Theme 2 - Measure of economic performance Flashcards
What is GDP?
- The total value added of all goods and services produced in an economy over a period of time
What is economic growth?
When the total value added of all goods and services produced in an economy increases - an increase in real GDP
Why is GDP measured in US dollars?
The US economy is the biggest in the world
What is GDP per capita?
The value of output produced by a country in a year divided by the population of that country
What is the difference between real and nominal values and value and volume?
Real values make adjustments for inflation
Nominal values are values at current prices
Real values can be described as the volume of national income, nominal values can be described as the value of national income.
The value is equal to the volumes multiplied by the current price level. The value of national income is its monetary value at the prices of the day; volume is national income adjusted for inflation and is expressed either as index number or in monetary terms
What are the national income measures?
GDP (gross domestic product)
GNI (gross national income)
GNP (gross national product)
What is GNI?
The value of goods and services produced by a country over a period of time plus net overseas interest payments and dividends. 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.
What is 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.
How do you calculate real GDP?
(nominal GDP/GDP deflator)x100
What is the GDP price deflator?
It measures the changes in prices for all the goods and services produced in an economy
How can national income measures be used to make comparisons about growth?
- Over time: Changing national income levels will show us whether the country has grown or shrunk over a period of time.
- Between countries: When countries have a difference in population, a difference in total GDP doesn’t necessarily mean a difference in living standards so to make comparisons, we work out GDP per capita. 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.
How is GDP used to compare growth over time?
- The data is compared to other countries to put figures in a context. Growth figures over a set period of time can be compared against similar countries to see whether the country has done well or not.
- The figures can also make judgements about economic welfare as growth in national income means a rise in living standards as 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.
What are the limitations of using GDP to compare living standards between countries and over time?
- Inaccuracies of data
- Inequalities
- Quality of goods and services
- Comparing different currencies
- Spending
- Other factors involved in living standards e.g. education
Why do inaccuracies of data limit the usefulness of using GDP to compare living standards between countries and over time?
Some countries are inefficient at collecting or calculating data and
therefore comparisons can become less effective.
o There is a ‘hidden’ or ‘black’ market in which people work without declaring
their income to avoid tax or to continue claiming benefits, and so GDP is underestimated because these incomes aren’t taken into account. This varies hugely between countries and may change overtime.
o GDP does not take into account home-produced services, for example in many poorer countries people work as subsistence farmers where they grow and consume their own crops without trading, and so the GDP is underestimated. This can also be true in the UK where DIY or the service of house-wives/husbands are not recorded.
o Errors in calculating the inflation rate means real GDP will be slightly inaccurate.
o Over time, 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.
o 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. For example, the government taxes people who are employed and then gives it straight to the people who are unemployed. Other examples include pocket money and the selling of second hand goods.
Why do inequalities limit the usefulness of using GDP to compare living standards between countries and over time?
Increased GDP may be the result of an increase in one group of people’s income, so a growth in the national income may not increase living standards everywhere. Income distribution changes over time and varies between countries, so makes comparisons between countries difficult
Why does the quality of goods and services limit the usefulness of using GDP to compare living standards between countries and over time?
The quality of goods and services now is much better than 50 years ago, but this isn’t necessarily reflected in the real price of these goods and services. Therefore living standards would have increased more than GDP would suggest since the quality has improved. Improved technology may have caused prices to fall, which would indicate falling living standards, when this isn’t the case
Why does comparing different currencies limit the usefulness of using GDP to compare living standards between countries and over time?
There are issues over which unit should be used to compare figures: they are usually converted into US dollars because of the size of the American economy. Some people argue that Purchasing Power Parity should be used to take into account the impact of differences in the cost of living in different countries.
Why does spending limit the usefulness of using GDP to compare living standards between countries and over time?
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.
Why is measuring GDP per capita important for an economy?
It is a measure of the average income in a country and enables comparisons to be made between countries in relation to changes in standard of living
What are the limitations of using GDP per capita to measure living standards and compare prosperity of countries?
- Regional variations
- Inequalities of income and wealth
- Externalities such as pollution and congestion
- The Black Economy/shadow economy
- Leisure and working hours
- Value of non-marketed output
What differences between developed and developing countries exist that make comparison of growth rates difficult?
- Bartering in developing countries may affect the value of the GDP figure (de-value)
- Doesn’t account for price differences in different countries
- Some goods/services are free in some countries but must be paid for in other countries
- Population growth in developing countries may account for most GDP growth
- High levels of subsistence production in developing countries often understate the GDP figure.
