Basic Concepts of Macroeconomics
Last Updated : 06 Apr, 2023
Macroeconomics is a part of economics that focuses on how a general economy, the market, or different systems that operate on a large scale, behaves. Macroeconomics concentrates on phenomena like inflation, price levels, rate of economic growth, national income, gross domestic product (GDP), and changes in unemployment.
“Macroeconomics is that part of economics which studies the overall averages and aggregates of the system”. – KE Boulding
Domestic Territory/Economic Territory
Domestic Territory or Economic Territory is an essential concept of national income accounting, which simply means the political frontiers of a country. However, the term Domestic Territory is used in a wider sense when it comes to national income accounting.
Along with Political Frontiers, Domestic Territory also consists of the following items:
1. Embassies, military establishments, and consulates of a country located abroad. Any embassy, military establishment, and consulate of a country that has an office or branch abroad are also included under the domestic territory of a country. Here, a consulate is a building or an office used by an officer. also known as consul, commissioned by the government of a country to reside in a foreign country for the promotion of the interest of the country to which he/she belongs. For example, Indian Embassy in the USA is a part of the domestic territory of India.
2. Ships and aircraft owned and operated by normal residents between two or more countries. If a normal resident of a country owns and operates ships and aircraft between two or more countries, then those ships and aircraft will be included in the domestic territory of the country. For example, airplanes operated by Air India between Japan and Russia are a part of the domestic territory of India.
3. Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of a country in the international waters where they have exclusive rights of operation. If a resident of a country operates fishing vessels, oil and natural gas rigs, and floating platforms in the international waters, it will be included in the domestic territory of that country. However, the resident must have rights of operation in the international waters. For example, if an Indian Fisherman operates a fishing boat in the international waters of the Pacific Ocean, it will be considered a part of the domestic territory of India.
However, the following are not included in the Domestic Territory of a country:
1. Embassies, military establishments, and consulates of a foreign country are not included in the domestic territory of a country. For example, USA Embassy in India is not a part of the domestic territory of India, instead, it will be a part of the domestic territory of the USA.
2. Any International organisation such as WHO, UNO, etc., located within the geographical boundaries of a country will not be a part of the domestic territory of that country.
Practice Question 1
Which of the following is a part of the domestic territory of India?
1. Indian Embassy in Pakistan.
2. An Indian organisation in Japan.
3. Office of HUL in Africa.
4. A company owned by an American in India.
5. USA Embassy in India.
Answer
1. Yes, it is a part of the domestic territory of India.
2. No, it is not a part of the domestic territory of India.
3. No, it is not a part of the domestic territory of India.
4. Yes, it is a part of the domestic territory of India.
5. No, it is not a part of the domestic territory of India.
Normal Residents
Any individual or an institution who ordinarily resides in a country and whose center of economic interest lies in that country is the Normal Resident of that country. The Centre of economic interest includes two things: First, the residents of a country lives or are located within the domestic territory. Second, from that location, these residents carry out basic economic activities of earnings, spending, and accumulation.
However, the following are not included under Normal Residents:
1. Foreign tourists and visitors: All the foreign tourists and visitors who visit a country for vacation, medical treatment, study, sports, etc., are not considered normal residents of that country.
2. Foreign staff of embassies, diplomats, officials, and members of the armed forces: The foreign staff of diplomats, officials, embassies, and the members of armed forces of a foreign country residing/living in a given country are not considered as the normal residents of that country.
3. International Organisations: International organisations like IMF, WHO, etc., situated in a country are not considered as the normal residents of that country. Instead, they are included under normal residents of the international area.
4. Employees of International Organisations: Employees working in International Organisations like WHO, UNO, etc., are not considered normal residents of the international area. Instead, they are included under the normal residents of the country to which they belong. For example, a Japanese working at the WHO headquarters, Geneva will be treated as a normal resident of Japan. However, if the employee works for more than one year in such International Institutions, then he/she will become a normal resident of the country in which the institution is located. Therefore, in the given example, if the Japanese work for more than one year at WHO headquarters, he will become a normal resident of Switzerland.
5. Crew members of foreign vessels, commercial travellers and seasonal workers: All the crew members of foreign vessels, commercial travellers, and seasonal workers are not considered normal residents of the country, provided they stay for less than one year.
6. Border workers: Border workers living near the international borders of a country who cross the border regularly to work in another country, are treated as the normal resident of the country in which they live, not of the country in which they work.
