Lecture-4

Definitions
 Inflation
 Is the decline of purchasing power of a given currency over time
 A quantitative estimate of the rate at which the decline in purchasing power occurs
 Itcan be reflected in the increase of an average price level of a basket of selected goods
and services in an economy over some period of time
 What Causes Inflation
 Inflationcan occur when prices rise due to increases in production costs, such as raw
materials and wages
 A surge in demand for products and services can cause inflation as consumers are
willing to pay more for the product
 Some companies reap the rewards of inflation if they can charge more for their
products as a result of the high demand for their goods
Definitions
 Market Basket of Goods:
 A selected group of consumer goods and services whose prices are tracked
for calculating a consumer price index and measuring the cost of living
 The consumer price index (CPI)
 Is the instrument to measure inflation
 Itis used to estimate the average variation between two given periods in
the prices of products consumed by households
 Itis a composite measurement of trends in the prices of products, at
constant quality
 When planning how you spend or save your money, the CPI can influence
your decisions
Definition
 Gross national product (GNP)
 Isan estimate of the total value of all the final products and services
turned out in a given period by the means of production owned by a
country's residents
 GNP is commonly calculated by taking the sum of personal consumption
expenditures, private domestic investment, government expenditure, net
exports, and any income earned by residents from overseas investments,
minus income earned within the domestic economy by foreign residents
 GNP= Consumption + Investment + Govt expenditure + net exports +
Income earned from overseas - income earned within the domestic
economy by foreign residents
The Data of Macroeconomics
 What Scientists, economists, and detectives have much in common?
 They all want to figure out what’s going on in the world around them
 How they do it?
 To do this, they rely on theory and observation
 They build theories in an attempt to make sense of what they see happening
 They then turn to more systematic observation to evaluate the theories’
validity
 Only when theory and evidence come into line do they feel they understand
the situation
Measuring the Value of Economic Activity: GDP
 Gross domestic product, or GDP, is often considered the best measure of
how well the economy is performing
 The purpose of GDP is to summarize all requisite data with a single number
representing the dollar value of economic activity in a given period of time
 There are two ways to view this statistic
 One way to view GDP is as the total income of everyone in the economy
 Another way to view GDP is as the total expenditure on the economy’s output
of goods and services
 GDP measures something people care about—their incomes
 How can GDP measure both the economy’s income and its expenditure on
output?
Income, Expenditure, and the Circular Flow
 Tounderstand the meaning of GDP more fully, we turn to national income
accounting, the accounting system used to measure GDP
 Suppose an economy has
 One product - Bread
 Single input – labour
 All the economic transactions that occur between households and firms in this
economy
Income, Expenditure, and the Circular Flow
 GDP measures the flow of dollars in this economy.
 We can compute it in two ways
 GDP is the total income from the production of bread, which equals the sum
of wages and profit—the top half of the circular flow of dollars
 GDP is also the total expenditure on purchases of bread—the bottom half
of the circular flow of dollars
 Tocompute GDP, we can look at either the flow of dollars from firms to
households or the flow of dollars from households to firms
Stocks and Flows
 Many economic variables measure a quantity of something
 A quantity of money
 A quantity of goods, and so on
 Economists distinguish between two types of quantity variables stocks
and flows
 A stock is a quantity measured at a given point in time
 A flow is a quantity measured per unit of time
 The amount of water in a bathtub is a stock
 Bathtub contains 50 gallons of water
 The amount of water coming out of the faucet is a
flow
 water is coming out of the faucet at 5 gallons per
minute
Stocks and Flows
 Stocks and flows are often related
 In the bathtub example, these relationships are clear
 Thestock of water in the tub represents the accumulation of the
flow out of the faucet
 The flow of water represents the change in the stock
 When building theories to explain economic variable it is often
useful to determine whether the variables are stocks or flows and
whether any relationships link them