GDP 1. Market value A convenient way to aggregate the different G+S produced in a modern economy.

However, not all economically valuable G+S are bought and sold in markets e.g. chores at home. 2. Final Goods and Services: For goods that are partly produced one year and partly produced in the next, economists determine the market value of final G+S indirectly, by adding up the value added by each firm in the production process. Value added = market value costs of inputs purchased from other firms.

3. Produced within a country during a given period Only production that takes place within the countrys borders is counted e.g. even cars produced by foreign-owned plants 4. The expenditure method for measuring GDP Inventories: goods that are produced but not sold, primarily capital goods & housing Amounts purchasers spend on various G+S = market values of that G+S 4 components of expenditure o Consumption expenditure, government purchases, net exports o Investment: Business fixed investment: purchase of capital goods Residential investment: construction of new homes and apartment building. Its treated as an investment by the business sector. Inventory investment: Goods a firm produces but doesnt sell during the current period are treated as if the firm had bought those goods from itself. National income accounting identity: Y = C + I + G + NX

5. GDP and incomes of capital and labour GDP = labour income + capital income (both measured prior to taxes)

6. Nominal GDP vs. Real GDP Real GDP is adjusted for inflation i.e. measures the actual physical volume of production. Nominal GDP measures the current dollar value of production. Unlike Nominal GDP, real GDP doesnt change if only the price of output has changed. Chain Volume Measurement rebasing occurs every year and resulting indexes are linked to arrive at the chain volume measures. Income effect of higher real wages Refers to the buying power of wages that is so much higher today than in the past, which means that people can often achieve a reasonable living standard by working fewer hours than they did in the past. GDP fails to reflect: Leisure time available Non-market activities e.g. volunteer services Increased pollution and the exploitation of finite resources Poverty and economic inequality GDP focuses on total production rather than on distribution of output The consumer price index: Measuring the price level CPI: a measure of cost of living during a particular period, measures the cost of a basket of G+S in a period relative to the same basket of G+S in the base year. CPI = Cost of base-year consumption basket of G+S in current year / Cost of base-year consumption basket of G+S in base year Inflation Inflation rate as at Dec 09 = [(CPIDEC09 CPIDEC08)/CPIDEC08] x 100 It is a sustained change in the economys price level i.e. theres a general rise in prices. It is not simply a rise in the price of individual G+S (change in relative prices).

The true costs of inflation 1. Shoe-leather costs The longer cash is held during a period of inflation, the larger is the reduction in purchasing power. To counteract this, people leave as much money as is possible in bank accounts where the interest paid acts to insulate moneys purchasing power from the effects of inflation. The inconvenience with the increased frequency of bank visits however, is a real cost of inflation. E.g. businesses may need to employ extra staff to make these trips, banks may need to employ extra staff to handle increased transactions 2. Noise in the price system With inflation, prices are affected by changes in S+D for a product and also by changes in the general price level. E.g. in an economy with little/no inflation, a supplier of specialty foods, will immediately recognize an increase in mushroom price as a signal to bring more to market. If inflation is high, the supplier must ask if price increase represents true demand or a result of general inflation. Suppliers need to know what is happening to other prices of G+S

3. Distortions of the tax system Tax rates are not indexed to the rats of inflation but based on nominal magnitudes Without indexing, inflation raises peoples nominal incomes forcing them to pay an increasing % of income in taxes (higher tax brackets; bracket creep) even if their real income may not have increased 4. Unexpected redistribution of wealth Inflation doesnt destroy purchasing power, it redistributes it Generally, high inflation rates help borrowers at the expense of lenders, borrowers are able to repay loans in less valuable dollars. A high inflation economy, encourages people to use up resources in trying to anticipate inflation and protect themselves against it.

5. Interference with long-run planning E.g. planning for retirement in early 20s, firms developing long-run investment and business strategies that look decades into future With high and erratic inflation, people might end up saving too little and compromise plans; saving too much, sacrificing more than you need 6. Menu costs The act of changing prices itself can impose significant costs

During periods of high inflation, real GDP per person, real consumption per person and real investment per person falls; trade and government budget deficits were larger too. Inflation and interest rates Real interest rate is the percentage increase in the real purchasing power of a financial asset. Nominal interest rate is the percentage increase in the dollar value of a financial asset. Real interest rate = nominal interest rate inflation rate; r = i - Fishers argument: r was set by forces relating to the willingness of people to save and invest, because these forces change slowly, only over reasonable period of time we would expect to see little change in r Deflation A sustained fall in the general level of prices. Creditors gain at debtors expense