Chapter -2 – Basic Concepts of Macroeconomics

LEARNING OBJECTIVES
2.1 DOMESTIC TERRITORY (ECONOMIC TERRITORY)
2.2 NORMAL RESIDENTS
2.3 FACTOR INCOME AND TRANSFER INCOME
2.4 FINAL GOODS AND INTERMEDIATE GOODS
2.5 CONSUMPTION GOODS AND CAPITAL GOODS
2.6 GROSS INVESTMENT, NET INVESTMENT AND DEPRECIATION
2.7 NET INDIRECT TAX (NIT)
2.8 NET FACTOR INCOME FROM ABROAD (NFIA)

2.1 DOMESTIC TERRITORY (ECONOMIC TERRITORY______________________

Domestic territory is a very important concept in national income accounting. In layman's language
domestic territory means the political frontiers of a country. However, for the purpose of national income
accounting, it is used in a wider sense.

On addition to political frontiers, domestic territory also includes:

1. Ships and aircrafts owned and operated by normal residents between two or more countries. For
example, planes operated by Air India between Russia and Japan are part of the domestic territory
of India. Similarly, planes operated by Singapore Airways between India and Japan are a part of the
domestic territory of Singapore.
2. Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a
country in the international waters where they have exclusive rights of operation. For example,
Fishing boats operated by Indian fishermen in international waters of Indian Ocean will be
considered a part of domestic territory of India.
3. Embassies, consulates and military establishments of a country located abroad. For example
Indian Embassy in Russia is a part of the domestic territory of India.

‘Consulate ’ is an office or building used by consul (an officer commissioned by the government to reside
in a foreign country to promote the interest of the country to which he belongs)

Domestic Territory does not include:

1. Embassies, consulates and military establishments of a foreign country. For example, Japanese
Embassy in India is a part of domestic territory of Japan.

2. International organisations like UNO, WHO, etc. located within the geographical boundaries of a
country.
According to the United Nations, Economic Territory or domestic territory is the geographical territory,
administered by a government within which, persons, goods and capital circulate freely.

Test Yourself
Which of the following are covered under the domestic territory of India?
1. An Indian Company in London.
2. Microsoft Office in India.
3. Company in India owned by a Japanese.
4. Office of Reliance Industries in New York.
5. Branch of Foreign Bank in India.
6. Indian Embassy in Japan.
7. Branch of State Bank of India in China.
8. Russian Embassy in India.
9. Tata rented its building to Google in America.
{Ans. Domestic Territory: 2, 3, 5, 6}

2.2 NORMAL RESIDENTS

Normal resident of a country refers to an individual or an institution who ordinarily resides in the
country and whose centre of economic interest also lies in that country. Normal residents include both,
individuals and institutions.
‘Centre of Economic Interest’ implies two things:
1. The resident lives or is located within the Domestic Territory; and
2. The resident carries out basic economic activities of earnings, spending and accumulation from that
location.
Following are not included under the category of Normal residents:
1. Foreign tourists and visitors who visit a country for recreation, holidays, medical treatment, study,
sports, conferences, etc.
2. Foreign staff of Embassies, officials, diplomats and members of the armed forces of a foreign
country, located in the given country.
3. International organisations like UNO, WHO, etc. are not considered as normal residents of the
country in which they operate. They are treated as the normal residents of international area.
4. Employees of international organisations are considered as residents of the countries to which they
belong and not of the international area. poor example, an American working in UNO office located
in India will be treated as normal resident of America.
However, if the employees are working for more than one year in such International Institutions, then they
become the normal resident a country in which such institutions are located. It means, in the given example,
if the American is working in UNO office in India for more than one year, then he will be treated as normal
resident of India.
5. Crew members of foreign vessels, commercial travellers and seasonal workers, provided their
stay is less than one year,
6. Border workers who live near the international border and cross the border on a regular basis to
work in the other country. They are treated as normal residents of the country where they live, and
not where they work,

Test Yourself
Identify the following as Normal Residents of India:
(a) Indian officials working in the Indian Embassy in USA.
(b) A Japanese tourist who stays in India for 2 months.
(c) Indians going to Pakistan for watching the cricket match.
(d) Indians working in the UNO office, located in America for less than 1 year.
(e) Indian employees working in WHO, located in India.
(f) Foreign tourists visiting India for a month to see the Taj Mahal.
(g) Indian Muslims going for the Haj pilgrimage.

Citizenship and Residentship are two different terms

Citizenship
It is basically a legal concept based on the place of birth of the person or some legal provisions allowing a
person to become a citizen. It means, Indian citizenship can arise in two ways:
(i) When a person is born in India, he acquires automatic citizenship of India.
(ii) A person born outside India applies for citizenship and Indian Law allows him to become Indian
Citizen
Residentship
 It is an economic concept based on the basic economic activities performed by a person.
 An individual is a normal resident of a country if he ordinarily resides in the country for a period
more and his centre of economic interest also lies in that country.
Example: A Chinese living in India for more than one year is a normal resident of India. However, he is
not a citizen (or national) of India as he does not hold citizenship of India. It means, a person can be a
citizen of one country and at the same time, a resident of another country.

