2.1 Measures of economic performance Flashcards
Define Economic Growth
Economic growth is the rate of change of output . It is an increase in the long term productive potential of the country which means there is an increase in the amount of goods and services that a country produces.
This is typically measured by the percentage change in real GDP per annum . It can also be shown through the shift of PPF.
Define GDP
Gross Domestic Product: The standard measure of output, which allows us to compare countries. It is the total value of goods and services produced in a country within a year.
GDP is an indicator of the standard of living in a country
What is the difference between Total GDP and GDP Per Capita?
Total GDP represents the overall GDP for the country whilst GDP per capita is the total GDP divided by the number of people in a country.
GDP per capita grows if national output grows faster than population over a given
time period, so there are more goods and services to enjoy per person.
What are the differences between Real Values and Nominal Values?
- Real values can be described as the volume of national income i.e. the size of the basket of goods
- Whilst nominal values represent the value of the national income i.e. the monetary cost of this basket of goods.
- The value is equal to the volume times the current price level.
- The value of national income is its monetary value at the prices of
the day; - the volume is national income adjusted for inflation and is expressed either
as index number or in money terms.
Define Gross National Income (GNI)
- The total value of goods and services produced by a country over a period of time plus net overseas interest payments and dividends.
- This means that it adds what a country earns from overseas investments and subtracts what foreigners earn in a country and send back home from the GDP.
It is affected by profits from businesses owned overseas and remittances sent home by migrant workers.
This is increasingly used rather than GDP because of the growing size of remittances and aid.
Remittances - The money or goods that migrants send back to families and friends in origin countries
Define Gross National Product (GNP)
- The value of goods and services over a period of time through labour or property supplied by citizens of a country both domestically (GDP) and overseas.
- This means it is the value of all the goods produced by citizens of a country, whether they live in the country or not,
- Whilst GDP is the value of all goods produced inside the country, whether they were produced by citizens of the country or not.
How do we make comparisons of growth over time?
- Changing national income levels will show us whether the country has grown or shrunk over a period of time.
- The data is compared to other countries to put figures in a context over a period of time
- The figures can also make judgements about economic welfare (A rise in living standards - the economy is producing more goods and services so people have access to more things
It is important to use real, per capita figures. If a country’s population grows over time, then this may cause a rise in GDP without a rise in living standards and so provide inaccurate comparisons. We use real GDP in order to strip out the effect of inflation. Inflation is rising prices and therefore can give the impression of GDP growing without any more services and goods being
produced.
How do we make comparisons of growth between countries?
We work out GDP per capita.
- When countries have a difference in population, a difference in total GDP doesn’t necessarily mean a difference in living standards
- It is possible for GDP to increase simply because of an increase in prices in the country and inflation is different in every country, so real GDP figures need to be calculated.
Problems of using GDP to compare standard of living:
- Inaccuracy of data: Some countries are inefficient at collecting or calculating data and therefore comparisons can become less effective.
- There is a ‘ hidden’ or ‘black’ market in which people work without declaring their income to avoid tax or to continue claiming benefits, (GDP is underestimated)
- GDP does not take into account home-produced services(subsistence farmers)
- Errors in calculating the inflation rate : real GDP will be slightly inaccurate
- Methods used to calculate GDP will change and so therefore it
can be difficult to compare countries overtime. Similarly, different countries
may use different methods to calculate their GDP. - Also, it is important to take away transfer payments, when money is paid to a person without any corresponding increase in output in the economy.(The government taxes people who are employed and then gives it
to the people who are unemployed.)
Inequalities: An increase in GDP may be due to a growth in income of just one group of people and so therefore a growth in the national income may not increase living standards everywhere. Income distribution changes overtime and varies
between countries so makes comparisons difficult.
● Quality of goods and services : The quality of goods and services is much higher
than those fifty years ago, but this is not necessarily reflected in the real price of
these goods and services. Therefore, living standards may have increased more than
GDP would suggest since the quality of goods and services has improved greatly.
Improved technology may allow prices to fall, suggesting falling living standards, when this is not the case.
● Comparing different currencies: There are issues over which unit should be used to compare figures
● Spending: Some types of expenditure, such as defence, does not increase standard
of living but will increase GDP. For example, the GDP of the UK was higher during
the Second World War than in the 1930s because a lot of money was spent on
defence which increased GDP but it is difficult to argue that standard of living was
higher in the Second World War. This therefore makes comparisons difficult as
spending varies overtime and between countries.
● There are also many other factors which are involved in living standards, such as education.
Define Inflation
- A general and persistent rise in the price level
- And a fall in the purchasing power of money
Limitations of CPI
- It is impossible for the figure to take into account every single good that is sold in the country and so therefore the CPI is not totally representative .
