BASIC CONCEPTS OF MACROECONOMICS

Domestic territory: geographical territory under the administration of a

government of a nation within which people, goods and capital of the nation can
move freely. It includes:
1. Political frontiers of the country
2. Aircrafts and ships owned and operated by normal residents and
operating in 2 or more countries.
3. Fishing vessels, oil and natural gas rigs, and floating platforms operated
by normal residents of a country in the international waters, where they
have exclusive rights of operation.
4. Consulates, embassies, and military establishments of a country located
abroad.
Does not include:
 Embassies, consulates, or military establishments of foreign countries
 International organization like UNO, WHO, etc. located within the
geographical boundaries of a nation.
 The companies of a nation located in another country.

Normal residents: normal residents of a country includes individuals and

institutions who ordinarily reside in a country and whose centre of economic
interest lie in that country.
Centre of economic interest refers to-
1. The individual is residing or located within the domestic territory of the
country
2. The resident carries out the basic economic activities of earning,
spending, and accumulating from that country.
Does not include:
1. Foreign tourists and visitors
2. Foreign staff of embassies, consulates, officials, members of armed forces
of foreign country in the given country
3. International organizations – they are treated as normal residents of
international area.
 4. Employees of international organization – they are treated as the normal
resident of the country they belong to and not of the international area or
of the country in which the organization is located.
So, if an American in working in UN in India, then he is the normal
resident of America.
But if any employee has been working more than one year then he is
treated as the resident of the country in which the organization is located.
So, in the above example, if the American has been working for more
than 1 year, he becomes a normal resident of India.
5. Crew members of foreign vessels, commercial travellers, and seasonal
workers, given their stay is less than 1 year.
6. Border workers – who live near the international border and often cross
the border to work in the other country. They are normal residents of the
country they live in and not of where they work.

CITIZENSHIP RESIDENTSHIP
Legal concept Economic concept
For a person to be a citizen of a An individual or an institution can be
country, they must be born in that a resident of a country if they
country or through some legal ordinarily reside in that country and
provisions that allow the said person have their centre of economic
to be a citizen of that country. interests within the domestic territory
of that country.
For a person to become an Indian
citizen:
1. Must be born in India
2. Or must apply to the
government and the Indian
Law must accept it.

Domestic product: includes production activity of those production units located

within the domestic territory of a country irrespective of whether they are
carried out by residents or non-residents. Final goods and services produced by
foreign nationals and Indian nationals within domestic territory of India will be
added to get India’s domestic product.
The money value of domestic product is domestic income.
National product: includes production activity which is carried out by the
normal residents of a country irrespective of where they are conducted – within
or outside the domestic territory.
The money value of national product is national income.

Factor incomes: the income which is received (in the form of rent, ages, interest,
and profits) by the factors of production for rendering factor services in the
production process.
Since it is earned for providing services it is a bilateral income.
Factor incomes are included in both national and domestic income.
It is an earning concept.
Transfer incomes: income received without rendering any productive service in
return.
Since it is received without rendering any service it is one sided, hence
unilateral income. Therefore not included in the national income or domestic
income.
It is a receipt concept.
Generally received by households and government.
Can be received either from within the domestic territory or from abroad.
Includes: taxes to government, subsidies by government, scholarships, old age
pension, unemployment allowance, pocket money, etc.
They are of 2 types:
Current and capital transfer income.
CURRENT TRANSFER CURRENT TRANSFER
Out of the income of the payer Out of the wealth of the payer
Regular in nature irregular
For consumption purposes For capital formation
Ex. Old age pension, gift, Ex. War damages, investment grant,
unemployment allowance capital gains tax

Final goods: goods which are used for consumption or for investment. They are
not meant to be resold nor to be used for further transformation in the
production process.
It includes:
1. Goods purchased by consumer households as they are meant for final
consumption.
2. Goods bought by firms for capital formation or investment – like
machinery.
Expenditure on final goods by consumer household = consumer expenditure
Expenditure on final goods by producers = investment expenditure.

Intermediate goods: those goods which are purchased for resale or for further
production in the same year.
Characteristics:
1. Intermediate goods remain within the production boundary. It is bought
by a production unit from a production unit.
2. Derived demand – as their demand depends on the demand for the final
goods.
3. Some value has to be added to the intermediate goods to make it available
for final consumption.
4. Durable goods bought by the government for military purposes are
included under intermediate as they are used to produce defence services
and not for market sale.
5. Value of intermediate goods is already included in the value of final
goods.
6. Not included in domestic or national income

Production boundary: line around the productive sector. Goods within the line
are intermediate. Outside the line are final goods.

Only final goods are included in the National/Domestic Income as the value of
intermediate is already included in the value of the final good. Including
intermediate goods again will lead to double counting.
Differentiation is done between these 2 to get correct value of GDP.
Goods consumed in the same year in which they are produced, are included in
intermediate goods.
Consumption goods: those goods which satisfy the wants of the consumers
directly. Further classified into:
DURABLE SEMI-DURABLE NON-DURABLE SERVICES
These goods can These goods can These goods can Non-material
be used again be used more than only be used goods which
and again for a once but for only a once. They are directly satisfy
considerable limited period of exhausted after the wants of the
period of time. time. Generally single act of consumers. They
have a life span of consumption. are intangible
around 1 year. activities.
Furniture, Clothes, crockery, Fruits, vegetables, Teacher, postman,
machines, shoes medicines. bank.
television.

