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The aggregates, the three methods of measuring them, the conversions between them, real versus nominal, and what the number does not tell you.
The most arithmetic-heavy chapter of the course. Half its marks are in knowing which items to include.
Chapter 1 ended with a circle and a claim.
Income flows in a circle between households and firms. Cut that circle at any of three points — production, income, expenditure — and you measure the same quantity.
Turn that identity into a number. Which transactions count? Which are double-counted? Which look like income but are not? And once we have the number, what exactly have we measured?
Almost every mark lost in this chapter is lost on one item in a list — a pension added, an intermediate good counted, a subsidy subtracted instead of added. The arithmetic is trivial. The classification is the exam.
Final vs intermediate, consumption vs capital, investment, depreciation, inventory.
Domestic territory, normal resident, NFIA.
GDP, NDP, GNP, NNP at MP and at FC — and the conversions.
Worked, firm by firm.
C + I + G + (X − M), worked.
COE + OS + MI, worked — same answer.
Include or exclude, and the one-line reason for each.
The GDP deflator, CPI, WPI.
Why a bigger GDP is not automatically a better country.
The single most important classification in the chapter. Get it wrong and every total is wrong.
Final good — a good that has crossed the boundary line of production and is ready for use by its final user: either for consumption or as investment. It will not be resold or used up in producing something else this year.
Intermediate good — a good bought by one producer from another for resale or for use up as a raw material in production during the same year.
Whether a good is final or intermediate depends entirely on who buys it and why — never on the physical good itself.
| The same good | Bought by | Classification |
|---|---|---|
| Milk | A household, to drink | Final (consumption) |
| Milk | A sweet shop, to make barfi | Intermediate |
| A car | A family, to drive | Final (consumption) |
| A car | A taxi company, to run as a taxi | Final (investment) |
| A car | A dealer, to resell | Intermediate |
Only final goods are counted in national income. Counting intermediate goods too would count the same value twice — the problem of double counting.
A farmer grows wheat worth ₹1,000 and sells it to a miller. The miller makes flour worth ₹1,600 and sells it to a baker. The baker makes bread worth ₹2,400 and sells it to households.
Is the contribution of these three firms ₹1,000 + ₹1,600 + ₹2,400 = ₹5,000?
No. The ₹1,000 of wheat is counted three times — once as wheat, again inside the value of flour, and again inside the value of bread. The economy has not produced ₹5,000 of new value; only ₹2,400 of bread plus whatever wheat and flour went directly to households.
Count only the value of final goods. Ignore all inter-firm sales. Used by the expenditure method.
Count every firm, but only the value it adds: its output minus what it bought in. Used by the value added (product) method.
Consumption goods — final goods that directly satisfy human wants.
Capital goods — final goods used in the process of production for more than one year, and which are themselves not used up in production.
Machinery, plant, factory buildings, transport equipment.
Capital goods are durable and reusable. Raw materials are also bought by producers, but they are used up in one round — so they are intermediate goods, not capital goods.
A refrigerator bought by a household is a consumer durable — final consumption. The identical refrigerator bought by a restaurant is a capital good — investment. Both are final goods; they enter national income under different heads.
Gross investment (Gross capital formation) = expenditure on fixed capital (machines, buildings) + change in inventory (change in stock).
Inventory — the stock of unsold finished goods, semi-finished goods and raw materials that a firm carries from one period to the next. Inventory is a stock; the change in inventory during the year is a flow, and it is that change which enters investment.
The firm decided to add to stock — e.g. building up before the festival season. A deliberate investment decision.
Sales turned out different from expectations. Goods went unsold, so stock rose without the firm intending it — or a sales surge ran stock down.
National income accounting counts all change in stock as investment, planned or not. A firm that fails to sell has, in the accounts, "invested in its own goods". This is a bookkeeping device that makes the identity output = expenditure hold every single year — and it is exactly the device Chapter 4 uses to explain how equilibrium is reached.
An unplanned rise in inventory means firms produced more than buyers wanted. The goods are sitting in the warehouse tying up money. The natural response next period is to cut production — which cuts employment and income.
This is the mechanism behind the sentence "output adjusts to demand" that you will meet formally in Chapter 4. Unplanned inventory change is the signal that moves output.
