GDP AND OTHER MEASURES OF INCOME

The data of Macroeconomics
Components of GDP are:
1. Consumption
2. Investment
3. Government Purchases and National Defense
4. Exports - Imports
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In 2005 the US GDP =12.5 Trillion, to simplify it let’s compute the GDP per Capita.
GDP per Capita = = $42,123
GDP per Capita measures the amount of expenditure per average American.
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Components of GDP
How the GDP is used?
(1) About 2/3 of GDP ($29,505/person) was spent on consumption.
(2) Investment = $7,095
(3) Government purchases= $7,978 per person, of which $1,981was spent by the federal government on National Defense.
(4) The average American bought goods and services imported from abroad and produce goods that were exported to other nations. (Net Exports= Exports – Imports). Net exports can take positive or negative sign.

When exports exceed imports it takes the positive sign.
When imports exceed exports it takes the negative sign.







(5) The average American earned less from selling to foreigners than he spent on foreign goods. This implies that he imports more than he exports.
The average American must be financed either by:
a) Taking out loans from foreigners.
b) Selling them some of his assets.
The average American borrowed $2,452 from abroad in 2005.
If the reverse occurred, this means that Net Exports has a positive sign, the average American must…
a) lend loans, or
b) Buy assets, for example, investing in the German or the Japanese treasury bills.

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Other Measures of Income
We add or subtract some variable to GDP.
(1)


Gross National Product (GNP)
· We add payments of factor income, such as (wages, profits, rent …) that comes from abroad.

· We subtract payments of factor income that go to the rest of the world, because they do not have the American nationality for example if we are in the US.
· Therefore, GNP = GDP + factor income from abroad – factor income to abroad.
In the US, payments of factor income from abroad approximately equal payments of factor income to abroad.
To Sum up,
· GDP measures the total income produced domestically no matter who earned it residents or foreigners.
· GNP measures the total income earned by residents no matter the place where they earned it.


(2)
EXAMPLE
The difference between GDP & GNP
A Japanese citizen lives in the US, owns an apartment building…,
· The rental income he receives is a part of the US GDP, because it is earned in the US.
· It is not a part of the US GNP because the Japanese do not have the American nationality. It is a factor payment to abroadNet National Product (NNP)
We subtract the Depreciation of Capital; which is the amount of the economy’s stock of plants, equipments, residential structure that wears out during the year.
Thus,
NNP = GNP - Depreciation of Capital
Depreciation is:
· Consumption of fixed capital, and;
· The Cost of producing the output of the economy.

(3) National Income
We subtract the indirect business taxes such as the “sales taxes” because they make a wedge between:
- The prices the consumer pay for goods, and
- The prices the firms receive.
This tax is not revenue to a business firm, because the government takes it back from firms.
v The rationale of subtracting these taxes is that firms do not receive it. They are not a part of the National Income. Thus,
National Income = Net National Product – Indirect Business Taxes. Or,
NI = GNP – Depreciation of Capital – Indirect Business Taxes.
v National Income Accounts divide the National Income into five components depending on the way the income is earned:
1. Consumption of employees = wages and benefits earned by workers.
2. Proprietor income = the non-corporate business such as the small firms.
3. Rental income that the landlords receive.
4. Corporate profits = income of corporations after payments to their workers.
5. Net Interest = the interest domestic firms pay – the interest they receive + the interest earned from foreigners.

(4) Personal Income
Personal income is the amount of income that households and non-corporate business receives.
We need to make three adjustments to move from National Income to Personal Income.
Adjustment No.1
We reduce the National Income by the amounts that corporations earn but do not pay out which are:
a. Retaining earnings, and
b. The taxes they pay to the government.
To do so, we subtract the corporate profits that consists of: (Corporate taxes + Dividends + Retained Earnings), then we add Dividends.
Adjustment No.2
We increase national income by the net amount that government pays as transfer payment.
Net Government Transfers = Government Transfers to individuals – Social Insurance contributions paid to the government
Adjustment No.3
We add personal interest incomeWe include the interest of the households rather than the interest the business pay.
We subtract government interest
We add the Difference
The difference = Net Interest




We add the difference between them because the interest on the government debt is part of the interest the households earn, but is not part of the interest the households pay out.

Summary of the Adjustments that should be done to the National Income to transfer it to Personal Income:
Adjustment No.1
Reducing National Income by subtracting the amounts that corporations earn but do not pay out: (1) Retaining Earnings, (2) the taxes they pay to the government.

