4.2.1 - The measurement of macroeconomic performance

Macroeconomic Policy Objective =

A target or goal that a government wishes to achieve

4 Main Policy Objectives of UK Government

PUBE

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Prices (Inflation) - Limit/control inflation to achieve price stability (2%±1%)

Unemployment - Create & maintain employment / minimise unemployment

Balance of Payments - Attain a satisfactory balance of payments on current account, avoidance of a persistent external deficit

Economic Growth - Achieve economic growth, improve living standards & levels of economic welfare (as high as possible but also steady & sustainable)

Inflation =

A persistent rise in the average price level

Balance of Payments =

The difference between the flow of money into and out of a country in a given time period.

Current Account Deficit =

When a country imports more than it exports

Short-run Economic Growth =

Increase in real GDP in an economy over a period of time

Long-run Economic Growth =

Increase in an economy's potential level of real output

3 Other Policy Objectives

Equality - Reduce income inequality

Balancing the Budget - Reduce fiscal budget deficit & national debt

Living Standards

Fiscal Budget Deficit =

When a government's expenditure is greater than tax revenue received.

(i.e. When a government spends more than it receives in tax revenue)

National Debt =

Accumulation of prior years' fiscal budget deficits

Conflicts when trying to achieve Policy Objectives

Memory Hook: Smiley face on PUBE

P-UB-E

P-E

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P & U: Gov reflates the economy (thru policies to stimulate economic activity) to increase output to LOWER UNEMPLOYMENT --> factors of production become more scarce --> increases costs of production --> average price level increase --> INFLATION INCREASES

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P & E: Gov reflates the economy (thru policies to stimulate economic activity) to increase output to ACHIEVE ECONOMIC GROWTH --> factors of production become more scarce --> increases costs of production --> average price level increase --> INFLATION INCREASES

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B & E: Gov reflates the economy (thru policies to stimulate economic activity) to increase output to ACHIEVE ECONOMIC GROWTH --> inflation increases --> less internationally price competitive --> less exports, more imports --> WORSENING BALANCE OF PAYMENTS POSITION / current account position.

Real GDP =

Total value of goods and services produced in an economy, over a period of time, adjusted for inflation

Lead Indicator

A performance indicator that provides information about the FUTURE state of the economy

Lag Indicator

A performance indicator that provides information about PAST and possibly CURRENT economic perfomance and the extent to which policy objectives have been achieved.

Performance Indicator

Provides information for judging the success or failure of a particular type of government policy (such as fiscal policy or monetary policy) in meeting the macroeconomic objectives

i.e. information for judging how well an economy is performing relative to its macroeconomic objectives

Index Number =

• A unit-free number used in an index to enable ACCURATE COMPARISONS to be made

• The base year index number is typically 100

• Changes over time are expressed in percentage terms around the base

Consumer Price Index (CPI) =

A measure of inflation that tracks changes in price level of a representative basket of goods & services within an economy.

Human Development Index

Used to compare economic development across countries/within a country over a period of time.

(GNI per Capita, Mean Years of Schooling, Life Expectancy)

Effective Exchange Rate Index

The value of a country's currency relative to a trade weighted basket of other currencies.

Sterling Trade Weighted Index

Shows changes in exchange rates weighted to value of trade undertaken with various countries

Index # =

(Raw Number / Base Year Raw Number) x 100

Weighted Index =

Index x Weight (%)|

An average index made up of a combination of other indices

National Income =

The flow of new output produced by an economy in a particular period of time.

3 Ways of Measuring National Income

• Output - measures the actual g&s produced by the economy

• Income - measures the incomes received by labour & other FoP when producing the g&s

• Expenditure - measures the spending of these incomes on the g&s

Why is National Income a Measure of Living Standards?

• ↑National Income → ↑Output → More g&s being shared amongst citizens → Individuals & households have more g&s → ↑Level of consumer satisfaction & welfare → ↑Living standards

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• ↑National Income → ↑Total incomes received by labour & other FoP when producing the g&s → ↑Average incomes → More money to spend on g&s → ↑Material standard of living

Limitations of National Income Data to assess living standards

Technical Difficulties with measurement:

• Output measure - Risk of Double-counting (e.g. counting both output of potato farmer and crisp manufacturer)

• Income measure - Need to exclude non-income money flows (e.g. u/e benefits should not count)

• Expenditure measure - Need to exclude expenditure on imports

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Nominal vs Real:

• Need to adjust to ‘Real National Income’, which removes the effect of inflation

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Need to be Per Capita:

• If population growth > national income rise, then national income is not actually rising per person and living standards actually is falling

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Informal Economy:

• Informal economy represents unregulated activities (e.g. black market, drugs, subsistence, tuition)

• The larger the informal economy, the larger the understatement of national income

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Composition of National Income:

• Rise in national income may be due to more capital goods, not more consumption → consumer welfare not increased

• More regrettables may be produced

• Income inequality may be widened

• May be more negative externalities

• Richer does not mean happier

Purchasing Power Parity (PPP) =

Adjusts exchange rate between countries for price level differences so that the exchange is equivalent to each currency’s purchasing power.

Why is it important to use purchasing power parity (PPP) exchange rates when making international comparisons of living standards?

Helps minimise misleading international comparisons that can arise with the use of market exchange rates.

Market exchange rates fluctuate substantially, so when GDP is compared by converting to another currency, it may show higher or lower GDP than what is true.

So PPP ER allows for accurate comparisons between economies.