Indian Economy PDF 7th Edition 2023-24

7th Edition 2023-24 INDIAN ECONOMY (GENERAL STUDIES – CIVIL SERVICES EXAMINATION) “In this age of information overload, this book presents the most precise as well as comprehensive, relevant and analytical content” by VIVEK SINGH Important Features of the Book  Covers both prelims and mains section of GS Paper III (economic development)  Includes static and conceptual part as well as fully updated current issues  Lays emphasis on conceptual clarity, supported with diagrams, graphs, flowcharts and a lot of examples  Thoroughly updated with economic data and schemes  Includes previous year UPSC Prelims and Mains Questions  Includes economic terms at the end of the book for easy reference  UPSC (CSE) syllabus has been mapped with relevant chapters in the book  Important keywords have been highlighted in bold  Includes Budget 2023-24 and Economic Survey 2022-23  The book covers State PCS exams and RBI, NABARD, SEBI syllabus also For all the latest economy related updates, you can join authors telegram channel: “Economy by Vivek Singh” (https://t.me/VivekSingh_Economy) or you can mail at [email protected] INDIAN ECONOMY – USPC (CSE) SYLLABUS and mapping of Chapters Preliminary Exam Syllabus:  Economic and Social Development-Sustainable Development, Poverty, Inclusion, Demographics, Social Sector Initiatives, etc. [Chapters 1, 2 and 4 covers the major syllabus but you need to read rest of the chapters also.] Main Exam Syllabus:  Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment [Chapter 6, 7 & 8]  Inclusive growth and issues arising from it [Chapter 8]  Government Budgeting [Chapter 4]  Major crops-cropping patterns in various parts of the country, - different types of irrigation and irrigation systems storage, transport and marketing of agricultural produce and issues and related constraints; e-technology in the aid of farmers [Chapter 10 & 11]  Issues related to direct and indirect farm subsidies and minimum support prices; Public Distribution System- objectives, functioning, limitations, revamping; issues of buffer stocks and food security; Technology missions; economics of animal-rearing [Chapter 9, 10 & 11]  Food processing and related industries in India- scope’ and significance, location, upstream and downstream requirements, supply chain management [Chapter 12]  Land reforms in India [Chapter 5]  Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth [Chapter 6 and 7]  Infrastructure: Energy, Ports, Roads, Airports, Railways etc. [Chapter 14]  Investment models [Chapter 14] Contents 1 Fundamentals of Macro Economy......................................................................... 1 1.1 Introduction..................................................................................................... 1 1.2 Economic Organization (the three problems).......................................... 1 1.3 Economic Systems......................................................................................... 2 1.4 Four Sectors of Economy............................................................................. 3 1.5 Private Sector.................................................................................................. 4 1.6 Types of Goods................................................................................................ 6 1.7 Investment....................................................................................................... 7 1.8 Circular Flow................................................................................................... 9 1.9 Gross Domestic Product.............................................................................. 12 1.10 GDP Calculation Methodology by NSO..................................................... 15 1.11 Macroeconomic Variables........................................................................... 16 1.12 Nominal and Real GDP................................................................................ 17 1.13 Productivity, Capital Output Ratio and ICOR........................................ 20 1.14 Potential GDP................................................................................................ 22 1.15 Nominal, PPP and Real Exchange Rates.................................................. 23 1.16 GDP, Welfare, Development and Human Capital................................... 27 1.17 World Bank & IMF Classification of Countries...................................... 29 1.18 Inflation Indices............................................................................................ 30 1.19 Previous Years Questions........................................................................... 34 2 Money and Banking- Part I................................................................................... 37 2.1 Introduction................................................................................................... 37 2.2 Functions of Money..................................................................................... 39 2.3 Exchange Rate Systems.............................................................................. 39 2.4 Securities....................................................................................................... 41 2.5 Government Securities................................................................................ 45 2.6 Corporate Bond Market in India............................................................... 48 2.7 Financial Markets......................................................................................... 50 2.8 Types of Company........................................................................................ 51 2.9 Accounts and Deposits................................................................................ 52 2.10 Money Supply................................................................................................ 53 2.11 Money Circulation........................................................................................ 55 2.12 Money Creation............................................................................................. 58 2.13 Monetary Policy............................................................................................ 59 2.14 RBI and its Functions.................................................................................. 65 2.15 RBI’s sources of Income and Economic Capital Framework.............. 76 2.16 Crypto currency and Central Bank Digital Currency (CBDC)............. 77 2.17 Indian Financial System............................................................................. 80 2.18 National Strategy for Financial Inclusion (2019-24)............................ 87 2.19 Base Rate, MCLR and External Benchmark Rate.................................. 88 2.20 BASEL Norms................................................................................................. 92 2.21 Prompt Corrective Action (PCA)................................................................ 95 2.22 Systemically Important Financial Institutions..................................... 96 2.23 Foreign Investment...................................................................................... 97 2.24 Currency Swap and Forex Swap.............................................................. 101 2.25 GIFT (Gujarat International Financial Tech) City............................... 103 2.26 Strategic Disinvestment........................................................................... 104 2.27 Balance of Payment (BoP)......................................................................... 106 2.28 Liquidity Trap.............................................................................................. 111 2.29 Inflation........................................................................................................ 112 2.30 Phillips Curve.............................................................................................. 113 2.31 Previous Years Questions......................................................................... 114 3 Money and Banking - Part II............................................................................... 125 3.1 History of Indian Banking and Reforms................................................ 125 3.2 Relationship between RBI and Government of India......................... 130 3.3 Should large corporate be allowed to open their own banks?.......... 131 3.4 Financial Stability and Development Council (FSDC)........................ 133 3.5 Development Financial Institutions (DFIs)........................................... 133 3.6 Categorization of Loans............................................................................ 134 3.7 SARFAESI Act 2002................................................................................... 136 3.8 NPA Crisis and Bad Bank.......................................................................... 137 3.9 RBI Circular (June 2019) on Resolution of NPAs................................ 138 3.10 Insolvency and Bankruptcy Code 2016................................................. 139 3.11 Advance Pricing Agreement (APA).......................................................... 143 4 Government Budgeting........................................................................................ 146 4.1 Introduction................................................................................................. 146 4.2 Budget Procedure....................................................................................... 148 4.3 Government Accounts............................................................................... 150 4.4 Budget Classification................................................................................. 151 4.5 Government Deficits.................................................................................. 152 4.6 Fiscal Policy................................................................................................. 154 4.7 Fiscal Responsibility and Budget Management (FRBM) Act 2003... 156 4.8 Perspectives on Deficit and Debt............................................................ 158 4.9 Monetization of Deficit and Deficit Financing.................................... 164 4.10 Fiscal Council.............................................................................................. 165 4.11 India’s Tax System..................................................................................... 166 4.12 Goods and Services Tax (GST)................................................................. 173 4.13 Direct Tax Reforms.................................................................................... 180 4.14 Funds Transfer from Centre to States/UTs.......................................... 181 4.15 Previous Years Questions......................................................................... 186 5 Land Reforms......................................................................................................... 