similarly, in the process of making producer goods
infrastructure like roads, bridges, airports or jetties. or capital goods, value addition can be observed. For
example, a producer of machinery (that may be used
But all the capital goods produced in a year do not by baker for example) also undertakes value
constitute an addition to the capital stock already addition: he may be starting with steel as an input
existing. and producing the machinery as a final output.

A significant part of current output of capital goods Since the capital good which is used to carry out
goes in maintaining or replacing part of the existing production undergoes wear and tear, the producer
stock of capital goods. This is because the already has to undertake replacement investments to keep
existing capital stock suffers wear and tear and the value of capital constant. The replacement
needs maintenance and replacement. investment is same as depreciation of capital.

A part of the capital goods produced this year goes If we include depreciation in value added then the
for replacement of existing capital goods and is not measure of value added that we obtain is called
an addition to the stock of capital goods already Gross Value Added.
existing and its value needs to be subtracted from
gross investment for arriving at the measure for net If we deduct the value of depreciation from gross
investment. This deletion, which is made from the value added we obtain Net Value Added. Unlike
value of gross investment in order to accommodate
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gross value added, net value added does not include machines. But one half of his value addition,
wear and tear that capital has undergone. equivalent to one machine, went into covering up
depreciation, and only one half was new (net)
For example, let us say a firm produces Rs 100 worth addition to the stock of machines.
of goods per year, Rs 20 is the value of intermediate • Thought 8: From Baker’s perspective, his total (or
goods used by it during the year and Rs 10 is the gross) investment was the cost he must have paid
value of capital consumption (depreciation). to the Engineer for two machines. Can you tell
what was the ‘net investment’ made by the
The gross value added of the firm will be, Rs 100 – Rs Baker?
20 = Rs 80 per year. The net value added will be, Rs
100 – Rs 20 – Rs 10 = Rs 70 per year. CONCEPT OF GROSS VALUE ADDED
Net value added of the firm i = Gross value added AND GROSS DOMESTIC PRODUCT
by the firm i (GVAi ) – Depreciation of the firm i (Di)
If we sum the gross value added of all the firms of
the economy in a year, we get a measure of the value
Let us de-jargonise (simplify) the concept of
of aggregate amount of goods and services
depreciation:
produced in the economy in a year (just as we had
• Thought 1: Do you remember the Farmer-Baker
done in the wheat-bread example). Such an estimate
model? In that model, let us introduce a third
is called Gross Domestic Product (GDP). Thus,
economic agent – an Engineer. So now we have a
Farmer-Baker-Engineer model.
GDP = Sum total of gross value added of all the firms
• Thought 2: Farmer does value addition by way of
in the economy.
producing wheat. Baker does value addition by
way of producing bread. And Engineer does value
If there are N firms in the economy, each assigned
addition by making machines for the baker.
with a serial number from 1 to N, then
• Thought 3: Assume that baker has 5 machines.
On 1st January, 2020, the Baker decides to scrap
GDP = GVA1 + GVA2 + ..... + GVAN
an old, underperforming machine and replace it
with a new one. Taking into consideration the
Therefore,
increased demand for his bread, the baker
decides to add a sixth machine to his stock of
GDP = ∑ GVAi
machines.
• Thought 4: Baker places an order for two new
KEY DEFINITION:
machines with the Engineer. The two new
machines that the Engineer supplies to the baker
Gross Domestic Product (GDP): Aggregate value
appear to be value addition by Engineer in the
of goods and services produced within the
economy.
domestic territory of a country. It includes the
• Thought 5: But one machine is used to replace an replacement investment of the depreciation of
old machine that has been scrapped and only one capital stock.
additional machine has been added to the
Baker’s stock of machines.
• Thought 6: Therefore, Baker’s stock of machines
was depleted as one old, underperforming
machine was scrapped (depreciation). Baker
undertook ‘replacement investment’ to replenish
his stock of machines.
• Thought 7: From Engineer’s perspective, his total
(or gross) value addition was that of two

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EXPENDITURE METHOD – SALIENT

