Theme 2 - The UK Economy Flashcards
What is economic growth?
Economic growth is the rate of change of output . It is an increase in the long term productive potential of the country which means there is an increase in the amount of goods and services that a country produces.
How is economic growth measured?
This is typically measured by the percentage change in real GDP per annum . It can also be shown through the shift of PPF.
What is GDP an indicator of?
What does it represent?
GDP is an indicator of the standard of living in a country.
Total GDP represents the overall GDP for the country whilst GDP per capita is the total GDP divided by the number of people in a country.
GDP per capita grows if national output grows faster than population over a given time period, so there are more goods and services to enjoy per person.
Real GDP strips out the effects of inflation whilst nominal GDP does not.
What is GDP?
Gross Domestic Product: The standard measure of output, which allows us to compare countries. It is the total value of goods and services produced in a country within a year.
What are real values VS nominal values?
Real values can be described as the volume of national income i.e. the size of the basket of goods, whilst nominal values represent the value of the national income i.e. the monetary cost of this basket of goods. The value is equal to the volume times the
current price level. The value of national income is its monetary value at the prices of the day; the volume is national income adjusted for inflation and is expressed either as index number or in money terms.
How can we measure national income?
Gross national income
Gross national product
What is gross national income?
The value of goods and services produced by a country over a period of time plus net overseas interest payments and dividends.
This means that it adds what a country earns from overseas investments and subtracts what foreigners earn in a country and send back home from the GDP. 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 gross national product?
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. This means it is the value of all the goods produced by citizens of a country, whether they live in the country or not, whilst GDP is the value of all goods produced inside the country, whether they were produced by citizens of the country or not.
How do we make comparison about growth over time?
Changing national income levels will show us whether the country has grown or shrunk over a period of 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.
How do we make comparison about growth 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
What are purchasing power parities?
A metric to compare economic productivity and standards of living between countries is purchasing power parity (PPP). PPP is an economic theory that compares different countries’ currencies through a “basket of goods” approach.
They provide an alternative to using exchange rates for comparisons of GDP. These are useful when comparing countries as it takes into account the cost of living (how much has to be spent to maintain living standards), and so will help us better compare living standards.
The difference between the highest and lowest GDPs will be smaller when PPP is used as poorer countries have a much lower cost of living than richer ones. For example, in Kenya £2 a day in their own currency is enough to survive on, whilst it
isn’t in the UK.
What are the problems of using GDP to compare standard of living?
- Inaccuracy of data = Some countries are inefficient at collecting data, there may be hidden or black markets which people work without declaring their income. This makes GDP underestimated. Errors in calculating the inflation rate means GDP will be inaccurate.
- GDP doesn’t take into account home-produced services making GDP underestimated.
- Inequalities = an increase in GDP may be due to growth in income of just one group of people and so growth in national income may not increase living standards everywhere.
- Quality of goods and services = the quality of goods and services is higher now but this is not necessarily reflected in the real price. So living standards may have increased more than GDP would have suggested. Improved technology may allow prices to fall suggesting falling living standards, but this is not the case.
- Comparing different currencies = there are issues over which unit should be used to compare figures.
- Spending = Some types of expenditure like defence, does not increase standard of living but it 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.
What is another measure of welfare, not including GDP?
GDP only measures income but there are other factors affecting welfare. The UN happiness report found six key factors : real GDP per capita, health, life expectancy, having someone to count on, perceived freedom to make life choices, freedom from corruption, and generosity.
This is the National Wellbeing / happiness report.
How can national wellbeing measure welfare?
In 2010, the UK Prime Minister launched the Measuring National Wellbeing report to measure how lives are improving. They found that self-reported health, relationship status and employment status most affect personal well-being.
They ask 4 key questions about life satisfaction, anxiety, happiness and worthwhileness, where people answer on a scale of 0 “not at all” to 10 “completely”. The report is now updated on a quarterly basis, rather than annually.
