BQ Learning: Understanding National Income Accounts
BQ Learning: What is GDP? How is it measured? What does it tell us about the economy?
This is a series of explainers to educate and inform watchers of the economy. In association with CRISIL as knowledge partner.
GDP or gross domestic product is one of the most closely tracked economic indicators. What is GDP? Where is the data derived from? And how is it computed?
To begin understanding that we must first understand the concept of national income accounting.
What Is National Income Accounting?
National income accounts is a set of aggregate statistics – a ‘spreadsheet’ of the economy, as it were, and its parts.
These accounts are put together by the government's statistical agencies. Estimates of production in various sectors (e.g. agriculture, manufacturing, services, etc.) are put together by these agencies through surveys, compilation of budget documents and annual reports of firms, and extrapolation methods.
GDP is the most widely used metric of output in the economy and is classically defined as the ‘final value of all goods and services produced in an economy in a given period of time’ (e.g. a quarter or a year). GDP is considered as an acceptable indicator of health of an economy, but does not always reveal the overall standard of well-being of a country.
How is GDP measured?
GDP can be measured using three equivalent approaches:
Production approach: Sums up the ‘value added’, i.e. the value of all the final goods and services produced, minus that of intermediate inputs which go into the production process.
Expenditure approach: Sums up the value of purchases made by consumers, the investments made by firms, and purchases/spend by the government.
Income approach: Adds up the income generated broadly from two factors of production— labour (such as remuneration received by employees) and capital (operating surplus, profits of firms).
What is the difference between nominal and real GDP?
Nominal GDP is measured using ‘current’ prices, that is, prices prevailing over the given reference period. Over time, change in nominal GDP not only captures the change in value added of goods and services, but also the change in their prices.
Real GDP in contrast, adjusts for change in prices. By measuring production at ‘constant’ prices, i.e. prices in a designated base year, it allows for comparability of production over the years. In India’s latest GDP series, real GDP is measured at fiscal 2012 base year prices.
What is the process followed in India?
The National Statistics Office provides quarterly and annual estimates of GDP.
It compiles two headline measures: GDP and gross value added (GVA). GVA is defined as the economy’s output calculated through the value-added approach where only the value-added at every stage of production is accounted for. GDP can be derived from GVA by adding indirect taxes and deducting subsidies.
Thus, GDP provides a demand side perspective of output, while GVA gives the supply side.
The NSO's GDP estimates have the following sub-components:
Here, C= private consumption expenditure, I= investment (both, by private sector and government), G= government consumption expenditure, X= exports of goods, M= imports
GVA is disaggregated as:
How is pace of an economy measured?
An indicator of how fast an economy is growing, is its growth rate over a reference period.
In India, GDP growth rates for a particular quarter are reported in a ‘year-on-year’ (y-o-y) manner, i.e. output in the present quarter is compared to its value in the corresponding period from a year ago. For instance, the GDP data release for Q1 in fiscal 2022, showed that the economy had grown 20.1% over the output seen in Q1 of fiscal 2021, the previous year.
Taking the y-o-y growth rate removes the effects of seasonality that may occur if the comparison is with the period just prior.
Globally, few economies such as the United States or the Euro area also report GDP growth rates on a quarter-on-quarter basis (along with the y-o-y figures), wherein they compare growth of an economy over the previous quarter, using seasonal adjustment models.
What are the shortcomings of assessing the economy via GDP alone?
GDP is essentially a measure of output in an economy, not entirely a measure of standard of living or welfare.
It measures only those activities of production which have a monetary value, and leaves out the others, for instance unpaid household work. Further, it also includes activities which may not entirely contribute to a society’s well-being (e.g. production of goods which increase carbon emissions).
Hence, it can be considered only one of the indicators in assessing a nation’s overall welfare.
This is the first part in a BQ Learning series on core economic concepts.