BASIC ECONOMIC TERMS
GROSS DOMESTIC PRODUCT (GDP)
The gross domestic product (GDP) or gross domestic income (GDI) is a basic measure of a
country's overall economic output. It is the market value of all final goods and services made
within the borders of a country in a year.
It is often positively correlated with the standard of living, though its use as a stand-in for
measuring the standard of living has come under increasing criticism and many countries are
actively exploring alternative measures to GDP for that purpose.
GDP can be determined in three ways, all of which should in principle give the same result.
1. Product (or output) approach: The most direct of the three is the product approach,
which sums the outputs of every class of enterprise to arrive at the total.
2. Expenditure approach: Works on the principle that all of the product must be bought
by somebody, therefore the value of the total product must be equal to people's total
expenditures in buying things.
3. Income approach: Works on the principle that the incomes of the productive factors
("producers," colloquially) must be equal to the value of their product, and determines
GDP by finding the sum of all producers' incomes.
GDP = private consumption + gross investment + government spending + (exports −
imports)
Private Consumption:
It represents household spending on all goods and services. Fluctuations in Private
Consumption reflect the country's spending mood. As this figure trends positive it
indicates that consumers are stimulating the economy by spending more. However, one
cannot size up economic growth solely based on this report. Individuals can increase
consumption unsustainably if not matched by income growth.
Gross Investment:
The total amount of investment without taking account of the cost of depreciation.
Government spending:
It is classified by economists into three main types.
Government purchases of goods and services for current use are classed as government
consumption.
Government purchases of goods and services intended to create future benefits, such as
infrastructure investment or research spending, are classed as government investment.
Government expenditures that are not purchases of goods and services, and instead just
represent transfers of money, such as social security payments, are called transfer
payments.
Government spending can be financed by seigniorage, taxes, or government borrowing.
Exports
It refers to the sales outside the country.
Imports
It is the purchase of foreign goods and services.
In the name "Gross Domestic Product,"
"Gross" means that GDP measures production regardless of the various uses to which
that production can be put. Production can be used for immediate consumption, for
investment in new fixed assets or inventories, or for replacing depreciated fixed assets.
"Domestic" means that GDP measures production that takes place within the country's
borders.
Indian GDP:
The Indian economy is the 12th largest in USD exchange rate terms. India is the second
fastest growing economy in the world. India’s GDP has touched US$1.25 trillion. India has
made remarkable progress in information technology, high end services and knowledge
process services.
However, the cause for concern is that the rapid growth has not been accompanied by a
just and equitable distribution of wealth among all sections of the population. This
economic growth has been location specific and sector specific. For e.g. it has not
percolated to sectors where labour is intensive (agriculture) and in states where poverty is
acute (Bihar, Orissa, Madhya Pradesh and Uttar Pradesh).
Today, the service sector is contributing more than half of the Indian GDP. It takes India
one step closer to the developed economies of the world. Earlier it was agriculture which
mainly contributed to the Indian GDP.
GROSS NATIONAL PRODUCT (GNP)
GNP measures the value of goods and services that the country's citizens produced
regardless of their location. GNP is one measure of the economic condition of a country,
under the assumption that a higher GNP leads to a higher quality of living, all other things
being equal.
MACROECONOMICS
It (from prefix "macro-" meaning "large" + "economics") is a branch of economics that deals
with the performance, structure, and behavior of the economy of the entire community
(either a nation, a region, or the entire world). Macroeconomists study aggregated
indicators such as GDP, unemployment rates, and price indices to understand how the
whole economy functions. Macroeconomists develop models that explain the relationship
between such factors as national income, output, consumption, unemployment, inflation,
savings, investment, international trade and international finance.
Macroeconomic models and their forecasts are used by both governments and large
corporations to assist in the development and evaluation of economic policy and business
strategy.
TRADE DEFICIT/SURPLUS
If the imports are more than the exports, trade deficit is observed. If the exports are more
than imports, then trade surplus is observed.
INVESTMENT
It means putting money to work in hope of generating even more money. It is related to
saving or deferring consumption.
Investment is defined as any use of resources intended to increase future production
output or income.
The two basic forms of investment are direct investment on buildings and machinery and
indirect investment on financial securities like bonds and shares.
INFLATION
Inflation is an upward movement in the average level of prices. Its opposite is deflation,
a downward movement in the average level of prices. The boundary between inflation
and deflation is price stability.
Technically, inflation erodes the purchasing power of a unit of currency; so one gets less
for the same amount of money. Inflation usually refers to consumer prices, but it can also
be applied to other prices (wholesale goods, wages, assets, and so on). It is usually
expressed as an annual percentage rate of change on an Index Number.