To do so,
· Subtract corporate profits
· Add Dividends
Adjustment No. 3
Net Interest = personal interest – government interest
Adjustment No.2
Net Government transfer =
Government transfers to individuals – social insurance corporations.

Therefore,
Personal Income = National Income
- Corporate profits
+ Dividends
+ Government Transfers to individuals
- Social insurance contributions
- Net Interest
+ Personal interest income

(5) Disposable Income
Disposable income is the amount households and non-corporate business have available to spend after satisfying their tax obligations.
We subtract:
· Personal Tax payment
· Certain non-tax payments to the government
Disposable Income = Personal Income – (Personal Taxes and non-tax payment)
v Seasonally Adjusted GDP, the data of GDP and GNP are adjusted to remove the regular seasonal fluctuations.
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Measuring the Cost of Living
The cost of living can be measured by using:
1. The Consumer Price Index (CPI)
It is the prices of the basket of goods and services relative to the price of the same basket in some base year.
ü How consumers measure CPI before using it to measure the cost of living?
- CPI is the overall level of prices.
- Inflation is the increase in the overall level of prices.
How economists measure changes in the cost of living?
o By constructing a CPI, collecting the prices of thousands of goods and services
o Turning the prices of many goods and services into a single index measuring the overall level of prices.
o We compute an average of all prices this approach will treat all goods and services equally.
o We weigh different items by computing a basket of goods and services purchased by a typical consumer.



Summary
ü GDP consists of consumption, investment, government purchases and National Defense, Net Exports = Exports – imports
ü If net exports has a negative sign finance must be made by either loaning from foreigners, or selling the government assets.
ü GNP = GDP + Payment of income factors from abroad – payments of income factors to abroad.
ü Net National Product = GNP – Depreciation of Capital.
ü National Income = NNP – Indirect Business Taxes
ü Personal Income = National Income
plus Corporate Profits
minus Dividends
plus Transfer payment to individual
minus Social Insurance contributions
plus Personal Interest Income
minus Government interest
ü Disposable Income is the income available to households and non-corporate firms to spend after satisfying their tax obligations. = personal income – (personal tax & non-tax payment)
ü Seasonally adjusted GDP to remove the regular seasonal fluctuations.
ü Consumer Price Index is used to measure the cost of living by calculating weaighted average prices of differenet goods and services in one pasket relative to the prices of the same basket in some base year.

Recent Trends in Investment & the Investment Process

This lecture discusses the following points:
1. Recent trends in the investment environment
2. The investment process

1. Recent trends in the investment environment
The investment environment has changed dramatically because of four forces:
1) Globalization
2) Securitization
3) Financial Engineering
4) Information Technology and computer networks

1) Globalization
- Globalization here means that investment is no longer limited to domestic assets, but it extends to foreign markets to invest internationally as well.
- Or simply, it is a tendency toward a world wide investment environment, and the integration of a national capital markets.
The expansion to foreign markets can come through four ways:
a) American Depository Receipts (ADRs)
ADRs are domestically traded securities that represent claims to share in foreign stocks. Or simply it is a claim on a foreign stock by a domestic shareholder.
The broker or “the domestic bank” acts as intermediary by purchasing an inventory of stock from some foreign issuer which always will be “foreign bank”, then the intermediary which is the “domestic bank” issues an ADR that represent a claim to some number of those foreign shares held in inventory.
Advantages of ADR: Allow investors to diversify without foreign currency problems.
Disadvantages of ADR: ADRs are subject to the risk of exchange rate fluctuations.
My comment on how to avoid the disadvantage:
If the government has a tendency toward encouraging this kind of investment, it can hold its exchange rate fixed toward the host country exchange rate. For example $1=LE3 and keeping it as it is fixed.