EXPENDITURE METHOD OF POINTS
CALCULATING NATIONAL INCOME
The expenditure method is a system for calculating
gross domestic product (GDP) that combines
KEY DEFINITION consumption, investment, government spending,
and net exports.
Expenditure method of calculating national
income: Method of calculating the national It is the most common way to estimate GDP. It says
income by measuring the aggregate value of final everything that the private sector, including
expenditure for the goods and services produced consumers and private firms, and government
in an economy over a period of time. spend within the borders of a particular country,
must add up to the total value of all finished goods
and services produced over a certain period of time.
An alternative way to calculate the GDP is by looking
at the demand side of the products. This method is The GDP under this method is calculated by
referred to as the expenditure method. summing up all of the expenditures made on final
goods and services.
REVISITING THE FARMER-BAKER
TWO-SECTOR MODEL There are four main aggregate expenditures that go
In the Farmer-Baker example that we have described into calculating GDP:
before, the aggregate value of the output in the CONSUMPTION BY HOUSEHOLDS
economy by expenditure method will be calculated ▪ Let C be the aggregate final consumption
in the following way. expenditure of the entire economy.
• In this method we add the final expenditures ▪ Notice that a part of C is spent on imports of
that each firm makes. Final expenditure is that consumption goods.
part of expenditure which is undertaken not for ▪ Let Cm denote expenditure on the imports of
intermediate purposes. consumption goods.
• The Rs 50 worth of wheat that the Farmer ▪ Therefore C – Cm denotes that part of aggregate
consumed will be counted as the final final consumption expenditure that is spent on
expenditure received by him. (Assume that the domestic firms.
Farmer’s family pays Rs 50 to the Farmer for the
wheat that they consume.) INVESTMENT BY BUSINESSES
• The Rs 50 worth of wheat which the Baker buys ▪ Let I be the aggregate final investment
from the Farmer counts as intermediate goods, expenditure of the entire economy.
hence it does not fall under the category of final ▪ Notice that a part of I is spent on imports of
expenditure. investment goods.
• The Rs 200 worth of bread that Baker sells to his ▪ Let Im denote expenditure on the imports of
customers will be counted as the final investment goods.
expenditure received by him (i.e. final ▪ Therefore I-Im denotes that part of aggregate
expenditure incurred by households in buying final investment expenditure that is spent on
the bread from Baker). the domestic firms.
• Therefore, the aggregate value of output of the ▪ Capital formation is a term used to describe the
economy is Rs 200 (final expenditure received net capital accumulation during an accounting
by the baker) + Rs 50 (final expenditure received period for a particular country. The term refers
by the farmer) = Rs 250 per year. to additions of capital goods, such as
equipment, tools, transportation assets, and

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electricity. It is the result of investment activities

QUESTION 1
undertaken by firms and government.
Q. In an open economy, the Gross Domestic
GOVERNMENT SPENDING ON GOODS AND Product (Y) of the economy is: (C, I, G, X, M stand
SERVICES for Consumption, Investment, Govt. Expenditure,
▪ Similarly, G – Gm stands for that part of total exports and total imports respectively.)
aggregate final government expenditure that is [2000]
spent on the domestic firms, where G is the (a) Y = C + I + G + X
aggregate expenditure of the government of the (b) Y = I + G –X + M
economy and Gm is the part of G which is spent (c) Y = C + I + G + (X – M)
on imports. (d) Y = C – G + I + (X – M)
▪ Exports (X), which is nothing but spending by the Answer: C
external sector on purchasing goods and
services produced by the domestic sector.

QUESTION 2
The formula for GDP is:
Q. Economic growth in country X will necessarily
GDP = (C – Cm) + (I – Im) + (G – Gm) + X have to occur if [2013]
(a) there is technical progress in the world
It can also be written as: economy
(b) there is population growth in X
GDP = C + I + G + (X – Cm – Im – Gm) (c) there is capital formation of X
(d) the volume of trade grows in the world
GDP = C + I + G + (X – (Cm + Im + Gm)) economy
Answer: C
GDP = C + I + G + (X – M)

Where, M = Cm + Im + Gm (i.e. M = total imports)

Let us de-jargonise (simplify) the expenditure

method of calculating the GDP:
• Thought 1: We know that GDP is nothing but the
aggregate value of goods and services produced
within the domestic territory of a country.
• Thought 2: All the final goods that are being
produced – be they consumer goods or producer
goods – are being purchased by economic agents
– households, firm, government and the foreign
buyer.
• Thought 3: So the total expenditure incurred by
economic agents on purchasing final goods and
services should be the same as the total value of
final goods and services produced within the
domestic territory of a country (i.e. the GDP).

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INCOME METHOD OF COMPARISON OF THE THREE

CALCULATING NATIONAL INCOME METHODS OF ESTIMATING GDP –
PRODUCT METHOD, EXPENDITURE
KEY DEFINITION: METHOD AND INCOME METHOD
Income method of calculating national income:
Method of calculating national income by
measuring the aggregate value of final factor
payments (= income) made in an economy over a
period of time.

The income approach to measuring gross domestic

product is based on the accounting reality that all
expenditures in an economy should equal the total
revenue generated by the production and sale of all
economic goods and services.
Let us look at a numerical example to see how all the
It also assumes that there are four major factors of three methods of estimating GDP give us the same
production in an economy and that all revenues answer.
must go to one of these four sources. That is,
revenues earned by all the firms put together must Example: There are two firms, A and B. Suppose A
be distributed among the factors of production as uses no raw material and produces cotton worth Rs.
salaries, wages, profits, interest earnings and rents. 50. A sells its cotton to firm B, who uses it to produce
cloth. B sells the cloth produced to consumers for Rs.
Therefore, by adding all of the sources of income 200.
together, a quick estimate can be made of the total
productive value of economic activity over a period. GDP IN THE PHASE OF PRODUCTION
OR THE VALUE ADDED METHOD
The formula for GDP is: Value Added (VA) = Sales – Intermediate Goods

GDP = W + P + In + R, where Thus,

VAA = 50 - 0 = 50
W = Total wages and salaries received by all factors VAB = 200 - 50 = 150
of production
Thus,
P = Total profits received by all factors of production GDP = VAA + VAB = 200

In = Total interest received by all factors of GDP IN THE PHASE OF DISPOSITION

production OR THE EXPENDITURE METHOD

R = Total rent received by all factors of production. GDP = Sum of final expenditure or expenditures on
goods and services for end use

In the above case, final expenditure is expenditure

by consumers on cloth. Therefore, GDP = 200.