"Inflation is too many dollars chasing too few goods". To understand how this works,
imagine a world that only has two commodities: Oranges picked from orange trees, and
paper money printed by the government. In a year where there is a drought and oranges are
scarce, we'd expect to see the price of oranges rise, as there will be quite a few dollars
chasing very few oranges. Conversely, if there's a record crop or oranges, we'd expect to see
the price of oranges fall, as orange sellers will need to reduce their prices in order to clear
their inventory. These scenarios are inflation and deflation, respectively, though in the real
world inflation and deflation are changes in the average price of all goods and services, not
just one.
Before the Great Depression of 1930, prices were as likely to fall as rise during any given
year, and in the long run these ups and downs usually cancelled each other out. By
contrast, by the end of the 20th century, 60-year-old Americans had seen prices rise by
over 1,000% during their lifetime. The most spectacular period of inflation in
industrialized countries took place during the 1970s, partly as a result of sharp increases
in oil prices implemented by the OPEC cartel.
(cartel: An agreement between two or more firms of the same industry to co-operate in
fixing prices and/or carving up the market by restricting the output. Although the desire to
form cartels is strong as it reduces competition, it is not easy to actually form cartels
because of the strict laws.)
Ideally, macroeconomic policy should aim for stable prices.
INDEX NUMBER
Inflation is measured by an index of consumer (retail) prices. An index number is an
economic data figure reflecting price or quantity compared with a standard or base
value. The base usually equals 100 and the index number is usually expressed as 100
times the ratio to the base value. For example, if a commodity costs twice as much in
1970 as it did in 1960, its index number would be 200 relative to 1960. Index numbers
are used especially to compare business activity, the cost of living, and employment.
HYPER-INFLATION
A scenario where the inflation rises at a very high rate, how much is high is really high is
still debated. Typically, hyper-inflation leads to complete loss of confidence in the
country’s currency and people start looking for other forms of money like gold, physical
assets and foreign currency. This is a big problem because it is unstable and
unpredictable, for if it was predictable, people could plan on the basis of expected price
rise.
MACROECONOMIC POLICY
A policy by government and central banks, usually intended to maximize growth while
keeping down inflation and unemployment. The main instruments of macroeconomic
policy are changes in the rate of interest and money supply, known as monetary policy,
and changes in taxation and public spending, known as fiscal policy. The fact that
unemployment and inflation often rise sharply, and that growth often slows or GDP falls,
may be evident of poorly executed macroeconomic policy.
MONETARY POLICY
This is under the control of central banks and is used to control the money supply and
interest rates, and hence manage demand.
FISCAL POLICY
The control of economy by controlling the government spending and revenue collection
by taxes.
PURCHASING POWER PARITY
Purchasing power parity (PPP) is a theory which states that exchange rates between
currencies are in equilibrium when their purchasing power is the same in each of the two
countries. This means that the exchange rate between two countries should equal the ratio of
the two countries' price level of a fixed basket of goods and services. When a country's
domestic price level is increasing (i.e., a country experiences inflation), that country's
exchange rate must be depreciated in order to return to PPP.
PPP is helpful in comparing the living standards in different countries, as it indicates the
appropriate exchange rate to use when the prices in different countries are expressed in a
common currency.
Purchasing Power Parity and Baseball Bats
First suppose that one U.S. Dollar (USD) is currently selling for ten Mexican Pesos (MXN) on
the exchange rate market. In the United States wooden baseball bats sell for $40 while in
Mexico they sell for 150 pesos. Since 1 USD = 10 MXN, then the bat costs $40 USD if we buy
it in the U.S. but only 15 USD if we buy it in Mexico. Clearly there's an advantage to buying
the bat in Mexico, so consumers are much better off going to Mexico to buy their bats. If
consumers decide to do this, we should expect to see three things happen:
1. American consumers desire Mexico Pesos in order to buy baseball bats in Mexico. So they
go to an exchange rate office and sell their American Dollars and buy Mexican Pesos. This
will cause the Mexican Peso to become more valuable relative to the U.S. Dollar.
2. The demand for baseball bats sold in the United States decreases, so the price American
retailers charge goes down.
3. The demand for baseball bats sold in Mexico increases, so the price Mexican retailers
charge goes up.
Eventually these three factors should cause the exchange rates and the prices in the two
countries to change such that we have purchasing power parity. If the U.S. Dollar declines
in value to 1 USD = 8 MXN, the price of baseball bats in the United States goes down to $30
each and the price of baseball bats in Mexico goes up to 240 pesos each, we will have
purchasing power parity. This is because a consumer can spend $30 in the United States for
a baseball bat, or he can take his $30, exchange it for 240 pesos (since 1 USD = 8 MXN) and
buy a baseball bat in Mexico and be no better off.
In the long run having different prices in the United States and Mexico is not sustainable
because an individual or company will be able to gain an arbitrage profit by buying the
good cheaply in one market and selling it for a higher price in the other market (This is
explained in greater detail in “
ARBITRAGE
It is the opportunity to buy an asset at a low price, then immediately sell it in a different
market for a higher price.