b) Purchase of foreign securities that are offered in the currency of the domestic country.
c) Buy mutual fund that invest internationally, mutual funds are companies that buy shares on other people behalf.
d) Buy derivative securities with payoffs that depend on prices in foreign security markets.
2) Securitization
- Securitization was first introduced by Government National Mortgage Association. GNMA.
- Securitization means converting illiquid assets (mortgage loans) into marketable securities. These securities aggregate individual home mortgages into relatively homogeneous pools. Each pool acts as backing (financing) for a GMNA pass-through security. Investors who buy GNMA securities receive prorated shares of all the principal and interest payments made on the underlying mortgage pool.
- Securitization of mortgages means mortgages can be traded just like other securities.
Abuse of Securitization
Securitization has been used to allow US banks to unload their portfolios of shaky loans to developing nations. The so-called Brady Bonds were formed by securitizing bank loans to several countries in shaky fiscal condition.
3) Financial Engineering:
Creating a new hybrid asset or a new hybrid security by either:
a) Bundling: combining more than one security into a composite security. Or,
b) Unbundling: Breaking up and allocating the cash flow from one security to create several new securities.
Advantages of Financial Engineering
Such creative engineering of new investment products allows one to design securities with custom-tailored risk attributes.
Question: Financial Engineering creates custom-tailored securities. Comment
Answer: The process of bundling and unbundling is called financial engineering and it is referred to the creation and design of securities with custom-tailored characteristics, Financial engineers view securities as bundles of (possible risky) cash flows that may be carved up and rearranged according to the needs or desires of traders in the security markets.
4) Computer Networks
When talking about the effect of computer networks on the investment environment, we can mention the three important innovations:
a) Online trading: connects a customer directly to a brokerage firm
Advantage:
Online trading can process trades more cheaply and therefore can charge lower commissions.
b) Online information dissemination: vast amounts of data can be cheaply and widely obtained through the internet. Individual investors today can obtain data, investment tools, and even analyst reports that just a decade ago would have been available only to professionals.
c) Automated trade crossing: the networks allow members to post buy or sell orders and to have those orders matched up or “crossed” with orders of traders in the system.
Advantage:
The interference of an intermediary such as securities dealer will be unnecessary because the automated trade crossing will do this job.


2. The Investment Process

Before examining the investment process we have to know that:
- The investor’s portfolio: is simply his collection of assets.
- Asset Classes: are stocks, bonds, real estate, commodities, and so on.
- The composition of one’s portfolio depends on (1) his goal (2) his tolerance to risk.
The investment process consists of three stages:
a) Asset Allocation: the asset allocation decision is the choice among the broad asset classes
b) Security Selection: the security selection decision is the choice of which particular securities to hold within each asset class
c) Security Analysis: security analysis is analysis of the value of securities to evaluate and identify mispriced securities.
Why we do security analysis?
To evaluate and identify mispriced securities. Securities are correctly priced only in Efficient Markets.
Efficient Market assumes that investors process all relevant information about securities quickly and efficiently, that is security price reflects all the information available to investors concerning the value of the security. In this market, there would be neither underpriced nor overpriced securities.
Portfolio’s Management Strategies under the hypothesis of Efficient Markets:
A. Passive Management
Buying and holding a diversified portfolio without attempting to identify mispriced securities.
B. Active Management
Attempting to identify mispriced securities or to forecast broad market trends.

Q: Under Efficient Market, does the investor who adopt the passive management strategy will continue adopting his strategy for ever?
Answer: under Efficient Market hypothesis all securities are correctly priced, so the investors will only set the proportions between each asset classes at the first time he establishes his portfolio, and then this proportion will stay the same because each security is correctly priced. However, if the market conditions do not change the investor’s goals change. We know that the composition of one’s portfolio depends on his (1) degree of risk tolerance that will be held constant under the Efficient Market hypothesis, and (2) his goals which will never be hold constant because it changes over time.

Progress in the Struggle for Meaningful Development: Brazil

How would Brazil’s Development performance be evaluated and future priorities chosen?
The comments presented herein reflect the evolution of the term development by examining the experience of Brazil in Development.
The answer of this question is not as simple as the question is. If this question was imposed at the beginning of the 1950s to the end of 1960s, its answer would depend primarily only on the calculation of the rate of real Gross National Income (GNI). Real per capita GNI as a measure of Economic Development only takes into consideration the ability of a nation to expand its output at a faster rate than the rate of population growth. A little or secondary attention would be paid to problems of poverty, discrimination, unemployment, and income distribution. GDP per capita in the period of 1965-1990 was 1.4%, and for 1990-2000 it was 1.5%. The textbook argues that the period 1965-1980 was a “lost decade of development”. Nevertheless, Brazil’s performance was the best in Latin America.
By the mid of the 1970s and the beginning of the 1980s, if the same question was re-asked, the answer would be definitely different and more complex than just dividing the Gross National Income by the number of population to calculate the per capita GNI. During this period the so-called “Capabilities Approach” of Amartya Sen was introduced in which he argued that economic development can not be merely measured by GNI or by utility as conventionally understood; what matters is not things a person has, but what a person is or what he can do. This shows that priorities started to be given to the non-economic, non-quantifiable, factors such as discrimination, education, health system, and the like. Therefore, to accurately evaluate the development performance of Brazil, a set of non-economic variables should be considered as well as the economic variables.

