This is the third in a series of articles, capturing my notes from Prof Dholakia's lecture...
In this article, we look at the two main objectives of our national policy - growth in GDP, and curbing Inflation.
GDP, the Gross Domestic Product, captures the national income, measured through the concept of production (and not consumption). Remember, income is a flow, not a stock, and hence has to be measured over a period of time. GDP therefore represents how much we are producing in the nation over a given period of time.
Let us take a simple example, where the country produces only three products: cotton (produced value = 100), cloth (150) and clothes (210). Since the final product is only clothes, the GDP would be 210. But this is politically incorrect, since it excludes cotton and cloth, which is equally important to the economy! Hence, instead of the final product only, we measure the value addition (output - input) at each stage. This results in GDP = value of cotton (100, assuming 0 inputs), cloth (50) and clothes (60) = 210, exactly the same as before, but politically much more correct!
The national income, or GDP, is thus the aggregation of value additions in all its industries & sectors.
Let's consider the national P&L (profit and loss) statement. The incomes comes from sales. What about the expenditures? It comprises cost of raw materials, fuel/power, depreciation, salaries/benefits, rent (land cost), interest, taxes AND profits. Why is profit an expense? Think about it this way - you pay salaries to retain the workers, the rent to retain the land, interest to retain capital, and the profits to retain enterprenuers in the industry!
Since the P&L statement is balanced, we can say,
Sales = (Raw Materials + Fuel) + (Worker Cost + Rent + Interest + Profits)
Remember, only Profits can be negative, and this is the risk of enterpreneurship.
Now, Sales - (Raw Materials + Fuel) = (Worker Cost + Rent + Interest + Profits) = Value Addition
Thus, VA, as used in the calculation of the GDP, is not just the profits, but also includes the labour wages, rent, interest generated in the system.
India has Inflation target of 5% and GDP targets of 9% (growth). Let's see what this means.
We know, Sales = Price * Quantity
With increase in rates as above, we get,
Growth in Sales = 1.05 * 1.09 = 1.1445, which is approximately 14%.
What does this mean? It means that on an average, with the targets we have set for ourselves, any enterprise will show growth in value addition of around 14%. To be a leader in this economy, a company/enterprise will need to grow at twice this rate - and with a 28% growth rate over 15 years, the company will grow 32 times what it is today!
Now let's look at Inflation. Inflation is the growth in prices, and the target 5% relates to the growth rate for prices, not the price levels themselves!
The government typically targets the wholesale price index (WPI), which reflects the cost of production of a basket of goods. Consumers, on the other hand, are affected by the consumer price index (CPI), related to the cost of living, and this is what your dearness allowance tries to compensate you for. Remember, the basket of goods considered for WPI and CPI are very different, though there might be some overlap like food items. WPI considers industrial materials, fuel etc, and does not consider services. CPI accounts for rent, services and other items instead.
Obviously, if your company's real inflation is below the national rate, you can take the difference and pass it on to your customers, or rake in the profits!
Now, Money Supply = Price * Quantity. However, remember, money moves and changes hands, and this means that the actual money required in the system is much less. The rate at which money changes hands is called the velocity of circulation, which typically remains constant.
Assuming that quantity also remains constant, it is clear that money supply directly influences prices. To reduce prices, reduce the money supply!
With this, we come to the end of this series of articles.. hope you enjoy reading them as much as I enjoyed writing them!
In this article, we look at the two main objectives of our national policy - growth in GDP, and curbing Inflation.
GDP, the Gross Domestic Product, captures the national income, measured through the concept of production (and not consumption). Remember, income is a flow, not a stock, and hence has to be measured over a period of time. GDP therefore represents how much we are producing in the nation over a given period of time.
Let us take a simple example, where the country produces only three products: cotton (produced value = 100), cloth (150) and clothes (210). Since the final product is only clothes, the GDP would be 210. But this is politically incorrect, since it excludes cotton and cloth, which is equally important to the economy! Hence, instead of the final product only, we measure the value addition (output - input) at each stage. This results in GDP = value of cotton (100, assuming 0 inputs), cloth (50) and clothes (60) = 210, exactly the same as before, but politically much more correct!
The national income, or GDP, is thus the aggregation of value additions in all its industries & sectors.
Let's consider the national P&L (profit and loss) statement. The incomes comes from sales. What about the expenditures? It comprises cost of raw materials, fuel/power, depreciation, salaries/benefits, rent (land cost), interest, taxes AND profits. Why is profit an expense? Think about it this way - you pay salaries to retain the workers, the rent to retain the land, interest to retain capital, and the profits to retain enterprenuers in the industry!
Since the P&L statement is balanced, we can say,
Sales = (Raw Materials + Fuel) + (Worker Cost + Rent + Interest + Profits)
Remember, only Profits can be negative, and this is the risk of enterpreneurship.
Now, Sales - (Raw Materials + Fuel) = (Worker Cost + Rent + Interest + Profits) = Value Addition
Thus, VA, as used in the calculation of the GDP, is not just the profits, but also includes the labour wages, rent, interest generated in the system.
India has Inflation target of 5% and GDP targets of 9% (growth). Let's see what this means.
We know, Sales = Price * Quantity
With increase in rates as above, we get,
Growth in Sales = 1.05 * 1.09 = 1.1445, which is approximately 14%.
What does this mean? It means that on an average, with the targets we have set for ourselves, any enterprise will show growth in value addition of around 14%. To be a leader in this economy, a company/enterprise will need to grow at twice this rate - and with a 28% growth rate over 15 years, the company will grow 32 times what it is today!
Now let's look at Inflation. Inflation is the growth in prices, and the target 5% relates to the growth rate for prices, not the price levels themselves!
The government typically targets the wholesale price index (WPI), which reflects the cost of production of a basket of goods. Consumers, on the other hand, are affected by the consumer price index (CPI), related to the cost of living, and this is what your dearness allowance tries to compensate you for. Remember, the basket of goods considered for WPI and CPI are very different, though there might be some overlap like food items. WPI considers industrial materials, fuel etc, and does not consider services. CPI accounts for rent, services and other items instead.
Obviously, if your company's real inflation is below the national rate, you can take the difference and pass it on to your customers, or rake in the profits!
Now, Money Supply = Price * Quantity. However, remember, money moves and changes hands, and this means that the actual money required in the system is much less. The rate at which money changes hands is called the velocity of circulation, which typically remains constant.
Assuming that quantity also remains constant, it is clear that money supply directly influences prices. To reduce prices, reduce the money supply!
With this, we come to the end of this series of articles.. hope you enjoy reading them as much as I enjoyed writing them!
No comments:
Post a Comment