Introduction to macroeconomics
Indian Economy: Pre and Post-Independence
Introduction
The Indian economy is a vast and complex system that deals with the production,
distribution, and consumption of goods and services across various sectors. It is
characterised by a mixed economic structure, where both the public sector
(government) and the private sector (individuals and businesses) play vital roles in
economic development. India’s economy is also diversified across three major sectors —
agriculture (primary), industry (secondary), and services (tertiary).
Over time, India has transformed from a traditional agrarian economy to one of the
fastest-growing economies in the world. This transformation can be best understood by
analysing the economic conditions before and after independence in 1947. While the
pre-independence period was marked by colonial exploitation and economic
stagnation, the post-independence era focused on development, self-reliance, and
planned growth. This shift laid the foundation for modern India’s journey towards economic
progress.
Key Features of the Pre-Independence Indian Economy
1. Colonial Exploitation:
British rule focused on using India’s resources for their benefit. There was no
intention to develop India economically.
2. Agrarian Dominance:
Majority of the population depended on agriculture, but it was backward, with low
productivity and high dependence on monsoons.
3. Decline of Indian Industries:
Traditional handicrafts and textile industries were destroyed due to the dumping of
British machine-made goods.
4. Lack of Modern Industrialisation:
Very limited industrial development took place, mostly controlled by British capital,
and served colonial interests.
5. Underdeveloped Infrastructure:
Infrastructure like railways and ports existed, but it served colonial trade purposes,
not national development.
6. Widespread Poverty and Low Living Standards:
High poverty levels, poor health and education facilities, and widespread
unemployment were common.
Key Features of the Post-Independence Indian Economy
1. Planned Economic Development:
India adopted Five-Year Plans starting from 1951, focusing on agriculture, industry,
health, and education.
2. Mixed Economy Model:
India chose a combination of socialist policies (government control) and capitalist
growth (private sector participation).
3. Public Sector Expansion:
The government took control of key industries (steel, power, transport) to build a
strong foundation for development.
4. Green Revolution:
Introduced in the 1960s, it helped increase agricultural productivity, especially in
food grains like wheat and rice.
5. Economic Reforms (1991):
India liberalised its economy by reducing government control, encouraging private
investment, and opening up to foreign trade.
6. Growth of the Service Sector:
In recent decades, IT, banking, and communication services have become major
contributors to India’s GDP.
Current Challenges Faced by the Indian Economy
India is one of the fastest-growing economies in the world, but it still faces several economic
challenges that affect its growth and development. These challenges are related to poverty,
employment, inequality, infrastructure, and external factors like global economic conditions.
Addressing these issues is essential for achieving inclusive and sustainable growth.
1. Unemployment and Underemployment
● Unemployment is a major issue, especially among the youth and educated
population.
● Many people are working in jobs that do not match their skills or education levels
(underemployment).
● The informal sector still dominates, where job security and income stability are low.
2. Poverty and Income Inequality
● Although poverty levels have reduced over the years, millions of people still live
below the poverty line.
● There is a growing gap between the rich and the poor.
● Economic benefits are not evenly distributed across different regions and social
groups.
3. Inflation and Rising Prices
● The prices of essential goods like food, fuel, and medicines often rise, leading to
inflation.
● Inflation reduces the purchasing power of common people, especially the poor and
middle class.
● Controlling inflation while maintaining growth is a tough task for policymakers.
4. Agricultural Distress
● A large part of the population still depends on agriculture, but the sector is suffering
due to:
○ Low productivity
○ Dependence on monsoons
○ Lack of modern technology and irrigation
○ Farmers’ debts and rising input costs
● Farmer suicides and protests are signs of deep-rooted issues in rural India.
5. Infrastructure Deficiencies
● Inadequate infrastructure in transport, electricity, water supply, and digital access
limits economic development.
● Poor infrastructure in rural areas affects investment, employment, and overall living
standards.
6. Fiscal Deficit and Public Debt
● Government spending is often more than its income, leading to a fiscal deficit.
● High fiscal deficit increases the public debt, which becomes a burden for future
generations.
7. Education and Skill Development Gaps
● Although literacy rates have improved, the quality of education is still low in many
areas.
● There is a mismatch between education and industry needs, resulting in
unemployable graduates.
● Skill development programmes are not reaching enough people effectively.
8. Health Sector Challenges
● The COVID-19 pandemic exposed weaknesses in India’s healthcare infrastructure.
● Public spending on health is still low.
● Many people in rural areas do not have access to basic medical facilities.
9. Environmental Degradation
● Rapid industrialisation and urbanisation have led to pollution, deforestation, and
climate change effects.
● Sustainable development is needed to protect natural resources for future
generations.
10. External Economic Pressures
● Global issues like oil price fluctuations, geopolitical tensions, and currency
depreciation affect the Indian economy.
