5 MACROECONOMICS

Biswa Swarup Misra

GDP and Economic Well-Being

Real GDP per capita is the main indicator of the
average persons standard of living.

But GDP is not a perfect measure of

well-being.

Robert Kennedy issued a very eloquent

yet harsh criticism of GDP:

MEASURING A NATIONS INCOME

B.S.Misra

Gross Domestic Product

does not allow for the health of our
children, the quality of their
education, or the joy of their play.
It does not include the beauty of
our poetry or the strength of our
marriages, the intelligence of our
public debate or the integrity of our
public officials.
It measures neither our courage, nor our wisdom,
nor our devotion to our country. It measures everything,
in short, except that which makes life worthwhile, and it
can tell us everything about America except why we are
proud that we are Americans.
- Senator Robert Kennedy, 1968

GDP Does Not Value

the quality of the environment
leisure time
non-market activity, such as the child care
a parent provides his or her child at home

an equitable distribution of income

MEASURING A NATIONS INCOME

B.S.Misra

Then Why Do We Care About GDP?

Having a large GDP enables a country to afford
better schools, a cleaner environment,
health care, etc.

Many indicators of the quality of life are positively

correlated with GDP. For example

MEASURING A NATIONS INCOME

B.S.Misra

GDP and Life Expectancy in 12 Countries

90

Life
expectancy 85
(in years)

Japan

80

U.S.

75
Indonesia

China

70

Germany

Mexico
Brazil

65

India

60

Russia

Pakistan
Bangladesh
Nigeria

55
50
$0

$10,000

$20,000

$30,000

Real GDP per capita, 2002

$40,000

GDP and Adult Literacy in 12 Countries

Adult 100
Literacy
(% of 90
population) 80

Russia
China

Mexico

Germany

Brazil
Indonesia

70

Nigeria

60

India

50

U.S.

Japan

Pakistan

40
Bangladesh

30
$0

$10,000

$20,000

$30,000

Real GDP per capita, 2002

$40,000

GDP and Internet Usage in 12 Countries

Internet
Usage
(% of
population)

60
U.S.

50
Japan

40

Germany

30
20
China

10

Mexico
Brazil
Russia

0
$0

$10,000

$20,000

$30,000

Real GDP per capita, 2002

$40,000

Need for New Measures of Performance

Between 1990 and 2008, the wealth of these two countries as measured by
GDP per capita rose 34% and 120% respectively.

Natural capital, the sum of a country's assets, from forests to fossil fuels and
minerals, declined 46% in Brazil and 31% in India, according to a new
"Inclusive Wealth Indicator" designed to augment GDP as a measure of
economic progress.

When measures of natural, human and manufactured capital are

considered together to obtain a more comprehensive value, Brazil's
"Inclusive Wealth" rose just 3% and India's rose 9% over that time.

"The work on Brazil and India illustrates why Gross Domestic Product is
inadequate and misleading as an index of economic progress from a longterm perspective.

A country could completely exhaust all its natural resources while posting
positive GDP growth. We need an indicator that estimates the wealth of
nations natural, human and manufactured and ideally even the social and
ecological constituents of human well-being."

http://www.eurekalert.org/pub_releases/2012-03/essp-bge032712.php
MEASURING A NATIONS INCOME

B.S.Misra

The Size of Indian Economy

The trillion-dollar club
Country
United States
Japan
Germany
China
United Kingdom
France
Italy
Spain
Canada
Brazil
Russia
India *

GDP in Dec '06

($ billion)
13,458
4,464
2,890
2,554
2,358
2,227
1,841
1,217
1,273
1,067
975
* 1000

First crossed $1trillion mark on

31/12/1969
31/12/1980
31/12/1987
31/12/1998
30/09/1990
31/12/1989
31/03/1990
31/12/2004
31/12/2005
29/09/2006
N/A
25/04/2007

Source: Credit Suisse estimates

http://www.state.gov/r/pa/ei/bgn/3454.htm
Session 2-3

MEASURING A NATIONS INCOME

B.S.Misra

Big Mac Index: The Economist

Looks at the prices of a Big Mac burger in McDonald's

restaurants in different countries.

