GDP and inflation

Question 1

what is GDP

Answer 1

gross domestic product

measure of market value of the output of the economy in a given period

Question 2

Total spending on domestic products - measuring GDP

Answer 2

spending by households, firms, the government and the residents of other countries on domestic products

Question 3

Total domestic production - measuring GDP

Answer 3

= value of output minus the value of all inputs

Question 4

Total domestic income - measuring GDP

Answer 4

wages, profits, self-employed income, taxes received by the government

Question 5

Circular flow model

Answer 5

Households provide labour force for firms

firms provide goods and services

value added by firms = income

households buy the goods and services

Question 6

Exports

Answer 6

goods and services produced in the country and sold to households, firms and govts. abroad so included in GDP

Question 7

Imports

Answer 7

goods and services produced in other countries so not included in GDP

Question 8

How do we incorporate government?

Answer 8

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)

Question 9

GDP equation

Answer 9

= consumption + Investment + government spending + Trade balance (aggregate demand)

Question 10

Consumption

Answer 10

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

Question 11

Investment

Answer 11

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

Question 12

Government spending

Answer 12

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

Question 13

Trade balance

Answer 13

= Exports - imports

surplus if positive, deficit if negative

Question 14

Shortcomings of GDP

Answer 14

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

Question 15

Inflation

Answer 15

an increase in general price level in the economy, usually measured over a year

Question 16

Inflation trends

Answer 16

upward spikes in periods of economic crisis

general downward trend worldwide since the 1970s

tends to be higher in poorer countries

Question 17

Ways to measure inflation

Answer 17

consumer price index (CPI)

GDP deflator

Question 18

CPI

Answer 18

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

Question 19

GDP deflator

Answer 19

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

Question 20

Business cycle

Answer 20

alternating periods of positive and negative growth rates

Question 21

Recession

Answer 21

period when output is declining or below its potential level

Question 22

what is the economy potential level?

Answer 22

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

Question 23

why do we care about business cycles?

Answer 23

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

Question 24

Okun’s Law

Answer 24

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)

Question 25

Okun’s law equation

Answer 25

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)

Question 26

Should we care about unemployment?

Answer 26

it’s correlated with higher stress levels

but correlation isn’t causation

Question 27

causation vs causality

Answer 27

reverse causality is when A affects B but B also affects A

omitted variable is when C also affects A and B