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GDP IN THE PHASE OF DISTRIBUTION period by the means of production owned by a

OR INCOME METHOD country's citizens.

Let us look at the firms A and B again. GNP is commonly calculated by taking the sum of
personal consumption expenditures, private
Now, of this 50 received by A, the firm gives Rs. 20 to domestic investment, government expenditure,
the workers as wages, and keeps the remaining 30 as net exports and any income earned by residents
its profits. from overseas investments, minus income earned
within the domestic economy by foreign residents.
Similarly, B gives 60 as wages and keeps 90 as profits Net exports represent the difference between what
(recall that 50 has been paid by B to A for cotton). a country exports minus any imports of goods and
services.
Recall that GDP by income method = sum total of
factor incomes, which is equal to total wages The formula for GNP is:
received (workers of A and B) and total profits
earned (by A and B), which is equal to 80 + 120 = GNP = GDP + (Factor income earned by the
200. 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
IMPORTANT MACROECONOMIC employed in the domestic economy)
IDENTITIES
Hence, GNP = GDP + Net factor income from abroad
GROSS NATIONAL PRODUCT
(Net factor income from abroad = Factor income
GNP and GDP are very closely related concepts, and earned by the domestic factors of production
the main differences between them comes from the employed in the rest of the world – Factor income
fact that there may be companies owned by foreign earned by the factors of production of the rest of
residents that produce goods in India, and the world employed in the domestic economy).
companies owned by Indians that produce goods
for the rest of the world and revert earned income
to domestic residents in India.

For example, there are a number of foreign

companies that produce goods and services in India
and transfer any income earned to their foreign
residents. Likewise, many Indian corporations
produce goods and services outside of Indian
(all figures in Billions of USD; source: Investopedia)
borders and earn profits for India’s residents.
NET NATIONAL PRODUCT
Where GDP looks at the value of goods and services
produced within a country's borders, GNP is the We have already noted that a part of the capital gets
market value of goods and services produced by all consumed during the year due to wear and tear.
citizens of a country—both domestically and This wear and tear is called depreciation.
abroad.
If we deduct depreciation from GNP the measure of
Thus, GNP is an estimate of total value of all the aggregate income that we obtain is called Net
final products and services turned out in a given National Product (NNP).

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The formula for NNP is: NNP at factor cost = National Income (NI) = NNP at
market prices – (Indirect taxes – Subsidies)
NNP = GNP – Depreciation NNP at factor cost = National Income (NI) = NNP at
market prices – Net indirect taxes
DISTINCTION BETWEEN NET
NATIONAL PRODUCT AT MARKET Where, Net indirect taxes = Indirect taxes –
PRICE AND NET NATIONAL PRODUCT Subsidies.
AT FACTOR COST

It is to be noted that all the variables discussed so KEY DEFINITION:

far are evaluated at market prices.
Gross National Product (GNP): GDP + Net Factor
But market price includes indirect taxes. When Income from Abroad. In other words GNP includes
indirect taxes are imposed on goods and services, the aggregate income made by all citizens of the
their prices go up. Indirect taxes accrue to the country, whereas GDP includes incomes by
government. We have to deduct them from NNP foreigners within the domestic economy and
evaluated at market prices in order to calculate that excludes incomes earned by the citizens in a
part of NNP which actually accrues to the factors of foreign economy.
production.
Net National Product (NNP) (at market price):
Similarly, there may be subsidies granted by the GNP – depreciation.
government on the prices of some commodities. So
we need to add subsidies to the NNP evaluated at NNP (at factor cost) or National Income (NI): NNP
market prices. at market price – (Indirect taxes – Subsidies).

Example: Market price of commodity X should be Rs QUESTION 3

100 per unit; since government wants to reduce Q. National Income is: [1997]
price of commodity X for the end user, it decides to (a) Net National Product at market price
give a subsidy of Rs 20 per unit to the manufacturer (b) Net National Product at factor cost
and asks the manufacturer to sell commodity X at Rs (c) Net Domestic Product at market price
80 per unit; so essentially, manufacturer is still (d) Net Domestic Product at factor cost
getting Rs 100 per unit for commodity X; it is this Rs Answer: B
100 that gets distributed amongst various factors of
production. That is why we need to add subsidy to
market price to arrive at factor cost.
QUESTION 4
The measure that we obtain by doing so (reducing Q. The most appropriate measure of economic
indirect taxes and adding subsidies to NNP at growth is its: [2001]
market prices) is called Net National Product at (a) Gross Domestic Product of a country
factor cost or National Income. (b) Net Domestic Product
(c) Net National Product
The formula for NNP at factor cost (which is also (d) Per Capita Real Income
referred to as National Income): Answer: D

