Understanding Key Economic Indicators and Growth

Posted on Jan 16, 2025 in Economy

Consumer Price Index (CPI) and Real Value

The Consumer Price Index (CPI) is used to deflate nominal values into real values, allowing us to compare purchasing power over time. The formula is:

Real Value (year y) = Nominal Value (year x) * (CPI (year y) / CPI (year x))

For example, the real US federal minimum wage has declined by $3 since 1960. Market imperfections, such as lack of information, lack of competition, or high costs of entry, can contribute to this.

Unemployment and Business Cycles

The natural rate of unemployment is the normal level of unemployment. It has four contributors:

  • Frictional
  • Structural
  • Seasonal
  • Real-wage/classical unemployment

Cyclical unemployment refers to short-term fluctuations. Business cycles are the patterns of these short-term ups and downs.

Real GDP and Economic Growth

Real GDP is the rate at which income increases when we keep prices fixed. It describes a country’s economic productivity over time.

Given the growth rate in nominal GDP and inflation, the real GDP growth rate is:

Real GDP Growth Rate = Nominal GDP Growth Rate – Inflation Rate

Combining real GDP with population data gives us real GDP per capita, which describes the change in purchasing power for the average person over time.

Given the growth rate in nominal GDP:

Real GDP per Capita Growth Rate = Nominal GDP Growth Rate – Inflation Rate – Population Growth Rate

Economic growth builds on itself over time.

GDP per capita in any year can be calculated as:

GDP (year a) = GDP (year b) * (1 + Growth Rate)(year a – year b)

Rule of 70

A simple shortcut to understand how many years it takes for GDP to double is the Rule of 70:

Years Until Income Doubles = 70 / Real GDP Growth Rate

Factors Influencing GDP Growth

The growth of a nation’s GDP can be expressed as:

g(y) = g(A) + a * g(K) + (1 – a) * g(L)

Where:

  • g = growth rates of a variable measured in percentage change
  • a = share of GDP distributed to owners of capital
  • 1 – a = share of GDP distributed to laborers
  • g(A) = growth in technology
  • g(K) = growth in capital
  • g(L) = growth in labor

Aggregate Expenditure and Demand

Aggregate Expenditure is made up of:

  • Consumption (C)
  • Investment (I)
  • Government Spending (G)
  • Net Exports (X – M)

Aggregate Demand is also composed of Consumption (C) (roughly 66%), Investment (I), Government Spending (G), and Net Exports (X – M).

Marginal Propensity to Consume and Save

Disposable income = Consumption + Saving

The Marginal Propensity to Consume (MPC) is the fraction of each additional dollar of disposable income that is spent on consumption.

MPC (between 0 and 1) = Change in Consumption / Change in Disposable Income

The Marginal Propensity to Save (MPS) is:

MPS = 1 – MPC

Consumption and Planned Aggregate Expenditure

Total consumption can be broken down as:

Total Consumption = Autonomous Consumption + Income-Dependent Consumption

Or:

C = a + bYd

Where:

  • C = current consumption
  • a = autonomous consumption
  • b = marginal propensity to consume
  • Yd = disposable income

Planned Aggregate Expenditure (PAE) is:

PAE = A + bY

Where:

  • bY = income-dependent expenditure
  • A = a + I + G + NX (autonomous spending, not affected by income)

Multiplier Effect

The multiplier is calculated as:

Multiplier = 1 / (1 – MPC)

Aggregate Demand and Supply

Aggregate Demand (AD) represents the real GDP demanded at alternative price levels. It is downward sloping.

AD will shift right (increase) if there is:

  • Increased consumer spending
  • Expanding business
  • Increase in government spending
  • Tariff ends/decreases
  • Increased demand for goods

AD will shift left if the opposite occurs.

Taxation Multiplier

The taxation multiplier is:

Taxation Multiplier = -MPC / (1 – MPC)

Aggregate Supply (AS) represents the real GDP supplied at different price levels. It is upward sloping.

Long-Run Aggregate Supply (LRAS)

An increase in LRAS can be caused by:

  • Technological innovation, leading to greater production using the same number of inputs
  • Increase in available capital
  • Increase in available labor supply
  • Universal primary education

A decrease in LRAS is caused by the opposite of these factors.

An increase in consumer confidence leads to an increase in AD, which in turn causes a decrease in SRAS.