ECONOMIC CONCEPTS

What Is Inflation

Inflation is a quantitative measure of the rate at which the average price level of a basket
of selected goods and services in an economy increases over some period of time.

It is the rise in the general level of prices where a unit of currency effectively buys less
than it did in prior periods.

Often expressed as a percentage, inflation thus indicates a decrease in the purchasing

power of a nation’s currency.

Inflation can be contrasted with deflation, which occurs when prices instead decline.
Inflation is the rate at which the general level of prices for goods and services is rising and, consequently,
the purchasing power of currency is falling.

Inflation is classified into three types: Demand-Pull inflation, Cost-Push inflation, and Built-In inflation.

Most commonly used inflation indexes are the Consumer Price Index (CPI) and the Wholesale Price Index
(WPI).

Inflation can be viewed positively or negatively depending on the individual viewpoint and rate of change.

Those with tangible assets, like property or stocked commodities, may like to see some inflation as that
raises the value of their assets.

People holding cash may not like inflation, as it erodes the value of their cash holdings.

Ideally, an optimum level of inflation is required to promote spending to a certain extent instead of saving,
thereby nurturing economic growth.
 Causes of Inflation

Rising prices are the root of inflation, though this can be attributed to different factors. In the context
of causes, inflation is classified into three types: Demand-Pull inflation, Cost-Push inflation, and Built-
In inflation.

Demand-Pull Effect

Demand-pull inflation occurs when the overall demand for goods and services in an economy
increases more rapidly than the economy's production capacity.

It creates a demand-supply gap with higher demand and lower supply, which results in higher prices.
For instance, when the oil producing nations decide to cut down on oil production, the supply
diminishes. This lower supply for existing demand leads to a rise in price and contributes to inflation.
 Cost-Push Effect
Cost-push inflation is a result of the increase in the prices of production process inputs.
Examples include an increase in labor costs to manufacture a good or offer a service or increase in the
cost of raw material.
These developments lead to higher cost for the finished product or service and contribute to inflation.
Built-In Inflation
Built-in inflation is the third cause that links to adaptive expectations.
As the price of goods and services rises, labor expects and demands more costs/wages to maintain
their cost of living.
Their increased wages result in higher cost of goods and services, and this wage-price spiral continues
as one factor induces the other and vice-versa.
 What is Consumer Price Index (CPI)?

The Consumer Price Index (CPI) is a measure that examines the weighted
average of prices of a basket of consumer goods and services, such as
transportation, food, and medical care.

It is calculated by taking price changes for each item in the predetermined

basket of goods and averaging them.

Changes in the CPI are used to assess price changes associated with the cost of
living.

The CPI is one of the most frequently used statistics for identifying periods of
inflation or deflation.
The Consumer Price Index measures the average change in prices over time that consumers pay for a
basket of goods and services.

CPI is the most widely used measure of inflation and, by proxy, of the effectiveness of the government’s
economic policy.

The CPI statistics cover professionals, self-employed, poor, unemployed and retired people in the country
but excludes non-metro or rural populations, farm families, armed forces, people serving in prison and
those in mental hospitals.

CPI-W measures the Consumer Price Index for Urban Wage Earners and Clerical Workers while the CPI-U
is the Consumer Price Index for Urban Consumers
 Unemployment
Unemployment, according to the Organisation for Economic Co-operation and Development
(OECD), is persons above a specified age (usually above 15) not being in paid employment or
self-employment but currently available for work during the reference period.
Unemployment is measured by the unemployment rate as the number of people who are
unemployed as a percentage of the labour force (the total number of people employed added
to those unemployed).
Unemployment can have many sources, such as the following:
new technologies and inventions
the status of the economy, which can be influenced by a recession
competition caused by globalization and international trade
policies of the government
regulation and market
What Is Natural Unemployment?

Natural unemployment, or the natural rate of unemployment, is the minimum unemployment rate
resulting from real or voluntary economic forces.

Natural unemployment reflects the number of people that are unemployed due to the structure of the
labor force, such as those replaced by technology or those who lack certain skills to gain employment.

Key Takeaways

Natural unemployment is the minimum unemployment rate resulting from real or voluntary economic
forces.

It represents the number of people unemployed due to the structure of the labor force, including those
replaced by technology or those who lack the skills necessary to get hired.

Natural unemployment persists due to the flexibility of the labor market, which allows for workers to flow
to and from companies.
In order to calculate the natural rate, first add the number of frictionally

unemployed (FU) to the number or people who are structurally unemployed (SU),

then divide this number by the total labor force. (FU + SU) ÷ LF = Natural rate of

unemployment.
 What is GDP Deflator?

The GDP deflator is a measure of the change in the annual domestic production due to change in price

rates in the economy and hence it is a measure of the change in nominal GDP and real GDP during a

particular year calculated by dividing the Nominal GDP with the real GDP and multiplying the resultant

with 100.

It’s a measure of price inflation/deflation with respect to the specific base year and is not based on a

fixed basket of goods or services but is allowed to be modified on a yearly basis depending on

consumption and investment patterns.

The GDP deflator of the base year is 100.

In the below template, we have calculated this Deflator for the year 2010 using the above-mentioned
formula of GDP Deflator.
So, GDP Deflator calculation for the year 2010 will be –
Economic Growth

Economic growth refers to an increase in aggregate production in an economy. Often, but not
necessarily, aggregate gains in production correlate with increased average marginal productivity.

That leads to an increase in incomes, inspiring consumers to open up their wallets and buy more,
which means a higher material quality of life or standard of living.

In economics, growth is commonly modeled as a function of physical capital, human capital, labor
force, and technology.

