1. Chapter 2Chapter 2 Gross Domestic IncomeGross Domestic Income (GDI) and(GDI) and Gross Domestic ProductGross Domestic Product (GDP(GDP((

2. The four-sector circular flow model describesThe four-sector circular flow model describes the operation of the economy and the linkagesthe operation of the economy and the linkages between the main sectors in the economy.between the main sectors in the economy. The four -sector model is based on dividing theThe four -sector model is based on dividing the economy into four sectors as follow;economy into four sectors as follow; 1. Individuals1. Individuals (house holds)(house holds) CC 2. Businesses2. Businesses II 3. Government3. Government GG 4. International Trade4. International Trade ( X-M )( X-M )

3. The circular flow of incomeThe circular flow of income:: The circular flow of income: implies that every dollar spent by someone for purchasing is considered an incomeincome for someone else; This income is also representing the value of the good or service. Therefore, a dollar of expenditurea dollar of expenditure = a dollar of income = value of the good or service = production value.

4. Illustration of the circular flowIllustration of the circular flow of incomeof income:: To illustrate the circular flow of income, we assume initially that we have a simple economy that consists of two sectorstwo sectors; Business sector and the individuals sector assuming that all the individuals sector income is spent on consumptions goods and services the figure below illustrates this concept where there is a cash flow between the individuals

5. Sum of all finalSum of all final goods and servicesgoods and services = GDP= GDP BusinessesBusinesses II Production ElementProduction Element returns = nationalreturns = national incomeincome HouseholdHousehold IndividualsIndividuals CC Wages + salaries+ capital return+ rentsWages + salaries+ capital return+ rents Final goods and services 2 4 3 Circular flow for income in two sectors economyCircular flow for income in two sectors economy

6. Explanation of sectors processesExplanation of sectors processes:: 1. The individuals sector supplies the business sector with all production factors such as labor , capital and natural resources 2. The business sector uses the production factors in the production process, so they produce goods and services which the individuals sector use for consumption.

7. 3. For business sector to receive the production elements services from the individual sector, the individual sector receives returns, these returns are represented in wages, salaraies, return of capital, retrun on investment, land rental (natural resources). * All of these retrurns or incomes are called local income.local income.

8. 4. The individuals sector buys its needs and services that the business sector produce and pays in reurn for these needs an income (local income), the sum of these final goods and services is represented by the Gross Domestic Product GDP and this is illustrated in the previous figure and also illustrates the total expenditure that consists of the consumer spending for the individual sector in this simple economy.

9. Therefore, we have a cash flow from once sector that is met with a cash flow with the same value from another sector. GDP from goods and services that were produced by the business sector through the production elements that had income, which means the production has generated income, these incomes have been spent on the GDP from its different goods and services as illustrated below.

10. To be more realistic, we have to take into account the other sectors of the macroeconomics such as the government sector and the external world (imports & exports). In addition to business sectors and individual sectors. This sictualr flow for income is illustrated by the new figure below. In this figure we notice, that the individual sector does not spend its income on consumption.

11. The channels of Individual SectorThe channels of Individual Sector incomeincome A- Goods and services consumption which means the Private Consumption Expenditure and its value goes directly to the business sector (arrow 1)

12. B-B- SavingsSavings:: it remaining unspent part of the income for the purpose of spending in the future or may be invested, therefore, this savings would find its way to the financial market (banks, saving institutions, etc.) whose task to gather all the savings and make it available for investors in the form of loans, that is used to purchase investment goods, these goods represent part of 2 as illustrated ( arrow 1) GDP value goes to the business sectors.

13. C. Net Taxes:C. Net Taxes: is the deductable part of the income that goes directly to government to finance its expenditure on goods and services purchased from the business sectors as in (arrow 3). Since the government pays salaraies and payments for seniors and retired people (social security payments or pension) those represent part of the family sector. * To net taxes is calculated by deducting the social security payments from the taxes paid to government

14. D- Imports:D- Imports: the individual sector finally imports the goods and services from outside because they are available nationally and in return, the business sector exports goods and services that are produced nationally

15. Cash flow for a 4 sectors economy (individuals,Cash flow for a 4 sectors economy (individuals, Business, governmental, internationalBusiness, governmental, international(( National income (wages, salaries,National income (wages, salaries, returns, capital, rentsreturns, capital, rents(( Household SectorHousehold Sector CC Business SectorBusiness Sector II FinancialFinancial MarketMarket Government Sector GGovernment Sector G International Trade X - MInternational Trade X - M Private Consumptive Spending (1Private Consumptive Spending (1(( SavingSavingInvestment (2Investment (2(( Net taxesNet taxes Government consumptiveGovernment consumptive spending (3spending (3(( Imports (3Imports (3((Exports (4Exports (4((

16. We notice from the above circular cash flow that the domestic products main spending was by the domestic income which the individual sectors gets Gross Doemstic Income (GDI) = Gross Domestic Product (GDP) Thereofer, we can deduce the meaning and concept of the following GDP, GDI and Total Expecditure.

