Personal Income and Personal Disposable Income; Real versus Nominal GDP;
GDP Deflator.
[A PROJECT OF ECONOMICS]
Supervised by- Dr. Hari Chand
Assistant Professor Economics.
Himachal Pradesh National Law University, Shimla (HPNLU).
Submitted by- Aman Singh Sengar.
Roll no. 164.
Enrollment no. 1020220164.
Session-2022-2027
INDEX
1. Acknowledgement and Bonafede certificate.
2. Price Effect.
3. Income Effect.
4. Substitution Effect.
5. Case Study.
BONAFIDE CERTIFICATE.
This certificate is to declare that this project based upon ‘Price effect, Income effect, Substitution
effect’ is an original work of Aman Singh Sengar who is a bona fide student of Himachal
Pradesh National Law University, Shimla.
Signature:
Aman Singh Sengar.
ACKNOWLEDGEMENT
The accomplishment of this project is owed to the constant support and guidance of people to
whom I’d like to convey my sincerest gratitude.
Dr. Digvijay Katich, our Political Science professor, enabled me to complete this project, with
his constant encouragement. His valuable help and guidance were instrumental in this project
and in resolving all the doubts encountered during the making of this project.
Library staff aided me in my research for the project through the usage of the online databases
and journal collection available in the library.
Lastly, I would like to sincerely appreciate my parents and friends for their constant
encouragement and moral support to enable me to complete this project.
INCOME:
Income refers to the money or financial resources that an individual or organization earns or
receives over a specific period. It typically includes wages, salaries, profits, rents, dividends, and
interest generated from various sources. Income can be derived from various sources, such as
employment, investments, business activities, rental properties, royalties, and more.
Individuals earn income through their work, such as regular employment, self-employment, or
freelance work. They receive wages, salaries, bonuses, and commissions from their employers in
exchange for their services. Self-employed individuals generate income through their business
activities or by providing services directly to clients or customers.
Investments can also generate income in the form of dividends from stocks, interest from bonds
or savings accounts, and capital gains from the sale of assets. Rental income is earned by
individuals who own and lease out properties, such as apartments, houses, or commercial spaces.
It's important to note that income can vary significantly based on factors such as occupation,
skills, experience, education, geographic location, and economic conditions. Different industries
and professions have varying income levels, and individuals may have multiple sources of
income contributing to their overall earnings.
Taxes are often applied to income, with governments levying income tax on individuals and
businesses based on their earnings. The tax rates and regulations governing income tax vary by
country and jurisdiction.
Personal income:
Personal income refers to the total earnings an individual receives from various sources, such as
employment, investments, and other forms of income. It includes wages, salaries, bonuses, tips,
commissions, rental income, dividends, interest, and any other money received.
The amount of personal income can vary greatly depending on factors such as occupation,
education, experience, location, and economic conditions. Some individuals may have a single
source of income, such as a regular salary from employment, while others may have multiple
sources contributing to their overall personal income. It's important to note that personal income
is subject to taxation, and individuals are typically required to report their income to the relevant
tax authorities and pay applicable taxes on their earnings. The specific tax obligations and rates
can vary depending on the jurisdiction and the individual's income level.
Personal Income = NI
Personal Income = NI – corporate profits minus dividends – social security
contribution + personal interest income received from the
g o v e r n m e n t a n d c o n s u m e r s + t r a n s f e r p a y m e n t s t o persons.
GROSS DOMESTIC PRODUCT (GDP):
Gross Domestic Product (GDP) is a key macroeconomic indicator that measures the total value
of all final goods and services produced within a country's borders during a specific period. It
serves as a measure of the overall economic activity and is widely used to assess the size and
growth of an economy.
Here are some important points about GDP:
1. Calculation: GDP can be calculated using three main approaches:
a. Expenditure Approach: This calculates GDP by summing up the total expenditures on final
goods and services in the economy. It includes consumption by households, investment by
businesses, government spending, and net exports (exports minus imports).
b. Income Approach: This calculates GDP by summing up the incomes earned by individuals
and businesses in the economy. It includes wages, salaries, profits, rents, and interest.
c. Production or Value-Added Approach: This calculates GDP by summing up the value added
at each stage of production. It avoids double-counting by considering only the value added at
each production stage.
