INCEPTS OF MACROECONOMICS LEARNING OBJECTIVES DOMESTIC TERRITORY (ECONOMIC TERRITORY) 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) 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 ofa country. However, for the purpose of national income accounting, it is used in a wider sense. Inaddition 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. 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. 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. "is an office or building used by ‘country to promote the | x » 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. 24ted within the geographic 2. International organisations like UNO, WHO, ete. loca boundaries of a country. ‘Which of the following are covered 4. An indian Company in London. 2. Microsoft Office in India. 8. 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. ‘under the domestic territory of India? 2.2 NORMAL RESIDENTS 2 Normal resident of a country refers to an individual or an institution who ordinarily resides the country @nd whose centre of economic interest also lies in that country. Normal residen include both, individuals and institutions. “Centre of Economic Interest’ implies two things: 1. The resident lives or is located within the Domestic Territory; and >. The resident carries out basic economic activities of earnings, spending and accumula 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 tre study, sports, conferences, etc. Foreign staff of Embassies, officials, diplomats and members of the armed forces of foreign country, located in the given country. 3. International organisations like UNO, WHO, etc. are not considered as normal residents’ the country in which they operate. They are treated as the normal residents of internatio area. 4, Employees of international organisations are considered as residents of the cou which they belong and not of the international area, fo" ¢"p!° an American’ UNO office located in India will be treated as normal resident of America. nv » Crew members of foreign vessels, commercial their stay is less than one year.oj Macroeconomics 23 6. Border workers who 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. ‘Identify the following as Normal Residents of india: (a) Indian officials working in the Indian Embassy in USA. = (b) Avapanese tourist who stays in India for 2 months. © Indians going to Pakistan for watching the cricket match. — (@) Indians working in the UNO office, located in America for less than 1 year. yf, (e) Indian employees working in WHO, located in India. ——— {) Foreign tourists visiting India for a month to see the Taj Mahal. (g) Indian Muslims going for the Haj pilgrimage. — {Ans. Normal Residents: (a), (0), (4), (2) ()) 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 (When a person is born in India, he acquires automatic citizenship of India. (i) Aperson bom outside India applies for citizenship and Indian Law allows him tobecome Indian Citizen. Residentship « Itis 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 and ‘National Product’. period more than one year and his centre of economic interest also lies in that country. ere te ee Vent ean lagna ceeiapriirte The concepts of Domestic Territory and Normal Resident help to estimate ‘Domestic 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. it means, final goods and services produced by Foreign Nationals (ike Honda, Pepsi, etc.) and by indian Nationals (like Patanjali, Reliance, Tata, etc.) within the domestic taritory of India, willbe added to get India's domestic product without distinguishing between nationals and non-national. The money value of domestic product is termed as Domestic Income. 2. The concept of Normal Resident helps to estimate ‘National Product’. National Product normal residents irrespective of fact whether24 Introductory 2.3 FACTOR INCOME AND TRANSFER INCOME Factor Income Factor income refers to income received by factors of production" for rendering fact, in the production process. * Itis received for providing factor services of land, labour, capital and enterprise, income is earned for contributing to production process, it is a Bilateral Income. * Factor income of normal residents of a country is included in the National Inco © Examples: Rent, wages, interest and profit. * It should be noted that Factor Incomes and Factor Payments are the two sides 0 coin. It is factor income from the viewpoint of the owners of factors of prodi it is factor payment from the viewpoint of the producers of goods and services, _ Transfer Income Transfer income refers to income received without rendering any productive service in * Itis a unilateral (one-sided) concept. * It is not included in National Income as it does not reflect any production of goo services. * Itcan be received either within the domestic territory of a country or from abroad. * Examples: Old age pension, scholarship, unemployment allowance, pocket money, Transfer receipts are of two types: (i) Current Transfer; (i) Capital Transfer. 1. Current transfers are made out of income, whereas, capital transfers are made out of wealth of the payer. 2. Current transfers are generally regular in nature, whereas, capital transfers are imegulk 3, Current transters are meant for consumption purposes, whereas, capital transfers are! for capital formation. 