If a Big Mac costs US$4 in the U.S. and GBP3 in Britain, the
PPP exchange rate would be 3 for $4.

The Big Mac Index is presumably useful because

it is based on a well-known good

whose final price, easily tracked in many countries
includes input costs from a wide range of sectors in the

local economy, such as agricultural commodities labour,

advertising, rent and real estate costs, transportation,
etc.
The Big Mac Index is inaccurate in certain cases because
of the different market conditions that exist in differing
10
Session 4 McDonald's
MEASURING Alocations.
NATIONS INCOME
B.S.Misra

Why PPP Exchange Rates?

Currencies are traded for purposes other than trade in goods
and services, e.g., to buy capital assets whose prices vary
more than those of physical goods.

Also, different interest rates, speculation, hedging or

interventions by central banks can influence the foreignexchange market.

A purchasing power parity exchange rate equalizes the

purchasing power of different currencies in their home
countries for a given basket of goods.

It is often used to compare the standards of living between

countries, rather than a per-capita gross domestic products

comparison at market exchange rates

Session 4

MEASURING A NATIONS INCOME

B.S.Misra

11

Inflation and Unemployment

12

Discussion Objective
We look for the answers to these questions:

What are the different measures of Inflation

Does CPI represent true Inflation?

13

Inflation Measurement in India

GDP Deflator is the only measure of inflation that takes
into account the inflation in all the goods and
services produced in the economy.
Consumer Price Index is a weighted sum of prices of a
standard basket of goods and services consumed by
a typical domestic consumer.
Wholesale Price Index is a price index of goods and
services that are sold by producers.
The WPI measures price changes from the perspective of
the seller.
If producers are receiving higher prices from their sales to
wholesalers we can expect that retailers would have to
charge higher prices soon that gets reflected in a
higher CPI.
14

Inflation Measurement in India

To account for differences in consumption patterns
across households the CPI is compiled for
industrial workers, urban non-manual employees,
and agricultural labourers.
Both the CPI and the WPI are measured using base
year quantities as weights. Price indices that do
this are called Laspeyre indices.
A Laspeyre price index is calculated from a basket of fixed quantities of a
given list of goods. We first calculate the total price of the basket of goods
in the base period. Let the price index in the base period be 100. Then we
calculate the total price of exactly the same basket of goods in a subsequent year
j.
Next we compute the ratio of the total price of the basket of goods in period j
divided by the total price of the basket in the base period. The price index in
year j then is this ratio multiplied by 100. It tells us the expenditure that must
be incurred in year j as a fraction of the expenditure in the base year in order
that we may obtain the same bundle of goods as in the base year.
15

Inflation Measurement in India

While the CPI-UNME is compiled and released by
the Central Statistical Organisation (CSO), Ministry
of Statistics and Programme Implementation, the
rest three are compiled and released by the
Labour Bureau, Ministry of Labour.

CPI-UNME has been discontinued

16

Comparing WPI and CPI

Wholesale Price Index

Consumer Price Index

Movement in wholesale prices of CPI for Industrial Workers measures

676 commodities
retail price of 260 goods/services
Index available on Monthly basis
With lag of 1 month
Base year is 2004-05

Index constructed on a monthly

basis with lag of 1 month
Base year is 2001

17

Commodities Included in WPI

Major
Group/Group
All
Commodities
Primary
Articles
Fuel and
Power

1970-71 1981-82

1993-94 2004-05

360

447

435

676

80

93

98

102

10

20

19

19

334

318

555

Manufactured
Products
270

18

Weightage Diagram
Major
Group/Group
All
Commodities
Primary
Articles

1970-71

1981-82

1993-94

2004-05

100

100

100

100.

41.667

32.295

22.025

20.118

Fuel and
Power

8.459

10.663

14.226

14.910

Manufactured
Products

49.874

57.042

63.749

64.972
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Differences between WPI and CPI

WPI
Fuel group gets a much
higher weight
Services not included

CPI
Food gets maximum
weightage
Miscellaneous group
includes services such as
transport, education,
health, etc.