190 5.1 Land Rights before Independence.......................................................... 190 5.2 Land Reforms post-independence........................................................... 191 5.3 Land Acquisition Act 2013....................................................................... 195 5.4 Model Agricultural Land Leasing Act 2016........................................... 197 5.5 Land Pooling Policy.................................................................................... 199 5.6 Digitization of land records...................................................................... 200 5.7 Previous Years Questions......................................................................... 200 6 Indian Economy [1947 – 2014].......................................................................... 201 6.1 Impact of British Rule on Indian Economy.......................................... 201 6.2 Economy after Independence.................................................................. 202 6.3 Economic Situation after Nehru (1965 to 1991)................................. 210 6.4 Economic Reforms of 1991 (LPG Reforms)........................................... 213 6.5 Economy Jumped from Agriculture to Services.................................. 220 6.6 Planning Commission and Five Year Plans........................................... 222 6.7 Previous Years Questions......................................................................... 226 7 Indian Economy after 2014................................................................................ 227 7.1 NITI Aayog.................................................................................................... 227 7.2 Manufacturing............................................................................................. 228 7.3 Make in India............................................................................................... 230 7.4 Smart Manufacturing: Industry 4.0........................................................ 232 7.5 Micro Small and Medium Enterprises (MSME)..................................... 234 7.6 Index of Industrial Production and Core Industries........................... 237 7.7 Production Linked Incentive Scheme (PLIS)........................................ 238 7.8 Start-ups and Policy Enablers for Innovation...................................... 238 7.9 National Policy for Skill Development and Entrepreneurship......... 239 7.10 Land banks and National Single Window System (NSWS).................. 241 7.11 E-Commerce................................................................................................ 242 7.12 FDI in Retail................................................................................................ 243 7.13 FDI in Insurance......................................................................................... 244 7.14 Aatma Nirbhar bharat................................................................................ 245 7.15 Previous Years Questions......................................................................... 250 8 Inclusive growth and issues................................................................................ 251 8.1 Inclusive Growth......................................................................................... 251 8.2 Poverty Estimation in India..................................................................... 255 8.3 Demographic Dividend.............................................................................. 258 8.4 Labour Laws in India.................................................................................. 259 8.5 Fixed Term Employment.......................................................................... 265 8.6 Migrant Labour............................................................................................ 266 8.7 Employees’ Provident Fund Organization (EPFO)............................... 267 8.8 National/New Pension System (NPS)...................................................... 268 8.9 Informal and Formal Economy................................................................ 270 8.10 Unemployment and its types................................................................... 271 8.11 Underemployment...................................................................................... 273 8.12 PLFS and AQEES......................................................................................... 274 8.13 Rising Income Inequality.......................................................................... 275 8.14 Poverty Eradication: Public services or Income support.................. 277 8.15 Sustainable Development Goals (SDG)................................................... 278 8.16 Socio Economic Indicators....................................................................... 280 8.17 Previous Years Questions......................................................................... 282 9 Subsidies................................................................................................................. 284 9.1 Introduction................................................................................................. 284 9.2 Different ways of disbursing/implementing subsidies....................... 284 9.2.1 Price Subsidies......................................................................................... 285 9.2.2 Direct Benefit Transfer (DBT)............................................................... 285 9.2.3 Income Support....................................................................................... 286 9.3 Fuel Subsidies............................................................................................. 287 9.4 Fertilizer Subsidies.................................................................................... 287 9.5 Food Subsidy............................................................................................... 291 9.5.1 Food Corporation of India (FCI)........................................................... 292 9.5.2 Public Distribution System (PDS)........................................................ 294 9.5.3 National Food Security Act (NFSA) 2013........................................... 295 9.6 Shanta Kumar Committee Recommendations..................................... 297 10 Agriculture - Part I............................................................................................ 300 10.1 Introduction................................................................................................. 300 10.2 Agriculture in India: A brief history....................................................... 301 10.3 Minimum Support Price (MSP)................................................................. 305 10.4 PM – AASHA................................................................................................. 308 10.5 PM – KISAN.................................................................................................. 308 10.6 Agriculture Extension Services............................................................... 309 10.7 Krishi Vigyan Kendras (KVK)................................................................... 310 10.8 Farmers Producer Organization (FPO)................................................... 311 10.9 Marketing of Agricultural Produce......................................................... 313 10.9.1 Agriculture Produce and Marketing Committee (APMC) Acts... 313 10.9.2 Electronic - National Agriculture Market (e-NAM)........................ 314 10.9.3 [Model] Agri Produce and Livestock Marketing Act 2017.......... 316 10.10 Contract Farming....................................................................................... 316 10.11 Agriculture Based Clusters....................................................................... 319 10.12 Agriculture Infrastructure Fund.............................................................. 320 10.13 Animal Husbandry Infrastructure Development Fund....................... 321 10.14 Pradhan Mantri FasalBima Yojana (PMFBY)......................................... 321 10.15 Doubling Farmers’ Income....................................................................... 323 10.16 Agriculture Export Policy 2018............................................................... 325 10.17 A comparison of Indian Agriculture with China (2018-19)............... 328 10.18 Previous Years Questions......................................................................... 328 11 Agriculture - Part II........................................................................................... 331 11.1 Irrigation in India....................................................................................... 331 11.2 Farming System and Cropping Pattern in India.................................. 336 11.3 Food Systems.............................................................................................. 337 11.4 Animal Husbandry...................................................................................... 338 11.5 National Livestock Mission...................................................................... 340 11.6 Mission for Integrated Development of Horticulture (MIDH)........... 341 11.7 National Bamboo Mission......................................................................... 341 11.8 Genetically Modified (GM) Crops............................................................. 342 11.9 Organic Farming......................................................................................... 345 11.10 Zero Budget Natural Farming (ZBNF)..................................................... 348 11.11 Integrated Farming System (IFS)............................................................ 350 11.12 Agroecology.................................................................................................. 351 11.13 Conservation Agriculture.......................................................................... 352 11.14 Protected Cultivation................................................................................ 354 11.15 Permaculture............................................................................................... 356 11.16 Use of Technology in Agriculture............................................................ 357 11.17 Previous Years Questions......................................................................... 360 12 Supply Chain and Food Processing Industry............................................... 362 12.1 Supply Chain: An Introduction................................................................ 362 12.2 Food Processing Industry......................................................................... 363 12.3 Essential Commodities Act 1955............................................................ 367 12.4 Supply Chain Schemes.............................................................................. 368 12.4.1 Price Stabilization Fund (PSF)............................................................. 