Contents 1, Final Goods and Intermediate Goods 7 De 7. Domestic (or Economic) Territ 41.1 Final Goods Country ° pus 12 Intermediate Goods $. Normal Residents ofa Country 2, Production for Self Consumption and 9, Net Factor Income from Abroad Production for Exchange 10. Net Indirect Taxes \ 3, Consumer Goods and Producer Goods 11. Factor Income and Transfer Income | 3.1 Consumer Goods 4.1 actor Income 3.2. Producer Goods 112 Transfer Income 4, Slocks and Flows 12, Major Sectors of an Economy | 5. Investment 6. Depreciation (or Consumption of Fized Capital) Macroeconomics deals with the study of ageregates, such as national income, employment, expenditure, “exports and imports ctc. of an economy. On the basis of these aggregates, national governments formulate their policy programmes to maximise the economic welfare of people. In our study of macroeconomics, | Wwe shall be working with certain basic terms and concepts. It, therefore, becomes necessary to understand | them clearly. In this chapter, we shall briefly describe some of these concepts at one place. 1. Final Goods and Intermediate Goods In economies, the term ‘good’ is de fined as any commodity (natural or man-made) or service that commands a price in the market. In other words, we use the ferm good 2s “economic good. Goods are often classified into final and intermediate goods. 1.1 Final Goods Gootls which are used by their ultimate users are called fnal goods. These goods are used either for Final consumption of for final investment, These are not meant for resale. In ther words. final goods do not ion (change) in the process of production. These are called final because undergo any further transforma ese are | once these are sold. they eross the production boundary and reach their final users. Produetion boundary is the line around the producing sector. ead sensiinnintitti Scanned with CamScannerof Final Goods inal goods are classified into 3 categories : 1. Consumer goods 2. Capital goods 3. Investment in stocks 2 (1) Consumer Goods : Final goods may be used both by consumers as well as producers. Goods consumed by their ultimate consumers are called consumption goods or consumer goods, Consumption goods like food and clothing, watches, TV sets etc, and serviees like that of doctor or teacher etc. when consumed by their ultimate consumers are called final goods. (2) Capital Goods : There are capital goods, which are also called final goods. Capital goods are not fequired to enter into further stages of production or resale. They are meant for final investment, ‘They are. thus, called final investment goods and producers are their final users. They have derived demand as their demand depends on demand for final goods. It should be clearly understood that final goods are neither resold nor used for any further transformation in the process of production. © goods are purchased by one production unit from other Production units, If these purchased goods are neither used up nor resold during the year of their purchase, they will add to the stock. This additian to the stock at the end of the year is an investment called investment in stocks or inventory investment, These unsold goods during the year of purchase are treated as final goods (3) Investment in Stocks : Intermedi 1,2 Intermediate Goods Uimermediate yoods ave those goods which are (a) used as raw material for production of other goods or (b) for resale in the same year ‘Two Characteristics of Intermediate Goods The above definition of intermediate goods indicate the following two characteristics : (i) Intermediate goods are used up for producing other goods ©. the year of purchase. The ‘din the commodity for which they are used. are also known as (ii) These yoods are resold during the same ye of these inputs s mery ir ultimate users. non-factor inputs, The valu Intermediate goods, thus, are not ready for use by th Examples : mers which is us 1 mill purchases sugarcane from the d to produce sugar. (i) Suppose that a su Sugarcane, thus, is an intermediate (ii) Sugar is pureh: ler from sugar mill is meant for resale. So, sugar in the hands of dealer is called an intermediate good vod ed by a whole (iii) Some durable goods (used in defence services) are also treated as intermediate goods. These include : (a) the weapons of destruction, such as missiles, rockets, bombs, etc, and (b) equipments needed to deliver them, such as vehicles, tanks, missile carriers and any other fixed assets, These re treated as raw materials needed for producing defence services. (iv) Spares of machinery are also treated as intermediate goods. However, wo necessary conditions should be followed : 12 | A-One Introductory Macroeconomics Scanned with CamScannerThe life : © vel Lh new part should be around one year or slightly more. ew ‘ Abbi ee aL not be high. For example, tyre purchased by a trans} isanintermediate good but expedite on the replacement of nator engine Wi ate consumption. It is because ofits high value, port company | not be called Basis of Classification aoe and wot onthe bel kod and Intermediate goods fs made on the basis of the use of the Prete good. However t product itself, For example, tea leaves purchased by the consumers i. fal good overs eves ae ot consumed in he sme fom, They at used in preparing as it is not veant pal nor at the hands of any consumer is not an economic activity i F sale in the market, But tea leaves will not be called final goods, ifthe same are used in a restaurant where drinkable tea is sold to consumers. D ‘com the abs ce goods From the above explanation, we may now summarize the difference between the final goods and intermediate goods as under inction between final goods and interme Basis Final Goods Intermediate Goods Intermediate goods (a) are used as raw materials to produce other goods or {b) forresalein the same year (i. the year of their purchase). Intermediate goods move from one stage of production tc another. Sovalue is added to these goods. | Their value is not included wl national income. 