CHAPTER 2

Basic Concepts of Macroeconomics

2.1 DOMESTIC TERRITORY (ECONOMIC TERRITORY)

2.2 NORMAL RESIDENTS
2.3 FACTOR INCOME AND TRANSFER INCOME
• CURRENT TRANSFERS vs CAPITAL TRANSFERS
2.4 FINAL AND INTERMEDIATE GOODS
• PRODUCTION BOUNDARY
2.5 CONSUMPTION AND CAPITAL GOODS
2.6 GROSS INVESTMENT/ NET INVESTMENT (DEPRECIATION)
2.7 MARKET PRICE / FACTOR COST (NET INDIRECT TAXES)
• DOMESTIC INCOME/ NATIONAL INCOME (NET FACTOR INCOME FROM
ABROAD)
2.8 NET FACTOR INCOME FROM ABROAD
2.1. DOMESTIC TERRITORY / ECONOMIC
TERRITORY

Economic territory is the geographical

territory administered by the government
within which persons, goods and capital can
circulate freely.
- United Nations
 Domestic Territory includes:
• (a) Ships and aircraft operated by the
residents between two or more
countries.
• (b) Fishing vessels, oil and natural gas
rigs operated by residents in the
international waters.
• (c) Embassies, consulates, military
bases etc. located abroad.
Fishing vessels OIL RIGS
 ECONOMIC TERRITORY DOES NOT INCLUDE:

1. Embassies, consulates and military

establishments of a foreign country.

2. International organizations like WHO, UNO

located within the geographical boundaries
of a country.
 TEST YOURSELF
Are the following within the domestic territory of India?
• Indian High Commission based in Tokyo.
(Yes)
• Qatar Embassy in New Delhi.
(No)
• The office of UNDP in Mumbai.
(No)
• Passenger planes operated by Air France between India and
Paris.
(No)
• Ships operated by Hindustan Shipping Ltd. Between Colombo
and Dubai.
(Yes)
 2.2. NORMAL RESIDENTS
Normal resident of a country refers to an individual
or an institution who:

Ordinarily resides in the country for one year or

more

Whose centre of economic interest also lies in that

country.

Center of economic interest implies the resident is

located within the domestic territory and he
carries basic economic activities of earnings,
spending and accumulation from that location
 Citizenship and Residentship

CITIZENSHIP RESIDENTSHIP

Legal concept based on place Economic Concept based

of birth
A person can become a
citizen when he completes
legal formalities and the law
allows him to be so.
(passport and voting rights)
on economic activities
performed by a person
A person becomes a
resident of a country after
one year.

Remember: A person can be a citizen of one country and at

the same time, a resident of another country.
 Following are excluded from the category of
normal residents:

Foreign staff of
Foreign tourists
Embassies, International
and visitors who
officials, organizations like
visit a country for
diplomats and UNO,IMF, WHO
recreation,
members of the are treated as the
holidays, medical
armed forces of a normal residents
treatments,
foreign country, of international
study, sports,
located in the area.
conferences etc.
given country.
 Following are excluded from the category of
normal residents:
E
Employees of Border workers who live
international X
near the international
organizations like UNO, C border and cross the
IMF, WHO are considered E
as residents of the border on a regular basis
countries to which they P to work in the other
belong for only one year.. T country. They are treated
(After that residents of a I as normal residents of the
country where office is O country where they live,
located) not where they work.
N
 TEST YOURSELF
Are the following residents of India?
• Australian students studying in JNU.
(No)
• Indian labour working in Bangladesh and crossing borders daily.
(Yes)
• Indians working at the local office of the WHO.
(Yes)
• Indians who have gone to England for medical treatment.
(Yes)
• The Canadian High Commissioner posted since last 2 years at
the Canadian High Commission in New Delhi.
(No)
Significance of these two concepts
DOMESTIC TERRITORY: This concept helps us to calculate
Domestic Product which includes production activities of
production units located in the economic territory
irrespective of fact whether carried out by the residents or
non-residents. (WHERE)

NORMAL RESIDENTS: This helps us to calculate National

Income which includes production activities of normal
residents irrespective of fact whether performed within the
domestic territory or outside it. (WHO)
GNP GDP
 2.3. Different types of Income

FACTOR INCOME TRANSFER INCOME

Income received for Income received

rendering productive without rendering any
services (two sided - productive services
bilateral) (one sided- unilateral)

EARNED INCOME UNEARNED INCOME

E.g. Pocket money,

E.g. Rent, interest, scholarship, gifts,
wages, profit donations, unemployment
allowance, old-age pension