NNP at factor cost = National Income (NI) = NNP at

market prices – Indirect taxes + Subsidies

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On the other hand, the households do receive

QUESTION 5
interest payments from private firms or the
Q. The term National Income represents: [2001]
government on past loans advanced by them. And
(a) gross national product at market prices minus
households may have to pay interests to the firms
depreciation
and the government as well, in case they had
(b) gross national product at market prices minus
borrowed money from either. So, we have to deduct
depreciation plus net factor income from
the net interests paid by the households to the firms
abroad
and government.
(c) gross national product at market prices minus
depreciation and indirect taxes plus subsidies
The households receive transfer payments from
(d) gross national product at market prices minus
government and firms (pensions, scholarship,
net factor income from abroad
prizes, for example) which have to be added to
Answer: C
calculate the Personal Income of the households.

QUESTION 6 The formula for Personal Income (PI):

Q. The national income of a country for a given
period is equal to the [2013] Personal Income (PI) = NI – Undistributed profits –
(a) total value of goods and services produced by Net interest payments made by households –
the nationals Corporate tax + Transfer payments to the
(b) sum of total consumption and investment households from the government and firms.
expenditure
(c) sum of personal income of all individuals However, even PI is not the income over which the
(d) money value of final goods and services households have complete say. They have to pay
produced taxes from PI.
Answer: D
If we deduct the Personal Tax Payments (income
tax, for example) and Non-tax Payments (such as
PERSONAL INCOME AND PERSONAL fines) from PI, we obtain what is known as the
DISPOSABLE INCOME Personal Disposable Income.

We can further subdivide the National Income into The formula for Personal Disposable Income (PDI):
smaller categories. Let us try to find the expression
for the part of NI which is received by households. Personal Disposable Income (PDI) = PI – Personal
We shall call this Personal Income (PI). tax payments – Non-tax payments.

First, let us note that out of NI, which is earned by Personal Disposable Income is the part of the
the firms and government enterprises, a part of aggregate income which belongs to the households.
profit is not distributed among the factors of They may decide to consume a part of it, and save
production. This is called Undistributed Profits (UP). the rest.

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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NOMINAL GDP AND REAL GDP

KEY DEFINITION
KEY DEFINITION
Undistributed profits: That part of profits earned
by the private and government owned firms which Real GDP: GDP evaluated at a set of constant
are not distributed among the factors of prices.
production.
Nominal GDP: GDP evaluated at current market
Corporate tax: Taxes imposed on the income prices.
made by the corporations (or private sector firms).
Base year: The year whose prices are used to
Net interest payments made by households: calculate the real GDP.
Interest payment made by the households to the
firms – interest payments received by the
households.
NOMINAL GDP
Transfer payments to households from the
government and firms: Transfer payments are Nominal GDP, or nominal gross domestic product, is
payments which are made without any a measure of the value of all final goods and
counterpart of services received by the payer. For services produced within a country’s borders at
examples, gifts, scholarships, pensions. current market prices.

Personal Income: National Income – In calculating nominal GDP, we only use current
Undistributed profits – Net interest payments quantities at current year prices.
made by households – Corporate tax + Transfer
payments to the households from the government If, for instance, India produced only three products—
and firms. coffee, tea, and rubber, let’s say—nominal GDP
would be calculated by first multiplying the
Personal tax payments: Taxes which are imposed quantity of each product produced by its current
on individuals, such as income tax. market price, and then adding the three results
together. In order to calculate it, we first need to
Non-tax payments: Payments made by know the quantity of each product produced and the
households to the firms or the government as up-to-date average price for that product.
non-tax obligations such as fines.
Therefore, (coffee quantity x coffee’s current market
Personal Disposable Income (PDI): PI – Personal price) + (tea quantity x tea’s current market price) +
tax payments – Non-tax payments. (rubber quantity x rubber’s current market price) =
Nominal GDP

It can then be further reduced to the nominal GDP

per capita by dividing the nominal GDP by the
country’s population.

REAL GDP

Real GDP is GDP evaluated at the market prices of

some base year.

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Base year is the year whose prices are being used to base year) will be 120 X Rs 10 = Rs 1200. This
calculate the real GDP. indicates a 20% increase over 2000, which is also
the same as the increase in bread production
For example, if 2012 were chosen as the base year, between 2000 and 2002.
then real GDP for 2019 is calculated by taking the
quantities of all goods and services purchased in DIFFERENCE BETWEEN NOMINAL
2019 and multiplying them by their 2012 prices. GDP AND REAL GDP

