Professional Documents
Culture Documents
Ch.2 - Basic Concept of Macroeconomics
Ch.2 - Basic Concept of Macroeconomics
LEARNING OBJECTIVES
2.1 DOMESTIC TERRITORY (ECONOMIC TERRITORY)
2.2 NORMAL RESIDENTS
2.3 FACTOR INCOME AND TRANSFER INCOME
2.4 FINAL GOODS AND INTERMEDIATE GOODS
2.5 CONSUMPTION GOODS AND CAPITAL GOODS
2.6 GROSS INVESTMENT, NET INVESTMENT AND DEPRECIATION
2.7 NET INDIRECT TAX (NIT)
2.8 NET FACTOR INCOME FROM ABROAD (NFIA)
‘Consulate ’ is an office or building used by consul (an officer commissioned by the government to reside
in a foreign country to promote the interest of the country to which he belongs)
2. International organisations like UNO, WHO, etc. located within the geographical boundaries of a
country.
According to the United Nations, Economic Territory or domestic territory is the geographical territory,
administered by a government within which, persons, goods and capital circulate freely.
Test Yourself
Which of the following are covered under the domestic territory of India?
1. An Indian Company in London.
2. Microsoft Office in India.
3. Company in India owned by a Japanese.
4. Office of Reliance Industries in New York.
5. Branch of Foreign Bank in India.
6. Indian Embassy in Japan.
7. Branch of State Bank of India in China.
8. Russian Embassy in India.
9. Tata rented its building to Google in America.
{Ans. Domestic Territory: 2, 3, 5, 6}
Test Yourself
Identify the following as Normal Residents of India:
(a) Indian officials working in the Indian Embassy in USA.
(b) A Japanese tourist who stays in India for 2 months.
(c) Indians going to Pakistan for watching the cricket match.
(d) Indians working in the UNO office, located in America for less than 1 year.
(e) Indian employees working in WHO, located in India.
(f) Foreign tourists visiting India for a month to see the Taj Mahal.
(g) Indian Muslims going for the Haj pilgrimage.
The concepts of Domestic Territory and Normal Resident are important to estimate ‘Domestic Product’
and ‘National Product’.
1. The concept of Domestic territory helps to estimate ‘Domestic Product’. Domestic Product
includes production activity of production units located in the economic territory irrespective
of fact whether carried out by the residents or non-residents. The money value of domestic
product is termed as Domestic Income.
2. The concept of Normal Resident helps to estimate ‘National Product’. National Product includes
production activities of normal residents irrespective of fact whether performed within the
economic territory or outside it. The money value of national product is termed as National
Income.
The concepts of Domestic Income and National Income have been discussed in detail later in the chapter.
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.
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).
They are generally purchased by one production unit from another production unit, i.e. intermediate goods
remain within the production boundary.
However, all purchases by one production unit from other production units are not intermediate purchases.
For example, purchases of building, machinery, etc. are not intermediate purchases (if they are not meant
for resale) as their value is not included in the value of final good. In fact, such purchases are termed as
final products as they are purchased for investment.
They have ‘Derived Demand’ as their demand depends on demand for final goods.
Durable goods (like trucks, aircrafts, vehicles, etc.) purchased by Government for military purposes
are included under the category of intermediate goods as they are used to produce defense services
and not for market sale.
Value of intermediate goods is merged with the value of final goods. For instance, suppose a miller
buys wheat worth `700 and converts it into flour worth `1,000. Now, the value of flour (final good)
includes the value of wheat (intermediate good).
Production Boundary
The concept of production boundary is very significant to understand the difference between intermediate
and final goods. The production boundary is the line around the productive sector. As long as goods
remain within the production boundary, they are intermediate goods and when a good comes out of this
boundary, it becomes a final good.
In the given diagram, there are 3 production units (A, B and C). The thick border drawn around these three
units is the Production Boundary. Within this limit, cotton and thread are intermediate goods. Cloth is a
final good as it lies outside the purview of production boundary.
(i) Sugar is an intermediate good when it is used by sweet shop for making sweets. However, if it is
used by the consumers, then it becomes a final good.