Capital goods: goods that are used for the production of other goods and
services.
Characteristics:
1. They are used in future for productive purposes and have a lifetime of
several years
2. They have to be repaired or replaced as they depreciate over a period of
time
3. Capital goods = durable use consumer goods based on who the user is –
producer or household consumer
4. Derived demand
5. Do not get merged in the production process – they do not lose their
identity in the production process.
Producer goods: goods used by producer for the production of other goods and
services. They are of 2 types:
1. Single use producer goods: includes raw materials which get used up in
the production process.
2. Capital goods: includes fixed assets which are durable and can be used
again and again for several years.
*not all producer goods are capital goods. But all capital goods are producer
goods.
 CONSUMPTION GOODS
Direct demand – satisfy wants
directly.
Do not promote production capacity
Generally have less life expectancy
CAPITAL GOODS
Derived demand – satisfy wants
indirectly
Increase the production capacity
Have more life expectancy

Investment or capital formation: addition to the capital stock of the economy.

Ex. Construction of a building, purchase of machinery, addition to the
inventory, etc.
Depreciation: fall in the value of fixed assets due to normal wear and tear,
passage of time, or expected obsolescence.
Also known as consumption of fixed capital, as a part of the fixed capital is
used in the process of production.
Due to depreciation, fixed capital must be replaced from time to time – for
which funds are required. Provision for these funds is done on annual basis and
is called depreciation reserve fund.
Reasons for dep:
1. Normal wear and tear – continuous use of fixed asset decreases their
productive capacity and value.
2. Passage of time – even if not used in the business, passage of time
decreases its value due to factors like rain, winds, weather.
3. Expected obsolescence – change in technology or change in demand for
the goods or services.
Gross investment: addition to the capital stock before making allowance for
depreciation. It doesn’t show the actual change in the economy’s stock of
productive assets for a given year.
Net investment: addition to capital stock for the year after making allowances
for depreciation. It shows the actual addition made to the capital stock of the
economy in a given period of time.

Expected obsolescence: fall in the value of a fixed asset due to change in

technology or change in demand. Since it is an expected loss, it is managed by
making provision – depreciation reserve fund
Unexpected obsolescence: fall in the value of a fixed asset due to natural
calamities, theft, fire, etc. Since this loss in unexpected, it is termed as Capital
Loss.
Capital loss: fall in the value of a fixed asset due to unforeseen obsolescence.
No provision can be made for this as it is unexpected. Although, insurance is
done of fixed assets to minimize the loss.
It hampers the production process. (Depreciation doesn’t)

Net indirect taxes: difference between indirect taxes and subsidies

Indirect tax: taxes imposed by the government on the production and sale of
goods and services.
Ex. GST, Basic Customs Duty, Central Excise And VAT On Petroleum
Products, Excise On Liquor, Electricity Duties, Stamp Duty, Securities
Transaction Tax, Entry Taxes And Toll, etc.
Indirect taxes increase the price of the product in the market.
Subsidies: financial assistance provided by the government to the producers to
fulfil its social welfare objectives.
Ex. LPG cylinders are sold at subsidised rate.
Characteristics:
1. Aka economic or financial assistance
2. It is a transfer payment, as it is financial assistance given by govt. to
producers while govt. doesn’t get anything in return in consideration for
the same.
3. Given to promote exports and encourage firms to set up their industries in
backward areas
4. Completely opposite to IT as it reduces the market price of a commodity
5. Does not contribute to value addition as it doesn’t contribute to current
flow of goods and services.

Factor cost (FC): amount paid to the factors of production for their contribution
in the production process
Market price (MP): price at which the product is actually sold in the market. It
includes indirect taxes and excludes subsidies.
Net factor income from abroad – NFIA: difference between the factor income
from rest of the world and factor income to rest of the world.
FIFA: income earned by the normal residents of a country from the rest of the
world in the form of wages, salaries, dividend, profits, interest, and rent.
FITA: income to non-residents for their factor services within the economic
territory.

While counting national income, we add FIFA to domestic income (due to

contribution of normal residents to production outside the economic territory)
and subtract FITA (due to contribution of non-residents to production inside the
economic territory)
NFIA can be positive, negative, and zero. It is 0 in closed economy as it
doesn’t deal with rest of the world sector.
Net compensation to employees: difference between the income received by
resident workers employed abroad for less than 1 year, and similar payments
made to non-residents employed within the domestic territory of the country for
less than 1 year.
Net income received from property and entrepreneurship: difference between
income received from property and entrepreneurship in the form of rent,
interest, and dividend by residents, and similar payments made to non-residents.

Retained earnings is part of the profit which is kept as a reserve once corporate
tax and dividends have been paid.
Net retained earnings: difference between retained earnings of resident
companies located abroad and non-resident companies located within the
domestic territory.