7 Examples of Current transfers: Old age pension, gifts, unemployment allowance, Examples of Capital transfers: Investment grant, capital gains tax, war damages, eC. S Factor Income Vs Transfer Income 4 | Basis | ___Factor income | Itrefers to income received by factors of | It refers to income received without production for rendering factor services | rendering any productive service in the production process. return. Aasic Concepts of Macroeconomics 25 It is neither included in National and Domestic Income. Income nor in Domestic Income. Concept _ It is an earning concept. It is a receipt concept. | Recipient _| It is received by factors of production | It is generally received by (land, labour, capital and enterprise). | households and government. Example —_| Rent, Wages, Interest and Profit. ‘Scholarship, Old age pension, 1 Unemployment allowance, etc. 2.4 FINAL GOODS AND INTERMEDIATE GOODS All things that satisfy human wants are called goods. On the basis of end use of goods, they can be mainly classified into two heads: (i) Final Goods; and (ii) 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 mill purchased by households). (ii) Goods purchased by firms for capital formation or investment (like machinery rurchased by a firm). Expenditure on final goods purchased by households is called ‘Consumption Expenditure’ and expenditure on final goods purchased by the producers is called ‘Investment Expenditure’. So, Expenditure on Final Goods = Consumption Expenditure + Investment Expenditure. 't must be noted that final goods are neither resold nor used for any futher transformation in the eine. 4 > : 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, ie. intermediate goods remain within the production boundary.Introductory h + They have ‘Derived Demand’ as their demand depends on demand for final . They are not yet ready for use by their final users, i.e.some value has to be intermediate goods, For example, Sugar purchased by a sweet shop is an as some value is to be added to sugar for making sweets. « Durable goods (like trucks, aircrafts, vehicles, etc.) purchased by Government purposes are included under the category of intermediate goods as they are used to defense services and not for market sale. + Value of intermediate goods is merged with the value of final goods. For instance, miller buys wheat worth % 700 and converts it into flour worth @ 1,000. Now, the 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. Inthe given diagram, there are 3 production units (A, Band 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. Farmer A produces: Cotton worth & 2,000 and Sells it to B B produces Thread worth % 3,000 and sells itto C C produces Cloth worth % 4,500 and sells it to Consumers PRODUCTION BOUNDARY How to. Sica Goods as: Intermediate Goods and Final Goods The distinction between intermediate goods and final goods is made on the basis of the product and not on the basis of product itself, A commodity can be an intermediate good as 4 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. if itis used by the consumers, then it becomes a final good, (ii) Similarly, milk is an intermediate good when itis used in dain é k 'y shops for resale, it becomes a final good when itis used by the households, ombaal cof Macroeconomics 27 National Income includes only Final Goods nly final goods are included in national income. The intermediate goods are not included jn the national income as they are already included in the final goods. If their value is added again, it will lead to double counting. Goods used up in the same year are Intermediate Goods Itshould always be remembered that intermediate goods are used up in the same year. If they than one year, then they are treated as final goods. remain for more Final Goods Vs Intermediate Goods Basis Final Goods d Intermediate Goods ‘Meaning | Final goods refer to those goods which | Intermediate goods refertothosegoods | are used either for consumption or for | which are used either for resale or for | investment. further production in the same year. Nature They are included in both national and | They are neither included in national domestic income. income nor in domestic income. Value They are ready for use by their final | They are not ready for use, .e.some addition _|users i.e. no value has to be added to |value has to be added to the inter- the final goods. mediate goods. Production | They have crossed the production |They are still within the production Boundary _ | boundary. boundary. Milk purchased by households for [Milk used in dairy shop for resale, coal ‘consumption, car purchased as an |used in factory for further production. investment. Items categorised as Intermediate Products and Final Products 1. Paper purchased by a publisher. It/s an intermediate product as paper is used for further production during the same year. 2. Furniture purchased by a school. {CBSE, Delhi 2011 (I)} tis a final product because it is purchased for investment. 3. Milk purchased by households. tis a final product as itis 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. Itis an intermediate product as coal is used for further production during the same year. 6. Computers installed in an office. {CBSE, Deihi 2011 (I)} Itis a final product because it is purchased for investment. 7.Coal used by consumer households. Itis a final product as it is used by households for final consumption. Example8. Mobile sets purchased by a mobile dealer. These are intermediate products because these are purchased for resale. 