In 2012-2016, life satisfaction, happiness and worthwhile have continued to rise whilst anxiety levels fell but have begun to rise slightly. This could be as unemployment is falling/GDP is rising but concerns over global security could be causing anxiety.
What are some findings from the national happiness report (Easterlin Paradox and happiness with people around you)?
One key finding of psychological research is that happiness and income are positively related at low incomes i.e. if you are poor and your income increases, you will be happier, but higher levels of income aren’t associated with increases in happiness i.e. rich people aren’t necessarily happy and increases in their income
won’t necessarily make them happier. This is called the Easterlin Paradox. An increase in consumption of material goods will increase happiness if basic needs aren’t met (shelter and food), but once these needs are met, an increase in consumption won’t increase long term happiness. For example, in the UK as we
already enjoy a high standard of living, even if GDP doubles, happiness will not increase.
Another finding is that income and happiness depends on the people around us. For example, if you are the richest out of everyone you associate yourself with, then you will be happier than someone who has the exact same income but is the poorest
out of everyone they associate with. Income is linked to social status and higher social status tends to make us happier.
What is consumption?
Consumption is spending on consumer goods and services over a period of time.
What is disposable income?
Disposable income (Y) is the money consumers have left to spend , after taxes have been taken away and any state benefits have been added. This means that disposable income is affected by government taxation as well as wages.
How does disposable income and the marginal propensity to consume determine consumption?
Disposable income is the most important factor in determining the level of consumption . Those who are earning a large income will be able to spend much more than those on a minimum wage.
However, we are also concerned with how much an increase in income affects consumption, this is called the marginal propensity to consume (MPC). For most people, MPC will be positive but less than 1 i.e. an increase in income increases
spending but spending doesn’t increase by as much as income. Some people will have an MPC of more than one as they use borrowing or savings to fulfil the demand for goods which is higher than their increase in income.
Poorer people tend to have a higher MPC as they are likely to spend much more of their increase in income whilst richer people are more likely to save it.
What is the average propensity to consume?
The average propensity to consume (APC) is the average amount spent on consumption out of total income.
In an industrialised country, the APC for the economy is likely to be less than one as people save some of their earnings.
APC = total consumption / total income
What is the formula for marginal propensity to consume?
MPC = change in consumption / change in income
What are savings?
Savings are what is not spent out of income.
What is the marginal propensity to save?
The marginal propensity to save (MPS) is how much of an increase in income is saved.
MPS = change in savings / change in income
What is the average propensity to save?
The average propensity to save (APS) is the average amount saved out of income.
APS = total savings / total income
What are the influences on consumer spending?
Interest rates Consumer confidence Wealth effects Distribution of income Tastes and attitudes
How does interest rates influence consumer spending?
Most major expenditures are bought on credit so therefore the
interest rate will affect the cost of the good for consumers. If interest rates are high, the price of the good will effectively be higher since more interest needs to be paid back and this will lead to a reduction in consumption. High interest rates also
increase mortgage repayments so reduce consumption. Also, a rise in interest rates decreases the value of shares and so people experience a negative wealth effect.
How does consumer confidence influence consumer spending?
One major factor that affects people’s spending is what
they think will happen in the future. If people are confident about the future and expect pay rises, then they will continue or increase their spending. If they expect high levels of inflation in the future, they will buy now as it will be at a cheaper price,
so consumption will increase. If they expect a recession and fear possible unemployment, consumption will decrease as people may save more. Expectations about a change in the taxation level will affect consumption: if consumers expect tax to increase prices in the future, they will buy now whilst if they expect it to reduce prices in the future, they will delay their purchases. Similarly, expectations on interest rates will affect consumption: if consumers expect interest rates to fall they may delay their purchases as things on credit will be cheaper.
How does wealth effects influence consumer spending?
