Measuring Economic Performance Flashcards
Define Macroeconomics
Macroeconomics is the study of an economy as a whole
What are the 7 key objectives?
When judging the performance of an economy (or a government) we look at 7 key objectives:
- economic growth
- employment/unemployment
- inflation rate
- current account of the balance of payments (exports, imports)
- government deficit and surplus
- redistributed income/wealth (reduced inequality)
- the environment
Describe the Circular flow of Income:
a) diagram
b) injections
c) leakages/withdrawals
a) Households provide firms with labour, Firms give wages/profits to households. Households provide firms with consumption, consuming services/goods from Firms.
b) Injections:
- Government Spending
- Exports
- Investment
c) Leakages/Withdrawals:
- Taxation
- Imports
- Savings
Define Economic growth
Economic growth is a change in National Income (Y)
Describe the most common measure of national income:
a) What is it and what are the ways of calculating it?
b) Definition
c) How do we use it?
d) What kind of payment is not included in GDP
a) Gross Domestic Product (GDP) is the most common measure of national income. There are 3 ways of calculating GDP: national output, national expenditure and national income. All 3 should be the same!
b) GDP = the total value of all goods and services produced in an economy over a period of time.
c) GDP figures are generally used to show comparison - either within a country over time or between different countries. We generally associate higher GDP with richer people/able to buy and consume more product and so higher standards of living
Although GDP is measured in money terms, we really use it as a measure of the quantity produced in an economy (which is why real GDP is important)
When looking at changes in (real) GDP we can use a simple year-on-year % change or we calculate an “index”, where we take a base year=100 and all other figures are relative to that. So if 2012 were the base year we would have (real GDP 2013/real GDP 2012)*100
d) Transfer payments are not included in GDP. A transfer payment is a payment without the production of a product. This includes pocket money, government benefits and sale of ‘second hand’ goods (including housing)
What are the 2 other measures of national income?
- Gross National Income (GNI) = GDP + net interest payments and dividends from abroad
- Gross National Product (GNP) = output of all UK firms (not firms in UK!)
What are the 3 types of GDP?
a) Nominal (or at current prices): actual GDP figures for each year
b) Real (or at constant prices): nominal GDP figures adjusted to account for a change in price level (inflation)
c) Per capita: this is (real) GDP per person
How accurate are GDP figures? (4)
- Statistical inaccuracies: there is a mass of data to be collected. Inevitably some things are missed or double-counted
- Home produced services: if you work on your own house/land and consume the product yourself then the output will not appear in GDP. This is common in developing countries
- Hidden economy: informal or black economy, include illegal activity and work done for cash to avoid tax. This is unknown to the government and difficult to count in GDP. Since 2014 EU and UK include an estimate in GDP, but it is unreliable.
- Public sector: hard to measure the output of NHS since it is not sold. It is usually measured by its cost, but this could mean improved efficiency actually reduces GDP
Problems comparing GDP over time: (6)
- Changing prices: inflation affects it - use real GDP
- Changes in population: larger population increases GDP - use real GDP per capita
- Quality of products: quality may improve but price stay the same (computers) and so GDP stays the same
- What types of goods are being produced: in war GDP may rise but the standards of living won’t
- Externalities: higher GDP may be associated with more externalities (pollution)
- Income distribution: GDP per capita only shows the average - it does not reflect how big the rich-poor gap is
Problems comparing GDP of different countries: (3)
- Different populations - use real GDP per capita
- Different distribution of income
- Different currencies - can’t use exchange rate as it varies daily. So instead we use PPP(Purchasing Power Parity) which calculates the actual buying power of a currency
How is PPP calculated? (+2 evaluation points)
Purchasing Power Parity (PPP) is calculated using a made-up exchange rate, such as the Big Mac index, so it reflects exactly how many goods and services you can buy with a currency. To make it more accurate we use a typical basket of goods (1 litre of milk, 1kg of rice, a car etc) and look at how much the basket would be worth it each country and use this as the PPP exchange rate
BUT
- How do we select the products?
- Different countries spend different % of their incomes on each good so this would affect the PPP
*international basket of goods is different from the one used for CPI calculations, it is more general
Define Growth and Development
Growth is an increase in real GDP (per capita, $PPP)
Development is a wider concept, it measures “living standards”, “quality of life”. This is inevitably linked to “being richer” (increased real GDP per capita), but it is not the same
What are the aspects that can be included when measuring development? (5)
Development is perhaps not measurable at all and is a subjective concept. There is no single measure of development, GDP is used to measure wealth, however this only gives us limited ideas of development. We need to consider other aspects such as:
1. A healthy life (measured by infant mortality rate, doctors per 10000, life expectancy etc)
2. Opportunities (measured by literacy rates, spending on education, measures of equality etc)
3. Infrastructure (measured by % of population with access to clean water, running water, electricity, telephone etc)
4. Safety (measured by homicide rates)
5. Poverty/income distribution (number of people living on less than $1.25/day, Gini coefficient etc)
and a variety of other factors
What is the most common composite measure of development and how is it measured?
Composite measure - composed of a number of factors.
