Download Inflation - Fabio Landini

Main Macroeconomic
Aggregates (II)
Lecture 15 – academic year 2014/15
Introduction to Economics
Fabio Landini
Questions of the day?
• What is the role of prices in the determination
of GDP?
• What is inflation and how it is measured?
• What is unemployment and how it is
measured?
• How can you decompose the GDP?
The role of prices: Real GDP and nominal GDP
GDP = value of the goods
Value of the goods = quantities x market prices
Which prices?
Nominal GDP: Value of the final goods and services
computed using the current quantities and prices
Real GDP: Value of the final goods and services
computed using current quantities and prices of a
specific year (called “the base year”)
Real GDP and Nominal GDP
A single good
Year
2000
2001
Quantity Price
100
100
103
102
Nominal GDP2000 =
price2000 x q.ty2000 = 100x100 =10000
Nominal GDP2001 =
price2001 x q.ty2001 = 102x103=10506
Real GDP and Nominal GDP
Nominal GDP growth=
Nom GDP2001 - Nom GDP2000 10506  10000

=
Nom GDP2000
10000
= 0,0506 = 5,06%
The growth of GDP is computed in order to know how
much the production has increased.
But 5,06% considers both the variation of products and
the variation of prices.
Real GDP and Nominal GDP
In order to know the actual increase in production we must
use the Real GDP
Base year = 2000
Real GDP2000 =
price2000 x q.ty2000 = 100x100 =10000
Important: Real GDP is equal to the nominal GDP2000
Real GDP2001=
price2000 x q.ty2001 = 100x103 = 10300
Important: It is different from the Nominal GDP2001 = 10506
Real GDP and Nominal GDP
Real GDP growth=
10300  10000
Real GDP2001 - Real GDP2000

=
Real GDP2000
10000
= 0,03 = 3%
It differs from the growth of nominal GDP = 5,06%
The growth of real GDP measures the variation of
production given a certain set of fix prices
What differentiate the growth of nominal GDP from
the growth of real GDP? The variation of prices,
namely inflation
Inflation
Inflation rate (π) = Rise in the general level of
prices in an economy over a period of time
Two ways to measure the level of prices:
•GDP deflator
•Consumer price index (CPI)
Inflation
1) GDP deflator: Diversity in the growth of
nominal and real GDP -> price variation
Nominal GDP
GDP Deflator 
Real GDP
Deflatort - Deflatort-1
πt 
Deflatort-1
Inflation
In the preceding example:
Nominal GDP2000  10000; Nominal GDP2001  10506
Base year = 2000
Real GDP2000 = 10000 ; Real GDP2001  10300
On the basis of the preceding formula we obtain:
Deflator2000
Nominal GDP 2000 10000
=
=
=1
Real GDP2000
10000
Nominal GDP2001 10506
Deflator2001 =
=
= 1, 02
Real GDP2001
10300
Inflation
Deflator2001 - Deflator2000 1, 02 -1
p=
=
= 0, 02 = 2%
Deflator2000
1
It is also possible to show that
π=n–g
where
g  annual rate of growth of real GDP
n  annual rate of growth of nominal GDP
Inflation
In our example we have
•n = 5,06%
•g = 3%
•π = 2%
Using the above formula we obtain
π = n – g = 5,06% - 3% = 2,06% ≅ 2%
The GDP deflator considers the prices of of all final
goods produced in the economy.
In many cases it is more interesting to look at the price
increase that characterize the goods that are purchased
by the consumers.
Inflation
2) Consumer price index (CPI) = considers only the
average goods that are purchased by the
consumers
Example
• Two goods: bread and clothes
• On average a consumer buys 1 cloth and 10 kg of bread
every year
Price 2000
Price 2001
Bread Clothes
1
100
1,1
101
Inflation
Price bread2000 = 1 -> Price bread2001=1,1 -> Δ = 10%
Price clothes2000 = 100 -> Price clothes2001101 -> Δ = 1%
Inflation -> average of the two variation
Important: no simple average, but average weighted by
the quantity consumed and the value of the goods
Inflation
Computation of the CPI:
Expenditure 2000
 q.ty bread x price bread2000 +
+ q.ty clothes x price clothes2000 
=10x1+1x100  110
Expenditure 2001
 q.ty bread x price bread2001 +
+ q.ty clothes x price clothes2001 
 10x1,1+1x101  112
Inflation
π 

