7 Gross Domestic Product (GDP) and Inflation Flashcards
What is GDP?
1.Market value of
2.Final Goods and Services 3.Produced in a country (domestic) in a
4.Given period of time (yearly basis)
Output method (market value of output) to calculate GDP
MARKET Price x Quantity (Value of each product)
Add all to form GDP
OR Total spending for Final goods - Value of Imports
What is a capital good?
A long-lived good used in the production of other goods and services eg houses, machines, delivery vehicles
What is Value Added? Formula?
Market value of product - Cost of Inputs purchased from other firms
Four users of final goods?
Households, Firms, Government, Foreigners
3 components of Consumption Expenditure (for households)?
- Durable (car, furniture)
- Non-durable goods (food, clothing)
- Services (education, taxi rides)
3 components of Investment (by firms)?
- Business fixed investment (new capital goods like PPE)
- Residential investment (new homes)
- Inventory investment (value at eoy - beg)
(Financial investment like bonds and stocks not counted in GDP - does not produce products to capture investment.
Car counted as consumption not investment - value depreciates)
What do government purchases exclude in GDP?
Transfer payments (receives no current goods or services) eg giving out social security and vouchers
What are Net Exports? (for foreigners)
Exports - Imports
(goods and services produced domestically and sold overseas - buying from overseas so not included in GDP)
*The balance are inventory (add value in inventory INVESTMENT)
What is the GDP Expenditures Equation?
Y = C + I + G + NX
GDP = Consumption + Investment + Government Purchases + Net Exports
3 methods to calculate GDP?
- Output method = P X Q
- Expenditure method - Y = C + I + G + NX
- Income method = Labour income + Capital income
How to calculate Income Approach to GDP?
GDP = labor income + capital income
labor income - wages, salaries, benefits, incomes of self-employed
capital income - physical capital (machines + profits) and intangibles
Why does GDP change over time?
Prices change & quantity of output changes
Adjusting for price changes:
- Compare GDP for diff years to see how much output changed, HOLD PRICES CONSTANT - outcome is called real GDP (if both output & price change - called nominal GDP)
- Expect GDP to be higher over time - more ex, more goods produced due to technology
- If produce more OUTPUT - economic growth - good
- If GDP is higher cause PRICE increase means inflation - not good
What is Real GDP? What is Nominal GDP?
Real GDP - BASE year price x current year output
Nominal GDP (current dollar value of production) - CURRENT year price x current year output
Will nominal GDP exceed real GDP during inflation (prices increase)?
Yes. Nominal GDP uses current year price while real GDP uses base year price (constant).
Price increase - price used to calculate nominal GDP will be higher
Why is Nominal GDP misleading?
Nominal GDP may exceed real GDP altho it produces less output BUT shows economic growth just cause PRICE increase - current (not base) year price x current year output
Why is real GDP a flawed measure of well-being?
GDP omits and undervalues some goods & services
Only measures MARKET transactions
- omits illegal transactions, volunteer work, household production (not counted in GDP - may look poor but actually self-sufficient in poorer countries since grow and consume own crops)
Omits value of: (all these affect well-being but not captured in GDP)
1. LEISURE
2. INTANGIBLE PEOPLE VALUE (crime rates, traffic congestion)
3. UNDERGROUND ECONOMY (unreported legal, illegal, casual labor paid in cash like tutoring)
4. ENVIRONMENTAL QUALITY (produce more output but cause pollution)
5. INCOME INEQUALITY
Formula for GDP per capita? (WELFARE MEASURE)
GDP/population
Shows: STANDARD OF LIVING
- material standard of living (more goods and services - more consumption)
- health and life expectancy
- education
What is CPI (Consumer Price Index) and its formula?
A measure of COST OF LIVING during a particular period (change in consumer prices)
Current year cost / base year cost
(Cost of a STANDARD BASKET of goods and services. Base year for CPI normally changes every 5 years)
Eg base year (2013) cost $680
2014 cost $850
CPI = 850/680 = 1.25
Base year CPI alw 1
Cost of living in 2014 is 25% higher than 2013 (inflation rate)
What is a price index?
Measures average price of GIVEN YEAR’S cluster of goods and services relative to the price of the same goods and services in a BASE YEAR
Depending on purpose:
- CPI - cost of living
- Producer price index - resources price
- Import/ export price index - traders
What is a GDP deflator? What is its formula?
Measures prices of goods and services included in GDP
(Nominal GDP/ Real GDP) X 100%
What is rate of inflation?
Annual % Change in price level (CPI)
If negative - deflation
How to adjust for inflation? (Compare values over time)
DEFLATING NOMINAL qty converts it to a REAL qty (remove effect of price changes)
- Divide nominal qty / price index (CPI)
^for each year, can compare $ that has more purchasing power in which year
What is Real Wage? Formula?
Wage paid in terms of purchasing power
Real wage = Nominal wage / CPI
- Nominal wage - how much dollars u earn
- Real wage - how much goods and services u can buy with ur money
What does indexing do?
Increases a NOMINAL qty each period by the % increase in a specified price index
- prevents purchasing power of nominal qty from being eroded by inflation
2 biases of CPI
- Quality adjustment bias
(does not measure quality change) - Substitution biases
(CPI uses FIXED basket of goods and services, but consumers will not buy same qty when price increases - will switch to substitutes - failing to account for substitutes overstate inflation)
What is noisy prices?
Buyers & sellers cant easily tell whether
- relative price of good is increasing or
- inflation is increasing the price of the good
response to changing prices is slow and costly since have to gather information
What is bracket creep?
Occurs when household is moved into higher tax bracket due to increases in NOMINAL but not REAL income
(Higher tax brackets have higher tax rates)
Earn higher cause of inflation (inc by 10%) - may not be able to compensate higher cost of living (inc by 15%)
Distortion caused by taxes - Does high inflation increase or decrease investment in PPE
Decrease
Capital depreciation allowance encourage purchase of capital goods eg govt allow u to keep $100 every year to buy $1k machine aft 10 years but it may not be $1k anymore
What is the Shoe Leather and Menu Cost?
More frequent, smaller withdrawals cost:
Shoe leather costs - more trips to the bank
Menu costs - updating price changes
What does unexpected redistribution of wealth result in?
If workers’ salaries are not indexed and inflation is higher than expected
- Salaries lose purchasing power
- Employers gain at the expense of workers
What is real interest rate? Formula?
Annual % increase in PURCHASING POWER of financial assets
real interest rate = nominal interest rate - inflation
r = i - pie symbol
(If inflation unexpected and very high, real interest rate might be negative - helps borrowers and hurt lenders - when lend money actually suffer because for a given nominal interest rate, higher the inflation rate, lower the real interest rate)
nominal interest rate - annual % increase in DOLLAR value of an asset
When real interest rate is high, as a lender, do you gain or lose more?
Gain
Higher real interest rate means that your returns retain more purchasing power after accounting for inflation, which increases the value of the interest you receive in real terms.
What is the fisher effect?
The tendency for nominal interest rates to be high when inflation is high and vice versa