- Taking into account the above non-economic factors, Brazil ranked 72nd on the UNDP’s Human Development Index, 9 position lower than would be predicted by its income.
- Although the child mortality rate is poor by the standards of comparable countries today, Brazil has made great progress from 1960, when its rate was 159/1000. 10% of children under the age of 5 suffer from malnutrition.
- Primary school completion rate is very low for an upper-middle-income country.
- Approximately 4% of the population are worked children, (7 Million the child labor/175 Million the overall population = 4%). Eradication of child labor was officially declared as a priority.

- Most of the poor in Brazil are black or Mulatto.
- Racism is a crime in Brazil, but no one has ever sent to jail for it.
- Even in the states where the Black constitutes the majority, their representation in the government is rare.


- According to World Bank estimates, in 2000, 25.4% of the population of Brazil lived on less than $2 a day, and 9% with incomes below $1 a day.

To conclude, when planning for or evaluating Economic Development performance, economic and non-economic considerations have to be integrated. Economics is not a value-free area of study. That’s why we may differ when selecting priorities because Economics is a social not an exact science. However, we all agree with what Mahatma Gandhi called for; “the realization of human potential”.

References:
Michael P. Todaro, Stephen C. Smith 2006, Economic Development 9th edition, Chapter 1 , Pearson Education Limited.

Economic Development

1 Traditional Economics and Neoclassical Economics
It is concerned with the efficient distribution of resources, least-cost allocation of scarce resources to reach the optimal growth of goods and services.
2 Economic of Development
Economics of development must deal with the economic, social, political, institutional mechanisms, both public and private, which are necessary to bring about rapid and large scale improvements in the levels of living for the peoples of Africa, Asia, Latin America, and the formerly socialist transition economies.
3 What do we mean by development?
- Development has traditionally meant the capacity of a national economy to generate and sustain an annual increase in its Gross National Income (GNI) at rate of 5% to 7% or more.
- An alternative economic index of the development has been the use of rates of growth of income per capita to take into account the ability of a nation to expand its output at a faster rate than the growth rate of its population.
- GNI per capita = (GNI / Population)
- Real GNI per capita = (monetary GNI per capita – inflation rate)
- Using levels and rates of growth of real per capita GNI.
- Levels and rates of real per capita GNI are normally used to measure the overall economic well-being of a population---how much of a real goods and services is available to the average citizen for consumption and investment.
- Economic development in the past has been typically seen in terms of the planned alteration of the structure of production and employment so that agricultures share of both declines and that of manufacturing and services increases.
- Development until recently nearly always seen as an economic phenomenon in which rapid gains in the overall and per capita GNI growth would either:
I. Trickle down to the masses in the form of jobs and other economic opportunities
II. Or, create the necessary conditions for the wider distribution of the economic and social benefits of growth.
- Problems of poverty, discrimination, unemployment, and income distribution were of secondary importance to getting the growth job done.
4 Sen’s Capabilities approach
- Income and wealth are not ends in themselves but instruments for other purposes.
- The capability to function is what really matters for status as a poor or non poor person.
- Economic growth can not be sensibly treated as an end in itself.
- Development has to be concerned with enhancing the lives we lead and the freedoms we enjoy.
- What matters is not things a person has, but what a person is or what he can do.
- Freedom of choice or control of one’s own life is itself a central aspect of most understandings of well-being.
5 Sen defined five sources of disparities between measured real income and actual advantage:
I. Personal Heterogeneity
II. Environment Diversities, (heating, clothing requirement in the cold)
III. Variations in social climate such as the prevalence of crime and violence and social capital
IV. Differences in relational perspectives
V. Distribution within the family
6 Three core values of development
I. Sustenance: The Ability to Meet Basic Needs
All people have certain basic needs without which life would be impossible, these life-sustaining basic human needs include food, shelter, health, and protection.
When any of these needs is absent or in critically short supply, a condition of absolute underdevelopment exists.
II. Self-esteem: to be a person
A sense of worth and self-respect, of not being used as a tool by others for their own ends.
III. Freedom from servitude: to be able to choose
Freedom involves an expanded range of choices for societies and their members together with a minimization of external constraint in the pursuit of some social goal we call development