Concepts of Domestic Territory and Normal Resident

The concepts of Domestic Territory and Normal Resident are important to estimate ‘Domestic Product’
and ‘National Product’.
1. The concept of Domestic territory helps to estimate ‘Domestic Product’. Domestic Product
includes production activity of production units located in the economic territory irrespective
of fact whether carried out by the residents or non-residents. The money value of domestic
product is termed as Domestic Income.
2. The concept of Normal Resident helps to estimate ‘National Product’. National Product includes
production activities of normal residents irrespective of fact whether performed within the
economic territory or outside it. The money value of national product is termed as National
Income.
The concepts of Domestic Income and National Income have been discussed in detail later in the chapter.

2.3 FACTOR INCOME AND TRANSFER INCOME

Factor Income
Factor income refers to income received by factors of production for rendering factor services in the
production process.
 It is received for providing factor services of land, labour, capital and enterprise
 Factor income of normal residents of a country is included in the National Income.
 Examples: Rent, wages, interest and profit.
*Factors of Production are the primary inputs, which are needed to produce goods and services. They are
broadly categorised under four heads: (i) Land; (ii) Labour; (iii) Capital; and (iv) Entrepreneur.
Transfer Income
Transfer income refers to income received without rendering any productive service in returns It is a
unilateral (one-sided) concept.
 It is not included in National Income as it does not reflect any production of goods and services.
 It can be received either within the domestic territory of a country or from abroad.
 Example Old age pension, scholarship, unemployment allowance, pocket money, etc.

Taxes received by the government are the transfer incomes of the government as they are received
without providing any productive service in return. Similarly, subsidies paid by the government are
transfer payments of the government.

Current Transfers Vs Capital Transfers

Transfer receipts are of two types: (i) Current Transfer; (ii) Capital Transfer.
1. Current transfers are made out of income, whereas, capital transfers are made out of the wealth of
the payer.
2. Current transfers are generally regular in nature, whereas, capital transfers are irregular.
3. Current transfers are meant for consumption purposes, whereas, capital transfers are meant for
capital formation.
4. Examples of Current transfers: Old age pension, gifts, unemployment allowance, etc. Examples
of Capital transfers: Investment grant, capital gains tax, war damages, etc.

Factor Income Vs Transfer Income

Basis Factor Income Transfer Income

Meaning It refers to income received by
factors of production for
rendering factor services in the
production process.
Nature It is included in both National
Income and Domestic Income.
Concept It is an earning concept.
It refers to income received
without rendering any
productive service in return.
It is neither included in
National Income nor in
Domestic Income.
It is a receipt concept.

Nature It is included in both National It is neither included in

Income and Domestic Income. National Income nor in
Domestic Income.
Concept It is an earning concept. It is a receipt concept.

Basis Factor Income Transfer Income

 Recipient It is received by factors of It is generally received by
production (land, labour, households and government.
capital and enterprise).
Example Rent, Wages, Interest and Scholarship, Old age pension,
Profit. Unemployment allowance,
etc.

2.4 FINAL GOODS AND INTERMEDIATE GOODS ________________________

Final Goods
Final goods refer to those goods which are used either for consumption or for investment
Final Goods include:
(i) Goods purchased by consumer households as they are meant for final consumption (like milk
purchased by households).
(ii) Goods purchased by firms for capital formation or investment (like machinery purchased by
a firm).
It must be noted that final goods are neither resold nor used for any further transformation in the process
of production.

Intermediate Goods
Intermediate goods refer to those goods which are used either for resale or for further production in the
same year.
Intermediate Goods include:
(i) Goods purchased for resale (like milk purchased by a Dairy Shop).
(ii) Goods used for further production (like milk used for making sweets).

Important Points about Intermediate Goods

They are generally purchased by one production unit from another production unit, i.e. intermediate goods
remain within the production boundary.
However, all purchases by one production unit from other production units are not intermediate purchases.
For example, purchases of building, machinery, etc. are not intermediate purchases (if they are not meant
for resale) as their value is not included in the value of final good. In fact, such purchases are termed as
final products as they are purchased for investment.

 They have ‘Derived Demand’ as their demand depends on demand for final goods.
 Durable goods (like trucks, aircrafts, vehicles, etc.) purchased by Government for military purposes
are included under the category of intermediate goods as they are used to produce defense services
and not for market sale.
 Value of intermediate goods is merged with the value of final goods. For instance, suppose a miller
buys wheat worth `700 and converts it into flour worth `1,000. Now, the value of flour (final good)
includes the value of wheat (intermediate good).

Production Boundary
The concept of production boundary is very significant to understand the difference between intermediate
and final goods. The production boundary is the line around the productive sector. As long as goods
remain within the production boundary, they are intermediate goods and when a good comes out of this
boundary, it becomes a final good.

In the given diagram, there are 3 production units (A, B and C). The thick border drawn around these three
units is the Production Boundary. Within this limit, cotton and thread are intermediate goods. Cloth is a
final good as it lies outside the purview of production boundary.

HOW to Classify Goods as: Intermediate Goods and Final Goods

The distinction between intermediate goods and final goods is made on the basis of the use of product and
not on the basis of product itself A commodity can be an intermediate good as well as a final good,
depending upon its nature of use.
For Example:

(i) Sugar is an intermediate good when it is used by sweet shop for making sweets. However, if it is
used by the consumers, then it becomes a final good.
(ii) Similarly, milk is an intermediate good when it is used in dairy shops for resale. However, it
becomes a final good when it is used by the households.

so, it must be noted that distinction is made on the basis of end use j/f end use of a good is consumption or
investment, then it is a final good. However, if the good is used for resale or further production (in the same
year), then it is an intermediate good.

