[2.1] Measures of Economic Performance

Question 1

What is nominal GDP?

Answer 1

GDP figures that have not been adjusted for price changes (inflation/deflation).

Question 2

What is the difference between total and per capita GDP?

Answer 2

Total GDP is the total value of all goods and services produced in an economy, whereas per capita GDP is the total GDP divided by the total population.

In other words, per capita GDP is GDP per person.

Question 3

What is Gross National Product (GNP)?

Answer 3

The market value of all goods and services produced by citizens of a country subtracted by the incomes earned by foreigners within the country.

GDP measures economic activity within a country’s borders, whereas GNP measures economic activity of a country’s citizens both inside and outside its borders.

Question 4

What is Gross National Income (GNI)?

Answer 4

The sum of a nation’s GDP and net incomes from abroad.

Question 5

What is Purchasing Power Parity (PPP)?

Answer 5

A way of adjusting the exchange rate so that an identical good in two countries has the same price when expressed in the same currency.

Question 6

How is GDP a limited measure to compare living standards in different countries over time?

Answer 6

• GDP does not give any indication of the distribution of income (most of the income could be held by a small minority, meaning living standards are low for most people).
• GDP without being adjusted for purchasing power (for example, using PPP) is not useful when comparing differences between countries.
• Large parts of the economy are hidden (the informal sector).
• GDP is not always an indication of welfare, there are other factors involved in welfare (e.g. community, social cohesion, non-monetary factors).

Question 7

What is the UK’s national well-being? How does this compare to other countries?

Answer 7

• In the UK, 91% of people are satisfied with their family life.
• Iceland has the most satisfied (95%), but Greece has the lowest satisfaction rates.

Question 8

What is the relationship between real incomes and subjective happiness?

Answer 8

In the UK, there has been no evidence of a relationship in recent years. Between 2007 and 2014, the UK’s GDP per capita grew by 5%, but there was no significant increase in national happiness (according to ONS).

Generally, as real incomes increase, the higher the life satisfaction score.

Question 9

What is inflation?

Answer 9

The sustained rise in the general price level of goods over time.

Inflation means that the cost of living increases, and the purchasing power of currency decreases.

Question 10

What is deflation?

Answer 10

Negative inflation, where the general price level of goods falls.

Deflation means that the cost of living decreases, and the purchasing power of currency increases.

Question 11

What is disinflation?

Answer 11

Disinflation is when the rate of inflation is falling. The price level is still rising, but the rate at which it is rising has slowed down.

Question 12

How is the rate of inflation calculated in the UK?

Answer 12

It is calculated using the Consumer Prices Index (CPI).

1. The CPI includes a ‘basket’ of goods that are commonly bought by households. This basket is chosen through a survey of households.
2. The CPI then calculates the price changes of the items in this basket over time.
3. Different items have different weightings/importance when it comes to calculating the overall weight - e.g. petrol is more important than toilet roll.
4. The CPI is calculated annually.

Question 13

What are the limitations of CPI in calculating the rate of inflation?

Answer 13

• The CPI is a measure of the goods purchased by the ‘average’ households, so is not relevant for all households. For example, many households do not own cars (which make up 14% of the CPI).
• Different age groups/social groups have different spending patterns.
• Housing makes up 16% of the CPI, but house prices have a very large variance between households.
• CPI is slow to be updated to the arrival of new goods that become important in households (e.g. new technologies, iPads, new phones).

Question 14

What is the Retail Prices Index (RPI)?

Answer 14

• An alternative measure of inflation to the CPI
• Unlike CPI, RPI includes housing payments such as council tax and mortgage payments.
• As a result, RPI tends to be 0.9 percentage points higher than the CPI.

Question 15

What is demand pull? How it is a cause of inflation?

Answer 15

When aggregate demand grows at a fast, unsustainable rate to put pressure on resources. As a result, producers are able to increase their prices - causing inflation.

It generally occurs when resources are fully employed.

Question 16

What are the potential causes of demand pull?