4. Production | Final goods remain outside the production | These goods remain within the production boundary and hence undergo further Boundary | boundary. transformation at the hands of any producer. 1, Use Final goods are meant for final use by consumers or firms. 2. Value No value is added to final goods. Addition 3. Treatment | While measuring national income, only the estimating value of final goods Is taken into account. LW Why is the Value of Intermediate Goods noc Included in National Income ? and intermediate goods lies in the fact that national The significance of distinction between final goods ra awetncludes value of only final goods (and not of intermediate goods). It fs because that val of ‘¢ value of final goods in whose production they are used. imermediate goods is already included in th This can be explained with the help of an bread, the total value of bread includes the value of flour also. If we bread both, the value of flour would be included twice. To include goods would imply double counting ~ that is, the flour imple. Example : Flour is used in making add the value of flour and the value the value of intermediate good: along with fin: would be counted more than one Examples : Final Goods Intermediate Goods Car purchased by dealer. = Car purchased bya household. @ Office furnitur ___|_* Office stationery, Some Basic Concepts of Macroeconomics 13 | Scanned with CamScanner 4Final Goods Intermediate Goods . School bus. © Diesel. * School building. @ Goods essential for the maintenance of building e-., colour, paints, cement ete. ‘© Tractor purchased by a farmer. > Diesel purchased by a farmer. Machine purchased by a production unit. @ Purchase of spares of machine by a production un «Books purchased by a student. @ Books lying with book seller. ‘© Sewing machine purchased by tailor. © Purchase of needles, thread ete, Classroom furniture Duster, chalk, marker pen etc. © Purchase of stationery by students. @ Purchase of stationery by school. 2. Production for Self Consumption and Production for Exchange @ Production for Self-Consumption : Production for self-consumption refers to those goods which are produced for self-consumption by the producers instead of sale in the market. For example, a small farmer grows wheat to meet his family consumption needs. Nothing is left for sale in the market, Hence, there is no saving for capital formation, Production for self-consumption is a part of current production, hence included in final output of an economy. © Production for Exchange : Production for exchange refers to those goods and services which are produced and sold in the market, The goods and services are produced with a profit motive. Difference The main points of difference between production for self-consumption and production for exchange from the view point of national income accounting are as follows : (i) Goods for self-consumption are produced by the producer houscholds whereas goods for exchange (¢ enterprises. are produced by corporate and quasi-corpa (ii) Production for self=consumption does not generate any surplus and hence does not involve investment. Production for exchange generates surplus and hence, provides funds for investment or capital formation. (iii) Imputed value of goods produced for self-consumption is included in the national income. However, the imputed value of services produced for self consumption (i.c., domestic services of housewives etc.) is not included as their valuation is very difficult. On the other hand, goods and services produced for exchange (for sale in the market) are included in the national income. 3. Consumer Goods and Producer Goods Itmay again be useful to draw a distinction between consumer goods and producer goods. 3.1 Consumer Goods Consumer goods or consumption goods which are used by the consumers for. atisfving their wants, Besides consumer households, these goods are also used by government and non-government organisations. General government (or government providing social welfare services like maintenance of law-and order, free health, free education ete.) purchases goods for the collective consumption and non-government organisations buy them for their employces. i. One Introductory Macroeconomics Scanned with CamScannerConsumer goods are classified into four categories, These are : bo" (p) Single-use consumer goods : These goods are used only once by their consumers. They lose their identity when consumed. Examples : Fruits, milk, biscuits, bread, cooking gas, vegetables etc. ay erie Consumer goods : These goods are repeatedly used by the consumers. They do not lose their identity when consumed, Examples : Car, television, washing machine etc. | (iil) Semi-durable goods : These goods can be used for a period of one year or slightly more. Examples : Crockery, clothes, shoes ete, " " (iv) Services : Services are also used by the consumers, Examples : Banking, insurance, health, education etc, These are called consumer services. 