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Some Macroeconomic Identities: GDP Deflator’s Role in Price Changes

December 5, 2023 1104 0

Macroeconomic Insights: GDP Deflator’s Impact on Economic Distribution

There are various macroeconomic identities and concepts related to national income measurement, including Gross National Product (GNP), Net National Product (NNP), National Income (NI), Personal Income (PI), and Personal Disposable Income (PDI). 

These identities help in understanding how income is distributed within an economy and how it is affected by various factors like depreciation, taxes, subsidies, and transfers.

  • Gross National Product (GNP): GNP represents the total economic output produced within a country, including income earned by domestic factors of production abroad minus income earned by foreign factors of production within the country.
  • It is calculated as GDP plus net factor income from abroad.

GNP = GDP + Net Factor Income from Abroad

  • Net National Product (NNP): NNP is obtained by subtracting depreciation (wear and tear of capital) from GNP. 
  • Depreciation does not contribute to anyone’s income, so it is deducted to obtain a more accurate measure of income.

NNP = GNP – Depreciation

  • National Income (NI): NI is NNP evaluated at market prices, taking into account indirect taxes and subsidies.
    • It represents the income that accrues to factors of production within the country.

NI = NNP at Market Prices – Net Indirect Taxes (Indirect Taxes – Subsidies)

Note

  • All these variables are evaluated at market prices. 
  • We get the value of NNP evaluated at market prices. 
  • But market price includes indirect taxes.
  • Indirect Taxes: When indirect taxes are imposed on goods and services, their prices go up. Indirect taxes accrue to the government. 
    • We have to deduct them from NNP evaluated at market prices in order to calculate the part of NNP that actually accrues to the factors of production.
  • Subsidies: Similarly, there may be subsidies granted by the government on the prices of some commodities (in India petrol is heavily taxed by the government, whereas cooking gas is subsidised).
    • So we need to add subsidies to the NNP evaluated at market prices. 
  • National Income: The measure that we obtain by doing so is called Net National Product at factor cost or National Income.

 

National Disposable Income = Net National Product at market prices + Other current transfers from the rest of the world

The idea behind National Disposable Income is that it gives an idea of what is the maximum amount of goods and services the domestic economy has at its disposal. 

Current transfers from the rest of the world include items such as gifts, aids, etc.

Private Income = Factor income from net domestic product accruing to the private sector + National debt interest + Net factor income from abroad + Current transfers from government + Other net transfers from the rest of the world.

Personal Income (PI): PI is the income received by households from NI.

  •  It is calculated by deducting undistributed profits, corporate tax, and net interest payments made by households, and adding transfer payments received from the government and firms.
  • Undistributed Profits (UP): NI, which is earned by the firms and government enterprises, a part of profit is not distributed among the factors of production. 
  • Transfer Payments: The households receive transfer payments from the government and firms (pensions, scholarships, prizes, for example) which have to be added to calculate the Personal Income of the households.
PI = NI – Undistributed Profits – Net Interest Payments Made by Households – Corporate Tax + Transfer Payments to Households

Personal Disposable Income (PDI): PDI is the income available to households after deducting personal tax payments (such as income tax) and non-tax payments (like fines) from PI. 

  • It represents the income that households have at their disposal for consumption or savings.

PDI = PI – Personal Tax Payments – Non-Tax Payments

Diagrammatic representation of the relations between these major macroeconomic variables

Diagrammatic representation of the relations between these major macroeconomic variables

  • NFIA: Net Factor Income from Abroad
  • D: Depreciation
  • ID: Indirect Taxes
  • Sub: Subsidies
  • UP: Undistributed Profits
  • NIH: Net Interest Payments by Households
  • CT: Corporate Taxes
  • TrH: Transfers received
  • by Households
  • PTP: Personal Tax Payments
  • NP: Non-Tax Payments.

Evaluating Economic Growth: Nominal vs. Real GDP Insight

Nominal GDP: Real-world Impact on Prices

  • Meaning: It is the total value of goods and services produced in an economy at current market prices.
    • It does not account for changes in prices over time.
  • Example: Suppose a country only produces bread. In the year 2000 it had produced 100 units of bread, price was Rs 10 per bread. 
    • GDP at current price was Rs 1,000.
    • In 2001 the same country produced 110 units of bread at price Rs 15 per bread. 
    • Therefore nominal GDP in 2001 was Rs 1,650 (=110 × Rs 15). 
    • Real GDP in 2001 calculated at the price of the year 2000 (2000 will be called the base year) will be 110 × Rs 10 = Rs 1,100.

Real GDP: Assessing Economic Growth Beyond Prices

  • Meaning: Real GDP is a measure of economic output that adjusts for changes in prices.
    • It evaluates goods and services at constant (base-year) prices, allowing for a comparison of production volumes across different years. 
  • Role of Real GDP: It helps eliminate the impact of price changes, making it a useful tool for assessing actual changes in economic production.

                              Real GDP = (Nominal GDP / GDP Deflator) * 100

GDP Deflator: Tracking Economic Price Shifts

  • The GDP Deflator Index: Analyzing Economic Price Trends
    • GDP Deflator is an index that measures the average change in prices of all goods and services included in GDP over time. 
    • GDP Deflator is calculated as the ratio of nominal GDP to real GDP, expressed as a percentage.

GDP Deflator = (Nominal GDP / Real GDP) * 100

  • A GDP deflator of 150% implies that prices have increased by 50% compared to the base year.

Consumer Price Index (CPI): Tracking Consumer Inflation Trends

  • It measures changes in the prices of a fixed basket of goods and services typically purchased by a representative consumer.
  • It quantifies the inflation experienced by consumers. 
  • CPI is expressed as a percentage change in prices from a base year (Currently 2012)

               CPI = (Cost of Basket in Current Year /   Cost of Basket in Base Year) * 100

Wholesale Price Index (WPI): Analyzing  Wholesale Price Shifts in Production

  • It is an index that tracks changes in the prices of goods at the wholesale level (Current Base year: 2011-12)
  • It is used to assess inflation in the early stages of production and distribution.
  • In some countries, it may be referred to as the Producer Price Index (PPI).

Difference between CPI and GDP Deflator: Contrasting Measures of Price Change

CPI

GDP Deflator

  • In CPI the goods purchased by consumers do not represent all the goods which are produced in a country. 
  • The GDP deflator takes into account all such goods and services.
  • It includes prices of goods consumed by the representative consumer, hence it includes prices of imported goods.
  • The GDP deflator does not include prices of imported goods.
  • The Weights are constant in CPI
  • They differ according to the production level of each good in the GDP deflator.

 

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UDAAN PRELIMS WALLAH
Comprehensive coverage with a concise format
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