Economic Growth

6 Major Macroeconomic Objectives

1) Sustainable Economic Growth

2) Price Stability

3) Equitable distribution of Income

4) Improve international competitiveness

5) Improve standards of living

6) Low level of unemployment

GDP

Total value of national output of goods + services produced in an economy over a given time period (usually a year/ quarter of a year)

How to calculate GDP

Expenditure

• AD (C + I + G + (X-M))

Factor Incomes

• Wages (labour), rent (land), interest (in exchange for financial capital), profit (entrepreneurship)

• EXCLUDES transfer payments (payments made by govt. to individuals without receiving any goods or services in return, e.g. benefits, pensions)

• This would be double counting (benefits is govt. simply redistributing income)

Value of Output

• Value added from each of the main economic sectors

(Sectors: Primary (e.g. farming, fishing & mining), Secondary - (construction, manufacturing), Tertiary (services e.g. tourism), Quaternary (e.g. business consultancy))

• VALUE ADDED = increase in market value of goods/services during each stage of production/supply

EG: we can measure the value of wheat produced by a farmer; we can then measure the additional value as a miller turns the wheat into flour (avoids double counting)

Value added = value of production - value of intermediate inputs used in supplying a good

UK industries

• De-industrialisation - Decline of manufacturing + construction

• Ongoing in UK - in 2018 manufacturing contributed 10% of GDP and 8% of all jobs

• In other countries (e.g. China), manufacturing account for larger percentage of national income

Services (tertiary sector)

• 2018 - 80% of GDP , 83% of jobs

Economic Growth

• Short run economic growth (actual) is the increase in the real value of goods and services produced, measured by annual percentage change in GDP

• Long run economic growth = increase in country’s productive capacity (potential output)

Nominal GDP

• Monetary value of the national output of goods and services, measured at current prices

• Value measure (takes into account prices + quantity)

Real GDP

• Nominal GDP adjusted for changes in price level (measured in constant prices)

• Volume measure (only takes into account quantity)

Limitations of GDP

• Income inequality

• Risk of double counting

• Doesn’t take into account other quality of life measures

• Dismisses informal activity (illegal/ unpaid work)

• Errors given vast data collection

• Quality of output ignored

• Dismisses negative externalities (Green GDP)

Positives of GDP

• Internationally comparable

• Comparable over time

• Correlates with HDI (human development index)

GNI (gross national income)

• GDP plus net factor income from overseas (income earned by domestic workers abroad minus income earned by foreigners domestically)

GNI = value of everything produced by factors of production owned by a country, no matter where they are located.

• Remittance money included (e.g. money sent back to families by workers abroad)

GDP per capita

GDP/ population

• Avg. measure of individual incomes in economy

PPP - Purchasing Power Parity

• Measures how many units of one country’s currency are needed to buy same basket of goods and services as can be bought with given amount of other currency

• In high cost of living countries (Switzerland), there is downward adjustment of PPP-adjusted GNI per capita (lower purchasing power)

• US experiences inflation, GBP converted to Dollars cannot buy same amount of goods, GBP is undervalued against dollar.

Exchange rate

• Nominal/floating exchange rate = actual market rate at which currency can be exchanged for another

• Real exchange rate - takes into account CHANGES in prices/costs

Big Mac Index

• Compares prices of Big Macs in countries compared to what they should be according to nominal exchange rate

• US price is $4.74, compares to other countries to see how under/overvalued local currency is against US dollar

Converting nominal to real GDP

Real GDP = Nominal GDP/ GDP deflator (new price index) x 100

Example:

• Let the nominal (money) value of UK GDP in 2016 be £1400 bn and let the price index for 2016 be 100

• In 2017, the nominal value of GDP rises to £1450 bn

• In 2017, price index rises to 103

• Therefore .......Real GDP in 2017

• = (Nominal GDP x 100/price index in 2017)

• = £1,450 bn x 100/103

• Real GDP = £1,408bn (expressed at constant 2017 prices)

Economic Wellbeing

• Statistic collected by ONS

• Considers personal life satisfaction/ anxiety/ stress of citizens

Median Income

• Better measure than GDP per capita as it rules out outliers (small no. of rich households)

Real income and subjective happiness relationship

Subjective happiness = self-reported measure of how individuals perceive their overall happiness + satisfaction with life

