Preface UNIT 5: NATIONAL INCOME AND RELATED AGGREGATES 1. Circular Flow of Income 2. Basic Concepts of Macroeconomics 3. National Income and Related Agaregates 4. Measurement of National Income UNIT 6: MONEY AND BANKING 5. Money 6. Banking: Commercial Banks and The Central Bank UNIT 7: DETERMINATION OF INCOME AND EMPLOYMENT 7. Aggregate Demand and Related Concepts 8. Income Determination and Multiplier 9. Excess Demand and Deficient Demand UNIT 8: GOVERNMENT BUDGET AND THE ECONOMY 10. Government Budget and the Economy, UNIT 9: BALANCE OF PAYMENTS. 11. Foreign Exchange Rate 12. Balance of Payments REVISION SECTION * Scanner CBSE (2007-2016) * Important Questions * Value Based, Evaluation & Multis * CBSE Sample Paper 2016-17 ( * CBSE Examination Paper 2016 Disciplinary Questions with Ansvrers) (Delhi) (with Marking Scheme) {All India) Question Paper India * CBSE Examination Paper 2016 Appendix-1; Demonetisation in Contents (ii) 11-114 2.1-2.20 3.1-3.57 41-4125 5.1 -5.20 6.1 -6.22 T.A-TAL 8.1-8.46 9.1-9.19 10.1 - 10.33 11,.1.-11.20 12.1 - 12.18 ‘seannea witn vamscanner1 CIRCULAR FLOW OF INCOME NING GBJECTIVES' 1.1. INTRODUCTION 1.2. MEANING OF CIRCULAR FLOW OF INCOME 1.3, STOCK AND FLOW 1.4 TYPES OF CIRCULAR FLOW 1.5 CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) 1.1 INTRODUCTION The unlimited and recurring wants of human beings have made the production process, a continuous process. In this process, different factors of production: Land, Labour, Capital and Enterprise are combined together for production of goods and services. * Firms produce goods and services with collective efforts of factors of production supplied by the household sector * Firm makes payment to the factors of production in the form of rent, wages, interest and profit (known as factor incomes). * The household sector spends this money on the purchase of goods and services produced by the firms. Thus, income flows first from firms to households in the form of factor payments and then, from households) to firms in the form of consumption expenditure. Such a flow of money is known as the circular flow of income. 4.2 MEANING OF CIRCULAR FLOW OF INCOME It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them. Phases of Circular Flow of Income There are 3 different phases (generation, distribution and disposition) in circular flow of income, as shown in the given diagram: ww Scamesty Ta scannea witn vamscannerIntroductory Macroeconomics 4. Generation Phase: In this phase, firms produce goods and services with the help of factor services. 2. Distribution Phase: This phase involves the flow of factor income (rent, wages, interest and profit) from firms to the households. Production Phase (Goneration of comay| Income Pnase {Distibution of income 3, Disposition Phase: In this phase, the income received by factors of production, is spent on the goods and services produced by firms. In this way, income generated in production units gia reaches back to production units and makes the circular flow complete. 1.3 STOCK AND FLOW ———— The concepts of stock and flow are used frequently in macroeconomics. Some of the macro variables relate to stock, while others relate to flow. Therefore, it is important to understand their meaning so that variables can be categorised as stock or flow. Stock Stock variable refers to that variable, which is measured at a particular point of time. For example, stock of goods in the godownas on 31" January, 2019. It means, stock variables are not time dimensional. Some more examples of stock variables are National wealth, National capital, Money supply etc. Flow Flow variable refers to that variable, which is measured over a period of time. For example, production of goods during the month of January 2019, birth rate in the year 2018, National Income in the year 2018 are flow variables. The ‘period of time’ could bea day, a week, a year, etc. It means, flow variables are time dimensional as they are measured for a period of time. Examples for Better Clarity * The amount of water in tank is the quantity of water in Sink ot water Ina tant the tank at a given point of time. On the other hand, water flowing into the tank from a tap is a flow of water being added to the tank per unit of time. © The total number of houses as on December 31, 2018 is the stock concept, while the number of houses constructed during the year 2018 is a flow variable. Flow of wate from tank scamecty scannea witn vamscannerCircular Flow of mcame 13 Difference between Stock and Flow Basis ____ Stock Flow al Meaning | Stock variable refers to that variable, | Flow variable velers to thal variable, ‘measured over a period of Time "does not have atime dimension, Tit has a time dimension as ils Dimension ‘magnitude can be measured over a Period of time. Nature of | itis a static concept. Nis a dynamic concept. concept Examples | 1. Population of india as on 31.08.16. 11. Number of births during 2018, 2. Total number of Maruti cars in Delhi. | 2. Maruti cars manulacturee during January, 2019. 3. Money supply (money in circulation). |3, Expenditure or transactions in money. 4. National Wealth. 4, National Income. 