2.1 Measures of Economic Performance

Question 1

Definition: GDP

Answer 1

The total market value of goods and services produced in an economy over a period of time

Question 2

Definition: Actual Economic Growth

Answer 2

An increase in real income or real GDP.

Question 3

Definition: Potential Economic Growth

Answer 3

An increase in the productive capacity in an economy.

Question 4

Definition: Purchasing Power Parity

Answer 4

The conversion of currencies where the same basket of goods can be bought in each economy while accounting for cost of living.

Question 5

Gross National Income

Answer 5

• GDP + net overseas interest payments and dividends.
• Used in HDI calculations.
• Accounts for income generated abroad that might be spent domestically.

Question 6

Benefits of using real GDP to measure economic growth.

Answer 6

• 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.

Question 7

Human Development Index (HDI)

Answer 7

• 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.

Question 8

Limitations of using GDP to measure Living Standards.

Answer 8

• 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.

Question 9

Definition: Subjective Happiness

Answer 9

Refers to self-reported levels of happiness within one’s life.

Question 10

Effect of real incomes on subjective happiness

Answer 10

• 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

Question 11

The Easterlin Paradox

Answer 11

• 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.

Question 12

Measures of National Wellbeing

Answer 12

• 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.

Question 13

Definition: Real Incomes

Answer 13

A change in incomes adjusted for inflation that changes the purchasing power that consumers have within the economy

Question 14

Inflation vs Deflation vs Disinflation

Answer 14

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.

Question 15

CPI Method

Answer 15

• 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).

Question 16

CPI Limitations

Answer 16

• 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.

Question 17

Alternative measures of Inflation

Answer 17

• 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.

Question 18

Demand Pull vs Cost Push Inflation

Answer 18

• 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.

Question 19

Inflation from increases in the money supply

Answer 19

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.

Question 20

Effect of Inflation on Consumers

Answer 20

• 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.

Question 21

Effect of Inflation on Firms

Answer 21

• 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.

Question 22

Effect of Inflation on the Government

Answer 22

• 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.

Question 23

Effect of Inflation on Workers

Answer 23

• 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.

Question 24

Wage Price Spiral

Answer 24

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.

Question 25

Effect of Inflation on Menu and Shoe-Leather Costs

Answer 25

As prices fluctuate more often, firms must adjust prices more often, increasing menu costs.
Inflation means that consumers go to greater efforts to minimise their depreciating cash holdings and increase their asset value which is less volatile. This results in people spending more time and energy to try to protect the value of their savings from being eroded.

Question 26

Employment vs Unemployment

Answer 26

Employment is where a person is engaged in paid work, either as an employee of a firm or being self employed.
Unemployment is where a person is not employed but are actively seeking for and available for employment

Question 27

Underemployment and Hidden Employment

Answer 27

Underemployment is where a worker is employed but are working fewwer hours than they desire or are in jobs that don’t utilise their full skillset.
Hidden Unemployment is where a worker is not actively seeking for a job but would take one if one is available.

Question 28

Economically Active vs Inactive

Answer 28

Economically active: People who are employed or actively seeking work (employed + unemployed)
Economically Inactive: People not working and not actively seeking work.

Question 29

Rates of Employment

Answer 29

Employment Rate: The % of the working age population currently employed
Unemployment Rate: The % of the Labour Force (Economically Active) who are unemployed.
Activity Rate: The % of the working age population that are economically active

Question 30

Types of Unemployment

Answer 30

Cyclical Unemployment is where unemployment is caused by a lack of demand for goods and services in an economy, typically during a recession
Frictional Unemployment is short-term unemployment where individuals are between jobs.
Real Wage/Classical Unemployment is where unemployment arises as wages are set above the equilibrium level, leading to an excess supply of labour.
Seasonal Unemployment is where unemployment is caused by seasonal fluctuations in demand.
Structural Unemployment is long-term unemployment caused by changes in the structure of the economy i.e industry decline.