Lecture 3

GVA and Deflating GDP

Economic Environment
PGP 26 D&E, PGP Finance-03
Ashok Thomas
Learning objectives

o What is GVA method and how we can interpret the data.

o Real vs nominal GDP (constant vs current prices)
o What is price index and converting nominal values to real values
o What is GDP deflator and how it could be used to calculate inflation

o Discussion video provided in the VC: Slide 15

27/06/2023 2
 Gross Value added definition
GVA at basic prices = Final output valued at basic prices – (minus)
intermediate consumption valued at purchasers' prices

27/06/2023 3
Understanding Gross value added (GVA) much better
Gross value added is the difference between value of output and value of
intermediate consumption.
 Step 1 Market Output: Output consists only of those goods and services; that
are produced within an establishment that becomes available for use outside
that establishment and whose production is complete.
Step 2: Identifying the Intermediary products which must be subtracted
Intermediate inputs are recorded and valued at the time they enter the production
process not at the time of acquirement.
 Intermediate consumption consists of the value of the goods and services consumed as inputs by a process of
production, excluding fixed assets.
 Some are transformed (Wheat to bread) Some used up (electricity)
 Also includes the value of all the goods or services used as inputs into ancillary activities such as purchasing,
sales, marketing, accounting, data processing, transportation, storage, maintenance, security, etc.

27/06/2023 4
How to value at what prices?
More than one set of prices may be used to value outputs and inputs
depending upon how taxes and subsidies on products, and also transport
charges, are recorded.
Basic prices: The basic price is the amount receivable by the producer from
the purchaser for a unit of a good or service produced as output minus any
tax payable, and plus any subsidy receivable
Example: 10000-500 (5% GST) + 200 (Subsidy)
 Transportation charges are invoiced separately

27/06/2023 GDP 5
Valuation of output and intermediate consumption
Value of final output: Output when multiplied by basic prices
Purchaser pays taxes to government
Purchaser receives the subsidy
The basic price measures the amount retained by the producer
and is, therefore, the price most relevant for the producer's
decision-taking
 Value of intermediate consumption: It is always performed at
purchaser's price

27/06/2023 GDP 6
 Three types of GDP from newspapers
Factor cost Basic Prices Market Prices

GDP at factor cost + (Production taxes less Production subsidies) = GVA at basic prices
Independent of volume of productions: License fees , Stamp duties
From 2014-15 India shifted from factor cost to basic prices in the way GDP is measured and using
GVA to measure GDP
The new methodology follows the UN’s System of National Accounts (SNA, 2008)
GVA at basic prices + ( Product taxes- Product subsidies) = GDP at market price
Product taxes and product subsidies are for per unit of production
GDP at factor cost+ ( Net interest taxes and subsidies ) = GDP at market price
where Net interest taxes and subsidies = Net of (Production taxes less Production subsidies)+ (Net of
Product taxes- Product subsidies)
What is the need for different methods?

27/06/2023 GDP lecture 7

27/06/2023 GDP Lecture 8
Quarter to Quarter growth

27/06/2023 GDP 9
V shaped vs W shaped Is it enough in absolute terms

27/06/2023 GDP 10
 Discussion of the video Video Link also uploaded in VC as Discussion video: Indianomics

Experts Discuss the India Q1 GDP

(16) India's Q1FY23 GDP Growth At 13.5%, Manufacturing Growth Disappoints In Q1FY23 |State Of Th
e Economy - YouTube
Questions ( find the answer from the experts)
 What is outlook of Kausik das on Q1? (3.05 to 4.30)
 Discuss the statisitics (04.30 to 5.45_
 What Anubhuti view ?Why she argues that informal activity is picking up ? (5.20- 7.20)
 DK Joshi points out the engines of growth and laggards in output (7.30 to 10.05)
 Poor manufacturing growth . Is it the revised estimate of last year to blame? ( 10.10 to 13.00)
 Soumya Kani ghosh argues against the whole argument and why he refuses revised estimate( 13.20 to 14.48)
 Why we might endup at 6.47 not 7.2 (15.00 to 19.00)
 Is it a recovery? ( 19.00 till end)

27/06/2023 11
Nominal, Real and Price index
Nominal values and real values are different, but related measures.
By understanding the differences, you can better determine the true costs and
benefits of economic decisions.
Nominal (or current) values are those that are actually stated or observed.  
Real values are those expressed in constant prices and are unobserved;  rather,
they are calculated from the nominal values using price level changes
The point of using real values is to eliminate the effects of price changes (inflation
or deflation). This distinction between nominal and real applies to measuring
variables -- like GDP, income, wages, money supply, wealth, and interest rates.
Hope everyone knows price index

27/06/2023 12
 NOW YOU TRY
Real and Nominal GDP
Real GDP
Quantity Price
Year of Bread of Bread Nominal (in 2011-12
GDP prices)
2010-11 10 20

2011-12 12 24

2012-13 13 26

 Compute nominal GDP in each year.