5. Quantity of wheat stored, 5. Quantity of wheat produced. I 1.4 TYPES OF CIRCULAR FLOW There are two types of circular flows: (i) Real flow; (Ii) Money Flow. Real Flow Real flow refers to the flow of factor services from houselialds to firms and the corresponding flow of goods and services from firms to households, Asscen in the diagram, households provide factor services i hdok ts ioc Sore) to the firms which, in turn, provide goods and services to tard, tabow, Capi them as a reward for their productive services. Ton Crim) * It is also known as ‘Physical flow’. * There is only exchange of goods and services between Le censor the two sectors without involvement of any money. Fig. 1.2 * Real flow determines the magnitude of growth process in an economy. For example, wher more factor services are offered to firms, then volume of production will be more and i speeds up the process of economic growth. oe fo refers to flow of factor payments from firms to haecholds for their factor services and corresponding flow Soeatie : of consumption expenditure from households to firms for once Lt purchase of goods and services produced by the firms. Housshoide) As seen in the diagram, firms make factor payment t _| households for their factor services and households: ‘spend tl ns alto Payment — income on purchase of goods and services produced by the — firms. rrr sre scannea witn vamseanner14 * Itis also known as ‘Nominal flow’, + It involves exchange of money between the two sectors. Difference between Real Flow and Money Flow Introductory Macroeconomics Basis Real Flow Money Flow Meaning It is the flow of goods and services | Itis the flow of money between lirms belween firms and households. and households. Kind of Tt involves exchange of goods and | It involves exchange of money. exchange _| services. - Ditficulty in. [There may be difficulties of barter | There is no such difficulty in case of exchange _| systemin exchange of goods and factor | money flow. services Alternative | Itis also known as Physical Flow. Itis also known as Nominal Flow. Name 4.5. CIRCULAR FLOW IN A SIMPLE ECONOMY (TWO-SECTOR ECONOMY) — A simple economy assumes the existence of only two sectors, i.e. household sector and firm sector. * Households are the owners of factors of production and consumers of goods and services. * Firms produce goods and services and sell them to the households. Itis the simplest form of closed economy", in which there is no government sector and foreign trade. Closed Economyis an economy which has no economic relations with rest of the world. Open Economy Is an economy which has economic relations with rest of the world. In order to make our analysis simple, we take some assumptions: 1. There are only 2 sectors in the economy: Households and Firms. It means, there is no government and foreign sector. 2. Household sector supplies factor goxtor Servicog services only to firms and the firms hire ea, Calan factor services only from households. KE syenptton Expendin, 3. Firms produce goods and services Goods and Sane 7 and sell their entire output to the households. Households receive factor income for their services and spend the entire amount on consumption of goods and services. - Households 5. There are no savings in the economy, Factor payme8® a0 i.e. neither the houscholds save from " Wages, inieros\ °° their incomes, nor the firms save from Goods ana service their profits. Fig. 1.4 | Scaesty re scannea witn vamseannerCircular Flow of income ‘s The Circular flow in Two-Sector economy can be better understood with the help of Fig, U- * The outer loop of diagram shows the real flow, i.e. flow of factor services from households: to firms and corresponding flow of goods and services from firms to households. * The inner loop shows the money flow, ie. flow of factor payments from firms to households and the corresponding flow of consumption expenditure from households to firms, Itmust be noted that entire amount of money, which is paid by firms as factor payments is paid back by the factor owners to the firms. So, there is a circular and continuous flow of money income. In the circular flow of income, production generates factor income, which is converted into expenditure. This flow of income continues as production is a continuous activity due to never- ending human wants. It makes the flow of income circular. Conclusions of Circular Flow ina Simple Economy * Total Production Total Consumption * Factor Payment = Factor Income * Consumption Expenditure = Factor Income * Real Flow = Money Flow Scat Tesora scannea witn vamseanner2 BASIC CONCEPTS OF MACROECONOMICS 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 concep! 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. In addition to political trontiors, domestic territory also inelitdes 1. Ships and aircrafts owned and operated by normal residents between two or more countries. For cwample planes operated by Air India between Rt 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. Tor 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 Indian Emba in Russia is a part of the domestic territory of India. iiding used by consul (an officer commissioned by the government to reside, ‘Consulate’ is an office or bul ina foreign country to promote the interest of the country lo which he belongs). Domestic Lerritory does not unclude 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 Scameaty TarSome scannea witn vamscanner5 Mk introductory Macroeconomes oy Introductory , “e UNO, WHO, etc. located within the geographical 2. International organisations boundaries of a country. “According to the Jnited Nations, Economic Teritory or domestic temtory is tne geographical territory, ‘tdminisiered by a government within which. persons, goods and capital circulate reel hoa ‘Which of the following are covered under the domestic territory of India? 