Gross Domestic Product
Economy refers to production, distribution and consumption of goods and services in a geographical region. The inputs to the production process are called factors of production. There are three classical factors of production viz. Land, Labour and Capital.
Modern economists consider entrepreneurship or human capital (skill) as fourth factor of production. In terms of service industry, Time can also be a factor of production.
Purpose of production is to produce goods (finished / unfinished / intermediary) and services, which are consumed via trade, distribution and final consumption. A good or a service is a product. A product is either tangible good or an intangible service. For example, a tourist guide does not sell anything but his product is his service. Every goods and service has a monetary value. When we combine all products of an entity, we may call it Gross Product. When we combine the monetary value of all the final goods and services produced in the economic territory of a country for a specified time such as a year, this will be called “Gross Domestic Product”. GDP is concerned with the final / finished goods and not the unfinished or intermediate goods. Unfinished / Intermediate goods are not counted in GDP. This is done to avoid double counting, once in an unfinished form, and once in a finished form.
Calculation of GDP
If we consider that unit price is P and number of units of final goods produced is G and final services rendered is S, then the GDP will be:
GDP= P*G + P*S
For example:
If unit price is Rs. 100 for 500 units of goods produced, then total goods produced is Rs. 50,000
If unit price is Rs. 500 for 300 units of services rendered, then total services produced is Rs. 15000
GDP is Rs. 50000+ Rs. 15000= Rs. 65000
The Components of GDP from expenditure side
In the direct method of GDP computation as discussed above, we sum up all the outputs of every class of enterprise to arrive at the total. There is an expenditure approach also to calculate the GDP, which has utmost importance. The Expenditure approach works on the principle that all of the product (goods or services) must be bought by somebody, therefore the value of the total product must be equal to people’s total expenditures in buying things. The four main components are consumption expenditures by households (C), gross private investment spending principally by firms (I), government purchases of goods and services (G), and net exports (exports minus imports EX – IM). Here is an equation that sums it up:
GDP = C + I + G + (X – I)
Consumption
Consumption is consisting of private (household final consumption expenditure) in the economy. These personal expenditures fall under one of the following categories: durable goods, non-durable goods, and services. Some examples are consumption expenditure in food, rent, jewellery, gasoline, and medical expenses.
Investment
This includes construction of a new mine, purchase of software, or purchase of machinery and equipment for a factory. Spending by households (not government) on new houses is also included in Investment.
Here, we must note that buying Financial Instruments or putting money in saving account is not investment in this context but is a ‘saving’. For national accounting purpose, the reason to put financial investments in savings is to avoid double-counting. If one buys shares in a company, and the company uses the money received to buy plant, equipment, etc., the amount will be counted toward GDP when the company spends the money on those things; to also count it when one gives it to the company would be to count two times an amount that only corresponds to one group of products. Buying bonds or stocks is a swapping of deeds, a transfer of claims on future production, not directly an expenditure on products.
Similarly, personal savings we put in the bank is loaned to businesses so that they can put it to work. When we put our money in the bank, the banking system uses our personal savings to give industry its reservoir of money to work from. That is the reason that the savings are not counted in GDP.
Government Spending
Government spending is the sum of government expenditures on final goods and services. It includes salaries of public servants, purchase of weapons for the military, and any investment expenditure by a government. However, it does not include any transfer payments, such as social security or unemployment benefits.
Exports and Imports
X (exports) represents gross exports. GDP captures the amount a country produces, including goods and services produced for other nations’ consumption, therefore exports are added. M (imports) represents gross imports. Imports are subtracted since imported goods will be included in the terms G, I, or C, and must be deducted to avoid counting foreign supply as domestic.
GDP at Current Prices and Constant Prices
GDP can be estimated at the current prices and constant prices. GDP at Current prices is the total market value of goods and services at current market prices. For example, if the average unit price of 100 goods + services is Rs. 100 in 2010 and Rs. 150 in 2015; then the GDP will be Rs. 10000 in 2010 but Rs. 15000 in 2015 at current prices. Thus, this figure does not take into account the inflation and despite being an increased figure in value; the increase in production is zero. Due to this, GDP at Current Prices is also known as Nominal GDP. In this figure inflation is not adjusted, so can be misleading. When it is estimated on the basis of some fixed prices prevalent at a particular point of time, this is called GDP at constant prices. If the average unit price of 100 goods + services is Rs. 100 in 2010 and Rs. 150 in 2015; then the GDP at current prices will be Rs. 10000 in 2010 but Rs. 15000 in 2015. However, GDP at constant prices will still be Rs. 10000, so GDP growth is zero in this case.
GDP at Factor Cost
The market value of the product includes cost plus indirect taxes (Excise or Service Tax, for instance) minus subsidies provided by the government. So, to arrive at a more accurate figure of the GDP, we add subsidy to GDP at Market Prices and reduce Indirect Taxes from it. This more accurate figure is called GDP at Factor Cost. The GDP at factor cost is nothing but an attempt to reach at a more realistic value of the GDP and it is represented by GDPFC
GDPFC= GDP – Indirect Taxes + Subsidies
We note here that GDP at factor cost figures are generally lower than GDP at market prices because sum total of Indirect Taxes is much more than subsidies. However, GDP at factor cost figures can be higher than GDP at market prices in a bizarre condition when sum total of subsidy is higher than the indirect taxes. Further, whenever there is a recession in the economy, growth in indirect taxes tends to fall while expenditure on subsidies tends to increase. Due to this, the gap between GDP at Factor Cost and GDP at Market prices tends to decrease. Further, GDP at Factor Cost at Constant Prices is called Real GDP because it takes into account the inflation, indirect taxes as well as subsidies . In India, till January 2015, the Economic growth was measured as the percent rate of increase in GDP at Factor Cost at constant prices aka real GDP.
India’s GDP in 2016-17
As per first advanced estimates, GDP Growth Rate is estimated at 7.1% in 2016-17. The growth in the second half of 2016-17 works out to 7.0 per cent as against 7.2 per cent in the first half. However, estimates of second half are based on the economic situation prior to the demonetization.