Expenditure 2001 - Expenditure2000
Expenditure 2000
112 - 110
110

 0,0181 = 1,81%
Inflation computed using the CPI measures the average
growth in the consumers’ expenditure
Important: 1,8% is an intermediate value between 10%
(Δ price of bread) and 1% (Δ price of clothes)
Important: CPI considers a fixed basket of goods which is
updated periodically
Inflation in Italy 1970-2011
25,0
INFLAZIONE (IN%)
20,0
15,0
10,0
5,0
0,0
1971
1974
1977
1980
1983
1986
1989
1992
ANNO
1995
1998
2001
2004
2007
2010
Inflation is usually positive
(prices increase over time)
25,0
INFLAZIONE (IN%)
20,0
15,0
10,0
5,0
0,0
1971
1974
1977
1980
1983
1986
1989
1992
ANNO
1995
1998
2001
2004
2007
2010
Inflation is different depending on the period
(>10% between 1974 and 1984 ; < 3% since 1997)
25,0
INFLAZIONE (IN%)
20,0
15,0
10,0
5,0
0,0
1971
1974
1977
1980
1983
1986
1989
1992
ANNO
1995
1998
2001
2004
2007
2010
Inflation
• Why do prices increase?
• What is it that determines the level of
inflation?
Some answers during the course….
Labour market
Employed = Those who currently have a job
Unemployed = Those who are looking for a job or are
going to start a new job (+ those who are under
unemployment protection programs)
Important: those who are not looking for a job are not
considered unemployed (e.g., housewife and students
are not unemployed)
Labour market
Labour force  Employed + Unemployed
Unemployed
Unemployment rate (u) 
Labour force
Important: Those who are not looking for a job are
counted neither in the numerator nor in the
denominator
The unemployment rate measures the portion of
workers who are unemployed
Labour market
Another problem: how to measure the portion of
workers over the total population -> participation rate
Participation rate =
Labour force
=
Tot. population under working age
ANNO
20
11
20
10
20
09
20
08
20
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
19
99
19
98
6
19
97
10
19
96
12
19
95
TASSO DI DISOCCUPAZIONE (IN %)
Unemployment rate in Italy, EU, US 1995-2011
13
ITA
11
UE
9
8
7
USA
5
4
3
The unemployment rate is usually positive (there are
workers who do not find a job)
The unemployment rate is different across countries
13
TASSO DI DISOCCUPAZIONE (IN %)
12
ITA
11
UE
10
9
8
7
6
USA
5
4
3
ANNO
Labour market
• Why is there unemployment?
• Why is unemployment different across
countries?
Some answers during the course…..
Decomposition of GDP
GDP – Measures the value of production of goods
and services
Goods and services are exchange din the market ->
Supply and Demand
It is possible to decompose GDP both on the side of
supply and on the side of demand
From the point of view of supply the GDP is equal to
the sum of the sectorial A.V. (2° definition
examined in Lecture 14)
Decomposition of GDP
From the point of view of demand it is possible to
decompose the GDP in different categories of
expenditure
a) Consumption (C) – Households’ purchase of
goods and services
•Durable goods (average life >3 years)
•Non-durable goods (average life <3 years)
•Services
Decomposition of GDP
b) Investment (I) – Firms’ purchase of capital goods
that are used as inputs in future production
activities (e.g. machines, plants, etc.)
A particular category is represented by the
investment in stockpile (goods that are not sold)
• It is not financial investment
Decomposition of GDP
c) Government expenditure (G) – Purchase of
goods and services by the public
administration (Government, public bodies,
etc.)
Decomposition of GDP
The sum C+I+G = expenditure in goods and services by
the residents of a country (national expenditure)
To compute the total demand of goods and services
(=demand of goods and services produced in the
economy) we must consider that:
• Some goods that are produced in the country are
sold abroad
• Some goods that are produced abroad are
purchased in the country
Decomposition of GDP
Therefore, to the national expenditure we must add
•Export (X) – Purchase of national goods and
services by the rest of the world (e.g. Italian wine
sold in Germany)
and subtract
•Import (Q) – Purchase of goods and services
produced abroad by the residents of the country
(e.g. Swiss cheese sold in Italy)
Decomposition of GDP
Therefore, the aggregate demand of national goods
and services (Z) is equal to:
ZC+I+G+X-Q
Some other important aggregate measures are:
•Commercial balance
Difference between import and export
•Public deficit
Difference between Government’s expenditure
and Government’s revenues