2.1 Measures of Economic Performance Flashcards
What is GDP
value of all newly produced final goods and services produced in an economy within a given time period
How is economic growth measured by rates
It is measured by rates of change of real GDP
What is a real value
a value without the effect of inflation
What is a nominal value
A value with the effect of inflation
What is the difference between total and per capital values
total is the total some
per capita is total/population
How can real and nominal values be described as
Real values can be described as the volume of national income i.e. the size of the basket of goods
nominal values represent the value of the national income i.e. the monetary cost of this basket of goods
What is GNI (Gross National Income)
GDP + net overseas intrest payments/ dividends
adds what a country earns from overseas investments and subtracts what foreigners earn in a country and send back home from the GDP
How do we make comparisons about growth over time and between countries
Data is compared to other countries to put figures in context while using real,per capita figure
What is Purchasing Power Parities (PPP)
the measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries’ currencies.
e.g. the exchange rate needed for say $100 to buy the same quantity of products in each country
What is PPP useful for
Comparing countries as it takes into account the cost of living
For example, in Kenya £2 a day in their own currency is enough to survive on, whilst it isn’t in the UK.
What are some of the problems of using GDP to compare standard of living
- inaccuracy of data; inaccuracy of collecting data, diifferent methods, black market
- Inequality; growth in gdp doesnt equal higher living standards
- Quality of g/s; may cause lower price
- different currencies
- Spending: some types of expenditure such as defence doesn’t increase standard of living but will increase GDP
What is the Easterlin Paradox
if you are poor and your income increases, you will be happier, but higher levels of income aren’t associated with increases in happiness
How does income and happiness depend on the people around you
if you are the richest out of everyone you associate yourself with, then you will be happier than someone who has the exact same income but is the poorest out of everyone they associate with
What is inflation
general progressive increase in prices of goods and services in an economy
What is deflation
decrease in the general price level of goods and services
What is disinflation
decrease in the rate of inflation – a slowdown in the rate of increase of the general price level of goods and services in a nation’s gross domestic product over time
What measure is used in the UK to measure inflation
Consumer Price Index (CPI)
How is the CPI calculated
- A representative shopping basket is created each year
- government officials collect 120,000 separate price quotations in 141 locations of around 600 products
- average household spending is worked out through the Living Costs and Food Survey, where around 5,500 families keep diaries of what they spend over a fortnight.
- the weighted price changes are then totalled to calculate the inflation rate
What are the limitations of the CPI
- not fully representative
- doesnt include housing
- overstimation as improved quality of goods led to price increase
- Hard to respond to new products
How is the RPI different to the CPI
● RPI includes housing costs such as mortgage and interest payments and council tax
● CPI takes into account the fact that when prices rise people will switch to product that has gone up by less. Therefore, the CPI is generally lower than the RPI.
● RPI excludes the top 4% of income earners and low income pensioners as they are not ‘average’ households whilst CPI covers all households and all incomes.
What are the 3 main causes of inflation
- cost push inflation
-
demand pull inflation
- growth of money inflation
Draw a diagram (using AD-AS) for the growth of an economy
- expansion of AS and AD
- Leads to expansion of LAS
What is cost push inflation and draw a diagram
When businesses find their costs have risen (decrease in AS) , they will put up prices to maintain their profit margins
caused by anything that reduces AS e.g. increase in tax, depreciation in exchange rate, rising wages
What is demand pull inflation
caused by an unsustainable rate of increase in aggregate demand (AD) leading to a positive output gap (actual GDP> potential)
when the economy is close to full capacity
What is growth of money supply inflation
there being too much money in the economy. If people have access to money they will want to spend it but if there is no increase in the amount of goods and services supplied, then prices will have to rise.