Please note only factor incomes are included in national income

TYPES OF TRANSFERS
 CURRENT vs CAPITAL TRANSFER
CURRENT TRANSFER CAPITAL TRANSFER
• 1. They are made out of • 1. They are made out of
INCOME the wealth of the payer.
• 2. They are generally • 2. They are irregular.
regular in nature • 3. They are meant for
• 3. They are meant for capital formation.
consumption purposes • 4. For example-
• 4. For example-old age investment grant, capital
pension, gifts, gains tax, war damage
unemployment etc.
allowance etc.
 Let’s do this activity
Identify factor and transfer incomes:
• Old age pension given to a woman.
Transfer Income
• Unemployment benefit.
Transfer Income
• Income earned by local Indian at the United nation office in
New Delhi.
Factor Income
• Rent received by Mr. A from XYZ enterprise.
Factor Income
• Donation received from abroad for a medical camp.
Transfer Income
• Subsidies/ Taxes
Transfer payment or income of the govt
 2.4. TYPES OF GOODS (EXPENDITURE)
INTERMEDIATE
FINAL GOODS GOODS

CONSUMPTION INVESTMENT RESALE USED UP

/ CONSUMER (milk
CAPITAL (milk
GOODS
GOODS purchased purchased
(Refrigerator /
milk purchased (refrigerator by dairy by tea stall
by households) purchased by shop) owner)
firm)

National income includes the value of final goods only. The value of intermediate
goods is not included in the national income because it is already included in the
value of final goods. Including intermediate goods separately will inflate or
overestimate the national income.
Remember :
• The distinction between intermediate goods and final goods is
made on the basis of end use of product and not on the basis of
product itself.

• A commodity can be both intermediate good as well as final good,

depending upon its nature of use.

• Exception: Durable goods like trucks, aircrafts, tanks etc purchased

by government for military purposes are included under the
category of intermediate goods as they are purchased to produce
defence services and not for market sale.

• Goods used up in the same year are intermediate, else are treated
as final goods.

• Intermediate goods remain within the production boundary like

raw material.
 Production Boundary

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 final good.
 Few more examples
FINAL GOODS INTERMEDIATE GOODS
Services of lawyer purchased Services of a lawyer purchased
by a consumer by a firm (used up)
Smart boards purchased by Chalks, dusters purchased by
school school (used up)
Electricity purchased by a Electricity purchased by a firm
household (used up)
Machine purchased by a firm Machine purchased by a
dealer of machines (resale)
 2.5. Consumption & Capital goods
Consumption goods can be :
• Durable goods (T.V, refrigerator etc.) FINAL
• Semi –durable goods ( Clothes, shoes etc.) GOODS
• Non durable goods (Milk, bread etc.)
• Services ( Teachers, doctors etc.)

Producer goods can be:

• Single-use producer goods (raw materials and non-factor inputs
like coal, wood, electricity, services of CA, doctors , lawyers etc.)
INTERMEDIATE GOODS
• Capital goods (like machinery, tools etc.) FINAL GOODS

CONCLUSION: All capital goods are producer goods but all

producer goods are not capital goods
 COMPREHENSIVE EXAMPLES
PRODUCT INTERMEDIATE GOODS
FINAL GOODS
Consumption goods Capital goods

CAR If purchased by If purchased by taxi If purchased by car

households driver as taxi dealer for resale
OR
if purchased by firm for
use in business

CLOTH If purchased by Cloth lying unsold with If purchased by tailor

households trader at the end of the for making dresses
fiscal year OR
If purchased by a
garment shop

SUGAR If used by households If lying unsold with If used by sweet shop

trader at the end of OR
year If purchased by grocery
shop

SERVICES OF DOCTOR If used by households If used by enterprises

 Let’s classify these as final or
intermediate goods:
• Legal services of a law firm used by Reliance India Ltd.
(Intermediate)
• Machinery bought by Nestle India Ltd.
(Final)
• Stationary purchased by a student.
(Final)
• Chart paper purchased by a private school.
(Intermediate)
• Cooking ranges bought by a dealer of home appliances.
(Intermediate)
• Paper purchased by a publisher.
(Intermediate)
• Packet of chips purchased by school canteen.
(Intermediate)
• Unsold coal with trader at the year end.
(Final)
 Quick Recap: (Domestic Income)
• Salary earned by Indian Resident in American Embassy in India.
(NO)
• Salary earned by American Resident in Indian embassy in
America.
(YES)
• Salary received by American Resident in Indian company/ bank in
America.
(NO)
• Salary of foreigner in foreign company in India.
(YES)
• Rent received by a company in India, which is owned by a non
resident
(Yes)
 Quick Recap: (National Income)
• Profit earned by branch of Foreign bank in India.
(No)
• Rent received by Indian residents on their buildings rented
out to foreigners in India.
(Yes)
• Profit of Reliance Industries from its chemical business in
Australia.
(Yes)
• Dividends received by an Indian from his investment in
shares of a foreign company.
(Yes)
• Salary received by an Russian employee working in Indian
Embassy in Russia.
(No)
 GROSS INVESTMENT/NET INVESTMENT
(Depreciation)
• GROSS INVESTMENT : Addition to the stock of capital before
making allowance for depreciation.
• NET INVESTMENT: Actual addition made to the capital stock
of an economy.
(During production process, some amount of fixed capital is
used up which is known as depreciation.)