2. Nominal vs. Real GDP: Nominal GDP is calculated using current market prices, while real
GDP adjusts for changes in the price level over time. Real GDP provides a more accurate
measure of economic growth by removing the effects of inflation. It allows for comparisons of
economic output across different time periods.
3. Economic Indicator: GDP is a crucial indicator of an economy's health and performance. It
provides insights into the overall size, growth rate, and productivity of an economy. Changes in
GDP over time indicate economic expansions or contractions, and GDP growth is often used as a
measure of economic well-being.
4. Limitations: While GDP is a widely used measure, it has certain limitations. It does not
capture non-market activities, such as household work or volunteer services, and does not
account for income distribution or environmental sustainability. Additionally, GDP does not
reflect the overall welfare or happiness of individuals in an economy.
5. International Comparisons: GDP is also used for comparing the size and economic
performance of different countries. However, due to variations in exchange rates, inflation rates,
and other factors, it is
important to adjust GDP figures using measures like purchasing power parity (PPP) to make
meaningful international comparisons.
GDP is a fundamental measure in macroeconomics and provides a snapshot of an economy's
production, growth, and overall economic activity. It is a crucial tool for policymakers,
businesses, and analysts to understand and evaluate the performance of an economy.
GDP DEFLATOR:
The GDP deflator, also known as the implicit price deflator for GDP, is a measure used to adjust
nominal gross domestic product (GDP) for inflation. It reflects changes in the overall price level
of goods and services produced in an economy over a specific period of time.
The GDP deflator is calculated by dividing nominal GDP by real GDP and multiplying the result
by 100. The formula is as follows:
GDP Deflator = (Nominal GDP / Real GDP) * 100
Nominal GDP represents the value of all final goods and services produced in an economy
during a given period, using current market prices. It does not account for changes in the price
level and may include the effects of both changes in prices and changes in the quantity of goods
and services produced.
Real GDP, on the other hand, is a measure of economic output that has been adjusted for changes
in the price level. It allows for a comparison of GDP across different time periods by holding
prices constant. Real GDP is calculated by using a base year's prices as a reference and adjusting
the quantities of goods and services produced in subsequent years to reflect changes in output.
By dividing nominal GDP by real GDP and multiplying by 100, the GDP deflator expresses the
ratio of nominal GDP to real GDP as a percentage. This percentage indicates the average change
in prices between the base year and the current year.
The GDP deflator is a broader measure of inflation compared to other price indices, such as the
Consumer Price Index (CPI) or the Producer Price Index (PPI). It encompasses price changes in
all goods and services produced in an economy, including those consumed by households,
businesses, and the government.
HOW TO CALCULATE:
The calculation of the GDP deflator involves dividing nominal GDP by real GDP and
multiplying the result by 100. Here's the step-by-step calculation process:
1. Obtain the nominal GDP for a specific year. Nominal GDP represents the total value of all
final goods and services produced in an economy at current market prices during a given period.
2. Determine the real GDP for the same year. Real GDP is a measure of economic output that
adjusts for changes in the price level. It allows for a comparison of GDP across different time
periods by holding prices constant.
3. Divide the nominal GDP by the real GDP obtained in Step 2.
4. Multiply the result by 100 to express the ratio as a percentage.
The formula for calculating the GDP deflator is as follows:
GDP Deflator = (Nominal GDP / Real GDP) * 100
By following this formula, you can calculate the GDP deflator for a specific year. Remember to
use consistent units of measurement (e.g., in billions or trillions of dollars) for both nominal and
real GDP to ensure accurate results.
Note: Real GDP is typically derived by using a base year's prices as a reference and adjusting the
quantities of goods and services produced in subsequent years to reflect changes in output. This
adjustment accounts for changes in the price level, allowing for a more accurate comparison of
economic growth.