- Different households spend different amounts on each good and so therefore the CPI only measures an average rate of inflation, and is not totally representative
- Moreover, it does not include housing costs, since this has tended to rise more than the price of other goods, the data may be lower than it should be. The CPIH includes housing costs.
- Since the figure is more recent than RPI, it is difficult to make comparisons with historical data
- CPI reflects the ‘Average Family’ - personal inflation rates differ
- Price fluctuations could distory the CPI (Food + Energy (Gas, electricity and fuel) - Demand and supply are price inelastic
- Core CPI removes the effect of Food energy and Gas
- Basket updates may be too slow (once a year) - May miss short term changes in spending habits
Some people argue that all inflation indices overestimate inflation because they don’t take into account the fact that goods and services have improved in quality, and so will obviously be more expensive.
Differences between RPI and CPI:
- RPI includes housing costs such as mortgage and interest payments and council tax, whereas CPI does not.
- 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.
- RPI uses an arithmetic mean (CPI - geometric mean which is always lower)
Effects of inflation on Consumers
- If people’s incomes do not rise with inflation then they will have less to spend , which could cause a fall in living standards.
- Those who are in debt will be able to pay it off at a price which is of cheaper value, but those who are owed money lose because the money they get back is of cheaper value.
- Consumers who have saved will lose out as their money is worth less.
- Psychological effects on consumers: because prices are rising, they may feel less well-off, even if their income is rising in line with inflation, and so this may cause them to decrease their spending.
Effects of inflation on Governments
- If the government fails to change excise taxes (taxes at a set amount e.g. £1) in line with inflation then real government 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.
Effects of inflation on Workers
- If workers do not receive yearly pay rises of the rate of inflation, they will be worse off and their living standard will decrease.
- Those in weaker unions tend to be most affected as they are unable to win wage rises in line with inflation.
- Deflation could cause some staff to lose their jobs as there is a lack of demand meaning firms see a fall in profit and have to decrease staff to cut costs.
Effects of inflation on Firms
- If inflation in Britain is higher than other countries, British goods will be more expensive. They will become less competitive and make them more difficult to export. This will also affect the balance of payments.
- Deflation isn’t good as it encourages people to postpone their purchases as they wait for the price to fall further.
- People will be more likely to save as the value of their money will rise in the future and they will be prevented from borrowing as deflation means the real value of their debt increases.
- This can lead to a fall in demand for goods, leading to a fall in firms’ profit, and in business confidence which can lead to a long term reluctance to invest.
- Firms will have to calculate new prices then change their menus, labelling etc. and this can be expensive.
How can we reduce the effects of infaltion?
Some of the costs can be reduced if inflation is anticipated, which will allow groups to plan for the future. This can be done through indexation, so wages or taxes are increased in line with inflation. An example of this is workers negotiating with employers for wage rises in line with the predicted CPI or RPI. However, indexation may in itself further inflation because
wage increases will reflect past increases. Therefore, if inflation has been at 10% previously but the government wants to reduce it to 2%, this will be difficult if workers are still getting a 10% pay rise due to indexation agreements.
What is Indexation?
This is where wages or taxes are increased in line with inflation
CPI Summary
- Expenditure survey carried out (By the ONS)
- A ‘consumer basket’ of most popular goods/services is formed with average prices attatched
- Prices of these goods/services are weighted based on (%) of income (0-1 For example 0.03 = 3% of income)
- Weighted prices are added to give the total weighted price of the basket
How do we calculate an index number?
(Raw Number/ Base year Raw Number) X 100
Costs of Inflation:
- Lower purchasing power
- Erosion of savings (Shoe leather costs)
- Lower exports (comptetitiveness)
- Wage/consumer price spirals
- Fiscal drag
- Inflationary noise
Benefits of Inflation
- Workers recieve higher wages (possibly through bargaining) + Imporves worker’s morale and productivity
- If inflation is low and stable, consumer consumption is natural
- Firms are encouraged to increase output if inflation is low and stable - they know they can raise their prices and earn more revenues
- Can keep unemployment low in a recession
- Reduces the real value of debt
- Improvement of Government finances
Define a Recession
- A recession is a significant decline in economic activity that lasts longer than a few months.
- A sustained period of weak or negative growth in real GDP (output) that is accompanied by a significant rise in the unemployment rate.
What is Nominal GDP?
- In economics, the use of the word nominal refers to the fact that the metric has not been adjusted for inflation
- Nominal GDP is the actual value of all goods/services produced in an economy in a one-year period
- There has been no adjustment to the amount based on the increase in general price levels (inflation)
What is Real GDP?
- Real GDP is the value of all goods/services produced in an economy in a one-year period - and adjusted for inflation
Exam Tip - When an exam question uses the phrase ‘at constant prices’ it is referring to real GDP. For example, a question may read, ‘Explain what is meant by a rise in GDP at constant prices’. This requires you to define real GDP and then explain the rise.