WHY IS CALCULATING REAL GDP MEANING

IMPORTANT? ▪ Nominal GDP: Total economic output produced
valued at a current market price.
Consider the following statements: ▪ Real GDP: Total economic output produced
▪ For example, suppose a country only produces valued at a constant market price.
bread.
CALCULATION
▪ In the year 2000 it had produced 100 units of
▪ Nominal GDP: Based on current market price.
bread, and price of bread in year 2000 was Rs 10
▪ Real GDP: Based on pre-determined base year
per bread. GDP at current price was Rs 1,000.
market price.
(This is the nominal GDP of year 2000)
▪ In 2001 the same country produced 110 units of PRICE CHANGE EFFECT
bread at price Rs 15 per bread. Therefore, ▪ Nominal GDP: Included
nominal GDP in 2001 was Rs 1,650 (=110 × Rs ▪ Real GDP: Excluded
15).
▪ If one were to only compare nominal GDP of VALUE
year 2001 with that of year 2000, without paying ▪ Nominal GDP: Usually higher due to inflation.
attention towards the prevailing price levels, one ▪ Real GDP: Usually lower than nominal GDP.
may conclude that since there is a 65% increase USAGE
in nominal GDP (from Rs 1,000 to Rs 1,650), ▪ Nominal GDP: Used for comparison across
there may be a 65% increase in bread different quarters of output in a year for same
production. country.
▪ But is there a 65% increase in bread production? ▪ Real GDP: More appropriate for comparison
No! There is only a 10% increase in bread across years and across countries.
production (from 100 units to 110 units),
whereas there is a 50% increase in the price level COMPLEXITY
(from Rs 10 to Rs 15 per bread)! ▪ Nominal GDP: Comparatively easier to calculate.
▪ This is where Real GDP helps us. It helps us in ▪ Real GDP: More difficult to calculate.
cancelling out the effect of price change and
ANALYSIS OF ECONOMIC GROWTH
correctly measure the changes in production
▪ Nominal GDP: Cannot segregate between
levels.
volume growth and growth due to price changes.
▪ Real GDP in 2001 calculated at the price of the
▪ Real GDP: Concentrates on volume growth only,
year 2000 (2000 will be called the base year) will
hence economic growth can be more
be 110 × Rs 10 = Rs 1,100.
appropriately analysed.
▪ When we compare real GDP of year 2001 with
nominal GDP of year 2000 (which is also the real COMPARISON ACROSS COUNTRIES
GDP since base year is 2000 itself), we notice an ▪ Nominal GDP: Not appropriate to compare
increase of 10% (from Rs 1000 to Rs 1100), which nominal GDP across countries with different
is the same as the increase in bread production. inflation rates.
▪ If production in year 2002 increases to 120
breads, real GDP in 2002 (assuming 2000 as the
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▪ Real GDP: Better index for measuring long-term produced in 2001 was 1.5 times the price in 2000.
economic performance and comparison across Which is true because price of bread has indeed
countries. gone up from Rs 10 to Rs 15. Like GDP deflator, we
can have GNP deflator as well.

GDP DEFLATOR, CONSUMER PRICE

INDEX, WHOLESALE PRICE INDEX CONSUMER PRICE INDEX

KEY DEFINITION
GDP DEFLATOR
Consumer Price Index (CPI): Percentage change in
KEY DEFINITION
the weighted average price level. We take the
prices of a given basket of consumption goods.
GDP Deflator: Ratio of nominal to real GDP.
Wholesale Price Index (WPI): Percentage change
in the weighted average price level. We take the
Let us revisit an example that we have studied
prices of a given basket of goods which is traded in
before.
bulk.
For example, suppose a country only produces
bread. In the year 2000 it had produced 100 units of
There is another way to measure change of prices in
bread, price was Rs 10 per bread. GDP at current
an economy which is known as the Consumer Price
price was Rs 1,000. In 2001 the same country
Index (CPI). This is the index of prices of a given
produced 110 units of bread at price Rs 15 per bread.
basket of commodities which are bought by the
Therefore, nominal GDP in 2001 was Rs 1,650 (=110
representative consumer.
× Rs 15). Real GDP in 2001 calculated at the price of
the year 2000 (2000 will be called the base year) will
CPI is generally expressed in percentage terms.
be 110 × Rs 10 = Rs 1,100.
We have two years under consideration – one is the
Notice that the ratio of nominal GDP to real GDP
base year, the other is the current year. We calculate
gives us an idea of how the prices have moved from
the cost of purchase of a given basket of
the base year (the year whose prices are being used
commodities in the base year. We also calculate the
to calculate the real GDP) to the current year.
cost of purchase of the same basket in the current
year. Then we express the latter as a percentage of
In the calculation of real and nominal GDP of the
the former. This gives us the Consumer Price Index
current year, the volume of production is fixed.
of the current year vis-´a-vis the base year.
Therefore, if these measures differ it is only due to
change in the price level between the base year and
For example let us take an economy which produces
the current year.
two goods, rice and cloth. A representative
consumer buys 90 kg of rice and 5 pieces of cloth in
The ratio of nominal to real GDP is a well-known
a year.
index of prices. This is called GDP Deflator. Thus, if
GDP stands for nominal GDP and gdp stands for real
Suppose in the year 2000 the price of a kg of rice was
GDP then, GDP deflator = GDP/gdp.
Rs 10 and a piece of cloth was Rs 100. So the
consumer had to spend a total sum of Rs 10 × 90 =
In the previous example, the GDP deflator is
Rs 900 on rice in 2000. Similarly, she spent Rs 100 ×
1,650/1,100 = 1.50 (in percentage terms this is 150
5 = Rs 500 per year on cloth. Summation of the two
per cent). This implies that the price of bread
items is, Rs 900 + Rs 500 = Rs 1,400.
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person has more income, he or she can buy more