National Income includes only Final Goods

Only final goods are included in national income. The intermediate goods are not included in the national
income as they are already included in the final goods. If their value is added again, it will lead to double
counting.
Example: Out of wheat and flour, only flour (final good) is included in National Income as value of flour
already includes the value of wheat (intermediate good).

Goods used up in the same year are Intermediate Goods I

It should always be remembered that intermediate goods are used up in the same year. If they remain for
more than one year, then they are treated as final goods.
Example: Suppose X L td. purchases 10 tonnes coal in 2018 for making glasses. Only 7 tonnes coal was
used up in 2018. Now, 7 tonnes coal will be taken as intermediate goods and remaining 3 tonnes coal will
be treated as final goods and will be included in National Income.

Final Goods Vs Intermediate Goods

Basis Final Goods Intermediate Goods

Meaning Final goods refer to those goods
which are used either for
consumption or for investment.
Nature They are included in both national
and domestic income.
Value They are ready for use by their
addition final users i.e. no value has to be
added to the final goods.
Production They have crossed the production
Boundary boundary.
Example Milk purchased by households for
consumption, car purchased as an
investment.
Intermediate goods refer to those
goods which are used either for
resale or for further production in
the same year.
They are neither included in
national income nor in domestic
income.
They are not ready for use, i.e.
some value has to be added to the
intermediate goods.
They are still within the
production boundary.
Milk used in dairy shop for resale,
coal used in factory for further
production.

Items categorised as Intermediate Products and Final Products

1. Paper purchased by a publisher.

It is an intermediate product as paper is used for further production during the same year.

2. Furniture purchased by a school. (CBSE, Delhi2011 (I)}

It is a final product because it is purchased for investment.

3. Milk purchased by households.

It is a final product as it is used by households for final consumption.

4. Purchase of rice by a grocery shop.

These are intermediate products because these are purchased for resale.

5. Coal used by manufacturing firms.

It is an intermediate product as coal is used for further production during the same year.

6. Computers installed in an office. {CBSE, Delhi2011 (II)}

It is a final product because it is purchased for investment.

7. Coal used by consumer households.

 It is a final product as it is used by households for final consumption.

8. Mobile sets purchased by a mobile dealer. {CBSE, Delhi2011 (II)}

These are intermediate products because these are purchased for resale.
9. Purchase of pulses by a consumer.
It is a final product as it is used by a consumer for final consumption.

10. Chalks, dusters, etc. purchased by a school. {CBSE, Delhi 2011 (I)}
These are intermediate products because these are taken to be used up completely during the same
year.

11. Fertilizers used by the farmers.

These are intermediate products because fertilizer is used for further production during the same
year.

12. Printer purchased by a lawyer.

It is a final product because it is purchased for investment.

13. Wheat used by the flour mill.

It is an intermediate product as wheat is used for further production during the same year or is meant
for resale.

14. Unsold coal with trader at year end.

It is a final product as the unsold coal is an investment for the trader.

15. Cotton used by a cloth mill.

It is an intermediate product as cotton is used for further production during the same year.

16. Wheat used by households.

It is a final product as it is used by households for final consumption.

17. Refrigerator installed by a firm.

It is a final product because it is purchased for investment.
18. Sugar used by a sweet shop.
It is an intermediate product as sugar is used for further production during the same year.

2.5 CONSUMPTION GOODS AND CAPITAL GOODS

"Final goods can be classified into two groups: Consumption Goods and Capital Goods.
Consumption Goods
Consumption goods refer to those goods which satisfy the wants of the consumers directly.
For example, Bread, butter, shirts, pens, television, furniture, etc.
Consumption goods can further be sub-divided into following categories:

1. Durable goods: u refers to those goods which can be used again and again over a considerable
period of time. For example, television, refrigerators, etc.

2. Semi-durable goods: Goods which can be used for a limited period of time are termed as semi-
durable goods. These goods have a life span of around one year. For example, clothes, crockery,
shoes, etc.

3. Non-durable goods: Goods which are used up in a single act of consumption are known as non- C
durable goods. (These goods cannot be used more than once, i.e. they lose their identity in single
act of consumption. for example, milk, bread, food grains, paper, etc.

4. Services: Services refer to non-material goods which directly satisfy the human wants. They are
intangible activities, i.e. they can neither be seen nor touched. For example services of teachers,
doctors, banks, etc.

Capital Goods
Capital Goods are those final goods which height production of other goods and services. For example,
plant and machinery, equipments, etc.
Some Points about Capital Goods
(i) They are used in future for productive purposes and have expected life time of several years.
(ii) They do not lose their identity in the production process, i.e. they do not get merged in the process
of production,
(iii) They need repairs or replacement over time as they depreciate over a period of time.
(iv) They have derived demand as their demand is derived from the demand for other goods, which they
help to produce.
All Producer Goods are not Capital Goods
It must be noted that all goods used by producer (known as producer goods) are not capital goods. Producer
goods include two types of goods:
 Single-use Producer Goods: It includes raw material like coal, wood, etc. They are not capital
goods as they cannot be repeatedly used in the production process.
 Capital Goods: It includes fixed assets like plant and machinery, which can be repeatedly used in
the production process

So, it can be said that all capital goods are producer goods, but all producer goods are not capital goods.
How to Classify Goods as: Consumption Goods and Capital Goods There is no clear cut line of demarcation
between consumption goods and capital goods. The same good can be consumption good and also capital
good. It depends on the ultimate use of the good. For example, a machine purchased by a household is
consumption good, whereas, ^f it is purchased by a firm for use in the business, then it is a capital good.

