SUBSIDIES

ANKIT KUMAR

PGT, ECONOMICS

BASIC CONCEPTS RELATED TO

NATIONAL INCOME

Final Goods

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Final goods refer to those goods which are used either for consumption or for investment.

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It includes:-

• Goods purchased by consumer households as they are meant for final consumption.
• Goods purchased by firms for capital formation or investment.

Intermediate Goods

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Intermediate goods refer to those goods which are used either for resale or for further production in the same year.

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Intermediate goods include:-

• Goods purchased for resale.
• Goods used for further production.

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Important point about Intermediate Goods

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• They are generally purchased by one production unit from another production unit.

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• They have derived Demand.

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• Durable goods purchased by Government for military purpose are include in intermediate goods.

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• Value of intermediate goods is merged with the value of final goods.

Production Boundary

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The Production boundary is the line around the productive sector.

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As long as good remain within the production boundary, they are intermediate goods and when a good comes out of this boundary, it becomes a final good.

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Classification of goods as

Intermediate goods and Final Goods

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Distinction is made on the basis of end use.

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• If end use of a good is consumption or investment, then it is final good.

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• However if the good is used for resale or further production,(in the same year) then it is intermediate goods.

Farmer

Flour

Mill

Bakery

Shop

Customer

Difference between final goods and intermediate goods

Basis

Final Goods

Intermediate goods

Meaning

Nature

Demand

Value Addition

Further use

Production Boundary

All goods which are used either for consumption or for investment.

They have a direct demand.

No value has to be added.

Final goods are used for final consumption.

They have crossed the production boundary.

They are included in both national and domestic income.

All goods which are used either for further production or resale in the same year.

They are neither include in national income nor in domestic income.

They have derived demand.

Some value has to be added to intermediate goods.

Intermediate goods are used for further production.

They are still within the production boundary.

Milk purchased by households.

Car purchased as an investment.

Milk purchased by shopkeeper.

Coal used in factory.

Example

Consumption goods

And

Capital Goods

Final goods can be classified into two groups:

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• Consumption Goods

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• Capital Goods

Consumption goods

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Consumption goods refer to those goods which satisfy the wants of the consumer directly.

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Consumption goods are of four type:-

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• Durable goods

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• Semi-durable goods

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• Non-durable goods

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• Services

Capital goods

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Capital goods are those final goods which help in production of other goods and services.

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• They are used in future productive purpose and have expected life time of several years.

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• They don’t lose their identity in the production process.

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• They need repairs or replacement over time.

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• They have derived demand.

All goods used by producer (producer goods) are not capital goods.

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Producer goods include two types of goods:-

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1. Single use producer goods.

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• Capital Goods.

Difference between

Consumer goods

And

Capital goods

Basis

Demand

Production Capacity

Expected Life

Example

These goods have direct demand.

They do not promote production capacity.

Most of the consumption goods have limited expected life.

Milk purchased by households.

Consumption Goods

Capital Goods

These goods have derived demand.

They help in raising production capacity.

Capital goods generally have an expected life of more than one year.

Plant and Machinery.

Example of

Consumer goods,

Capital goods &

Intermediate goods

Purchased by

household

Consumption

Good

Purchased by

Taxi driver

Capital

Good

Purchased by

Car dealer

Intermediate

Good

Stock and Flow

Stock

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• Stocks are economic variables measured at a given point of time.

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• For example:- stock of goods in the godown as on 31^st January,2017.

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• Stock variables are not time dimensional.

Flow

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• Flows are economic variables measured over a period of time.

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• For example: Production of goods during the month of January,2017.

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• Flow variables are time dimensional.

Difference between

Stock and Flow

Basis

Meaning

Time dimension

Nature of Concept

Examples

Stocks are economic variables measured at a given point of time.

It does not have a time dimension.

It is a static concept.

1. Population of India as on 31.03.2016.

2. National wealth.

Stock

Flow

Flows are economic variables measured over a period of time.

It has a time dimension

It is a dynamic concept.

1.Number of births during 2016.

2. National Income.

Gross investment,

Net Investment

& Depreciation

Investment

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Investment or capital formation refers to addition to the capital stock of an economy.

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Investment can be looked up in two forms:-

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1. Gross Investment

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• Net Investment

Gross Investment

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• Gross Investment is the total addition to the capital stock of an economy.

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• Capital stock consists of fixed assets and unsold stock.

