GDP and Price Elasticity

One of the factors in our macroeconomic models is GDP and how it is projected to change over the coming quarter. GDP stands for “gross domestic product”. So what is GDP?

GDP is produced when any good or service is created and paid for. When a tree is cut down and converted to paper and sold for a profit, it creates an addition to GDP. When that paper is converted to a bundle and sold to an office supply company, another round of profit is made. Then when that paper is converted to a calendar and sold for profit, it adds more to the GDP number. Every step of the process is an addition to GDP. In short, sales create GDP.

The better footing consumers have, the better sales generally are. Inflation can erode demand for products by rising fixed costs. As consumers feel too squeezed with bills and don’t get the corresponding raises to compensate, their spending behavior changes.

Think of this as a company would… If sales slow down we have two choices: cut costs or raise sales income. The fastest and least painful way to increase sales income is to raise prices. Some industries have strong price elasticity. Price elasticity is when a product can have a price hike and it doesn’t curb buyer demand. An example would be trash pickup services. If the city raises prices on trash pickup, the buyer is faced with canceling the service and taking the trash themselves or paying the extra fee. Here in Washington state, we just had trash service raised by 36% year over year, now that is inflation. Still, with this massive price hike, we will not see a change in behavior due to the monopoly on trash services.

Some businesses are not as lucky to have a strong price elasticity; those businesses are forced to grow the number of sales or cut costs. Most businesses choose to do a mixture of both. When businesses cut costs, it is a cut to another business’s income. The shrinking of GDP becomes a self-fulfilling prophecy.