Economic Indicators: GDP, Inflation, and CPI

Posted on Nov 6, 2024 in Economy

Economic Indicators: GDP, Inflation, and CPI

Unit 9: The Economic Indicator

1. The Macroeconomic Perspective

Macroeconomics examines the economy as a whole, unlike microeconomics, which focuses on individual markets, prices, and products.

Keynesian Economics

John Maynard Keynes, a leading 20th-century economist, established the foundation of modern macroeconomics with his book, “The General Theory of Employment, Interest, and Money” (1936). Keynes identified three crucial questions for economic stability:

  1. Why do production and employment sometimes decline, and how can unemployment be reduced? Economies experience cyclical fluctuations known as economic cycles.
  2. What causes general price increases (inflation), and how can it be controlled? Price and sales are key market signals.
  3. How can a country’s economic growth rate be increased? Long-term national prosperity is a primary goal of economic policy.

Economic policy objectives center on production, prices, and employment. Other important considerations include public finances, the balance of payments, and poverty reduction. Key economic indicators include:

  • GDP: Measures economic output.
  • Consumer Price Index (CPI): Tracks price changes, indicating inflation.
  • Activity rate, unemployment, and employment: Reflects a country’s workforce participation.

2. Production: Gross Domestic Product (GDP)

GDP is the monetary value of all final goods and services produced within a country’s borders over a specific period (usually one year).

Features of GDP
  • Follows a monetary pattern.
  • Only includes declared activities.
  • Considers only final goods’ value.
  • Measures production within a country’s borders.
  • Refers to production within a specific period.
Methods for Calculating GDP
  • Expenditure Approach: GDPmp = C + I + G + (X – M)
  • Value-Added Approach: GDPcf = VAa + VAb + … + VAz
  • Income Approach: GDPcf = L + B + S + S
Real GDP vs. Nominal GDP
  • Nominal GDP uses current market prices (P · Q).
  • Real GDP uses base-year prices (Q · Pricebase year).
Limitations of GDP
  • Excludes undeclared activities (shadow economy).
  • Omits non-monetary activities (housework, volunteering).
  • Ignores externalities (social costs and benefits).
  • Doesn’t directly measure wealth distribution, though per capita GDP or GNP provides an average.

National Accounts provide a comprehensive set of indicators for economic activity within a country.

  • GDPPm = Consumption + Investment + Government Spending + (Exports – Imports)
  • GDP = GNPpm + RFne – RFr
  • PNNpm = GNP – Depreciation
  • RN = PNNcf = PNNpm – Indirect Taxes + Business Subsidies
  • DPR = RN – (Earnings + Direct Taxes + Social Security) + CR (Pensions, Allowances, and other aid)

3. Average Price Level: Inflation

Causes of Inflation

Inflation is a persistent and widespread increase in prices. Two main theories explain its causes:

  • Demand-Pull Inflation: Excess demand exceeding supply leads to price increases.
  • Cost-Push Inflation: Increased production costs drive prices up. This includes:
    • Rising resource prices (e.g., energy).
    • Wage-price spirals (unions’ bargaining power).
    • Wage-wage spirals (competitive wage increases).
    • Market power (monopolies).
    • Interest rate increases.
Consequences of Inflation

High inflation reduces purchasing power and creates uncertainty.

Loss of Purchasing Power: If income growth lags behind inflation, living standards decline. Affected groups include:

  • Pensioners
  • Workers
  • Savers
  • Exporting companies (reduced competitiveness)

Beneficiaries include:

  • Debtors (reduced debt value)
  • Governments (reduced debt burden)
  • Importing companies (increased competitiveness)

Uncertainty: Fluctuating prices hinder decision-making for consumers and businesses.

Measuring Inflation

The Consumer Price Index (CPI) is commonly used to measure the general price level. The National Statistics Institute (INE) calculates Spain’s CPI, using data from the Spanish Family Budget Survey (EPF) to create a market basket of representative consumer goods.

The inflation rate is the percentage change in CPI over time. The Harmonized CPI allows for international inflation comparisons.

Features and Limitations of CPI

Spain’s CPI calculation incorporates several improvements:

  • Annual weight adjustments.
  • Five-year reviews of the market basket.
  • Inclusion of sales and discounts.

Limitations of the CPI include:

  • Exclusion of some goods and services (housing).
  • Use of a base year, which may not always be representative.
  • Difficulty in accounting for quality changes.
  • Reliance on the EPF, which may not perfectly represent all households.