Essentials of Investments Lectute #1

1. What do we mean by investments?
It’s an area of study concerned with how investors make their decisions in securities issued by government and other organizations, how investors make their decisions in securities and other assets.
Investors are individual investors, and institutional investors ( such as Banks).
2. Is it important to study investments?
Yes, to make well informed investment decisions.
3. Why do people invest?
People invest to make money, money does not fall from heaven, they invest to accumulate wealth and to achieve certain goals, and all of us are looking for a better life.
4. What is the difference between Saving and Investment?
Saving is deferring consumption by cutting aside part of one’s income to be used in the future.
Investment is creating new productive resources.
5. Is saving not important?
No, savings are fund available to investors at banks. Some people have good investment ideas but they do not have funds to launch their investments projects. So Banks play here as an mediator that matches between people who have funds, but do not have investment opportunities, and people who do not have funds but do have investment opportunities.
6. Can we consider a depositor an investor? (the economic viewpoint) See point 10
From an economic viewpoint, Saver is someone who deposits his money at a bank. Investor is the person who borrows to invest, (the borrower).
7. We have two types of assets: Real assets, (physical or tangible assets). Financial assets which are claims such as securities.
8. Stocks and Bonds are examples of securities.
People who invest in stocks are risk-tolerant, and those who invest in bonds are conservatives.
- Stocks do not specify fixed payments, and the stockholders are called residual claimant.
- Bonds specify periodic fixed payment.
9. Stocks and Bonds are issued in the primary market by business organizations to raise capital to invest in real assets (the physical or tangible assets).
10. The financial viewpoint:
It views people who save in banks as investors.
11. Are they related, the financial and the economic viewpoints?
- The economic viewpoint refers to the direct investment in assets, while the financial refers to the indirect way of investment in assets.
- The financial viewpoint is more popular.
12. Definition of investment
- Investment is the current commitment of money or other resources in the expectation of reaping future benefits. (The text book definition)
- Professor’s Al-Badwi Explanation:
· In the popular sense, it is the purchase of an asset whether a new or outstanding, physical or financial with the purpose of earning future return. Depending on our appreciation of the asset, the return is determined.
· This return should compensate us for, at least, three factors:
1- The passage of time (deferring consumption)
2- Inflation (decreasing the purchasing power)
3- Uncertainty (risk)

13. Dr Badwi comments that investment is not a game, and one should prepare himself for gain or loss otherwise he will face health problems.
14. How can we classify financial markets?
- Primary Market: are markets where financial assets (securities) are issued for the first time.
- Secondary Market: are markets where second-hand securities can be traded.
15. Which is more important than the other?
Primary market is important for the economy because it creates new productive resources. That’s why it should be active, whereas a secondary market is also important for the existence of the primary market to make it more attractive by giving an opportunity to those who face liquidity problems to sell their securities and bring their money back.

Why Economics For All

Why Economics for All?

Are you interested to know why that rise in the price of steel? Why at some places the rent for apartments or land is higher than that at other places? Why African countries, even though their abundance in natural resources, are characterized with low standard of living? The answers of these questions and more are answered by your study of Economics. Understanding Economics is the weapon to fight poverty. This statement is as true on the individual level as it is on the country level. Economics equips us with the tools that will help us in how to utilize our resources efficiently and effectively.
I think that we all have an economist inside us, we all make many economic decisions. Each one of us decide how to spend his income, how much to save, and how to invest the savings. We need to develop the economist inside us, and there is no a development tool better than the study of Economics as it provides us with a clear perspective of how best to make these decisions.
As we all are citizens in different communities and countries, we need to be good corporate citizens, knowing what is going on around us, understanding what politicians are saying during election campaigns, how taxes are determined, why we pay taxes. The study of economics will allow us to judge the effectiveness of economic policy, especially when voting for some one. The last thing I want to say is that Albert Einstein once said: “the whole of science is nothing more than the refinement of everyday thinking”. I am sure you, friends and colleague, will find economics interesting as I found it three years ago when I started my first course of economics.