1, An Indian Company in London. 2, Microsoft Ottice in India 3. Company in ingia owned by a Japanese. - 4. Ottice of Reliance Indusines in New York. 5. Branch of Foreign Bank in India 6. 7 8. 9 Indian Embassy in Japan Branch of State Bank of India in China. Russian Embassy in India. . Tata rented its building to Google in America. tans. 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 ot Leonomie Interest) imphes 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 net 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. Forcign 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. fr o1.r"):!> an Ame UNO office located in India will be treated as normal resident of America. an working in However, if the employees are working for more than one year in such Internation: it then .al Institutions, they become the normal resident a country in which such institutions are located. It means, in the given example, i the American is working in UNO otice in India for mor be treated as normal resident of india. ie tan one year than he ea 5. Crew members of forcign vessels, commercial travelle1 : 7 rsand 3 their stay is less than one year. seasonal workers, provided Scameaty rarSomet scannea witn vamscannerbasis to work in the ote nal border and cross the border on F country, They al sai ey are tr where they live, and not where they work Identity the following as Normal Residents of india: (2) Indian officials working in the Indian Embassy in USA. (b) A Japanese tourist who stays in India for 2 months bord a regular feated as normal residents of the country (C) Indians going to Pakistan for watching the cricket match, (d) Indians working in the UNO off a ice, located in Amenca for | (e) Indian employoes working in WHO, located in India, ent year (1) Foreign tourists visiting India for a month to see the Taj Mahal. (9) Indian Mustims going for the Haj pilgrimage. : (Ans, Normal Residents: (a), (c). (0), (0). (IF Citizenship and Residentship are two ditterent terms Citizenship It is basically a legal concep! based on the place of birth of the person or some legal provisions allowing a person to become a citizen. It means, Indian ci enship can arise in two ways: (i) When a person is born in India, he acquires automatic citizenship of India A person born outside India applies for citizenship and Indian Law allows him to become 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 period more than one year 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 ig nota citizen (or national) of india as he does not hold citizenship of India. It means, @ person can be a citizen of one country and at the same time, a resident of another country. Tae ar ‘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 tact 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 detal later in the chapter. Scameaty repScmrar scannea witn vamseanner24 Introductory Macrooconor, 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. 1ed for providing factor services of land, labour, capital and enterprise, | s of a country is included in the National Income, * Itis recei * Factor income of normal reside’ © Punnples Rent, wages, interest and profit, *Factors of Production are the primary inpuls, which are needed to produce goods and services. They are broadly categorised under four heads: () Lands (i) Labour; () Capital; and (iv) Enlrepreneur Transter Income Transfer income refers to income received without rendering any productive service in return, Itis 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. 1 vumples: Old age pension, scholarship, unemployment allowance, pocket money, ele. 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. ‘Transter receipts are of lwo types: (}) Current Transfer; (i) Capital Transter. 1. Current transters are made out of income, whereas, capital transters are made out of the wealth of the payer. 2. Current transters are generally regular in nature, whereas, capital transfers are irregular. 3. Current transters 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 ransters: Investment grant, capital gains lax, war damages, etc. Factor Income Vs Transter Income Basi Factor Income Transfer Income Meaning | ltrelers toincome received by factors ol | It refers to income received without production for rendering factor services | rendering any productive service in in the production process. felurn, Nature T1is included in both National Income | t is neither included in National | and Domestic Income. Income nor in Domestic Income. Concept _| itis an earning concept. Itis a receipt concept, po Scameaty rarScmra scannea witn vamscanneracroecononnes 25 ____Transfer Income is generally recewed by houscholds and governinent, Scholarship, Old age pension, Unemployment allowance, etc. 2.4 FINAL GOODS AND INTERMEDIATE GOODS Fi SS tL Goods, Final goods refer to those goods which are used either for consumption or for investment, Final Goods include: (1) Goods purchased by consumer households as they are meant for final consumption (like milk purchased by households), (11) Goods purchased by firms ‘im ‘for capital formation or investment (like machinery purchased by a firm). It must be noted that final goods are nelther 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 yi Intermediate Goods includ: (4) Goods purchased for resale (like milk purchased by a Dairy Shop). Gi) 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. 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 nol meant for resale) as their value 's not mcluded in the value of final good. In fact, such purchases are termed as final producis 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 8 1,000. Now, the value of flour (final good) includes the value of wheat (intermediate good). Scameaty rarSom scannea witn vamscanneraa 26 Introductory Macroecon 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 goad comes out of this boundary, Ht 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 pRODUCTION BOUNDRY 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 108 B produces Thread worth 2 3,000 and sells tt0C produces Cloth worth & 4,500 and sells to Consumers =) 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 4a 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 isan 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. If 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 itis 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 addi 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 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, Scameaty reson scannea witn vamscannerBasic Concepts ¢ 27 Suppose X Lid, purchases 10 tonnes coal in 2018 tor making glasses. Only 7 tonnes coal s ing y d Up in 2018. Now, 7 17 tonnes coal will be taken od ‘ 28 termediate goods a Coal willbe treated: as final goods and willbe included in National Income ng Stomnes Exampte was use Final Gx fs Vs Tater 7 ie Goods Final goods refer o those goods which | Intermediate goods reter to those goods @ used either for consumption or for | which are used ether for resale or for Basis Final Goods [interme Meaning i — messin, __|further production in the same year. They are cluded in both national and | They are nein included national = stic income. | income nor in domestic income Value [They are ready for use by their final They are not ready for uso, Le some 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 Example | 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. tis an intermediate product as paper is used for further production dunng the same year. 2. Furniture purchased by a school. (CBSE, Delhi 2011 ()) itis a final proauct because itis purchased for investment. 3. Milk purchased by households. dt is a tal 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 lor resale. 5. Coal used by manufacturing firms. ; Te amintermediate product as coal is used for further production during the Same YX 6. Computers installed in an office. (CBSE, Delhi 2011 (I) Itis a final product because it's, ‘purchased for investment. 7. Coal used by consumer households. ost tinal product as is used by nousenotds for final consumption. ler. 8, Mobile sets purchased by 4 mobile dealer. These are intermediate products because (hese are purchased for resale. 9. Purchase of pulses by a consumer. nis a final product as itis used by 2 ‘consumer for final consumption. CBSE, Dethi 2011 (I)} sters, etc. purchased by a school. (CBSE, ° oo intermedia products vvocause these are taken to be used up completely during the samme yeas. ilizers used by the farmers. — " no aig intermediate products because fertilizer iS Used for further production during the same year. 12. Printer purchased by a lawyer. ; 12 ipa final produc! because i is purchased for investment. [CBSE, Delhi 2011 (IN) Scameaty rps scannea witn vamscanner28 Introductory Macroveonoirncs 13, Wheat used by the flour mill. {t's an intermediate product as wheat Is used for further production during the same year or is meant for resalo | 14, Unsold coal with trader at year end. | M18 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. tis a final product as itis used by households for final consumption. 17. Retrigerator installed by a firm. Inis a final product because itis purchased for investment. 18. Sugar used by a sweet shop. !tis an intermediate produc! as sugar is used for further production during the same year. 2.5 CONSUMPTION GOODS AND CAPITAL GOODS $$“ ed into two groups: Consumption Goods and Capital Goods. Final goods can be clas: Consumption Goods Consumption goods refer to those goods which satisfy the wants of the consumers directly. For example, Bread, butter, shirts, pens, television, furniture, ete. Consumption goods can further be sub-divided into following categories: 1. Durable xoods: It refers to those goods which cun be used again and again over a considerable period of time, For exaniple. tele shich can be used for a limited period of time are termed as semi- Forexample,clothes, crockery, ion, refrigerators, etc. 2. Semi-durable goods: Good durable goods. These goods havea life span of around one ye shoes, ete. 3. Non-durable goods: Gootts which are used up in a single act of consumption are known as non- durable goods, These goods cannot be used more than once, ive. they lose their identity in single act of consumption. For vaumple, milk, bread, foodgrains, paper, ete. ervices: Services refer to non-material goods which directly satisfy the human wants. They are intangible activities, ic. they can neither be seen nor touched. 