368 12.4.2 SAMPADA............................................................................................... 368 12.4.3 PM Matsya Sampada Yojana (PMMSY)............................................... 369 12.4.4 Formalization of Micro Food Processing Enterprises Scheme......... 369 12.4.5 Operation Greens (TOP)........................................................................ 370 12.5 Supply Chain Infrastructure for Food Processing Industry.............. 371 12.6 Warehouse Receipts................................................................................... 372 12.7 FSS Act 2006 and FSSAI........................................................................... 373 12.8 Previous Years Questions......................................................................... 374 13 International Organizations............................................................................ 376 13.1 Bretton Woods Conference....................................................................... 376 13.2 General Agreement on Tariffs and Trade (GATT) 1947...................... 376 13.3 WTO Agreements........................................................................................ 378 13.4 Principles of WTO Trade........................................................................... 379 13.5 Other Agreements on Goods trade......................................................... 380 13.5.1 Sanitary and Phytosanitary (SPS) Measures...................................... 380 13.5.2 Agreement on Agriculture (AoA)........................................................... 381 13.5.3 Information Technology Agreement (ITA)............................................ 382 13.6 Trade Related Investment Measures (TRIMS)...................................... 383 13.7 General Agreement on Trade in Services (GATS)................................ 384 13.8 Intellectual Property Rights (IPR)........................................................... 385 13.9 Trade Related Aspects of Intellectual Property Rights (TRIPS)....... 388 13.10 Generic Drugs and Compulsory Licenses.............................................. 389 13.11 National Intellectual Property Rights Policy 2016............................. 390 13.12 WTO – Doha Development Agenda.......................................................... 391 13.13 Free Trade Agreements (FTAs) and RCEP............................................. 393 13.14 International Monetary Fund (IMF) and World Bank.......................... 396 13.15 Asian Infrastructure and Investment Bank (AIIB)............................... 400 13.16 New Development Bank (NDB)/ BRICS Bank........................................ 401 13.17 Previous Years Questions......................................................................... 401 14 Infrastructure and Investment Models......................................................... 403 14.1 Infrastructure Development: An Introduction..................................... 403 14.2 Public Private Partnership (PPP)............................................................. 403 14.3 Investment Models in Infrastructure..................................................... 407 14.4 Road Sector.................................................................................................. 409 14.5 Railways........................................................................................................ 410 14.5.1 Engine of future Economic growth...................................................... 410 14.5.2 High Speed Rail (HSR)/ Bullet Trains in India.................................. 412 14.5.3 Dedicated Freight Corridors (DFCs).................................................... 414 14.5.4 Railway Platform Modernization.......................................................... 415 14.5.5 Rail Development Authority (RDA)...................................................... 415 14.6 Industrial Corridors................................................................................... 416 14.7 Special Economic Zones (SEZ)................................................................. 417 14.8 SAGARMALA, CEZ and Ports.................................................................... 419 14.9 Airports......................................................................................................... 422 14.10 Multi-Modal Logistics Park....................................................................... 425 14.11 Coal, Coal Mines Act 2015 and MMDR Act 2015................................ 427 14.12 Power Sector................................................................................................ 429 14.13 Oil and Gas Sector...................................................................................... 432 14.14 The Real Estate Act 2016......................................................................... 434 14.15 Smart Cities and AMRUT.......................................................................... 435 14.16 Value Capture Finance (VCF)................................................................... 437 14.17 InvITs and REITs and NIIF....................................................................... 438 14.18 National Infrastructure Pipeline (NIP).................................................... 439 14.19 National Monetization Pipeline (NMP)................................................... 440 14.20 PM Gati Shakti............................................................................................ 442 14.21 National Logistics Policy 2022................................................................ 443 14.22 Previous Years Questions......................................................................... 444 15 Budget and Economic Survey......................................................................... 445 15.1 Budget (2023-24) Highlights.................................................................... 445 15.2 Economic Survey 2022-23....................................................................... 449 16 Terminology........................................................................................................ 453 Fundamentals of Macro Economy 1 Fundamentals of Macro Economy 1.1 Introduction Economics is the study of how societies use scarce resources to produce valuable goods and services and distribute them among different individuals. Certain European and North American countries are very rich (per person income is high which leads to higher living standard) while countries in Africa and Latin America are poor. Have you ever thought of the basic reason behind it? Even if the African countries are very rich in mineral resources like coal, iron ore, other metals, they are quite poor, while if you see Japan, it has very fewer natural resources but it has high per capita income. The basic reason behind this difference in the standard of living of these countries is that the government and the people in these developed/rich countries have efficiently exploited the limited resources of land, labour and capital for the betterment and development of its people. Economics is divided into two major subfields, Microeconomics and Macroeconomics. Microeconomics is the study of decisions that people and businesses (individual economic agents) make regarding the allocation of resources and prices of goods and services. For example, the study of what mix of products an individual purchase with a given amount of money is part of microeconomic study. Microeconomics would look at how a particular company whether small or big can maximize its production and capacity so that it can lower prices and better compete with its competitors in its industry. Macroeconomics, on the other hand, is the study of the national economy as a whole. Macroeconomics examines a wide variety of areas such as how total investment and consumption in the economy are determined, how central banks manage money and interest rates, what causes international financial crises, how an increase/ decrease in net exports would affect a nation's capital account and why some nations grow rapidly while others stagnate. The study of variables at the country level such as Gross Domestic Product (GDP) and how it is affected by the changes in the unemployment rate, interest rate and price levels is part of the macroeconomic study. The UPSC syllabus is about macro economy, which is concerned with the overall performance of the economy. 1.2 Economic Organization (the three problems) Every human society - whether it is an advanced industrial nation, a centrally planned economy, or an isolated tribal nation - must confront and resolve three fundamental economic problems. Every society must have a way of determining what commodities are to be produced, how these goods are made, and for whom they are produced. Indeed, these three fundamental questions of economic organization - what, how, and for whom - are as crucial today as they were at the dawn of human civilization. Let's look more closely at them: 1 Fundamentals of Macro Economy What commodities are to be produced and in what quantity? A society must determine how much of each of the many possible goods and services it will make and when they will be produced. Will we produce pizzas or shirts today? A few high-quality shirts or many cheap shirts? Will we use scarce resources to produce many consumption goods (like pizzas)? Or will we produce fewer consumption goods and more capital goods (like pizza making machines), which will boost production and consumption tomorrow? How are the goods to be produced? A society must determine who will do the production, with what resources, and what production techniques they will use. Who does the farming and who teaches? Is electricity generated from oil, from coal, or from the sun? Will factories be run by people or robots? For whom are the goods to be produced? Who gets to eat the fruit of economic activity? Is the distribution of income and wealth fair and equitable? How is the national product divided among different households? Are many people poor and a few rich? Does high income go to teachers or athletes or autoworkers or capitalists? Will society provide minimal consumption to the poor, or must people work if they are to eat? 1.3 Economic Systems What are the different ways in which a society can answer the questions of what, how, and for whom? Different societies are organized through alternative economic systems, and economics studies the various mechanisms that a society can use to allocate its scarce resources. We generally distinguish two fundamentally different ways of organizing an economy. At one extreme, government makes most economic decisions, with those on top of the hierarchy giving economic commands to those further down the ladder. At the other extreme, decisions are made in markets, where individuals or enterprises voluntarily agree to exchange goods and services, usually through payments of money. Let's briefly examine each of these two forms of economic organization. In the