A firm's opening stock on 1 April was ₹80 lakh and closing stock on 31 March was ₹65 lakh. During the year it bought new machinery for ₹120 lakh, and depreciation was ₹35 lakh.
Find (a) change in stock, (b) gross investment, (c) net investment. Comment on the sign of (a).
The change in stock is negative, and a negative change in stock is subtracted. The firm sold ₹15 lakh more than it produced this year by running down last year's stock — that ₹15 lakh of sales was last year's production, so it must not be credited to this year's output.
Students write "gross investment = 120 + 15 = 135" because they add the magnitude and ignore the sign. Always compute closing minus opening and carry the sign.
"Domestic" is about where. "National" is about whose. Two different questions, and every aggregate answers one of them.
Domestic (economic) territory — the political frontiers of a country plus:
It excludes foreign embassies, consulates and international organisations (UN, IMF offices) located inside the country.
Normal resident — a person or institution who ordinarily resides in a country and whose centre of economic interest lies there — that is, who carries on the bulk of their economic transactions from that country, normally for a year or more.
Citizenship is irrelevant. A Japanese national working in Bengaluru for three years is a normal resident of India. An Indian citizen working in Dubai for five years is not.
Net factor income from abroad = factor income earned by normal residents of India from the rest of the world − factor income earned by non-residents within India's domestic territory.
NFIA can be positive, negative or zero. For India it is typically negative — foreign firms earn more profit here than Indian residents earn abroad, so India's national income is a little below its domestic income.
NFIA counts factor income only. It does not include:
Will each of these be included in India's domestic income, its national income, both, or neither?
| # | Domestic | National | Reason |
|---|---|---|---|
| 1 | Yes | Yes | The Indian embassy abroad is India's domestic territory. |
| 2 | Yes | No | Produced inside India, but the income accrues to a non-resident — so it is deducted through NFIA. |
| 3 | No | Yes | A foreign embassy is not India's domestic territory, but the earner is a normal resident — added through NFIA. |
| 4 | No | No | A transfer payment from a non-resident. Not factor income at all. |
For every item ask: (1) Where was it produced? → domestic. (2) Who earned it? → national. Items 2 and 3 are the mirror pair that examiners love.
There are not eight aggregates to memorise. There are three yes/no switches, and every aggregate is one setting of the three.
Net National Product at Factor Cost = Net · National · Factor cost = all three switches at the right-hand setting. This one has a special name: National Income.
Depreciation (consumption of fixed capital) — the fall in the value of fixed capital during the year due to normal wear and tear and expected obsolescence. Gross − Depreciation = Net.
Net indirect taxes (NIT) = Indirect taxes − Subsidies.
Indirect taxes (GST, excise, customs) are added on to the price the buyer pays but never
reach the factors of production; subsidies are paid to producers so the buyer pays less
than the factors receive.
Market price − NIT = Factor cost.
A shirt sells for ₹1,180, of which ₹180 is GST. The producer receives ₹1,000, of which the factors — the weaver, the landlord, the lender, the owner — share the whole.
Market price ₹1,180 − indirect tax ₹180 = factor cost ₹1,000. If in addition the government paid the producer a ₹50 subsidy, factor cost would be ₹1,050: the factors get more than the buyer paid.
Going from MP to FC: − indirect taxes, + subsidies (i.e. − NIT).
Going from FC to MP: + indirect taxes, − subsidies (i.e. + NIT).
Write the conversion as an explicit line every time. Never fold it silently into a total.
We will use one economy for the whole chapter. Here it is, converted end to end. All figures ₹ crore, at current prices.
Any aggregate can be reached from any other by walking this chain and applying the signs. You will never need a formula sheet again.
GDPMP = 2,700 · Depreciation = 200 · NIT = 300 · NFIA = −50 (₹ crore)
| Aggregate | Built as | ₹ crore |
|---|---|---|
| GDP at MP | given | 2,700 |
| GDP at FC | 2,700 − 300 | 2,400 |
| NDP at MP | 2,700 − 200 | 2,500 |
| NDP at FC | 2,700 − 200 − 300 | 2,200 |
| GNP at MP | 2,700 + (−50) | 2,650 |
| GNP at FC | 2,650 − 300 | 2,350 |
| NNP at MP | 2,650 − 200 | 2,450 |
| NNP at FC = National Income | 2,650 − 200 − 300 | 2,150 |
GDP at MP — the market value of all final goods and services produced within the
domestic territory of a country during a year.