However, if the machinery is bought by the firm for resale, then it will be treated as an intermediate
good.
Consumption Goods Vs Capital Goods

Basis Consumption Goods Capital Goods

Satisfaction of These goods satisfy human Such goods satisfy human wants
Human wants wants directly. So, such goods indirectly. So, such goods have
have direct demand. derived demand.
Production They do not promote They help in raising production
Capacity production capacity. capacity.
Expected Most of the consumption Capital goods generally have an
Life goods (except durable goods) expected life of more than one
have limited expected life. year.

Comprehensive Example of Final Goods and Intermediate Goods

PRODUCT FINAL GOODS INTERMEDIATE
Consumption Capital Goods GOODS
Goods
Car If purchased by If purchased by taxi- If purchased by car dealer
household. driver as taxi. for resale.
Or
If purchased by firm for
use in business.
Cloth If purchased by Cloth lying unsold with If purchased by tailor for
households. trader at the end of making dresses. Or
accounting year (Capital If purchased by garment
formation). shop for resale.
Sugar If used by If lying unsold with trader If used by sweet shop for
households. at the end of year. making sweets. Or
If purchased by Grocery
shop for resale.
Services of If used by If used by enterprises.
doctor or households.
lawyer

2.6 GROSS INVESTMENT, NET INVESTMENT AND DEPRECIATION ______

Investment or capital formation refers to addition to the capital stock of an economy. For example,
construction of building, purchase of machinery, addition to inventories of goods, etc.
Investment can be looked up in two forms:
(i) Gross Investment
(ii) Net Investment

Gross Investment
Gross Investment is addition to the stock capital before making allowance for depreciation.
Capital stock consists of fixed assets and unsold stock So, gross investment is the expenditure on purchase
of fixed assets and unsold stock during the accounting year.

However, gross investment does not indicate the actual change in economy’s stock of productive assets for
a given year. During the production process, some amount of fixed capital is used up. This loss of fixed
capital is known as depreciation. By subtracting depreciation from gross investment, we get Net Investment

Net Investment
The actual addition made to the capital stock of economy in a given period is termed as Net Investment.
Net Investment = Gross Investment - Depreciation
Let us now understand the meaning of depreciation.

Depreciation (Consumption of Fixed Capital

Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time or
expected obsolescence change in technology.
The concept of depreciation is very important to differentiate between Gross value and the Net value.
'Gross' is inclusive of depreciation, whereas, 'net' excludes it.
Gross Value = Net Value + Depreciation
Depreciation is also known as: (i) Current Replacement Cost; (ii) Replacement cost of Fixed Capital; (iii)
Capital Consumption Allowance.

Calculation of Amount of Depreciation

Depreciation is also called consumption of fixed capital. It refers to that value of fixed capital (or fixed
assets) which is consumed (or used up) in the process of production. Because of depreciation, fixed assets
need to be replaced from time to time. Replacement of fixed assets requires funds. Provision for the funds
is made on annual basis. To illustrate, if a machine is purchased for `10,00,000 and its expected lifetime
of use is 10 years, then the annual provision for funds (to replace the machine after 10 years) is `1,00,000
(= `10,00,000 ÷ `10).
Depreciation of assets is mainly due to 3 reasons:
(i) Normal wear and tear: Continuous use of fixed assets in production process decreases their
productive capacity and value.
(ii) Passage of time: Value of fixed assets also decreases with the passage of time, even if they are not
being put to use in the business. Natural factors like rain, winds, weather, etc. contribute to fall in
their value.
(iii) Expected obsolescene: Value of fixed assets also decreases due to expected obsolescence (i.e. loss
in value due to change in technology or change in demand for goods and services).

Depreciation Vs Capital Loss

Basis Depreciation Capital Loss

Meaning It refers to fall in the value of It refers to loss in value of the
fixed assets due to normal wear fixed assets due to unforeseen
and tear, passage of time or obsolescence, natural
expected obsolescence. calamities, thefts, accidents, etc.
 Provisio Provision is made for No such provision is made in
n for loss replacement of assets as it is an case of capital loss as it is an
expected loss. unexpected loss.
Producti It does not hamper the It hampers the production
on production process. process.
process

NET INDIRECT TAX (NIT) ____________________________________________________

Net indirect tax refers to the difference between indirect taxes and subsidies.
Net Indirect Tax = Indirect Taxes - Subsidies
Let us discuss the two components of NIT:
(i) Indirect Taxes
Indirect taxes refers to those taxes which are imposed by the government on production and sale of
goods and services. For example, Goods and Services Tax (GST).
Indirect tax increases the price of the product in the market. For example,, if cost of producing one set of
speakers is `500 and Government levies GST of 10%, then price of speakers will increase to `550 due to
indirect taxes.