Practice Question 1
Which of the following is included under Normal Residents of India?
1. USA ambassador in India
2. Indian students going to study in Canada.
3. Americans coming to India for watching a cricket match.
4. American tourists staying in India for a month.
5. Indian employees working in WHO, located in India.
Answer
1. No, he will not be considered a normal resident of India.
2. Yes, they will be considered a normal resident of India.
3. No, they will not be considered a normal resident of India.
4. No, he will not be considered a normal resident of India.
5. Yes, they will be considered a normal residents of India.
Domestic Territory and Normal Residents are essential concepts for the estimation of Domestic Product and National Product of an economy respectively. Domestic Product of an economy involves all the production activities of a production unit which is situated in the economic territory of a country, no matter whether the activity is carried out by the residents or non-residents of the country. The money value of Domestic Product determined is known as Domestic Income. However, the National Product of an economy involves all the production activities performed by the normal residents of an economy, no matter whether the activity is performed within the economic territory or outside it. The money value of the National Product determined is known as National Income.
Citizenship and Residentship
Citizenship and Residentship are two different things. The former is a legal concept that is based on an individual's place of birth or any legal provision that allows the individual to become a citizen. In other words, one can be an Indian citizen in two ways. First, when a person is born in India, he/she automatically becomes a citizen of India. Second, if a person born outside India applies for citizenship of India and Indian Law allows him/her to become an Indian Citizen. However, the latter is an economic concept that is based on the basic economic activities performed by an individual. An individual is said to be a normal resident of a country if he/she ordinarily resides in that country for more than one year. Also, the individual's center of economic interest must lie in that country.
For example, An American living in India for more than one year is a normal resident of India. However, as the American does not have a center of economic interest in India, he is not a citizen of India. It means an individual can be a citizen of one country and a resident of another country at the same time.
Factor Income and Transfer Income
The income received by factors of production for rendering factor services in the production process is known as Factor Income. Here, factors of production are the primary inputs such as land, labour, capital, and entrepreneur required for the production of goods and services. For example, wages, rent, profit, and interest. While determining the National Income of an economy, factor income received by its normal residents is also included.
The income received by an individual without rendering any productive service in return is known as Transfer Income. Transfer Income is a unilateral concept and is not included in National Income, as it does not involve the production of goods and services. For example, Old age pension, pocket money, gifts, scholarship, etc. Transfer Income can be received either from abroad or within the domestic territory of a country.
Final Goods and Intermediate Goods
Final goods are those goods that do not require further processing and are ready to use. These goods are also called consumer goods and are manufactured for the purpose of direct use by the end consumer. In a nutshell, final goods are products that are manufactured by a company for consumption by the consumer in the coming time. These goods aim to satisfy the needs or wants of a consumer. They can be of two types: Consumption Goods and Capital Goods.
An intermediate good is a good used to produce a final good or finished good for the purpose of selling it to the consumers. Intermediate goods like salt can be a finished product, as it is consumed directly by consumers and can be used by producers to produce other food products.
Intermediate goods are sold between industries for the resale purpose or the production of other goods. These goods are also called semi-finished products, as they are used as inputs to manufacture the finished product.
Consumption Goods and Capital Goods
Consumption goods are the goods that satisfy the wants and needs of a consumer directly. For example, shirt, pen, bread, butter, etc. Consumption goods can be classified into four categories; namely, durable goods, services, semi-durable goods, and non-durable goods.
Capital goods are physical assets that an organization uses in the process of production to manufacture products and services that consumers will use later. Capital goods are also known as tangible goods, as they are physical in nature. It involves buildings, machinery, equipment, vehicles, tools, etc. Capital goods are not finished goods; rather, they are used to make finished goods.
Gross Investment, Net Investment and Depreciation
An addition to the capital stock of an economy is known as Investment or Capital Formation. It involves the construction of buildings, addition to inventories of goods, purchase of equipment, etc. Investment can be of two forms: Gross Investment and Net Investment.
Gross Investment
Gross Investment is referred to the total expenditure or investment that is made by an organization to acquire capital goods (which includes unsold stock and fixed assets). It is the gross value for such expenditure and it doesn't take the factor of depreciation into consideration. However, one cannot determine actual change in the stock of productive assets of an economy during a given year through gross investment. It is because, during the process of production, some amount of fixed capital is used by the organizations, also known as depreciation (and we do not take depreciation into consideration while calculating gross investment). By subtracting depreciation from gross investment, the net investment of an economy is obtained.