What is Purchasing Power Parities (PPP)?
- Purchasing power parity (PPP) is a conversion factor that can be applied to GDP, GNI and GNP
- It calculates the relative purchasing power of different currencies
- It shows the number of units of a country’s currency that are required to buy a product in the local economy, as $1 would buy of the same product in the USA
Limitations of Using GDP and GDP per capita for Comparisons
- Lack of information provided on inequality
- Quality of goods/services
- Does not include unpaid/voluntary work (Economic activity that does not appear in official figures)
- Differences in hours worked/Working conditions/Level of damage to the environment and different spending needs)
- Environmental factors
- Does not illustrate the extent of income equality - Distribution between the rich and poor
What is an Externality?
- An externality is a cost or benefit that is caused by one party but financially incurred or received by another
A side effect or consequence of an activity that is not reflected in the cost of that activity, and not primarily borne by those directly involved in said activity.
How can GDP be measured?
The expenditure approach
* adds up the value of all the expenditure in the economy
* This includes consumption, government spending, investment by firms and net exports (exports - imports)
The income approach
* adds up the rewards for the factors of production used
* Wages from labour, rent from land, interest from capital and profit from entrepreneurship
What is GDP?
- GDP is the value of all goods/services produced in an economy in a one-year period
- GDP measures the value of production within a country’s borders
- It does not consider the income earned by its citizens while operating outside of the country
What is Gross National Income (GNI)?
- Measures the income earned by citizens operating outside of the country + the GDP
- Many citizens employ their resources outside of a country’s borders - and then send the income home
What is Gross National Product (GNP)?
- GDP + income from abroad - income sent by non-residents to their home countries
GNP/capita provides a much more realistic view of a country’s wealth than GDP/capita
Why is using real GDP is a better comparison than nominal GDP?
One country may have a much higher rate of economic growth, but also a much higher rate of inflation. Real GDP provides a better comparison
Limitations of CPI *2
- Depending on what households buy the level of inflation for each one can vary significantly
- As an average, it also ignores regional differences in inflation e.g. London inflation may be much higher than Harrogate inflation
- One country may use the RPI & another the CPI
- The CPI does not capture the quality of the products in the basket
- The CPI only measures changes in consumption on an annual basis
- The CPI is prone to errors in data collection
Causes of Inflation
What is Demand pull inflation caused by?
Excess demand in the economy
Causes of Inflation
Demand Pull Inflation Diagram
- If any of the four components of AD increase, there will be a shift to the right of the AD curve from AD1 → AD2
- At the original price (AP1), there is now a condition of excess demand in the economy
- As prices rise, there is a contraction of AD and an extension of SRAS
- Prices for goods/services are bid up from AP1 → AP2
- Demand pull inflation has occurred
Causes of Inflation
Cost Push Inflation Diagram
Cost push inflation is caused by increases in the costs of production in an economy
- If any of the costs of production increase (labour, raw materials etc.), or if there is a fall in productivity, there will be a shift to the left of the SRAS curve from SRAS1→SRAS2
- At the original price (AP1), there is now a condition of excess demand in the economy
- As prices rise, there is a contraction of AD and an extension of SRAS
- Prices for goods/services are bid up from AP1→AP2
- Cost push inflation has occurred
Effects of Inflation
What is the Quantity Theory of Money ?
What are the Differences Between the ILO Labour Force Survey and the Claimant Count?
How do we calculate Unemployment Rate?
Total Labour Force = Employed + Unemployed
How do we calculate Employment Rate?
How do we calculate Labour Force Participation Rate?
Employment/Unemployment
How do we calculate Inactivity Rate?
Causes of Unemployment - Economic Cycle
Cyclical/Demand Deficient Unemployment:
- Cyclical unemployment occurs in times of recesson when demand for labour is low
- Similar to cyclical, demand deficient unemployment is when the economy is at equlibrium but below full employment (P1,Y1)
Causes of Unemployment - Economic Cycle
How to move equilibrium towards Full Employment:
Causes of Unemployment - Market Distortions
Real Wage Inflexibility + The Welfare Trap / Voluntary Unemployment
- Real Wage inflexibility - Trade Unions or National Minimum Wage can put the labour market into disequilibrium
- Classical economists would suggest lifting restrictions to allow wages to fall to market clearing levels
- WT+VE : Workers may choose not to work if the loss of unemployment benefits and increased tax means they are no longer better off or only marginally better off
Impacts of Unemployment on the Government and Society
Loss of output for the Economy (PPF):
- Unemployment means a loss of potential output (Represented on the PPF)
- The opportunity cost of each unemployed person is their foregone output
Impacts of Unemployment on Consumers
Changes in Demand for Normal and Inferior Goods:
- More Demand for Inferior Goods
- Less Demand for Normal Goods
Impact of Unemployment on other Macro Objectives Table:
