Economics: Key Concepts and Indicators

Economics: Key Concepts and Indicators

  • Economics is the study of markets and how price and participants interact across different markets (product, service, labor, financial).

  • Markets involve: what is exchanged, who participates, and the role of price.

Financial Markets Basics

  • Why do companies borrow? To form capital (capital formation).

  • How do they borrow?

    • Bank loans (availability, cost, maturity benefits/drawbacks).

    • Issue stocks: ownership claim on assets; no fixed maturity; secondary market liquidity.

    • Issue bonds: debt claim on company assets; long maturities (typically 10–30 years); illiquid; bought by insurers, pensions, etc.

  • Why buy stocks or bonds?

    • Stocks: appreciation potential, dividends, liquidity.

    • Bonds: regular interest payments; used to fund investments; prices move with interest rates.

  • Healthy markets require appropriate pricing, regulation, and liquidity; imbalances can imply risks to savers and borrowers.

Main Macroeconomic Topics

  • Key measures: Inflation, GDP, and unemployment.

  • Questions to ask about each:

    • How defined?

    • How measured?

    • How related to each other?

    • How used for policy and analysis?

Inflation

  • Definition: an increase in the overall price level; deflation is a decrease.

  • Causes:

    • Demand-pull: too much spending.

    • Cost-push: higher production costs.

Measurement of Inflation: CPI

  • Consumer Price Index (CPI) tracks how rising prices affect consumer income.

  • Source: Bureau of Labor Statistics (BLS) monthly survey of households/retailers.

  • Concept: measures average prices of a market basket purchased by a typical urban consumer.

  • Metro example: Denver–Boulder CPI for Colorado used for regional analysis.

The Market Basket Weights

  • Food and beverages: 16%

  • Housing: 40%

  • Apparel: 5%

  • Transportation: 18%

  • Medical care: 6%

  • Recreation: 6%

  • Education and communication: 5%

  • Other goods and services (tobacco, haircuts, funerals, etc.): 4%

Calculating the CPI

  • Formula: ext{CPI} = rac{ ext{Current cost of market basket}}{ ext{Base year cost of market basket}} imes 100

  • The CPI indexes the market basket to 100 in the base year.

  • Example context (illustrative): Market basket costs in Period 1 vs Period 2 to compute CPI for Period 2.

CPI Uses

  • Calculate the rate of inflation: percentage change in the CPI.

  • Calculate the real wage.

  • Calculate the real rate of interest.

  • CPI concepts: All items vs core inflation; by item and metro area; base year and trends.

Calculating the Rate of Inflation

  • Formula: ext{Inflation rate} = rac{CPIt - CPI{t-1}}{CPI_{t-1}} imes 100\%

  • Historic example: 1979 inflation with CPI(1978)=65.2 and CPI(1979)=72.6.

  • Notes: month-to-month CPI can be seasonally adjusted; substitution effects can cause CPI to overstate inflation.

  • 12-month percent change in CPI is often used for inflation trends.

Calculating the Real Wage

  • Real wage accounts for cost of living differences.

  • Formula (conceptual): ext{Real wage} = rac{ ext{Nominal wage}}{ ext{Price index}} imes 100

  • Uses: compare purchasing power across cities or over time (e.g., CPI or city-specific indices).

Price Indices and Uses

  • CPI: Consumer price index.

  • PPI: Producer price index.

  • GDP deflator: broader measure of prices used to adjust GDP for inflation.

  • GDP deflator relation: ext{Deflator} = rac{ ext{Nominal GDP}}{ ext{Real GDP}} imes 100

The Real Rate of Interest

  • Real rate reflects purchasing power after inflation: $$r_{ ext{real}} = i - \