National Income (NNP at FC) — the sum of factor incomes earned by the normal
residents of a country during a year.
The words final, within the domestic territory and during a year each carry a mark. Do not drop them.
The GDP at market price of a country in a year was ₹1,100 crore. Net factor income from abroad was ₹100 crore. Indirect taxes − subsidies was ₹150 crore and national income was ₹850 crore. Calculate the aggregate value of depreciation.
(NCERT Chapter 2, Question 7)
Depreciation = ₹200 crore.
Written as one line: NNPFC = GDPMP + NFIA − NIT − Depreciation ⟹ 850 = 1,100 + 100 − 150 − D ⟹ D = 200.
Notice you were not asked for national income — you were given it and asked for a step inside the chain. Set up the full chain as an equation with the unknown in it, then solve. This works for every "find the missing item" question.
Gross value added at market price (GVAMP) = Value of output − Intermediate consumption
A firm's production this year is what it sold plus what it made but has not yet sold. Sales alone understate production when stock is rising and overstate it when stock is being run down.
Because national income measures production during the year, not trade during the year. A firm that produced ₹100 crore of goods and sold only ₹80 crore of them still produced ₹100 crore — the remaining ₹20 crore sits in its warehouse as an addition to inventory, and is counted as the firm's own investment.
Using sales instead of value of output is the single most common way students lose the whole value-added question. Write the line "Value of output = Sales + Change in stock" explicitly before you subtract intermediate consumption.
Our three firms again: farmer sells ₹1,000 of wheat (₹900 to the miller, ₹100 to households); miller produces ₹1,600 of flour (₹1,400 to the baker, ₹200 to households); baker produces ₹2,400 of bread, all to households.
| Firm | Value of output | Intermediate consumption | GVA at MP |
|---|---|---|---|
| Farmer | 1,000 | 0 | 1,000 |
| Miller | 1,600 | 900 | 700 |
| Baker | 2,400 | 1,400 | 1,000 |
| Total | 5,000 | 2,300 | 2,700 |
Verify the answer by the final goods route instead: add up only what households actually bought.
Households bought wheat ₹100 + flour ₹200 + bread ₹2,400 = ₹2,700 crore. Identical.
This is not a coincidence — it is Chapter 1's identity. Total value added must equal total final expenditure, because every rupee of value added ends up embodied in some final good.
Calculate net value added at factor cost (₹ lakh):
| (i) Sales | 800 | (v) Opening stock | 60 |
| (ii) Purchase of raw material | 300 | (vi) Closing stock | 90 |
| (iii) Import of raw material | 50 | (vii) Depreciation | 70 |
| (iv) Indirect taxes | 60 | (viii) Purchase of machinery | 200 |
Measure the circle at the spending cut: add up all expenditure on final goods and services produced inside the domestic territory.
Spending by households and non-profit institutions serving households on final consumer goods and services — durable, semi-durable, non-durable and services.
The government's spending on final goods and services for collective consumption — largely the salaries of its employees and its purchases of supplies. Excludes transfer payments.
= Gross fixed capital formation (business fixed investment + residential construction + public investment) + change in stock.
Exports are produced here and bought by foreigners — add. Imports are produced abroad but are already sitting inside C, I and G — subtract.
Not because imports are "bad" or "a leakage". Because when a household buys a Korean phone, that ₹60,000 is already inside C, yet nothing was produced in India. Subtracting M removes foreign production that the C, I and G totals wrongly swept in.
Same economy as before. All figures ₹ crore, at current prices.
| Private final consumption expenditure | 1,800 | Exports | 150 |
| Government final consumption expenditure | 500 | Imports | 200 |
| Gross domestic fixed capital formation | 400 | Depreciation | 200 |
| Change in stock | 50 | Net indirect taxes | 300 |
| Net factor income from abroad | (−) 50 | Old-age pensions paid by government | 120 |
Find (a) GDP at market price and (b) National income.
Old-age pensions ₹120 crore was ignored. It is a transfer payment — the government receives no good or service in return, so no production corresponds to it. Every expenditure-method question plants at least one transfer payment. Never add it to G.
Measure the circle at the income cut: add up all factor incomes paid out by producing units in the domestic territory. This gives NDP at factor cost directly.
