Four switches: gross/net, domestic/national, market price/factor cost
Each aggregate is named by three words. Change one word = one adjustment.
- Gross → Net: subtract depreciation (consumption of fixed capital).
- Domestic → National: add NFIA. Domestic = produced inside the economic territory. National = earned by normal residents, anywhere.
- Market price → Factor cost: subtract net indirect taxes (NIT = indirect taxes − subsidies).
Net factor income from abroad (NFIA)
NFIA = factor income earned by our residents from abroad − factor income paid to non-residents in our country. It includes compensation of employees, rent, interest, profit and retained earnings. It can be negative.
Economic territory and normal resident
Economic territory includes embassies of India abroad, Indian ships and aircraft operating between countries, and fishing vessels and oil rigs in international waters run by Indian residents. It does not include foreign embassies in India. A normal resident is a person or institution whose centre of economic interest lies in the country (usually living there one year or more).
The eight aggregates
| Aggregate | Formula | Our numbers |
|---|---|---|
| GDPmp | start | 1000 |
| NDPmp | GDPmp − Dep | 900 |
| GNPmp | GDPmp + NFIA | 980 |
| NNPmp | GNPmp − Dep | 880 |
| GDPfc | GDPmp − NIT | 920 |
| NDPfc (domestic income) | GDPmp − Dep − NIT | 820 |
| GNPfc | GDPmp + NFIA − NIT | 900 |
| NNPfc (National Income) | GDPmp − Dep + NFIA − NIT | 800 |
(Dep = 100, NFIA = −20, NIT = 80.)
Real GDP, nominal GDP and the GDP deflator
Nominal GDP = output valued at current year prices. It can rise because output rose or because prices rose.
Real GDP = output valued at constant (base-year) prices. It rises only if output rises. So real GDP is the better measure of growth.
GDP deflator = (Nominal GDP ÷ Real GDP) × 100. It shows the change in the price level of all goods and services produced. Deflator 200 means prices are double the base year.
Example: base year 10 pens at ₹10 (GDP 100). Current year 12 pens at ₹20. Nominal = 240, real = 12 × 10 = 120, deflator = 200. Real growth = 20%.
GDP and welfare
Welfare means the well-being of people. GDP per person is often used as a rough guide, but it has limits:
- Distribution of GDP: if GDP rises but most of it goes to a few rich people, most people may not be better off.
- Non-monetary exchanges: home cooking, caring for elders, barter in villages are not counted, so GDP under-states welfare.
- Externalities: benefits or harms to others not paid for. A factory's pollution harms health but is not subtracted from GDP (negative externality). A garden that others enjoy is not added (positive externality).
- Also: what is produced (weapons vs medicines) and population growth matter.
Key formulas and definitions
- NDP = GDP − Depreciation
- GNP = GDP + NFIA
- Factor cost = Market price − Net indirect taxes
- NIT = Indirect taxes − Subsidies
- National Income = NNPfc = GDPmp − Dep + NFIA − NIT
- GDP deflator = (Nominal GDP ÷ Real GDP) × 100
Worked examples
1. GDPmp = ₹5000 cr, depreciation 400, NFIA 100, indirect taxes 350, subsidies 50. Find national income.
NIT = 350 − 50 = 300. NNPfc = 5000 − 400 + 100 − 300 = ₹4400 cr.
2. NNPfc = 2000, NIT = 150, depreciation = 200, NFIA = −50. Find GDPmp.
Work backwards: GDPmp = NNPfc + NIT + Dep − NFIA = 2000 + 150 + 200 − (−50) = 2400.
3. Factor income from abroad 80, factor income to abroad 120. Find NFIA and say whether GNP is more or less than GDP.
NFIA = 80 − 120 = −40. GNP = GDP − 40, so GNP is less than GDP.
4. Nominal GDP ₹600 cr, real GDP ₹400 cr. Find the GDP deflator.
Deflator = 600 ÷ 400 × 100 = 150. Prices are 50% above the base year.
5. Real GDP ₹800 cr, deflator 125. Find nominal GDP.
Nominal = Real × Deflator ÷ 100 = 800 × 1.25 = ₹1000 cr.
6. Base year: 100 kg rice at ₹20. Current year: 110 kg at ₹30. Find nominal GDP, real GDP, deflator and real growth.
Nominal = 110 × 30 = 3300. Real = 110 × 20 = 2200. Deflator = 3300 ÷ 2200 × 100 = 150. Real growth = (2200 − 2000) ÷ 2000 = 10%.
7. GDP of a country rose 8% but the richest 1% got almost all of the increase, and river pollution doubled. Has welfare risen?
Not necessarily. Unequal distribution means most people gained little, and the negative externality (pollution) lowers well-being, which GDP does not subtract.
Common mistakes
- Adding depreciation to go from gross to net. You must subtract it.
- Subtracting indirect taxes but forgetting to add back subsidies. Use NIT = indirect taxes − subsidies.
- Treating a rise in nominal GDP as growth in output. Remove price change first with real GDP.
- Thinking income of a foreign embassy in India is part of India's domestic product. Foreign embassies are not in our economic territory.