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, [or sniple, plant and machinery, equipments, etc. Scot repsomrar scannea witn vamscannerBasic Concepts of Mac economics 2.9 Some Pots about Capital Gants " (1) They are tsed 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, qi) (iv) They need repairs or replacement over time as they depreciate over a period of time. They have derived demand as their demand is derived from the demand forother goods, which they help to produce. Ua eT rr \ 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: includes raw material like coal, wood, ete. They are nol capital 900ds as they cannot be repeatedly used in the production process. * Capital Goods: It includes tixed 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. Th same good can be consumption good and also capital good. It depends on the ultimate use of the good. Fu example, a machine purchased by a household is consumption good, whereas, if itis purchased by a firm for use in the business, then i a capital good. "However, if the machinery is bought by the firm for resale, then it willbe treated as an intermediate good. Consumption Goods Vs Capital Goods L Basis Consumption Goods Capital Goods 1 fy human wants | These goods satisly human wants | Such goods satisly a an eae directly. So, such goods have direct | indirectly. So, such goods have derived wants demand. demand. Production | They donot promote production ‘They help inraising production capacity. Capacity capacity. i tal goods generally have an ted _| Mostof the consumption goods (except | Capi ie = durable goods) have limited expected | expected life of more than one year. life. Sawer sonra scannea witn vamscannerarama. S- ate Introductory Macroeconoines id Intermediat Comprehensis ef sample of Final Gs “PRODUCT | FINAL GOODS ~ | INTERMEDIATE |_____[Gonsumption Goods | CapitalGoods _)_—__ GOODS: Car \\purchased by | ‘purchased by taxi- | I! purchased by car household. diver as taxi doaler for resale, Or It purchased by firm for 7 use in business. | Cloth purchased by Cloth lying unsold |W purchased by tailor households. with trader at the end | for making dresses, of accounting year Or (Capital formation). | purchased by garment shop for resale ‘Sugar MWused by lying unsold with | Wused by sweet shop households. traderat the end of | formaking sweets. year. or it purchased by Grocery shop for resale. Services Wused by used by enlerprises. of doctor households. orlawyer 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: (1) Gross Investment (i) Net Investment Gross Investment Gross Investment is addition to the stock of 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 ) ‘assols for @ given year. During the production process, some amount of fixed capital is used up. This foss of lixed capital is known as depreciation. By subtracting depreciation from gross investment, we gel Net Investment. | Net Investment The actual addition made to the capital stock of economy in a given period is termed as Nel Investment. Net Investment = Gross Investment - Depreciation Let us now understand the meaning of depreciation. ba Scameaty rapsomrar scannea witn vamscannerormal w hunge in technology), Important to ditterentate between Hue. Gross’ is melusity of depreciation, whereas, lescen and tear, passage of time or expected ob The concept of depreciation is ve Gross value and the Net | (+) Deprenazen c ss Value = Net Value + Deprecia Depreciation is also known as: (i) Current Replacement Cost; (ii) Re Fixed: a (ii) Capital Consumption Allowance ea (Fenton coe ot Fired Conte Depreciation 1s also called consumption of fixed capital It refers to that value of fixed capital {or fixed assets) which ts consumed (or used up) in the process o! production Because of depreciation. fixed assets need 10 be replaced from time to me Replacement of fixed assols Fequires funds Provision tor the funds 15 made on annual basis To illustrate. i! a machine 1s Purchased for € 10.00.00 and its expected itetime of use 1s 10 years then the annual provision for funds (10 replace tne machine atter 10 years) is € 1,00,000 (= € 10,00,000 + 10) 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 (i) Passace of tine Value of fixed assets also decreases with the passage of time, even if they her, etc. are not being put to use in the business. Natural factors like rain, winds, we: contribute to fall in their value. (itt) Expected obsolvsccnce: 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 Itreters to fall in the value o! fixed assets | It refers to loss in value of the lixed due to normal wear and tear, passage | assets due tountoreseen obsolescence, of time or expected obsolescence. natural calamites, thelts, accidents, etc. Provision | Provision is made for replacement of | No such