XII-ECONOMICS

BETTER MINDS INSTITUTE

CH-2 BASIC CONCEPT OF MACROECONOMICS

DOMESTIC TERRITORY
Domestic territory is geographical territory administered by a
government within which persons, goods and capital
circulate freely.
Domestic territory also includes:
1. Ships and Aircrafts owned and operated by normal
residents between two countries:
For example- Planes operated by Air India between
London and Paris are a part of the domestic territory of
India.
2. Fishing vessels, oil and natural gas rigs and floating
platforms operated by the residents of a country in the
international water 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 establishment of a
foreign country: For example- Indian Embassy in Japan is a
part of the domestic territory of India.

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 DOMESTIC TERRITORY DOESN’T INCLUDES:
1. Embassies, consulates and military establishment of a
foreign country, for example the American Embassy in
India is the domestic territory of America and not India.
2. An international organization like UNO, WHO located
within the geographical boundaries of a country as these
are independent organizations.

NORMAL RESIDENTS
Normal residence of a country refers to an individual or
institution who ordinarily resides in the country and whose
centre of economic interest also lies in that country.
A person is said to have his economic interest in a country
when he conducts his economic transactions in that country
on a significant scale.

Normal residents include:

a) Citizens and institutions of a country who normally resides
and whose centre of economic interest lies within that country.
b) Citizens of other countries who continue to live in our
country for a period more than one year and whose centre of
economic interest lies within our country.
c) Citizens of our country working in international organizations
like, World Bank and IMF.

Following are not included in normal residents:

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 1. Foreign tourists and visitors .
2. Foreign staff of embassies, officials, diplomats and
members of the armed forces.
3. International organizations like WHO, UNO etc.
4. Employers of international organizations.
5. Border workers, who cross borders on a regular basis to
work in other countries.

CITIZENSHIP

Citizenship is basically a legal concept based on place of birth of

a person or some legal provisions allowing a person to become
a citizen.

It means Indian Citizenship can arise in two ways:

1. When a person is born in India, he acquired automatic

citizenship of India.
2. A person born outside India applies for citizenship and
Indian laws allow 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 country for a period more than one year and his
centre of economic interest also lies in that country.
 For example – a Chinese living in India for more than one
year is a normal resident of India. However, he is not a
citizen of India as he does not hold citizenship of India. It

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 means, a person can be a citizen of one country, and at the
same time, a resident of another country.

FACTOR INCOME AND TRANSFER INCOME

FACTOR INCOME
Factor income refers to income received by factors of
production for rendering factor services (Land, labour,
capital and enterprise) in the production process.

 Factor income of normal residents of a country is included

in the national income.
 For example, Rent wages, interest and profit.

TRANSFER INCOME
Transfer income refers to income received without
rendering any productive service in return.

 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 or a
country or from abroad.
 Examples – Old age pension, scholarship, unemployment
allowance, pocket money etc.

FACTOR INCOME VS TRANSFER INCOME

Basis Factor Income Transfer Income

 Meaning It refers to income It refers to income
received by factors of received without
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 production for rendering any
rendering factor productive service
services in the in return.
production process.
 Nature It is included in both It is neither
national income and included in
domestic income. national income
nor in domestic
income.
 Concept It is an earning It is a receipt
concept. concept.
 Recipient It is received by It is generally
factors of production received by
(Land commercial households and
capital and government.
enterprise).
 Example Rent, wages, interest Scholarship, old
and profit. age pension
unemployment
allowance etc.

FINAL GOODS AND INTERMEDIATE GOODS

FINAL GOODS
Find good refers to those goods which are used either for
consumption or for investment.
Final goods include:
 Goods purchased by consumer households as they are
meant for final consumption. For example, milk purchase
by households.
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 Good purchased by forms for capital formation or
investment. For example, machinery purchased by a firm
for generating revenue.
*It must be noted that final goods are neither resolved nor
use for any other 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:
 Goods purchase for resale for example, milk purchased by
a Dairy shop.
 Goods use for further production. For example, 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, purchase of building machinery, etc. are
not intermediate purchases. 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 aircraft vehicles, etc,
purchased by government for military purposes, are
included under the category of intermediate goods as
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 they are used to produce defense services and not for
market sale.
 Value of intermediate goods is included in the value of
final goods. For example, suppose a Miller buys wheat
worth Rs.700 and converts it into flour worth
Rs.1000.Now, the value of flour (final good) includes the
value of (intermediate good).

PRODUCTION BOUNDARY
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.

HOW TO CLASSIFY GOODS AS: INTERMEDIATE AND

FINAL GOODS
The distinction between intermediate goods and final goods
is made on the basis of the use of the product, and not on
the basis Of the product itself.
For example:
 Sugar is an intermediate good when it is used by the sweet
shop for making sweets. However, if it is used by the
consumers, then it becomes a final good.

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 So, it must be noted that difference is made on the basis
of the end use of the product.

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 value of final
goods.
For ex: 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).

*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.

