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Basic Concepts of Macroeconomics
Domestic or Economic Territory of a Country
Normally the meaning of a domestic territory is the political boundary of a country. But in economics it is used in a wider sense and bigger than the political boundaries of a country. According to United Nations. "Economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely" The basis for determining an economic territory is depend on the freedom of circulation of goods, capital and persons of that particular economy. Please note domestic territory is also known as as economic territory. It is clear that, if a country does not enjoy the freedom of circulation of goods, capital and persons in a particular part of the country, that part of the country cannot be treated as a domestic/economic territory of the country. Therefore domestic/economic territory includes:
- Territory comes within the political boundaries of a country including territorial waters.
- Aircrafts and ships owned and operated by the residents of a country between two or more countries. Example, American Airlines operating between India, UK and japan are parts of domestic territory of America. A passenger ship owned and operated by an American ferrying between UK and USA can also be treated as the domestic territory of USA because income generated by ferrying passengers goes to the US economy.
- Oil and natural gas rigs, Fishing vessels and floating platforms operated by the residents of a country in the international waters or engaged in extraction in areas where the country has exclusive rights of operation. Example : fishing in the international waters.
- Consulates, Embassies and military establishments of the country located abroad. Embassies of China, Russia, Japan located in USA are domestic territories of their own countries and not of USA.
Following does not include the domestic/economic territory
- International organizations like World Health Organization (WHO), United Nations (UN), Organization for Security and Co-operation in Europe (OSCE), Council of Europe (CoE), European Union (EU; which is a prime example of a supranational organization), and World Trade Organization (WTO) etc. which are physically located within geographical boundaries of a country, form part of international territory.
- Territorial Enclaves like embassies used or administrated by foreign governments.
Residental status of an Individual or organization
Now let us look at the concept of residential status of a person for determining the National Income of a country in economics. National income is the sum total of factor incomes earned by the normal residents of a country during a year. Therefore, there is special meaning and importance for the status of a normal resident in calculating National Income in macroeconomics.
A resident means a person or institution who ordinarily resides in a country and whose center of economic interest lies in that country. His center of economic interest lies in the country of residence. He brings all the income to his country. He is called a normal resident. It is to be noted that the period of stay should be at least one year or more but this condition does not apply to medical patients who are treated abroad and students studying abroad as they continue to remain part of their households in the home country.
Therefore, to be treated as a normal resident, one has to fulfill the following two conditions. They are:
- Having economic interest in the country of residence.
- Staying for more than a year in that country.
Now let us look at the meaning of "Centre of economic interest". It means the person or institution must carry out some economic activities such as spending, earning, accumulation and transactions etc. from the country of residence as well as it should be located within the economic or domestic territory of that country.
Normal residents cover the following:
- Non-Citizens residing in a country for more than a year.
A person can be a resident of the country at the same time can be a citizen of another country. Due to his birth, he can become a citizen of a country. He can also become a resident because he is staying more than a year in another country and his economic interests lies in the country of his residence where he is staying more than a year. Just like an American who is living in Japan for more than a year and doing business in Japan can be treated as a resident of Japan at the same time he is a Citizen of America by birth. An Indian living in America and working there more than a year can be treated as a resident of America at the same time he is an Indian by his citizenship. He is called a Non Resident Indian (NRI)
Another important point is to be noted is that international organizations like World Health Organization (WHO), World Bank, United Nations (UN) are not considered residents of the country in which these organizations operate but are treated as residents of international territory. At the same time the employees who are working in such organizations are treated as normal residents of the country, if they fulfill all the requirements required to get the status of a normal resident. United Nations (UN) located in New York, America is not normal resident of of America but an Indian works in UN office for more than a year will be treated as a resident of America.
Indians who work in Nepal by crossing the boarder in the morning and return to India in the evening cannot be treated as a resident of Nepal. They are treated as the residents of India.
Local employees who are working in foreign embassies can be treated as normal residents. American working in Indian embassy located in USA is the resident of USA. At the same time an Indian who is working at Indian embassy located in USA is treated as a resident of USA since a part of his income will be spent in the country of his residence i.e. USA.
Meaning of Investment in Macroeconomics.
Investment means addition to the stock of capital goods such as buildings, equipment or inventory that adds to the future productive capacity of the economy. It means addition or creation of physical assets which is useful for increasing the productive capacity of the economy. It doesn't mean that purchase of shares or financial assets. In economics, investments means the formation of capital goods which will increase the production in the coming years.
Gross investments is that part of investment which includes the normal wear and tear of the capital goods. The replacement cost or the normal wear and tear occurred to the capital goods over a period of time includes the gross investment. In short depreciation is included in the gross investment.
What is Depreciation?
Depreciation is the loss of value of fixed asset like building, machinery, tools, vehicles etc., due to its normal wear and tear in the process of production over a period of time. Machinery or vehicle lose its value when it is used (or not used) for a period of time. This loss in value of such capital goods are called depreciation. Such loss also known as consumption of capital goods. Every organization makes a provision for depreciation which is equal to the value of depreciation of that particular period. Provision for depreciation also known as current replacement cost.
Suppose a new machine used in production costs US$ 1000 and the life of the machine is 10 years. A provision for depreciation in the tune of $100 a year will be set apart under the accounting head "provision for depreciation". After ten years this account will have US$ 1000 ( $100 x 10 years = $1000) With this amount, old machine can be replaced. So this provision for depreciation also called the replacement cost of the machine. The fund accumulated during the life time of the machine is used to replace it when it wears out completely.
Gross investment is inclusive of depreciation or consumption of fixed capital.
By deducting depreciation from gross investment, we get net investment, i.e, net investment means gross investments minus depreciation
Net Investment = Gross investment - Depreciation
Point to be noted: New addition to the capital stock in the economy is measured by net investment and not by gross investment.