Now suppose the prices of a kg of rice and a piece of goods and services and his or her material well-being
cloth has gone up to Rs 15 and Rs 120 in the year improves. So it may seem reasonable to treat his or
2005. To buy the same quantity of rice and clothes her income level as his or her level of well-being.
the representative will have to spend Rs 1,350 and GDP is the sum total of value of goods and services
Rs 600 respectively (calculated in a similar way as created within the geographical boundary of a
before). Their sum will be, Rs 1,350 + Rs 600 = Rs country in a particular year. It gets distributed
1,950. among the people as incomes (except for retained
earnings). So we may be tempted to treat higher
The CPI therefore will be (1,950/1,400) × 100 = level of GDP of a country as an index of greater well-
139.29 (approximately). being of the people of that country. But there are
many reasons why this may not be correct.
WHOLESALE PRICE INDEX
LIMITATIONS OF GDP
It is worth noting that many commodities have two
sets of prices. QUALITY OF LIFE
▪ What it means? Sometimes called “well-being”;
One is the retail price which the consumer actually the standard of health, happiness, security, and
pays. The other is the wholesale price, the price at material comfort of an individual, a group of
which goods are traded in bulk. people, or a nation.
▪ GDP gives no idea about Quality of Life.
These two may differ in value because of the margin
NON-MARKET TRANSACTIONS
kept by traders. Goods which are traded in bulk
▪ What it means? Economic activity that takes
(such as raw materials or semi-finished goods) are
place in the informal sector (from babysitting, to
not purchased by ordinary consumers. Like CPI, the
lawn mowing, to illegal drug sales), sometimes
index for wholesale prices is called Wholesale Price
called the grey market or the black market
Index (WPI).
economy;
DIFFERENCE BETWEEN CPI AND GDP ▪ Non-market transactions are not recorded,
DEFLATOR taxed, or officially monitored by the government.
▪ Because of this, the output and income
1. The goods purchased by consumers (which the generated through non-market transactions is
CPI includes) do not represent all the goods not included in the calculation of a nation’s GDP.
which are produced in a country. GDP deflator
takes into account all such goods and services. INCOME INEQUALITY
2. CPI includes prices of goods consumed by the ▪ What it means? when a disproportionate share
representative consumer, hence it includes of a nation’s income is earned by a small
prices of imported goods. GDP deflator does not minority of households; for example, when the
include prices of imported goods. top 10% of households earn 80% of the total
3. The weights are constant in CPI – but they differ income in a country, there is a high degree of
according to production level of each good in income inequality;
GDP deflator. ▪ GDP does not account for income distribution in
any way.

SUSTAINABILITY
GDP & WELFARE ▪ What it means? The ability of a system to endure
indefinitely into the future;
Can the GDP of a country be taken as an index of ▪ An increase in GDP will only be sustainable as
the welfare of the people of that country? If a long as it does not deplete natural resources too

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rapidly nor exploit the environment in a way that OTHER IMPORTANT INDICATORS
diminishes the quality of life of the nation’s
households over time. Alternative indicators have been developed to
provide a more well-rounded measure of a nation’s
ECONOMIC BADS quality of life by different national and international
▪ What it means? Any outcome from economic organizations. These include:
activity that creates negative value for society,
such as air pollution from cars that harms human THE HUMAN DEVELOPMENT INDEX (HDI)
health and the environment; A composite measure of nation’s social and
▪ Unsustainable economic growth may diminish economic development developed by the United
the quality of life of a nation’s people. Nations that includes measures of health, wealth,
and education.
DEPRECIATION OF CAPITAL
▪ What it means? The decrease in the value of a
nation’s capital stock over time; THE GENUINE PROGRESS INDICATOR (GPI)
▪ GDP accounts for investment in new capital but A measure of a nation’s quality of life that includes
does not subtract the lost value of depreciated the income and output measured by gross domestic
capital. Because of this, GDP may overstate the product. This measure subtracts out the costs of
amount of economic activity in nations with negative effects related to economic growth such as
rapidly depreciating capital stocks. crime, environmental degradation, resource
depletion, and the costs of climate change. GPI nets
REAL GDP PER CAPITA the positives and negatives of economic activity to
▪ What it means? The real gross domestic product provide a more accurate measure of a nation’s
of a nation, divided by the nation’s population; quality of life than GDP alone.
this measure is an indication of the average
income of a nation’s people.
THE HAPPY PLANET INDEX (HPI)
A measure of a nation’s quality of life that includes
QUESTION 7
survey results on happiness, life expectancy at birth,
Q. Increase in absolute and per capita real GNP the degree of inequality across society, and the
do not connote a higher level of economic ecological footprint.
development, if [2018]
(a) industrial output fails to keep pace with Each of these indexes is a composite measure
agricultural output. weighing both income and non-income variables
(b) agricultural output fails to keep pace with such as life expectancy, literacy rates, environmental
industrial output. indicators, measures of inequality and so on. By
(c) poverty and unemployment increase. including these variables, they provide a measure of
(d) imports grow faster than exports. life quality that goes beyond the narrowness of a
Answer: C nation’s GDP value.