 Compute real GDP in each year using 2011-12 as the
base year.
13
NOW YOU TRY
Answers
nominal GDP multiply P & Q from same year
Real GDP
Year Quantity Price
of Bread of Bread Nominal (in 2011-12
GDP prices)
2010-11 10 20 200
2011-12 12 24
288
2012-13 13 26 338

real GDP multiply each year’s Q by 2011-12’s P

Real GDP
Year Quantity Price
of Bread of Bread Nominal (in 2011-12
GDP prices)
2010-11 10 20 200 240
2011-12 12 24 288
288
2012-13 13 26 338 312
14
We have two kinds of GDP ( observable and unobservable)

Nominal GDP : This is observable however has the influence of price level
Real variables: These are unobserved
 Can be calculated from the nominal values using price level changes.
 The point of using real values is to eliminate the effects of price changes (inflation or deflation).

How to purge out the effect of Prices from GDP?

Using price indexes : If we need to compare two time-periods, two countries which have
different output levels and price levels we should purge out at least one effect
o Decomposing the Nominal GDP to Output and Prices
o Real GDP = Nominal GDP / Price index
o Real GDP reflects the changes in goods and services, keeping prices constant

27/06/2023 GDP 15
Step 1 : Price index
Price index represents price level
Rising Price index = Inflation and Declining price level = Deflation
What is Price index?

Price index = 100* Current cost of a basket

Cost of basket in the base-year
 How do we accept a specific year as base year?
 Changing base year What are the criteria for change?
Price index numbers can be used to calculate Real GDP
Nominal GDP(GDP at current prices) / Price index = Real GDP(GDP at constant prices)
27/06/2023 GDP 16
 GDP Deflator: First price index

How can we tell whether GDP increase is the result of quantity increase
or price rise?
GDP is the value of all final goods and services: P1xQ1+P2xQ2+P3xQ3+
…..
Base year currently is 2011-12 ( Keeping prices constant)
GDP Deflator covers the entire spectrum of economic activities including
services, it is available on a quarterly basis with a lag of two months since
1996.
Nominal GDP
GDP deflator = 100 
Real GDP
GDP deflator

• The percentage changes in the GDP deflator measures the price level
changes over time using the actual purchases (quantities) of goods and
services in a given year.
•
GDP deflator22-23 = Market value of goods and services in 2022-23 at 2022-23 prices *100
• Market value of goods and services in 2022-23 at (2011-12) prices

06/27/2023 18
Activity

• Answer the following

1) Why in 2012 GDP
deflator shows
100?
2) What does 134.8
mean?
3) If GDP deflator
shows 98.3 it
means what?

06/27/2023 19
GDP at constant price GDP at market price

27/06/2023 Deflating GDP 20

Real & Nominal GDP Why we need to have both
?
• GDP at current prices : It has the price effect
along with quantity effect
• Real GDP is purging out the effect of Prices
from Nominal GDP
•If we need to compare two time-periods, two
countries which have different output levels and
price levels we should purge out at least one
effect
For comparison we use Real GDP
• Between quarters ( Q1 2019 vs Q1 2020)
• Between Countries (India vs BRIC nations)

06/27/2023 21
Some preliminary insights which you can derive from data

We need to choose a base year (In the base year the Real GDP and
Nominal GDP will be same?)
 When output increases and prices remain the same as in the base year
(Real GDP and nominal GDP are same?)
When Prices increase in the current year , without any increase in
output , then ( Nominal GDP > Real GDP)
When prices and output increase in the current year, the Real and
Nominal GDP increase at different rates.

27/06/2023 22
What else we can use the GDP deflator
To calculate Inflation
Inflation is the growth rate in prices of goods and services
Inflation rate between time periods ( Q1 2022-23 compared to Q1 2021-22 )

Inflation rate = GDP deflator of Q1 2022-23- GDP deflator of Q1 2021-22 *100

GDP deflator of Q1 2022-23

27/06/2023 23
Activity
GDP deflator Q1 2020-21 = Nominal GDP/ Real GDP *100 ( Slide 20)

GDP deflator of Q1 2019-20 = Nominal GDP/ Real GDP *100 ( Slide 20)

Now calculate the inflation

Inflation is rate of growth

Nominal growth rate of GDP – Inflation (based on GDP deflator) = Real
GDP growth rate
10% nominal growth -(4% ) = 6% real increase in GDP
27/06/2023 24