United States, and increasingly around the world, most economic questions are settled by the market mechanism. Hence their economic systems are called market economies. A market economy is one in which individuals and private firms make the major decisions about production and consumption. A system of prices, of markets, of profits and losses, of incentives and rewards determines what, how and for whom. Firms produce the commodities that yield the highest profits (the what) by the techniques of production that are least costly (the how). Consumption is determined by individuals' decisions about how to spend the wages and property incomes generated by their labour and property ownership (the for whom). The extreme case of a market economy, in which the government keeps its hands-off economic decisions, is called a laissez-faire economy. By contrast, a command economy is one in which the government makes all important decisions about production and distribution. In a command economy, such as one which operated in the Soviet Union during most of the twentieth century, the government owns most of the means of production (land and capital); it also owns and directs the operations of enterprises in most industries: it is the employer of most of the workers and tells them how to do their jobs; and it decides how the output of the society is to be divided among 2 Fundamentals of Macro Economy different people. In short, in a command economy, the government answers the major economic questions of what, how and for whom, through its ownership of resources and its powers to enforce decisions. No contemporary society falls completely into either of these polar categories. Rather, all societies are mixed economies, with elements of market and command both. Today most of the decisions in the developed and developing economies are made in the market place. But the government also plays an important role in overseeing the functioning of the market; governments pass laws that regulate economic life, produce goods, educational and police services. Most societies today operate as mixed economies. Command/Socialist Economy Market/Capitalist Economy Mixed Economy 1.4 Four Sectors of Economy From the economic point of view, a mixed economy is divided into four sectors. 1. Private Sector: All the enterprises owned by the private individuals or group of individuals belong to the private sector. The private sector consists of companies/firms/enterprises in India which are not owned by the government. 2. Government Sector: This sector includes public administration, police, defence, framing of laws and enforcing them. Apart from imposing taxes and spending money on various infrastructure and healthcare services and education etc., government also undertakes production activity through its companies like Coal India Ltd. (CIL), National Thermal Power Corporation (NTPC) etc. So, all the companies owned by the Central or State Governments i.e. Public Sector Undertakings (PSUs) also belong to the government sector. 3. Household Sector: A group of persons who normally live together and take food from a common kitchen constitutes a household. The size of a household is the total number of persons in the household. We should always remember that households consist of people. These people work in firms as workers and earn wages. They are the ones who work in the government departments and earn salaries and they are the owners of firms and earn profits. So, all the human beings (population) belong to household sector. Suppose a person named "John" works in "Coal India Ltd. (CIL)" which is a government company then John belongs to the household sector and the company CIL belongs to the government sector. 3 Fundamentals of Macro Economy Reliance Industries Ltd. (RIL) is owned by Mukesh Ambani but Mukesh Ambani belongs to the household sector and the "RIL" (which is a passive object and on whose name all the business is being carried out) belongs to the private sector. 4. External Sector: This sector consists of the exports and imports of goods and services flowing into the country or out of the country. It also includes the financial flows from and into the domestic country. Let us understand in detail the private sector first. 1.5 Private Sector All the firms or enterprises owned by private individuals or entrepreneurs belong to private sector and their basic function is production of output i.e. goods and services. To produce output, any enterprise will require certain inputs. An enterprise may require one input or it may require hundreds of inputs to produce the desired output. All the inputs that an enterprise may require are broadly divided into four categories i.e. entrepreneur, capital, natural resources and labour. 4 Fundamentals of Macro Economy Figure: The four factors/inputs of production combining together to produce output and the classification of output (goods and services) into consumption and capital goods. The four inputs that an enterprise requires to produce output (goods and services) are called the four "factors of production" or the "inputs of production". These four factors of production are the following (as shown in the figure): 1. Entrepreneur: The person who takes the risk and starts a new business. This person takes the risk to bring in capital, labour and natural resources together in the form of an enterprise and in return expects "Profit". The entrepreneur is a human being and he belongs to the household sector. 2. Capital: In today's world, capital can be physical, financial or intellectual. But from an economic point of view, only the physical capital goods are considered as capital. So, capital includes the building, machinery, equipment etc. The return for the capital is called "Interest". 3. Natural Resources: Natural resources include land and raw materials which are naturally available and are not produced through manmade processes. The return for the natural resources is called "Rent". 4. Labour: It is the human labour which may be physical or mental i.e., it can be unskilled, semi-skilled or skilled. When a human being provides his labour to the enterprise, in return he/she expects “wages”. The labour (who is providing the labour services) is a human being and belongs to the household sector. 5 Fundamentals of Macro Economy 1.6 Types of Goods Intermediate goods These are semi-finished goods which have been produced by a process but cannot be used as it is and need to go through further production process to be converted into a final good. For example, steel sheets. The steel sheets cannot be used as it is and needs to be transformed into final products like automobiles, appliances etc. Final goods These goods do not undergo any further transformation in the production process. Final goods can be of two types consumption goods and capital goods. 1. Consumption Goods: Goods which are consumed by the ultimate consumers or meet the immediate need of the consumer are called consumption goods. They can be of three categories. (i) Durable Consumption Goods: Consumption goods which do not get exhausted immediately but last over a period of time are called consumer durables. Life of consumer durables is generally more than 3 years. For examples home appliances, consumer electronics, furniture etc. (ii) Non-Durable Consumption Goods: Consumption goods which get consumed immediately and whose life is generally less than 3 years. For example, cosmetics, food, fuel, paper, clothing etc. (iii) Services: Services are intangibles and are a kind of consumption goods only, as, it is consumed immediately. For example, education, banking, telecom, healthcare etc. 2. Capital Goods: A particular good will be capital in nature only if it possesses the following three characteristics: (i) It is a produced durable output of a man-made process (ii) It again acts as an input for further production process (to be sold in the market) (iii) While acting as an input, it does not get transformed or consumed For example, Tractor. Tractor must have been produced in a factory so it is a produced durable output. Tractor again acts as an input in the production of agricultural products like wheat and rice. And while acting as an input it does not get transformed and remains as it is. (Wear and tear of tractor happens over a long period of time but we cannot say that the tractor is getting transformed or consumed) In strict sense the economists consider only the physical capital as the capital but in today's world intangible capital is increasingly becoming important. So, capital can be divided into three categories. (i) Physical Capital (capital goods) (ii) Financial Capital (money) (iii) Intellectual Capital (patents, copyrights etc.) 6 Fundamentals of Macro Economy Consumption and Capital goods: A particular good can be consumption as well as capital good. For example, washing machine. When a person is using washing machine at his home for washing of his own clothes then it will act as consumption good. But if the same washing machine is purchased by a businessman for providing laundry services, then it is acting as a capital good. Because in the latter case, washing machine is being used to produce washed clothes for the market and not for own consumption. So, whether a good is consumption or capital also depends on the purpose for which it is being used. If a good is being used to produce some other goods/services to be sold in the market then it will be a capital good. For example, when we purchase a car for our home then it is consumption good but when "Ola Cabs" purchase a car to provide transportation services for the market then the car becomes a capital good. Intermediate and Final good: A particular good can be final as well as intermediate. For example, "tea leaves". When a person is purchasing the "tea leaves" for his home consumption purpose then the "tea leaves" will be a final good. But when a tea seller is purchasing the "tea leaves" to prepare "tea" and sell it in the market then "tea leaves" is intermediate good and the "tea" is the final good. The distinguishing characteristic whether a good is final or intermediate is "the last transaction in the market". In case of tea seller, the last transaction in the market is of tea, so "tea" is final good. But in case of the person purchasing tea leaves for home purpose, "tea leaves" is the last transacted good in the market, so "tea leaves" will be final good. 1.7 Investment That part of the final output which comprises of physical capital goods is called gross investment. So, investment in a country is not measured as money put in a business or any economic activity but it is basically that portion of the final output (GDP) which consists of capital goods. Consider the following diagram: Suppose there is only one factory (capital good) in a country, which is worth Rs. one lakh and is producing consumption goods worth Rs. 700 and capital goods worth Rs. 300 in a 7 Fundamentals of Macro Economy particular year (say 2019-20) in an economy. This means that the GDP in 2019-20 