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order to arrive at market prices, we have to add

FACTOR COST, BASIC PRICES AND product taxes (less product subsidies) to the basic
MARKET PRICES prices.
In India, the most highlighted measure of national
As stated above, now the CSO releases GVA at basic
income has been the GDP at factor cost. The Central
prices. Thus, it includes the net production taxes but
Statistics Office (CSO) of the Government of India
not net product taxes.
has been reporting the GDP at factor cost and at
market prices.
In order to arrive at the GDP (at market prices) we
need to add net product taxes to GVA at basic
In its revision in January 2015 the CSO replaced GDP
prices.
at factor cost with the GVA at basic prices, and the
GDP at market prices, which is now called only GDP,
The formula for GVA at basic prices:
is now the most highlighted measure.
GVA at factor costs + Net production taxes = GVA at
The idea of GVA has already been discussed: it is the
basic prices
value of total output produced in the economy less
the value of intermediate consumption (the output
The formula for GVA at market prices:
which is used in production of output further, and
not used in final consumption).
GVA at basic prices + Net product taxes = GVA at
market prices
Here we discuss the concept of basic prices.

The distinction between factor cost, basic prices and

market prices is based on the distinction between
net production taxes (production taxes less
production subsidies) and net product taxes
(product taxes less product subsidies).

Production taxes and subsidies are paid or received

in relation to production and are independent of
the volume of production such as land revenues,
stamp and registration fee.

Product taxes and subsidies, on the other hand, are

paid or received per unit or product, e.g., excise tax,
service tax, export and import duties etc.

Factor cost includes only the payment to factors of

production, it does not include any tax.

In order to arrive at the market prices, we have to

add to the factor cost the total indirect taxes less
total subsidies.

The basic prices lie in between: they include the

production taxes (less production subsidies) but not
product taxes (less product subsidies). Therefore, in
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GROSS NATIONAL PRODUCT AT MARKET

SUMMARY PRICES (GNP MP )
▪ GNPMP is the value of all the final goods and
GROSS DOMESTIC PRODUCT AT MARKET
services that are produced by the normal
PRICES (GDP MP )
residents of India and is measured at the market
▪ GDP is the market value of all final goods and
prices, in a year.
services produced within a domestic territory of
▪ GNP refers to all the economic output produced
a country measured in a year.
by a nation’s normal residents, whether they are
▪ All production done by the national residents or
located within the national boundary or abroad.
the non-residents in a country gets included,
▪ To arrive at the value of GNP, Net Factor Income
regardless of whether that production is owned
from Abroad (NFIA) is added to GDP.
by a local company or a foreign entity.
▪ Everything is valued at the market prices.
▪ Everything is valued at market prices.
▪ GNPMP = GDPMP + NFIA
▪ GDPMP = C + I + G + X – M
GNP AT FACTOR COST (GNP FC )
GDP AT FACTOR COST (GDP FC )
▪ GNP at factor cost measures value of output
▪ GDP at factor cost is gross domestic product at
received by the factors of production belonging
market prices, less net product taxes.
to a country in a year.
▪ Market prices are the prices as paid by the
▪ GNPFC = GNPMP – Net Product Taxes – Net
consumers. Market prices also include product
Production Taxes
taxes and subsides.
▪ The term factor cost refers to the prices of NET NATIONAL PRODUCT AT MARKET
products as received by the producers. PRICES (NNP MP )
▪ Thus, factor cost is equal to market prices, minus ▪ This is a measure of how much a country can
net indirect taxes (NIT). consume in a given period of time.
o NIT = Indirect Taxes – Subsidies ▪ NNP measures output regardless of where that
▪ GDP at factor cost measures money value of production has taken place (in domestic
output produced by the firms within the territory or abroad).
domestic boundaries of a country in a year. ▪ NNPMP = GNPMP – Depreciation
▪ GDPFC = GDPMP – Indirect Taxes + Subsidies ▪ NNPMP = NDPMP + NFIA
▪ GDPFC = GDPMP – NIT
NNP AT FACTOR COST (NNP FC ) OR
NET DOMESTIC PRODUCT AT MARKET NATIONAL INCOME (NI)
PRICES (NDP MP ) ▪ NNP at factor cost is the sum of income earned
▪ This measure allows policy-makers to estimate by all factors in the production in the form of
how much the country has to spend just to wages, profits, rent and interest, etc., belonging
maintain their current GDP. to a country during a year.
▪ If the country is not able to replace the capital ▪ It is the National Product and is not bound by
stock lost through depreciation, then GDP will production in the national boundaries. It is the
fall. net domestic factor income added with the net
▪ NDPMP = GDPMP − Depreciation factor income from abroad.
▪ NI = NNPMP – Net Product Taxes - Net Production
NDP AT FACTOR COST (NDP FC )
Taxes
▪ NDP at factor cost is the income earned by the
▪ NNP = NDP + NFIA
factors in the form of wages, profits, rent,
interest, etc., within the domestic territory of a
country.
▪ NDPFC = NDPMP – Net Product Taxes – Net
Production Taxes