(ii) Subsidies
Subsidies are the 'economic assistance' given by the government to the firms and households, with a
motive of general welfare. In India, LPG cylinder is sold at subsidized rates.
• They are often granted to promote exports or to encourage firms for setting up the industries in the
backward areas.
Subsidies are opposite to indirect taxes as they reduce the market price of the commodity. In the example
of speakers, if the Government grants a subsidy of `10, then price of speakers will fall to `540 due to
subsidies.
• Subsidies may also be referred as 'Economic Assistance' or 'Financial Assistance'.

Factor Cost Vs Market Price

(a) Factor Cost (FC): It refers to amount paid to factors of production for their contribution in the
production process. In the given example, `500 is the 'Factor Cost'
(b) Market Price (MP): It refers to the price at which product is actually sold in the market. In the given
example, `540 is the 'Market Price'. It includes the indirect taxes and excludes the subsidies.
 Market Price = Factor Cost + (Indirect Taxes - Subsidies)
 Market Price = Factor Cost + Net Indirect Taxes
Calculate Net Indirect Taxes (NIT) in the following cases:

Case 1: (i) Indirect Taxes = 0; (ii) Subsidies = `100

Ans. NIT = 0- `100 = - `100
Case 2: (i) Indirect Taxes - `250; (ii) Subsidies = 0
Ans NIT = `250 - 0 = `250
Case 3: (i) Indirect Taxes = `200; (ii) Subsidies = `120
Ans NIT = `200 - `120 = `80

The concept of NIT is very important to differentiate between Factor Cost and Market Price. ‘Market Price’
includes net indirect taxes, whereas, ‘Factor cost’ excludes it. The concepts of indirect taxes and subsidies
does not arise in a two-sector economy including households and firms. This concept is relevant in a three-
sector and four-sector economy.

2.8 NET FACTOR INCOME FROM ABROAD (NFIA) _________________________

It refers to the difference between factor income received from the rest of the world and factor income
paid to the rest of the world.
NFIA = Factor income earned from abroad - Factor income paid abroad
 'Factor income from abroad' is the income earned by the normal residents of a country from the rest
of the world (ROW) in the form of wages and salaries, rent, interest, dividend and retained earnings.
 'Factor income to abroad' is the factor income paid to the normal residents of other countries (i.e.
non-residents) for their factor services within the economic territory.
Significance of NFIA
NFIA is significant to differentiate between 'Domestic Income' and 'National Income'. In practical
estimates, domestic income is estimated first and then, National Income is derived from Domestic Income
in the following manner:

National Income
= Domestic Income
+ Factor income from abroad (due to contribution of normal residents to production outside the economic
territory)
-Factor income to abroad (due to contribution of non-residents to production inside the economic territory)
The difference of Factor income from abroad and Factor income to abroad is termed as "Net factor income
from abroad" or popularly abbreviated as NFIA. So, National Income = Domestic Income + NFIA.

NFIA can be Positive, Negative or Zero

• NFIA is Positive when income earned from abroad is more than income paid to abroad.
• NFIA is Negative when income earned from abroad is less than income paid to abroad.
• NFIA is Zero when income earned from abroad is equal to income paid to abroad.

Components of NFIA
There are three main components of NFIA:
1. Net Compensation to Employees: It refers to difference between income from work received by
resident workers living or employed abroad for less than one year and similar payments made to
non-resident workers staying or employed within the domestic territory of the country for less than
one year.
2. Net Income from property and entrepreneurship: It refers to difference between income from
property and entrepreneurship (in the form of rent, interest and dividend) received by residents of
the country and similar payments made to the non-residents.
3. Net Retained Earnings: It refers to difference between retained earnings of resident companies
located abroad and retained earnings of non-resident companies located within the domestic
territory of the country.

Retained Earnings refer to that part of profits which is kept as reserve after paying the corporate tax and
dividends.
Thus, it may be concluded that:
Net factor income from abroad = Net compensation of employees + Net income from property and
entrepreneurship + Net retained earnings.
It must be noted that NFIA is zero in a closed economy as such economy does not deal with the rest of the
world sector.

Before we proceed further

Students must be very careful while dealing with NFIA. Quite often, NFIA is given in different forms. Let
us discuss treatment of NFIA in the following cases:
Calculate NFIA in the following cases:
Case 1: (i) Factor income from abroad = `500; (ii) Factor income to abroad = `300
Ans. NFIA = `500 - `300 = `200
Case 2: (i) Factor income from abroad = `250; (ii) Factor income to abroad = `620
Ans. NFIA = `250 - `620 = (-) `370
Case 3: Factor income to abroad = `150
Ans. NFIA = (-) `150
Case 4: Factor income to abroad = - `150
Ans. NFIA = `150

REVISION OF KEY POINTS

 Domestic Territory refers to the geographical territory administered by a government within which
persons, goods and capital circulate freely.
 Normal resident refers to an individual or an institution who ordinarily resides in the country for a
period more than one year and whose centre of interest also lies in that country.
 Factor Income is the income received by the factors of production for rendering factor services in
the process of production.
 Transfer Income refers to the income received without rendering any productive service in return.
 Final Goods refer to those goods which are used either for consumption or for investment.
 Intermediate Goods refer to those goods which are used either for resale or for further production
in the same year.
 Consumption goods refer to those goods which satisfy the wants of the consumers directly.
 Capital Goods are those final goods which help in production of other goods and services.
 Gross Investment refers to total investment made in a given period in an economy.
 Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time
and expected obsolescence.
 Net Indirect Tax refers to the difference between indirect taxes and subsidies.
 Net Factor Income from Abroad refers to the difference between the factor income received from
the rest of the world and the factor income paid to the rest of the world.
 Three Components of NFIA: (i) Net compensation of employees; (ii) Net income from property
and entrepreneurship; (iii) Net retained earnings.