What is the effect of inflation on consumers
- Less to spend = fall in living standards
- Those in debt will be able to pay it off cheaper, but inverse for those who are owed. Consumers who have saved will see their money is worth less
- Psychological effects on consumers of price rising
What is the effect of inflation on firms
- If inflation in Britain is higher than other countries, British goods will be more expensive and less competitive
- Have to calculate new prices
What is the effect of inflation on governments
- If government fails to change excise taxes in line with inflation then government real revenue will fall
- However, if they fail to change personal income tax allowances (the amount a worker can earn tax free) then real government income will increase and taxpayers will have less money
How does inflation effect workers
- If workers do not recieve yearly pay rises of inflation
How can some effects of inflation be anticipated
indecation - wages increased in line with predicted inflation
however this can make it difficult to control inflation by the government
What are the demand-side causes of inflation
-
Deep fall in AD causing a persistent recession / depression
- Large negative output gap – i.e. high level of spare capacity
What are the supply-side causes of inflation
- Improved productivity
- Technological advances
-
Significant fall in wage rates
- High exchange rate causing import prices to fall
What are the consequences of price deflation
- Holding back on consumer spending
- real value of debt rises with deflation
- The real cost of borrowing increases: Real interest rates will rise if nominal rates of interest do not fall in line with prices.
- Lower profit margin so reduced revenue
- Deflation can make exporters more competitive
What are the economic policies to avoid deflation
Low interest rates and quantitative easing
-
Other measures to stimulate aggregate demand
- Attempts to lower the value of the exchange rate (perhaps via central bank intervention to sell their currency in the market)
- Higher taxes on savings to encourage consumption
What are the main measures of unemployment
- Claimant count
- the International Labour Organisation (ILO) and the UK Labour Force Survey
What is the claimant count
number of people receiving benefits for being unemployed provided on a monthly basis
What is the labour force survey (LFS)
sample of people living in households and asking questions about personal circumstances to class people as employed, unemployed, or inactive according to the ILO definitions
What are the comparisons between the LFS and the Claimant Count
- some people arent elligble for benefits but are classed as unemplyoed so LFS is typically higher
- both seen as underestimating as they don’t recognise the hidden unemployed
What is the hidden unemployed
- working part time but would like to work full time
- on government training schemes who would prefer employment
- classed as sick or disabled
- who aren’t actively looking for jobs but would take a job if offered or are in education because they can’t get a job
What is unemployment and employment rate
employment rate is the percentage of the population of working age who are employed, and the unemployment rate is the percentage of the economically active who are unemployed.
What are the activity and inactivity rates
activity/participation rate is the percentage of the population of working age who are economically active whilst the inactivity rate is percentage of the population of working age who are inactive
What is under-employment
- underemployed are those who are in part time or zero hour contracts when they would prefer to be full time and people who are self-employed but would rather be employees.
- It also includes those who are in jobs which do not reflect their skill level
What is the effect of changes in inactivity
● Increases in inactivity will decrease the size of the labour force, therefore causing a fall in productive potential of the country . There will be a lower GDP and lower tax revenues as less people are working.
● However, decreases in inactivity could just result in more people being unemployed if there are no jobs available to them.
What is Frictional Unemployment
- People moving between jobs
- Isn’t serious and mostly short term
What is seasonal unemployment and what can be done to prevent it?
- Employment that is strongly seasonal in demand, requiring large numbers of people at specific times
-
Little can be done to prevent this in a free market economy
*
What is cyclical unemployment
- Unemployment due to a general lack of demand, also known as a Keynesian ‘demand deficient’ unemploymenyt
- Falls in demand, lowers profits and forces business to cut unemployment in order to control costs
What is real wage inflexibility
- Unemployment due to real wages being above their market clearing level which creates an excess supply of labour
- Caused by minimum wages and unemplyed workers refusing to take low paid jobs because of welfare benefits
What is structural unemployment
the demand for labour is less than the supply of labour in an individual labour market
What are some causes of structural unemployment
- Decline of manufacturing….loss of skilled jobs (e.g. car industry in Birmingham)
- Occupational immobility…people with a lifetime of skills in the shipbuilding industry would find it difficult learning computer skills.
- Geographical immobility….people may be unable to move due to housing costs or unwilling due to family ties.
- Long term regional decline…certain parts of Britain have experienced decline (e.g. South Wales)
-
Foreign competition – rising imports
- Outsourcing of production overseas…relocation of the textile industry from Yorkshire to the Far East.
What are the 3 types of structural unemployment
- Regional unemployment is where certain areas of a country suffer from very low levels of employment due to industry closures
- Sectoral unemployment is where one sector (primary, secondary and tertiary) suffers a dramatic fall in employment.
- Technological unemployment is where an improvement in technology means that jobs are replaced.