provision is made in case of for loss assets as it is an expected loss. capital loss as it is an unexpected 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: Saar scannea witn vamseannerUi) Indirect Taves Indirect taxes refers to those taxes which are sale of goods and services, |v evuniple. Goods imposed by the government on production ang) and Services Tax (GST). | rket. For exam, if cost of producing | Indirect tay increases the price of the product in the ma then price of speakers yl) 2500 and Government levies GST of 10%, one set of speakers increase to ® 550 due to indirect taxes. (ii) Subsidies Subsidies are the ‘economic assistance’ given a motive of general welfare. In India, LPG cylind ; + They are often granted to promote exports or to encourage firms for setting up the industries by the government to the firms and households, ler is sold at subsidized rates. 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 2 540 due to subsidic + Subsidies may also be referred as ‘Economic Assistance’ or ‘Financial Assistance’. Factor Cost Vs Market Price (a) Factor Cost (PCr 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’. [Market Price J (i) Market Price MP) Ttrefers to the price at which product is actually sold in the market. In the given example. 7 540 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 (+) Net indirect Taxes ‘soxmy joapur ion (-) Calculate Net Indirect Taxes (NIT) in the following cases: Case 1: (i) Indirect Taxes = 0; (ii) Subsidies = 7 100 Ans NIT=0-% 100=-2 100 i) Indirect Taxes = % 250; (ii) Subsidies = 0 Ans. NIT=%250-0=%250 Indirect Taxes = % 200; Ans. NIT = 2200 ~% 120 = 80 ii) Subsidies = 7 120 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. 28 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 Scameaty rerSome scannea witn vamscannerene a! Basic Concepts of Macroeconomics 2. 13 © “Factor income from abroat” a , from abvoat’is the income earned by the normal residents of a countey from. he rest of the wor in the “ i n estat the world (ROW) in the form of wages and salaries, rent, interest, dividend and ; retained earnings * ‘Factor income to abroad’ is the factor i 1 income to abroad’ is the factor income paid to the normal residents of other countries non-residents) for their factor s vices within the economic territory. Significance of NFIA NFIA is significant to differentiate between ‘Domestic Income’ 5 q and ‘National Income’. In practical estimates, domestic income is = 3 gf ; estimated first and then, National Income is derived from Domestic 22 if Income in the following manner: 38 Ee | Neonat nome = Lomas | i = 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 incume 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 eared from abroad is more than income paid to abroad. * NFIA is Negative when income earned from abroad is ess thant 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 forless 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 refer | 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 s to difference between income the domestic territory of the country. | Retained Earnings refer to thal part of profits which is kept as reserve after paying the corporate tax and dividends. ‘Scamecy arson scannea witn vamscanner2.14 Introductory Macroeconomy, Thues. st may be caneluded 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 ina closed economy as such economy does not deal with the rest of the world sector. Belore 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 NULA in the following eases: 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 = 8150 ‘Ans. NFIA = (-) 7150. Case 4: Factor income to abroad = - 2 150 Ans. NFIA = % 150 Scat reso scannea witn vamscanner“ee NATIONAL INCOME AND RELATED AGGREGATES SacI) Sea th pad 3.1 INTRODUCTION 3.2 BASIC AGGREGATES OF NATIONAL INCOME 3.3 SOLVED PRACTICALS 3.1 INTRODUCTION National Income is an important concept of macroeconomics. There are various aggregates or variants of national income. Each aggregate has a specific meaning, method of measurement and use. The various aggregates of national income are: 1, Gross Domestic Product at Market Price (GDP, 2. Gross Domestic Product at Factor Cost (GDP, . Net Domestic Product at Market Price (NDP, ‘ar ro) r) wr . Net Domestic Product at Factor Cost (NDP, or Domestic Income) 3 4, 5. Gross National Product at Market Price (GNP, 6. Gross National Product at Factor Cost (GNP xc) 7. Net National Product at Market Price (NNPyp) 8. Net National Product at Factor Cost (NP; or National Income) 3.2 BASIC AGGREGATES OF NATIONAL INCOME Inan economy, various goods and services are produced by different productive units during a period of one year. Such goods and services cannot be added together in terms of quantity (as we cannot add 5,000 tonnes of wheat + 10,000 mobile phones + 7,000 machines and so on). Therefore, these are expressed in terms of money. wir) 9! goods and services in terms There are many aggregates in national income to measure the value o of money. Let us start with Gross Domestic Product at Market Price (GDP yp). Gross Domestic Product at Market Price (GDP)jp) / It refers to gross market value of all final goods antl services produced within the domestic territory of a country during a period of one year. — © ‘Gross’ in GDP\,p signifies that no provision has been made for depreciation, ie. itineludes depreciation. 