What is the Human Development Index?
A tool developed by the un to measure and ran countries’s levels of social and economic development based on different criteria:
- life expectancy at birth
- Education; mean years of schooling and expected years of schooling
- GNI per capita
What is inflation?
The sustained increase in general price level over a period of time
What is deflation?
A fall on general price levels, it indicates a slowdown in the rate of growth of output in the economy
What is disinflation?
A reduction in the rate of inflation; prices continue to rise, but at a slower rate
What is stagflation?
Inflation rising at a time when the economy is in a recession
What is hyperinflation?
a phase of extremely rapid inflation
What are the effects of inflation on consumers?
- Fall in real disposable income, and they have less to spend, which could cause a fall in living standards
- Shoe leather costs (time taken to look for better deals)
- Lower consumer confidence
- Real value of debts fall
- Real value of savings and pensions decrease
- Real value of assets won’t change
- Psychological effects; because prices are rising, they may feel worse-off, even if their income is rising in line with inflation, which may cause them to decrease their spending
What are the effects of inflation on producers/firms?
- Business uncertainty
- Affects competitiveness; if inflation in Britain is higher than in other countries, British goods will become more expensive, and thus less competitive, making them more difficult to export, which will also affect the balance of payments
- If there is deflation, consumers will postpone their purchases until prices fall further, and people will be more likely to save as the value of their money will increase in the future, and they will borrow less as deflation means the real value of their debt increases. This can lead to a fall in demand for goods, leading to a firms’ fall in profit and business confidence, which can lead to a long term reluctance to invest
- Inflation is difficult t predict, so firms cannot plan for the future
- Wage inflation
- Flexibility to increase prices
- Menu costs (costs to reprice)
What are the causes of inflation?
- Demand pull inflation
- Cost push inflation
- Growth of the money supply
What is demand pull inflation?
- Total aggregate demand in the economy rises
- Aggregate supply cannot rise to match the increased demand, so prices are pulled up. Excess demand in the economy
- Causes are likely to be increased consumer demand, first spening on capital goods, export demand, and government spending
- Likely to occur when economy is near to full employment
What is cost-push inflation?
- Costs of production rise and firms pass this additional cost onto the consumers in the form of higher prices
- Costs are heavily affected by wage rises as this affects cost per unit. If productivity rises at the same rate as wages, cost per unit will remain the same
- Likely causes: wages, cost of fuel, raw materials, interest on loans, import prices
How is inflation measured?
The Consumer Price Index
It is measured using index numbers, which are based in price changes for a basket of approximately 600-700 goods and services commonly bought by typical households
The prices are updated every month by collecting more than 100,000 prices of goods and services across the country to determine the average - The Living Costs and Food Survey
The goods and services in the basket are weighted according to the proportion of income spent on them
How do you calculate a price index?
(new figure/base figure) x100
How do you calculate the weighted price of a basket of goods and services?
(Price of A x weight) +( price of B x weight) divided by the sum of weights
What are the limitations of using the CPI to calculate inflation?
- Not totally representative; impossible to take into account every single good sold, different households spend different amounts on each good, so it only measure an average rate of inflation
- Doesn’t include price of housing, which has tended to rise more than the price of other goods, so data may be lower than it should be
- It has limited use as it is a lagging indication - PPI may be better
- More recent than RPI, so difficult to make comparisons with historical data
- The quality of products is ignored; products have improved in quality so will obviously be more expensive
What is the Producer Price Index?
PPI measures the average change over time in the prices domestic producers receive for their output. It’s a measure of inflation at the wholesale level
What are the differences between the RPI and the CPI?
- RPI includes housing costs, such as mortgage and interest payments and council tax, where CPI does not
- CPI takes into account the fact that when prices rise people will switch to products that have gone up by less, so CPI is generally lower than 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 incomes
What are the effects on inflation on the government?
If the government fails to change excise taxes in line with inflation, then real government revenue will fall. If they fail to charge personal income tax allowance, then real government income will increase and taxpayers will have less money
Governments may also have to pay union workers more
What are the effects of inflation on workers?
- If workers dont 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
Evaluation of the effects of inflation
Some of these 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 meant by unemployment?
When people who are willing, able and available to work at the going wage rate in a suitable job, but cannot find work, despite an active search
What are the measures of unemployment?
- Claimant count
- ILO measure, using the Labour Force Survey
What is the Claimant Count?
A measure of unemployment calculated by counting the number of people claiming unemployment benefits on a particular day. Done on a monthly basis