3.2 Producer Goods Producer goods refer to those goods which are used ir ic e in the process of duction of goods and services. They may be categorized as under : proces aff ve (a) Intermediate goods : Intermediate goods refer to non-durable goods which are used (i) by the producers as raw materials during the production process. (c.g., use of electricity, office stationery ete.) or (ii) for resale in the same year. (For detail refer section 1) (b) Capital goods Capital goods refer to those goods of high value which are used to produce other goods and services for several years. These goods are fixed assets of the producers and involve depreciation. These goods are not meant for resale in the market and hence are final investment goods or final producer goods. Factory buildings, machines, office furniture are examples of capital goods. These are also called producer durables, as they arc used repeatedly and do not lose their identity in the production process. They need repairs or replacement as they depreciate over a period of time. They are, thus, final goods Remember, all capital goods are producer goods but all producer goods are not capital goods. Capital goods are one form of producer goods. For example, a farmer makes use of so many things like seeds, fertilizers, water, insecticides, tractor, harvesting machine etc. while growing a crop. Alll of these are producer goods, but producer durable goods like tractor, harvesting machines only are capital goods. 1n consumer goods and capital goods as under : ‘We may now sum up the basic difference betw. Basis ‘Consumer (or Consumption) Goods Capital Goods 1. Use These goods are used by their ultimate | These goods are used by the producers consumers. as final investment goods. Z. Satisfaction | These goods directly satisfy human wants. | These goods indirectly satisfy human wants. 3. Nature These goods may be of four kinds : | Capital goods are the producer durables. {i) consumer durables, (i) semi-durables, {iii) single use goods, (iv) consumer services. The wear and tear of consumer durables, | The cost of wear and tear of capital goods when put in use, is not taken into account | has to be deducted from gross national while measuring national income. income to obtain net national income. 4, Wear and Tear Some Basic Concepts of Macroeconomics is | Scanned with CamScannerr-”-—Ct—‘“—SOC~™~™ Significance : There is a trade-off between consumer goods and capital goods. If an economy produces morc of capital goods, itis producing less of consumer goods. But more the capital goods are produced now, more will be the productive capacity of the economy in future, In return, a Inrger volume of consumer ‘goods can be produced in future, Some Other Examples : fE Consumer Goods Producer Goods Fan used by a household © Fanina restaurant © Telephone ina house © Office telephone © Use of car asa taxi. ‘Sewing machine lying with a tallor. © Car for personal use ‘© Sewing machine purchased by ahousehold | Medicines kept in a medical store. # Personal camera @ Camera with a photographer. att Pe Stack of cotton lying with a textile mill ® Cotton used by a household [Gents id Producer Goods Consumer Goods © Medicines kept by household , a Single use goods | Semi-durable use | | eLrthae Durable use goods | (such as mill, (such as washin goods (such as eben food, services ofa | | SUCHSS Washing | Cloth, erockery jucation, he. doctor) | oa tte.) services ete.) c ¥. Intermediate goods (single use producer goods such as raw material, fuel ete.) Capital goods (such as machines, factory building ete.) 4. Stocks and Flows In economics, we come across with several variables can be classified into stocks and flows on the basis of time. Stock variables : A stock is @ quantity measured at a point of time. Stocks have no time dimension (length of time). They indicate the quantity of variable ata point of time. For example, capital is a stock. On 31" March 2011, capital employed by a firm is $100 crore, Another example of stock may be the bank balance in your account as on 1" January 2011, Thus, stock variables are not time dimensional. Other examples of stocks : Supply of money, foreign debt, population, number of persons employed, price level ete. BER one Introductory Macroeconomics — Scanned with CamScanner| Flow variables : 4 flow is a quantity measured aver a period of time. Thus, flows are measured th reference to a certain time period say per day, per month, per annum ete. So, they are time mensional, For example, national income is u flow variable, as it is measured per annum. Likewise, output is also a flow variable, as it has time dimension. Output (or production) is measured per uni oftime. Other examples of flow variables : Investment, expenditure, saving, depreciation, change in inventor profit and loss ete. Stock and flow can now briefly be distinguished us under : — Basis Stock Flow 4, Meaning Flow relates to the period of time. 2. Time Dimension Stock has no time dimension. Stock influences flow, For example larger the stock of capital more will be the flow of goods and services. Flow has time dimension, Flow influences stock. For example monthly increase in income of a household leads to growth in its wealth. Thus, income (a flow variable) influences wealth (a stock variable). ! Stock relates to a point of time. Income, expenditure, investment, production. Capital, wealth, supply of money and price level, Examples 5. Investment Investment means adilition to the stock of capital goods, such as buildings, equipments and invemory that adds to the fiture productive capacity of the economy. Itis the expenditure on the purchase of fixed assets and unsold stock during an accounting year. It, thus, refers to an addition in the stock of capital, Investment is also called capital formation, It can be expressed as under Tak I= Investment; K = Stock of capital; AK = Change in stock of capital in one year, Wher It should be clearly understood that investment does not imply expenditure on the purchase of shares or other financial assets. He real investment uch as mean cial investment by investment w Fixed Investment and Invento There are two main components of investment. Thes (i) Fixed investment and (ii) Inventory investment s of the producers “ived investment refers to an increase in the stock of fixed asse jase of capital goods like plant, machines, building ete, is called formation. Fixed investment : during a year; Expenditure on the purcl fixed investment. Fixed investment is also known as fixed capit Example : Suppose 4 transport