2 Cost of living, production and growth Flashcards
What is the CPI and how is it calculated
Measures overall level of prices of goods and services bought by consumers, computes cost of fixed basket of goods indifferent years - computed by statistical offices
Calculated:
- Fix basket - which prices are most important - then weight them
- Find prices at each point in time
- Compute basket cost - price x quantity
- Always use same basket
- Isolating the effect of price changes - Choose base year and compute CPI using it as a benchmark
- Calculate basket, divide by price of basket in base year and multiply by 100 - index relative to base year - Calculate inflation rate: index 2 - index 1 / index 1 x 100
What is PPI
Producer price index:
- Measures cost of basket bought by firms
- Changes in PPI often useful in predicting changes in CPI - as firms pass on costs, eventually to consume through higher prices
Personal price indices - always relevent but especially nowadays due to inflationary issues and pandemic
CPI can be fairly poor measure of inflation from specific individuals point of view - impact on different individual can vary a lot
What are some of the problems measuring cost of living?
- Substitution bias - some good prices rise more than others. Consumers substitute towards goods relatively less expensive, index assumes fixed basket so can overstate inflation
- Introduction of new goods - greater variety makes £ more valuable, cost of living declines - basket not updated that often
- Unmeasured quality changes - need to adjust prices to reflect change in quality - if a good becomes better its price effectively falls as £ further
- ONS tries to keep up with this via hedonic pricing improvements - Refers to average individual
- National average may not be relevant as basket different to an individuals basket
How does CPI compare to the GDP deflator?
GDP deflator - ratio of nominal to real GDP, reflects prices of all goods and services produced domestically
Retail price index - used before 2003, differs from CPI mainly in terms of basket considered - CPI excludes council tax and mortgage interest payments
GDP deflator and CPI inflation can differ - for example, oil prices rise - CPI goes up more than GDP deflator as oil weighted higher
How do you calculate ethe value of the £ compared to year T?
What is indexation?
Amount in £ today = £ in year T x price level today / Price level in year T
Indexation - automatic correction by law of a £ for effects of rises in the cost of living
- Pensions rise in line with CPI (but not RPI, RPI > CPI so government saes money and people lose out)
What is the rate of growth?
The growth in real GDP per person (or in real/nominal GDP)
Focus on long run trend opposed to short run cyclical movements of the business cycle
- Even small changes in growth can make difference over generations due to compounding - same as with prices, or interest rates
What determines long run economic growth
Proximate causes - reasonably easy to asses
- Also on fundamental causes - the drivers of promixate causes (such as K) such as trade, institutions, etc.
We did all this is Integration I if u wanna look at dat stuff
What is productivity - what are the determinants
Productivity:
- Quantity of goods and services produced from each unit of labour input
- Key determinant of GDP growth, living standards - at least potentially
- Salary increases tend to follow productivity increases
Determinants:
Physical capital:
- Equipment and structure used to produce goods and services stemmed from investments
Human capital:
- Knowledge and skills
Natural resources:
-inputs provided by nature
Technological knowledge:
- Society understanding of best ways to produce goods and services
What is the production function
Generally:
Y = Af(L,K,H,N)
A reflects the level of technology
- Frequently referred to as neo classicaly production function
- Captures relationship between factors and performance
- Increase in K is a proximate cause of growth. When we ask why K grows, this is a fundamental cause of growth
What happens when we raise inputs
E.g. capital investment:
- High savings rate, invest more current resources in production for future use
- Investing more, society consumes less to save more of current income, creates trade off
However, there are diminishing returns to proximate causes e.g. decreasing marginal product of capital - benefit of extra unit of K declines as quantity increases (with other factors held constant)
In long run, higher savings rate means higher investments and capital, but effect diminishes with output
What is the significance of diminishing marginal product of capital?
Creates catch up effect as poor countries tend to have potential to grow faster than richer countries
Why?
- Low productivity means small amounts of investment increase productivity substantially
- China grown faster than Japan despite lower average investment
In rich countries, since there is high productivity additional capital investment has a small effect on productivity
What is the effect of investment in human capital?
Schools, training etc. increase productivity and therefore output/capita
- Government role is public education, subsidising education workers, etc.
Risk of brain dream - people move from poorer to rich countries when educated or to get educated - UK benefited a lot from Greece from this
What is the effect of health and nutrition?
Human capital:
- Schooling and education but also investments leading to healthier population
Healthier workers stronger, smarter, more productive
Fogel found improved nutrition explains about 13 of income growth between 1790 to 1980
What is the effect of research and development
A in the production function
- New ideas and technology made
- Government encourages: grants, subsidies
- Patent systems - increase incentive to undertake R&D as gain rights for their research
- Patents in some cases may lower innovation by stopping other people building on ideas
What are the arguments against investment in R and D?
View is it is useful - so is schooling - as it raises A and H
Argument against:
- Cannot predict technological breakthrough
- Degrees and skills may not be useful in future and be wasted
- Public schooling brainwashing - weird ass point ngl