What are some labour scarring effects from high unemployment
- Loss of work experience
-
Loss of current/future income
- changing pattern of jobs in the economy
What are some policies to increase demand for labour
- Infastructure investment projects
- Financial support for apprenticeships
- Entreprise policies to life the rate of new business start ups
How to reduce occupational immobility
- Funding apprenticeships and training programmes
How to reduce geographical immobility
- Rise in house-building will help to keep property prices lower and encourage more affordable rents
- Active regional policy to create new jobs and businesses
What is the impact of unemployment on Firms
● There will tend to be a decrease in demand for their goods (but this depends on the YED) and so this could lead to a fall in profit.
● Long term unemployment can lead to loss of skills and reduce employability of workers, so firms have a smaller pool of skilled people to employ.
● They can offer low wages as people will take the job anyway because they know there is a lack of jobs so have few options.
What is the effect of unemployment on consumers
● Consumers suffer from less choice. The quality of goods may also decrease.
● The unemployed consumers lose out as they have less available to spend.
● However, firms may lower prices and put on sales in order to increase demand for their product.
What is the effect of unemployment on the government
● The reduced income results in a fall in tax revenues and higher spending on welfare payments for families with people out of work, incurring an opportunity cost as the money could be better spent elsewhere.
● This will result in an increase in the budget deficit. It will be likely that the government will have to raise taxation or scale back plans for public spending on public and merit goods, such as the NHS or education. They may need to increase borrowing.
What is the effect of unemployment on society as a whole
● Rising unemployment is linked to social deprivation. There is a relationship with crime and social dislocation
● It results in a loss of potential national output and represents an inefficient use of scarce resources. If people chose to leave the labour market permanently, then this will have a negative effect on LRAS
.● Taxpayers paying money to the unemployed is not a loss for the economy as it is a transfer payment but the economy is affected because there is a fall in national output and the social costs of the unemployed e.g. violence and crime.
What is the effect of unemployment on society as a whole
● Rising unemployment is linked to social deprivation. There is a relationship with crime and social dislocation
● It results in a loss of potential national output and represents an inefficient use of scarce resources. If people chose to leave the labour market permanently, then this will have a negative effect on LRAS
.● Taxpayers paying money to the unemployed is not a loss for the economy as it is a transfer payment but the economy is affected because there is a fall in national output and the social costs of the unemployed e.g. violence and crime.
What is the effect of migration on jobs
- Leads to increased jobs due to a circular flow of income
- Also leads to lower wages due to higher competition; people with low motivation and low skill are most affected
- Fill in shortages where skilled labour is needed
What are the 4 components of the Balance of Payments Accounts
- Current Account
- Capital Account
- Financial Account
- Balancing Item
What is the current account made up of
- Balance of trade in goods
- Balance of trade in services
- Net primary income (interest, profits, dividends and migrant remittances)
- Net secondary income (transfers i.e. contributions to EU, military aid, overseas aid)
What is the capital account
- Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts (example would be international buying and selling of land by businesses)
- Debt forgiveness/cancellation (forgiving debt counted as a negative)
- Capital transfers of ownership of fixed assets (i.e. international death duties)
What is the financial account
- includes transactions that result in a change of ownership of financial assets and liabilities between UK residents and non-residents
- Net balance of foreign direct investment flows (FDI)
- Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)
- Balance of banking flows (e.g. hot money flowing in/out of banking system)
- Changes to the value of reserves of gold and foreign currency
What is the balancing item
it gets rid of estimated errors and omissions to get the BOP=0
In a floating exchange rate what is the demand for curreny and BOP equivalent to
- demand = supply for currency
- BOP=0
Why is the BOP=0
- If there is a deficit on the current account there will be a surplus on the financial account
If there was an increase in interest rates this would cause hot money flows to enter the UK
What are key causes of Current Account Defecit
- Poor price and non-price competitiveness
- Strong exchange rate affecting demand for exports and imports
- High currency value increases prices of exports
- Appreciating currency also makes imports cheaper
- Recession in one or more major trade partner countries
- Volatile global prices (e.g. soft and hard commodities)
Conseqeuences of a current account defecit
- Loss of aggregate demand if there is a trade deficit (M>X) which causes weaker real GDP
- cause the currency to depreciate
- a loss of investor confidence, leading to capital flight
- Need to cut spending in the future. For example, during 2012-16, many countries in the Eurozone sought to reduce their budget deficit to comply with EU rules.
