Gross Domestic Product – UPSC Notes – Economy

Gross Domestic Product (GDP) measures the total value of all final goods and services produced within a country’s borders over a specified time period. GDP is often referred to as an indicator of a country’s economic performance and overall health. For example, if Country A produced 10 soaps in one year each worth ₹1, and 10 balls each worth ₹5, then the GDP of that nation would be ₹60. “Gross Domestic Product (GDP)” is one of the most important topics in the UPSC/IAS 2023 Economy syllabus which is discussed in this article in detail.

What is Gross Domestic Product (GDP)?

• GDP: Gross Domestic Product, measures the worth of a country’s economic activities.
• Sum of Final Prices: GDP is the total of final prices of goods and services produced within a specific time frame.
• Economic Vitality: GDP reflects a nation’s economic vitality, indicating growth, contraction, or stagnation.
• Comparative Measure: GDP allows for comparison of economic performance between countries and regions.
• Regular Calculation: GDP is calculated regularly to accommodate changes in production structure, pricing, and economic documentation.
• Components Considered: Private and public consumption, government outlays, investments, additions to private inventories, paid-in building expenses, and the foreign balance of trade are considered in GDP calculation.
• External Balance of Trade: The foreign balance of trade is the most significant component of a country’s GDP.

Balance of Trade (BOT)

The balance of trade (BOT) represents the difference between a country’s imports and exports for a specific time period.

• When the total value of exported goods and services to foreign nations exceeds the total value of foreign goods and services imported by domestic consumers, a country’s GDP rises. A country is considered to have a trade surplus when this happens.
• A trade deficit occurs when the total value of foreign goods and services imported by domestic consumers exceeds the total value of exported goods and services to foreign nations.

• History of GDP
  • Simon Kuznets: Economist at the National Bureau of Economic Research, proposed GDP concept in 1937.
  • Gross National Product (GNP): Previously widely used measurement system.
  • Embrace of GDP: Became primary measurement post-Bretton Woods conference in 1944.
• Criticism of GDP
  • Beginning in the 1950s: Doubts raised by economists and policymakers.
  • Absolute Indication: Some view GDP as insufficient, neglecting aspects like health, happiness, and equality.
  • Economic vs. Social Advancement: Critics highlight contrast between economic and social progress.
• Expert Opinion
  • Arthur Okun: Argued GDP is absolute metric of economic performance, with increases correlating with declines in unemployment.

Types of Gross Domestic Product

• Real GDP
  • Definition: Value of all goods and services generated by an economy in a given year, expressed in base-year prices.
  • Also Known As: Constant-price GDP, inflation-corrected GDP, etc.
• Nominal GDP
  • Definition: Measurement of economic output in a country considering current prices.
  • Implications: Doesn’t account for inflation, which may overstate growth rate.
  • Valuation: All products and services valued at actual selling prices in the year.
• GDP Per Capita
  • Definition: GDP per person in a country’s population.
  • Significance: Reflects average productivity or living standards.
  • Variants: Nominal, real (inflation-adjusted), and PPP (purchasing power parity) GDP per capita.
• GDP Purchasing Power Parity (PPP)
  • Explanation: Not a direct measure of GDP, but used to compare GDPs of different countries in “international dollars”.
  • Method: Adjusts for differences in local prices and costs of living for cross-country comparisons of real output, real income, and living standards.

Calculating Gross Domestic Product

• India’s GDP is calculated through two distinct methodologies, producing results that are closely aligned but not identical. The first method is rooted in economic activity (at factor cost), while the second is grounded in spending (at market prices).
• Further calculations involve Nominal GDP (based on current market prices) and Real GDP (adjusted for inflation). Among these four figures, GDP at factor cost is the most commonly observed and reported.

Economic Activity At Factor Cost

The factor cost figure is derived by gathering data on the net change in value for each sector over a specified period. This cost encompasses eight crucial industry sectors:

1. Agriculture, forestry, and fishing
2. Mining and quarrying
3. Manufacturing
4. Electricity, gas, water supply, and other utility services
5. Construction
6. Trade, hotels, transport, communication, and broadcasting
7. Financial, real estate, and professional services
8. Public administration, defense, and other services

The following example illustrates this calculation method.

Expenditure at Market Prices

The expenditure (at market prices) approach involves aggregating domestic spending on final products and services from various sources over a specified period. It encompasses household consumption spending, net investments (capital formation), government expenditures, and net trade (exports minus imports).

• While the GDP figures from the two approaches aren’t precisely identical, they are close.
• The spending method offers valuable insights into the key contributors to the Indian economy.
• For instance, domestic household spending, constituting 59.05 percent of the economy, is a factor contributing to India’s relative resilience to global economic downturns.
• Economies heavily reliant on exports are more susceptible to global recessions.

Formula For Calculating Gross Domestic Product

GDP = C + I + G + IX

where,

C = Consumption (Expenditure by households on goods and services)

I = Investment (Spending by businesses on capital goods like machinery, buildings, and technology)

G = Government Expenditure (Expenditure by the government on public services and infrastructure)

IX = Export – Import (The difference between exports and imports)

Importance of Gross Domestic Product

• Measure of Economic Performance
  • GDP is widely regarded as one of the primary indicators of a country’s economic performance.
  • It offers a quantitative representation of the total economic output, indicating whether an economy is expanding, contracting, or stagnant.
• Indicator of Economic Growth
  • A rising GDP generally signifies economic growth and prosperity.
  • It reflects the ability of an economy to produce more goods and services over time, leading to increased living standards and improved quality of life.
• Comparison among Countries
  • GDP allows for meaningful comparisons of economic performance among different countries and regions.
  • By comparing GDP figures, economists and policymakers can assess how well a nation’s economy is faring relative to others.
• Basis for Policy Formulation
  • Governments use GDP data to formulate economic policies and strategies.
  • The growth rate of GDP can guide decisions on fiscal and monetary policies, public spending, taxation, and investment incentives.
• Employment and Income Generation
  • A growing GDP often translates into increased employment opportunities and higher incomes for citizens.
  • As economic activities expand, businesses hire more workers, leading to reduced unemployment rates.
• Investment Decision-Making
  • Investors and businesses use GDP data to make informed decisions about investment opportunities.
  • A growing economy signals a conducive environment for business expansion and potential returns on investment.
• Resource Allocation
  • Governments allocate resources based on GDP data.
  • A healthy GDP growth can lead to increased tax revenues, which can be channeled into public services, infrastructure development, and social welfare programs.
• Monitoring Business Cycles
  • GDP helps in identifying business cycles, such as periods of economic expansion and contraction.
  • This information is crucial for policymakers to implement timely measures to stabilize the economy.
• Macroeconomic Stability
  • A stable and growing GDP contributes to overall macroeconomic stability.
  • It reduces the likelihood of extreme fluctuations in employment, inflation, and other economic indicators.
• Poverty Reduction and Welfare
  • While GDP alone doesn’t capture income distribution, a growing GDP can create opportunities for poverty reduction through increased employment, higher wages, and improved living conditions for the population.
• International Relations
  • A strong GDP enhances a country’s global standing and influences its relationships with other nations.
  • Economically robust countries often have more leverage in international negotiations and trade agreements.

Limitations

Excludes Non-Market Activities

• GDP primarily focuses on market transactions, excluding non-market activities like household production, volunteer work, and informal sector activities.
• This omission can lead to an underestimation of the total economic activity.

Ignores Income Distribution

• GDP does not provide information about how income is distributed among different segments of the population.
• A growing GDP could coexist with increasing income inequality, leading to skewed benefits.

Quality of Life and Well-being

• GDP does not account for the quality of life, well-being, or overall happiness of citizens.
• Economic growth, as measured by GDP, might not necessarily translate to improved living conditions or life satisfaction.

Environmental Impact

• GDP does not consider the environmental costs associated with economic activities.
• Economic growth may lead to increased pollution, resource depletion, and damage to ecosystems without reflecting these negative impacts in GDP calculations.

Informal Sector and Underground Economy

• GDP might not accurately capture the economic activities of the informal sector and underground economy, which are not always accounted for in official statistics.

Composition of Output

• GDP treats all economic activities as equal, without considering the composition of the output.
• Destructive activities, such as environmental degradation or producing harmful goods, contribute positively to GDP but have negative social implications.

Non-Monetary Transactions

• Non-monetary transactions, such as barter and self-subsistence agriculture, are not included in GDP calculations.
• This can lead to an incomplete representation of economic activity.

Does Not Differentiate Between Essential and Non-Essential Spending

• GDP treats all expenditures as equal, regardless of whether they contribute to essential needs like healthcare, education, and infrastructure or non-essential consumption.

No Consideration of Income Distribution

• GDP does not consider whether the generated income is equitably distributed among the population.
• A high GDP per capita does not necessarily mean that all citizens enjoy a high standard of living.

Does Not Account for Unpaid Work

• GDP does not account for unpaid work, particularly domestic work performed primarily by women.
• This omission can undervalue the contributions of such work to the economy.

Ignoring Future Implications

• GDP does not account for the depletion of natural resources or the long-term impacts of economic activities on future generations.

Gross Domestic Product Calculation in India Since 2015

• Base Year Change
  • Government switched to a new base year of 2011-12 for national accounts in January 2015, replacing the previous base year of 2004-05.
• Methodology Change
  • Central Statistics Office (CSO) discontinued GDP at factor cost and adopted GDP at market price and Gross Value Addition (GVA) measure.
  • GDP at market price = GDP at factor cost + Indirect Taxes – Subsidies.
• Impact on Growth Rate
  • With the switch to the new base year, the economy’s growth rate was predicted to be 6.9% in 2013-14, up from 4.7% in 2004-05. Similarly, the 2012-13 growth rate was increased to 5.1% from 4.5%.
• New Data Series
  • Latest series’ base year changed from 2004-05 to 2011-12, and a new data series, MCA-21, was used for the organized private sector.
• MCA-21 Database
  • Contains information on all companies registered with the Ministry of Corporate Affairs, identified by a unique 21-digit code, MCA-21.
  • Covers financial institutions and regulatory bodies like SEBI, PFRDA, and IRDA, along with local organizations and institutions.
• Methodology Changes
  • New methodology uses Gross Value Added (GVA) to measure value added to the economy, replacing the use of IIP (Index of Industrial Production).
  • Data source shifted from IIP to MCA 21, expanding coverage to include a wider range of entities.
• Expansion in Agricultural Income Calculation
  • New methodology expands scope of calculating value addition in agriculture beyond using farm produce as a proxy.
• Inclusion of Financial Entities
  • Under the new methodology, coverage extends to include entities like stockbrokers, asset management funds, pension funds, and stock exchanges, beyond just a few mutual funds and NBFCs.
• Trading Income Data Source
  • Old system used data from NSSO’s 1999 establishment survey for trading income, while the new series uses data from the 2011-12 survey.

Conclusion

The methodologies for calculating GDP have evolved over time to adapt to changing measures of economic activity and the production and consumption of new, developing kinds of intangible assets. GDP enables policymakers and central banks to assess whether the economy is declining or increasing, whether it requires stimulus or restraint, and whether threats such as recession or inflation are imminent.

FAQs on Gross Domestic Product

Question: What is Gross Domestic Product?

Answer: Gross Domestic Product (GDP) is a measure of the total value of all goods and services produced within a country’s borders over a specific time period, typically a year or a quarter.

Question: What is a simple definition of GDP?

Answer: A simple definition of GDP is the monetary value of all finished goods and services produced within a country’s borders in a specific time period.

Question: How does GDP affect the economy?

Answer: GDP affects the economy by serving as an indicator of its overall health and performance. It reflects the country’s economic activity, growth, and productivity. Changes in GDP can influence government policies, investment decisions, and consumer confidence.

Question: What is Nominal GDP?

Answer: Nominal GDP is GDP evaluated at current market prices, without adjusting for inflation or deflation. It represents the actual monetary value of goods and services produced within a country’s borders.

Question: Is a high GDP good?

Answer: Generally, a high GDP is considered positive as it indicates a strong and growing economy. It often correlates with higher employment rates, increased income levels, improved living standards, and better infrastructure. However, a high GDP alone may not necessarily reflect equitable distribution of wealth or overall well-being.

Question: What is GDP used for?

Answer: GDP is used for various purposes, including assessing the economic health and performance of a country, comparing the economic output of different countries, informing policymaking decisions, guiding investment strategies, and analyzing trends in economic growth.

Question: Who measures GDP in India?

Answer: In India, the Central Statistics Office (CSO), which is a part of the Ministry of Statistics and Programme Implementation, is responsible for measuring GDP.

Question: What is the GDP percentage of India?

Answer: As of the latest available data, India’s GDP percentage represents a significant portion of the global economy, contributing around 3-4% to the world’s GDP.

Question: Is India’s GDP growing?

Answer: India’s GDP has experienced periods of growth and fluctuations over time. While there have been instances of rapid economic expansion, there have also been periods of slower growth or contraction. The growth trajectory of India’s GDP is influenced by various factors such as government policies, global economic conditions, and domestic demand.

UPSC PYQ Prelims

Question: Consider the following statements: (UPSC 2018)

• 1) The Fiscal Responsibility and Budget Management (FRBM) Review Committee Report has recommended a debt-to-GDP ratio of 60% for the general (combined) government by 2023, comprising 40% for the Central Government and 20% for the State Governments.
• 2) The Central Government has domestic liabilities of 21% of GDP as compared to that of war of GDP of the State 2 Governments.
• 3) As per the Constitution of India, it is mandatory for a State to take the Central Government’s consent for raising any loan if the former owes any outstanding liabilities to the latter.

Which of the statements given above is/are correct?

• (a) 1 only
• (b) 2 and 3 only
• (c) 1 and 3 only
• (d) 1, 2 and 3

Answer: (c)

Question: A decrease in the tax-to-GDP ratio of a country indicates which of the following? (UPSC 2015)

• 1) Slowing economic growth rate
• 2) Less equitable distribution of national income

Select the correct answer using the code given below.

• (a) 1 only
• (b) 2 only
• (c) Both 1 and 2
• (d) Neither 1 nor 2

Answer: (a)

Question: When the Reserve Bank of India reduces the Statutory Liquidity Ratio by 50 basis points, which of the following is likely to happen? (UPSC 2015)

• (a) India’s GDP growth rate increases drastically
• (b) Foreign Institutional Investors may bring more capital into our country
• (c) Scheduled Commercial Banks may cut their lending rates
• (d) It may drastically reduce the liquidity to the banking system

Answer: (c)

Question: The ratio of Nominal GDP to Real GDP is called:

• GDP Deflator
• Incremental capital-output ratio
• Purchase Power Parity
• None of the above

Answer: (a)

Question: In the context of the Indian economy, consider the following statements. (UPSC 2011)

1. The growth rate of GDP has steadily increased in the last five years.
2. The growth rate in per capita income has steadily increased in the last five years.

Which of the statements given above is/are correct?

• (a) 1 only
• (b) 2 only
• (c) Both 1 and 2
• (d) Neither 1 nor 2

Answer: (b)

Question: Which is a measure of the GDP per person in a country’s population?

• (a) GDP Per Capita
• (b) Incremental capital-output ratio
• (c) Purchase Power Parity
• (d) None of the above

Answer: (a)

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