34 Scameaty rarSomrar scannea witn vamscanner3.2 Introductory Macroeconomics + ‘Domestic’ in GIM,,, signifies that it includes goods and services produced by all units located within the domestic territory (irrespective of fact whether produced by residents oF non. residents). + ‘Market Price’ in GDP jp signifies that it includes amount of indirect taxes paid and excludes amount of subsidy received, i.e. it shows that net indirect taxes (NIT) have been included. * ‘Product’ in GDP,,, signifies that only final goods and services have to be included. By making adjustments in GDPy, we can derive other aggragates. Gross Domestic Product al Factor Cost (GDP;) It refers to grass money value of all the final goods and services produced within the domestic territory of a country during a period of one year. GDP = GDP yp — Net indirect Taxes Net Domestic Product at Market Price (NDP\p) It refers to net market value of all the final goods and services produced within the domestic territory o| acountry during a period of one year. NOP\yp = GDP\yp ~ Depreciation Net Domestic Product at Factor Cost (NDP,c) It refers to net money value of all the final goods and services produced within the domestic territory q a country during a period of one year. NDP;¢ = GDP, - Net Indirect Taxes - Depreciation NOP; is also known as Domestic Income or Domestic factor income. GDPyp GOP, c, NDPyp and NOP,, are four Domestic concepts. The term (+) Dep (NT ‘Domestic’ signifies that contribution of only those producers (whether resident NOP et MP (cop at Fc) or non-resident) is lo be included who are within the domestic territory of the country. ‘*? t __tyararreje PP Gross National Product at Markel Price (GNP, uP) rs lo gross market value of all the final goods and services produced by the normal residents of country during a period of one year. GNP,p= GDP,,, + Net factor income from abroad Scameaty rarsamear scannea witn vamseannerNational Income and Related Aggregates 3.3 Must be noted that GNP yp than GDP yp When NFI However, GNPypwi can be less rus ja pcan bo fess ‘ie When NFIA is negative. , GNPypwill be Gross National Product at Factor Cost (GNP, ro) It refers to (OSS money value of all the final goods ard services produced by the normal residents of a country during a period of one year. GNP,¢ = GNP,p~ Net Indirect Taxes Net National Product at Market Price (NNP\jp) It refers to net market value of all the final goods and services produced by the normal residents of @ country during a period of one year. NNPiyp= GNP,,.~ Depreciation Net National Product at Factor Cost ({NNP,c) It refers to net money value of all the final goods and services produced by the normal residents of a country during a period of one year. NNPy¢ = GNPjyp— Net Indirect Taxes - Depreciation itmust be noted that NP, is also known as National Income. Relationship Between Four National Concepts GNPyp GNP,c. NNPyp and NNP,¢ = ,__»{GnPa MP}, are four National concepts. The term (+) Dop Gye “National’ signifies that production of only normal residents of the country isto [WNP st MP GNP at FC be included even il they are outside the ic terri (+) NIT () Dep domestic territory of the country. w harap" Domestic Income (NDP, .) Vs National Income (NNPj_) Basis Domestic Income National Income Nature of Concept itis a territorial concept as it includes the value 6! final goods and services produced within domestic territory of a country. Mt is a national concept as it includes the value of final goods and services Category of a it considers all producers within the domestic territory of the country. produced in the entire world Wconsiders all producers who are NFIA It does not include NFIA. Itincludes NFIA. normal residents of the country. + Scameaty rarsomr scannea witn vamscanner3.4 Introductory Macroeconomics DOMESTIC INCOME | (NDPyc) | {-) Not Factor income from abroad (+) Depreciation (-) Net inavrect Taxes { NNP ot MP. GOP at FC Lee (-) Deoreciation (+) Not Indieoct Taxes GNP at MP GOP at MP | T T (4) Net Indirect Taxes {-) Depreciation GNP at FC NDP at MP (+) Net Factor income from abroad (-) Net indirect Taxes {¢) Depreciation NATIONAL INCOME (NNP,c) Gross Domestic Product at Market Price Vs National Income Basis L Gross Domestic Product at | National Income (NNP,-) Market Price (GDP ys) Nature of Its a temntonal cancept as tinciudes | It is a national concept as tt includes Concept value of final goods and services the value of tinal goods and services produced within domestic temtory of | produced in the entire world a county a Category of | i considers all the producers within | it considers the producers who are Producers | the domestic territory of the country. | normal residents of the country. Wet Indirect | ltis at market price, .e.ilincludes net | It's at factor cost, 1e. it excludes net taxes indirect taxes. indirect taxes Depreciation | Itis inclusive of depreciation. It does not include depreciation. Steps for Calculating Practicals ‘of Basic Aggregates of National Income There are eight basic aggregates of National Income: | 4 Domestic Concepts : GDPy, GDP. NOP\yp NDP National Concepts: GNPyp GNP; NNPyp NNPpe