Understanding GDP, Inflation, and Their Impact on the Economy

Posted on Feb 3, 2025 in Economy

Production Levels: GDP and Its Components

To correctly use the Gross Domestic Product (GDP), we should try to break it down into different expenditure concepts:

Private Consumption (C): Represents the final goods consumed by households. This is the largest component of expenditure, constituting almost 60% of GDP.
Investment (I): This is the part used by companies to renew their equipment, facilities, etc. It is an important component of GDP as it influences the future production of enterprises.
Government Spending (G): These are the expenditures on goods and services provided by public entities, such as municipalities and administrations.
Exports and Imports: The importance lies in the difference between a country’s exports (X) and imports (M). This difference reflects a country’s dependence on foreign and internal flows.

For the calculation of GDP, only final products are taken into account, since intermediate products are already included in them. Considering both intermediate and final products would lead to double-counting. (For example, consider bread and flour).
The GDP refers only to the production taking place within the borders of the country, regardless of the ownership of the company that produces it. (For example, Apple computers manufactured in Spain are counted in Spain’s GDP, although Apple is an American company). However, for a Spanish company with factories in several countries, only the production of its plants in Spain will be considered for the Spanish GDP calculation.
The GDP is related to a period, usually one year. So, a product manufactured in 2009 and sold in 2010 falls under the GDP of 2009, the year of manufacture, not the year of sale.
GDP is calculated using a monetary standard, referring to a particular currency and not products. It is estimated by multiplying the quantity produced by the unit price.

Inflation does not consider:

Inflation of Demand: This could be due to excess aggregate demand over aggregate supply. When this happens, companies tend to raise their prices because more people are demanding products than are being offered.
Cost Inflation: Wages always tend to increase, even in periods of recession, because if they fall, it can create tensions in the labor market. These wage increases cause consumers to increase their consumption, leading to a rise in production. Companies, seeing increased costs, raise their prices.

Low Inflation
Inflation is predictable and controlled, acting slowly.
Runaway Inflation
It is quite aggressive for the market and affected Latin American countries during the 1980s, with inflation rates reaching up to 650%. If this type of inflation persists, it can lead to serious economic dysfunctions. Consumers feel insecure, and individuals with financial resources prefer to invest in tangible assets like buildings and land, whose value is not as affected by inflation.
Hyperinflation
This is a consequence of poor inflation control. Two notable cases in Latin American countries saw inflation rise by 500% while wages rose by only a few percentage points. Those who suffered most were workers with savings in banks, realizing that after a few months, their money was worth much less. Another case is that of the Weimar Republic in Germany during the 1920s. In less than two years, from 1922 to 1923, inflation rose by one trillion percent (what used to cost 100 marks came to cost 1 billion). In this situation, people tend to get rid of cash before investing in property, as prices continue to rise, and wages vary from month to month.