GDP at Factor cost, Basic Prices and Market prices

Calculating GDP from various Perspective:

Factor Cost:

• It includes payments only to the factors of production i.e. rent for land, interest for capital, wages for labour and profit for entrepreneurship. 
• It does not include any tax or subsidy and reflects producer side exclusively. 
• It is also said to be the revenue price of the final goods and services sold by the producers.

Revenue Price or Factor Cost = Market Price – Net Indirect Taxes

Whereas:
Net Indirect Taxes = Indirect Taxes – Subsidies
Hence, Factor Cost = Market Price – Indirect Taxes + Subsidies

Market Price:

• It refers to the transacted price in actual market and it includes all the indirect taxes such as custom duty and Goods and Services Tax). 
• It is when we have to add product taxes (less product subsidies) to the Basic prices. 
• It reflects exclusively consumer side.

Market Price =Factor Cost +production taxes +Product Taxes - production subsidies -Product subsidies = Basic prices +Product taxes -Product subsidies 

BASIC PRICE:

• The basic prices lie in between the factor cost and Market price.
• It includes the production taxes (less production subsidies) but not product taxes (less product subsidies).

Basic prices= Factor Cost +production taxes- Product subsidies

PRODUCTION TAX/SUBSIDY: 

• Production taxes or production subsidies are paid or received with relation to production and are independent of the volume of actual production.
• Examples of production taxes are land revenues, stamps and registration fees. Some production subsidies include subsidies to Railways, input subsidies to farmers etc.

PRODUCT TAX/SUBSIDY: 

• Product taxes or subsidies are paid or received on per unit of production. 
• Some examples of product taxes are excise tax, sales tax, service tax,GST and import and export duties. Product subsidies include food, petroleum and fertilizer subsidies, etc. 

Methods of calculating GDP: There are three methods of calculating GDP:

●       Expenditure method

●       Income method

●       Production method or GVA Method

ECONOMIC AGENTS IN AN ECONOMY :

• House Holds:  Consumer of goods and Services Provider of Factors of production : All the human beings ie population belongs to households
• Firms: Commonly known as factories , companies and industries
• Government
• Financial Sector: Banks and other financial intermediaries

Income Method: 

• This method calculates the Income received by the residents of a country by rendering their services ie factors of production ie land ,labour, capital  and Entrepreneurship. 
• It is GDP at factor cost.

National Income is calculated compiling income of factors of production viz., land, labour, capital and entrepreneur.

National Income =Total Wage + Operating surplus (Total Rent + Total Interest + Total Profit) + Mixed income

Mixed Income : 

• It refers to the earning/income of self employed individuals in an economy.
• It is combination of wages and profits as the individuals provide their money as well as labor
• Examples are doctors ,lawyers ,CA etc .

Expenditure Method:

•  It measures  spending done by three main agencies ie Households, Firms and the Government on currently-produced final goods and services in an economy.
• This final expenditure is made up of the sum of 4 expenditure items, namely;

• Consumption (C): Personal Consumption made by households, the payment of which is paid by households directly to the firms which produced the goods and services desired by the households.

• Investment Expenditure (I): It is Investment by private firms in  an economy in a given time period.

•Government Expenditure (G): Government expenditures comprises of: Consumption and  investments. Government expenditure on pension schemes, scholarships, unemployment allowances etc. are not included in this as all of them come under transfer payments.

• Net Exports (X-IM): From producer's perspective, whatever is being produced can be either consumed by domestic customers or government or foreigners, or will pile up as inventory.

National Income = Consumption (C) + Investment Expenditure (I) + Government Expenditure (G) + Net Exports (X-IM)

WHY IMPORTS ARE SUBTRACTED :

Now all that a domestic customer purchases is C, goods and services consumed by government is G, inventory goes under “I” but we're still left with accounting of what the foreigners consumed. So for that sake, we include exports too as X. In case of imports ,there is no income of the Indian as the money is going out of the country .Imports are already accounted under “domestic consumption” again so we avoid double accounting here.

Expenditure method as per NSO :

NSO categorizes expenditures as follows :

1. household consumption expenditure (PFCE);
2. government consumption expenditure (GFCE);
3.  and capital formation comprising fixed capital formation and stock accumulation.

Household Consumption Expenditure: 

The household consumption expenditure referred to as private final consumption expenditure (PFCE) ,consists of expenditure by households on non-durable consumer goods and services and all durable goods except land and buildings.

Government Final Consumption Expenditure (GFCE): 

Government final consumption expenditure comprises of the compensation to the Government Employees and purchases of goods and services by the Government including purchases abroad.

Gross Capital Formation: 

Gross Capital Formation includes only produced capital goods (machinery, buildings, roads, etc.) and improvements to non-produced assets. The components of gross capital formation are:

 • gross fixed capital formation

 • changes in inventories

• acquisition less disposal of valuables(such as jewellery and works of art)

• Gross Fixed Capital Formation (GFCF) includes purchases of new assets within the domestic market like buildings, transport equipment, machinery, breeding stock etc.; import of new assets; own account production of new assets such as production of rail engines, wagons, trucks, aero-planes, farm machinery, breeding stock of fish, sheep, cows etc. by the enterprise; purchase of new houses by consumer households and net purchase of second hand physical assets from abroad.

• Change in stocks (inventories)(CIS) consists of the difference between the opening stock and the closing stock.

 • Saving: Saving represents the excess of current income over current expenditure of various sectors of the economy.  For a closed economy, savings equals capital formation during the year, whereas for the open economy savings equals capital formation plus net capital inflow from abroad during the year.

Product Method (or Value Added Method, Output Method):
Gross value added (GVA): 

• GVA  is defined as the value of output less the value of intermediate consumption. 
• It is used to measure the output or production contribution of a particular sector. 
• When such GVAs from all sectors (∑ GVA) are added together we can get the GDP (at market price).

In the given example, wheat is a final product for farmer, flour for miller and bread for baker. As a general practice, every producer treats his commodity as the final output. It means: Total value of output = 500 + 700 + 1,000 = Rs 2,200. But ,

1.The value of wheat is included in the value of flour.

2. The value of flour is included in the value of bread. So, there is problem of double counting.

How to Avoid Double Counting?

(i) Final Output Method: According to this method, value of only final goods should be added to determine the national income. In the given example, value of bread of Rs 1,000 sold to final consumers should be taken in the national income.

(ii) Value Added Method: According to this method, sum total of the value added by each producing unit should be taken in the national income. 

In the given example, value added by farmer (Rs 500), miller (Rs 200) and baker (Rs 300), i.e. total of Rs 1,000 should be included in the National Income. So GDP calculation by both the methods comes out to be the same.

Understanding GVA and GDP: 

Gross Domestic Product (GDP) of any nation represents the sum total of gross value added (GVA) (i.e, without discounting for capital consumption or depreciation) in all the sectors of that economy during the said year after adjusting for taxes and subsidies. 

Gross Value Added = Output of Final Goods and Services – Intermediate Consumption

• National Income = Gross Value Added + Indirect Taxes – Subsidies

Technically:

GDP at Market Prices = ∑ GVA at basic prices + ∑  product taxes –  ∑ product subsidies.

GVA at basic prices =  ∑ GVA at factor prices +  ∑ production Taxes – ∑ Production subsidies

GVA at factor prices =  cost incurred on factors of production.

Remember:

GVA is for a particular sector

∑GVA is for the economy

GDP is for the economy