Measures of Economic Performance

P2 - Topic 1

GDP

Total value of final goods and services produced within a country's borders in a period

GNI

GDP + net income from abroad (profits, interest, remittances)

Nominal vs real GDP

Nominal = current prices. Real = adjusted for inflation (constant prices)

Real GDP from nominal GDP

Nominal GDP ÷ price index × 100

Real GDP growth rate (formula)

(Real GDP now − Real GDP before) ÷ Real GDP before × 100

GDP per capita

GDP ÷ population (average output per person)

Total vs per capita GDP

Total = size of economy. Per capita = average per person, so better for living standards

Value vs volume

Value = output × price (rises with inflation). Volume = quantity of output (price effect removed)

Index number (formula)

(Value in year ÷ Value in base year) × 100

Working back: population

GDP ÷ GDP per capita

Working back: GDP

GDP per capita × population

Positive vs negative growth

Positive = real output rising. Negative = real output falling

Recession

Two consecutive quarters of negative economic growth (falling real GDP)

PPP (purchasing power parity)

Adjusts for price-level differences so the same income buys the same basket of goods in each country. Used to compare real GDP/GNI internationally

When is GNI above GDP?

When net income from abroad is positive (e.g. large remittances, as in the Philippines)

Why GNI is better than GDP for Ireland

Multinationals' profits flow out, so GDP overstates income actually received by Irish residents

GDP limitation: inequality

Per capita is an average, so rising GDP can hide gains going to a few. Use the Gini coefficient or median income

GDP limitation: non-market output

Unpaid work, subsistence farming and the informal (shadow) economy are missed or undercounted

GDP limitation: externalities

Pollution and resource depletion are not deducted from GDP; clean-up spending actually raises it

GDP limitation: quality of life

Health, education, leisure, safety and freedom are not captured directly

GDP limitation: price levels and exchange rates

Market exchange rates misstate living standards. PPP helps but uses imperfect baskets

GDP limitation: composition and data quality

GDP counts spending, not whether it improves wellbeing (e.g. rebuilding after a disaster). Data reliability varies by country

Easterlin paradox

Within a country richer people report higher happiness, but rising national income over time raises average happiness little (diminishing returns to income)

Indicators of happiness and wellbeing

World Happiness score, Human Development Index (HDI), Genuine Progress Indicator (GPI)

Inflation

Sustained rise in the general price level (rate of change of the price index)

Deflation

Sustained fall in the general price level (negative inflation rate)

Disinflation

Falling rate of inflation: prices still rise, but more slowly

CPI

Index of the cost of a weighted basket of goods and services bought by typical households

Inflation rate (formula)

(CPI now − CPI before) ÷ CPI before × 100

Why CPI items are weighted

By share of household spending, so big-spend items move the CPI more

CPI limitations

Basket may not suit all households. Substitution bias. Quality changes and new products. Weights go out of date

Producer (wholesale) price index

Prices firms pay or charge at the factory gate. A rise signals consumer inflation later (leading indicator)

Demand-pull inflation

AD rises faster than AS can meet. Too much spending chasing too few goods

Cost-push inflation

Higher production costs (wages, raw materials, energy, taxes) shift SRAS left

Inflation from money supply

Money supply grows faster than output, so the price level rises

Causes of deflation

Falling AD. Increase in AS. Fall in the money supply

Effects of inflation: consumers and workers

Purchasing power falls. Real wages fall if pay lags prices. Savers lose if the real interest rate is negative

Effects of inflation: firms and investment

Menu costs and uncertainty. Costs rise. Lower investment if inflation is unstable

Effects of inflation: government and distribution

Real value of debt falls. Hurts fixed incomes and savers, helps borrowers

Effects of inflation: competitiveness

Higher domestic prices make exports dearer and imports cheaper, worsening the current account

Effects of deflation

Consumers delay spending so AD falls. Real debt burden rises. Unemployment rises

ILO definition of unemployment

Without a job, available to start within 2 weeks, and actively sought work in the last 4 weeks

Unemployment rate

Unemployed ÷ labour force × 100

Labour force

Employed + unemployed

Economic inactivity

Not working and not seeking work (students, retired, carers, long-term sick, discouraged workers)

Frictional unemployment

Short-term, between jobs while searching

Seasonal unemployment

Caused by seasonal demand (tourism, agriculture)

Structural unemployment

Mismatch of skills or location after industries decline. Long-term. Caused by occupational and geographical immobility

Demand-deficient (cyclical) unemployment

Low AD in a downturn, so firms cut labour

Real wage inflexibility

Wages held above equilibrium (minimum wage, unions), so labour supply exceeds demand

Underemployment

Working fewer hours or below skill level than wanted

Effects of unemployment

Workers: lost income and skills. Firms: lower demand. Public finances: less tax, more benefits. PPF: output inside the frontier. Society: inequality, crime, health

Net migration and employment

Raises labour supply and AD. Fills shortages, but may add unemployment pressure if jobs are scarce

Reading employment data

Falling unemployment with rising inactivity may hide discouraged workers, so look at all three rates

Balance of payments

Record of all transactions between a country's residents and the rest of the world in a period

Current account components

Trade in goods, trade in services, primary income, secondary income (transfers)

Balance of trade in goods and services

Exports minus imports. Deficit = imports exceed exports. Surplus = exports exceed imports

Visible vs invisible trade

Visible = goods. Invisible = services

Current account deficit vs surplus

Deficit: outflows exceed inflows. Surplus: inflows exceed outflows

Comparing growth between countries and over time

Use real GDP growth rates (and per capita, PPP-adjusted for levels). A high rate from a low base can mean a smaller absolute increase

Effects of inflation: current account

Exports become less price-competitive and imports relatively cheaper, so the current account tends to worsen (unless trading partners' inflation is higher)

Effects of deflation on firms and government

Firms: falling revenues and profits, real debt burden rises, investment cut. Government: tax revenue falls, real value of debt rises

Effects of deflation on competitiveness

Domestic prices fall relative to rivals', so exports become more price-competitive (only beneficial if deflation is caused by rising AS, not falling AD)

Effects of unemployment on consumers

Lower incomes reduce spending and confidence, so even employed consumers save more for fear of job loss

Employment rate

Employed ÷ working-age population × 100

Economic inactivity rate

Inactive ÷ working-age population × 100

Capital account

Transfers of capital assets and non-produced assets (e.g. debt forgiveness, migrants' transfers). Usually small

Financial account

Flows of investment: FDI, portfolio investment (shares, bonds), other investment (loans, deposits) and reserve assets

Primary income

Income from abroad on factors of production: wages, profits, interest and dividends

Secondary income

Current transfers with no exchange of goods or services: remittances, foreign aid, contributions to international bodies

Why the balance of payments always balances

A current account deficit is financed by a surplus on the capital and financial accounts (plus errors and omissions), so the overall total is zero