company has a fleet of 20 trucks which rises to 24 trucks in during 2016-17. Then fixed investment during the year 2016-17 will be 4 trucks. An inerease in the number of increase in the scale of production which further means increase in the level of output assets implies Some Basic Concepts of Macrocconomics ML Scanned with CamScannerrT” EEE Inventory Investment : Inventory investment, on the other hand, refers to the change In stock of (i) finished goods, (ii) semi-finished goods and (ii) raw material during an accounting year. Inventory of finished goods is essemtial to meet the rising demand. And inventory of raw material becomes necessary to avoid the situation of short supplies. However, sometimes there is also undesired stock investment, This happens when market conditions tum unfavourable. Gross Investment and Net Investment Gross Investment : Gross investment is the toral addition made to the capital stock of an economy in a given period. Capital stock consists of fixed assets and unsold stock. So, gross investment is the expenditure on purchase of fixed assets and unsold stock during a year. Gross investment also includes expenditure on the purchase of new assets which are meant to replace the existing wom-out machinery. Fixed assets are used for several years, when they become obsolete, they need to be replaced. Replacement of fixed assets, due to their normal wear and tear is a part of oss investment, But is dees not Iead (o inerease in the existing stock of capital of the economy. It only maintains the existing stock of capital intact Net Investment : Ner investment means net addition to the stock of capital during a year Mes penditure on the replacement of worn-out fixed assets is exeluded from gross investment, we obtain net investment, Therefore, net addition to economy's capital stock is measured by net investment {instead of gross investment). Net investment is expressed as : Net Investment = Gross Investment ~ Depreciation It is net investment (and not gross investment) which raises the level of capital stock of the economy. Significance of Net Investment Net investment raises the level of output in the econom; © Additional availability of capital per unit of labour also inereases the efficiency or productivity of labour. Thus, net investment promotes growth and development of the economy. 6. Depreciation (or Consumption of Fixed Capital) The term depreciation refers to the fall in the value of fixed assets (capital goods) duc to normal wear and tear and expected obsolescence. Depreciation pital be the value of fixed capital by iso called consump Normal Wear and ar: Production of goods involve wear and tear of fixed pital like machines, his is, in fact, called consumption, tools, buildings ete, due to their constant use in production, 1 of fixed capital, 2 The value of fixed assets also falls with the passage of time even when these are not used in production, Natural factors like weather, rain, wind ete. contribute to this fallin value. (iii) Expected Obsolescence : The value of fixed assets also falls due to expected (or fore n) obsolescence, It has two components : (a) Change in Technology : The value of fixed capital goods falls due to change in technique of production. For example, due to the introduction of comput the manual typewriters have become obsolete. One Introductory Macroeconomics Scanned with CamScanner) Change in Demand : Change in fashion results in fall demand for nylon clothes in fvouroftere-cauen cates aah eee eledue te lta evorae euideed. , machines producing nylon elotbes Depreciation Reserve Fund ciation, fixed assets need to be re pyc to depreciation, | 0 be replaced afer the expi i requires some provision of funds whichis generally made annually Ferexen de cst purchased fr® 2,00,000 whose expected lites 10 yea iimual pti 2,00,000) . “ - The fund so accumulated is, called depreciation reserve fund (or replacement investment or replacement cost). The estimated value of depreciation for all theproduetion units in the economy during an accounting years called current replacement cost inour example, an amount of %2,00,000 is called replacement cost, whereas the annual Provision of 220, 000 is called current replacement cos ‘ ir replacement an + Suppose a machine is hen, the annual provision for fund (to replace themachine afer 10 years) should be 220,000 ( Thus, current replacement cost is another name of dey ; ’ reciation, Since depreciation is esti ° annum, itis a flow variable p p is estimated per Significance of Depreciation Reserve Fund Depreciation reserve fund is v machines ete. were not replaced on time, the production eap: oft, the level of income/output would fall. The econ Itmay also be caught i demand essen al to keep the pital stock of an economy intact. If wor out ily of the economy would decline. Asa result ny may slip into a state of economie slowdown. 10. low level of equilibrium trap, wherein low income causes low demand, low ' low output which again implies low income and so on. A fall in value of fixed capital due to (i) natural calamities (e.g., earthquakes, floods, fires ete.) and (ii) unforeseen factors like war and thefts ete. is not considered while estimating depreciation. This called capital las: Consumption of fixed capital (or depreciation) can be distinguished from capital loss as under : Basis Depreciation Capital Loss TL. Meaning | Itrefers tofallin value of a fixed capital asset | It refers to loss in value of a fixed capital due to normal wear and tear, expected | asset due to a unforeseen obsolescence obsolescence and passage of time. and natural calamities, thefts, accidents, depression etc 2. Provision | Asit is an expected loss, provision (in form | As it is an unexpected loss, no such of depreciation reserve fund) is made frit. | provision is made fort, However, itcan be | recovered by getting fixed assets insured. 