Development Metrics -I

Measuring the size of the economy

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Development metrics quantify socio-economic development and poverty. These metrics are similar to the metrics we use to measure physical parameters like distance, motion, pressure and temperature. For example, we use metrics like speed, velocity, and acceleration to measure a physical body's movement. Similarly, the parameters discussed in this article help to estimate the size of the economy and poverty. Typically, these metrics are used to assess the size of a particular region's economy, such as either a country or a region or a district. Some of the frequently used measures are:

  1. Gross Domestic Product (GDP),

  2. Gini Index,

  3. Human Development Index (HDI),

  4. Poverty Line, and

  5. Multi Poverty Index.

Gross Domestic Product (GDP)

GDP is one of the most widely used metrics to measure the size of a country's economy. It is defined as:

Gross domestic product (GDP) is the market value of all the final goods and services produced in a specific period and region.

The following points need to be considered while calculating the GDP of a nation.

  • Periodicity of Calculation: The GDP is normally calculated on an annual basis. Sometimes GDP is also calculated quarterly to monitor the growth of the economy.

  • Finished vs Raw material: The cost and value of only finished products are considered while calculating the GDP. A finished product is a product that can not be sold further as a part of another product. For example, the value of milk produced shall not be considered when it is the part of the tea, cheese, paneer, butter, and other milk-based products.

  • Imported vs Non-imported: Analysts shall take the value of products and services of those objects manufactured within the geographical boundaries when they calculate the nation's GDP. The cost of imported services and products sold in a country is not considered in the GDP of the importing nation.

  • Goods vs Services: The value of goods and services are normally differentiated while calculating the GDP. Few examples of goods are TV, Cars, Dairy products, Agricultural products, Machinery and Equipment. Few examples of services are restaurants, hotels, banking services etc. When someone buys a good, buyers own the purchased products. Services are paid on a per-use basis. The buyer or consumer consumes services.

  • Organization of Economy: To calculate GDP, the economy is typically organized into four sectors such as Agriculture, Industry, Manufacturing and Services.

Methods to Calculate GDP

There are three different methods to calculate GDP. These are:

  1. Production-based Method

  2. Income-based method

  3. Expenditure-based method

Production-based Method

This method is based on the value of goods produced and services offered during a specific period. The formula used is

Gross value added = Gross Value Output - Value of Intermediate Consumption

Here,

  1. Gross Output Value is the sale price of a product or a service.

  2. Value of Intermediate Consumption is the amount required to pay for raw materials, wages and others.

  3. Gross Value Added is the value of the product.

Example Let us consider a car manufacturing company that has manufactured ten cars and sold at Rs. 1 lakhs/car. The {\em gross output value} in this case will be Rs. 10,00,000/-. Suppose the manufacturing cost of the car is Rs. 55,000/-per car, then the value of intermediate consumption, in this case, is Rs. 5,50,000/-. The gross value added is Rs. 4,50,000/-.

The GDP is the sum of gross value added by all the products manufactured and services offered within the geographical boundary during a specific period.

Income-based Method

In this GDP calculation method, the income earned by individuals, industries and government agencies is considered to calculate GDP. The formula employed in this method is:

GDP = COE + GOS + GMI + (T – S)

Here,

  1. Compensation Of Employees (COE) measures the total remuneration paid to employees for the work done.

  2. Gross Operating Surplus (GOS) Often known as profits of an incorporated business

  3. Gross Mixed Income (GMI) It is the same measure as GOS, but for unincorporated businesses.

  4. T-S: This component calculates the income of the national government. It is the difference between taxes collected and subsidies granted on production and imports.

Expenditure-based method

In this method of calculation of GDP, the expenditure incurred to produce goods and services are considered. The formula used for this purpose is:

Y = C + I + G + (X - M)

The individual terms are explained below. Here,

  1. C (Consumption) Expenditure incurred on consumables such as food, rent, jewellery, gasoline, medical expenses, and labour wages are included. But expenditures incurred on the purchase of new housing are not considered.

  2. I (investment) This kind of expenditure includes constructing a new mine, purchasing software, or purchasing machinery and equipment for a factory. Spending by households (not the government) on new houses is also included in investment. But expenditure incurred for the purchase of financial instruments such as shares and debentures are not considered. Such purchases are savings.

  3. G (government spending) It is the sum of government expenditures on final goods and services. It includes the salaries of public servants, purchases of weapons for the military, and any government investment expenditure.

  4. (X-M) It is the difference between expenditure on export and import of goods and services.

All three methods of calculating GDP are equivalent and GDP by any method will lead to same result.

GDP-Derived metrics

Here, let us define some of the metrics derived from GDP.

  • Growth Rate: This metric is used to compare GDP between two different periods. This is an indicator of the growth economy, while simple GDP is a measure of the size of an economy, how small or big it is. The growth rate is calculated as below:

  • Gross National Product (GNP) This metric is the modified version of GDP in which income earned by its citizens residing abroad is also taken into consideration.

    GNP and GDP are the same when all the business within a country are owned by its nationals, and no citizen of the country owns a business outside the country.

  • Gross Domestic Product per Capita It is the ratio of GDP of a country with its population size. It is the measure of a country's standard of living.