The world is a big place with a lot of people in it. And these people wake up, go to work and make money. If you’ve never wondered or looked at the total amount of money that was made, I want to show you how to look at it and why it’s an important number to know.
Not The Whole World Exactly
For the sake of understanding, let’s stick with a single country. Canada, say. There are two numbers we’re concerning ourselves with here.
The second number we’re looking at is something called CPI or the “consumer price index.” The consumer price index measure the movement in the prices of goods sold in a certain industry on a per household basis. This number is often used to measure inflation, which makes sense. If you look at the rising costs of commodities (oil, corn, lumber, etc.), they always seem to go up, just like inflation does.
The Inflation Effect
If you look at the GDP from one year to the next, you’ll find it goes up and down. In bad economic times, the GDP goes down. In good economic times, the GDP goes up. In other words, when the economy goes down, people are buying fewer homes and cars and everything else. They’re eating more McDonald’s and less lobster. While the GDP shows how much money was made on the sales of things, it’s the CPI that shows us how inflation is growing. The importance of this is that public opinion heavily weighs on the side of the belief that inflation is affected by the health of the economy. This is vaguely true. While the health of the economy affects many things, inflation is affected only by the demand for a certain currency.
Where these two numbers actually relate to each other is in the revenue generated by sales taxes. The government has things it needs to pay for and it depends on income and sales taxes to pay for these things. If there’s a shortfall in paying for these things, the money is made up by printing money. This, of course, creates more of something and the more of something there is, the less people want it and the less valuable it becomes.
At the end of each year, the bill to run a country is huge. There are vast social programs that need to be sustained, bonds that need to be paid out, a military that needs to be funded, and the list goes on. So while the GDP and the CPI aren’t directly related, it’s easy to see why people get the ideas confused.
Simply because the country is selling less stuff may or may not mean that the CPI will go up; and simply because the cost of things go up doesn’t mean that we’ll necessarily sell less of it.