3. Production | It does not retard the production process. | It retards the production process, Process { |. Treatment | Depreciation is deducted from gross income while estimating national income. Capital losses are not a part of depreciation and hence, are not taken into account while estimating national income ‘or depreciation is used to differentiate between gross and net . yross investment ete.) inelude depreciation. nsumption of fixed capit trross variables (like gross incom tion has to be deducted trom gross variable, Significance : C An national accounting. To find out net variable, depr some Bosc concepts of macroeconomics MEM Scanned with CamScanner7. Domestic (or Economic) Territory of a Country The concept of domestic territory is another important concept used in national income necounting. For the purpose of national accounting, itis different from political territory of a country, It is used as economle territory. Economic territory rwfers to the geographical territory administered by a government within which persons, goods and capital circulate freely, The freedom of circulation of persons, goods and capital is the basic criterion of economic territory for including in it, 1 ineludes the following : (i) Political territory including sea waters, (i) Ships, atreratls ete. operated by residents of the country between two or more countries, For example, Indian ships moving between Russia and Japan form the part of domestic territory of India, Foreign aircrafts and ships moving within Indian territories are not included in India's domestic tertitor (1D Fishing vessels, oil and natural gas rigs and floating pli country in the international waters or engaged in ext exclusive rights of exploitation (iv) Embassies, consulates and military bases ete. embassies in UK, USA, Japan form parts o consulates ete. located within the Ind In short, economic territory of forms operated by the residents of the tion in areas over which the country has. of the country located abroad. For example, Indian the domestic territory of Ini reiggn embassies, 1 lerrilories are not included in India’s domestic territory. country certain areas outside its political boundat sons, goods and capital circu ludes some areas of its political boundary and includes Economic territory is the geographical territory within which e freely. There are wo ty tional income aggregates domestic product and national product. ed within the: -onomic territory is termed as domestic product such ity of the production units loca P, NDP. [Production Activity 2 | Outside the Domestic Territory — y. | Included in Domestic Product or | Domestic Income Domestic Product or Domestic Income | Examples of Income : Included in Domestic Product ] Not included in Domestic Product (Domestic Income) of India | (Domestic income) of India © Profit earned by Tata Motors in India © Profit e: # Profit earned by branch of foreign bank in India| ‘arned by Reliance industry in Malaysia Profit earned by branch of SBI in USA. BE bone tntroductory macroeconomics Scanned with CamScannerIncluded In Domestle Product Not Included In Domestic Product (Domestic Income) of India {Oomestic Income) of Indla @ Salaries paid to the residents of USA workin i king I gin] © Salaries pald to Indian residents working In indian embassy in USA, Japanese embassy in India. @ Profit carned by Microsoft (an American] © Rent paid by Russian embassy in India to an company) in India, Indian resident. ‘© Rent received by Indian from his building in USA. ‘@ Rent received by Indian residents for their buildings rented out to foreigners in India. 8. Normal Residents of a Country A resident is defined as a person or an institution who ordinaril one year or more) ina country and whose centre of economic interest les economic interest it is meant that (a) the resident lives or is located within the economic territory: and « period of stay should be at feast in that country. By centre of sid (b) the resident carries out the basic economic activities (of earning, spending und accumulation) from that location. nd Citizen nd citizen are two different Differe ‘The term resident should not be confused with the term citizen. Resident terms. A person can be a citizen as well as a resident, but it is not necessary that a citizen of a country is necessarily the resident of that countzy. A person can be a citizen of one country and at the same time aresident of another country. For example, an NRL is a citizen of India but a resident of the country in which he lives. Citizenship is basically a legal concept based on the place of birth of the person or some citizen. On the other hand, residentship is an economic ¢ Between the Concepts of Re legal provisions allowing a person to becom concept based on the basic economic activities performed by & person jot treated as the normal residents of the country where they ‘The following persons or institutions are are living or located ‘tors or tourists visiting the country for studies, medic ‘They are the residents of their respective counttie: Dbassies and consulates and members of foreign armed forces located in the Ircatment, recreation, to take (i) Foreign v part in sports ete. (ii) Foreign staff of em country. (iit) The crew of foreign ships, aircrafts ete ‘onal organisations, such as the world bank, World Health Org ry Fund ete. They fall under ‘international are: ‘mployces of international organisations are considered residents of the countries to which they belong, But, i they are staying for a period of one year or more then they become the normal residents of the country where the organisation is located. inisation, International (iv) Intern: Mone Thus, normal residents can be of 3 types. They include residing in the country of which they are the nationals, such as Indians (i) Nationals