Income from property and entrepreneurship:
The income of a farmer, shopkeeper, doctor or artisan who supplies several factors at once — own labour, own land, own capital, own enterprise — so their earnings cannot be split into wage, rent, interest and profit.
Large and important in India.
Because factors receive only what is left after indirect taxes are handed to the government and after depreciation is set aside. Income received by factors is factor cost, and it is net.
| Compensation of employees | 1,200 | Mixed income of self-employed | 250 |
| Rent and royalty | 200 | Depreciation | 200 |
| Interest | 150 | Net indirect taxes | 300 |
| Dividends | 150 | Net factor income from abroad | (−) 50 |
| Corporate tax | 100 | Interest on national debt | 80 |
| Undistributed profit | 150 | Scholarships given by government | 40 |
Find (a) NDP at factor cost, (b) National income, (c) GDP at market price.
| Method | What is added up | Lands at | ₹ crore | National income |
|---|---|---|---|---|
| Value added | Σ (Output − Intermediate consumption) | GDPMP | 2,700 | 2,150 |
| Expenditure | C + I + G + (X − M) | GDPMP | 2,700 | 2,150 |
| Income | COE + Operating surplus + Mixed income | NDPFC | 2,200 | 2,150 |
Because of Chapter 1's circle. Whatever a firm produces it sells (counting unsold goods as sold to itself), and whatever it receives from selling it pays out to factors or to the government as indirect tax or sets aside as depreciation. Nothing leaks out of the accounting. The three methods are three ways of reading the same ledger.
Value added and expenditure land at GDPMP; income lands at NDPFC. You must still walk the chain to national income. Students who "get 2,200" from the income method and "2,700" from the expenditure method and think one is wrong have simply forgotten which switch each method sets.
For every doubtful item: include or exclude, and a one-line reason. Learn the reasons, not the list — new items appear every year.
| Item | Treatment | Reason |
|---|---|---|
| Sale of a second-hand car | Exclude | No current production; it was counted in the year it was made |
| Commission earned by the used-car dealer | Include | A productive service rendered this year |
| Purchase of shares / debentures | Exclude | A financial transaction — a change of ownership of paper, not production |
| Brokerage on the share purchase | Include | A service rendered this year |
| Capital gain on selling land | Exclude | A rise in the price of an existing asset; nothing was produced |
| Old-age pension, scholarship, unemployment allowance | Exclude | Transfer payment — received without rendering any factor service |
| Interest on national debt (public debt) | Exclude | Government borrows for consumption, so treated as a transfer |
| Bonus / dearness allowance paid to workers | Include | Part of compensation of employees |
| Rent-free accommodation given by an employer | Include | Compensation of employees in kind |
| Imputed rent of an owner-occupied house | Include | A housing service is produced and consumed, so it is valued and counted |
| Vegetables a farmer grows and eats himself | Include | Production for self-consumption is still production; valued at market price |
| Services of a housewife | Exclude | Non-market service; no reliable way to value it (a known limitation, not a principle) |
| Expenditure on raw materials by a firm | Exclude | Intermediate consumption — would be double counting |
| Purchase of a machine by a firm | Include | Final good — investment (gross fixed capital formation) |
| Construction of a new house | Include | Investment — a newly produced capital good |
| Payment of corporate tax by a firm | Exclude separately | Already contained within profit; adding it again double counts |
| Purchase of a car by a household | Include | Final consumption expenditure (consumer durable) |
| Entertainment tax / GST received by government | Include in MP only | An indirect tax — part of market price, not of factor cost |
State with reason whether each is included in India's national income:
National income is what the country earned. Very little of it reaches a household's hands untouched.
Personal income — the total income actually received by households from all sources, whether earned or not.
Personal disposable income — the part of personal income that a household is actually free to spend or save.
Take what the nation earned. Remove the part companies kept (undistributed profit) and the part the government took from companies (corporate tax). Add back the money the government hands over for free (pensions, scholarships). Then remove the government's cut from households (income tax). What is left is what actually reaches a bank account.
Same economy. National income (NNPFC) = 2,150. Also (₹ crore): undistributed profit 150, corporate tax 100, net interest paid by households 40, current transfers from government and ROW 180, personal income tax 240, fees and fines paid to government 20.