(ii) Similarly, milk is an intermediate good when it is used in dairy shops for resale. However, it
becomes a final good when it is used by the households.
so, it must be noted that distinction is made on the basis of end use j/f end use of a good is consumption or
investment, then it is a final good. However, if the good is used for resale or further production (in the same
year), then it is an intermediate good.
10. Chalks, dusters, etc. purchased by a school. {CBSE, Delhi 2011 (I)}
These are intermediate products because these are taken to be used up completely during the same
year.
1. Durable goods: u refers to those goods which can be used again and again over a considerable
period of time. For example, television, refrigerators, etc.
2. Semi-durable goods: Goods which can be used for a limited period of time are termed as semi-
durable goods. These goods have a life span of around one year. For example, clothes, crockery,
shoes, etc.
3. Non-durable goods: Goods which are used up in a single act of consumption are known as non- C
durable goods. (These goods cannot be used more than once, i.e. they lose their identity in single
act of consumption. for example, milk, bread, food grains, paper, etc.
4. Services: Services refer to non-material goods which directly satisfy the human wants. They are
intangible activities, i.e. they can neither be seen nor touched. For example services of teachers,
doctors, banks, etc.
Capital Goods
Capital Goods are those final goods which height production of other goods and services. For example,
plant and machinery, equipments, etc.
Some Points about Capital Goods
(i) They are used in future for productive purposes and have expected life time of several years.
(ii) They do not lose their identity in the production process, i.e. they do not get merged in the process
of production,
(iii) They need repairs or replacement over time as they depreciate over a period of time.
(iv) They have derived demand as their demand is derived from the demand for other goods, which they
help to produce.
All Producer Goods are not Capital Goods
It must be noted that all goods used by producer (known as producer goods) are not capital goods. Producer
goods include two types of goods:
Single-use Producer Goods: It includes raw material like coal, wood, etc. They are not capital
goods as they cannot be repeatedly used in the production process.
Capital Goods: It includes fixed assets like plant and machinery, which can be repeatedly used in
the production process
So, it can be said that all capital goods are producer goods, but all producer goods are not capital goods.
How to Classify Goods as: Consumption Goods and Capital Goods There is no clear cut line of demarcation
between consumption goods and capital goods. The same good can be consumption good and also capital
good. It depends on the ultimate use of the good. For example, a machine purchased by a household is
consumption good, whereas, ^f it is purchased by a firm for use in the business, then it is a capital good.
However, if the machinery is bought by the firm for resale, then it will be treated as an intermediate
good.
Consumption Goods Vs Capital Goods
Gross Investment
Gross Investment is addition to the stock capital before making allowance for depreciation.
Capital stock consists of fixed assets and unsold stock So, gross investment is the expenditure on purchase
of fixed assets and unsold stock during the accounting year.
However, gross investment does not indicate the actual change in economy’s stock of productive assets for
a given year. During the production process, some amount of fixed capital is used up. This loss of fixed
capital is known as depreciation. By subtracting depreciation from gross investment, we get Net Investment
Net Investment
The actual addition made to the capital stock of economy in a given period is termed as Net Investment.
Net Investment = Gross Investment - Depreciation
Let us now understand the meaning of depreciation.
Net indirect tax refers to the difference between indirect taxes and subsidies.
Net Indirect Tax = Indirect Taxes - Subsidies
Let us discuss the two components of NIT:
(i) Indirect Taxes
Indirect taxes refers to those taxes which are imposed by the government on production and sale of
goods and services. For example, Goods and Services Tax (GST).
Indirect tax increases the price of the product in the market. For example,, if cost of producing one set of
speakers is `500 and Government levies GST of 10%, then price of speakers will increase to `550 due to
indirect taxes.
(ii) Subsidies
Subsidies are the 'economic assistance' given by the government to the firms and households, with a
motive of general welfare. In India, LPG cylinder is sold at subsidized rates.
• They are often granted to promote exports or to encourage firms for setting up the industries in the
backward areas.
Subsidies are opposite to indirect taxes as they reduce the market price of the commodity. In the example
of speakers, if the Government grants a subsidy of `10, then price of speakers will fall to `540 due to
subsidies.