will be Rs. 1000 (which is the total production of both consumption and capital goods) and the gross investment in the economy will be Rs. 300 or (Rs 300/Rs1000) 30%, as investment is measured as the percentage of output which consists of capital goods. In the above example, if the country imports capital goods worth Rs. 100 in the year 2019- 20 then the gross investment will be Rs. 300 + Rs. 100 i.e. Rs. 400 and investment percent will be Rs. 400/ Rs. 1000 = 40%. This is because Rs. 400 worth of capital goods is getting added in the economy. But if we also export capital goods worth Rs 40 then the gross investment will be Rs. 300 + (Rs. 100 - Rs. 40) i.e. Rs. 360 and investment percent will be 36%. Investment in the economy is also called Gross Capital Formation. Gross Capital Formation = Gross Fixed Capital Formation (machinery + equipment + new construction + intellectual property) + Net acquisition of valuable Metals like gold, silver, platinum, gems and stones + Change in stock/inventory Now when the factory runs for a year then wear and tear happens in the factory which is called depreciation. Depreciation is also defined as consumption of physical capital. In the above example Rupees one lakh worth of capital goods produce Rs. 700 consumption goods and Rs. 300 capital goods, but during this production process suppose there is wear and tear of Rs. 50 in the factory. This implies that to produce Rs. 700 of consumption goods and Rs. 300 of capital goods there is a loss of Rs. 50 of capital goods in the economy i.e. net production of capital goods (investment) in the economy is Rs. 300 minus Rs. 50. Net Investment = Gross Investment - Depreciation = Rs. 300 - Rs. 50 = Rs. 250 The chart represents gross fixed capital formation (investment) of India in the last few years 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 30.10% 28.70% 28.20% 28.20% 29.50% 28.50% 27.30% 28.90% 29.20% 30.50% 30.00% 30.10% 29.50% Investment as % of GDP 29.50% 29.20% 29.00% 28.90% 28.70% 28.50% 28.50% 28.20% 28.20% 28.00% 27.50% 27.30% 27.00% 26.50% 26.00% 25.50% 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 8 Fundamentals of Macro Economy 1.8 Circular Flow For simplicity, let us assume that as of now there is no government and external sector and only the private sector and the household sector are present in the economy. Case I Assume that the household sector is not saving anything and hence all the goods and services produced by the private sector will be consumed by the household sector. (First A step will happen then B then C and then D) Expenditure Rs. 100 Suppose the enterprise produces the burgers as it is demanded by the people in the household sector. To produce the burger the enterprise will require certain inputs like entrepreneur (the owner of the enterprise), the capital (the machine to produce burger), the natural resources (land & water and other intermediate goods wheat, salt etc.) and labourers. The entrepreneur and the labourer belong to the household sector. Suppose the capital and the natural resources are also being provided by some individuals who belong to the household sector. So, all these four factor services (entrepreneur, capital, natural resources and labour) are being provided by the individuals belonging to the household sector and which has been represented in the above figure by arrow A. By using these inputs, suppose the enterprise produces a burger which it wants to sell in the market for Rs. 100 (Market Price = Rs. 100). Since the burger is sold in the market for Rs. 100, the whole amount of Rs. 100 generated from sale of the burger will be distributed among the people who are providing the four factor services i.e., entrepreneurship, labour, capital and natural resources. Since the burger is being produced with the contribution of these four factors (inputs), the Rs. 100 generated by selling it in the market will ultimately be distributed (by arrow B) among these four service providers as profit (say Rs. 40), wages (Rs. 10), rent (Rs. 20) and interest (Rs. 30) and will go to the household sector. Hence, interest, rent, wages and profit must add up to the value of the product produced i.e., Rs. 100. 9 Fundamentals of Macro Economy The household sector will now spend this Rs. 100 (by arrow C) to purchase the burger worth Rs. 100 produced by the enterprise and the enterprise will return (by arrow D) the burger of Rs. 100 to the household sector. The amount of money representing the aggregate (total) value of goods and services is moving in a circular way and hence it represents the circular flow of income in the economy. The two arrows on the top (C & D) represent the goods and services market - the arrow C represents the flow of payments for the goods and services, the arrow D represents the flow of goods and services to the household sector. The two arrows on the bottom (A & B) of the diagram similarly represent the factors of production market. The arrow A going from the households to the firms symbolises the services market that the households are providing to the enterprises and the enterprises are using these services for manufacturing the output. The arrow B going from the enterprises to the household sector represents the payments made by the firms to the households for the services provided by the household sector. The value of the burger i.e., Rs. 100 is called the Gross Domestic Product (GDP) of the country for that year. Since the amount of money representing the aggregate value of goods and services, is moving in circular way, if we want to estimate the aggregate value of goods and services (GDP) produced during a year, we can measure the annual value of flows at any of the lines indicated in the diagram. For example, if we measure the GDP by the aggregate value of spending that the firms receive for the final goods and services which they produce (by line C) then this method is called the expenditure method. If we measure the flow at D by measuring the aggregate value of final goods and services produced by all the firms, then it is called product method (value added). If we measure the total factor payments at B then it is called the income method. Thus, we can measure the aggregate output (GDP) in three ways. In the above case, the households were producing the burger and purchasing the same burger from the enterprise and consuming it. They were spending all their income earned during the production process on the purchase of goods and services. They were not saving at all. In such a situation, the production in the economy will remain stagnant i.e. they will produce the same one burger worth Rs. 100 each year and consume. Now, suppose the households want to increase their consumption of burgers. But this will be possible only when the private sector i.e. the enterprises produce more burgers. And the burger production can be increased only when there are more burger machines (capital goods) in the economy. Hence, the private sector must produce burger machines first in order to produce more burgers in future. Let us see how this is possible. Case II The household sector now decides to spend only Rs. 70 for its consumption purpose and save Rs. 30 out of the total Rs. 100 earned. The household sector will be providing the same factor services (their value of work done is same i.e. Rs. 100) and the enterprise will be producing goods in total worth Rs. 100 only 10 Fundamentals of Macro Economy but now the enterprise will produce burger worth Rs. 70 (because now the household sector wants to consume burgers worth Rs. 70 only) and other goods worth Rs. 30. By arrow B the enterprise will return Rs. 100 as factor payments to the household sector. The household sector will spend Rs. 70 through arrow C and the enterprise will return the burger worth Rs. 70 to the household sector through arrow D. This burger will be consumed by the household sector. Now there is Rs. 30 savings left with the household sector (which they may deposit in a financial institution like banks) and there is Rs. 30 (capital goods) lying with the enterprises. The other enterprises present in the private sector will borrow Rs. 30 (which the household sector has saved in banks) from banks and will purchase the Rs. 30 capital goods from the enterprises. The Rs. 30 goods produced by the enterprises will be capital good in nature and not a consumption good as it has been produced for the private sector (and not for the household sector). This Rs. 30 of capital goods (which may be burger machines) will help in increasing the production of burgers in future years. So, if the household sector will save Rs. 30, then the same value of capital goods will be produced in the economy. If the household sector buys only Rs. 60 consumption goods and saves Rs. 40 then the enterprises will produce Rs. 60 consumption goods for the household sector and the rest Rs. 40 goods they will produce for the private sector which will be capital goods. This implies that, savings is equal to the production of capital goods in the economy (when there is no government and external sector). So, if an economy wants to produce more capital goods, then it will have to save more also. Greater the saving in the economy, greater will be the production of capital goods. As we know, that portion of the final output which comprises of capital goods is also called investment, hence savings will be equal to investment and higher the savings, higher will be the investment. This shows that if an economy wants to produce more goods and services in future years then it must produce capital goods (i.e., investment) first, which in turn implies that the economy should save more. Higher the savings, higher will be the capital goods produced in the economy which will propel the economy on a higher growth path. 11 Fundamentals of Macro Economy When India got independence, our economy was producing 95% consumption goods and 5% capital goods i.e., savings was only 5%. At that time, we wanted to increase the output of the economy to serve millions of starving populations and hence we started saving more. More savings led to an increase in production of capital goods in the economy which further increased the production of goods and services. In 2019-20, India's savings was around 28% of the GDP which means India was producing around 72% consumption goods and 28% capital good i.e., investment. China has consistently been able to produce more than 40% capital goods out of the total output (GDP) of their economy which has propelled China into the fastest growing economies of the world. 