A-level economics: 2.1 Measures of economic performance - content

GDP

value of goods & services produced in economy in 1 year

rising GDP

positive economic growth

higher incomes

more jobs

higher consumption

higher standard of living

falling GDP

negative economic growth

lower incomes

less jobs

lower consumption

lower standard of living

real GDP

adjusted for inflation

calculated using constant prices

prices held at level of chosen base year

nominal GDP

not adjusted for inflation

calculated using current prices

e.g. nominal vs real GDP - pizzeria

year 1: sold £500,000 worth of pizza

year 2: sold £900,000 worth of pizza

80% increase - doesn’t mean pizzeria produced 80% more pizzas in year 2 than year 1, price likely increased

year 1: 50,000 x £10 = £500,000

year 2: 60,000 x £15 = £900,000

increase in income due to increase in price & increase in output

must consider changing prices to find how much of increase in GDP was due to higher output

to find change in output - hold price constant (£10 - price of pizza in year 1))

year 1: 50,000 x £10 = £500,000

year 2: 60,000 x £10 = £600,000

in real terms, output increased by 20% not 80% (calculated without change in price to find change in output)

total GDP

economic output of country

GDP per capita

GDP divided by population = economic output per person

value of GDP

nominal GDP

measures monetary worth of goods & services at current prices

not adjusted for inflation

volume of GDP

real GDP

measures physical quantity of goods & services produced

adjusted for inflation

GNI

GDP + net primary income + net secondary income

total foreign & domestic income earned by country’s residents

net primary income

wages, salaries, other income earned by country’s residents working abroad

earnings from foreign investments (dividends & interest)

net secondary income

transfers of money between countries

e.g. remittances (money sent as gift) from foreign workers to families in home countries, international aid

GNP

total value of goods & services produced by country’s residents & companies, regardless of where they are located

(GDP has to be produced within country)

comparing rates of growth between countries

assess relative economic performance

reveal disparities in development

highlight factors contributing to growth

comparing rates of growth over time

reveal economic patterns & trends (long-term)

identify periods of economic expansion, recession, or stagnation

purchasing power parity

items should cost same in different countries based on current exchange rate

measures how many units of one currency needed to buy same basket of goods & services that can be bought with given amount of another currency

calculated by comparing price of basket of comparable goods & services in different countries

PPP-adjusted figures in international comparisons

countries with high cost of living - PPP-adjusted GNI per capita (income) lower than unadjusted

countries with low cost of living - PPP-adjusted GNI per capita (income) higher than unadjusted

Big Mac Index

measures each currency against common standard (McDonald’s burger) manufactured in standard size, composition & quality

convert average national Big Mac prices to US dollars - can compare same goods

tells us whether currency under/overvalued in foreign exchange markets

limitations of using GDP to compare living standards between countries & over time

issues with measurement & data - currency exchange rates vs PPP, excluding non-market activities, untracked economic activities

issues with interpretation & scope - income inequality, environmental factors & externalities, changing living standards

UK national wellbeing

measures wellbeing not just income

affected by income, health, relationships, freedom & corruption

captures non-economic aspects of wellbeing

evaluation of UK national wellbeing

subjective - depends on personal feelings

hard to compare between countries - hard to collect data

changes over time/depending on mood

relationship between real incomes & subjective happiness

low income - positive relationship between happiness & income (poverty → comfort)

once basic needs met - marginal increase in happiness from extra income decreases (comfort → higher comfort)

evaluation of relationship between real income & subjective happiness

increase in income → economic growth → higher living standards → higher life satisfaction/happiness

inflation

sustained increase in general price level leading to fall in purchasing power/value of money

disinflation

fall in rate of inflation

deflation

when prices actually fall

CPI (consumer prices index)

tracks changes in average price level of basket of goods & services bought by typical household over time

used for assessing inflation & cost of living

compares current prices of items in basket to prices of same items in base year

% change in comparison reflects inflation/deflation rate

calculating rate of inflation using CPI - CPI = (indices)

using new price index

calculating rate of inflation using CPI - CPI = (prices)

calculating rate of inflation using CPI - inflation rate =

limitations of CPI in measuring rate of inflation

not representative of all households - excludes some groups (e.g. highest/lowest incomes); different spending patterns

sampling errors & inaccurate data - low response rates; unreliable survey data

doesn’t include housing costs - e.g. mortgage payments/rent

time lag in updating basket - basket only updated annually → changes in tastes & new products not reflected quickly

changes in quality - inflation calculated only on price change → seems higher as doesn’t reflect rise in quality

difficulty measuring digital services - many have no clear price (e.g. free online services)

