Key Economic Concepts: GDP, Inflation, and Development
Understanding Key Economic Concepts
Calculating GDP Using the Income Approach
How do we calculate GDP using the income approach? Which are all the incomes that should be included?
The income approach calculates GDP by summing all income and rents received by households, businesses, and governments. The incomes included are:
- Wages, salaries, and social contributions
- Rents, interest, and dividends
- Undistributed profits
- Mixed income
- Depreciation
- Direct taxes
Understanding Inflation
Explain how inflation works using the different types of inflation.
Inflation is a persistent increase in the general price level. It reduces purchasing power for consumers and businesses. Hyperinflation can cause severe economic and social crises.
Types of inflation:
- Demand-pull: When demand exceeds production capacity.
- Cost-push: When production costs increase prices.
- Built-in: When rising prices lead to wage increases to maintain living costs.
The Importance of Reducing Budget Deficit
Why is it so important to reduce budget deficit?
A budget deficit occurs when government spending exceeds its earnings. Reducing it is crucial because:
- It reduces the need to cut spending in the future.
- It prevents an increase in public debt.
- It avoids potential inflation.
- It prevents a potential rise in bond yields.
- It reduces interest payments on loans.
- It prevents crowding out.
- It maintains confidence in the economy.
The Significance of Inflation
Why is inflation so important?
When there is no inflation, prices go down (deflation). Deflation can slow consumption and economic growth, potentially causing a deflationary spiral. Central banks aim for price stability, often defined as a yearly inflation rate of 2%.
Pros of Inflation:
- Increases the resale value of assets.
- Reduces the real value of debt.
- Optimum levels encourage spending.
Cons of Inflation:
- Reduces purchasing power.
- Reduces saving.
- Some prices rise before others.
Understanding Risk Premium
What is Risk Premium? Why can it grow?
The risk premium is the difference between the interest rate paid by one country and another with a more stable economy. When investors feel less confident, the risk premium increases. The difference in interest rates is multiplied by 100 to express it in basis points. Germany’s economy is considered the most stable in Europe, resulting in the lowest interest rates.
Dimensions of the Human Development Index
What dimensions does the human development index include? Why?
The Human Development Index (HDI) measures average achievement in key dimensions of human development: a long and healthy life, being knowledgeable, and having a decent standard of living. The HDI uses metric indices for each of these three dimensions.
Calculating GDP Using the Output Approach
How do we calculate GDP using the output approach?
The output approach calculates GDP by adding the gross value added of all industries in the economy, minus net taxes on production. Gross value added is the gross value of output at market prices minus the value of intermediate consumption at factor cost. GDP = sum of GVA (output value – intermediate consumption – taxes on production + subsidies).
Measuring Inflation
How do we measure inflation?
The Consumer Price Index (CPI) measures how consumer prices change over time based on a basket of goods. It is calculated as a weighted average of these prices, giving more importance to items that people spend more money on.
How it is calculated:
- Define the basket of goods.
- Collect prices.
- Calculate the cost of the basket.
- Choose a base year and calculate the index.
Types of Inflation:
- General: Measures how the prices of the basket change together.
- Core Inflation: Measures the rising prices of everything except food and energy.
- Harmonized: Measures inflation in the EU and Eurozone for international comparisons.