Synonyms or Similar Terms of this Chapter

Domestic Territory Economic Territory
Factor Income Earned Income
Transfer Income Unearned Income
Investment Capital Formation
Depreciation  Consumption of Fixed Capital
 Current Replacement Cost
 Replacement Cost of Fixed Capital
 Capital Consumption Allowance
Subsidies  Economic Assistance
 Financial Assistance

HOTS HIGHER ORDER THINKING SKILLS QUESTIONS

Q. 1. Classify the following as factor income or transfer income:
(i) Unemployment allowances.
(ii) Salary received by Rakesh from a company.
(iii) Financial help to earthquake victims.
(iv) Compensation received from the employer.
(v) Claim received from Insurance company by an injured worker.
(vi) Birthday gift received from a friend.
(vii) Bonus received on Diwali.
Ans. Factor Income: (ii), (iv), (vii); Transfer Income: (i), (iii), (v), (vi).

Q. 2. Classify the following as final goods or intermediate goods.

(i) Machine purchased by a firm.
(ii) Soft drinks purchased by the school canteen.
 (iii) Clothes purchased by an individual.
(iv) Coal purchased by a factory.
(v) Electricity consumption in a business.
(vi) Book purchased by a student.
(vii) Books purchased by a book seller.
(viii) Postage stamps purchased by a consumer.
(ix) Postage stamps purchased by a business unit.
(x) Exhaust fans used for making water coolers.
(xi) Seeds purchased by a farmer to produce wheat.
(xii) Seeds purchased for kitchen gardening.
(xiii) Machines purchased by a dealer of machines. {CBSE, All India 2010}
(xiv) Car purchased by a household. {CBSE, All India 2010}
(xv) Sewing machine purchased by a housewife.
Ans. Final Goods: (i), (iii), (vi), (viii), (xii), (xiv), (xv); Intermediate Goods: (ii), (iv), (v), (vii), (ix), (x),
(xi),(xiii).

Q. 3. What is meant by factor income to abroad? State its components. {CBSE, Delhi 2002}
Ans. Factor income to abroad refers to the factor income paid to the normal residents of other countries (i.
e. non-residents) for their factor services within the economic territory.
Components of factor income to abroad:
(i) Compensation of employees paid to the non-resident workers working within the economic
territory.
(ii) Income from property (rent, interest) and entrepreneurship (dividend) paid to the rest of the
world.
(iii) Fletained earnings of enterprises owned by non-residents within the domestic territory.
{Note: it must be noted that components of ‘Factor income to abroad’ are asked and not of ‘Net factor
income from abroad’}

Q. 4. Which among the following are capital goods and which are consumer goods (or consumption
goods)and why?
(a) A car used as a taxi
(b) Refrigerator in a hotel
(c) Air-conditioner in a house {CBSE, All India 2018}
Ans. (a) A car used as a taxi: It is a capital good because it is used for producing services for generating
income.
(b) Refrigerator in a hotel: It is a capital good because it is used for providing services over a period
of time to the production unit.
(c) Air-conditioner in a house: It is a consumer good because it is used for satisfaction of a want by
a household.

Q. 5. Which among the following are final goods and which are intermediate goods? Give reasons.
(a) Milk purchased by a tea stall.
(b) Bus purchased by a school.
(c) Juice purchased by a student from the school canteen.
Ans. (a) It is an intermediate good as milk is purchased by a tea stall for further production.
 (b) It is a final good as bus is treated as an investment for the school.
(c) It is a final good as juice purchased by a student is meant for consumption purpose.

TRUE AND FALSE

Are the following statements true or false? Give reasons.
1. Intermediate goods have a derived demand, while final goods have direct demand.
True. Intermediate goods have a derived demand as their demand depends on demand for final
goods. On the other hand, final goods have a direct demand as they satisfy the wants directly.

2. Bread is always a consumer good. {CBSE, Sample Paper 2010}

False. It depends on the end use of bread. When it is purchased by a household, it is a consumer
good. If it is purchased by restaurant, it is a producer (intermediate) good.

3. Gross investment can be equal to net investment.

True. It is possible when depreciation is zero.

4. Market price is always more than factor cost.

False. Market price can be less than factor cost if net indirect taxes (NIT) are negative. Market price
can also be equal to factor cost if NIT is zero.

5. A good can be an intermediary good in one case and a final good in another case.
True. A good can be an intermediate good as well as a final good, depending upon its nature of use.
For example, a car purchased by a household is a final good, whereas, it will be an intermediate good
if it is purchased by a car dealer.

6. The concept of normal resident applies to individuals only.

False. The concept applies to institutions also, in addition to individuals.

7. In final goods, no value is to be added.

True. Because final goods have crossed the production boundary.

8. Butter is only a final product. {CBSE, Delhi Comptt. 2012}

False. It depends on the end use of butter. If butter is purchased by a household, then it is a final
good. However, if it is purchased by a bakery shop for making cakes, then it is an intermediate good.