17. Gross Domestic Product (GDP(: is the sum of all final goods and services that are produced nationally in specific period of time usually (one year)

18. Gross Doemstic Income (GDI(: is the sum of production elements that contributed in the production process (contributed in the GDP) in specific period of time usually (one year). Total Expenditure:Total Expenditure: is the total demand and is represented by the private consumption expenditure, investment consumption, government expenditure, net difference between (exports-imports) in specific period of time usually (one year).

19. Gross Domestic Product (GDPGross Domestic Product (GDP(( Is measured in three different approaches 1. Product 2. Income 3. Expenditure

20. Product ApproachProduct Approach:: This is divided into two methods:

21. A) The final value approach: the country sums up all what has been produced from a final goods and services in a monetary value in a specific period of time usually one year and the sum is the domestic product. Primary and medium goods and services are not included in this GDP Calculation, this approach does just account for the final goods and services. The final good is the one that is purchased for a potential use not for sale or for waste.

22. B) Value added method: Value added =Value added = Production value production needs at every stage of the production stages

23. ExampleExample Product Production Stages Additional Value Wheat 70 70 Flour 130 60 Bread 200 70 We notice that the value 400 200

24. We see that the bread value as a final good = the sum of the added value = 200. However, if we calculate the sales value in the three stages = 400, that would be twice as much as the bread cost and this is a misleading value that leads to a double standard in the Gross Demostic Product. Therefore, the GDP can be calculated as follow: The final value of the good estimated by the market price May also be calculated the sum of the added value to the good (70+60+70 = 200) and the two values are the same

25. 2-Income approach: This approach sums the following four factors: a. Salaries and wages: for all employed in the state, whether in the private or public sector b. Profit and interests: such as companies profits and bank interests c. Rentals: includes all rentals in the state d. Small business incomes: such as warehouses, supermarkets and restaurants

26. Net National Income =Net National Income = wages and salaries + profits and interests + rents + small businesses owner income Gross Domestic Product with Market Value: Net national Income + indirect taxes + amortization of capital subsidies on production

27. 33..Spending MethodSpending Method:: Using this method, we add 4 types of spending: 1- Private consumption spending ( C ) 2- Investment Spending ( I ) and that includes two elementsand that includes two elements Capital goods such as machines and buildings Change in goods inventory such as primary, medium and final goods * When somebody buys stock, this is considered an investment from his perspective, but that is not considered an investment from the societys perspective because it is a process of ownership change.

28. 3. Government Spending: ( G ) includes all government needs of goods, furniture and different materials for hospitals , schools , universities and any requirements for society.

29. 4. External world Sector ( X-M ) This sector consists of imports and exports, and this sector equal export import. GDP (by this method)= Private consumption Spending (C)+ Investment Spending (I ) government spending (G) + Net Outside spending (X-M )

30. Gross domestic Product ( GDP ) & Gross National Product ( GNP ) Gross Domestic Product (GNP) = gross national product + net outside production elements returns. Net outside production elements returns = is the difference between what comes in the state (+) and what goes out of the state (-) Net outside production elements returns = gross domestic product - gross national product.

31. Example: If all income from outside to society is = 800 Million, and all the income that goes out the society is = 1000, and the ( GDP )= 6500 Million, now calculate the GNP. Solution: GNP = GDP - Net outside production elements returns Net outside production elements returns = 1000-800 = - 200 Gross national product (GNP) = 6500-200 = 6300 Million

32. Other measures for income and product: Important rules:Important rules: 1. Gross national product ( GNP) = net national product + capital amortization 2. Net national product ( NNP ) = Gross national product capital amortization 3. Personal income ( PI ) = net national income retirement financial payments taxes on profits indistributed profits + social security payments 4. Disposable personal income ( DPI ) = personal income direct taxes on income 5. Disposable personal income ( DPI ) = consumption + saving

33. 6. Consumption ( C ) = Disposable personal income saving 7. Saving = disposable personal income consumption 8. Disposable personal income = personal income personal taxes (direct) 9. Personal income = disposable income + direct taxes

34. 10. Gross domestic product (GDP) = net Domestic product + capital amortization 11. Net domestic product ( NDP )= gross domestic product capital amortization 12. Capital amortization = gross domestic product net gross product 13. Gross investment = net investment + capital amortization 14. Net Investment = gross investment capital amortization 15. Capital amortization = gross investment net investment