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• Gross investment is the expenditure on purchase of fixed assets and unsold stock during the accounting year.

Net Investment

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The actual addition made to the capital stock of economy in a given period is termed as Net Investment.

Net Investment = Gross Investment - Depreciation

Depreciation

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Depreciation is an annual allowance for normal wear and tear and foreseen obsolescence of a fixed capital asset.

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Depreciation of assets is mainly due to reasons:

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1. Normal wear and tear

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• Passage of time

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• Expected obsolescence

Calculation of amount of Depreciation

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• Fixed assets need to be replaced from time to time.

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• Replacement of fixed assets requires funds.

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• Provision for the funds is made on annual basis.

Purchased for ₹100000

Expected Lifetime is 20 Years

Then annual provision is

100000/20 = ₹5000

Depreciation

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Net

Investment

Gross

Investment

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Net

Investment

Depreciation

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Gross

Investment

Difference between

Depreciation and Capital Loss

Basis

Meaning

Provision for loss

Production Process

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

Provision is made for replacement of assets.

It does not hamper the production process.

Depreciation

Capital loss

It refers to loss in value of the fixed assets due to unseen obsolescence, natural calamities, thefts, accidents, etc.

No such provision is made.

It hampers the production process.

Industrial classification-

Primary, Secondary and Tertiary Sector

Primary Sector

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• Primary sector includes production units exploiting natural resources like land, water, subsoil assets, etc.

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• It is primary because it is a source of basic raw materials for the secondary sector.

Secondary Sector

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• Secondary sector includes production units which are engaged in transforming one physical good into another physical goods.

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• Such activities are called manufacturing activity.

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• It is called secondary because it is dependent upon the primary sector for raw material.

Tertiary sector

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• Tertiary sector includes production units engaged in producing services.

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• This sector finds third place because its growth is mainly dependent on the primary and secondary sectors.

Inventory

And

Change in Inventories

Inventory

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The stock of unsold finished goods, or semi-finished goods or raw materials which a firm carries from one year to the next year is called Inventory.

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Inventory is a stock variable.

Change in Inventories

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• Change in inventory is the difference between Closing inventory and opening inventory.

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• Change in inventories(stock) is a flow variable.

Change in inventories = Closing Stock – Opening Stock

Factor Income

And

Transfer Income

Factor Income

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• Factor income refers to income received by factors of production rendering factor services in the production process.

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• It is received for providing factor services of land, labour, capital and enterprise.

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• Factor income of normal residents of a country is included in the National Income.

Transfer Income

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• Transfer income refers to income received without rendering any productive services in return.

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• It is unilateral concept.

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• It does not included in national income.

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• It can be received either within the domestic territory of a country or from abroad.

Difference between

Factor Income &

Transfer Income

Basis

Meaning

Nature

Concept

Recipient

Example

Factor Income

It is included in both national Income and Domestic income.

It is earning concept.

It is received by factors of production.

Rent, Wages, Interest and Profit.

It is the income received by factors of production for rendering factor services.

Transfer Income

It is the income received without rendering any productive service in return.

It is neither included in National income nor in Domestic income.

It is receipt concept.

It is generally received by households and government.

Scholarship, Old age pension, etc.

Domestic Territory

And

Resident

Domestic Territory

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Economic Territory or Domestic Territory is the geographical territory, administered by a government within which persons, goods and capital circulate freely.

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Those parts of political frontiers of a country where the government of that country does not enjoy the above freedom are not included in Economic territory of that country.

Based on the “Freedom” criterion the scope of domestic is as follow:

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• Political frontiers or geographical boundaries including territorial water and air space.

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• Embassies, consulates, Military bases, etc. located abroad.

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• Ships, Aircrafts etc. operated by the residents between two or more countries.

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• Fishing vessels, oil and natural gas rigs, etc. operated by the residents n the international or other areas over which the country enjoys the exclusive rights of jurisdiction.

Domestic territory does not include:

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• Embassies, consulates and military establishments of a foreign country.

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• International organisations like UNO, WHO, etc. located within the geographical boundaries of a country.

Normal Residents

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A Resident ,weather a person or an institution, is one whose center of economic interest lies in the domestic territory of the country in which he lives.

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Center of Economic Interest implies two things:

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1. The resident lives or is located within the domestic territory.

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• The Resident carries out basic economic activities of earning, spending and accumulation from that location

Following are not included under the category of Normal Residents:

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• Foreign tourists and visitors.

