Basic Concepts of National Income

Basic Concepts

What is a good?

It is any physical object, natural or man-made or services rendered that could command a price in the market. The goods are classified into two categories:

• Consumption goods and Capital goods.
•  Final goods and Intermediate goods.

S.No.	Consumption goods	Capital goods
1	They are those goods which are purchased or own produced for the satisfaction of wants or needs.	They are those goods which are purchased for producing other goods with the motive of generating income or profit.
2	The goods are used by the households.	These goods are used by the firms.
3	They are further classified into: Durable goods: These goods are used for longer period of time. For e.g.: Furniture, T.V., A.C., etc. Non-durable goods: These goods are used for the short period or immediate consumption. For e.g.: Food, vegetables, fruits, etc.	They are further classified into: Durable goods: These goods are used for longer period of time. For e.g.: Land, machine, factory, vehicle, etc. Non-durable goods: These goods are used for short period or immediate consumption. For e.g.: Raw material, fuel, electricity, etc.
Difference between Final goods and Intermediate goods: S.No. Final goods Intermediate goods 1 They are those goods which are used either for consumption or for investment. They are those goods which are used either for resale or for further production in the same year. 2 They are included in both domestic and national income. They are not included in national income and domestic income. 3 They have a direct demand as they directly satisfy the wants. They have a direct demand as their demand depends on the demand for final goods. 4 For e.g.: Milk purchase by households, Car purchased as an investment. For e.g.: Milk used in dairy shops, coal is used in factories for further production.

*Intermediate goods must satisfy two characteristics:

a)      Goods purchased from one production unit to another production unit.

b)      It must be consumed in the same year or must be resold.

*Exceptions of Intermediate goods:

   a)    All durable capital goods purchased by one production from another production unit are treated as Final goods because these goods are purchased for own use and are investment expenditure of these firms.

  b)   Those goods purchased by the government in the form of defense goods like fighter planes, guns, bullets, etc. are treated as Intermediate goods because they are treated as raw materials for providing defense services to the mission.

Q. All final goods are consumption goods?

 No, because final goods are also includes durable final goods.

Q. All consumption goods are final goods?

No, because consumption goods are also includes non-durable final goods.

Points to ascertaining the Final and Intermediate goods:

  ·      Vegetables purchased by a family.

              Final goods because it is purchased for satisfaction of want.

        ·      Vegetables purchased by Dominoz.

              Intermediate goods because the vegetable seller is one firm and dominoz is another firm.

        ·       Electricity expenses at MSVV.

              Intermediate goods because electricity supplier is one firm and MSVV is another.

        ·       Computer purchased by a school.

              Final goods because it is an investment expenditure of the school and purchase for own use.

        ·       Chalk purchased by a school.

             Intermediary goods because it will be consumed within the same year and is purchased from             one firm and school being another firm.

        ·      Furniture purchased by office.

             Final goods because it is an investment expenditure and is purchased for own use.

        ·     Car purchased by a taxi company.

             Final goods because it is an investment expenditure and purchased for own use.

        ·     Fuel expense of taxi company.

             Intermediate goods because fuel supplying is one firm and taxi is another firm.

What is circular flow of income?

It refers to cycle of generation of income in the production process, its distribution among the factors of production and finally, its circulation from households to firms in the form of consumption expenditure on goods and services produced by them.

What are the phases of circular flow of income?

The phases of circular flow of income are as follows:

  a)  Generation phase: In this phase, firms produce goods and services with the help of factor services.

   b)    Distribution phase: This phase involves the flow of factor income from firms to households.

  c)    Disposition phase: In this phase, the income received by the factors of production is spent on the goods and services produced by the firm.

Types of Circular Flow:

 a)   Real flow: It refers to the flow of factor services from households to firms and the corresponding flow of goods and services from firms to households.

b)  Money flow: It refers to the flow of factor payments from firms to households for their factor services and corresponding flow of consumption expenditure from households to firms for purchases of goods and services by the firms.

Two sector

Three sector

Four sector

Classical Theory of Employment:

According to Keynes, classical economics refers to traditional or conventional principles of economics. It is based on the assumptions of full employment. Full employment refers to an economic condition in which every individual employed where the demand for labour is equivalent to supply of labours at every level of real wages. According to modern economics, full employment refers to a situation in which the vacancies and competent individuals are at equilibrium.

 Say’s Law of Market:

This law was given by J.B. Say of French economist of 90^th century. According to him the demand creates it all demand. 

Production of goods worth Rs. 10 crore		Creation of Income by the way of wages, rent, interest to the tune of Rs.10 crore.
Supply of goods worth Rs.10 crore.		Income of Rs.10 crore becomes the source of demand for goods worth Rs.10 crore.

Assumptions of Say’s Law:

       ·     Whatever income in the economy generates is instantly spent on either consumption goods or capital goods.
       ·     There is perfect competition in the product and free exchange economy for the application of Say’s Law.

         ·         All the saving is invested and income is spent immediately.

         ·         Flexibility in interest rate makes the savings and investments.

         ·         There is no interference of government in the functioning of economy.

         ·         Decision-making and limits the market size on the basis of production volume.

         ·         No restriction on market entry as the market is expandable.