Find personal income and personal disposable income.
Personal income = ₹2,040 crore; Personal disposable income = ₹1,780 crore.
PDI is the income that appears on the horizontal axis of the consumption function. PDI = Consumption + Saving, and how a household splits it is exactly what Chapter 4 is about.
Private income — the total factor income from all sources plus current transfers, accruing to the private sector (households and private firms) — i.e. national income minus the part earned by government enterprises and government property, plus interest on national debt and current transfers.
National disposable income — the income the whole nation has at its disposal for consumption and saving.
Net NDI = NNPMP + Net current transfers from the rest of the world.
Gross NDI = GNPMP + Net current transfers from the rest of the world.
NNPMP = 2,450. If net current transfers from abroad = 60, then Net national disposable income = 2,450 + 60 = ₹2,510 crore, and Gross NDI = 2,650 + 60 = ₹2,710 crore.
India's GDP rose from ₹100 lakh crore to ₹110 lakh crore. Is the country producing more?
You cannot tell. GDP could have risen because more goods were produced, or because the same goods were sold at higher prices, or any mixture of the two. A rupee total confuses quantity with price.
Nominal GDP (GDP at current prices) — the value of final goods and services produced in a year, valued at that year's own prices.
Real GDP (GDP at constant prices) — the value of final goods and services produced in a year, valued at the prices of a fixed base year.
Holding prices fixed means a rise in real GDP can only come from producing more goods. Real GDP is a quantity index wearing a rupee costume. Growth rates are always quoted in real terms.
A two-good economy. Base year 2015–16.
| Good | 2015–16 price | 2015–16 quantity | 2025–26 price | 2025–26 quantity |
|---|---|---|---|---|
| Rice (quintal) | ₹10 | 100 | ₹15 | 120 |
| Cloth (metre) | ₹20 | 50 | ₹25 | 60 |
Find (a) nominal GDP of 2015–16, (b) nominal GDP of 2025–26, (c) real GDP of 2025–26, (d) the GDP deflator for 2025–26, (e) real growth over the decade.
Output really rose by 20%. The reported rupee figure rose by 65%. The remaining 45 percentage points were price rise — and the deflator of 137.5 says exactly that: prices are 37.5% above the base year.
Nominal = current quantity × current price. Real = current quantity × BASE price. The quantity is always the current year's. It is the price that gets frozen.
GDP deflator — an index of the general price level, obtained as the ratio of nominal to real GDP.
Covers all goods and services produced domestically. Its basket changes every year with the composition of output. Not published as a survey — it falls out of the national accounts.
Price of a fixed basket bought by a typical household — food, fuel, housing, clothing. Includes imported consumer goods. Excludes machinery and other goods households do not buy. This is the index the RBI targets.
Prices of goods traded in bulk at the wholesale stage. Excludes services entirely. In some countries called the Producer Price Index.
The nominal GNP of an economy was ₹2,500 crore in a particular year. The GNP of that country during the same year, evaluated at the prices of the base year, was ₹3,000 crore. Calculate the GNP deflator. Has the price level risen between the base year and the year under consideration?
The deflator is 83.33, which is below 100. So the price level has fallen since the base year — prices are about 16.67% lower than in the base year. The economy has experienced deflation.
Real GDP exceeds nominal GDP. The same physical output is worth more at base-year prices than at today's prices — which can only mean today's prices are lower. A deflator is simply the answer to "are today's prices above or below the base year's?": above 100 means above, below 100 means below.
The chapter's last idea, and the one most likely to appear as a 4- or 6-mark question: the limitations of GDP as an index of welfare.
GDP is a good measure of economic activity and a poor but not useless proxy for welfare. It is used because it is measurable, comparable and correlated with welfare — not because it defines it.
Externalities — benefits or harms that a firm or individual causes to others for which they are not paid and do not pay. They are not reflected in market prices, and therefore not in GDP.
An oil refinery on a river produces ₹500 crore of output — GDP rises by ₹500 crore. Its effluent kills the fish that a fishing village lived on. Welfare has fallen; GDP has not recorded the fall.
A firm builds a road to its own factory. Villagers along the route use it free. Welfare has risen by more than the ₹10 crore recorded in GDP — GDP understates the gain.
A cyclone destroys a city. In the year that follows, GDP rises sharply because of all the rebuilding. Has welfare risen? What does this reveal about GDP?