9. Purchase of pulses by a consumer. tis a final product as itis used by a consumer for final consumption. CB 10. Chalks, dusters, etc. purchased by a school. { are These are intermediate products because these are taken to be used up completely the 11. Fertilizers used by the farmers. * YhesSushittreae noes because fertilizer is used for further production during the 12, Printer purchased by a lawyer. Its a final product because it is purchased for investment. 13. Wheat used by the flour mill. Its an intermediate product as wheat is used for further production during the same. year or resale. 14. Unsold coal with trader at year end. ssibcvie Ot (ae tis a final product as the unsold coal is an investment for the trader. 15. Cotton used by a cloth mill. Its an intermediate product as cotton is used for further production during the same year. 16. Wheat used by households. 1oIs19 97197 .9.i omnes Its a final product as it is used by households for final consumption. 17. Refrigerator installed by a firm. Itis.a final product because it is purchased for investment. 18. Sugar used by a sweet shop. Its 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 dit For example, Bread, butter, shirts, pens, television, furniture, etc. Consumption goods can further be sub-divided into following categories: 1. Durable goods: It refers to those goods which can be used again and again over a 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 a3! durable goods. These goods have a life span of around one year. Foy. example, clothes, shoes, etc. 3. Non-durable goods: Goods which are used up in a single act of consumption are known durable goods. These goods cannot be used more than once, ie, they lose their i single act of consumption. For example, milk, bread, foodgrains, paper, etc. 4. Services: Services refer to non-material goods which directly satisfy the human wants. intangible activities, i.e, they can neither be seen nor touched. For example, teachers, doctors, banks, ete, ‘ee ea ee i Bos Concepts of Macroeconomics 29 Capital Goods Capital Goods are those final goods which help in production of other goods and services. For ‘exomple, 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, ie. they do not get merged in the process of production. (ii) 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. () Capital Goods are Durable Use Consumer Good for Households: When a good (say, refrigerator) is used by a producer (say, Confectionery Shop), then it is a Capital Good. However, the same good, i.e. refrigerator is a durable use consumer good for the households. So, if the end-user of a durable good is a producer, then it is a capital good. However, if the end-user is a household, then it is a durable use consumer good. ‘All Producer Goods are not Capital Goo Producer goods are those goods which are used in the production of other goods. All goods used by producer, i.e. all producer goods are not capital goods. Producer goods jinclude two types of goods: * Single-use Producer Goods: It includes raw material ike 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, if it is purchased by a firm for use in the business, then it is a capital good. Consumption Goods Vs Capital Goods These goods satisfy human wants | Such goods satisfy human wants directly. So, such goods have direct | indirectly. So, such goods have derived demand, demand.AAS se, Capital goods generally have expected life of more than one year, Comprehensive Example of Final Goods and Intermediate Goods Hf purchased by Hf purchased by taxi- | If purchased by car household. driver as taxi. dealer for resale. Or If purchased by firm for use in business. | If purchased by a Cloth lying unsold | If purchased by tailor households. with trader at the end | for i ‘of accounting year (Capital formation). If purchased by garment shop for resale. Ifused by flying unsold with | If used by sweet shop] households. trader at the end of for making sweets. } year. Or ; lf purchased by ; Grocery shop for resale, | Services fused by Itused by of doctor households. 2.6GROSS INVESTMENT, NET INVESTMENT AND DEPRECIATION Investment or capital formation refers to addition to the capital stock of an economy.For construction of building, purchase of machinery, addition to inventories of goods, Investment can be looked up in two forms: (i) Gross Investment (ii) Net Investment ’ Gross Investment Gross Investment is addition to the stock of capital before making allowance for depreciat Capital stock consists of fixed assets and unsold stock. So, gross investment is the on purchase of fixed assets and unsold stock during the accounting year.pase. ‘of Macroeconomios 2M 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) o( ama) Depreciation refers to a fall in the value of fixed assets due to normal wear j and tear, passage of time or expected obsolescence (change in technology). The concept of depreciation is very important to differentiate between 3 Gross value and the Net value. ‘Gross’ is inclusive of depreciation, whereas, | ‘net’ excludes it. {_Net_} Gross Value = Net Value + Depreciation , as: (i) Current Replacement Cost; (ii) Replacement cost of Fixed Capital: \ Allowance. feat = 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 ‘of 1,00,000 so accumulated is called Depreciation Reserve Fund. wonerpaidea ) Depreciation of assets is mainly due to 3 reasons: () Normal wear and tear: Continuous use of fixed assets in production process decreases their productive capacity and value. ()) 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, ete contribute to fall in their value. (ii) Expected obsolescence: Value of fixed assets also decreases due to expected obsolescence (ie. loss in value due to change in technology or change in demand for goods and services). Sed ed Value of fixed assets may decrease either due to ' ‘Expected Obsolescence! ‘or due to ‘Unexpected Obsolescence’. « Expected Obsolescence occurs due to change in technology or change in demand lor goods and services. As expected obsolescence is an expected loss, it is managed by making provision for Depreciation Reserve Fund. » Unexpected Obsolescence occurs due to natural calamities like earthquake, floods, etc, or due to thefts, accidents, etc. Loss of value of fixed assets due to unexpected obsolescence ‘is termed as ‘Capital Loss’.212 Depreciation Vs Capital Loss. eee 'trefers to fallin the value of fixed assets | It refers to loss in value of the fixed due to normal wear and tear, passage | assets due to unforeseen. , of time or expected obsolescence. _| natural calamities, thefts, accidents, ete. Provision [Provision is made for replacement |No such provision is made in case of for loss ‘of assets as it is an expected loss. | capital loss as it is an unexpected loss, Provision is maintained through | However, insurance of fixed assets Depreciation Reserve fund. done to minimise the loss. Production |It does not hamper the production | It hampers the production process. process _| process. 2.7 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), Basic Customs Duty, Central Excise and VAT on Petroleum Products, Excise on Liquor, Electricity Duties, Stamp Duty, Securities Transaction Tax, Property Tax, Entry Taxes and Toll, etc. 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 ‘financial assistance’ provided by the government to producers to fulfil its social welfare objectives, In India, LPG cylinder is sold at subsidized rates. * They are often granted to promote exports or to encoura: in the backward areas. * Subsidies are opposite to indirect taxes as they reduce the market price of the In the example of speakers, if the Government grants a subsidy of ® 10, then price of sp will fall to % 540 due to subsidies. * Subsidies may also be referred as ‘Economic Assistance’ or ‘Financial Assistance’ * Subsidy is a ‘Transfer Payment as it is the financial assistance provided by the, to producers to fulfil its social welfare objectives. Government does not get return in consideration for the same. Subsidy does not contribute to any value as it does not contribute to current flow of goods and services. ge firms for setting up thei‘asic Concepts of Macroeconomics 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, 7 500 is the ‘Factor Cost’. (b) Market Price (MP): Itrefers to the price at which product is actually (Market Price } 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 followinig cases: Case 1: (i) Indirect Taxes = 0; (ii) Subsidies = % 100 0-%100=-%100 ) Indirect Taxes = ® 250; (ii) Subsidies = 0 ( (+) Net indirect Taxes Sexe, @u1pU YON (-) Ans. NIT =% 200-% 120 =% 80 %250-0=% 250 é > . ¢ ae Case 3: (i) Indirect Taxes = % 200; (ii) Subsidies = % 120 x a @e 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. a NFIA = Factor income earned from abroad — Factor income paid abroad ( We “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. 4) Factor income to abroad’ is the factor income paid to the normal residents of other countries (ie. non-residents) for their factor services within the economic territory. Significance of NFIA ("National _} 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: (4) Net Factor income from abroad ‘peoage WOH ‘ewiooul 201984 19N (~) 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) difference of Factor income from abroad and Factor income to-abroad is termed as “Net or 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. * NFIA is Negative when income earned from abroad is less than income paid to abr * 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: Net Compensation to Employees:It refers to difference between income from work: by resident workers living or employed abroad for less than one year and similar made to non-resident workers staying or employed within the domestic territory country for less than one year. ‘ 2, Net Income from property and entrepreneurship: It refers to difference between from property and entrepreneurship (in the form of rent, interest and dividend) 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 ‘companies located abroad and retained earnings of non-resident companies located the domestic territory of the country. gs refer to that part of profits which is kept.as reserve after paying the: Thus, it may be concluded that: NET FACTOR INCOME FROM ABROAD (NFIA) ‘Net Compensation of Net Income from Property Employees (Net COE) and Entrepreneurship p en nn Before we proceed further Students must be very careful while dealing with NFIA. Quite often, NFLA is given in di forms. Let us discuss treatment of NFIA in the following cases: Calculate NFIA in the following cases: Case 1: (j) 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 Net Retained Eamings