GDP and inflation Flashcards
what is GDP
gross domestic product
measure of market value of the output of the economy in a given period
Total spending on domestic products - measuring GDP
spending by households, firms, the government and the residents of other countries on domestic products
Total domestic production - measuring GDP
= value of output minus the value of all inputs
Total domestic income - measuring GDP
wages, profits, self-employed income, taxes received by the government
Circular flow model
Households provide labour force for firms
firms provide goods and services
value added by firms = income
households buy the goods and services
Exports
goods and services produced in the country and sold to households, firms and govts. abroad so included in GDP
Imports
goods and services produced in other countries so not included in GDP
How do we incorporate government?
treat it as another producer - public services are bought via taxes
assume that cost of production captures the value added (since there are no prices)
GDP equation
= consumption + Investment + government spending + Trade balance (aggregate demand)
Consumption
includes goods and services purchased by households
goods are tangible, services are intangible
durable goods such as cars, household appliances are counted as consumption even if it is more an investment decision
Investment
spending by firms on new capital: new machinery and equipment etc
spending on residential structures
inventory is counted as investment: unsold items, raw materials and intermediate goods
Government spending
spending on roads, defence, schools etc
most of it in health and education
includes both central and local government
excludes government transfers (e.g pensions & unemployment benefits) - this is received by households as income so recorded as investment or consumption
Trade balance
= Exports - imports
surplus if positive, deficit if negative
Shortcomings of GDP
doesn’t account for the impact of production and consumption on the environment
flawed measure of living standards (not always equally spread out )
government goods and services might be valued more than their production costs
excludes informal care work and housework (done mainly by women) - doesn’t tell anything about inequality, home production not counted
Inflation
an increase in general price level in the economy, usually measured over a year
Inflation trends
upward spikes in periods of economic crisis
general downward trend worldwide since the 1970s
tends to be higher in poorer countries
Ways to measure inflation
consumer price index (CPI)
GDP deflator
CPI
measures the general level of prices that consumers have to pay for goods and services, including consumption taxes
based on a representative bundle of consumer goods (“cost of living”)
inflation = change in CPI
= (CPIt - CPI t-1)/ CPI - 1 x100%
CPI = expenditure of bundle/ expenditure of bundle in base year x 100
GDP deflator
measure of the level of prices for domestic produced output (ratio of nominal to real GDP)
tracts prices components of GDP
allows GDP to be compared across countries over time
we need to measure inflation to compare aggregate variables measure at different points in time
GDP is only measured at current prices
Business cycle
alternating periods of positive and negative growth rates
Recession
period when output is declining or below its potential level
what is the economy potential level?
other definition of recession:
significant decline in economic activity spread across the economy that can last from a few months to more than a year
the decline has to be prolonged and widespread: visible in real GDP, real income, employment, industrial production, and wholesale-retail sales
why do we care about business cycles?
economic agents want to know about these fluctuations in advance
if a recession is forecast, then the central bank would cut interest rates to encourage spending
firms and households want to know these changes in interest rates in advance to plan their spending and investment decision (e.g mortgages)
for the government a recession will increase unemployment implying lower tax revenues and higher spending on benefits
Okun’s Law
changes in the rate of GDP growth are negatively correlated with the unemployment rate
ie if GDP decreases, unemployment increases
we say that unemployment is countercyclical (increases in recessions, decreases in booms)
Okun’s law equation
change in unemployment rate over time
= alpha + Beta (real GDP growth)
alpha = the intercept
Beta = Okun’s coefficient (usually negative
doesn’t always work (in Germany there was no unemployment increase in 2009 crisis)
Should we care about unemployment?
it’s correlated with higher stress levels
but correlation isn’t causation
causation vs causality
reverse causality is when A affects B but B also affects A
omitted variable is when C also affects A and B