Wealth is a stock of assets. People with greater wealth tend to
have greater levels of consumption, known as the wealth effect: a change in consumption following a change in wealth. The wealth effect is experienced when real house prices rise as owners now have more wealth so are more confident with
spending as they know that if they go into financial difficulty they could simply borrow more against the house, since their house is worth more than their current mortgage. It can also be experienced when share prices rise as people may sell some of their shares and spend the money or may be more confident in spending the money they have as they know they have the shares to fall back on in case of financial difficulty.
Greater wealth will improve a consumer’s confidence and thus lead to greater spending.
How does distribution of income influence consumer spending?
Those on high incomes tend to save a higher percentage
of their income than those on low incomes and so a change in the distribution of money in the economy will affect the level of consumption. If money is moved from the rich to the poor, consumption is likely to increase as the poor have a higher MPC.
How do tastes and attitudes influence consumer spending?
In our modern society, there is a strong materialistic drive
that encourages people to have the newest and the best and therefore spending can be very high, in some cases even above income. If people were less materialistic, consumption would decrease.
What is investment?
Investment is the addition of capital stock to the economy i.e. machines and factories used to produce other goods and services. It is only seen as investment if real products are
created so buying a share in a company would be saving but buying new machinery is investment.
What is gross investment?
Gross investment is the amount of investment carried out and ignores the level of depreciation,
What is net investment?
Net investment is gross investment minus the value of depreciation.
What are the influences on investment?
Rate of economic growth Business expectations and confidence (animal spirits) Demand for exports Interest rates Influence of government and regulations Access to credit Retained profit Technological change Costs
How does rate of economic growth influence investment?
In a growing economy, there will be higher levels of investment as businesses would be more confident about their investments and the higher demand would lead to a higher return rate on the investment. For example, buying a new machine would lead to more products being made, but if the economy was declining these products wouldn’t be bought so there would be no or little return on the investment. On top of this, a growing economy needs more investment in order to cope with the higher levels of demand. If the same products and the same output is being produced every year, and no more is demanded, investment will stay the same as firms only have to replace old machines. However, if the economy is growing, firms will need to increase investment to match the level of demand and if it is shrinking, firms will not need to replace their old machines and so investment will
fall.
What is the accelerator theory when talking about investment?
The investment over a period of time is the change in real income times the capital-output ratio. The capital output ratio is the amount of investment needed to produce a given amount of goods. Thus, if incomes rise, the level of investment will rise.
How does business expectations and confidence (animal spirits) influence investment?
When businesses are confident about the future and expect future growth, investment will increase as they want to prepare for the future. If they are fearful of the future, then they will not
invest money in new ideas or machinery. John Maynard Keynes used the term ‘animal spirits’ to describe the feeling of managers and owners of firms on whether their investment would be profitable. He argued that it is difficult to measure.
How does demand for exports influence investment?
If the world economy is booming, demand for exports is likely to increase and therefore exporting firms’ investment is likely to increase to cope with this extra demand. This will have a knock-on effect and encourage other firms to increase their investment.
How does interest rates influence investment?
Most investment is done through borrowing. High interest rates
mean that borrowing is more expensive, so a business needs to be more confident of good profits in order to cover the extra costs of borrowing. Other investment is done through retained profits or savings. A rise in interest rates increases the opportunity cost of a business using retained profits as they are able to get higher interest payments than before. Keynes’ Marginal Efficiency of Capital (MEC) graph shows how higher interest rates will lead to a fall in investment. This displays the expected rate of return from an investment at a particular given time. If interest rate is at 10% then firms need an expected rate of return which is at least equal to 10% to make it worthwhile.
How does the influence of government and regulations influence investment?
Governments can encourage investment by their own policy decisions. For example, they could offer tax breaks or grants to businesses to try and encourage them to invest. Regulations also affects investment as a highly regulated economy tends to see less investment as regulation increases the cost and time taken to invest, such as planning regulations.
How does access to credit influence investment?
Investment will be lower when an investment has a high risk
attached to it, as it means there will be less access to credit and interest rates will be higher. In recessions, it is usually more difficult to access credit as risks are higher and banks become more risk aware, fearing firms will not be able to pay the money back.