While solving practicals of National Income, we are often required to calculate one of the ba i aggregate out of the other 7 aggregates. For better understanding of the steps, let us nal that we have to calculate NDP,- from GNP agp? ‘The various steps are: Step 1. Formulate an equation by putting ‘Aggregate to be calculated on the left hand side’ ang “Aggregate given on the right hand side’. Considering the given example, the equation will be: NDPpq = GNPyyp = Adjustments. Scameaty resem scannea witn vamscannerNational income an Related Aggregates Step 2. Identify the “Ady ts’ and calculate t AS we have 10 calculate NDP... tom GNP yp. there are thvee acyustments required, ns * [iin GNP yo signities Gross. i. it includes depreciation So, Dopreciaton will be subtracted MOM GNP yp to arrive at NNPyyp * (N'in GNP yp Signities National, 1 @. includes Net Factor Income trom Abroad (NFIA).So, NFIA ‘mill be subtracted from NNPyp to arrive at NDP» * MP" in GNP yp signities Market Price. 1.1 includes Net Indirect Taxes (NIT). So, NIT will be subtracted from NDPyp to arnve at NDP pe. The equation will become: ‘NDP... = GNP1,.- Depreciation - NFIA - ‘NIT. Alter putting the respective values of GNP yp, Depreciation, NFIA and NIT, we can calculate NDPj. Let us understand this with the help of following illustrations: Illustration 1. Calculate NDP at FC. (i) GNP at MP (i) Depreciation (ili) Net Factor Income {rom Abroad (iv) _Net Indirect taxes Solution: Inthe given question, NOP, is to be calculated from GNP,,.. Itcan be calculated through following steps: ‘Step 1. Formulate an equation by putting NDP,,on the lett hand side’and"GNP,,, on the right hand side’ NDP, = GNPy p= Adjustments Step 2. Identify the ‘Adjustments’ and calculate the answer. Depreciation, Net Factor income from Abroad (NFIA) and Net Indirect taxes (NIT) wil be subtracted from GNP),p to arrive at NDP, o. NDP,, = GNPyp ~ Depreciation - NFIA - NIT 8,000 - 600 - 300 - 700 26,400 crores. NDP yg Illustration 2. Calculate GDP at MP. () NNPat FC (ii) Depreciation (iii) Subsidies (iv) Factor Income from Abroad (v)_ Indirect Taxes (vi) Factor Income to Abroad Scameaty rerSome scannea witn vamscannerSolution: i Inthe givon question, GDP,» is to be calculated trom NNPy¢-lt can be calculated through following steps. Step 1. Formulate an equation by putting GOP p08 the lelt hand side’ and NP, on the right hand side GOP yp NNP,- + Adjustments Step 2. identity the Adjustments’ and calculate the answer. Depreciation and Net indirect taxes (NIT) wil be added while Net Factor Income from Abroag (NFIA) willbe subtracted Irom NNP,- to arrive at GDP yp GOP yp = NNP,, + Depreciation - NFIAY + Nit? = 2000 + 200 ~ (110-50) + (180-70) GDP yp = © 2.250 crores. Note: NFIA” = Factor Income from Abroad ~ Factor Income to Abroad, NIT? = Indirect Taxes ~ Subsidies ‘Solved Practical: For more practicals of Basic Aggregates of National Income, refer ‘Section 3.7: 3.39 SOLVED PRACTICALS ____———————— rena kee Net indirect Taxes = Market Price - Factor Cost Depreciation = Gross Value - Net Value Net Factor Income from Abroad = National Value - Domestic Value GDP,¢ = GDP - Nel Indirect Taxes NDP yp = GOPyp ~ Depreciation Domestic Income of NDP,- = GDPy, - Depreciation - Net Indirect Taxes GNPyp = GOP, + Net Factor Income from Abroad GNP pe = GNPyp- Net Indiroct Taxes, NNPyp = GNP,» — Depreciation National Income or NNP,_ = GNP,,»- Depreciation - Net Indirect Taxes () GNP atMP (ii) Subsidies (ii) Depreciation (iv) Net Factor income from abroad (W)_ Indirect tax Solution: NDP at FC GNP at MP - Depreciation - Net Factor i i NE i ME Depot Net Fugit cig from abroad — [Indirect tax Subsidies} Ans. NDP at FC = 25,400 crores Scameaty apse scannea witn vamscannerNational In lational Income and Related Aggregates 7 The Solution of Example 1 can also be presented as: i) ~ ii) - (iv) = (vy — Gi} 6,000 — 100 ~ 400 — {300 - 200} = 2 5.400 crores Ans. NDP at FC = Example 2. Calculate National Income or NNP at FC. Particulars GOP at MP (ii) Consumption of Fixed Capital (iil), Goods and Seruices Tax (iv) Factor income from abroad (v) Subsidies: (vi)_Factor income to abroad 400 crores. Solution: National Income or NNP at FC = GDP at MP - Consumption of Fixed Capital + (Factor income from abroad ~ Factor income to abroad) ~ (Goods and Services Tax ~ Subsidies) = 5,500 ~ 300 + (150 ~ 250) - (120-70) = ©5,050 crores Ans. NNP at MP = & 5,050 crores 2S6,ceo4a sory e(urt- Gre = 30) Example 3. Calculate GNP at FC. 25,000 NOP at MP Depreciation 4 5,000 (iii), Subsidies 30 Factor income from abroad 400 600 Factor income to the rest of the world Solution: Note: In the given example, only subsidies are (i) Add subsidies (as factor cost 1s to be calculated from the market price): oF (ii) Write formula as: (Indirect taxes - Subsidies) and put value of marect taxes as Zero. GNP at FC = NDP at MP + Depreciation + (Factor income from abroad — Factor income to the rest given. There can be two ways to solve this: of the world) + Subsidies = 25,000 + 5,000 + (400 - 600) + 30 29,830 crores ‘The Solution of Example 2 can also be presented = NDP at MP + Depreciation + (Factor income of the world) - (Indirect tax - Subsidies) as: from abroad - Factor income to the rest Scameaty arson scannea witn vamscanner