Rich societies not necessarily happier than poorer ones

Easterlin Paradox

• Life satisfaction does rise with average incomes up to a point, after which it plateaus (marginal gain in happiness declines)

• Because we find relative income important

Inflation

Sustained increase of average price levels of goods and services over a given period of time in an economy

Deflation

Sustained decline in the general price levels over time (below 0%)

Disinflation

Fall in rate of inflation - prices rise but at a slower rate

Stagflation

Rising inflation during a recession (caused by cost-push inflation)

Hyperinflation

Period of very high rates of inflation - leads to loss of confidence in country’s economy

CPI

• Main measure of inflation in UK

• Select base year for prices

• Carry out “expenditure survey” (thousands of households)- tracks what people are buying

• Representative, weighted basket of over 700 goods + services used (updated yearly)

• Weights according to percentage of income

• Weighted basket prices converted to index prices

• Percentage change is annual inflation rate

Find the CPI for 2018

Limitations of CPI for calculating rate of inflation

• Not everyone follows spending patterns of average family - personal inflation rates differ

• Price fluctuations of certain goods (food, energy) distorts CPI because their demand is price inelastic (avoided by CORE CPI (CPI minus prices of these goods) or PPI - producer price index, price of goods when manufactured)

• Doesn’t include housing costs (CPIH does)

• Basket updates too slowly

• Doesn’t account for change in quality of a good

RPI

• Includes cost of home ownership

• Calculated arithmetically

• Produces higher rate

Cost Push inflation

• SRAS shifts left

• Increase in cost of production for firms in economy

• Passed on as higher cost of produce

Cost push inflation causes

Increase in:

• Raw material prices

• Wages

• Business taxes

• Price of imported raw material due to weak exchange rate

Demand pull inflation

• AD curve shifts right

• Greater pressure on existing FOPs

• Price mechanism - prices of FOPs increase

• Increased cost of production for firms, passed on to consumers as higher prices of products

Demand pull inflation causes

• Decreased interest rates

• Lower income/corporation tax

• Higher consumer/business confidence

• Weaker exchange rate - imports become more expensive, so less demand for them

• Increased govt spending

Effects of inflation

• Wage/consumer price spiral - employees bargain for higher wages (anticipating inflation) companies pass on prices to consumers, spirals

• Decrease in real value of income

• Erodes savings - interest rates not in line with inflation

• Shoe leather cost - time, inconvenience spent trying to avoid holding cash when high inflation

• Lower export competitiveness - reduces revenue from exports, bad for trade dominant countries

• Consumers buy in advance to protect from higher prices, increased AD - inflation spirals further

• Fiscal drag - workers dragged into higher tax brackets (but wages rise in line with inflation, no gain) but pay more tax

• Inflationary noise - rate is volatile, price signaling loses value. Uncertainty means that consumption put off, leading to lower growth.

Winners + losers from high inflation

Winners

• Debtors

• Firms whose prices rise more than costs

• Workers with bargaining power

Losers

• Lower income workers, lower bargaining power

• Exporting firms (become less competitive)

• Retired people on fixed incomes

Evaluation of effects of inflation

Depends on:

• rate of inflation

• type - demand pull is better (higher growth, lower unemployment)

• Stability (inflationary noise)

• Anticipated or not

• Duration

Growth of money supply

Leads to inflation - “too much money chasing too few goods”

Quantity theory of money

Expressed using Fisher Formula

• MV = PT (M = money supply, V = velocity of money - how many times it changes hands, P = Price levels, T = Total volume of output)

• V and T are constant. Assume that if M increases, P increases.