Basis Final Good Intermediate Good

 Meaning Final goods refer to Intermediate goods
those goods which refer to those goods
are used either for which are used either
consumption or for for resale or for further
investment. production in the same
year.
 Nature They are included They are neither
both in national and included in national
domestic income. income, nor in
domestic income.
 Value They are ready for They are not ready for
Addition use by their final use i.e. some value has
users, i.e. no value to be added to the
has to be added to intermediate goods.

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 the final goods.
 Production They have crossed They are still within the
Boundary the production production boundary.
boundary.
 Example Milk purchased by Milk used in dairy shop
households for for resale, coal used in
consumption, car factory for further
purchased as an production.
investment.

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, pen, shirts, furniture etc.
Consumption goods can be further classified into the
following categories:
1. Durable goods: It 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: It refers to those goods which can be
used for a limited period of time. These goods have a
lifespan of around one year. For example, clothes,
crockery, shoes, etc.

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 3. Non-Durable Goods: Goods, which are used up in a single
act of consumption are known as non-durable goods.
These goods cannot be used more than once. For example,
milk, bread, paper, etc.
4. Services: Services refer to non-material goods, which
directly satisfy the human wants. They are intangible
activities. For example, services of teachers, doctors,
banks, etc.

CAPITAL GOODS
Capital goods are those final goods which help in 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 lifetime of several years.
ii. 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

 Single-use producer goods: It includes raw material like
coal, wood, etc. They’re 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.

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HOW TO CLASSIFY GOODS AS: CONSUMPTION 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

Basis Consumption Goods Capital Goods
 Satisfaction These goods satisfy Such goods satisfy
of human human wants human wants
wants directly. indirectly.
 Production They do not promote They help in raising
Capacity production capacity. production capacity.
 Demand Such goods have Such goods have
direct demand. derived demand.
 Expected Most of the Capital goods
Life consumption goods generally have
have limited expected life of
expected life. more than one year.

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, etc.

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 GROSS INVESTMENT
Gross investment is the addition to the stock of capital
before making allowance for depreciation.
Gross Investment = Net Investment + Depreciation

NET INVESTMENT
Net investment refers to the actual addition made to the
capital stock of economy in a given period.
Net Investment = Gross Investment – Depreciation

DEPRECIATION
Depreciation refers to a fall in the value of fixed asset due
to normal wear and tear, passage of time, or expected
obsolescence (change in technology).
Gross Value = Net Value + Depreciation

*Depreciation is also known as:

 Current replacement cost
 Replacement cost of fixed capital
 Capital consumption allowance

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 asset also decreases with
the passage of time, even if they are not being put to use
in the business. Natural factors like rain, wind, weather,
etc. contribute to fall in their value.

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iii. Expected Obsolescence: Value of fixed asset also
decreases due to expected obsolescence (loss in value due
to technology or change in demand for goods or services).

DEPRECIATION VS CAPITAL LOSS

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

NET INDIRECT TAX

Net indirect text refers to the difference between indirect
taxes and subsidies.
Net Indirect Tax = Indirect Tax – Subsidies
Indirect Tax

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 Indirect tax refers to those taxes which are imposed by the
government on the production and sale of goods and
services . For example, Goods and service tax (GST).
For example, if cost of producing one set of Speaker is
Rs.500 and Govt. levies GST of 10%, then the price of
speaker will be Rs.550 due to indirect taxes.

Subsidies
Subsidies are the economic assistance given by
government to the firms and households with a motive of
general welfare. For example, the cost of speaker is
Rs.550, and govt. grants a subsidy of Rs.10, then price of
speakers will fall to Rs.540 due to subsidies.

Factor Cost VS Market Price

a) Factor Cost: It refers to amount paid to factors of
production for their contribution in the production
process. For example, Rs.500 was the factor cost of one
speaker.
b) Market Price: It refers to the price at which product is
actually sold in the market. For example, Rs.540 is the
market price in the above example.

 Market Price = Factor Cost + Net Indirect Taxes

 Market Price = Factor Cost + (Indirect Tax-Subsidies)

NET FACTOR INCOME FROM ABROAD

It refers to the difference between factor income received
from rest of the world and factor income paid to the rest of
the world.

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NFIA = Factor income received from rest of the world – factor
income paid to rest of the world.
 ‘Factor income from abroad’ is the income earned by the
normal residents of a country from the rest of the world in
the form of wages and salaries, rent, interest, dividend and
retained earnings.
 ‘Factor income to abroad’ is the factor income paid to
normal residents of other countries for their factor
contribution in the country.

National Income = Domestic Income + Factor income from

abroad – Factor income to abroad

The difference of factor income from abroad and factor

income to abroad is termed as ‘Net factor income from
abroad’ or NFIA.
National Income = Domestic Income + NFIA

COMPONENTS OF NFIA

1. Net compensation to employees: It refers to difference

between income from work received by resident workers
living for 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 (rent, interest and dividend) received by

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 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.

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.

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