2.1 Flashcards
What is real GDP and why is it beneficial?
- GDP that have been adjusted to remove the effects of inflation
- A country may have a higher level of economic growth but also a much higher rate of inflation thus, real GDP provides a better comparison
Purchasing Power Parity
A way to compare currencies by looking at how much the same basket of goods and services cost in different countries. It shows what your money can buy in one country compared to another.
GDP
The value of all final goods and services produced in a country in a one-year period
How is actual economic growth shown?
An increase in real income or real GDP
What is potential economic growth?
An increase in the productive capacity in a country
What does an increase in GDP show?
Increase in output/income/expenditure
Why is taking GDP per capita useful?
It takes into account population differences between countries
What are the limitations of GDP?
- Lack of information about inequality; GDP per capita can only give an average income
- Quality of goods and services are undefined; the value of goods and services could increase whiles the quality decreases
- Difference in hours worked; if a country has the same GDP as another but with lesser hours worked, there is a higher standard of living which is not indicated by GDP
- Environmental factors; negative externalities of production are not measured, a country where fewer negative externalities are produced from the same GDP as another would have a higher standard of living
What does GDP not measure?
- Citizens working abroad sending money back as remittance
- Non-residence sending money back to their home country as remittance
GNI
GDP + net income from citizens abroad
GNP
GDP + income from citizens abroad - income sent by non-residents to their home countries
Remittance real-world example
Brazilian delivery drivers in the UK
The strong value of the pound against the real means that the remittance sent back home has strong purchasing power
Why do developing countries see a larger gap between GNP and GDP?
Multinational companies (MNCs) typically go to developing countries for cheaper factors of production i.e. call-centres in India, then send their profits elsewhere
What is the Easterlin Paradox and why does it happen?
- As overall income rises, happiness will rise until a point where happiness is stagnant or even diminishing in relation to an increase in income
- This is can be due to social comparison theory and adaptation
What does GNI not measure?
Doesn’t account for remittance of non-residence to their home countries
What can we understand from the Easterlin paradox?
- Economic growth should not be the sole intention of governments, reducing inequality may have more impact on standards of living than having more money
- The Easterlin Paradox showed how overtime overall more money does not lead to more happiness this can be explained by the social comparison theory
What is the social comparison theory in application to relative income?
- Proposes that individuals base their happiness levels on relative income to others
- If an individuals income is higher than the group average, they feel happier; if lower, it can lead to dissatisfaction
Inflation
- A sustained rise in the general price level
- Most commonly measured by a change in the CPI
Deflation
A fall in the general price level
Disinflation
- Where prices rise more slowly than they did in the past
- For example: the rate of inflation may fall from 3% to 2%
CPI formula
Cost of basket in year X over the cost of basket in base year x100
What is the process of finding the CPI?
- A basket of goods and services is selected to best represent the spending habits of an average household (this can differ from year to year)
- Next, these goods and services are weighted based on their proportion of household spending (e.g. a higher proportion of household spending is allocated to food over shoes)
What is the UK target of CPI inflation
2% (+/- 1%)
Limitations of using CPI as a measure of inflation
- Doesn’t account for housing costs such as rent and mortgage interest payments which take up a large proportion of household income
- Average household does not account for whole population (cultural differences); some households will see significantly different inflation levels
- Doesn’t account for changes in product quality i.e. if production quality changes in line with price level
- Only measures changes in consumption once a year and changes in consumption can occur more frequently
RPI
An index used to measure inflation which includes housing costs (CPI + housing costs)
What is demand-pull inflation
- An increase in the general price level which is caused by an increase in any of the components in AD (e.g. investment, government spending or net imports)
- The outwards shift of the AD curve
What is cost-push inflation?
- An increase in the general price level caused by increased production costs such as rise in wages or fall in exchange rate
- An inwards shift of AS
What are the effects of inflation on consumers?
- The real value of savings falls as prices rise; if price levels are rising at a higher rate than interest rates for savings, the value of savings are falling
- Decrease in purchasing power
- Fall in real income for those on fixed incomes, particularly pensioners
What are the effects of inflation on firms?
- Loss of international competitiveness; inflation leads to higher production costs which means exports become more expensive and imports relatively more cheap
- Fall in foreign investment; inflation decreases the value of said currency so, their investment could be more valued elsewhere
- Increase uncertainty; inflation leads to a rise in production costs, if it is uncertain on how much production costs will rise by, firms will pull back on long-term investment to avoid lower-than-expected ROIs
What is the wage price spiral?
Refers to the loop between higher prices and higher wages
- As prices rise, workers demand wage increases as they have less purchasing power
- This ‘spirals’ as rising wages lead to higher production costs which in turn leads to cost-push inflation thus, raising prices
What is the effect of inflation for the government?
- Reduces international competitiveness of export industries which reduces the size of the injection to the circular flow of income
- Trade-offs for combating inflation; for example, increase in minimum wage will increase unemployment
Unemployment
A situation where someone is of working age, able and willing to work and actively seeking employment but is unemployed
Labour force
The amount of people of working age who are willing and able to work
(They can be unemployed)
Underemployment
A situation where individuals are employed but are either working fewer hours than they desire or are overqualified for their jobs
What are the two ways unemployment can be measured in the UK?
- Claimant count
- Labour force survey (main)
What does the claimant count do?
Counts the number of people claiming job seekers allowance (JSA) in the UK
What is the criteria for someone who is economically inactive?
Someone who is of working age (16-64) but not willing to work
What is the Labour Force Survey?
A measure of unemployment calculated using surveys of those out of work in the last 4 weeks and ready to start in the next 2 weeks
How do you calculate unemployment rate?
Unemployed over labour force (employed + unemployed) x100
What are the issues/limitations of the claimant account in measuring unemployment?
- Difficult to compare between countries; conditions to claim benefits can vary and some countries may not even offer this
- Not everyone will claim; out of embarrassment or not fitting criteria
What are the issues/limitations of the Labour Force Survey?
- Sampling size; difficult to generalise a fraction of the population to account for the whole population
- Hidden unemployment; discouraged workers no longer actively seek employment thus are considered economically inactive
What is the balance of payments?
A record of all the financial transactions that occur between a country and the rest of the world