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Q2. With reference to ‘Gross Domestic Product’,

MCQS FOR PRACTICE which of the following statements is not correct?
1. It is the total value of all finished goods and
Q1. Which of the following statements is correct services produced in the country in one financial
with respect to ‘Public Goods’? year.
1. They are considered as non-rivalrous as they 2. It includes the value of finished goods and
don't dwindle in supply as people consume services produced by foreigners within the
them. boundary of an economy.
2. They are considered non-excludable as they are
available to all and cannot be withheld even from Select the correct answer using the code given
people who do not contribute to its public below:
funding. (a) 1 only
3. They are associated with free-rider problem. (b) 2 only
Select the correct answer using the code given (c) Both 1 and 2
below: (d) Neither 1 nor 2
Answers: D
(a) 1 and 2 only
(b) 2 and 3 only Explanation:
(c) 1 and 3 only About Gross Domestic Product:
(d) 1, 2 and 3 ▪ GDP is the total value of all finished goods
Answer: D produced in the country in one financial year.
(Hence statement 1 is correct)
Explanation: ▪ To avoid double-counting, GDP includes the
About Public Goods: final value of the product, but not the parts (or
▪ Economists refer to public goods as "non- intermediate goods) that go into it. For example,
rivalrous" and "non-excludable," and most such an Indian footwear manufacturer uses laces and
goods are both. other materials made in India. Only the value of
▪ Their non-rivalry refers to the fact that the goods the shoe gets counted; the shoelace does not.
don't dwindle in supply as people consume ▪ It doesn't matter if it is produced by citizens or
them; a country's defenses, for example, do not foreigners. If they are located within the
run out or diminish as its population grows. country's boundaries, their production is
(Hence statement 1 is correct) included in GDP. (Hence statement 2 is correct)
▪ Non-excludability means just that; the good is
available to all and cannot be withheld, even
from people who do not contribute to its public Q3. With reference to ‘capital goods’, consider the
funding. (Hence statement 2 is correct) following statements:
▪ That characteristic, in turn, leads to what is called 1. They don’t transform, or change shape in the
the free-rider problem with public goods. Since production process.
you need not contribute to the provision of a 2. They are bought for meeting immediate need of
public good to benefit from it, some people will the consumer.
inevitably choose to use the good and yet shirk Which of the statements given above is/are
the public responsibility to help pay for it. correct?
(Hence statement 3 is correct) (a) 1 only
(b) 2 only
(c) Both 1 and 2
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(d) Neither 1 nor 2 Q5. With reference to ‘Nominal GDP’, which of the
Answer: A following statements is correct?
(a) It measures total economic output produced
Explanation: valued at a constant market price.
About Capital Goods: (b) It is used for comparison across years and across
▪ Capital goods, on the other hand, are assets that countries.
are used in the production of consumer goods. (c) It concentrates on volume growth only and does
Key thing to note about capital goods is that they not include price growth.
(d) None of the above
don’t transform, or change shape in the
Answer: D
production process. (Hence statement 1 is
correct)
Explanation:
▪ They are goods which are bought not for
About Nominal GDP:
meeting immediate need of the consumer but
▪ Total economic output produced valued at a
for producing other goods. (Hence statement 2
current market price. (Hence option A is not
is not correct) correct)
▪ Based on current market price.
Q4. The term Gross Domestic Product at Factor cost ▪ Used for comparison across different quarters
represents: of output in a year for same country. (Hence
(a) Gross domestic product at market prices minus option B is not correct)
depreciation. ▪ Cannot segregate between volume growth and
(b) Gross domestic product at market prices minus growth due to price changes. (Hence option C is
depreciation plus net factor income from not correct)
abroad.
(c) Gross domestic product at market prices minus
indirect taxes plus subsidies.
(d) Gross domestic product at market prices minus
net factor income from abroad.
Answer: C

Explanation:
About Gross Domestic Product at Factor cost:
▪ GDP at factor cost is gross domestic product at
market prices, less net product taxes.
▪ Market prices are the prices as paid by the
consumers. Market prices also include product
taxes and subsides.
▪ The term factor cost refers to the prices of
products as received by the producers.
▪ Thus, factor cost is equal to market prices, minus
net indirect taxes (NIT).
o NIT = Indirect Taxes – Subsidies
▪ GDP at factor cost measures money value of
output produced by the firms within the
domestic boundaries of a country in a year.
▪ GDPFC = GDPMP – Indirect Taxes + Subsidies
• GDPFC = GDPMP – NIT
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