Thursday, October 10, 2013

13. Measuring the Economy: GDP

GDP refers to the total market value of all the final goods and services produced and sold in within the borders of a specific geographical area (such as within the borders of a country) within a given period - normally a year. Why is it calculated? Often students say it is to enable governments to manage the economy. Governments don't manage economies - they are pretty powerless to do so and it is not their function to do so. At best they can only create the climate in which individuals and firms can do business and set up some rules as how production and trade can take place - usually modern governments do this by removing the obstacles in the way of production and trade. These conditions relate to the monetary and fiscal frameworks of a country. Countries that have less government involvement in the economy have higer GDP growth rates than countries with larger government involvement (EFW Report, 2013). A low tax regime would for example attract more Foreign Direct Investment than contries with high taxes. GDP is measured through various methods that attempt to measure economic activity during the different stages of the circular flow of income and expenditure. One point of measurement is when expenditure takes place. So what is measured is all the expenditure by the main actors on final goods - this includes the consumption expenditure by individuals, expenditure by governments and net purchases by foreigners (less imports). C.M. Heydenrych Johannesburg 2013.

Wednesday, October 9, 2013

12. Inflation - Cost push

One reason given for the phenomenon of inflation is so-called cost-push inflation. In a popular student resource ( the following is given as one part of this phenomenon: 1. Component costs: e.g. an increase in the prices of raw materials and components. This might be because of a rise in global commodity prices such as oil, gas copper and agricultural products used in food processing – a good recent example is the surge in the world price of wheat. Companies would ostensibly then respond to rising costs, by increasing their prices of this product to protect profit margins. this is then LABLELLED as Cost-push inflation. Somewhere someone got it wrong - because if businesses increase their prices the consumers will have to pay more for that product. Given a fixed amount of disposable income they will have less available to pay for other products. The demand for the other products will fall and so will the price level for the other products (put in a different way the demand for all other products will shift to the left and prices will fall commensurate to the price rise of this product). The aggregate siuation will however stay exactly the same without ANY rise in price that could be linked to inflation. It is only when there is a similtaneous rise in the money supply that there could be a general rise in the aggregate price level - inflation (cost push) can only be explained in an environment of an increase in money supply. The conclusion that I come to is that cost push is cancelled out by the move to the left in Demand curve in the demand-pull explanation of inflation in a situation where there is a stable money supply. AGGREGATE SUPPLY AND DEMAND STAYS THE SAME IRRESPECTIVE OF THE PRICE LEVELS OF INDIVIDUAL components of the aggregates in a situation of a stable (fixed) money supply. If anyone has a different view, or if I have missed out on something, please let me know.