● Trade deficits and dependency on imports (especially oil and electronics) are also
concerns.
Sustainable Economic Development
Sustainable Economic Development means achieving economic growth that meets the
needs of the present generation without harming the ability of future generations to meet
their own needs. It aims to strike a balance between economic growth, social progress,
and environmental protection. For a country like India, sustainable development is
essential to ensure inclusive prosperity, preserve natural resources, and maintain long-term
economic stability.
India has been making progress in various sectors, but achieving sustainability remains a
complex challenge due to multiple social, political, economic, and global factors.
Key Components of Sustainable Economic Development
1. Social Development
● Improving healthcare, education, housing, and sanitation
● Empowering women, youth, and weaker sections
● Promoting social justice and inclusion
2. Economic Growth with Equity
● Ensuring that economic benefits are shared equally
● Providing equal opportunities for employment and entrepreneurship
● Bridging the gap between urban and rural as well as rich and poor
3. Economic Diversification
● Reducing dependence on agriculture alone by promoting manufacturing, services,
and green industries
● Encouraging innovation, start-ups, and clean technologies
4. Sustainable Infrastructure
● Building eco-friendly transport, smart cities, and green energy projects
● Improving access to clean water, electricity, and digital infrastructure
5. Effective Government Policies
● Enforcing environmental laws
● Promoting sustainable practices through schemes like:
○ National Solar Mission
○ Smart Cities Mission
○ Swachh Bharat Abhiyan
6. International Cooperation
● Committing to global agreements like the Paris Climate Agreement and UN
Sustainable Development Goals (SDGs)
● Sharing resources, technologies, and expertise through global partnerships
Challenges in Achieving Sustainable Economic Development
1. Social Inequality
● A large gap still exists between the rich and the poor.
● Marginalised communities have limited access to education, healthcare, and
employment.
● Gender inequality also affects social and economic development.
2. Inadequate Infrastructure
● Many rural and semi-urban areas still lack basic facilities like roads, water supply,
sanitation, and internet connectivity.
● This limits access to markets, services, and opportunities for sustainable growth.
3. Political and Governance Issues
● Delay in policy implementation due to bureaucratic inefficiency or corruption
● Lack of long-term planning due to frequent political changes
● Poor coordination between central and state governments
4. Environmental Degradation
● Rapid urbanisation and industrialisation are causing pollution, deforestation, and
climate change
● Excessive exploitation of natural resources threatens sustainability
5. Global Challenges
● Global factors like recession, pandemics (e.g., COVID-19), climate change, and
geopolitical tensions (e.g., wars, trade conflicts) can affect India’s economic
stability and growth.
● Dependence on imports (like crude oil, electronics) makes India vulnerable to
external shocks.
Circular Flow of Income
The Circular Flow of Income is an economic model that shows how income flows
between different sectors of the economy — mainly between households and firms. It
helps us understand how money, goods, and services move in an economy continuously.
Basic Concepts
● In an economy, households provide factors of production (like land, labour, and
capital) to firms.
● In return, firms pay households wages, rent, interest, and profits (i.e., income).
● Households then use this income to buy goods and services from the firms,
creating expenditure.
● Firms use this expenditure to continue producing goods and paying income to
households — and the cycle continues.
This continuous movement of money and goods is called the circular flow of income.
Two-Sector Model (Basic Model)
In the simplest form, the circular flow involves two sectors:
1. Households
● Own the factors of production (land, labour, capital, entrepreneurship)
● Supply these factors to firms
● Receive income in return
● Spend this income to buy goods and services
2. Firms
● Produce goods and services
● Buy factors of production from households
● Pay factor payments (wages, rent, etc.) to households
● Sell products to households and receive revenue
Households → (factors of production) → Firms
Firms → (income) → Households
Households → (expenditure on goods) → Firms
Firms → (goods & services) → Households
Expanded Models(4 sector economy model)
3. Government Sector
● Collects taxes from households and firms
● Provides public goods and services (like roads, defence, education)
● Spends on welfare schemes, subsidies, infrastructure, etc.
4. Financial Sector
● Includes banks and financial institutions
● Households save money in banks (called leakages)
● Firms borrow from banks for investment (called injections)
5. Foreign Sector
● Deals with exports and imports
● Money coming in from exports = injection
● Money going out for imports = leakage
Importance of the Circular Flow of Income
● Shows interdependence between different sectors
● Helps measure national income and economic activity
● Explains how income is generated and spent
● Useful in policy-making to manage demand and supply
National Income: A Brief Overview
National Income refers to the total monetary value of all goods and services produced by
a country’s residents over a specific period, usually a year. It is a key indicator of a country’s
economic performance and helps to measure the standard of living, economic growth, and
overall well-being of its population.