Q. What is domestic or economic territory?

According to United Nations, domestic territory is that geographic territory administered by the government within which persons, goods and capital circulate freely. Domestic territory includes the following:

   a)      Ships and aircrafts owned and operated by normal residents between two or more countries. For e.g.: Planes operated Air India between India and Russia or between Russia and Japan are a part of domestic territories of India.

  b)      Fishing vessels, oil and natural gas rigs, floating platforms operated by residents of a country in the international waters where they have exclusive rights of operations. For e.g.: Fishing boats operated by Indian fishermen in international water of Indian ocean will be considered as a part of domestic territory of India.

 c)   Embassies, consulates and military establishment located abroad. For e.g.: India embassy in Russia is a part of domestic territory of India.

 d)      All foreign company offices in India are part of domestic territory and it excludes the following:

        ·      Embassies, consulates and military establishment of foreign country in India.

      ·   International organizations like UN, WTO, World Bank, IMF. If their offices are located in India, then they aren’t a part of domestic territory in India.

Q. Who are residents or normal residents?

Resident refers to an individual or an institution who ordinarily recites in the country and whose centre of economic interest also lines in that country. Following are not included under the category of normal residents:

• Foreign tourist and visitors who visit the country the country for recreation, holdings, medical treatment, studies sports etc. are the residents of the country where they belong.
• All the foreign staff of embassies, departments and members of the armed forces are the residents of the country where they belong.
• All the offices of international organizations located in any country are considered as the residents of international area. For e.g.: World Bank, UN, WHO, etc.
• All the foreign staff of any international organization are the residents of the country where they belong.
• Crew members of ships or airlines are the residents of the country where they belong. For e.g.: Pilot, captain, air hostess, etc.
• Border workers who live near international borders and cross the border on daily or weekly wages regularly are treated as the residents of the country where they live and not where they work. Following are included under the category of normal citizen: a person can be a citizen of a country if he is born in a country or satisfies some other legal activities like marrying a foreign national, adoption.

Q. What is factor income and transfer income?

S.No.	Factor Income	Transfer Income
1	It refers to income received by factor of production for rendering factor services in the production process.	It refers to income received without rendering any productive services in return.
2	It is included in both domestic and national income.	It is not included in both domestic and national income.
3	It is earning concept.	It is a receipt concept.
4	It is received by factor of production (land, labour, capital and entrepreneur).	It is received by households and government.
5	For e.g.: Rent, wages, interest and profit.	For e.g.: scholarship, old age pension, unemployment allowances, etc.

Q. What is depreciation or consumption of fixed capital or capital consumption allowances?

 It refers to fall in the value of fixed assets due to normal wear and tear, passage of time or expected obsolescence (outdated).

What is Capital loss?

It is fall in the value of any asset due to unforeseen reasons like natural calamities (flood, earthquake, etc.), fire, theft, sudden change in government policy, etc. 

Difference between Depreciation and Capital loss:

S.No.	Depreciation	Capital loss
1	It refers to fall in the value of fixed assets due to normal wear and tear, time or expected obsolescence.	It refers to loss in the value of any assets due to unforeseen obsolescence, natural calamity, fire, theft, etc.
2	Provision is made for replacement of assets as it is an expected loss	No such provisions are made for such loss as it is an unexpected loss.
3	It doesn’t hamper (affect) the production process.	It hampers the production process.

Q. What is net factor income from Abroad (NFIA)?

It refers to the difference between factor income received from abroad and factor income paid to the rest of the world.

     NFIA = Factor income earned – Factor income paid.

Components of NFIA:

• Net compensation of employees: It refers to difference between income of work received by resident workers living or employed abroad and similarly payment made to non-resident workers staying or employed within the domestic territories of a country within one year.
• Net income from property and entrepreneurship: It refers to difference between income from property and entrepreneurship received by residents of the country and similar payments made to the non-residents.
• Net retained earnings: It refers to difference between net retained earnings of resident companies located in abroad and related earnings non-resident companies located within the domestic territory of a country.

Q. What is net indirect tax?

It is the difference between indirect tax and subsidies.

          NIT = Indirect tax – Subsidies.

Indirect taxes refer to those taxes which are imposed by the government on production and sale of goods and services. And subsidies are the financial assistance given by the government to an enterprise on production of certain commodities.

Difference between Gross investment and Net investment:

S.No.	Gross investment	Net investment
1	The total addition made to the capital stock of an economy in a given period.	The actual addition made to the capital stock of an economy in a given period.
2	It includes depreciation.	It doesn’t include depreciation.
3	Gross investment = Net investment + Depreciation.	Net investment = Gross investment – Depreciation.

 *Investment/Capital formation: Additional made to the stock of capital during a period is called investment or capital formation.

Q. What is the difference between capital and investment? Explain with example.

Capital is the accumulated stock of capital goods which are used for producing new goods at the beginning of the accounting year. Investment is the addition made to the stock of capital during a period of time. This can be explained with the help of a numerical example:

Suppose the capital of a firm at the beginning of the year is Rs.10 lakh and the capital at the end of the year is Rs.11 lakh. The additional capital of Rs. 1 lakh is the investment and the capital for the new year will be Rs.11 lakhs.

Q. Machine purchased is always a final good? Do you agree?

No, because of the following reasons:

·         If machine is purchased by a household for its own satisfaction, then it is a final good.

·         If a machine is purchased by a production unit for its own use, it is a final good because it will not be consumed in the same year. But if a machine is purchased by one production and resold to another production unit in the same year, then it will be treated as an intermediate good.