European Finance and Economy Lesson 2

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European Finance and Economy

esson un amen a conom cTerms

Prof. Dr. Brigitta Herrmann

10/13/2011



Outline

1. How is the GDP measured?

2. Understanding inflation rate

3. Relationship between Inflation rate and

.

2. Savings

3. Investment

4. Employment

4. Budget Deficit

5. Government Debt

13.10.2011 2Prof. Dr. Brigitta Herrmann




GDP (Gross Domestic Product):

• Measure of the economic performance of a nationaleconomy over a given period

• Gives the value of final goods and services produced

consumption for the production of other goods and

services, without subsistence production, without

black market)





GDP:

• 3 Methods of Calculation:

• Production

• Distribution





• Calculation of GDP:

• Production method: example Germany 2005 inbio €

Output 4,088.72- intermediate consumption 2,082.36

= gross value added 2,006.36

+ taxes less subsidies on products 218.04

= gross domestic product 2,224.40






• Expenditure method: example Germany 2005 in bio €

Final consumption expenditure of households 1,306.98

+ investment 384.13

+ government final consumption expenditure 417.30+ exports 919.07

– imports 803.08

= gross domestic product 2,224.04

Y=C+I+G+X-I






• Distribution method: example Germany 2005 in bio €Compensation of employees (residents) 1,137.64

+property and entrepreneurial income 576.05

= , .

+government taxes on production and importsless subsidies 207.94

+consumption of fixed capital 327.96

=gross national income 2,249.59

–primary income from the rest of world (balance)25.19=gross domestic product 2,224.40





1. Inflation: persistent increase of prices

• Inflation rate:

= percentage by which prices of goods and

= rate by which the purchasing power of people

in a country has declined in a specified period

(month or year (expressed in an annualized

figure)





• Calculation of inflation rate: price indices

• Consumer Price Index• Cost of Living Index

• Producer Price Index

• Commodity Price IndexFormula: Inflation Rate = (Po- P-1)* 100 / P-1,

• Po = present average price

• P-1 = price that existed last year





• Causes of inflation:

1. Increase of money supplyor

2. Decrease of goods supplied

.monetary policy)

Supply of money is big compared to products one canbuy with the money

=> prices rise• High lending levels

• Declines in exchange rates





Ad 2. Decrease of goods supplied causes inflation:

• Increases in production costs• Increases in labour costs

• Decrease in availability of limited resources (e.g.

food, oil)





• Effects of inflation:

economic and social• Purchasing power decreases (problem especially for

low-income groups)

• Real value of money decreases=> effect on interest rates

=> effect on savings

=> effect on investments=> effect on employment





• Effects of inflation rate on interest rates:

• if inflation rate increases => interest rates will risebecause: people saving money want to be

compensated for losses in value of money due to

n a onQuestions:

• How fast is adaptation process?

• What other factors influence adaptation process?





• Effects of inflation rate on savings:

• if interest rates rise=> Savings will rise,

• if consumers are able to save money (not too

poor)• if inflation is not too high, if so

=> Savings decrease but shift to real assets







Effects of inflation rate on employment:

If wages have not adapted:=>Unemployment may be reduced (reduced costs

because of reduced real wa es

If wages have adapted (risen) and if investments arereduced

=> unemployment rises




4. Budget Deficit

• Budget Deficit:

• Government Budget = summarized version of :• Anticipated revenues

and

of a government (formulated by the executive andpassed by the legislature as a legal document)Government Budget: focus on distribution of wealth for

• economic• political and

• social purposes




4. Budget Deficit

• Budget Deficit:

• Public expenditures > public revenues⇒Must be financed by loans

⇒Interest rates on government bonds increase

Depending on types of expenditures:

⇒Employment might increase⇒Private investment might be crowded out




5. Government Debt

Overall government debt

= accumulated debts• Problem: even if no new debts, overall debt is

existing debts

• Government debt should be seen in relation to

growth rate

• If growth rate is higher than real interest rate

=> not a big problem




Thank ou ver much

for your attention !


European Finance and Economy Lesson 2

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