Human Development Index (HDI) is the most common one, used by UNDP. It is based on:
- Wealth - GNI per capita PPP
- Health - life expectancy
- Education - years of school enrolment - past and predicted
Each of the 3 areas is given a score out of 1, where 1 is the best country in the world. These scores are then averaged out to give an HDI value. Thus the highest HDI is 1
Discuss advantages (5) and disadvantages (4) of HDI:
Advantages:
- Composite: not based on a single aspect of development, gives us more rounded views
- Reliable: the measures required are fairly reliable, easy and cheap to collect. Most countries collect this data
- It indicates GDP has been used to increase social welfare: “GDP rank - HDI rank” is a useful measure of social welfare (health and education)
- Government policies: use of education and health is a sign of successful government policies
- Future development: HDI is a sign of welfare in the future (a healthier, more skilled work force should mean more productive labour, so rising GNI and so more tax money to spend on health care and education)
Disadvantages:
- Poverty/Distribution of income - an indication of that would help HDI. The use of GNI per capita may not reflect median incomes or the rich-poor gap
- Other areas of development are not included (infrastructure, political freedoms etc)
- Problems with individual measures (is ‘years of education’ a good measure of quality? problems with GNI)
- It assumes 3 components are equally important, it is a simple average of the 3 values and there is a value judgement. We could argue that one is more important than others
Define Inflation, Deflation and Disinflation
Inflation - a sustained rise in the general price level across an economy.
Deflation - a sustained fall in the general price level across an economy.
Disinflation - a fall in the rate of inflation.
What is a measure of inflation and how is it calculated?
Consumer Price Index (CPI) is a measure of inflation. Prices of a representative range of goods and services (a basket of goods) need to be recorded on a regular basis. In the UK, the basket is calculated from the result of the Living Costs and Food Survey. Every year, a few thousand households are asked to record their expenditure for a month. From these figures it is possible to calculate how the average household spends its money. Prices are recorded in different areas of the country and in different types of retail outlets, by surveyors, monthly. These results are then averaged out to find the average price of goods and this figure is converted into index number form. Changes in the price of food are more important than changes in price of, say, tobacco because a larger proportion of total household income is spent on food than on tobacco. Therefore the figures have to be weighted before the final index can be calculated. The basket of goods has to be changed every year to reflect changes in consumer spending.
What is PPI?
Producer Price Index (PPI) is a weighted index of prices measured at the wholesale, or producer level. It can serve as a leading indicator for CPI. PPI also presents the inflation picture from a different perspective than CPI. Tracking PPI allows one to determine the cause of changes in CPI.
Define Cost-push inflation and Demand-pull inflation
Cost-push inflation - inflation caused by increases in the costs of production in the economy (‘imported inflation’ if you import FoPs and their prices rise)
Demand-pull inflation - inflation caused by excess demand in the economy
What are the costs of high inflation? (6)
Inflation is generally considered to be a problem. The higher the rate of inflation the greater the economic cost
- Growth and Unemployment: high inflation is typically unpredictable. Both consumers and firms find it hard to predict what will be the rate of inflation next month or next year. This unanticipated inflation ,ages it difficult to plan for the future. So both I and C go down, GDP falls and there is higher unemployment
- Competitiveness: if inflation rises faster in the UK than elsewhere and the value of pound stays the same, exports become less competitive and imports more competitive ↓(X-M) -> loss of jobs in domestic economy and lower growth
- Redistributional costs: anybody on fixed income will suffer, ie pensions on a fixed rate that are not adjusted for inflation. Also workers who are not able to negotiate a pay rise at least in line with inflation will suffer falls in their real incomes. Also, interest rates, if they are smaller than inflation, borrowers are better off and savers are worse off. If taxes are not changed, there is less tax revenue
- Psychological and Political costs: price increases are very unpopular even if people’s incomes go up by more than the rate of inflation
- Shoe-leather costs: when prices are going up customers ‘shop around’ ie spend more time shopping, which is a cost. It also leads to households and firms holding less cash. The higher the rate of inflation, the higher the opportunity cost of holding cash, since nominal interest rates are higher
- Menu costs: when prices are changing restaurants need to change menus, shops - labels, vending machines and parking meters, take account of price increases
What is anticipated inflation and how does it help?
Anticipated inflation allows economic actors to plan for the future and adjust their decisions to take inflation into account. One way to do it is through indexation. This is when economic variables like wages or taxes are increased in line with inflation
What are the costs of deflation? (2)
Over the past 50 years, the main problem that countries have faced is high rates of inflation. However there could also be problems with deflation. For example in Japan between 1995 and 2014, Japan experienced 9 years of falling prices. They were mainly caused by a lack of demand, but also caused demand to be depressed.
- Low consumer confidence: consumers are concerned about the future as they may buy a certain good for a cheaper price then. This leads to low business confidence and lower investment, as the real cost of borrowing is higher (even though the interest rates are very low)
- Effect on asset values: it encourages households to save rather than spend which leads to low or negative rates of economic growth
What are the benefits of low inflation?
Many central banks set a target for inflation of around 2%. This is a very low rate of inflation, but is still a positive increase in prices.
- It avoids the problems associated with deflation and high inflation
- It gives policy makers room to adjust the economy if inflation goes above or below target
- At 2% the real value of borrowing falls gradually over time. This is seen as desirable because it makes it easier for those who borrow to finance C and I to repay their borrowing.
- It also doesn’t impact much on the incentive to save because it is argued that savers don’t take the real erosion of their savings into account. They suffer from money illusion, thinking that inflation is zero
Define Labour force
Labour force (active population) - those in work or actively seeking work