Net Investment
Net investment is the actual addition made by the organizations to the economy's capital stock in a given period. In other words, it is determined by subtracting depreciation from the gross investment of an economy.
Net Investment = Gross Investment - Depreciation
Depreciation
A reduction in the monetary value of fixed assets due to wear and tear caused by continuous use or any other reason is known as Depreciation. Capital goods that a business does not consume within a year of production cannot be completely deducted, as business expenses in the year of their purchase, rather, they must be depreciated over the period of their valuable lives, with the business taking partial tax deductions divided among the years that the capital goods are in use. This is done through techniques of accounting, such as depreciation or devaluation. Depreciation represents the annual loss of the tangible asset’s monetary value during the period of its valuable life. Other names for depreciation are Current Replacement Cost, Replacement Cost of Fixed Capital and Capital Consumption Allowance.
For example, If equipment is purchased for ₹80,000 and its expected lifetime of use is 4 years, then the depreciation value of the given equipment will be ₹80,000/4, i.e., ₹20,000.
Depreciation is essential to determine the difference between gross and net value. The Gross Value of an economy includes depreciation; however, its net value excludes depreciation. An asset is depreciated because of three reasons: Normal wear and tear, Passage of time, and Expected obsolescence.
Normal wear and tear: If an asset is continuously used for the production process, its productive capacity and value decrease.
Passage of time: The value of a fixed asset also reduces over the course of time, even if they are not used by the companies for the production process. In this case, the value of fixed assets falls because of natural factors, like wind, water, rain, etc.
Expected obsolescence: Sometimes the value of a fixed asset declines because of the expected obsolescence, including changes in demand for goods and services, changes in technology, etc.
Depreciation is different from Capital Loss.
| Basis | Depreciation | Capital Loss |
|---|
| Meaning | A reduction in the monetary value of fixed assets due to wear and tear caused by continuous use, the passage of time, or expected obsolescence. | A loss in the value of a fixed asset because of unforeseen obsolescence, accidents, thefts, natural calamities, etc. |
| Provision for loss | As depreciation is an expected loss, a provision for its replacement is made by the organizations. | As a capital loss is an unexpected loss, no provision for its replacement is made by the organizations. |
| Production process | Depreciation does not hamper the production process of an organization. | Capital loss hampers the production process of an organization. |
Net Indirect Tax (NIT)
It refers to the difference between indirect taxes and subsidies. Indirect Taxes are the taxes imposed on the production and sale of goods and services by the Government of a country, For example, GST (Goods and Services Tax). An indirect tax imposed on a good or service results in an increase in its price in the market. However, subsidies are the economic assistance given to firms and households by the government with the aim of the general welfare. It is also known as financial assistance.
Net Indirect Tax = Indirect Taxes - Subsidies
Net Factor Income from Abroad (NFIA)
It is the difference between the factor income earned by a country from abroad/rest of the world and factor income paid by a country abroad/rest of the world. Factor income from abroad is the income earned by a country's normal residents from the rest of the world for the factor services provided by them. The income is earned in the form of rent, wages, interest, salaries, dividends and retained earnings. However, Factor income to abroad is the income paid by a country's normal residents to the normal residents of other countries (i.e., non-residents of the former country) for the factor services given by them within the economic territory.
Net Factor Income from Abroad = Factor income earned from abroad - Factor income paid abroad
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What are the different measures to control Excess Demand and Deficient Demand?When demand is more than what is necessary to utilise resources fully, it is called Excess Demand. In simple terms, when planned aggregate expenditure is more than aggregate supply at full employment, excess demand arises. However, when demand is not sufficient to fully utilise resources, it is refe
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Excess and Deficient Demand in Three-Sector EconomyExcess and Deficient Demand in Three-Sector Economy When demand is more than what is necessary to utilise resources fully, it is called Excess Demand. However, when demand is not sufficient to fully utilise resources, it is referred to as Deficient Demand. Excess Demand and Deficient Demand can occu
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What is Fiscal Policy and how it used to correct Excess Demand and Deficient Demand?Meaning of Fiscal Policy A fiscal policy is the policy of the central government which aims at controlling the situation of the money supply in the economy. Simply put, fiscal policy includes using taxation, government spending, and borrowing to change the level and growth of output, aggregate deman
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Chapter 5: Government Budget and the Economy
Chapter 6: Open Economy Macroeconomics
Foreign Exchange Rate : Meaning and TypesWhat is Foreign Exchange Rate?A medium of exchange for goods and services is called currency. In a nutshell, it is money issued by governments and accepted for payment in the country. It comes in the form of coins and paper. Every nation has a currency that is widely accepted within its boundaries.