RPI (retail prices index)

includes housing costs

usually higher than CPI - sensitive to interest rate changes → affect mortgage interest

ONS switched from RPI to CPI - overestimates inflation

demand pull inflation definition

1. economic growth too fast

2. excess AD (AD > economy’s productive capacity)

3. general price level increases

too much money, too few goods

demand pull inflation causes

excess demand

cut in interest rates (encourages spending)

higher wages

increased consumer confidence (affected by job security, value of assets)

rising house prices (positive wealth effect)

increased money supply

demand pull inflation chain effects

economy at/close to full employment - increase in AD → increase in price level

higher wages → consumers’ disposable income increased → consumption increased → demand increased

firms reach full capacity → increase prices → higher inflation

near full employment with labour shortages - workers can get higher wages → increases spending power

AD can increase due to increase in any of its components (C + G + I + X-M)

economic growth above long-run trend rate of growth → demand pull inflation

demand pull inflation graph

cost push inflation definition

affected by supply-side factors

production costs increase → businesses raise prices

cost push inflation causes

(all production costs)

higher wages (most significant cost for firms, firms raise prices to maintain profit)

import prices

devaluation (increased cost of imported goods (raw materials))

increase in VAT
inflation expectations (e.g. higher prices → workers demand higher wages → wage price spiral)

cost push inflation chain effects

higher wages → firms’ costs increased → firms increase prices

trade unions present united front → bargain for higher wages (collective bargaining)

increase in costs for firms → businesses increase prices

devaluation/depreciation (have to pay more to buy same good) → import prices increase → increase in inflation

oil prices increase → impacts most goods in economy → cost push inflation

high inflation expectations → workers demand higher wages → firms increase prices

low inflation expectations → temporary rise in prices

cost push inflation graph

growth of money supply - cause of inflation

too much money in economy

increased demand but no increase in supply → prices rise

effects on inflation on consumers

incomes don’t rise with inflation → less to spend → fall in living standards

reduces real value of debt → those in debt can pay it off cheaper, those owed money get back money of cheaper value

money saved of less value → savers lose out

psychological effect → feel poorer due to rising prices → decrease spending

effects on inflation on firms

higher in Britain → British goods more expensive → less competitive → harder to export (also effects balance of payments)

deflation → expect prices to fall further → postpone purchases

deflation → more likely to save (value of money will rise in future), less likely to borrow (real value of debt increases) → fall in demand → fall in profits & business confidence → long-term reluctance to invest

hard to predict → firms can’t plan for future

calculate new prices → change price labelling (expensive)

effects on inflation on government

govt doesn’t change taxes to be in line with inflation → real govt revenue falls

govt doesn’t change personal income tax allowances (amount worker can earn tax free) → real govt revenue increases & taxpayers have less money

effects on inflation on workers

don’t receive yearly pay rises of rate of inflation → worse off in real terms → fall in real incomes → living standards decrease

those in weaker unions most affected → unable to win wage rises in line with inflation

deflation → lack of demand → fall in firms’ profit → staff lose jobs to cut costs

unemployment definition

someone of working age (16-67), willing & able to work & actively seeking work but cannot find a job

claimant count

number of recipients of job seeker’s allowance & those on universal credit required to look for work (UC also includes employed)

narrow definition of unemployment - only includes those actively seeking work & receiving govt benefits

live data - have to go to job centre every week

published monthly

international labour organisation & UK labour force survey

ILO unemployment definition: individuals of working age who are without work, actively seeking work & available for work

UK labour force survey - primary source of unemployment data in UK (& follows ILO definition)

broader & more comprehensive picture of unemployment - includes those not eligible for benefits

quarterly basis (every 3 months)

approx. 90,000 people

conditions: looking for work in last 4 weeks, available to start in next 2 weeks

claimant count vs LFS

people in claimant count not LFS: working in hidden economy (avoid tax), fraudulently claim benefits

people in LFS not claimant count: unemployed not eligible for benefits (e.g. partner working, looking for work along full-time study)