9. End-use of the goods categorise the goods as intermediate goods and final goods.
True. If the end-use of the good is for further production or resale, then the good is an intermediate
good. However, if the end-use of the good is consumption or investment, then the good is a final
good.

10. Final goods include only those goods which are consumed by the households.
False. Final goods include those goods which are either consumed by the households or purchased
by the producers for investment purposes.

11. Both ‘Expected Obsolescence’ and ‘Unexpected Obsolescence’ are considered for determining the
amount of depreciation.
 False. Only ‘Expected Obsolescence’ is considered for determining the amount of depreciation.

12. National Income is always more than the Domestic Income.

False. National Income can also be less than domestic income when net factor income from abroad
is negative. National Income is always more than the Domestic Income only when net factor income
from abroad is positive.

13. All purchases by a production unit from other production units are intermediate products.
False. Because all such purchases are not necessarily used up for further production or resold during
the year. For example, products like machines, vehicles, etc. are final products even though they are
purchased by a production unit from other production units.
Note: As per CBSE guidelines, no marks will be given if reason to the answer is not explained.

REVISION EXERCISE
Multiple Choice Questions (MCQs)
1. Which of the following are covered under the domestic territory of India?
(a) State Bank of India in London (b) Google office in India
(c) Office of Tata Motors in Australia (d) Russian Embassy in India

2. Which one of the following is an intermediate product?

(a) Purchase of pulses by consumers (b) Machine purchased by a firm
(c) Wheat used by a flour mill (d) Wheat used by households

3. Which one of the following is not an example of final goods?

(a) Chalk, dusters, etc. purchased by a school (b) Fertilizers used by the farmers
(c) Wheat used by the flour mill (d) All of the above

4. Which of the following constitute the reason for difference between Market Prices and Factor Cost?
(a) Indirect Taxes (b) Subsidies
(c) Both (a) and (b) (d) Neither (a) nor (b)

5. If factor cost is greater than market price, then it means that:

(a) Indirect Taxes > Subsides (b) Indirect Taxes = Subsidies
(c) Indirect Taxes < Subsides (d) Indirect Taxes ≥ subsidies

6. Final goods refer to those goods which are used either for ___ or for .
(a) Consumption, investment (b) Consumption, resale
(c) Resale, investment (d) Resale, further production

7. Net factor income from abroad is:

(a) Exports minus Imports
(b) Visible Exports minus Visible Imports
(c) Factor incomes received from abroad minus factor incomes paid abroad
(d) Factor incomes received from abroad
8. Depreciation means:
(a) Destruction of a plant in a fire accident (b) Loss of fixed assets overtime due to wear and tear
(c) Loss of fixed assets in an earthquake (d) Closure of the plant due to lockout

9. Market price and Factor cost will be equal when there is:
(a) No direct tax (b) No indirect tax
(c) No subsidy (d) No indirect tax and no subsidy

10. Which of the following is an example of transfer income?

(a) Bonus (b) Unemployment Allowance
(c) Compensation from the employer (d) All of the above

11. Which of the following is an example of an intermediate goods?

(a) Car sold by a dealer of second hand cars (b) Steel and cement used to construct a flyover
(c) Fertilizers purchased by a farmer (d) All the these

12. Sugar purchased by a Sweet shop is an_____good, while it is a____good when it is purchased
by a consumer.
(a) capital, final (b) final, intermediate
(c) intermediate, final (d) final, producer

13. Identify the missing item in the following flowchart: {CBSE, Delhi 2016}

(a) Depreciation (d) Net Indirect Taxes

(c) Net Factor Income from Abroad (d) Indirect Taxes

14. Which of the following flowchart correctly establishes the treatment of ‘Depreciation’?
{CBSE, Foreign 2016}

15. Depreciation of fixed capital assets refers to: {CBSE, Delhi 2016}
 (a) Normal wear and tear (b) Foreseen obsolescence
(c) Normal wear & tear & foreseen obsolescence (d) Unforeseen obsolescence

16. Unforeseen obsolescence of fixed capital assets during production is: {CBSE, Foreign 2016}
(a) Consumption of Fixed Capital (b) Capital Loss
(c) Income Loss (d) None of the above

17. Refrigerator purchased by a confectionery shop is an example of:

(a) Final Good (b) Intermediate Good
(c) Capital Good (d) Both (a) and (c)

18. Which of the following is an example of Non-durable good?

(a) Milk (b) Bread
(c) Both (a) and (b) (d) Clothes

19. Addition to the capital stock of an economy is termed as:

(a) Investment (b) Capital Loss
(c) Consumption of Fixed Capital (d) All of these

20. Japanese Embassy in India is a part of domestic territory of:

(a) India (b) Japan
(c) Both (a) and (b) (d) International Area

21. Foreign embassies in India are a part of India’s: (Choose the correct alternative)
{CBSE, Delhi Comptt. 2017}
(a) Economic territory (b) Geographical territory
(c) Both (a) and (b) (d) None of the above

22. Goods purchased for the following purpose are final goods: (choose the correct alternative)
{CBSE, All India Comptt. 2017}
(a) For satisfaction of wants (b) For investment in firm
(c) Both (a) and (b) (d) None of the above

Answer Key
1 B 11 D 21 B
2 C 12 C 22 C
3 D 13 B 23
4 C 14 A 24
5 C 15 C 25
6 A 16 B 26
7 C 17 D 27
8 B 18 C 28
 9 D 19 A 29
10 B 20 B 30

Very Short Answer Type Questions (1 Mark each)

Q. 1. Give the meaning of factor income.
Ans. Factor income refers to the income received by the factors of production for rendering factor services
in the process of production.

