GDP and National Income

GDP & National Income

• Y represents the total output, also known as GDP
• CC stands for consumption, which refers to household spending
• II signifies investment, representing business spending on capital
• GG denotes government spending
• XX indicates exports
• MM shows imports
• X-M represents net exports
• GDP measures the market value of all final goods and services produced within a country in a specific period
• Nominal GDP uses current prices
• Real GDP uses constant base-year prices and adjusts for inflation
• The GDP Deflator is calculated as (Nominal GDP ÷ Real GDP) × 100
• The expenditure approach to calculating GDP is GDP = C + I + G + (X - M)
• To avoid double counting, only final goods should be counted such as a car, and not intermediate goods like tires
• Income equals expenditure, meaning every transaction involves a buyer and a seller
• Nominal GDP example: 10 apples at $2 each equals $20
• Real GDP example: 10 apples at $1 (base year price) equals $10
• GDP Deflator example: (20 ÷ 10) × 100 = 200

Inflation & CPI

• CPI measures the cost of a fixed basket of consumer goods
• Inflation Rate is calculated as ((CPI Year 2 - CPI Year 1) ÷ CPI Year 1) × 100
• Core CPI excludes food and energy prices, which are volatile
• CPI uses a fixed basket of goods, while the GDP deflator uses current production
• Substitution bias in CPI overstates inflation by not accounting for cheaper substitutes
• CPI Basket Cost Example: A basket costing $200 in the base year costs $220 in the current year
• CPI Calculation Example: $220 ÷ $200 × 100 = 110
• Inflation Rate Calculation Example: (($110 - $100) ÷ $100) × 100 = 10%

Production & Growth

• A represents technology or total factor productivity
• LL represents labor
• KK represents physical capital
• HH represents human capital
• NN represents natural resources
• F(·) represents the production function, illustrating the relationship between inputs and output
• Production Function: Y = A · F(L, K, H, N), where output depends on labor, capital, tech
• Diminishing Returns: More capital leads to smaller output gains
• Solow Model: Steady state occurs when investment equals depreciation
• Technological progress drives long-run growth
• Convergence happens when poorer economies grow faster by adopting technology
• Steady State example: If depreciation is 5%, investment must be 5% of capital to maintain output

Saving & Investment

• S represents national saving
• TT represents taxes
• Private Saving is calculated as Y - C - T
• Public Saving is calculated as T - G
• National Saving is calculated as S = Y - C - G
• Loanable Funds Market: Equilibrium is where saving equals investment
• Crowding Out: Government borrowing reduces private investment
• Closed Economy: S = I
• Real Interest Rate is the nominal rate minus inflation
• Private Saving example: Income $1,000 - Taxes $150 - Consumption $700 = $150
• Public Saving example: Taxes $150 - Government Spending $200 = -$50 (deficit)

Finance Basics

• PV represents present value
• FV represents future value
• r represents interest rate or discount rate
• n represents number of periods (years)
• E(R) represents expected return
• σ represents standard deviation (risk)
• Present Value is calculated as PV = FV ÷ (1 + r)^n
• Efficient Market Hypothesis (EMH): Prices reflect all information
• Diversification reduces risk, e.g., holding stocks and bonds
• Risk-Return Tradeoff: Higher risk leads to higher expected return
• Behavioral Finance describes irrational investor behavior
• Present Value example: PV of $1,000 in 5 years at 7% is approximately $713

Unemployment

• Unemployment Rate is calculated as (Unemployed ÷ Labor Force) × 100
• Types of unemployment: frictional (job search), structural (skills mismatch), and cyclical (recession)
• Natural Rate of Unemployment: Frictional + Structural (excluding cyclical unemployment)
• Discouraged workers are not counted in unemployment figures
• Policy tools include job training (structural) and stimulus (cyclical)
• Labor Force example: 160M employed + 10M unemployed = 170M
• Unemployment Rate example: (10 ÷ 170) × 100 ≈ 5.9%

Monetary System

• Money Functions: Medium of exchange, store of value, and unit of account
• Money Multiplier is calculated as 1 ÷ Reserve Ratio
• Fed Tools include open-market operations, discount rate, and reserve requirements
• Fractional-Reserve Banking: Banks lend out most deposits
• Federal Funds Rate is the interest rate banks charge each other
• Money Creation example: Reserve ratio is 10%. Deposit of $100 leads to bank lending $100, then $90, and the money supply increases by $900 (multiplier = 10)