The concept of domestic territory (Economic territory) is different from the geographical or political territory of a country. Domestic territory of a country includes the following:
- Political frontiers of the country including its territorial waters.
- Ships, and air crafts operated by the normal residents of the country between two or more countries for example, Air India’s services between different countries.
- Fishing vessels, oil and natural gas rigs and floating platforms operated by the residents of the country in the international waters or engaged in extraction in areas where the country has exclusive rights of operation.
- Embassies, consulates and military establishments of the country located in other countries, for example, Indian embassy in U.S.A. It excludes all embassies, consulates and military establishments of other countries and offices of international organizations located in India.
The term normal resident is different from the term nationals (citizens). A normal resident is a person who ordinarily resides in a country and whose centre of economic interest also lies in that particular country. Normal residents include both nationals (such as Indians living in India) and foreigners (non-nationals living in India).
For example, Nepalese living in India for more than one year and performing economic activities of production, consumption and investment in India, will be treated as normal residents of India. On the contrary, Indian citizens, living abroad (say in USA) for more than one year and performing their basic economic activities there, will be treated as normal resident of that country where they normally reside. They will be considered as non-residents of India (NRIs).
Intermediate and Final Goods
Intermediate goods are those goods which are meant either for reprocessing or for resale. Goods used in the production process during an accounting year are known as intermediate goods. These are non-durable goods and services used by the producers such as raw materials, oil, electricity, coal, fuel, etc. and services of hired engineers and technicians, etc.
Goods which are purchased for resale are also treated as intermediate goods. For example, Rice, wheat, sugar, etc. purchased by a retailer or wholeseller.
Goods which are used either for final consumption by the consumers or for investment by the producers are known as final goods. These goods do not pass through production process and are not used for resale. For example, bread, butter, biscuits, etc. used by the consumer.
Whether a good is a final good or an intermediate good depends on its use. For example, milk used by a sweet maker is an intermediate good but when it is used by the consumer it becomes a final good.
Intermediate goods are not included in the calculation of national income. Only final goods are included in the calculation of national income because value of intermediate goods is included in the value of final goods. If it is included in national income it will lead to the problem of double counting.
Value of Output
Production units use non-factor inputs like raw materials (intermediate goods) and factor inputs (land, labour, capital and entrepreneurship) for production. Various firms and production units produce different types of goods. Money value of all goods and services produced is known as value of output.
Value of output = Quantity × Price
Producing units sell their output in the market. However, it is not necessary that the whole of the output produced during an accounting year is sold during that very year. Therefore, the unsold produce forms a part or the stock or inventories. So, change in stock or inventories is also a part of value of output. Thus, value of output can also be measured as:
Value of output = Sales + change in stock
Value of output includes value of intermediate consumption also. National income does not include intermediate consumption expenditure. So for calculation of National Income, it must be deducted from value of output to avoid the problem of double counting.
After deducting value of intermediate goods from value of output, we get value added. So, value added is the difference between value of output and intermediate consumption expenditure.
Value Added = Value of output - Intermediate Consumption Expenditure
For example, suppose a farmer produces cotton worth Rs.500 and sells it to the cloth mill. The cloth mill produces cloth worth Rs.1,500. It produces 300 metres of cloth and market price of cloth is Rs.5 per metre. But in this value, value of cotton is also included and cotton used by cloth mill is an intermediate good, so value of cotton i.e. Rs.500 will be intermediate cost. Therefore value added will be Rs.1000.
Gross and Net Measure
The value of output and value added calculated above is a gross measure because when goods are sold out in the market these include all type of costs. During production process fixed capital assets like machines, building, etc. get depreciated and their value goes down. This is known as normal wear and tear of machinery or consumption of fixed capital or depreciation.
So every production unit makes provision for depreciation. When it is included in value of output and value added, these are called Gross Value of output and Gross Value added respectively. If depreciation is not included in value of output and value added, these are called Net Value of output and net value added respectively.
Net Value = Gross Value - Depreciation
Net Value of output = Gross Value of output – Depreciation
Net Value of added = Gross Value of added – Depreciation
Market Price and Factor Cost
The buyers purchase goods from the market and the price paid by them is known as market price. The sellers pay a part of this price as indirect taxes to the Government.
Indirect taxes are those taxes which are levied by the government on sales and production and also on imports of the commodities in the form of sales tax, excise duties, custom duties, etc. These taxes increase the market price of the commodities.
Subsides: Sometimes, Government gives financial help to the production units for selling their product at lower prices fixed by the government. Such help is given in case of those selected commodities whose production the Government wants to encourage. If you deduct these subsidies from indirect taxes, you get net indirect taxes.
Net Indirect Taxes: It is the difference between indirect tax and subsidy.
Net Indirect Tax = Indirect Tax - Subsidy
Value Added at Market Price - Net Indirect Tax (NIT) = Value Added at Factor cost (FC)
Value Added at MP - Indirect Tax + Subsidy = Value Added at FC
Domestic Income and National Income
The sum total of value added by all production units within domestic territory of a country is called domestic product. Both residents and non-residents render factor services to these units. Therefore, the income generated in these units is shared by both the residents and non-residents as their factor income.
To get contribution of only normal residents (or their factor income earned within the domestic territory) you have to deduct the factor payments made to the non-residents. These factor payments are known as factor payments made to the rest of the world.
The residents, in addition to their factor services to the production units located in the economic territory of a country, also provide factor services to the production units outside the economic territory i.e., to the rest of the world (ROW). In return for these services they receive factor incomes from the rest of the world.
Thus, National income is the sum total of factor incomes earned by the normal residents of a country within and outside the economic territory. Therefore,
National Income = Domestic Income + Factor income received from ROW – Factor payments made to ROW
Net Factor Income from ROW: It is the difference between factor incomes received from ROW and factor payments made to ROW
National Income/Product = Domestic Income/product + Net factor income form abroad
(i) Gross Domestic Product at market price + Net factor income from abroad = Gross National Product at market price.
(ii) Net Domestic Product at market price + Net factor income from abroad = Net National Product at market price.
(iii) Net Domestic Product at Factor cost + Net factor income from abroad = Net National Product at factor cost.
Net National Product at factor cost is called National Income of a country.
Nominal and Real GDP
When the money value of goods and services included in GDP is estimated on the prices of current year, it is called GDP at current prices or nominal GDP. Here, current prices mean the prices of the year of which GDP is estimated.
On the other hand, when the value of goods and services included in GDP is estimated on the prices of base year, you get GDP at constant prices or real GDP.
Increase in real GDP implies increase in the production of goods and services. Therefore, the calculation of GDP at constant prices or real GDP gives the correct picture of the economic performance of an economy.