Important terms to be learnt Macro Economics: – Macroeconomics is the study of aggregate economic variables of an economy. Consumption goods:- Are those which are bought by consumers as final or ultimate goods to satisfy their wants. Egg: Durable goods car, television, radio etc. Non-durable goods and services like fruit, oil, milk, vegetable etc. Semi durable goods such as crockery etc. Capital goods – capital goods are those final goods, which are used and help in the process of production of other goods and services. E. G. : plant, machinery etc.
Final goods: Are those goods, which are used either for final consumption or for investment. It includes final consumer goods and final production goods. They are not meant for resale. So, no value is added to these goods. Their value is included in the national income. Intermediate goods intermediate goods are those goods, which are used either for resale or for further production. Example for intermediate good is- milk used by a tea shop for selling tea. Stock: – Quantity of an economic variable which is measured at a particular point of time.
Stock has no time dimension. Stock is static concept. Egg: wealth, water in a tank. Flow: Flow is that quantity of an economic variable, which is measured during the eroded of time. Flow has time dimension- like per her, per day etc. Flow is a dynamic concept. Egg: Investment, water in a stream Depreciation : The loss to value to fixed assets due to its normal wear and tear. Concept of domestic (economic) territory Domestic territory is a geographical territory administered by a government within which persons, goods and capital circulate freely. Areas of operation generating domestic income, freedom of circulation of persons, goods and capital) Scope identified as *Political frontiers including territorial waters and air space. *Embassies, consulates, military bases etc. Coated abroad but including those located within the political frontiers. *Ships, aircrafts etc. , operated by the residents between two or more countries. Page *Fishing vessels, oil and natural gas rigs etc. Operated by the residents in the international waters or other areas over which the country enjoys the exclusive rights or Jurisdiction.
Resident (normal resident):Normal resident is a person or an institution who ordinarily resides in that country and whose center of economic interest lies in that country. (The Centre of economic interest implies 🙁 1) the resident lives or is located within he economic territory. (2) The resident carries out the basic economic activities of earnings, spending and accumulation from that location 3. His center of interest lies in that country. Mixed Income of self employed: Income of self employed persons and unincorporated enterprises which use their own resources is called mixed income of self employed.
Such income is called mixed income. It is mixture of rent, interest wages and profit. Net Indirect tax: It is defined as the difference between indirect tax and Subsidies. Relation between national product and Domestic product. Domestic product concept is based on the production units located within domestic (economic) territory, operated both by residents and non-residents. National product concept based on resident and includes their contribution to production both within and outside the economic territory.
National product = Domestic product + Residents contribution to production outside the economic territory (Factor income from abroad) – Non- resident contribution to productiveness the economic territory (Factor income to abroad) 1 . Explain the circular flow of income in a 2 sector economy Page 4 In a 2 sector economy the 2 sectors are the households and the firms. The following assumptions are made. 0 There are only 2 sectors firms and households 0 Households supply factor services to firms and firms hire factor services from households. 0 Household spend their entire income on consumption. Firms sell all that is produced to the household 0 There is no government or foreign trade. The economic interdependence between the household and firm are as follows 0 The household sector supply factor services to the firms and firms sell that is produced to the household. Therefore whatever is produced by the firm is consumed by the 0 This type of flow – flow of factor services from the household to the firm and flow of goods and services from firms to households is known as Real flow. 0 Household receive their income in the form of wages, rent interest and profit for providing factor services to firms.
The household spend their income for the purchase of goods and services from the firms. 0 The consumption expenditure of the household will be equal to the money received by the firm. 0 Thus the payment made by the firm for the services of factors of production will mom back to the firm in the form of payment for goods and services. This flow of income is called as Money flow. The inner 2 arrows indicate the real flows and the outer 2 arrows reflect money flows. There are 2 markets product market and the factor market. 2 .
Distinguish between factor Payment and transfer income Factor payment It is defined as income received by factors of production Factor income = Wages + rent+ interest+ profit It is an earning concept It is received for rendering productive services It is included in the estimation of National Income Transfer income households enterprises and non profit institutions from government and viscera Transfer income = capital transfer+ current transfer It is a receipt concept Productive services are not rendered It is not included in the estimation of Page Distinguish between final goods and intermediate goods Intermediate goods These goods are those goods which are used in the further production of other goods and services or resale. The value of intermediate goods is not included in National Income Consumers do not consume intermediate goods These goods lie within production boundary Their demand is in the form of derived demand They are also called non factor inputs Examples are raw materials Final goods These goods are used directly for consumption and capital formation While calculating National Income value of Final goods is added.
Final goods are sold to consumers for consumption or used as investment by producers. These goods cross the production They are demanded directly They are called finished product. Consumer goods such as shirt pen etc. Capital goods such as stocks of raw materials lying in process are examples of finished goods. 4 Explain the steps involved in measuring National Income using Output method or Explain the steps involved in measuring National Income using Product method or Value added method. Output method measures National Income from output side. It measures the contribution of each producing enterprise in the domestic territory of the country. TEETH (Value added method 0 Sales + change in stock + production for self consumption = value of output 0 Change in stock = closing stock – opening stock 0 Value of output – Intermediate consumption = Gross value added (Gimp) 0 NP FCC (N. I) = Gimp (-) consumption of fixed capital (depreciation) (+) Net factor income from abroad ( -) Net indirect tax. Page 6 The following are the steps involved in the estimation of National Income Step 1 Identify all the producing units in the domestic economy and classify them into 3 industrial sectors such as primary secondary and tertiary sectors. 2. Estimate Gross value added by deducting the value of intermediate consumption. 3 .