No. The rebuilding restores what already existed; the city is at best back where it started, and its people lost a year of other production. GDP counts the flow of new production but never the destruction of the existing stock of wealth. So a disaster followed by reconstruction registers in GDP as a boom. This is a limitation of GDP as a welfare measure, not a sign that disasters are good.
GVAMP = Value of output − Intermediate consumption
GDPMP = C + I + G + (X − M)
NDPFC = COE + Operating surplus + Mixed income
NNPFC = GDPMP + NFIA − Depreciation − NIT
Distinguish between stock and flow. Between net investment and capital, which is a stock and which is a flow? Compare net investment and capital with the flow of water into a tank.
A stock is measured at a point of time and has no time dimension; a flow is measured over a period of time and is meaningless without one. Capital is a stock — it is the amount of plant and machinery in existence on a given date. Net investment is a flow — the addition to that capital during a year.
The tank: the water standing in the tank at 4 p.m. is the stock, corresponding to capital. The water flowing in through the pipe, measured in litres per hour, is the flow, corresponding to net investment. The flow changes the stock; the stock is the accumulation of past flows.
What is the difference between planned and unplanned inventory accumulation? Write down the relation between change in inventories and value added of a firm.
Planned inventory accumulation is a deliberate decision by the firm to add to stock — for example, building up before a festival. Unplanned inventory accumulation happens when sales turn out lower than expected, so goods remain unsold and stock rises without the firm intending it (and unplanned decumulation when sales exceed expectations).
Relation: Value added = Value of output − Intermediate consumption, where Value of output = Sales + Change in inventories. So a rise in inventories adds to value added and a fall subtracts from it — production, not sales, is what value added measures.
The excess of private investment over saving of a country in a particular year was ₹2,000 crore. The amount of budget deficit was (−) ₹1,500 crore. What was the volume of trade deficit that year?
Trade deficit = ₹500 crore.
Read it economically: the private sector wanted to invest ₹2,000 crore more than it saved. The government supplied ₹1,500 crore of that by running a surplus. The remaining ₹500 crore had to be borrowed from abroad — and borrowing from abroad is importing more than you export.
This one identity ties three chapters together: the private saving–investment gap (Ch 4), the budget deficit (Ch 5) and the current account deficit (Ch 6) must always sum to zero.
In a single day Raju, the barber, collects ₹500 from haircuts; over this day his equipment depreciates in value by ₹50. Of the remaining ₹450, Raju pays ₹30 sales tax, takes home ₹200 and retains ₹220 for improvement and buying of new equipment. He further pays ₹20 as income tax from his income.
Find Raju's contribution to (a) GDP (b) NNPMP (c) NNPFC (d) Personal income (e) Personal disposable income.
(a) ₹500 (b) ₹450 (c) ₹420 (d) ₹200 (e) ₹180
Raju is a firm and a household in one person. The sum forces you to see that the same ₹500 becomes a smaller and smaller number as you strip out wear and tear, the government's indirect take, the part retained in the business, and the government's direct take. Every aggregate in this chapter is one of those strips.
Calculate national income by (i) the income method and (ii) the expenditure method (₹ crore):
| (i) Compensation of employees | 900 | (vii) Private final consumption expenditure | 1,400 |
| (ii) Rent | 150 | (viii) Government final consumption expenditure | 350 |
| (iii) Interest | 100 | (ix) Gross domestic fixed capital formation | 480 |
| (iv) Profit | 250 | (x) Change in stock | (−) 20 |
| (v) Mixed income of self-employed | 400 | (xi) Net exports | (−) 30 |
| (vi) Net factor income from abroad | (−) 20 | (xii) Consumption of fixed capital | 180 |
| Net indirect taxes | 200 | National debt interest | 60 |
National income = ₹1,780 crore by both methods.
The agreement is the check. If your two answers differ, you have either made an arithmetic slip or wrongly included a transfer payment / intermediate item — go back and find it before moving on. Never write two different national incomes.
We have measured the flow. Now: what is it flowing in?
Every arrow in the circular flow is a money payment. But where does that money come from, who is allowed to create it, and what happens to the whole circle if there is suddenly more or less of it? Chapter 3 opens the machine that supplies the medium in which everything you have measured is denominated.