20

CPI (Industrial Workers)

Year

GDP Deflator

WPI

CPI (IW)

1994-95

10.00

12.60

10.08

1995-96

9.08

7.99

10.21

1996-97

7.55

4.61

9.27

1997-98

6.46

4.40

7.02

1998-99

7.98

5.95

13.11

1999-00

3.80

3.27

3.38

2000-01

3.52

7.16

3.74

2001-02

3.13

3.60

4.28

2002-03

3.89

3.41

4.10

2003-04

3.80

5.46

3.73

2004-05

4.37

6.42

4.00

2005-06

4.45

4.43

4.23

2006-07

5.76

5.42

6.83

21

Measuring Inflation
Price level A measure of the average
prices of goods and services in the
economy.
Inflation rate The percentage increase
in the price level from one year to the
next.

22

The New Approach to Capture Inflation

Present CPI numbers do not encompass all the segments of
the population in the country and as such they do not
reflect the true picture of the price behavior in the country.

It is therefore necessary to compile a CPI which takes into

account the consumption patterns of all segments of the
population.

As such, the CSO started publishing the new series of

Consumer Price Index(CPI) numbers for Rural, Urban and
Combined (Rural +Urban) on base 2010 taking all
segments of rural and urban population from the month of
January, 2011

http://mospi.nic.in/Mospi_New/upload/t4_18sep12.pdf
B.S.Misra

23

The New Approach to Capture Inflation

These indices will be available for five major groups
namely Food, beverages and tobacco; Fuel and light;
Housing; Clothing, bedding and footwear, and
Miscellaneous.

CPI (Urban) and CPI(rural) numbers are compiled at

State/UT as well as at all- India level.

Weighting diagrams (consumption patterns) of the CPI

(Urban) have been derived from the results of the NSS 61st
round of Consumer Expenditure Survey (2004-05).

http://pib.nic.in/newsite/erelease.aspx?relid=696
36
24

Weightage in CPI
CPI-R
Food Beverage and Tobacco
Fuel and Light
Clothing, Bedding and Footwear
Housing
Miscellaneous
MEASURING A NATIONS INCOME

CPI-U
59.31
10.42
5.36
24.91

CPI-Combined
37.15
49.71
8.4
9.49
3.91
4.73
22.53
9.77
28
26.31

B.S.Misra

25

Measuring Inflation

Is the CPI Accurate?

It is important that the CPI be as accurate as
possible, but there are four biases that make
changes in the CPI overstate the true inflation
rate:
Substitution bias.
Increase in quality bias.
New product bias.
Outlet bias.
26

Reasons why the CPI may overstate inflation

Substitution bias: The CPI uses fixed weights, amounts to assuming each
month the consumer purchases the same amount of each product in the
market basket.
so it cannot reflect consumers ability to substitute toward goods whose
relative prices have fallen.
New Product Bias: As composition of index is changed infrequently, newly
introduced goods whose price fall sharply in the initial years is not captures
while computing inflation
Quality Improvement Bias:
Price rise also capture the Quality improvements in the product and
allowance for the same should be made. Increase in prices of the product
partly reflect reflect improved quality and partly pure inflation

Outlet Bias: Purchases from discount stores and internet purchases often at
discounted prices are not reflected in the CPI which is based on price
statistics collected from traditional full price retail stores
27

Measuring Inflation
The Consumer Price Index
Consumer price index (CPI) An average
of the prices of the goods and services
purchased by the typical urban family of
four.

BASE YEAR (1999)

PRODUCT
Eye examinations

QUANTITY PRICE EXPENDITURES

2008

2009

PRICE

EXPENDITURES
(ON BASE-YEAR
QUANTITIES)

PRICE

EXPENDITURES
(ON BASE-YEAR
QUANTITIES)

$50.00

$50.00

$100.00

$100.00

$85.00

$85.00

Pizzas

20

10.00

200.00

15.00

300.00

14.00

280.00

Books

20

25.00

500.00

25.00

500.00

27.50

550.00

Total

$750.00

$900.00

$915.00

28

Measuring Inflation
The Consumer Price Index

FORMULA

Expenditures in the current year

100
CPI =
Expenditures in the base year

APPLIED TO 2008

APPLIED TO 2009

$900

100 = 120
$
750

$915

100 = 122
$
750

122 120

100 = 1.7%
120

29