Answer 16

• A depreciation in exchange rate, making exports cheaper (so demand for them increases) and imports more expensive (remember aggregate demand is X - M).
• Lower taxes or greater government spending, giving consumers more disposable income to spend on goods and services. This results in increase in aggregate demand.
• Lower interest rates may make savings less attractive (reduction in withdrawals) and borrowing more attractive. This increases consumer expenditure.
• High grow in UK export markets - foreign countries buying our goods mean our aggregate demand increases.

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Question 17

What is cost push? How is it a cause of inflation?

Answer 17

The cost push occurs when firms face rising costs of production, meaning that they are forced to raise their prices. This causes inflation.

Question 18

What are the potential causes of cost push?

Answer 18

• A rise in the price of raw materials (e.g. rise in oil prices).
• A rise in the price of labour (e.g. as a result of minimum wage legislation).
• Indirect taxes (specific and ad valorem) increase costs of firms.
• Depreciation in exchange rate makes imports more expensive, driving up costs of raw materials for firms.
• An expectation of inflation in the future can cause the cost push. It is likely consumers will ask for higher wages if they expect prices to rise in the future. This will raise the costs of firms.

Question 19

What is meant by ‘growth in the money supply’? How is this a cause of inflation?

Answer 19

Growth of the money supply occurs when more money is flowing in the economy - for example, this may occur if the Bank of England prints more money.

There will be more money ‘chasing’ the same number of goods, causing a rise in prices.

Question 20

How does inflation affect consumers?

Answer 20

• Low income consumers will be worst affected, as the price of necessities rises (e.g. food and clothing).
• Consumers with loans will benefit, as the real value of the loan will decrease.

Question 21

How does inflation affect firms?

Answer 21

• Costs of production may rise as workers demand higher wages.
• With higher inflation, interest rates are also likely to be higher - meaning the cost of investment is much higher.
• Less confidence among business as prices are constantly changing.
• High inflation could make firms less competitive on an international level due to higher domestic costs of production.

Question 22

How does inflation affect the government?

Answer 22

• The government will have to spend more on welfare and the state pension in order to compensate for higher prices.

Question 23

How does inflation affect workers?

Answer 23

• Real incomes fall, less disposable income.

- Inflation means firms face higher costs, which may lead to workers being made redundant.

Question 24

What are the two ways of measuring employment?

Answer 24

• The claimant count.

- The Labour Force survey carried out using International Labour Organisation (ILO) standards.

Question 25

What four criteria are tested in the Labour Force Survey?

Answer 25

• Being out of work for at least four weeks
• Being able and willing to start work within 2 weeks
• Be available to work at least 1 hour per week (meaning part time unemployment is included in the survey).

Question 26

What are the flaws of using the claimant count to evaluate unemployment?

Answer 26

The claimant count doesn’t include unemployed people with high income spouses (who are not eligible for unemployment benefit).

Not everyone who is unemployed will claim the benefit, meaning that the claimant count gives an underestimated level of unemployment.

Question 27

What is the difference between unemployment and underemployment?

Answer 27

The unemployed are those willing and able to work but are not employed. The unemployed are actively seeking work and can start within the next 2 weeks if they find a job.

The underemployed are those with employment that is not using their full productive potential - for example, part-time workers who want to work full-time, or workers who are overqualified for their current position.

Question 28

What is the impact of unemployment on consumers, firms, and workers?

Answer 28

• Unemployment means consumers have less disposable income to spend on goods/services.
• With high unemployment, there is a large supply of labour, so costs of labour are lower for firms.
• Firms may see a decline in revenue as consumers lose their jobs and cannot afford to buy their goods/services.
• Firms may need to spend more money retraining workers who have been unemployed for a long period of time.
• Workers who are unemployed are not utilising their full productive potential, and may lose learned skills over time.

Question 29

What is the impact of unemployment on the government and society?

Answer 29

• The government must spend more money on unemployment benefit such as Jobseeker’s Allowance (JSA).
• The government will receive less tax revenue from income tax and indirect taxes (as consumer spending will fall).
• On society, there will be negative externalities such as crime and vandalism.
• Society will experience a welfare loss as workers are not producing goods or services that would otherwise be produced.

Question 30

What is economic inactivity?

Answer 30

The economically inactive are those who are not looking for work and are not in employment.

These include discouraged workers who have been out of work for extreme periods of time, as well as people who are out of work for social reasons - such as full time mothers and carers for the disabled.

