Key Concepts in Economics: Markets, GDP, Inflation & Employment

Posted on Aug 18, 2025 in Economy

Market Structures & Competition

Perfect Competition Markets

Goods and services are exchanged voluntarily at a price fixed by the market as a result of the free operation of the laws of supply and demand. In this situation, not a single company has enough power to influence the price, so all companies compete on equal conditions.

Imperfect Competition Markets

One or more companies have the power to influence price, to a greater or lesser extent. The smaller the number of companies, the greater their influence on the price. Hence, imperfectly competitive market models are classified by the number of companies participating in the market.

Market Classifying Criteria

  • Number of firms
  • Price-taker capacity
  • Product homogeneity
  • Competition level
  • Transparency
  • Entry and exit barriers

Entry Barriers

These are the costs a newcomer company would incur when entering a specific market.

Common entry barriers:

  • Cost advantages of existing competitors
  • Product differentiation
  • High capital investment requirements

Exit Barriers

These are the costs a company would incur when exiting a market, or the losses from not recovering invested capital.

Perfect Competition Market Evolution

  1. Growth: If sellers achieve above-normal profits, new producers or sellers enter the market, imitating established companies.
  2. Surplus: As new vendors enter, the supply of goods increases. Because products are undifferentiated, excess supply is created, leading sellers to lower prices to clear surpluses. As a result, profits decline.
  3. Maturing: As a result of oversupply, the period of above-normal profits ends, and some companies exit the market for more profitable ventures. Remaining companies adapt production processes or seek other strategies to continue. In this phase, companies continue to imitate each other, and prices fall further.
  4. Stabilization: As more companies leave the market, the remaining few recover customers and begin to reap profits again because supply decreases and price wars subside. The income companies earn during this period is called normal profit, as it covers expenses and provides a minimum return for the entrepreneur.

Monopoly vs. Oligopoly Comparison

  • In a monopoly, there is only one firm. There is minimal competition and transparency, entry and exit barriers are high, and the firm has significant pricing power. Monopolies often invest in marketing and advertising to differentiate their products.
  • In an oligopoly, there are a few firms. Competition is intense, and transparency is often low. Products can be homogeneous or differentiated, and both entry and exit barriers exist. Firms have considerable pricing power. A significant risk in an oligopoly is collusion, where competitors make secret agreements.

Foundational Economic Principles

Adam Smith’s Economic Principles

  • Free market operation.
  • Self-interest as the economic engine.
  • Advocacy for private property.
  • Opposition to public body intervention.

Market Failures & Government Intervention

Understanding Market Failures

Market failure is an economic situation characterized by an inefficient distribution of goods and services in a free market. In such cases, individual incentives for rational behavior do not lead to rational outcomes for the group.

Key Types of Market Failures

  • Instability of economic cycles
  • Existence of public goods
  • Externalities
  • Imperfect competition
  • Unequal income distribution

Externalities: Internal & External Costs

Internal Costs: These costs are linked to the use of productive resources such as salaries, rents, and interest, and are accounted for by firms.

External Costs: These costs are borne by citizens not directly linked to the firms, as a consequence of the firm’s activity, without receiving any compensation. Pollution is a major example.

Defining Externalities

Externalities are consequences derived from economic activity that affect individuals other than those directly involved, and are not reflected in the prices of the goods and services produced.

External Cost: The cost of an economic activity that falls on individuals other than those who carry it out.

External Benefit: The benefit of an economic activity received by individuals other than those who carry it out.

Economic Policy: Public Intervention

Refers to the actions and tools used by public bodies to intervene in economic activity and steer it in a specific direction, either towards growth or slowdown.

Intervention: Public consumption and production of goods and services to foster the economy and address a lack of private demand. These ideas are attributed to John Maynard Keynes (1883-1946), an English economist.

Non-Intervention: Allowing markets to operate freely, enabling them to overcome crisis situations. These liberal ideas were championed by Hayek (1899-1992), Friedman, and others.

Economic Cycles & Indicators

The Economic Cycle

The economic cycle refers to the fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as Gross Domestic Product (GDP), interest rates, total employment, and consumer spending can help determine the current stage of the economic cycle.

Economic Expansion

Economic activity, including Gross Domestic Product (GDP), grows along with the employment rate.

Economic Recession

Economic activity, including GDP, declines along with the employment rate.

Gross Domestic Product (GDP)

The monetary value of all final goods and services produced within a country’s borders during a specific time period.

