Economic Analysis: formula sheet

Key formulas

Expenditure approach

GDP = C + I + G + (X − M)

C = private consumption, I = investment, G = government spending, X − M = net exports. Imports are subtracted.

Income approach

GDP = Wages + Rent + Interest + Profit (+ depreciation and net indirect taxes, at market prices)

Adds up incomes earned by factors of production. Adjustments are needed to move between factor cost and market price.

GNP

GNP = GDP + Net factor income from abroad

Net factor income = income earned by residents abroad − income earned by foreigners in the country.

Real GDP and deflator

GDP deflator = (Nominal GDP ÷ Real GDP) × 100

Real GDP = Nominal GDP ÷ deflator × 100. Real GDP removes price effects.

Net and market price links

NDP = GDP − Depreciation; GDP at market price = GDP at factor cost + Indirect taxes − Subsidies

Net means after depreciation. Factor cost excludes taxes and adds back subsidies.

Inflation rate

Inflation (%) = (Index this year − Index last year) ÷ Index last year × 100

Works for CPI or WPI. It is the percentage change in the index.

Phase sequence

Expansion → Peak → Contraction → Trough → Expansion

Peak is the top and trough is the bottom. Growth slows at the peak and recovers after the trough.

Leading indicator

Turns BEFORE the economy

Used to forecast. Examples: new orders, stock indices, building permits, consumer confidence, yield spread.

Coincident indicator

Turns WITH the economy

Used to identify the current phase. Examples: industrial production, employment, personal income, sales.

Lagging indicator

Turns AFTER the economy

Used to confirm a trend. Examples: unemployment rate, bank credit outstanding, inventories, inflation.

Repo rate

RBI lends to banks (against government securities)

Raising it tightens policy. Cutting it eases policy.

Reverse repo rate

RBI borrows from banks (absorbs liquidity)

Do not confuse direction with repo. Banks earn this rate.

CRR

CRR = cash kept with RBI ÷ NDTL

Held as cash with the RBI. Earns no interest on this balance.

SLR

SLR = liquid assets held ÷ NDTL

Held by the bank itself in cash, gold or government securities.

OMO direction

Buy securities → liquidity ↑; Sell securities → liquidity ↓

Buying is easing. Selling is tightening.

Policy stance rule

Tightening: repo ↑, CRR ↑, SLR ↑, OMO sale; Easing: the opposite

Tightening is used to fight inflation. Easing is used to support growth.

Fiscal deficit

Fiscal deficit = Total expenditure − (Revenue receipts + Non-debt capital receipts)

Non-debt capital receipts are items such as loan recoveries and disinvestment proceeds. It equals the government's net borrowing requirement.

Revenue deficit

Revenue deficit = Revenue expenditure − Revenue receipts

Only revenue items are used. Capital items are left out.

Primary deficit

Primary deficit = Fiscal deficit − Interest payments

A primary surplus means the government is not borrowing to pay for non-interest spending.

Deficit as a ratio

Fiscal deficit ratio = (Fiscal deficit ÷ GDP) × 100

Use GDP at current market prices, as quoted in the Budget.

Effective revenue deficit

Effective revenue deficit = Revenue deficit − Grants for creation of capital assets

It adjusts for revenue spending that actually builds assets.

Balance of payments identity

Current account + Capital account (incl. reserves change) = 0

A current account deficit is financed by net capital inflows or by a fall in reserves.

Trade balance

Trade balance = Exports of goods − Imports of goods

Negative means trade deficit. It is only one part of the current account.

Current account

CA = Trade balance (goods) + Net services + Net primary income + Net secondary income

Remittances sit in secondary income.

Exchange rate quote

Exchange rate = ₹ per 1 unit of foreign currency

A rise in the number means the rupee has depreciated.

Percentage change in the rupee

Depreciation of ₹ (%) = (New rate − Old rate) ÷ Old rate × 100, when quoted as ₹ per $

Use the same quote on both dates.

Interest rate parity (idea)

Forward premium ≈ Domestic interest rate − Foreign interest rate

A currency with higher interest rates trades at a forward discount, approximately.

Real GDP growth (approx.)

Real growth ≈ Nominal growth − Inflation

Approximation for exam use. Real GDP is measured at constant prices.

Growth accounting idea

Output growth ≈ contribution of labour + contribution of capital + productivity growth

Productivity growth is the part not explained by more labour or capital.

Savings-investment identity (open economy)

Investment = Domestic savings + Foreign savings (net capital inflow)

Foreign savings equals the current account deficit. If savings exceed investment, the country has a current account surplus.

Top-down sequence

Economy → Industry → Company

Bottom-up is the reverse: Company → Industry → Economy.

Quick revision

• GDP measures the value of final goods and services produced in an economy over a period.
• Inflation is a sustained rise in the general price level; CPI and WPI measure it differently.
• IIP tracks changes in the volume of industrial production over time.
• Leading indicators move before the cycle turns, coincident ones with it, lagging ones after it.
• Monetary policy is run by the RBI and works through money supply and interest rates.
• Fiscal policy is run by the government through taxation and spending.
• Higher interest rates usually slow borrowing and demand and tend to pressure bond prices.
• A fiscal deficit means government spending exceeds its receipts excluding borrowing.
• Balance of payments records a country's transactions with the rest of the world.
• A weaker rupee generally helps exporters and raises the cost of imports.
• Always ask which way a change pushes growth, inflation, rates and the currency.
• Check whether a question asks for the cause, the effect or the measure.

Common mistakes

• Treating GDP and GNP as the same or reversing them Fix: Remember GDP is by location, GNP is by nationality. GNP = GDP + net factor income from abroad.
• Saying WPI includes services Fix: WPI covers goods only. CPI includes both goods and services.
• Classifying the unemployment rate as a coincident or leading indicator. Fix: Remember that firms hire and fire only after demand changes. Employment levels are often treated as coincident, but the unemployment rate is a classic lagging indicator.
• Swapping peak and trough. Fix: A peak is a mountain top, the highest point. A trough is a valley, the lowest point.
• Saying the RBI lends to banks at the reverse repo rate. Fix: Repo: RBI lends. Reverse repo: RBI borrows.
• Treating an OMO purchase as tightening. Fix: When the RBI buys securities, it pays out money, so liquidity rises.
• Counting borrowings as a receipt when computing fiscal deficit Fix: Remember that fiscal deficit is the borrowing need. Exclude debt receipts, or you will get zero.
• Confusing revenue deficit with fiscal deficit Fix: Revenue deficit uses only revenue items. Fiscal deficit uses total expenditure and all non-debt receipts.
• Treating the trade deficit and the current account deficit as the same. Fix: Trade balance covers goods only. Current account adds services, income and transfers.
• Putting FDI or FPI in the current account. Fix: Investment and borrowing flows belong to the capital (financial) account. Dividends and interest paid are current account income.

Exam tips

• Expect direct 'which of the following is correct' questions on GDP versus GNP and CPI versus WPI. Learn the scope keywords.
• Watch for words such as 'only', 'always' and 'includes services'. They are common trap markers.
• For calculations, write the formula before the numbers. Most errors are sign errors on imports or net factor income.
• Wrong answers cost 25% of the question's marks, so skip a question only if you cannot narrow it to two options.
• Know that IIP is a volume index with a base year and covers mining, manufacturing and electricity.
• Memorise one or two examples for each indicator type. Questions usually ask you to classify a named indicator.
• Unemployment rate, inflation, bank credit and inventories are the usual lagging examples. Stock indices, new orders, permits and confidence are the usual leading ones.
• Watch for options that say a leading indicator guarantees a turn. Those are traps.