of a count living in India, Nationals of a country iving abroad temporarily (for less than one year) but their interest lie inthe re the nationals such as Indians living temporarily in the foreign countries. (iy country of whieh they (iiiy Foreigners living in a country for more than one year. Some Basie Concepts of Macroeconomic: MIM aw Scanned with CamScannerSignificance of the Concept : National product or income ineludes production activities of residents, no matter whether performed within the economic territory or outside it. Production Activity Non-residents of the country t Not Included in National Product or National Income Normal residents of the country, Examples of Income : Not included in National Product {National Income) of India * Profit earned by General Motors (a US Company) in India. Profit earned by branch of City Bank in India. Salaries paid to Russian residents working in Included in National Product (National Income) of India * Profit earned by an Indian company in USA. Profit earned by branch of S81 in England. © Salaries to Indian residents working in the] © Chinese embassy in India Indian embassy in Russia © Rent paid by Russian embassy in India to an| © Profit earned by Nestle (an American Company) Indian resident, ee __in india. - ‘© Rent received by an Indian from his building in| Rent received by a foreigner from his building Singapore. in India, 9. Net Factor Income from Abroad Net factor income from abroad (NFLA) is the difference between factor income received from abroad by normal residents of a country and factor income paid to the non-residents of the country. NEIA = Factor income received from abroad Factor income paid to abr ed from abroud’ is the income earned by the nortual residents of a country from rent, interest, dividend and retained camings. And ‘factor income to id to the non-residents of other countries for their fi country ‘actor income rece’ abroad in the form of wi abroad’ is the factor income the domestic territory of the tor services within Components of NFIA ‘There are three main components of NFIA (I) Net Compensation of Employ The difference between income received from work by residents from other countries and similar payments made to non-residents, is ealled net compensation of employees. 7One Introductory Macroeconomics Scanned with CamScanner =a —@) N let Income from Property and Entrepreneurship : Itrefers to the difference between income from property and entrepreneurship received by residents from other countries and similar payments made to non-residents, 2) Net Retained Earnings : lis the difference between retained camings of resident companies from abroad and retained camings of non-resident companies located within the domestic territory. Inmay be noted that net factor income from abroad can be negative as well as positive, NFIA is negal when income eamed by foreigners from domestic territory is more than the income eamed from abroad. Itwill be positive when income camed by foreigners from domestic territory is less than the income eamed from abroad, Significance : Net factor income from abroad is used to differentiate between national income and domestic income. By adding NFIA to domestic income, we get national income, Similarly, if we deduct NFIA from national income, we obtain domestic income. Thus, oe National income = Domestic income + NFIA Domestic income = National income ~ NFIA : Another similar concept namely ‘Net Factor Income to Abroad’ needs to be mentioned here. Remember, net factor incume to abroad is a negative expression of net factor income from abroad. For example, if net factor income from abroad is 7100 crore, then net factor to abroad will be %(-)100 crore. Net factor income to abroad = Factor income to abroad — Factor income from abroad Examples of NFIA: 1. Profits eamed by a branch of State Bank of India in England is factor income from abroad. 2. Compensation of employees to Indian employees working in Japanese Embassy in India is factor income from abroad. It is because Japanese embassy in India lies outside the domestic territory of India. 3, Profits eared by a branch of an American Bank in India is factor income to abroad, as it eamed by America from India. 4, Salaries paid by Indian government to Americans working in Indian embassy in America is not included in India's NFIA. Though, it will be included in India’s domestic income as Indian embassy in America is a part of India’s domestic territory. 5, Rent paid by a foreign embassy in India to the Indian owner of building is factor income from abroad. 6, Interest received by Indians on debentures purchased in London is a part of India’s NFIA. spore is a part of India's NFIA. 7. Profits eared by a resident company of India in Sit 10. Net Indirect Taxes Net indirect tax is the difference between indirect taxes and subsidies. ¢ Indircet Taxes (IT) : Taxes which are imposed by the government on the production and sale of commodities are called indirect taxes. Sales tax, excise duty, custom duty are some examples of indirect taxes. They tend to raise the price of goods. © Subsidies (S) : Subsidies are the cash grants given by the government to the enterprises for production of certain commodities or to promote exports of goods or to sell goods at prices lower Some Basie Concepts of Macroeconomics Scanned with CamScannerthan the market price, These are opposite to indirect taxes. They reduce the market price of a commodity, The difference between Indirect taxes and subsidies Is called net Indirect taxes. Net Indirect Taxes (NIT) = Indirect taxes (IT) ~ Subsidies (S) Or NIT=IT-S Significance : Net indirect taxes are used to differentiate between the concepts of ‘market price’ and “factor cost’. # Market price (MP) is the price at which the product is sold and purchased in the market. It includes indirect taxes and excludes