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Currency Depreciation and Currency AppreciationWhat is Currency Depreciation?It refers to the decrease in the value of the domestic currency (₹) in terms of one or more foreign currencies (like $). It makes domestic currency less valuable and more is required to buy a unit of currency. For example, if the price of $1 rises from ₹60 to ₹64, then
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Demand and Supply for Foreign ExchangeWhat is Foreign Exchange?Foreign exchange refers to foreign currency. For example, for an Indian resident, the Indian rupee (₹) is a domestic currency that can be used as a medium of exchange in India. But the Indian rupee (₹) can not be used as a medium of exchange outside India. The currency used
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Determination of Exchange RateWhat is Foreign Exchange?Foreign exchange refers to foreign currency. For example, for an Indian resident Indian rupee(₹) is a domestic currency that can be used as a medium of exchange in India. But the Indian rupee (₹) can not be used as a medium of exchange outside India. The currency used in oth
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Foreign Exchange Market : Meaning, Functions and TypesEvery nation has a unique currency that it uses for commerce and business, in India, it's Indian Rupee, but what about the global market? The lack of flexibility of the currencies makes them a barrier to international trade. The Foreign Exchange Market was formed to solve this problem. This is a spe
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Fixed Exchange Rate System | Meaning, Methods, Merits and DemeritsA medium of exchange for goods and services is called currency, which is different from one country to another country. However, a country’s currency cannot be used in another country. For this purpose, the currency of one country is converted into the currency of another country, and the rate
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Flexible Exchange Rate System | Meaning, Merits and DemeritsA medium of exchange for goods and services is called currency, which is different from one country to another country. However, a country’s currency cannot be used in another country. For this purpose, the currency of one country is converted into the currency of another country, and the rate at wh
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Managed Floating Exchange Rate System : Meaning, Objectives, Merits and DemeritsA medium of exchange for goods and services is called currency, which is different from one country to another country. However, a country’s currency cannot be used in another country. For this purpose, the currency of one country is converted into the currency of another country, and the rate at wh
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Devaluation of Currency| Meaning, Reasons, Effects, Example and Critical EvaluationSometimes there arise some situations when the value of the domestic currency tends to increase drastically and faces monetary barriers. The government and the central bank intervene with some effective monetary policies for the correction of exchange rates, trade deficits, etc. One of these practic
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Depreciation of Currency : Effects, Examples and Critical EvaluationWhat is Depreciation of Currency?Currency Depreciation refers to a decrease in the value of a currency as compared to other currencies in a floating exchange rate system. Market forces of demand and supply work towards the depreciation of the currency and determine a currency depreciation rate. The
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Difference between Devaluation and DepreciationDevaluation and Depreciation are two examples of a situation when the value of domestic currency falls in terms of foreign currencies. Even though both include a reduction in the value of domestic currency, the way in which it happens is different. What is Devaluation? Devaluation means deliberately
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Balance of Payment and its Components: Capital and Current AccountUsually, government records all the transactions that arise between a country and the outside world. This record is titled Balance of Payments. Balance of Payments can also be known as the Balance of International Payments. It is a statement of all transactions between entities in one country and th
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Difference between Current Account and Capital Account of BoPBalance of Payment is a statement of all transactions between entities in one country and the outside world over a specified time period, such as a quarter or a year. It lists all interactions between residents of one country and residents of other countries that involve businesses, organizations, o
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Difference between Balance of Payment and Balance of TradeBalance of Payment and Balance of Trade are two important terms that are sometimes confused as the same. The former is a statement of all transactions between entities in one country and the outside world over a specified time period; however, the latter is the difference between the Export and Impo
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Balance of Payments: Surplus and Deficit, Autonomous and Accommodating Transactions, Errors and OmissionsA balance of payment (BoP) is a summary statement that lists all of the transactions that took place within a specific period between the resident and the outside world. The Balance of Payment indicates the extent to which a country saves enough money to cover its imports. It also reveals whether th
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Important Formulas
CBSE Previous Year Papers (2020)