2.1 Measures of Economic Performance Flashcards
Definition: GDP
The total market value of goods and services produced in an economy over a period of time
Definition: Actual Economic Growth
An increase in real income or real GDP.
Definition: Potential Economic Growth
An increase in the productive capacity in an economy.
Definition: Purchasing Power Parity
The conversion of currencies where the same basket of goods can be bought in each economy while accounting for cost of living.
Gross National Income
- GDP + net overseas interest payments and dividends.
- Used in HDI calculations.
- Accounts for income generated abroad that might be spent domestically.
Benefits of using real GDP to measure economic growth.
- Easiest figure to calculate.
- The trend of growth is similar to most other figures.
- Accounts for inflation and allows for a more standardised comparison between economies.
Human Development Index (HDI)
- Made up of: mean/expected years of schooling, life expectancy, GNI per capita.
- Accounts for economic output but also for social factors, more comprehensive view on growth.
Limitations of using GDP to measure Living Standards.
- Income Inequality not accounted for (prevalent in developing countries
- Ignores unpaid services like voluntary work which contributes to welfare
- Shadow economies unaccounted for.
- Spending against negative externalities is included in GDP but isn’t efficient.
- Changes in quality over time might not be reflected.
- Ignores quality of life and satisfaction
- Some forms of spending might have time lags before their impact is felt on living standards.
Definition: Subjective Happiness
Refers to self-reported levels of happiness within one’s life.
Effect of real incomes on subjective happiness
- Increased real incomes
- Increased disposable incomes
- More goods and services purchased
- Needs and wants purchased
- Increased utility
OR - Increased disposable incomes
- Increased saving
- Increased long term security
- Increased consumer confidence
Overall increased subjective happiness
The Easterlin Paradox
- Argues that happiness is not proportional to real incomes after a certian point.
- After all needs have been met, there are marginal diminishing returns.
- People are concerned with relative incomes rather than absolute incomes.
Measures of National Wellbeing
- The Gross National Happiness (GNH) Index is used to measure quality of life and wellbeing that isnt accounted for in GDP.
- However, GNH is only an official measure in Bhutan
- In the UK, the ONS measures wellbeing from reports and questionnaires tracking headline indicators.
Definition: Real Incomes
A change in incomes adjusted for inflation that changes the purchasing power that consumers have within the economy
Inflation vs Deflation vs Disinflation
Inflation is a general and sustained increase in the general price level over a period of time.
Deflation is a fall in the general price level
Disinflation is a decrease in the rate of price level rise where prices are rising but at a lower rate than before.
CPI Method
- Create a virtual basket of the most commonly bought goods and services
- Calculate what proportion of expenditure is spent on each product
- Track the prices of each item and multiply by the weighting to form a price level and a price index
- Inflation is then calculated by measuring percentage changes in the index over time (CPI is monthly).
CPI Limitations
- Doesn’t include housing costs which comprise of a large part of household expenditure.
- The basket of goods and services are changed only once a year but trends are changed quicker than this
- Doesn’t account for quality as prices may rise but that is because the quality has also risen.
Alternative measures of Inflation
- RPI is a more inclusive measure than CPI as it includes mortgage interest payments but isn’t reliable for international comparisons as it is based on domestic interest rates.
- CPIH is CPI including owner-occupier housing costs which takes into account council tax and rent value, not house prices. This is the main measure used by the ONS to calculate inflation.
Demand Pull vs Cost Push Inflation
- Demand Pull inflation is inflation as a result of increases in Aggregate Demand
- Cost push inflation is caused by an increase in the cost of production and/or a decrease in the capital stock and spare capacity.
Inflation from increases in the money supply
Money supply is the amount of spending power in the economy. Inflation occurs when the money supply increases above the rate of economic growth.
Individuals will spend more money to purchase the same number of goods which leads to firms raising prices.
Controlled by the government and Bank of England through Quantitative Easing, Reducing Interest Rates and Bond Buyback.
Effect of Inflation on Consumers
- Real value of Savings falls as prices rise (if rate of inflation > interest rate)
- Purchasing power of those on fixed incomes (pensions, benefits) falls leading to a fall in living standards
- Those with high levels of debt benefit from inflation as the real value of the debt falls.
Effect of Inflation on Firms
- Loss of International Competitiveness as prices rise
- Lower Business confidence due to economic uncertainty
- FDI falls as inflation erodes the value of money.
- Firms can make wage rises below the rate of inflation so real cost of production falls.
Effect of Inflation on the Government
- Redistribution of Income as those on fixed incomes have their real income fall.
- Inflation reduces the real interest rate so the cost of borrowing and real debt value for the government falls.
- A little inflation is good as it indicates healthy economic growth while cushioning against deflation and a recession.
Effect of Inflation on Workers
- Workers may find their real wage falling as wage rises may be below the rate of inflation
- Inflation during periods of recession can help boost economic growth, creating derived demand for labour.
Wage Price Spiral
Where a rise in wages increases the cost of production for firms. This is then passed on to consumers through higher prices causing inflation. This results in workers demanding higher wages to maintain their purchasing power.