1.9 Gross Domestic Product The total final value of goods and services produced within the domestic territory of a country in a specified time period (generally a financial year) is called Gross Domestic Product. GDP can be calculated by three methods: 1. The Product or Value-Added Method In this method we calculate the aggregate annual value of goods and services produced and to arrive at this we add up the value of all goods and services produced by all the firms in an economy. Let us take an example: Suppose there are only two kinds of producers in the economy. One is the farmer who produces wheat and the other is the baker who produces bread. Assume that the farmer who produces wheat do not require any input other than the physical labour. Suppose the farmer produces Rs. 100 worth of wheat, out of which he consumes Rs. 50 of wheat and sells Rs. 50 of wheat to the baker. And suppose the baker do not require any input other than the Rs. 50 wheat which he purchases from the farmer. The baker uses this Rs. 50 of wheat completely and produces bread worth Rs. 200. Farmer Rs. 50 + Rs. 50 (consumed) = Rs. 100 wheat produced Baker Purchase + Value Addition = Rs. 200 bread produced The farmer has produced Rs. 100 of wheat for which it did not need assistance of any inputs. Therefore, the entire Rs. 100 is rightfully the contribution or the value addition of the farmer. But the Rs 200 bread produced by the baker is not entirely his own contribution because to produce this bread the baker has purchased wheat from the farmer worth Rs. 50. So the value added by the baker will be equal to the value of production of the firm (baker) - value of intermediate goods used by the firm. Since, there are only two firms in the economy, one is baker and the other is farmer, to calculate the GDP we will add value addition by both these firms. GDP = Value addition by Baker + Value addition by Farmer = (Rs. 200 - Rs. 50) + (Rs. 100) = Rs. 150 + Rs. 100 = Rs. 250 12 Fundamentals of Macro Economy Value addition by the farmer is Rs. 100. Value addition does not depend on whether the farmer is selling the wheat in the market or consuming himself. Value addition is basically "the value/price that somebody's work will fetch in the market" and it includes profit also. By the standard definition, GDP should be equal to the final value of all goods and services produced in the economy. So, we can cross check the above example. GDP = Final value of all goods produced = Final value of wheat + Final value of bread = Rs. 50 + Rs. 200 = Rs. 250 (which is same as above calculated from the value-added method) Out of the Rs. 100 wheat produced by the farmer, only Rs 50 wheat consumed by the farmer is final good. The wheat that the farmer sold to the baker worth Rs. 50 is an intermediate good and not final good. 2. Expenditure Method An alternative way to calculate GDP is by looking at the expenditure side of all the sectors. Whatever goods and services are produced in the economy are ultimately purchased by the four sectors of the economy i.e. household sector, government sector, private sector and external sector. So, if we add the expenditures done by these four sectors on the purchase of final goods and services produced by the firms within the domestic territory then it shall be equal to the GDP of the country.  The household sector spends only on the consumption goods (denoted by C')  The private sector spends only on capital goods (investment) barring some exceptions when firms buy consumables to treat their guest or for their employees (denoted by I')  The Govt. sector purchase both capital and consumption goods (denoted by G')  The external sector also purchases both consumption and capital goods from our economy which is basically called the exports from India (denoted by X). GDP = C' + I' + G' + X = C - Cm + I - Im + G - Gm + X = C + I + G + X - (Cm + Im + Gm) = C + I + G + X - M GDP = C + I + G + X - M C', I' and G' are all expenditure on domestically produced final goods as we are trying to calculate GDP. And C, I and G are expenditure by the three sectors on domestic and imported both final goods.  Since C' is expenditure of household sector on domestically produced consumption goods, so this can also be written as expenditure on domestic and imported both consumption goods (C) - expenditure on imported consumption goods (Cm) i.e. C - Cm 13 Fundamentals of Macro Economy  Similarly, I - Im will represent the expenditure by private sector on domestically produced capital goods i.e. investment expenditure; and  G - Gm will represent the expenditure by government sector on domestically produced consumption and capital goods.  And Cm + Im + Gm represents the total imports by the country combining the household, private and government sector. The above formula of GDP can also be written as: GDP = Private consumption (C) + Private investment (I) + Government Investment and Consumption (G) + exports (X) - imports (M) GDP = [Private consumption + Government consumption] + [Private investment + Government investment] + Exports – Imports =Total consumption + Total Investment + Exports - Imports In GDP, the major component is private consumption which is around 60% of GDP, Government consumption is around 11%, total investment is around 29% and exports minus imports is around -2%. When, the government and the external sector are present in the economy, then the savings and investment may vary but an increase in savings generally leads to an increase in the investments and the circular flow will always hold true. Whatever income households receive, either they spend it for consumption or save it (S) or pay taxes (T). So, GDP = C + S + T C+I+G+X-M=C+S+T I+G+X-M=S+T (I - S) + (G-T) = M -X If there is no govt. and no external sector then, G = T = M = X = 0 and hence, I = S 3. Income Method It has already been stated in the beginning that the sum of the final goods produced in the economy must be equal to the income received by all the four factors of production i.e., wages, rents, interests and profits. This follows from the simple idea that the revenues earned by all the firms put together must be distributed to those who has contributed in the production process which are basically the four factors of production entrepreneurship, labour, capital and natural resources. GDP = Profit earned by all the firms + Interest received by all the capital deployed + Rent received for the natural resources + Wages earned by all the labourers GDP = Profit + Interest + Rent + Wages 14 Fundamentals of Macro Economy The concept of domestic territory (economic territory) is different from the geographical or political territory of a country. Domestic territory of a country includes the following:  Political frontiers of the country including its territorial waters.  Ships, and aircrafts operated by the residents of the country between two or more countries for example, Air India’s services between different countries.  Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of the country in the international waters or engaged in extraction in areas where the country has exclusive rights of operation.  Embassies, consulates and military establishments of the country located in other countries, for example, Indian embassy in U.S.A., Japan etc. It excludes all embassies, consulates and military establishments of other countries and offices of international organisations located in India. Thus, domestic territory may be defined as the political frontiers of the country including its territorial waters, ships, aircrafts, fishing vessels operated by the residents of the country, embassies and consulates located abroad etc. 1.10 GDP Calculation Methodology by NSO NSO calculates GDP by Value Added Method and Expenditure Method both. Under Value Added Method, it calculates the value addition done by various economic activities viz:  Agriculture, Forestry and Fishing  Mining and Quarrying  Manufacturing  Electricity, Gas, water supply and other utility services  Construction  Trade, Hotels and transport, and communication and services related to broadcasting  Financial, Insurance, real estate and professional services  Public administration and defence and other services Under Expenditure Method, it adds up the various components of expenditure viz:  Private (Final) Consumption Expenditure (it is basically household expenditure)  Government (Final) Consumption Expenditure  Gross Fixed Capital Formation (Investment expenditure of private and government)  Net of Exports and Imports Though GDP measured from either side should be equal, since reliable data is not available for private consumption expenditure, there is always a difference in the two ways of measuring GDP. The difference is usually put as “discrepancies” in the expenditure approach of measuring GDP. GDP of India = All States Gross Domestic Product (SGDP) + Output from Centre specific activities like Railways, Defence, Central Highways etc. + Embassies located in other countries + Fishing vessels, oil and natural gas rigs, floating platforms etc. operated by the residents of the country in the international waters. 15 Fundamentals of Macro Economy 1.11 Macroeconomic Variables Gross Domestic Product (GDP) measures the aggregate/total production of final goods and services taking place within the domestic territory of the country during a year. But it may be possible that the foreign nationals working within India have contributed in that GDP production. So, now we are interested in measuring the output/earnings made by Indian residents only whether in India or abroad which is termed as Gross National Product (GNP). GNP is that income or product which accrues to the economic agents who are residents of the country. (i.e., income earned by the Non-Resident Indians (NRIs) will not be part of India's GNP). To calculate GNP, we add the factor income of Indians from abroad in GDP and subtract the contribution of foreigners in India's GDP. Gross National Product (GNP) = GDP + Factor income earned by the 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 employed in the domestic economy GNP = GDP + Net factor income from abroad (NFIA) Factor income is basically the income earned by the four factors of production i.e., profit, rent, interest and wages but it does not include the transfer payments. Hence GNP is the sum of GDP and factor income and it does not include transfer payments (free money) received from the rest of the world (for example remittances). National Disposable Income = National Income + Transfer payments The figure below presents a diagrammatic representation of the relations between the various macroeconomic variables. NFIA Depreciation Depreciation Indirect Taxes - Indirect Subsidy Taxes - GNP Subsidy GDP (Gross NNPMP National (National NNPFC NDPMP Income) Income or NDPFC Net National Income) Gross Domestic Product (GDP) + NFIA = Gross National Product (GNP) Gross Domestic Product (GDP) - Depreciation = Net Domestic Product (NDP) Gross National Product (GNP) - Depreciation = Net National Product (NNP) 16 Fundamentals of Macro Economy "Gross National Product (GNP) is also called Gross National Income; and Net National Product (NNP) is also called Net National Income or just National Income." Let us try to understand the Factor Cost and Market Prices Suppose few people produced a burger and they wanted to sell it in the market at Rs. 100 i.e. they want Rs. 100 for their effort in the production of burger. This means that the total factor cost of the burger which