Gross Domestic Product/ GDP is the final value of all goods and services produced in the economy in a given year. Before reading this article, I suggest you read this article: Gross Domestic Product (GDP) Demystified.
Now, we will look at the changes in the method to calculate GDP. India made three basic changes in the calculation of GDP in 2016. As per the changed method, India’s GDP growth rate was revised to 6.9% for the year 2013-14, up from 4.7% earlier.
- The base year for calculation of GDP has been changed from 2004-2005 to 2011-2012.
- GDP is now calculated at market price instead of factor cost.
- A new database that is more comprehensive is used.
Initially, we used the prices for the year 2005 to calculate GDP. Now we use the prices for the year 2012. So, the base year to calculate GDP has been changed from March 2005 to March 2012. It is not a significant change as the base year to calculate GDP is regularly updated.
Another change was that previously GDP was calculated at factor cost. Now, it is calculated at market price. The factor cost is the prices of goods received by the producers. The market price is the price paid by consumers.
Why is there a difference between factor cost and market price?
- The price that the consumer pays is inclusive of indirect taxes like sales tax etc. Thus, indirect taxes are included the in market price. But, they are not included in factor cost as producers do not actually receive these taxes. They have to pay it to the Government.
- The other source of difference is subsidies. Consumers do not pay subsidies, but producers receive it. So, subsidies are not included in the market price, but it is included in factor cost. Let say the actual price of an LPG cylinder is Rs.1000, but the Government subsidises it by Rs.500. Then, consumers will have to pay only Rs.500 for the cylinder but the producer will receive Rs.1000. He will be paid the remaining 500 by the Government.
Therefore, GDP at market prices = GDP at factor cost + indirect taxes – subsidies
This change is in line with the method used internationally to compute GDP.
Lastly, the Government changed its database to make it more comprehensive. It includes the data of all the companies registered with the ministry of corporate affairs (MCA). Earlier Annual Survey of Industries (ASI) was used. ASI comprises 2 lakh factories from the manufacturing sector, but now the Ministry of Corporate Affairs (MCA) has said to include 5 lakh factories from informal and unlisted sectors too.
The new database covers financial institutions and regulatory bodies like- SEBI, PFRDA, and IRDA as well. Local organizations and institutions are well represented in this series.
To collect the data from the unorganized sector, a survey is carried out every five years, and in between those five years, a proxy is used based on the organized sector data.
To summarise, Government has done three major changes in the method of calculating GDP and it is a step in the right direction. As per the new methodology, the GDP growth rate for the year 2014-15 is 7.3%.
[You may also read: What is the difference between Nominal GDP and PPP GDP?] & [What is the Reason for the Economic Slowdown in India?]
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Hey ! Can you please explain why change in methodology lead to upward rise in GDP growth number ?
There were two major changes done in the GDP calculation. The change in the base year caused a negligible impact on the growth. Some part of the increase in GDP growth must be because of using market prices instead of factor cost for the GDP calculation.
Another change is using larger data set for calculation of GDP. Data for the new GDP series have been collected from 5 lakh companies instead of 25,000 earlier. The informal sector has also been included. Other sectors like recycling, LED TV sets which were not taken into account earlier etc. have now been incorporated. Trading activities by manufacturing firms is also a part of GDP. All in all, data collection have been made more comprehensive.
Hope this helps:)
Thanks
This article is lucid and concise.But in the new methodology there are few other concepts like GVA at Base Price, Production and product taxes and subsidies and many other equations as given in the economic survey.Can you please throw some light on it?
Let us break it down:
1.) GDP has always been calculated at GVA (Gross value-added). GVA is value of output less intermediate consumption. Let’s illustrate it with an example: The economy produces bread, guns and flour. Flour is used as an intermediate good (raw material/ input) in the production of bread. If we take the final value of all goods in GDP, there will be double-counting of the flour that was used in the production of bread (as the price of flour is included in the price of bread also).
So, to avoid double counting of flour, we will take only the value-added of each product.
Value-added of bread= Value of bread – Value of intermediate goods (flour etc.),
This is a very simplified calculation of GDP. There are many intermediate goods required in the production of a good and so, to calculate value-added, we’ll deduct the prices of all those intermediate goods.
2.) Production taxes or subsidies are taxes that are independent of the actual production. Examples of production taxes are land revenues, stamp and registration fees etc. which you have to pay whether the output is 0 or 1 lakhs.
Examples of production subsidies are input subsidies to farmers, subsidies to villages and small industries, administrative subsidies to corporations or cooperatives, etc.
3.) Product taxes are taxes which are paid per unit of output. Eg- excise duty which you have to in proportion to the output manufactured. Other examples: sales tax, service tax
4) Product subsidies are received per unit of output. eg: food, petroleum and fertilizer subsidies, interest subsidies given to farmers, households, etc. through banks.
5) So, GVA/GDP at basic prices= GVA at factor cost + (Production taxes – Production subsidies). In this, only production taxes and subsidies are included.
6) GVA/GDP at market prices = GVA at basic prices + (Product taxes- Product subsidies)
7) We can directly calculate GDP at market prices by GDP at factor cost.
GVA/GDP at market prices= GVA at factor cost + (indirect taxes – subsidies)
Hope it helps.