LFS > claimant count

can go in different directions - LFS only sample & different types of people asked → short term changes in rate; events in labour market not covered by claimant count (e.g. more students looking for work alongside studies)

both underestimate figure as don’t include: part-time workers wanting full-time work, sick/disabled, not actively looking but would take job if offered, in education unable to find work

unemployment vs underemployment

unemployment: no job despite actively seeking work

underemployment: working in role part-time/low-skilled/below qualification level (not in any unemployment stats)

employment rate

% working age population who are employed

unemployment rate

% economically active population who are unemployed

inactivity rate

% working age population who are economically inactive (not in work, not seeking work)

changes in employment rate

higher employment → less dependency on welfare, higher output → higher living standards, higher tax revenue, stronger economic growth

changes in unemployment rate

higher unemployment → lower output, lower incomes, higher govt spending on benefits, more spare labour (labour demand < supply),

lower unemployment → higher output, higher incomes, lower govt spending on benefits, risk of labour shortages (labour demand > supply) & inflationary pressure (wage bargaining)

changes in inactivity rate

increase in inactivity → decrease size of labour force → fall in productive potential of country → lower GDP & lower tax revenues (less people working)

structural unemployment

lack of suitable skills for job available

result of deindustrialisation (automation → manufacturing sectors decline → workers not skilled enough)/other structural changes in economy

links to occupational immobility of labour (mismatch between skills of employee & skills required by vacant position) - new jobs require new skills (retraining cost)

frictional unemployment

workers seeking better job/in between jobs

affects new entrants to labour market & people on short-term employment contracts (move between jobs)

always frictional unemployment regardless of stage of business cycle

helps provide supply of labour for employers

reduced by: job info more available, job search more affordable

e.g. mothers returning to labour market

seasonal unemployment

seasonal workers without paid jobs due to time of year when there are seasonal changes in demand, production & unemployment

e.g. farming, tourism

demand deficient/cyclical unemployment

involuntary unemployment due to lack of aggregate demand for goods & services

decreased demand for labour

economy slows down/recession → demand decreases → companies lay off workers

real wage inflexibility

workers reluctant to see real wages fall during economic downturn

real wages drop when nominal wages don’t rise as fast as prices

Keynesians argue wages can be slow to adjust downward due to: long-term labour contracts, trade union collective bargaining, social norms about fair pay

workers & employers reluctant to renegotiate contracts/reduce wages during downturns → persistent real wages levels too high relative to labour demand

natural rate of unemployment

rate of unemployment when labour market in equilibrium

significance of migration for employment & unemployment

increased migration → increased labour supply → migrants earn & spend income → increased AD → increased demand for labour → unemployment may not rise

(unemployment doesn’t rise due to higher demand for labour)

increased labour supply → decreased equilibrium wage (esp lower-paid, low-skilled jobs) → more competition for jobs (lower wages → need money even more)

significance of skills for employment & unemployment

increased economic development → increased demand for high-skilled labour → skills mismatch → structural unemployment → unfilled jobs → migrants may fill gaps if skills fit

effects of unemployment on consumers

unemployed → lower income → decreased spending

high unemployment areas → decreased range/quality of goods → less choice

possible decreased prices/promotions - firms try to boost demand

effects of unemployment on firms

lower consumer income → decreased demand → decreased profits

long-term unemployment → decreased skills in labour force → smaller skilled labour supply

increased labour supply → firms can pay lower wages

effects of unemployment on workers

lower income → decreased living standards

psychological impact → stress, illness, family breakdown, suicide

long-term unemployment → decreased skills → lower employability

employed workers → decreased job security & increased fear of redundancy

increased labour supply → decreased bargaining power → lower wages

effects of unemployment on government

decreased tax revenue (income tax) & increased welfare spending → increased budget deficit → less money for public spending

may increase taxes/decrease public spending/increase borrowing

effects of unemployment on society

increased social deprivation (lack of access to essential resources) → increased crime, poor health, lower life expectancy

decreased local demand → decreased incomes → further job losses (negative multiplier)

loss of potential output → inefficient resource use

decreased LRAS (if workers leave labour market) → decreased economic growth, inside PPF

benefits are transfer payment (govt distribution of wealth, not direct loss to economy)

real loss = decreased output & increased social costs

balance of payments

measures country’s transactions with rest of world

record of all money coming into & going out of country (includes payments for goods, services & financial transactions)

all transactions between residents & non-residents of national during period

components of balance of payments

current account

capital account

financial account

current account components

net balance of trade in goods

net balance of trade in services

net primary income

net secondary income

current account deficits & surpluses

deficit: value of imports (M) > value of exports (X)

surplus: value of imports (M) < value of exports (X)

macroeconomic objectives (main 4)

low unemployment

low & stable inflation

economic growth rate similar to other countries

balance of payments equilibrium

current account & macroeconomic objectives

high economic growth: increased demand → increased imports → current account deficit

high unemployment: decreased demand → decreased imports → deficit improves

govt wants export led growth: economic growth, high employment, improves current account balance, could cause inflation

interconnectedness of economies through international trade

increasing proportion of output of individual economy which is traded internationally

more people/companies own assets in other countries

increasing migration between countries

more technology being shared faster

countries are more interdependent → change in economic condition of one affects another