Question 31

What will an increase in the economically inactive mean for the UK economy?

Answer 31

The size of the labour force will decrease, meaning the productive potential of the economy will decrease (inward shift of PPF curve).

Question 32

What are the five main causes of unemployment? List them.

Answer 32

• Structural unemployment
• Frictional unemployment
• Seasonal unemployment
• Demand deficiency and cyclical unemployment
• Real wage inflexibility

Question 33

What is structural unemployment?

Answer 33

It occurs when there is a decline in demand for a particular industry or niche, or particular skills within an industry.

For example, British factory workers losing their jobs as a result of off-shoring to China is structural unemployment.

Some skills also experience unemployment as labour is replaced by capital (e.g. workers by robots). This is technological unemployment.

Question 34

How does occupational immobility of labour worsen structural unemployment?

Answer 34

If workers lose their jobs due to the decline in one industry, they will stay unemployed for longer if they lack transferable skills to work in new, in-demand industries.

Question 35

What is frictional unemployment?

Answer 35

The unemployment experienced between losing a job and finding a new one.

This unemployment is not damaging as it is only short-term, but it does mean that the economy will never be at a 100% full employment.

Question 36

What is seasonal unemployment?

Answer 36

When demand for labour in an industry falls based on time of years.

For example, the loss of demand for labour in the tourist industry during winter months.

Question 37

What is cyclical unemployment (demand deficiency)?

Answer 37

The unemployment caused by a national fall in demand for goods and services (usually during periods of slow economic growth or recession).

If demand is lower for goods and services, firms are forced to cut back on labour in order to protect profits and reduce costs.

Question 38

How is real wage inflexibility a cause of unemployment?

Answer 38

This is the type of unemployment that is caused by the labour market operating at a price above the equilibrium (e.g. as the result of a minimum wage).

If allowed to fall to the equilibrium, unemployment would be much closer to zero. As a the result of minimum wage legislation and trade unions, wages cannot fall to the equilibrium so a surplus of labour will be in the market relative to the demand from firms - therefore, there is unemployment.

Question 39

How does immigration impact employment/unemployment?

Answer 39

The supply of labour increases, resulting in more unemployment and potentially lower wages.

Higher skilled migrant labour could boost productivity, but may replace lower skilled domestic labour.

Question 40

What is the Balance of Payments?

Answer 40

A record of all financial transactions made between consumers, firms, and government from one country to another.

Question 41

What is the current account on the balance of payments?

Answer 41

The balance of trade in goods and services.

Question 42

What is a current account deficit?

Answer 42

A current account deficit occurs when the money spent on imports is greater than the money received through exports.

Question 43

What is a current account surplus?

Answer 43

A current account surplus occurs when the money received through exports is greater than the money spent on imports.

Question 44

What are the four main macroeconomic objectives of the UK government?

Answer 44

1. Sustainable economic growth (2-3% pa)
2. Low, stable inflation (2%)
3. A sustainable current account on the balance of payments
4. Full employment

Question 45

What will happen to economic growth if we have a current account surplus?

Answer 45

If we have a current account surplus, there will be a greater inflow of money into our circular flow of income. This results in an increase in aggregate demand and economic growth.

Question 46

What will happen to the current account during a recession (negative economic growth)?

Answer 46

The current account deficit will decrease (or surplus will increase) as consumer spending levels fall on imported goods.

Question 47

What will happen to the current account during periods of economic growth?

Answer 47

There will be a larger current account deficit as consumers have more income to spend on spend on imported goods.

Question 48

How might the current account impact inflation?

Answer 48

If we have a large current account deficit, are importing expensive raw materials, there may be cost-push inflation in the economy as a result of increased costs of production for firms.

Question 49

In theory, what should the sum of all countries’ current accounts (trade balances) combined be?

Answer 49

Zero, as imports must equal exports on a global level.

For one country’s import, there must be another country’s export.

Question 50

Why are countries interdependent?

Answer 50

A change in the economic conditions in one country will affect exports and imports in other countries.

For example, if the EU (the biggest destination for UK exports) experiences a recession, demand for UK goods will decline. This will result in a larger current account deficit, acting as a downward pressure on economic growth.