is equal to profit plus interest plus rent plus wages shall be equal to Rs. 100. So in this case GDP at Factor Cost will be equal to Rs. 100. But when they went to the market to sell the burger, government imposed an indirect tax of Rs. 10 on the burger. So now they will have to sell the burger in the market at a price of Rs. 110, so that they can fetch Rs. 110 from the market out of which they will keep Rs. 100 for themselves (factor cost) and Rs. 10 will be given to the government as tax. So, Market Price = Factor Cost + Indirect Tax = Rs. 100 + Rs. 10 = Rs. 110 Similarly, if government gives subsidies, Market Price = Factor Cost - Subsidies Hence, Market Price = Factor Cost + (Indirect Taxes- Subsidies) In India (since January 2015 onwards) we calculate GDP at Market Prices rather than at Factor Cost. The way we are calculating GDP at MP and FC, similarly NDP can also be calculated at MP and FC and GNP and NNP can also be measured at MP and FC. Per capita GDP: If the population of the country in any particular year say 2020-21 is P and the GDP is Y then per capita (i.e. per person) GDP will be Y/P. Now, if the population growth of our country is say 1% (in 2021-22) and GDP growth of the country is say 8% (in 2021-22) then per capita GDP in 2021-22 will be (1.08 Y)/ (1.01 P) = 1.069 Y/P. Hence, in percentage terms per capita GDP growth in 2021-22 will be 6.9%. Year 2020-21 2021-22 GDP Y 1.08 Y Population P 1.01 P Per capita GDP Y/P 1.08 Y/ 1.01P Per capita GDP Growth 1.08/1.01 (= 6.9%) 1.12 Nominal and Real GDP Real GDP growth measures growth in quantity only and nominal GDP measures growth in value (which includes quantity and prices both). Now, suppose an economy produces wheat and rice. The quantities produced and the market price is given in the table. 17 Fundamentals of Macro Economy 2011-12 2012-13 2013-14 2014-15 Wheat 10kg X Rs. 11kg X Rs. 12kg X Rs. 12.5kg X Rs. 12/kg 10/kg 10.5/kg 11/kg Rice 8kg X Rs. 12/kg 9kg X Rs. 10kg X Rs. 10.5kg X Rs. 13.5/kg 12.5/kg 13/kg Nominal 10X10 + 8X12 = 11X10.5 + 12X11 + 10X13 12.5X12+ 10.5X13.5 GDP Rs. 196 9X12.5 = Rs. 228 = Rs. 262 = Rs. 291.75 To calculate Real GDP, we take the price of any year as constant and declare it as a base year. So, suppose we declare 2011-12 as base year then we will take price of wheat as Rs. 10/kg and price of rice as Rs. 12/kg as constant in all the subsequent years to calculate the real GDP in the following years. Real 10X10 + 8X12 11X10 + 9X12 = 12X10 + 10X12 12.5X10 + 10.5X12 = GDP = Rs. 196 Rs. 218 = Rs. 240 Rs. 251 Since January 2015, National Statistical Office (NSO) under the Ministry of Statistics and Programme Implementation (MoSPI) has changed the base year for calculation of GDP to 2011-12. So, if we want to calculate India's Real GDP for 2014-15, we will have to take the quantities produced in 2014-15 and the prices of 2011-12 (base year). And if we want to calculate the Nominal GDP of 2014-15 then we will have to take the quantities produced in 2014-15 and the market prices of the same year i.e., 2014-15. Before 2015, NSO was not using market prices to calculate GDP, rather it was using Factor Cost i.e., Market Price excluding indirect taxes and subsidies. Now, as per the global best practices and the IMF's World Economic Outlook projections based on GDP at market prices, India has changed its methodology of GDP calculation at market prices. In India, economic growth is measured by real GDP i.e., GDP at constant Market Prices. Consider the above table once again. 2011-12 2012-13 2013-14 2014-15 Nominal GDP Rs.196 Rs.228 Rs.262 Rs.291.75 Change in Nominal GDP 16.3% 14.9% 11.4% Real GDP Rs.196 Rs.218 Rs.240 Rs.251 Change in Real GDP 11.2% 10.1% 4.6% 18 Fundamentals of Macro Economy So, economic growth from 2011-12 to 2012-13 will be measured by change in Real GDP (and not nominal GDP) which is 11.2 % In the above example, Real GDP is steadily/consistently increasing from 2011-12 to 2014- 15 but "change in real GDP" is decreasing from 11.2% to 4.6%. (And same is true for nominal GDP also). Above is a case of economic growth as real GDP is increasing. To calculate GDP at market prices, first we calculate GDP at factor cost/basic prices and then we separately add the governments total indirect taxes including both GST and non- GST tax revenue of Central and State governments. Let us take an example: Suppose there is a farmer who sold wheat in Rs. 100 which then was purchased by ITC which converted wheat into flour (Aashirwaad atta) and sold it in Rs. 500 to a restaurant. The restaurant converted flour into chapati and sold the chapati in Rs. 1000 to a customer in the restaurant. The customer in total paid Rs. 1100 (i.e. Rs. 1000 plus 10% tax) If we have to calculate GDP at market price, first we will calculate GDP at factor cost/basic prices and then add separately the taxes. GDPMP = GVA factor cost/basic prices + Indirect taxes – Subsidies GVA by farmer (agriculture sector) = Rs. 100 GVA by ITC (Industrial sector) = Rs. 500 – Rs. 100 = Rs. 400 GVA by Restaurant (Service sector) =Rs. 1000 – Rs. 500 = Rs. 500 GVA factor cost/basic prices = Rs. 100 + Rs. 400 + Rs. 500 = Rs. 1000 Indirect taxes – subsidy = Rs. 100 GDPMP = Rs. 1100 There is a slight difference between GVA basic prices and GVA factor cost. GVA basic prices = GVA factor cost + Production Taxes - Production subsidies GDPMP = GVA basic prices + product taxes - Product subsidies Land revenue is a kind of production tax and railway subsidies are a kind of production subsidies. Production taxes and production subsidies are independent of the volume of actual production. Production taxes – Production subsidies are negligible as compared to other parameters, so we can ignore it and hence for all practical purposes, we can say that GVA basic prices = GVA factor cost As per the second advance estimates released by NSO, the GDP of India at current market prices (nominal) is around Rs. 272 lakh crores for 2022-23 as against Rs. 235 lakh crores in 2021-22 showing a (nominal) growth of 15.9 percent. 19 Fundamentals of Macro Economy The GNP of India at current market prices (nominal) is around Rs. 267 lakh crores for 2022-23. GDP of India at constant market prices (2011-12) in the year 2022-23 is around Rs. 160 lakh crores as against Rs. 149 lakh crores in 2021-22, showing a growth of 7 percent. The following chart represents Real GDP growth rate of India in the last few years. 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 7.40% 8.00% 8.30% 6.80% 6.50% 3.90% -5.80% 9.10% 7.00% 10.00% Real GDP growth 9.10% 8.00% 8.00% 8.30% 7.40% 7.00% 6.80% 6.50% 6.00% 4.00% 3.90% 2.00% 0.00% 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 2020-21 2021-22 2022-23 -2.00% Year -4.00% -6.00% -5.80% -8.00% 1.13 Productivity, Capital Output Ratio and ICOR First let us develop the general concept of average productivity and marginal productivity. 1 Acre Land 5 Labourers 2 Tonne production If one acre of land produces 2 Tonnes of food grains, then; Productivity of Land = Output =2 Tonne = 2 Tonne/acre Input (land) 1 acre Productivity of Labour = Output = 2 Tonne = 0.4 Tonne/labour Input (labour) 5 labourer The above two are basically average productivity. 20 Fundamentals of Macro Economy If by adding one extra labour, production increases by 0.2 tonne, then Marginal productivity of labour = change in output = 0.2 tonne = 0.2 tonne/labour change in labour 1 labour Similarly, we can calculate productivity of capital = Output Capital Higher is the productivity of capital, it is good for the economy. The inverse of “productivity of capital” is Capital/Output ratio. Capital output ratio is the ratio of capital to output. It measures how much of capital is required per unit of output. So, if more capital is required per unit of output, then the capital is less efficient. Hence, it also measures (average) efficiency of capital (but it is inverse of productivity/efficiency). Capital Output Ratio = Capital Output Higher the capital/output ratio, it is bad for economy. If Capital/Output ratio is 3/1, that means Rs. 1 unit of output is produced from Rs. 3 units of capital. And if Capital/Output ratio is 4/1, that means to produce Rs. 1 unit of output, Rs. 4 units of capital is required. So, 3/1 is better than 4/1 for the economy. We measured capital/output ratio because we are not interested in measuring the productivity of capital rather, we want to know that in India how much (average) capital is required to produce one unit (Rupee one) of output/GDP. Our target variable is “output/GDP” and we are always interested in knowing that if we have to produce one unit of output then how much capital will be required. So, now we are more interested in knowing that how much new/additional capital (in value/rupee) will be required to increase the output by one more unit (in rupee). This is because whenever a new government comes, it tries to attract new investment and hence it is more interested in knowing that if it has to increase the GDP by one additional unit then how much additional capital will be required. And for that we have another term called Incremental Capital Output Ratio (ICOR). (Our target variable is GDP/Output, so we/Govt. is always interested in knowing that how much extra capital will be required to produce one extra unit of output rather than the other way around). Incremental Capital Output Ratio (ICOR) is defined as how much additional capital will be required to produce one additional unit of output. ICOR = change in capital = (change in capital/GDP) = investment % in GDP change in output (change in output/GDP) % change in GDP 21 Fundamentals of Macro Economy ICOR represents how efficiently the new/additional capital is being used in a country to produce output. If ICOR of India = 5, that means India requires Rs. 5 value of extra capital goods to produce Rs. 1 of additional output. Investment % in GDP = “ICOR” X “% change in GDP” From the above formula, if our ICOR is 5 and we want economic growth of 8% then we will have to do 40% investment. But if somehow, we are able to reduce our ICOR to 4 (by making ourselves more efficient) then we can achieve the same 8% economic growth with just 32% of investment. The incremental capital output ratio is a catch-all expression. It depends upon a multiple number of factors such as governance, quality of labour which again depends on education and skill development levels, and technology etc. For example, if the labour is not skilled and he is not able to use the machines properly then our output produced will be less and our ICOR will increase even if there is no problem with the machine/capital. 