Q. 2. What is meant by transfer income?

Ans. Transfer income refers to the income received without rendering any productive service in return.

Q. 3. Out of factor income and transfer income, which one is included in the national income?
Ans. Factor income.

Q. 4. Define current transfers. {CBSE, Delhi 2003}

Ans. Current transfers refer to transfers made out of the current income of the payer and added to the
current income of the recipient.

Q. 5. Define final goods. {CBSE, All India Comptt. 2013}

Ans. Final goods refer to those goods which are used either for consumption or for investment.

Q. 6. What is meant by intermediate goods?

Ans. Intermediate goods refer to those goods which are used either for resale or for further production in
the same year.

Q. 7. Can purchase of a new car be categorised as an intermediate good?

Ans. Yes, purchase of a new car can be categorised as an intermediate good if it is purchased by a car
dealer for resale.

Q. 8. Define consumption goods? {CBSE, All India 2012, Delhi Comptt. 2014 (II)}
Ans. Consumption goods refer to those goods which satisfy the wants of the consumers directly.

Q. 9. Define capital goods. {CBSE, Delhi 2012, Delhi Comptt. 2014 (I)}
Ans. Capital Goods are those final goods which help in the production of other goods and services.

Q.10. What is meant by Net factor income from abroad?

Ans. Net factor income from abroad refers to the difference between the factor income received from the
rest of the world and the factor income paid to the rest of the world.

Q.11. Give an example of a person who is staying abroad for a period more than one year and still he is
treated as normal resident of India.
Ans. An Indian working in Indian Embassy in USA will be treated as normal resident of India.

Q.12. Define ‘depreciation’. {CBSE, All India 2011, All India Comptt. 2014}
 OR
What is meant by ‘Consumption of fixed capital’? {CBSE, Delhi Comptt. 2013}

Ans. Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time
or expected obsolescence (change in technology).

Q.13. Define capital formation. {CBSE, Delhi Comptt. 2011}

OR
Define investment. {CBSE, Delhi Comptt. 2013 (III), 2014 (III)}
Ans. Capital formation refers to addition to the capital stock of an economy. For example, construction of
building, purchase of machinery, etc.

Q.14. Define Gross Investment. {CBSE, Foreign 2016}

Ans. Gross Investment is addition to the stock of capital before making allowance for depreciation.

Q.15. Give two examples of intermediate goods. {CBSE, All India 2013, Delhi Comptt. 2014 (III)}
Ans. (i) Milk used in dairy shop for resale; (ii) Coal used in factory for further production.

Q.16. Define ‘resident’? {CBSE, Delhi Comptt. 2013 (II)}

Ans. Resident refers to an individual or an institution who ordinarily resides in the country and whose
centre of economic interest also lies in that country.

Q.17. What are ‘subsidies’? {CBSE, Sample Paper 2017}

Ans. Subsidies are the ‘economic assistance’ given by the government to the firms and households, with
a motive of general welfare.
Short Answer Type Questions (3-4 Marks each)
1. Distinguish between factor income and transfer receipt. {CBSE, Delhi 2003}
2. Distinguish between intermediate products and final products. Give examples.
{CBSE, Delhi 2009, Delhi Comptt. 2015, Delhi 2017} OR
Explain the basis of classifying goods into intermediate and final goods. Give suitable examples.
{CBSE, Delhi 2010 (I, III), All India 2017(1)}
3. ‘Machine’ purchased is always a final good.’ Do you agree? Give reasons for your answer.
{CBSE, Sample Paper 2012}
4. Which of the following expenditures incurred are on intermediate products and which are on final
products? You must state reason for your answer: {CBSE, Delhi 2001}
(i) Purchase of ticket for train journey by an individual.
(ii) Purchase of eatables by a firm.
(iii) Purchase of a car by an employer for office use by his employees. l-lint Intermediate Products:
(ii); Final Products: (i), (iii).
5. Discuss the meaning of consumption goods and capital goods.
6. Distinguish between consumer goods and capital goods. Which of these are final goods?
{CBSE, Delhi 2010 (II)}
7. What is meant by net factor income from abroad? Briefly discuss its various components.
8. Define intermediate goods and final goods. Can milk be an intermediate good? Give reasons for your
answer. {CBSE, All India Comptt. 2015 (III)}
 Hint for 2nd Part: Milk purchased by a restaurant is intermediate good because it is purchased for
reselling.
9. Distinguish between: (a) Final good and intermediate good; (b) Consumption good and capital good.
{CBSE, All India Comptt. 2016}
10. What are capital goods? How are they different from consumption goods? {CBSE. Delhi 2018}

Long Answer Type Questions (6 Marks each)

1. Explain the concept of normal residents.
2. Briefly discuss the meaning of domestic territory.
3. Discuss the concept of factor income and transfer income with the help of examples.
4. Distinguish between Intermediate product and final product, giving suitable examples in support of
your answer. {CBSE, Delhi2005}
*****