Gross domestic product and inflation

Grossdomestic product and inflation

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Grossdomestic product and inflation

Grossdomestic product

GDP,also referred to as the gross domestic product, refers to theeconomic market standards for its goods and services which are beingproduced by that nation’s businesses. The GDP can either grow orretard depending as a result of various factors. The growth in GDP ofany given state takes place when that nation allows its privatesector to carry out its operations in an unregulated way. The mainfactors that usually affect the growth of GDP include availability ofeconomic resources at cheap prices, strong business and consumerconfidence as well as high wage and labor output (Douglas, 2012).Growth, therefore, is not something that occurs in every nationsimultaneously or via similar factors.

TheAmerican GDP has been growing at a significantly slow rate since thedeep recession that took place between the year 2008 and 2009. Duringthe three years that followed the recession, the American economy’soutput grew at less than a half of the exhibited rate. This is incomparison to the previous recoveries since the end of the SecondWorld War. Both the potential GDP and the ratio of real GDP to thepotential GDP grew at a rate less than a half of the previousrecoveries (Douglas, 2012).

Inthe attempts of disaggregating the unusual slow output growth sincethe end of the past recession, the CBO’s also known ascongressional budget office’s analysis, reveals that this pace isattributed to two main factors. These include slow growth of theeconomy’s productive capacity as well as slow growth of real outputcompared to the productive capacity although to a lesser extent.Specifically, CBO estimated that approximately two-thirds of thediscrepancy between the growths of real GDP in this recovery can beattributed to the sluggish growth of the potential GDP (Douglas,2012). That sluggish growth tends to reflect a weaker performancethan that occurred on average in the previous recoveries by all thechief determinants of the potential GDP.

Oneof the determinants is the potential employment. Unemployment is onefactor that tends to retard the growth of GDP to a very great extent.This is because there is a great level of dependency in that economyhence reduced investments (Douglas, 2012). It is essential to notethat following the recent recession approximately 8.6 millionindividuals lost their jobs. The rate of unemployment rose from 5% asof December 2007 to 10% in October 2009. However, statistics showsthat it had fallen to 6.1% by June of 2014. This happens to be one ofthe main causes that led to the retardation of the American economyafter the recession. It is essential to note that the American GDP isprojected to hit 14.7 trillion USD in the year 2014 recording anincrease of 3.9 trillion USD. This shows that employment plays avital role in the growth of nation’s GDP.

Theother determinant was the potential total factor productivity. Thisentails the average real output per unit of both the combined laborand the capital services that were adjusted for variations over thebusiness cycle. The last determinant was the productive services thatwere available from the economy’s capital stock. According to CBO,the remaining one-third of the uncommon slowness in the real GDP’sgrowth is attributed to the slow pace in the ratio of the real GDP tothe potential GDP. The assessment of CBO indicated that this scenariocan be attributed to a shortfall in the general demand for theeconomy’s goods and services. In their attempts to identify causesof the experienced shortfall in demand, CBO did an analysis of thecontribution of each chief demand’s component (Douglas, 2012).

Asopposed to previous recoveries, this recovery revealed a slow growthin four demand components. One of the components is the purchases ofgoods as well as services by the local governments as well as thestate. The other component is the federal government’s purchases ofgoods and services. The third component was the residentialinvestment. This entailed the construction of new homes, brokers`commissions and home improvements primarily. The final component thatrecorded a slow growth is the consumer spending (Douglas, 2012).These four revealed a slow growth rate and eventually led to a slowgrowth of the economy.

Inflation

Inflationcan be defined as an increase in the price level. In other words, theprice levels of many goods as well as services like food, housing,transportation, apparel and fuel must have increased for an inflationto be declared in a given economy. If an increase in prices takesplace of just few types of either goods or services, the condition isnot necessarily inflation. There are various factors that areattributed to the occurrence of inflation. One of the factorsattributed to the occurrence of inflation is the rise of theaggregate demand for the goods and services in a given economy morerapidly than that economy`s capacity of production (Nicholas, 2011).This scenario creates an inflation termed as demand-pull inflation.As indicated in the chart one below, increase in money in a giveneconomy tends to increase the demand of goods and services from D0 upto D1.

Inthe short run, the businesses in that economy fail to increasesignificantly production and hence supply tends to remain constant.The economy’s equilibrium shifts from A to B with prices risingthus causing inflation. New technology and marketing can create thedemand-pull inflation for certain asset and products classes(Nicholas, 2011). For instance, the Apple brand commands elevatedprices, a kind of inflation, solely for its products. Thecontemporary technology in the form of the financial derivativestriggered the formation of asset inflation in the housing market in2005 to 2006 in the United States.

Anotherfactor that tends to contribute to the occurrence of inflation is anincrease of production process inputs. This scenario develops aninflation called cost-push inflation (Nicholas, 2011). A rapidincrease in wages and rising prices of raw materials are the commonfactors that cause this inflation. For example, a sharp rise in theimported oil’s price in 1970s which led to an increase in the costof production together with transportation. Increased productioncosts eventually led to a decrease in supply from S0 to S1. Anincrease in the overhaul price level as a result of the equilibriumpoint shifted from Z to Y as indicated in chart two. Naturaldisasters can create the cost-push inflation although temporarily.For example, the way the hurricane Katrina did to the oil refineries(Nicholas, 2011).

Theother factor that is responsible for creating inflation is the moneysupply expansion. This entails the money supply over-expansion. Themoney supply extends from just cash to credits, mortgages and loans.The prices of nearly everything will escalate even though neither thedemand nor the supply of these goods has changed. This factor isattributed to the occurrence of inflation that took place in 2005 to2006 in the housing prices (Nicholas, 2011). There are certainstrategies that can get employed so as reduce inflation in any giveneconomy. According to Nicholas (2011), inflation tends to bringeffects such as social unrest, hoarding, unemployment and investmentbubbles which can be classified as negative effects. On positiveside, inflation tends to wipe out negative effects of deflation,remove debts and brings about Mundell-Tobin effect.

Oneof the strategies is breaking the inflationary expectations. Thegovernment should come up with something that will convince thepublic that their government is committed to inflation reduction.This will make the public confident and hence most of the economicalprocesses will tend to resume to normalcy thus reducing inflation.The other strategy is reducing the production cost. Anything thatwill tend to reduce the production cost when the economy isexperiencing inflation will help to increase goods in the economy,thus meeting both the demand and supply. The third strategy isreducing aggregate demand. When the economy is facing inflation, thegovernment need to reduce its purchases or increase the taxes.Increased taxes will leave businesses and workers with less income todispose. This will eventually lead to return of normalcy in thateconomy.

References

Douglas,W. (2012). CBO:WhatAccounts for the Slow Growth of the Economy After the Recession?Retrieved From:

http://www.cbo.gov/sites/default/files/43707-SlowRecovery.pdf

Nicholas,P. (2011). Causesof Inflation, Effects of Inflation (and Why they Both Matter).RetrievedFrom:

http://www.gobankingrates.com/personal-finance/causes-inflation-effects-inflation-matter/