Let us start with very basic definition of GDP, Monetary value of Goods and services produced in an economy within economic territory. Say only 5 kurkure are made in economy (Consider in 2014), Value of 5 kurkure i.e rs 100 will be our GDP.
Constant Vs Current Price:
In 2015, Price of Kukure comes out 105 i.e 21*5. Let us consider this 1 rs increase as inflation. Now GDP at current price will be 105 , but GDP at constant price will be 100, i.e adjusted for inflation.
Factor Cost Vs Market Price:
Next is difference between Factor cost and Market price,
Suppose value of Kurkure at “factory gate” is 17 rs and till it reach retail shop in market, Tax is added and subsidies are subtracted to it’s price . Say 17 + 3 (Excise) – 0 (Subsidies) = RS 20.
Prior to recent calculation changes in GDP:
Earlier to have a real outlook, CSO i.e Central Stats Organization was giving us national figure of GDP @ factor cost @ constant price. That in our example will be RS 17 (Price of kurkure at factory gate) * 5 = rs 85.
Now Value Of GDP after revision has been given at GDP @ Constant price @ market price i.e GDP @ Constant market price . So, Value in our example will be = 20 * 5 = Rs100.
How currently will CSO calculate GDP figure which is mentioned in Economic Survey ? :
Following formula will help us reach to our goal of calculating GDP
GVA at basic prices + product taxes – product subsidies = GDP @ market price @ Current price
Where GVA is Gross value added taken at basic price.
First let me state same example: say, material for making 5 kurkure costed 30 rupees and After making them they were sold at rs 100 market value. Now, 100-30 = Rs 70 will meet the company’s employee income, bills, expenses et al. & what remains will be company’s profit.
In other words 70 rs will act for, CE i.e compensation of employees; OS: operating surplus; MI: mixed income; and, CFC: consumption of fixed capital
I am making it too stupid now:
CE will be salaries of employees
Operating surplus is earning of company without paying taxes and deducting depreciation
CFC is simply depreciation i.e how much kurkure making machine has depreciated or wore and tore.
Coming back to GVA,
Definition : value of an output (5 kurkure i.e 100) less the value of inputs (Value of Inputs i.e 30, raw material)
GVA at basic prices = CE + OS/MI + CFC + production taxes less production subsidies
Earlier we have seen difference between market price & factor cost , i.e subsidy and taxes on PRODUCT, not PRODUCTION
But, What is this Basic price ??
Come back to concept of factor cost , When we exclude tax and subsidy from market price of product we get factor price. But certain tax and subsidies already comes into scenario when the PRODUCTION was happening. say Taxes like land revenues, stamps and registration fees and tax on profession & Subsidies on Production like subsidies to Railways, input subsidies to farmers, subsidies to village and small industries, administrative subsidies to corporations or cooperatives.
So GVA at basic price will include these PRODUCTION taxes and subsidies.
Again writing, PRODUCT taxes or subsidies are paid or received on per unit of product, hence decide market price.
Now we will derive our value of GDP @ Constant market price:
Σ GVA at basic prices (i.e Add all GVA of all production units of all sector) + product taxes – product subsidies = GDP @ Current price @ Market price
So if we take out Inflation :
Σ GVA at basic prices + product taxes – product subsidies = GDP @ Constant Market Price (Which is our newly calculated GDP).
Q) If we take out our Raw material value i.e rs 30, won’t our GDP show a Shrunk figure, or in our example if we deduct our raw material price our GDP will come from 100 to 70.
A) Kindly note , Rs 30 will also be added as Kurkure brought this product from another production unit, which will be income for that production unit.