35. Example 1: assume that you have the following dataassume that you have the following data:: Retirement paymentsRetirement payments 40 Rentals 24 Capital amortization 180 Indirect taxes 163 Family consumption 1080 Gross investment 240 Taxes on profits 65 Wages and salaries 1028 Undistributed profits 18 Government spending 365 Exports 17 Social security payments 20 Imports 117 Direct taxes 40 Distributed profits 117 Small business owners income 97

36. Calculate the following: 1. Gross national product using the income and spending methods 2. Net national product 3. Personal income 4. Saving

37. Solution: a. Gross national product using the spending method = C + I + G + (X M ) 1080 + 240+ 365 + ( 17- 10) = 1692 Million b. Gross national product (using the income method) = net national income + capital amortization + indirect taxes ( net national income = wages and salaries + distributed profits + rentals + small business owners income ) = 1028 + 117 + 65 + 18 + 24 +97 = 1692 Million

38. c. Net national product = gross national product capital amortization = 1692-180 = 1512 Million d. Personal income = net national income retirement payments undistributed profits taxes on profits + social security payments = 20+65-18-40-1349 = 1246 Million e. To get the saving, we should calculate the disposable income Disposable income = personal income direct taxes = 1246-40= 1206 Million (M) Savings = disposable income family consumtion sector = 1206-1080 = 126 M

39. Example 2 : assume that you have the following dataassume that you have the following data:: Distributed profits 13 Gross Investment 46 Indirect taxes 22 Exports 9 Direct taxes 38 Disposable income 190 Imports 12 Private savings 10 Government consumption 84 Retirement payments 23 Capital amortization 52

40. Calculate the followingCalculate the following:: 1- Gross national product (DNP) 2- net national product (NNP) 3- net national income (NNI) 4- personal income ( PI )

41. SolutionSolution:: Gross national product ( GNP ) = C+ I + G + ( X-M ) We need to calculate the family consumption which is C = disposable income savings = 190-10 = 180 M Gross National Product (GNP) =180 + 46 + 84 ( - 3 ) = 307 M Net National product = GNP capital Amortization = 307-52=255 NNI = NNP indirect taxes = 255-22 = 233 Personal income ( PI ) = disposable income + direct taxes = 190+38=288

42. Monetary National Product & Real National Product Monetary National ProductMonetary National Product is the sum of all final goods and services that have been produced by current prices

43. Real National ProductReal National Product Real National ProductReal National Product is the sum of all final goods and services that have been produced by fixed prices. The national product is the sum of all values of final goods and services that is produced in a certain period of time. However, the national product inflates from one year to another because the prices of goods and services increase from one year to another.

44. Example: let us assume that the national product for 2000 was 1000 Million and in 2001 was 1300 Million dolar, even though the final process for the final goods was fixed in these two years, the national product has increased from 1000 to 1300 Million. The reason was increasing the prices in 2000 therefore, the national product value was inflated and thus the two years cant be compared. To overcome this problem, we have to exclude the effect of change in prices in these two years using the price index numbers.

45. Price Index Numbers: There are many types of price index numbers such as price index number for consumers, wholesale prices, and retail process and so on. Simple Index Number: assume that we have three commodities whi are materials. Flour, and pencils

46. Table 2-2 Commodity Primary Year 100% Price in 2000 Comparison Price in 2005 Materials (Meter) 2 3 Pencils 1 3 Flour (Kgm) 1 2

47. To find the simple index number,To find the simple index number, we do two simple thingswe do two simple things:: 1. First Step1. First Step we get the price ratio in 2005 (compared year) to year (2000) (primary Year) = Materials Priec in 2005/Materials Price in 2000= 3/2, 3/1, 2/1 = 1.5, 3, .5 Materials = 1.5 , pencils = 3, flour = 2

48. 2. Second step we get the average for the three ratios are as follows: The simple index number = [2+3+1.5] / (3) *100 = 216% Since the index number for the primary year is 100%, then the increase percentage in the compared year is 216-100 = 116%. If the result was less than 100 as 80 for example, the price would decrease more in 2005 relative to 2000 by 20%.

49. The weighted index numberThe weighted index number One of the disadvantages of the simple index number that it equalize the relative significance of different goods, even though of its various significance for individuals. The family for example needs a daily amount of bed but may need the same for pencils. For example, if we give the materials a weight of 15%, pencils 5%, and flour 80%, in order to have a total weight of 100%.

50. Table 2-3Table 2-3 Commodities (1) Price in 2000 in dollars (2) Price in 2005 in dollars (3) Weights (4) Primary X Weights (5) Comparison X weights (6) Materials (m)Materials (m) 2 3 15 30 45 PencilsPencils (Dozen)(Dozen) 1 3 5 5 15 Wheat (kgm)Wheat (kgm) 1 2 80 80 160 100 115 220

51. StepsSteps:: 1. Allocate a weight for every commodity in the family budget, column (4) 2. Multiply the commodity price for the primary year and the comparison year in its weight and we get column (5), and column (6) 3. Find the sum of column 5 & the sum of column 6

52. 4. The sum of column 6 is divided by the sum of column 5 and multiplied by a 100 and we get the weighted index number for prices. The weighted price index = (220/115) x100 = 191% The percent increase in prices = 191-100 = 91%, we see that this result is smaller than that which we got in the simple index number in 116% and that because an appropriate weight has been given to each commodity.