(-) DEPRECIATION

GROSS CAPITAL NET CAPITAL

FORMATION FORMATION

(+) DEPRECIATION

National Income does not include depreciation

 Depreciation and Capital loss
DEPRECIATION/ REPLACEMEMT
COST/ CONSUMPTION OF FIXED
CAPITAL/ CAPITAL CONSUMPTION
ALLOWANCE
It refers to fall in the value of fixed
assets due to:
• normal wear and tear
• passage of time
• expected obsolescence
Provisions are made for this as it is
an expected loss
It does not hamper the production
process
CAPITAL LOSS
It refers to loss in the value of the
fixed assets due to:
• unforeseen obsolescence
•natural calamities
•thefts
• accidents
No provisions are made for this as it
is an unexpected loss
It hampers the production process
MARKET PRICE/ FACTOR COST (Net Indirect Taxes)
• FACTOR COST is the amount paid to factors of production.
• MARKET PRICE is the price at which product is actually sold
in the market.
Net Indirect Taxes (NIT) = Indirect Taxes - Subsidies

(-) NIT

MARKET PRICE FACTOR COST

(+) NIT

National Income does not include Net Indirect Taxes

 DOMESTIC INCOME/ NATIONAL INCOME (NFIA)
• DOMESTIC INCOME: includes income earned within the
economic territory both by the residents and non-residents.
• NATIONAL INCOME: includes income earned by the normal
residents of a country both inside and outside the economic
territory
(-) NFIA

NATIONAL DOMESTIC
INCOME INCOME

(+) NFIA

National Income includes NFIA

DOMESTIC PRODUCT
NORMAL RESIDENT
Net Factor Income From Abroad
FIFA- FITA
Net Factor Income from Abroad (NFIA)
Net factor income from abroad =
Factor income from abroad (received by Indian residents abroad)
– factor income to abroad (paid to non-residents within the territory)
NFIA = FIFA – FITA
NFIA = Income of # in ROW – Income paid to X within the territory
National Income = Domestic Income + NFIA
Domestic income = income of # and X within the territory (box)
National Income (Income of only # )= Domestic Income + Income of #
abroad – Income of X within the territory

Rest of the World

India
# # #
X X X
X ## # # #
## X # # # #
Net Factor Income from Abroad (NFIA)
• NFIA is positive when FIFA > FITA
• NFIA is negative when FIFA < FITA
• NFIA is zero when FIFA = FITA
Note : NFIA is also zero for a closed economy.

Components of NFIA
Net Net Income from
Net Retained
Compensation of Property and
Earnings
Employees Entrepreneurship
 COMPONENTS OF NFIA

NET NET INCOME FROM

NET RETAINED
COMPENSATION PROPERTY AND
EARNINGS
OF EMPLOYEES ENTREPRENEURSHIP
NET COMPENSATION OF EMPLOYEES

It refers to the difference

between income from work
received by resident workers
living or employed abroad for
less than one year and similar
payments made to the non
resident workers staying or
employed within the domestic
territory of the country for
less than one year.
 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 the similar payments
made to the non-residents.
 NET RETAINED EARNINGS

It refers to the difference

between retained
earnings of resident
companies located abroad
And the retained earnings
of non resident
companies located within
the domestic territory of
the country.
NFIA vs NET EXPORTS
 Test yourself

1. Calculate the value of national product for

an economy, when its domestic product is
Rs. 1,000 crores and the net factor income
from abroad is Rs (-)250 crores.
2. Calculate the domestic product for an
economy if the national product is Rs 1,000
and net factor income from abroad is (-) Rs
250 crores.
 TRUE OR FALSE?
• Gross = Net + NFIA.
False
• Factor cost = Market price +NIT.
False
• Gross = Net + depreciation.
True
• National Product = Domestic product – NIT.
False
• Domestic product = National Product - NFIA.
True
• Market price = Factor cost + NIT.
True