Aggregate supply block

To achieve the aim of this study easily, the aggregate supply, the GDP component, will be divided into the production from the oil sector (XOIL), and the production from the nonoil sector (XNOIL). The aggregate supply block consists of one behavioural stochastic equation, which is the real non-oil gross domestic product, (XNOILR), and one identity, which is the real gross domestic product (GDPR).

139 Challen and Hagger (1983), as previously noted, have shed light on econometric modelling by exploring varying types of econometric models and the review of these models has clarified that there are two dominant approaches representing the theoretical foundation of the modelling process. First, there is the aggregate demand, which is based mainly on Keynesian economics as a theoretical ground; the Keynesian view, in this regard, stresses that the increase in aggregate demand will eventually lead to an increase in income and employment (Matlanyane, 2005). The second approach is to aggregate supply and this depends on the theoretical foundation of the classical and neoclassical economic theory, as well as on the so-called supply-side economics8F

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, which are defined in their simplest mode as ‘‘the application of price theory -so-called microeconomics- in the analysis of problems concerning economic aggregates - so-called macroeconomics’’ (Ture, 1982; 11).

In fact, the supply-side economics’ view originally stems from the classical and neoclassical economic theory (Raboy, 1982; Ture, 1982). However, it differs from those theories in being reliant on the role of public economic policies and it attaches great importance in stimulating the available economic potential (Ture, 1982) whereby the fundamental argument acknowledges that ‘‘fiscal policy affects incentives to invest, economic efficiency and economic growth by way of changing relative prices’’ (Matlanyane, 2005; 38).

This school of thought emerged in the economic literature after the conventional Keynesian theory doctrines failed to introduce an agreeable exegesis to the contradiction in the stagflation phenomenon9F

10

. This stream of thought advocates that a government should reduce the barriers that confront the private sector by

9 For more details about supply side economics, see these excellent articles: Ture (1982), Raboy (1982), Lucas (1990) and Phelps (1991).

10 Actually not only Keynesian theory which failed to explain the phenomenon of stagflation, but also the monetarist school failed, in turn, to provide an appropriate interpretation for this phenomenon: see in this regard, (Tsoulfidis, 2010; 325-326), but there is a new exposition for this phenomenon by the Keynesian economists for more details see , (Zhang, and Clovis, 2010).

140 creating a favourable environment for investment and production and making it more flexible by reducing regulations which will enable the private sector to play its ascribed role. According to the supply side economists, the barriers are represented in the tax component of a fiscal policy, which is imposed by a government on income and capital (Raboy, 1982).

It is worthwhile noting that the policy implication of this school ‘‘focus on the view that increased saving is necessary for increasing capital formation that can raise productivity and hence economic growth’’ (Matlanyane, 2005; 38).

With regard to the practical side of supply-side economics, there are two approaches: the production function approach and the cost structure approach. The first approach focuses on the relationships between the outputs and inputs. In contrast, the main concern is directed, on the one hand, on analysing the demand and supply of economic resources and, on the other, as to how to incorporate the technology factor to the function; the second approach is concerned with the harmony between the factor costs and the prices. In this regard, it should be noted that there is no specific difference between the two approaches and, in reality, they are treated as identical to each other. However, the process of selecting either of these approaches depends on a number of factors; the most important are the goal of the study and the method that is used in the analysis growth (Matlanyane, 2005).

The measurement of the GDP could be reached in the economy as a whole from the supply side by using the production method or from the demand side by using the expenditure method. Likewise, the analysis of the sectoral supply sector could be achieved by using variables from each of them, or by the mixing of the two sides’ variables (Abohobiel, 1983).

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4.2.3.1 Real non-oil gross domestic product (XNOILR)

The aggregate supply block in this study is divided into two separate sectors namely the production from the oil sector (XOIL) and the production from the nonoil sector (XNOIL). The production from the nonoil sector can be represented by a behavioural equation; the explanatory variables are selected from the two sectors mentioned above and can be described as follows:

XNOILR = F (KNOILR, KNOILR_1, IMCAPR, IMCAPR_1, CRNOILR)

Where:

XNOILR = Real non-oil gross domestic product,

KNOILR = Non-oil real capital stock,

KNOILR_1 = Lagged non-oil real capital stock,

IMCAPR= Real imports of capital goods,

IMCAPR_1 = Lagged real imports of capital goods, and

CRNOILR = Bank credit to non oil sector

4.2.3.2 Real gross domestic product (GDPR)

The real gross domestic product is treated as an identity in this model as follows:

GDPR= XNOILR+ XOILR

Where:

GDPR = Real gross domestic product,

XNOILR = Real non-oil gross domestic product, and,

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