1.14 Potential GDP Potential GDP is the real value of goods and services that can be produced when a country's factors of production are fully employed. It is the maximum sustainable level of output that an economy can produce. When an economy is operating at its potential (trend), there are high levels of utilization of the labour force and the capital stock. Potential output is determined by the economy's productive capacity which depends upon the inputs available (capital, land, labour etc.) and the economy's technological efficiency. Potential GDP tends to grow slowly because inputs like labour and capital and the level of technology changes quite slowly over time. Potential GDP growth also changes slowly with time depending on various factors like political set up, governance, infrastructure, health and education of the people, utilization of capital etc. As per economic survey 2015-16, the potential GDP growth of our country is between 8% to 10%. Actual GDP is subject to business cycle swings i.e. the cycles of upturn and downturn. During downturn, the actual GDP falls below the potential level and during upturn, the actual GDP rises above the potential GDP level. Technically, a recession is defined as (at least) two consecutive quarters of negative economic growth as measured by a country's real GDP. A recession is a period of significant decline in total output, income and employment, usually lasting from 6 months to 18 months and marked by widespread contractions in many sectors of the economy. A severe and protracted recession is called depression. Economic (growth) slowdown is generally considered as the phase when GDP growth rate of the economy is declining but it may still be positive. 22 Fundamentals of Macro Economy (Real) GDP Trend (Potential) GDP Actual GDP Upturn Downturn 2010 2015 2020 2025 Year Let us take an example to understand recession. Year 2012 2013 2014 2015 Real GDP Rs.100 Rs.108 Rs.112 Rs.115 Real GDP growth 8% 3.7% 2.7% In the above example the country is not going through any recession as real GDP (output) of the economy is still increasing even if the growth rate of GDP is decreasing. The recession occurs when the growth rate of GDP becomes negative or output starts decreasing. The above is a case of economic (growth) slowdown and not recession. India has faced recession five times in 1957-58 (-1.2%) [Drought], 1965-66 (-3.66%) [drought/war], 1972-73 (-0.32%) [drought/Oil crisis] and 1979-80 (-5.2%) [Drought/political instability] and 2020-21 (-6.6%) [Covid-19]. 1.15 Nominal, PPP and Real Exchange Rates 1. Nominal Exchange Rate (NER) NER = Price of one currency in terms of another currency. For example, if we can purchase one dollar by paying rupees 70 in the market, that means NER is: $1 = Rs. 70 Now this exchange rate can also be written as Rs. 70/$ or $.014/Rs. But the standard followed is ‘abroad’ with respect to ‘domestic’. So, we will use the standard format: So, $1 = Rs. 70, means NER is “$.014 per Rs”. The NER depends on the market forces of demand and supply. If more and more people are purchasing dollars in the exchange market, then the demand of dollar increases and dollar will become stronger or appreciate. But if more and more tourists are coming to India and are converting their dollars and demanding rupees then rupee will appreciate. 23 Fundamentals of Macro Economy 2. Purchasing Power Parity (PPP) Exchange Rate Suppose NER is $1 = Rs.70 and India and US produce just one burger each which are exactly same in quantity and quality. India US And, Burger Price is Rs. 35 $1 PPP exchange rate means that if $1 can purchase one burger in US then that same burger can be purchased in how many rupees in India. To calculate PPP exchange rate in the above case, we just need to compare the prices of the burger in both the countries. In the above case by comparing the prices of burger in India and US, we get, $1 = Rs. 35. So, $1 = Rs. 35 is the PPP exchange rate (or it can also be written as $.028/Rs). This implies that whatever Rs. 35 can purchase in India, the same item/items can be purchased in US in $1 i.e., purchasing power of Rs. 35 in India is equal to purchasing power of $1 in US. Or we can also say that purchasing power of $.028 in US is equal to purchasing power of Rs. 1 in India, so PPP exchange rate is $.028 per Rs. So, PPP exchange rate is: $ 1 = Rs. 35 i.e. $ (1/35) per Rs i.e. $ 0.028 per Rs So, PPP exchange rate can be derived as = Abroad Price/Domestic Price (We can write it as domestic price/abroad price also, but standard is abroad/domestic). Above example was a case of just one product. But, if both the countries are producing several commodities then to calculate PPP exchange rate, consider the same basket of commodities which are produced in both the countries and compare the prices, whatever we will get that will be PPP exchange rate. For example, consider the following: India US Consider a basket of Consider the same basket one unit each of 100 of one unit each of 100 commodities commodities Suppose the price of the basket of commodities in India is Rs 2000 and the price of the same basket of commodities in US is $100. This means that purchasing power of Rs. 2000 in India is same as purchasing power of $100 in US. So, PPP exchange rate will be $ 100 = Rs. 2000 i.e. $1 = Rs. 20 i.e. $.05 per Rs. (Abroad Price/Domestic Price) This means that whatever we can purchase in Rs. 1 in India, the same items can be purchased in $.05 in US. 24 Fundamentals of Macro Economy If the inflation rate is different in both the countries then PPP exchange rate will change with time. But if both countries have same rate of inflation or zero inflation then PPP exchange rates will remain constant. When Nominal Exchange Rate becomes equal to PPP exchange rate, we say that the currencies of the two countries are at purchasing power parity. As per IMF "The purchasing power parity between two countries is the rate at which the currency of one country needs to be converted into that of a second country to ensure that a given amount of the first country's currency will purchase the same volume of goods and services in the second country as it does in the first." 3. Real Exchange Rate (RER) Consider the above example of burger: NER: $1 = Rs. 70 ($.014/Rs) India US 1 burger 1 burger = Rs. 35 = $1 In the above example, we can see that burger is costing $1 in US while in India burger can be purchased in Rs. 35 or $0.5. So, we can say that Indian burgers are cheaper or Indian burgers are more competitive and hence in the above case India will export burgers while US will import burgers. So, let us calculate trade competitiveness i.e., which country’s trade is more competitive? Trade competitiveness will depend on three parameters:  Price of burger in India (Domestic Price)  Price of burger in US (Abroad Price)  Nominal Exchange Rate (NER) As we are following the standard ‘Abroad with respect to domestic’, so we will calculate trade competitiveness of US with respect to India. Trade competitiveness of US w.r.t. India Price of burger in India 1/Price of burger in US Nominal Exchange Rate So, Trade competitiveness of US w.r.t. India = Domestic Price X Nominal Exchange Rate Abroad Price = Nominal Exchange Rate (Abroad price/Domestic price) 25 Fundamentals of Macro Economy = NER PPP = Rs. 35 X $.014/Rs. $1 = 1/2 And this is also called ‘Real Exchange Rate’ (RER) i.e., RER = NER/PPP (US w.r.t. India)  Trade competitiveness of US w.r.t. India is ½ (1), this means that US products are twice competitive as compared to India which means that in any amount of money if we are able to purchase certain items from India, then in the same money we will be able to purchase twice the number of items in US.  And one thing we need to understand that if some currency is appreciating then it means that its value is increasing and it will be costlier to purchase that currency and hence its costlier to purchase the goods from that country (by purchasing that country’s currency) and then we say that that country’s trade is becoming less competitive. So, when a currency appreciates (either in real or nominal terms) then it means that its trade is becoming less competitive.  In the case of NER, if the exchange rate is $.014/Rupee and if its value is increasing to $.028/Rupee that means we are getting more dollars per rupee and hence we say that rupee is appreciating and this means that rupee trade is becoming less competitive.  In the same way, if the value of ½ (abroad w.r.t. domestic) in case of real exchange rate is increasing that means rupee is appreciating and since rupee is appreciating, so Indian trade is becoming less competitive or US trade is becoming more competitive.  Now if we want to create an index of real exchange rate and represent the value ½ with 100, then if ½ is increasing (Refer the figure below) that means the real index number 100 will increase, and we will say that rupee is appreciating (in real terms) and rupee (Indian) trade is becoming less competitive.  And if ½ is decreasing then the number 100 will decrease (Refer the figure below) which will mean that rupee is depreciating in real terms and hence (Indian) exports will become more competitive. So, real exchange rate tells about the trade competitiveness and it already includes the effect of nominal exchange rate. 26 Fundamentals of Macro Economy  If India wants to measure its export competitiveness with respect to its trading partners with just one parameter, then it calculates Real Effective Exchange Rate (REER) which is a weighted average (with respect to trade value) of the Real Exchange Rates of its trading partners. Similarly, if India wants to calculate its nominal exchange rate with respect to a group of other countries, then it can calculate Nominal Effective Exchange Rate (NEER).  When Real Exchange Rate = 1, Nominal Exchange Rate = PPP Exchange rate, and we say that the currencies are at purchasing power parity. This means that goods cost the same in two countries when measured in the same currency.  From the below figure we can see that from Dec 2017 to Oct 2018, the index value is decreasing that means rupee has depreciated in both REER and NEER terms that means ‘trading partners’ trade has become less competitive and India’s trade has become more competitive. And from Oct 2018 to January 2019, rupee has appreciated in both REER and NEER terms. Figure: Movement of Indices in REER and NEER (2017-18 = 100) 1.16 GDP, Welfare, Development and Human Capital GDP measures the total market value of goods and services produced in an economy in a year. It does not claim to measure welfare or wellbeing or inequality or happiness. An economy can have rising levels of inequality, falling levels of democratic norms, falling levels of civil liberties, increasing air and water pollution, worsening gender equality etc. and still have rising levels of GDP. The question is: Does the existence of any (or all) of these ills imply that GDP is a faulty measure of “the total market value of all final goods and services”? The answer is: No. 27 Fundamentals of Macro Economy The GDP is a simple measure and criticizing it by judging it based on social or moral norms would be completely missing the point of using GDP. It is true that GDP often fails to account for all the things that bring down our welfare and diminish our wellbeing. For instance, damage done by the use of fossil f

Indian Economy PDF 7th Edition 2023-24

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