Estimate Net Value added by deducting the value of Depreciation 4. Estimate Net Value added at Factor cost by deducting NIT. Therefore NAVA (FCC) = Value of output – Intermediate consumption – depreciation – NIT By adding up the net value added at factor cost of all industrial units in the domestic rewriter of the economy we get AND (FCC) 5. To estimate the National Income we add NAIF to AND (FCC). NP (SEC) = AND (SEC) + NAIF Precautions to be taken while adopting this method: 1 Avoid double counting: Value added equals value of output less intermediate cost. There is a possibility that instead of counting Value added one may count value of output.
Counting the Value of output will lead to counting the same output more than once. This will lead to over estimation of National Income. There are 2 methods of avoiding it. 0 Count only value added 0 count only the value of the final products 2. Do not include sale of second hand goods. Sale of second hand goods is not a production activity. The good should not be treated as fresh production and therefore do not qualify for inclusion in National Income. However, any brokerage or commission paid to facilitate the sale is a fresh production activity. It should be included in production but to the extent of brokerage or commission only. 3. Self consumer output must be included.
Output produced but retained for self consumption, rather than selling in the market is output and must be included in National Income. Services of owner occupied alluding, farmer consuming his own produce etc are some examples INCOME METHOD 5 Explain the steps involved in estimation of National Income using Income method Income method measures National Income from the side of the payments made to the primary factors of production for their productive services in an accounting year. If factor income generated by all the production units in the domestic territory is estimated and aggregated for an accounting year we get AND (FCC) or domestic income Steps involved 1 . Identity the producing enterprises which employ factors of production 2.
Classify actor payments and estimate payments, Factor payments are generally classified into page 7 Compensation of employees (wages and Salaries) Operating surplus (Rent + Interest + profit + Royalties) Mixed Income of self employed. Summing up all the factor payments made within the domestic territory we get domestic factor Income or AND (FCC) 3. National Income = AND (SEC) + NAIF. Precautions to be taken while using this method 0 Avoid transfers. National Income includes only factor payments. I. E. Payment for the services rendered to the production units by the owners of factors. Any payment for which no revive is rendered is called a transfer, and not a production activity. Gifts, donations etc are examples.
Since transfers are not a production activity it must not be included in National Income. 0 Avoid capital gain. Capital gain refers to the income from the sale of second hand goods and financial assets. Income from the sale of old cars, old house, bonds, debentures, etc are some examples. These transactions are not production transactions. So, any income arising to the owners of such things is not a factor income. 0 Include income from self consumed output When a house owner lives in that house he does not pay any rent. But, infant he pays rent to himself. Since rent is payment for services rendered even though rendered to the owner itself, it must be counted as factor payment. Include free services provided by the owners of the production units. Owners work in their own unit but do not charge salary. Owners provide finance but do not charge interest. Owners do production in their own buildings but do not charge rent. Although they do not charge, yet the services have been performed. The imputed value of these must be included in the National Income. EXPENDITURE METHOD 6 Explain the estimation of National Income using expenditure method. The expenditure method measures all the final expenditure on GAP. Expenditures are classified as Private final consumption expenditure Government final consumption expenditure Gross domestic capital formation and Net Exports. 1 .
Identify all economic units or institutional units incurring final expenditure Example households, firms and government sector. 2. Classify Tindal expenditure into Private Tindal consumption expenditure, final consumption expenditure, Gross capital formation and Net Exports. Rent (Gross capital formation = Gross domestic fixed capital formation + changes in stock). Net export = export – import. Page 8 3. Add the final expenditure to get GAP (PM) 4. Deduct depreciation from GAP (PM) to derive AND (PM) 5. Deduct NIT from AND (PM) to get AND( SEC). 6. Add EN-IA to AND (SEC) to get NP (SEC) Formula 1 . Government final consumption expenditure. 2. Private final consumption expenditure. 3. Net Export. 4. Gross domestic capital formation. Gross Domestic fixed + Change in stock Capital formation Gimp = (l) + (2) + (3) + (4) NP FCC = Gimp – consumption of fixed capital + NAIF- Net indirect taxes Note: If capital formation is given as Net domestic capital formation we arrive at Impend. Capital formation = Investment Precautions to be taken while using the expenditure method 0 Avoid intermediate expenditure By definition the method includes only final expenditures, I. E expenditure on consumption and investment. Like in the value added method, inclusion of intermediate expenditure like that on raw materials, etc will mean double counting. Do not include expenditure on second hand goods and financial assets. Buying second hand goods is not a fresh production activity.
Buying financial assets is not a production activity because financial assets are neither goods nor services. Therefore hey should not be included in estimates of National Income. 0 Include the self use of own produced final products. For example, a house owner using the house for seep. Although explicitly he does not incur any expenditure, implicitly he is making payment Payment of rent to himself. Since the house is producing a service, the imputed value of this service must be included in National Income. 0 Avoid transfer expenditure A transfer payment is a payment against which no services are rendered. Therefore no production takes place. Since no production takes place it has no place in National Income.