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• Foreign staff of Embassies, officials, diplomats and members of the armed forces.

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• International organisations like UNO, WHO, etc.

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• Crew members of foreign vessels, commercial travelers and seasonal workers provides their stay is less than one year.

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• Border worker who live near the international border and cross the border on a regular basis.

Citizen and Resident

Citizen:-

It is basically a legal concept based on the place of birth of the person or some legal provisions allowing a person to become a citizen.

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Resident:-

It is an economic concept. An individual is a normal resident of a country if he ordinarily resides in the country for a period more than one year and his center of economic interest so lies in that country.

Implications of the concepts of Domestic Territory & Resident

• The concepts of Domestic Territory and Normal Resident are important to estimate ‘Domestic Product’ and National Product’.

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• Production inside the Domestic Territory is included in Domestic Product.

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• Production by Residents of the country is included in National product.

Domestic Product

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Domestic product includes production activity of the production units located in the economic territory irrespective of weather carried out by the residents or non residents.

Production

Where ?

Inside the Domestic Territory

Included in domestic Product

Outside the Domestic Territory

Not included in Domestic Product

National Product

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National product includes production activities of Residents irrespective of weather they are performed within the Economic Territory or outside.

Production

By whom?

Residents of the Country

Included in National Product

Non- Residents of the country

Not included in National Product

Relation between National Product and Domestic Product

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Normally domestic product is estimated first.

National product is derived in the following way:

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Residents’ contribution to production outside the economic territory is called “Factor Income From abroad”.

Non-residents’ contribution to production inside the economic territory is called “Factor Income to abroad”.

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National product =

Domestic Product

+ Residents’ contribution to production outside the economic territory

– Non-residents’ contribution to production inside the economic territory

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Factor Income from abroad,

Factor income to abroad &

Net Factor income from abroad

Factor income from abroad

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Factor income from abroad is the income earned by normal residents of a country from the rest of world in the form of wages and salaries, interest, dividend and retained earnings.

Factor income to abroad

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Factor income to abroad is the factor income paid to the Non-residents (Residents of the other country) for their factor services within the economic territory.

Net Factor income from abroad

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

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NFIA can be Positive, Negative or Zero.

NFIA = Factor income earned from abroad – Factor income paid to abroad

Significance of NFIA

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NFIA is significant to differentiate between ‘Domestic Income’ and ‘National Income’.

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National Income =

Domestic income + Residents’ contribution to production outside the economic territory – Non-residents’ contribution to production inside the economic territory

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National Income = Domestic Income + NFIA

Relation between

Domestic production,

National production &

NFIA

Income from abroad & Income to abroad

Income from abroad > Income to abroad

Income from abroad < Income to abroad

Income from abroad = Income to abroad

Positive (+)

Negative (-)

Zero (0)

NFIA

Relation between National product & Domestic Product

National > Domestic

National < Domestic

National = Domestic

Indirect tax

And

Subsidy

Indirect tax

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• Indirect tax is a tax imposed by the government on production and sale of goods and services.

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• It is a tax where the payer and bearer of the tax are different people.

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• Imposition of indirect taxes by the government increases the market prices of goods and services.

Subsidy

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• Subsidy is a form of financial assistance given by the government to firms and households with a motive of general welfare.

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• Subsidy granted by the government reduce the market prices of goods and services.

Net Indirect tax

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Net Indirect tax is the difference between indirect taxes and subsidies.

Net Indirect Tax = Indirect Taxes - Subsidies

Market price

And

Factor cost

Market Price

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• Market price is the price at which product is actually sold in the market.

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• It includes the Indirect taxes and excludes the Subsidies.

Factor Cost

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Factor cost is amount paid to factors of production for their contribution in the production process.

Factor cost = Market price – Indirect taxes + subsidies

Factor Cost =Market Price –Net Indirect taxes

Factor

Cost

Market Price

Relation between

Market Price, Factor Cost & NIT

Indirect taxes & Subsidies

IT > Sub.

IT < Sub.

IT = Sub.

Positive (+)

Negative (-)

Zero (0)

NIT

Relation between MP & FC

MP > FC

MP < FC

MP = FC

Sub.

IT

Market Price

NIT

Factor Cost

Sub.

IT

Market Price

(-) NIT

Factor Cost

Sub.

IT

Market Price

(0) NIT

Factor Cost

Thank You

ANKIT KUMAR

PGT, ECONOMICS