Simply put, increasing the quantity or quality of the working age population, the tools that they
have to work with, and the recipes that they have available to combine labor, capital, and raw
materials, will lead to increased economic output.
How do you calculate economic growth?

Expenditures approach. This method calculates the sum of expenditures by final

consumers of products ...

GDP = Consumption + Investment + Gov’t Spending + (Exports - Imports)

Income approach. Less commonly used, this method accounts for all the
incomes earned and costs incurred in the country’s production.

Value-added approach. This calculation measures the total sales of an area

minus the value of services or supplies added during the course of production
 Opportunity Cost
When an option is chosen from alternatives, the opportunity cost is the "cost" incurred by not
enjoying the benefit associated with the best alternative choice.

The New Oxford American Dictionary defines it as "the loss of potential gain from other alternatives
when one alternative is chosen.“

In simple terms, opportunity cost is the benefit not received as a result of not selecting the next best
option.

The notion of opportunity cost plays a crucial part in attempts to ensure that scarce resources are
used efficiently.

Opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone,
lost time, pleasure or any other benefit that provides utility should also be considered an opportunity
cost
Production, cost, and efficiency
In microeconomics, production is the conversion of inputs into outputs. It is an economic process that uses inputs to
create a commodity or a service for exchange or direct use.
Production is a flow and thus a rate of output per period of time.
Distinctions include such production alternatives as for consumption (food, haircuts, etc.) vs.
investment goods (new tractors, buildings, roads, etc.),
public goods (national defence, smallpox vaccinations, etc.) or
private goods (new computers, bananas, etc.), and "guns" vs "butter".
Opportunity cost is the economic cost of production: the value of the next best opportunity foregone. Choices must
be made between desirable yet mutually exclusive actions. It has been described as expressing "the basic relationship
between scarcity and choice
Inputs used in the production process include such primary factors of production as labour services, capital (durable
produced goods used in production, such as an existing factory), and land (including natural resources). Other inputs
may include intermediate goods used in production of final goods, such as the steel in a new car.
Economic efficiency measures how well a system generates desired output with a given set of inputs and available
technology. Efficiency is improved if more output is generated without changing inputs, or in other words, the
amount of "waste" is reduced
 Macroeconomics

The circulation of money in an economy in a macroeconomic model.

Macroeconomics examines the economy as a whole to explain broad aggregates and their interactions "top
down", that is, using a simplified form of general-equilibrium theory.
Such aggregates include national income and output,
the unemployment rate, and
price inflation and
subaggregates like total consumption and investment spending and their components.
It also studies effects of monetary policy and fiscal policy.
Since at least the 1960s, macroeconomics has been characterized by further integration as to micro-based
modelling of sectors,
including rationality of players,
efficient use of market information, and
imperfect competition.
Business cycle

The economics of a depression were the spur for the creation of "macroeconomics" as a separate
discipline. During the Great Depression of the 1930s, John Maynard Keynes authored a book
entitled The General Theory of Employment, Interest and Money outlining the key theories of
Keynesian economics. Keynes contended that aggregate demand for goods might be insufficient
during economic downturns, leading to unnecessarily high unemployment and losses of
potential output.
 Inflation and monetary policy
Money is a means of final payment for goods in most price system economies, and is the unit of
account in which prices are typically stated.
Money has general acceptability, relative consistency in value, divisibility, durability, portability,
elasticity in supply, and longevity with mass public confidence.
It includes currency held by the nonbank public and checkable deposits.
It has been described as a social convention, like language, useful to one largely because it is useful to
others. In the words of Francis Amasa Walker, a well-known 19th-century economist, "Money is what
money does" ("Money is that money does" in the original)
As a medium of exchange, money facilitates trade.
It is essentially a measure of value and more importantly, a store of value being a basis for credit
creation.
Money can reduce the transaction cost of exchange because of its ready acceptability. Then it is less
costly for the seller to accept money in exchange, rather than what the buyer produces.
 Fiscal policy
❑Governments implement fiscal policy to influence macroeconomic conditions by
adjusting spending and taxation policies to alter aggregate demand.

❑When aggregate demand falls below the potential output of the economy, there is an
output gap where some productive capacity is left unemployed.

❑Governments increase spending and cut taxes to boost aggregate demand. Resources
that have been idled can be used by the government.
 International economics

International trade studies determinants of goods-and-services flows across

international boundaries.
It also concerns the size and distribution of gains from trade.
Policy applications include estimating the effects of changing tariff rates and
trade quotas.
International finance is a macroeconomic field which examines the flow of capital
across international borders, and the effects of these movements on exchange
rates.
Increased trade in goods, services and capital between countries is a major
effect of contemporary globalization
 Development economics

Development economics examines economic aspects of the economic

development process in relatively low-income countries focusing on
structural change,
poverty, and
economic growth.
Approaches in development economics frequently incorporate social
and political factors
 Labor economics
Labor economics seeks to understand the functioning and dynamics of the markets for
wage labor.

Labor markets function through the interaction of workers and employers. Labor
economics looks at the suppliers of labor services (workers),

the demands of labor services (employers), and attempts to understand the resulting
pattern of wages, employment, and income.

In economics, labor is a measure of the work done by human beings.

 Welfare economics

Welfare economics uses microeconomics techniques to evaluate well-being from allocation of productive
factors as to desirability and economic efficiency within an economy, often relative to competitive general
equilibrium.
It analyzes social welfare, however measured, in terms of economic activities of the individuals that
compose the theoretical society considered.
Accordingly, individuals, with associated economic activities, are the basic units for aggregating to social
welfare,

whether of a group,
a community, or
a society, and there is no "social welfare" apart from the "welfare" associated with its individual units.
Thank You