EXAMPLE:
Let's consider a simplified example to illustrate the calculation and interpretation of the GDP
deflator:
Suppose we have an economy with two goods: apples and oranges. We will calculate the GDP
deflator for two consecutive years, Year 1 and Year 2, using the following data:
Year 1:
- Nominal GDP: $1,000
- Real GDP: 500 units of apples + 300 units of oranges
Year 2:
- Nominal GDP: $1,500
- Real GDP: 600 units of apples + 400 units of oranges
To calculate the GDP deflator for Year 1, we divide the nominal GDP by the real GDP and
multiply by 100:
GDP Deflator (Year 1) = (Nominal GDP Year 1 / Real GDP Year 1) * 100
= ($1,000 / (500 apples + 300 oranges)) * 100
= $1,000 / 800 * 100
= 125
The GDP deflator for Year 1 is 125, indicating that the average price level of goods and services
in Year 1 is 125% of the base year (or reference year).
Similarly, we calculate the GDP deflator for Year 2:
GDP Deflator (Year 2) = (Nominal GDP Year 2 / Real GDP Year 2) * 100
= ($1,500 / (600 apples + 400 oranges)) * 100
= $1,500 / 1,000 * 100
= 150
The GDP deflator for Year 2 is 150, indicating that the average price level of goods and services
in Year 2 is 150% of the base year.
Interpreting these results, we can say that prices have increased by 25% (from 100 to 125)
between Year 1 and the base year, and by 50% (from 100 to 150) between Year 2 and the base
year. This indicates inflation or changes in the overall price level over time.
The GDP deflator provides a measure of inflation and allows for comparisons of price levels
between different years, reflecting changes in the purchasing power of a currency. It is a useful
tool for understanding inflationary trends and making adjustments to economic indicators to
account for changes in the price level.
SIGNIFICANCE OF GDP DEFLATOR:
The GDP deflator is an important economic indicator that serves several purposes:
1. Inflation Measurement: The GDP deflator is a comprehensive measure of inflation because it
reflects price changes in the entire range of goods and services produced within an economy. It
provides insights into the overall price level and allows policymakers, analysts, and businesses to
assess inflationary trends over time.
2. Real GDP Calculation: The GDP deflator is crucial for calculating real GDP, which is GDP
adjusted for changes in the price level. Real GDP is a key indicator of economic growth because
it allows for comparisons of economic output across different time periods, stripping out the
effects of inflation. By dividing nominal GDP by the GDP deflator, analysts can derive real GDP
figures, which provide a more accurate picture of economic performance.
3. Economic Policy Formulation: The GDP deflator plays a significant role in formulating
economic policies. Governments and central banks use inflation measures like the GDP deflator
to monitor price stability and make informed decisions regarding monetary policy, interest rates,
and fiscal policy. By understanding the overall price level, policymakers can implement
appropriate measures to manage inflation and stimulate or stabilize economic growth.
4. International Comparisons: The GDP deflator allows for international comparisons of
economic performance. Since different countries may use different currencies and experience
varying rates of inflation, comparing nominal GDP alone may not provide an accurate
representation of relative economic strength. By using the GDP deflator, analysts can adjust for
differences in price levels and make more meaningful comparisons between economies.
5. Income and Wage Adjustments: The GDP deflator is also used to adjust income and wage
figures for changes in the price level. When analysing changes in personal income or wage
growth, it is important to account for inflation to determine the true purchasing power of
individuals. Adjusting these figures with the GDP deflator helps assess changes in real income
and wages, providing a more accurate measure of economic well-being.
In summary, the GDP deflator is a valuable economic indicator that measures inflation, helps
calculate real GDP, guides economic policy decisions, facilitates international comparisons, and
enables adjustments for income and wages. Its comprehensive nature makes it a useful tool for
understanding and analysing economic trends and performance.
Its roles include monitoring and measuring inflation, adjusting nominal GDP for inflation,
guiding policy decisions, adjusting income and wage figures, and facilitating international
comparisons. It provides important insights into the overall price level, economic performance,
and welfare of individuals and is crucial for policymakers, economists, and analysts in making
informed decisions and assessments.