subsidies. © Factor cost (FC), on the other hand, refers to all payments made by the firm to the factors of production for their contribution in the process of production. From the view point of producer, s called factor cost. Market price includes indirect taxes and excludes subsidies. Therefore, market prige is the sum total of factor cost and net indirect taxes. Madl = Factor cost + Net indirect taxes Or t Price Market Price = Factor cost + Indirect taxes ~ Subsidies Factor cost is the difference between market price and net indirect taxes. Therefore, factor cost can be estimated from the market price as under : Factor cost arket price ~ Net indirect taxes Or Factor cost = Market price ~ Indirect taxes + Subsidi © Why are indirect taxes deducted from and subsidies added to Market price ? Conceptually, the value of domestic product whether estimated at market price or at factor cost should be identical. This is so because the final value of the goods and services (market prices) must be equal to the cost involved in their production (factor cost). However, the market value of goods and services is not the same as the carnings of the factors of production. © Why are ‘indirect taxes’ deducted ? In the calculation of domestic product, the value of goods and services at market prices are taken into consideration which includes indirect taxes. Therefore, the entire market price is not received by factors of production. Due to this reason, indirect taxes are deducted from market price for calculating the value of domestic product at factor cost. © Why are ‘subsidies’ deducted ? Generally, government provides subsidy (.c., economic assistance) to the producer or distributor, so that the commodity may be sold at lower prices. In this ease, market price becomes lower to what factors of production actually get. Hence, for calculating the actual factor income, subsidy amount is added to market price. It should be clearly understood that both indirect taxes and subsidies are transfer payments. Hence, they cannot be included in national income. They are only subtracted from and added to market price to obtain national income which is always measured at factor cost. Il s-one tntroductory Macroeconomics Scanned with CamScanner —La j1. Factor Income and Transfer Income Income is broadly categorized into factor incomes and transfer incomes. 11.1 Factor Income Factor income refers to income received by the factors of production for rendering factor services in the we of production. This is the reward of factors of production for the services rendered by them in the production process. Rent, wages, interest and profit are fictor incomes. Income of land is rent, of labour is wage. of capital is interest and of enterprise is profit, To earn factor income, onc has to contribute in the production process. We cannot receive factor income without contributing to production. So, factor income is a bilateral income and hence, is an camed income. It should be clearly understood here that factor incomes and factor payments are the two sides of the same coin. Factor incomes are viewed from the side of owners of factors production who receiv remuneration in lict of their services, whereas factor payments are viewed from the side of firms (‘e., producers of goods and services) who make payments to the owners of factors of production, Factor payments, thus, are costs to the firms and become incomes in the hands of factors of production. Factor incomes are included in national income. 11.2 Transfer Income There are also certain types of incomes which are received without making any corresponding conte to the production of goods and s Incomes which are received without rendering any productive service are called transfer incomes. Thus, transfer income is only receipt concept, It is one sided income ic., unilateral income. Old age pension, scholarship to students, unemployment allowance 10 tunemployed people, flood relief, pocket money ete. are examples of transfer income. They are merely transferred without getting in retum any productive services from their recipients. Hence, they are not included in national income. ervic under : ¢ between factor income and transfer income a We may sum up the differen | ‘Transfer Income Basis Factor Income 1. Meaning |e refers to the income accruing to the | It refers to the income received without owners of factors of production, | any good and service, « 12. Nature J itis an earned income as itis received | It is an unearned income as itis received without rendering any productive service. in lieu of factor services po ee 3, Estimation in __| It is included in national income. | leis not included in national income National Income 4. Type of income | Itis a bilateral income. terest and profits Scholarship to students, unemployment 7 allowance, old age pension, pocket [money etc. Itis a unilateral income. 5. Examples Rent, wage, 12. Major Sectors of an Economy For the purpose of proper and systematic study of circular low of income, an economy can broadly be divided into 4 sectors. These sectors are explained below : (i) Households : Households refer to single individuals or a group of individuats for whom commie decisions are taken jointly. They are the owners of factors of production, namely’ : Some Basle Concepts of Macroeconomics MAEM Scanned with CamScanner(a) land, (b) labour, (e) capital and (d) enterprise, Households provide factor services to the producing seetor of the economy and earn income which is called factor income, They spend thi income to meet theit consumption requirements in the present and alsosave a part of income for fiture tse, They also pay: tives. : (i) Firms: Firms are the producing units. They hite factor services from the households and produce a variety of goods andl servives, They also suye and pay Wxes, ii) Government : Government