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Periodic reports are framed after certain intervals regarding inflation rates, GDP growth, CPI, WPI, and the like. Does it leave you confused as to what to infer from such reports? If yes, then I am writing this post for you. We will learn the Basics of Indian Economy and understand what these complex terms actually mean.

Let’s start off with the most used term, i.e, GDP (Gross Domestic Product).

Gross Domestic Product as the term suggests is the monetary value of final goods and services produced within a country for a specific period of time. But, we refrain from including proceeds from illegal activities and value of work done out of love and affection without any payment, the reason for former is that it is not supported by law and the latter is not included because of lack of data to calculate its value.

GDP estimates are considered to be a primary indicator of a country’s economic well-being.GDP is generally expressed as a comparison with previous year or quarter. Suppose, the GDP for 2014-15 is 7% (Imaginary) this implies that the economy has grown by 7% over the past one year. Usually, for comparison purposes, GDP of all the countries is converted into U.S. Dollars using either market exchange rates or purchasing power parity exchange rates and then measured against each other. You can take a look at ranking of GDP growth 2014 .

How does it impact the Stock Market ?

Understanding it in simpler terms, bad economic growth implies lower profits for a company and hence lower stock prices. Investors usually desist from investing in economies with falling GDP rates.

Is increasing GDP always considered favorable for the economy?

Not always. Increase in GDP may sometimes come at a cost of environmental damage, dissatisfaction, and decreasing quality of life. Constructing new factories leads to an elevation in GDP rates but the pollution it causes is never accounted. Construction of dams again raises the GDP but it leads to a large amount of displacement amongst people residing at that place and hence decreases their quality of life. So, increasing GDP is not actually favourable for the economy from every aspect.

Coming to the rescue, United Nations maintains a Human Development Index which ranks countries not only based on GDP per capita , but on other factors, such as life expectancy, literacy, and school enrollment.

The above explains Nominal GDP which is most of the times not considered as a reliable indicator of real growth because it largely gets affected by the prices prevailing at the current time period. Even with the same output, inflation can lead to a rise in GDP but we can avoid this issue with the help of Real GDP.

Real GDP

Real GDP is basically expressing Nominal GDP on the basis of a fixed unit value. For example: Expressing the GDP of a country between 2005 and 2010 taking base year as 2005 ( any recent normal year which is free from any type of disaster, calamity or economic slowdown). In order to calculate this real GDP figure for each year, the nominal GDP of the country (its national output) must be multiplied by a factor known as the GDP Price deflator that is equal to the relative rise in prices of goods and services (inflation) over this period of time.

I mentioned above about the calculation of GDP which can be done in two ways : Using market exchange rates or purchasing power parity rates. Market exchange rates is no new term for us, Let’s discuss about purchasing power parity.

So, under purchasing power parity, what we do is that we decide upon a basket of goods. The price of such basket is calculated in every country and then the price is converted in US dollars for comparison. The estimation is a bit complicated because of different types of goods consumed in each country, different quality of goods and different price levels; adjustments needs to be made to overcome such difficulties.

Purchasing power parity rates are sometimes considered better than the market exchange rates because of the stability and because of the fact that market exchange rates seems to be relevant only for traded goods, as non-traded goods and services are way cheaper in low income countries as compared to high income countries because of lower wages maybe.

Next in line is inflation, in simpler terms it is basically a continuous rise in prices over a certain period of time. Inflation is not considered good for the economy. But, do we desire zero inflation? No, certainly not; because inflation is a sign of growing economy. Let’s see how:

If economy is growing, this implies people are rewarded with more choices and income, which in turn leads to more demand for all the available goods and services, when demand exceeds the supply, prices rise and hence inflation occurs.

At times, inflation becomes negative (like WPI in the recent past), so is it a situation of rejoice or worry? In the context of Indian economy where inflation is skyrocketing, negative inflation might be taken as a situation of rejoice.

With inflation comes two more terms:

  • Deflation: It is just the opposite of inflation ,ie, a fall in prices.
  • Disinflation: It refers to a slower rate of inflation.

Both of them seems quite similar, the major difference is that in case of the former the prices actually fall while the latter doesn’t imply a fall but a slow increasing rate.

Recently in 2013 , Consumer Price Index (CPI) replaced Wholesale Price Index (WPI) as a main measure of inflation. Let’s learn more about these terms.

Wholesale Price Index (WPI) is basically a representative of basket of wholesale goods traded between the corporations. The data regarding WPI is released monthly unlike previously where it used to be released every week. The commodities for WPI are chosen based on their importance in a particular region. The new base year 2011-12 uses 676 items to calculate WPI. Movement of each commodity is tracked and then the WPI is calculated.

Consumer Price Index (CPI) is basically a representative of basket of consumer goods and services consumed by households. In 2013 CPI replaced WPI as a main measure of inflation, I am yet to find the reason for that.

Few more important terms :

  1. Trade Deficit– When the imports exceed the exports of a country, it is said to have a trade deficit. Mathematically, Trade deficit= Value of imports- Value of exports
  2. Real Income– Real Income refers to the income left with the consumer to spend on his needs after cutting out the necessary payments such as tax.
  3. Money Supply– It refers to the total amount of money circulating in a country.
  4. Fiscal Policy– It refers to the policy regulated by the government to manage the revenue and expenditure of a country. Government issues budget every year which is a part of fiscal policy. If expenditure exceeds revenue, then government resorts to borrowings. The difference between Expenditure and Revenue is known as Fiscal Deficit.
  5. Monetary Policy– It refers to the policy managed by central bank of a country by various tools. These tools are the rates and ratios managed by them. I have discussed about these in my previous post, you can take a look and have a better understanding about the same.

The topic is quite vast, I might have missed out on certain concepts. The idea was to brief about the basic and the important concepts. I hope it helped.

Leave a comment if you have any query, or if you want to add something please feel free to do that too.

Thank you.