• Subsidies may also be referred as 'Economic Assistance' or 'Financial Assistance'.
(a) Factor Cost (FC): It refers to amount paid to factors of production for their contribution in the
production process. In the given example, `500 is the 'Factor Cost'
(b) Market Price (MP): It refers to the price at which product is actually sold in the market. In the given
example, `540 is the 'Market Price'. It includes the indirect taxes and excludes the subsidies.
Market Price = Factor Cost + (Indirect Taxes - Subsidies)
Market Price = Factor Cost + Net Indirect Taxes
Calculate Net Indirect Taxes (NIT) in the following cases:
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.
National Income
= Domestic Income
+ Factor income from abroad (due to contribution of normal residents to production outside the economic
territory)
-Factor income to abroad (due to contribution of non-residents to production inside the economic territory)
The difference of Factor income from abroad and Factor income to abroad is termed as "Net factor income
from abroad" or popularly abbreviated as NFIA. So, National Income = Domestic Income + NFIA.
Components of NFIA
There are three main components of NFIA:
1. Net Compensation to Employees: It refers to difference between income from work received by
resident workers living or employed abroad for less than one year and similar payments made to
non-resident workers staying or employed within the domestic territory of the country for less than
one year.
2. Net Income from property and entrepreneurship: It refers to difference between income from
property and entrepreneurship (in the form of rent, interest and dividend) received by residents of
the country and similar payments made to the non-residents.
3. Net Retained Earnings: It refers to difference between retained earnings of resident companies
located abroad and retained earnings of non-resident companies located within the domestic
territory of the country.
Retained Earnings refer to that part of profits which is kept as reserve after paying the corporate tax and
dividends.
Thus, it may be concluded that:
Net factor income from abroad = Net compensation of employees + Net income from property and
entrepreneurship + Net retained earnings.
It must be noted that NFIA is zero in a closed economy as such economy does not deal with the rest of the
world sector.
Q. 3. What is meant by factor income to abroad? State its components. {CBSE, Delhi 2002}
Ans. Factor income to abroad refers to the factor income paid to the normal residents of other countries (i.
e. non-residents) for their factor services within the economic territory.
Components of factor income to abroad:
(i) Compensation of employees paid to the non-resident workers working within the economic
territory.
(ii) Income from property (rent, interest) and entrepreneurship (dividend) paid to the rest of the
world.
(iii) Fletained earnings of enterprises owned by non-residents within the domestic territory.
{Note: it must be noted that components of ‘Factor income to abroad’ are asked and not of ‘Net factor
income from abroad’}
Q. 4. Which among the following are capital goods and which are consumer goods (or consumption
goods)and why?
(a) A car used as a taxi
(b) Refrigerator in a hotel
(c) Air-conditioner in a house {CBSE, All India 2018}
Ans. (a) A car used as a taxi: It is a capital good because it is used for producing services for generating
income.
(b) Refrigerator in a hotel: It is a capital good because it is used for providing services over a period
of time to the production unit.
(c) Air-conditioner in a house: It is a consumer good because it is used for satisfaction of a want by
a household.
Q. 5. Which among the following are final goods and which are intermediate goods? Give reasons.
(a) Milk purchased by a tea stall.
(b) Bus purchased by a school.
(c) Juice purchased by a student from the school canteen.
Ans. (a) It is an intermediate good as milk is purchased by a tea stall for further production.
(b) It is a final good as bus is treated as an investment for the school.
(c) It is a final good as juice purchased by a student is meant for consumption purpose.
5. A good can be an intermediary good in one case and a final good in another case.
True. A good can be an intermediate good as well as a final good, depending upon its nature of use.
For example, a car purchased by a household is a final good, whereas, it will be an intermediate good
if it is purchased by a car dealer.
9. End-use of the goods categorise the goods as intermediate goods and final goods.
True. If the end-use of the good is for further production or resale, then the good is an intermediate
good. However, if the end-use of the good is consumption or investment, then the good is a final
good.
10. Final goods include only those goods which are consumed by the households.
False. Final goods include those goods which are either consumed by the households or purchased
by the producers for investment purposes.