performs different functions in every economy. qt on aduimistrative services like defence, law and order, health and education ete, 1t performs | these services with the objective of social welfare, HU his no intention of earning profits. This kind of government is called general goverument, Besides, like private firms, italso produces: goods and services with the aim of earning profit, It runs pubhie sector enterprises (¢.g.. Indian railways, Air ludia, Indian Oil Corporation, BHEL ete.) to earn profits. Ht should be noted here that value of services provided by the general government is estinvated on te basis of their cost to the government while value of goods and services produced by the government is estimated on the basis of their market value, (iv) Rest of the World : Today every economy in the world is an open economy: services and capital from other countries. Against these inflows, payments are made to other countries, Rest of the world sector is also called an external sector, spends money NAUK es isely Meaning of Goods : Good in economics is defined as any physical object (natural or man made) or service which commands a price in the market. This is called an economic good. B Intermediate Goods and Final Goods Intermediate Goods : Intermediate goods are those goods which are purchased by one production unit from other production units, Value Is to be added to these goods. They have derived demand as their demand depends upon demand for final goods. Final Goods : Final goods refer to those goods which are either used for consumption by households or for final investment by firms. These goods are not meant for resale, B Consumer Goods and Producer Goods Consumer goods : Consumer goods (also called consumption goods) refer to those goods which satisfy human wants directly. Bread, butter, clothes, furniture, television, vehicles etc. are some examples of consumer goods. Producer Goods : Producer goods refer to those goods which are used by producers while producing other goods and services. They are of two types : intermediate goods (also known as non-factor inputs) and capital goods, Capital goods are final investment goods. @ Gross Investment and Net Investment : Gross investment means total addition made to the stock of capital during an accounting year. It is also called gross capital formation. There are two components of gross investment : (i) fixed investment and (ii) stack investment. Net investment means net addition made to the capital stock of an economy in a year. indicates the actual change in economy's capital stock. During the process of production some amount of fixed capital is used up which is called depreciation, This has to be deducted from gross investment to get net investment. WEED one tntroductory nacroeconomes Scanned with CamScannerConsumption of Fixed Capital (or Depreciation) : It refers to a fall In the value of fixed Pe lassets due to normal wear and tear and foreseen obsolescence. Value of fixed assets also "declines with the passage of time even if they are nat used In the process of production. Depreciation Is also known as consumption of fixed capital, The term depreciation Is used to differentiate between gross and net. Ifthe value of a fixed capital asset falls due to unforeseen obsolescence or due to natural calamities like floods, earthquakes or due to thefts etc, It Is called capital loss. B Stacks and Flows : Stocks refer to those varlables which are measured at a point of time. Wealth, capital, population are examples of stock variables, Flow variables refer to those variables which are measured over a period of time. National Income, national output, investment, depreciation are some examples of flow variables. & Domestic Territory (or Economic Territory) : Economic territory of a country Is different from its political territory. It is based on economic criterion. It Includes the following: (1) Political frontiers including territorial water and air space. (il) Embassies, consulates, military bases etc. located abroad. (iil) one and aircrafts owned and operated by normal residents between two or more nations, (lv) Fishing vessels, oil and natural gas rigs etc. operating by the residents of a country In the international waters where they have exclusive rights of operation. Normal Resident : Normal resident refers to an individual or an institution who ordinarily resides in the country and whose centre of economic interest also lies in that country. Production by the residents of a country is called national product or national income, whereas production carried out in economic territory is called domestic product or domestic income. m Net Factor Income from Abroad : Its the difference between the factor income received from the rest of the world and the factor income paid to the rest of the world. Components of NFIA : (i) Net compensation of employees; (il) Net factor income from property and entrepreneurship; (iii) Net retained earnings. Net Indirect Taxes : Net indirect taxes is the difference between indirect taxes and subsidies. lm Factor Income and Transfer Income : Factor incomes are the incomes received by factors of production. Transfer incomes are unilateral payments. @ Major Sectors of an Economy : A modern economy consists of 4 major sectors : (i) Household Sector : This sector provides factor services to firms and buys goods and services from them. (il) Producing Sector : This sector includes all those engaged in production activity. Praducers/firms hire factor services from the household sector. (iii) Government Sector : As general government, it provides services of public welfare free of cost. The government also acts as producer. (Iv) External Sector : This sector is engaged in export and import of goods and capital with other countries. Some Basic Concepts of Macroeconomics Scanned with CamScanner