Key Characteristics of GDP

  • Measured in currency
  • Includes only legal and declared activities
  • Includes only final goods
  • Includes only production within national borders
  • Measures production over a specific time period, usually a year

Limitations of GDP Measurement

  1. Black economy (undeclared activities)
  2. Non-monetary activities
  3. Unaccounted externalities
  4. Excludes product quality
  5. Does not reflect wealth distribution

Nominal vs. Real GDP

Nominal GDP: The monetary value of all goods and services produced by a country at current market prices in the year they are produced. When studying GDP evolution over time, in situations of high inflation, a substantial increase in prices—even with constant production—can lead to a significant increase in nominal GDP, solely due to price inflation.

Real GDP: Defined as the monetary value of all goods and services produced by a country or economy, valued at constant prices (i.e., according to the prices of a base year). This calculation is performed using the GDP deflator, based on the inflation index, or by computing the value of goods using prices from a specific reference year, regardless of their production year.

Alternative Economic Indicators

Green GDP: Some economists refer to Green GDP as a modification of conventional GDP, subtracting the value of deteriorated natural resources. This accounting method seeks greater realism in assessing whether economic activity increases or reduces national wealth.

Human Development Index (HDI): This index combines statistics on:

  • Life expectancy.
  • Education: adult literacy rate and combined gross enrollment rate in primary, secondary, and higher education.
  • GDP per capita.

Happy Planet Index (HPI): An alternative index measuring development, human, and environmental well-being. It is designed to assess countries’ development based on life expectancy, subjective perception of happiness, and ecological footprint.

Gini Index: Measures income or wealth inequality, ranging from 0 (perfect equality) to 100 (maximum inequality).

National Accounting & Income

National Accounting

Refers to the economic indicators that measure the overall economic situation of a specific country over a period of time.

Key National Accounting Indicators

Gross National Product (GNP): The monetary value of all final goods and services produced by a country’s citizens and companies, both domestically and abroad, during a specific time period.

National Income (NI): The total income earned by a country’s citizens before taxes and social security deductions. Also known as Gross National Income.

Disposable Income Per Capita (DI): The total income obtained by a country’s citizens after taxes and social security deductions. Also known as Net National Income, it represents the amount of money a household can truly spend.

Advantages of Free Competition

  • Fosters innovation and technological progress through the search for more efficient production methods.
  • Increases public access to a wider variety of goods and services due to competitive price reductions.
  • Enables better value for money, as prices decrease while salaries may remain stable.
  • Facilitates market entry for new firms, leading to job creation.

Public Finance & Welfare

Understanding Taxes

Equity Principle: Public expenses that enable the corrective action of the state must be financed by all citizens according to their economic capacity.

Taxes: State financing is primarily generated through taxes paid by all citizens. Most taxes are progressive, meaning the more you earn, the more you pay.

The Welfare State

The welfare state refers to state intervention aimed at ensuring the well-being of citizens. It was established after WWII to address social shortcomings. It provides universal benefits (e.g., health, education), paid benefits (e.g., retirement), and social benefits (e.g., social canteens, social housing).

Inflation & Employment

Causes of Inflation

Demand-Pull Inflation: Occurs when aggregate demand outpaces aggregate supply. This can be driven by:

  • Companies: Forecasting improvements and increasing investment.
  • Public Sector: Increased government spending.
  • Families: Reduced savings and increased consumer spending.

Cost-Push Inflation: Occurs when the cost of production increases. This can be due to:

  • Rising natural resource prices.
  • Market power of monopolies, allowing them to raise product prices.
  • Wage increases exceeding productivity gains.
  • Rising interest rates, making loans more expensive for companies.

Consequences of Inflation

Retired people, workers, savers, and export companies are often the most negatively impacted, as their incomes or assets may not keep pace with inflation. Furthermore, if a country experiences a significantly higher inflation rate than its trading partners for an extended period, its exports become less price-competitive in world markets, as higher production costs reduce company profitability.

Conversely, individuals with debt, states (especially those with large national debts), and import companies often benefit, as they can repay debts with money that has depreciated in value.

However, inflation creates widespread uncertainty, making economic planning more difficult and potentially freezing investments and hindering development.

Employment Indicators

  • Population: All citizens.
  • Active Population: Employed and unemployed individuals aged 16 to 64.
  • Non-Active Population: Individuals outside the labor market.
  • Activity Rate: (Active Population / Total Population) x 100
  • Unemployment Rate: (Unemployed People / Active Population) x 100
  • Occupation Rate: (Employed People / Active Population) x 100

Employment Statistics Sources

  • EPA (Encuesta de Población Activa – Labor Force Survey): Conducted quarterly by INE (National Statistics Institute) in approximately 65,000 households since 1970.
  • Number of Social Security Affiliates: Indicates employment rates and types of contracts.
  • Public Employment Service: SEPE (Servicio Público de Empleo Estatal) or regional equivalents like Lanbide in Euskadi.