Key Aspects of National Income
1. Total Income of a Nation: National income represents the aggregate income
earned by the factors of production (land, labor, capital, and entrepreneurship) within
a country, including income from both domestic and foreign activities.
2. Economic Health: By measuring national income, governments and economists can
assess the economic health of a country, plan policies, and make decisions to
promote growth and improve living standards.
1. Gross Domestic Product (GDP)
GDP at Market Price (GDPmp)
● Definition: GDP at market price is the total value of all goods and services
produced within the country during a specific period, measured at the current
market prices. This value includes all indirect taxes (e.g., sales tax, VAT) and
excludes subsidies.
● Formula:
GDP at Market Price (GDPmp) = GDP at Factor Cost (GDPfc) + Indirect Taxes -
Subsidies
GDP at Factor Cost (GDPfc)
● Definition: GDP at factor cost measures the total value of goods and services
produced within the country, but excluding indirect taxes (like VAT or excise) and
including subsidies given by the government.
● Formula:
GDP at Factor Cost (GDPfc) = GDP at Market Price (GDPmp) - Indirect Taxes +
Subsidies
2. Gross National Product (GNP)
GNP at Market Price (GNPmp)
● Definition: GNP at market price is the total value of all goods and services
produced by a country’s residents, both within the country and abroad, during a
specific period, measured at market prices. It includes the net income from abroad
(income earned by residents abroad minus income earned by foreigners in the
country).
● Formula:
GNP at Market Price (GNPmp) = GDP at Market Price (GDPmp) + Net Factor
Income from Abroad (NFIA)
GNP at Factor Cost (GNPfc)
● Definition: GNP at factor cost is the total value of goods and services produced by
the country’s residents, measured at factor cost (excluding indirect taxes and
including subsidies). It also includes the net factor income from abroad.
● Formula:
GNP at Factor Cost (GNPfc) = GDP at Factor Cost (GDPfc) + Net Factor Income
from Abroad (NFIA)
3. Net Domestic Product (NDP)
NDP at Market Price (NDPmp)
● Definition: NDP at market price is the total value of all goods and services
produced within the country, after adjusting for depreciation (wear and tear of
capital). It is measured at market prices.
● Formula:
NDP at Market Price (NDPmp) = GDP at Market Price (GDPmp) - Depreciation
NDP at Factor Cost (NDPfc)
● Definition: NDP at factor cost is the total value of goods and services produced
within the country after adjusting for depreciation, measured at factor cost (i.e.,
excluding indirect taxes and including subsidies).
● Formula:
NDP at Factor Cost (NDPfc) = GDP at Factor Cost (GDPfc) - Depreciation
4. Net National Product (NNP)
NNP at Market Price (NNPmp)
● Definition: NNP at market price is the total income earned by a country’s
residents, after adjusting for depreciation, measured at market prices. It includes
net factor income from abroad.
● Formula:
NNP at Market Price (NNPmp) = GNP at Market Price (GNPmp) - Depreciation
NNP at Factor Cost (NNPfc)
● Definition: NNP at factor cost is the total income earned by a country’s residents,
after adjusting for depreciation, measured at factor cost (i.e., excluding indirect
taxes and including subsidies).
● Formula:
NNP at Factor Cost (NNPfc) = GNP at Factor Cost (GNPfc) - Depreciation
Summary of Formulas
Concept Formula
GDP at Market Price GDPmp = GDPfc + Indirect Taxes - Subsidies
(GDPmp)
GDP at Factor Cost GDPfc = GDPmp - Indirect Taxes + Subsidies
(GDPfc)
GNP at Market Price GNPmp = GDPmp + Net Factor Income from
(GNPmp) Abroad (NFIA)
GNP at Factor Cost GNPfc = GDPfc + Net Factor Income from
(GNPfc) Abroad (NFIA)
NDP at Market Price NDPmp = GDPmp - Depreciation
(NDPmp)
NDP at Factor Cost NDPfc = GDPfc - Depreciation
(NDPfc)
NNP at Market Price NNPmp = GNPmp - Depreciation
(NNPmp)
NNP at Factor Cost NNPfc = GNPfc - Depreciation
(NNPfc)
● GDP is concerned with the total economic output within a country.
● GNP expands this by considering income from abroad.
● NDP and NNP adjust for depreciation, showing the net value of production.
Methods of calculating national income
1. Value Added Method (Production Method)
Concept:
This method estimates national income by measuring the value added at each stage of
production. Value added is the difference between the value of output and the value of
intermediate goods used in production.
Steps :
1. Identification and Classification of Production Yields:
Classify the economy into various sectors such as primary (agriculture), secondary
(industry), and tertiary (services), and identify the outputs produced.