If I can buy an asset for Rs 5, turn around and sell it for Rs 20 and make Rs 15 for myself, it
is arbitrage.
GLOBALISATION
A buzz word that refers to the trend for people, firms and governments around the world
to become increasingly dependent on and integrated with each other.
This can be a source of tremendous opportunity, as new markets, workers, business
partners, goods and SERVICES and jobs become available, but also of competitive threat,
which may undermine economic activities that were viable before globalisation.
It has come to dominate the world since the nineties of the last century with the end of
the cold war and the break-up of the former Soviet Union.
Globalisation has brought in new opportunities for developing countries. Greater access
to developed country markets and technology transfer leads to improved productivity
and higher living standard.
But globalisation has also thrown up new challenges like growing inequality across and
within nations, volatility in financial market and environmental deteriorations. Another
negative aspect of globalisation is that a great majority of developing countries remain
removed from the process.
Consequences:
The implications of globalisation for a national economy are many. Globalisation has
intensified interdependence and competition between economies in the world market.
This is reflected in Interdependence in regard to trading in goods and services and in
movement of capital. As a result, domestic economic developments are not determined
entirely by domestic policies and market conditions. Rather, they are influenced by both
domestic and international policies and economic conditions. It is thus clear that a
globalising economy, while formulating and evaluating its domestic policy cannot afford
to ignore the possible actions and reactions of policies and developments in the rest of
the world. This constrained the policy option available to the government which implies
loss of policy autonomy to some extent, in decision-making at the national level.
RECESSION & DEPRESSION
A period of general economic decline; typically defined as a decline in GDP for two or
more consecutive quarters. A recession is typically accompanied by a drop in the stock
market, an increase in unemployment, and a decline in the housing market. A recession
is generally considered less severe than a depression, and if a recession continues long
enough it is often then classified as a depression.
FOREIGN DIRECT INVESTMENTS (FDI)
Investing directly in production in another country, either by buying a company there, or
expanding the existing business.
Generally companies invests directly, banks prefer indirect investment in stocks or
bonds.
FDI plays an extraordinary and growing role in global business. It can provide a firm
with new markets and marketing channels, cheaper production facilities, access to new
technology, products, skills and financing. For a host country or the foreign firm which
receives the investment, it can provide a source of new technologies, capital, processes,
products, organizational technologies and management skills, and as such can provide a
strong impetus to economic development.
WHOLESALE PRICE INDEX
The Wholesale Price Index or WPI is the price of a representative basket of wholesale
goods. Only some countries including India use the changes in this index to measure
inflation. The Indian WPI figure is released weekly on every Thursday and influences
stock and fixed price markets. The purpose of the WPI is to monitor price movements
that reflect supply and demand in industry, manufacturing and construction. This helps
in analyzing both macroeconomic and microeconomic conditions.
Calculation of Wholesale Price Index
The wholesale price index consists of over 2,400 commodities. The indicator tracks the
price movement of each commodity individually. Based on this individual movement, the
WPI is determined through the averaging principle.
ABSOLUTE ADVANTAGE
If a person, firm or country produces more goods and services than the other producers,
with the same amount of resources, then the former is said to be in an absolute
advantage over the latter.
BANKRUPCY
When the court judges that a debtor will be unable to make the payments owed to a
creditor.
BEAR
An investor who thinks that the price of a particular security is going to fall.
BULL
An investor who thinks that the price of a particular security is going to rise.
CAPITAL ADEQUACY RATIO
The ratio of bank’s capital to its total assets, which have to be maintained above a
minimum level so that there little risk of bank going bust.
CLOSED ECONOMY
An economy that does not take part in international trade.
DIRECT TAX
Tax levied on the wealth of a person or firm
MERGERS & ACQUISITIONS
When two companies join, either by merging into one another or by one company taking
over the other. There are 3 kinds of mergers between firms : horizontal integration, in
which two similar companies are involved, vertical intergration, in which two companies
at different stages merge and diversification in which the companies have nothing in
common.
PRICE/EARNINGS RATIO
A method to judge whether the shares are cheap or expensive; the ratio of market price
of the share to the earnings per share of the company.
OLIGOPOLY
An oligopoly is a market form in which a market or industry is dominated by a small
number of sellers (oligopolists). The word is derived, by analogy with "monopoly", from
the Greek oligoi 'few' and poleein 'to sell'. Because there are few sellers, each oligopolist
is likely to be aware of the actions of the others. The decisions of one firm influence, and
are influenced by, the decisions of other firms.
STAGFLATION
When prolonged recession and inflation co-exist
WINDFALL GAINS
Income which is not expected, like winning a lottery.
Some links
http://glossary.econguru.com/ : An exhaustive dictionary
http://www.economicswisconsin.org/guide/glossary.htm : Overview of the most essential terms.