11. Both ‘Expected Obsolescence’ and ‘Unexpected Obsolescence’ are considered for determining the
amount of depreciation.
False. Only ‘Expected Obsolescence’ is considered for determining the amount of depreciation.
13. All purchases by a production unit from other production units are intermediate products.
False. Because all such purchases are not necessarily used up for further production or resold during
the year. For example, products like machines, vehicles, etc. are final products even though they are
purchased by a production unit from other production units.
Note: As per CBSE guidelines, no marks will be given if reason to the answer is not explained.
REVISION EXERCISE
Multiple Choice Questions (MCQs)
1. Which of the following are covered under the domestic territory of India?
(a) State Bank of India in London (b) Google office in India
(c) Office of Tata Motors in Australia (d) Russian Embassy in India
4. Which of the following constitute the reason for difference between Market Prices and Factor Cost?
(a) Indirect Taxes (b) Subsidies
(c) Both (a) and (b) (d) Neither (a) nor (b)
6. Final goods refer to those goods which are used either for ___ or for .
(a) Consumption, investment (b) Consumption, resale
(c) Resale, investment (d) Resale, further production
9. Market price and Factor cost will be equal when there is:
(a) No direct tax (b) No indirect tax
(c) No subsidy (d) No indirect tax and no subsidy
12. Sugar purchased by a Sweet shop is an_____good, while it is a____good when it is purchased
by a consumer.
(a) capital, final (b) final, intermediate
(c) intermediate, final (d) final, producer
13. Identify the missing item in the following flowchart: {CBSE, Delhi 2016}
14. Which of the following flowchart correctly establishes the treatment of ‘Depreciation’?
{CBSE, Foreign 2016}
15. Depreciation of fixed capital assets refers to: {CBSE, Delhi 2016}
(a) Normal wear and tear (b) Foreseen obsolescence
(c) Normal wear & tear & foreseen obsolescence (d) Unforeseen obsolescence
16. Unforeseen obsolescence of fixed capital assets during production is: {CBSE, Foreign 2016}
(a) Consumption of Fixed Capital (b) Capital Loss
(c) Income Loss (d) None of the above
21. Foreign embassies in India are a part of India’s: (Choose the correct alternative)
{CBSE, Delhi Comptt. 2017}
(a) Economic territory (b) Geographical territory
(c) Both (a) and (b) (d) None of the above
22. Goods purchased for the following purpose are final goods: (choose the correct alternative)
{CBSE, All India Comptt. 2017}
(a) For satisfaction of wants (b) For investment in firm
(c) Both (a) and (b) (d) None of the above
Answer Key
1 B 11 D 21 B
2 C 12 C 22 C
3 D 13 B 23
4 C 14 A 24
5 C 15 C 25
6 A 16 B 26
7 C 17 D 27
8 B 18 C 28
9 D 19 A 29
10 B 20 B 30
Q. 3. Out of factor income and transfer income, which one is included in the national income?
Ans. Factor income.
Q. 8. Define consumption goods? {CBSE, All India 2012, Delhi Comptt. 2014 (II)}
Ans. Consumption goods refer to those goods which satisfy the wants of the consumers directly.
Q. 9. Define capital goods. {CBSE, Delhi 2012, Delhi Comptt. 2014 (I)}
Ans. Capital Goods are those final goods which help in the production of other goods and services.
Q.11. Give an example of a person who is staying abroad for a period more than one year and still he is
treated as normal resident of India.
Ans. An Indian working in Indian Embassy in USA will be treated as normal resident of India.
Q.12. Define ‘depreciation’. {CBSE, All India 2011, All India Comptt. 2014}
OR
What is meant by ‘Consumption of fixed capital’? {CBSE, Delhi Comptt. 2013}
Ans. Depreciation refers to a fall in the value of fixed assets due to normal wear and tear, passage of time
or expected obsolescence (change in technology).
Q.15. Give two examples of intermediate goods. {CBSE, All India 2013, Delhi Comptt. 2014 (III)}
Ans. (i) Milk used in dairy shop for resale; (ii) Coal used in factory for further production.