53. The Index Number for Prices using Lasbeer Method Table (2-4( Commodity (1) Primary year, price in 2000 in dollars (2) P Purchased quantity (3) Q The compari son year Price x quantity (4) PQ Price in 200 5 (5) P Purchased quantit y (6) Q Price x Quant ity 2005 PQ Materials (m) 2 20 40 3 20 60 Pencils (dozen) 1 10 10 3 10 30 Wheat (kgm) 1 50 50 2 50 100 Sum 4100 4190

54. The index number for prices using Lasbeer method = (190/100)x100 = 190% The percent increase in prices in the comparison method in 1406 against the primary year is 2000=190-100=90% Note: when choosing the primary year, it has to be a normal year where increase or decrease in prices should not be very high so that the value for the index number is not affected. After figuring out the index number, we find the real national product. The real domestic product = (the national monetary product/ price index number )x100 The real domestic product = (38000/190)x100 = 20000 Million

55. Example 1 If you have the national monetary product and the index numbers, calculate the real national product: YearYear The domestic monetaryThe domestic monetary productproduct Idex number forIdex number for pricesprices 2000 4000 100 2001 6000 120 2003 10000 200 2005 12000 220

56. The domestic real product = (the domestic monetary product / index number for prices for the same year ) x 100 = 4000 Million The domestic real product for 2000 = (4000/100)x100 = 4000 Million The domestic real product for 2001 = (6000/120)x100 = 5000 Million The domestic real product for 2003 = (10000/200)x100 = 5000 Million The domestic real product for 2005 = (12000/220)x100 = 5454.5 Million The domestic monetary product: The domestic monetary product = (the real domestic product x the index number )/ 100

57. Example 2 If the real domestic product for a certain year is 5000, and the index number is 120, calculate the monetary product? The domestic monetary product = (120x5000)/100 = 6000 Million

58. Example 3: if the domestic monetary product is 6000 and the real product for the same year is 5000 , ohw much is the index number for prices for the same year? The index number = (6000/5000) x100 = 120

59. Important NotesImportant Notes:: 1. If the index number for the comparison year is greater than the index number for the primary year, then the real product is smaller than the monetary product. 2. If the index number for the comparison year is smaller than the index number for the primary year, then the real product is greater than the monetary product. 3. If the index number for the comparison year =100, then the real product and the monetary product are going to be equal.

60. Domestic product reducerDomestic product reducer This is different from the other index numbers in that it takes into consideration the capital commodities investment in addition to the consumption goods and services. The real domestic product using the lowering method = (monetary doemstic product / doemstic product reducer) x 100

61. Example 4Example 4 If the monetary doemstic product (MDP) for a certain country in 1980 was $20,000 billion and the domestic product reducer (DPR) for the same year was 200. Calculate the real domestic product (RDP) for this country in that year? RDP = (20000/200)x100 = $10000 billion DPR = (MDP/RDP)x100 = (20000/10000)x100 = 200% MDP = (RDPxDPR)/100 = $20000 billion

62. Significance of calculating theSignificance of calculating the Domestic ProductDomestic Product Disadvantages of calculating the domestic products are as follow: 1. Many data are required to get to the sum of all the final goods and services produced by the state which lead to possible errors 2. In most cases, it is hard to get the same value for domestic product, if we follow the added value and the final goods values because of measurement errors and inaccuracy

63. 3. A lot of services are not accounted for when calculating the domestic product such as the services offered by the house wife in her household or the doctor for his family 4. Many factors that gets in the calculation of the domestic product are estimated such as the consumption of the farmer for some of his products or capital consumption and these estimates are not accurate.

64. Advantages of knowing the significance of the Domestic Product: 1. Understanding these calculations summarize the economical activities that the state has implemented in one year 2. Understanding these calculations calrify the returns of the production components in one year. 3. Calculations of the doemstic product are considered the most important tools for analysis for designing economical plans, and that help forecast the future properly

65. Cautions when using the domesticCautions when using the domestic products values are as followsproducts values are as follows:: 1. Avoid using these values as a indicator for economical welfare in the state 2. Caution should be exercised when comparing the monetary doemestic product from one year to another in realizing the whether the state is back warding or forwarding. 3. Caution should be exercised when comparing the domestic product among different countries so that the purchasing power for the currency in every country has to be taken into consideration.

66. THE END