- Opportunity cost of debt interest payments.
- Potential rise in bond yields. may struggle to attract sufficient investors to buy bonds. If this happens, bond yields will rise causing the deficit to be more expensive to finance.
Reasons to not worry about current account defecit
- If financed by long-term capital inflows, it can increase the productive capacity
- In globalisation, it is easy to attract sufficient capital flows
- If defecit gets too large it will cause a devaluation which helps reduce the defecit
- Provides an outlet for domestic demand and prevent inflation
How can a current account defecit be financed
The financing of a deficit is achieved by:
- Selling reserves ( gold/ forex )
- Borrowing
What are the causes of a current account surplus
- A large and persistent surplus of savings (S) over investment (I) for households, firms and the government.
- A large gap between exports (X) and imports (M), when net income balance and net transfers are small
- An export surplus may be the result of very high prices for exports of commodities such as oil and gas.
Consequences of a Current Account Surplus
- A surplus on the current account would allow a deficit to be run on the capital account e.g. surplus foreign currency can be used to fund investment in assets located overseas
- Current account surplus countries nearly always have fairly strong exchange rates as a result
What is crowding out
a process where an increase in government spending
leads to a fall in private sector spending.
What is financial crowding out
If the government increases it’s spending – say through selling bonds – The demand for money will increase, which, ceteris paribus, raises interest rates.
At higher interest rates, both consumer spending and investment spending are likely to fall.
The aggregate effect on the economy is that financial resources are diverted from private firms to be used by the public sector.
How does financial crowding out lead to a fall in GDP
Initially, via a multiplier effect, national income increases, but as a result of the government selling securities in the financial markets, the demand for scarce loanable funds increases.
This drives up interest rates, which causes a contraction in the demand by the
private sector for investment goods (capital) as well as reducing the demand for
consumer goods. This, in turn, leads to a fall in GDP.
What is crowding out in relation to the labour market
a relative increase in the public sector may push up wages in order to attract workers from the private sector.
The increased demand for labour reduces unemployment and ‘tightens’ the labour market, leading to possible shortages of labour available for the private sector use as well causing upward pressure on wage levels across the economy.
What fundamental financial fact drives crowding out
that financial and real resources are ultimately scarce, and if one sector of the economy increases its use of these resources, fewer are available for use in other sectors.
What is the Ricardian Equivalence
This means that attempts to stimulate an economy by increasing debt-financed government spending will not be effective because investors and consumers understand that the debt will eventually have to be paid for in the form of future taxes.
The theory argues that people will save based on their expectation of
increased future taxes to be levied in order to pay off the debt, and that this will offset the increase in aggregate demand from the increased government spending.
What did Barro say to support the Ricardian Equivalence
an increase in government spending will lead individuals and organisations to expect interest rates to rise in the future, they will save more in order to pay higher interest rates.
What is the evaluation of crowding out
it may be a weak effect, this depends on the various elasticities that exist in the relevant markets.
if the supply of loanable funds is elastic and the demand for capital is inelastic, the impact of higher interest will be relatively small.
What evidence did Enrice Moretti from MIT find about federal spending to oppose the ‘crowding out’ theory
Government spending leads to an increase in private spending; a ‘crowding in’ effect
What are 3 reasons for the crowding in effect
- Frontier technology projects have extremely high fixed costs so by letting the public
sector fund the research, it allows the private sector to realise higher
profits. -
“Spillover effects”, where new technologies find different applications
in the private sector. GPS, for instance, was first developed to help
missiles find their targets -
Credit constraints on the private sector, where a project is difficult to
fund without government support due to, say, an economic downturn.
Why does frontier/speculative funding have a crowding in effect
the potential outcomes from speculative research and development are inherently unknowable, which makes a new project impossible to justify commercially.
What is net trade
How is the RPI different to the CPI
● RPI includes housing costs such as mortgage and interest payments and council tax
● CPI takes into account the fact that when prices rise people will switch to product that has gone up by less. Therefore, the CPI is generally lower than the RPI.
● RPI excludes the top 4% of income earners and low income pensioners as they are not ‘average’ households whilst CPI covers all households and all incomes.