2. Estimation of Gross Domestic Product at Market Price (GDPmp):
Calculate the gross value of output for each sector and deduct the value of
intermediate consumption to arrive at Gross Value Added (GVA). Sum up all
GVAs and add indirect taxes, subtract subsidies to get GDPmp.
3. Calculate Domestic Income (GDPfc):
Subtract net indirect taxes (indirect taxes - subsidies) from GDPmp to get GDP at
factor cost (GDPfc).
4. Estimate Net Factor Income from Abroad (NFIA):
Add NFIA to GDPfc to get Gross National Income at Factor Cost (GNPfc).
Precautions :
● Intermediate goods are not to be included to avoid double counting.
● Sale and purchase of second-hand goods are not included, as they do not reflect
current production.
● Production of services for self-consumption (e.g., home cleaning by family
members) is excluded.
● Production of goods for self-consumption (e.g., vegetables grown for family use)
is excluded, except in special cases where they can be estimated.
● Change in stock of goods (inventory) is included in the current year’s production.
● Sale and purchase of shares, bonds, and debentures are included only to the
extent of brokerage/commission; the value of the financial asset itself is not
counted.
2. Income Method
Concept:
This method calculates national income by summing the incomes earned by all factors of
production – land, labour, capital, and enterprise – within the domestic territory.
Steps:
1. Identification and Classification of Production Yields:
Identify all sectors of the economy and classify their production activities.
2. Estimation of Factor Income Paid by Each Sector:
Record all payments made to the factors of production (wages, rent, interest, profit,
and mixed income).
3. Calculation of Domestic Income (NDPfc):
Sum all factor incomes to calculate Net Domestic Product at Factor Cost
(NDPfc).
4. Add Net Factor Income from Abroad:
Add NFIA to NDPfc to get Net National Product at Factor Cost (NNPfc), which is
the national income.
Components of Factor Income:
● Compensation of Employees – wages, salaries, benefits.
● Rent – income from land use.
● Interest – income from capital investment.
● Profit – operating surplus or income from entrepreneurship.
● Mixed Income – earnings of self-employed individuals.
Precautions:
● Transfer incomes such as pensions, donations, scholarships, and subsidies are
excluded.
● Income from sale of second-hand goods is excluded.
● Income from sale of shares, debentures, and financial instruments is excluded
(only broker commissions are included).
● Illegal incomes and windfall gains are excluded.
● Imputed rent of owner-occupied houses is included, as it represents a productive
service.
3. Expenditure Method
Concept:
This method calculates national income by adding all final expenditures made in the
economy, including consumption, investment, government purchases, and net exports.
Steps:
Here’s a simpler version of the Expenditure Method steps:
1. Identify Who is Spending:
Identify all the groups that spend money in the economy, such as:
○ Households (people buying goods and services)
○ Businesses (companies investing in things like machinery or new buildings)
○ Government (government spending on services like education, healthcare,
etc.)
○ Foreign Sector (exports and imports of goods and services)
2. Classify the Types of Spending:
Group the spending into different categories:
○ Consumption (C) – Spending by households on things like food, clothing,
and services.
○ Government Spending (G) – Government spending on public goods like
defense, education, and infrastructure.
○ Investment (I) – Spending by businesses on buildings, machinery, and
inventory.
○ Net Exports (X - M) – Exports (things sold abroad) minus imports (things
bought from abroad).
3. Calculate Domestic Income (NDPfc):
○ Add up all the types of spending to calculate Gross Domestic Product
(GDP).
GDP=C+I+G+(X−M)GDP = C + I + G + (X - M)
○ To find the value at Factor Cost (GDPfc), subtract any taxes and add any
subsidies.
○ Subtract depreciation (wear and tear on things like machinery) to get Net
Domestic Product (NDPfc).
4. Estimate Net Factor Income from Abroad (NFIA):
○ Add the Net Factor Income from Abroad (income earned by citizens from
other countries minus income earned by foreigners in your country) to NDPfc
to get National Income (NNPfc).
Precautions:
● Expenditure on intermediate goods is not included, as it leads to double counting.
● Transfer payments (scholarships, pensions, subsidies) are not included as they do
not reflect current production.
● Purchase of second-hand goods is excluded, as these do not represent current
year production.
● Purchase of financial assets (shares, debentures, etc.) is excluded. However, any
commission involved is included.
● Expenditure on own-account production (like building a house for self-use) is
included, if it can be estimated.
Summary Table
Method Key Idea Main Formula/Approach
Value Added Sum of value added at GDPmp = Gross Output – Intermediate
each stage Consumption
Income Method Sum of all factor NNPfc = Compensation + Rent + Interest +
incomes Profit + Mixed Income
Expenditure Sum of all final GDPmp = C + I + G + (X - M)
Method expenditures