• Hyperinflation often attributed to money supply

Causes of deflation

Malign - demand side deflation

• Deep fall in demand in economy - cause by persistent recession/depression

• High level of spare capacity

Benign - supply side deflation

• AS in economy rises quicker than AD

• Attributed to technological improvements

• SRAS shifts outwards

Effects of deflation

• Delayed spending

• Reduction in GDP

• Real value of debt increases

• Real cost of borrowing increases (real interest rates rise if nominal do not fall in line with deflation)

• Lower profit margins

• Lower confidence (value of assets falls)

• Exporters more competitive,

Unemployed definition

• Of working age (16-64)

• Willing and able to work

• Actively seeking but unable to find job

• Looking to start within next two weeks, has actively sought work within last 4 weeks

Claimant count

Number of recipients of JSA (job seeker’s allowance) + those who must be looking for work to claim Universal Credit (UC)

Limitations of Claimant count as a measure of UE

1) There are unemployed who do not meet criteria for benefits (have a partner in employment, have savings, are under 18)

2) Stigma around claiming - people might feel shame

3) Not internationally comparable

Advantages of Claimant count measure of UE

• Inexpensive

• Easy to see regional differences

• Data produced monthly

Labour Force Survey method

• LFS (Labour Force Survey), approach taken by ILO (International Labour Organisation)

• Asks 60,000 households to classify as employed, unemployed or economically active

Unemployed = Without a job, want a job, have actively sought work in the last four weeks, and are able to start workwithin the next two weeks; or out of work, have found a job and are waiting to start it in the next two weeks

Advantages of LFS method

• ILO measure so internationally comparable

• More representative

• Criteria is consistent - so historically comparable

Limitations of LFS

1) Only 60000 households - prone to sampling errors

2) Costly + time consuming

3) Only done quarterly, updates may be delayed

4) Doesn’t take into account under employment - those on zero hour contracts

5) Headline rate doesn’t reveal disparities (gender, race, regional etc.) which are used to reveal structural flaw in economy

Long term unemployed

Unemployed for at least one year

Labour force

No. of working age who are able, available and willing to work

Full employment

Enough unfilled job vacancies for all unemployed to take work

Economically inactive

Of working age but not working/seeking paid work (don’t count as unemployed)

Main reasons:

• Student in full time education

• Looking after family

• Long term illness

• Retired (early)

• Discouraged workers

Employment rate

% of population working age in full time / part time paid work (employed / total working age population x 100)

Unemployment rate

unemployed/ economically active x 100

Under employed

• People looking for extra hours

• People who are over qualified - their labour is under-utilised

Cyclical unemployment

• Demand deficient unemployment

• Caused by weak AD in economy - reduced demand for labour

• Results in contraction in national output - workers made redundant as a result

• Demand for labour is derived from demand for goods and services

• Cyclical employment rises quickly in recession (subject to trade cycle)

Frictional unemployment

• Workers in between jobs

• School leavers

• Always present in labour market

• Temporary, voluntary form of unemployment

Structural unemployment

• Lack of suitable skills among workers for available jobs

• Result of de-industrialisation / other structural changes of economy (automation, globalisation, industry decline)

Geographical immobility - workers unable to move from area of high unemployment to those with labour shortages
(cost of living, transport)

Occupational immobility - workers being unable to move between different types of jobs/sectors, because of lack of relevant skills/qualifications

REVISE DIAGRAMS FOR EACH TYPE OF UNEMPLOYMENT IN BOOK

Unemployment trap

• Little financial incentive to start working because loss of welfare benefits + paying of income tax results in them being worse off

Seasonal unemployment

• When seasonal workers are without jobs because of time of year

• Demand for labour in industries fluctuates predictably according to time of year, weather, holidays

Real wage inflexibility

• Classical unemployment

• Real wages are too high, leading to excess supply of labour in labour market due to insufficient demand of employers

• Minimum wages (push up wage above free market equilibrium, leading to excess workers and unemployment), collective bargaining of trade unions

• Monopsony employer (single buyer of type of labour, like NHS for nurses) causes employment to be lower than free market equilibrium

• Wages are “sticky downwards” (Keynesian view), are hard to adjust downward due to bargaining, pay cuts are damaging to morale

Define real wage inflexibility

Real wage inflexibility occurs when real wages fail to adjust downward to clear the labour market, causing persistent unemployment.

Negatives of long term unemployment

Longer without a job, harder it is to find way back into employment (skills worsen due to economic inactivity, motivation falls)

Leads to hysteresis (event continues even when causes of it have been removed) - total capacity of labour market falls as workers de-skill

Costs of UE

• Slower long run trend rated of economic growth

• Risk of deflation/ disinflation - falling AD

• Increased strain on NHS, mental health poor

• Increased income inequality, crime levels

• Increase in relative poverty

• Lower standards of living, purchasing power

• Erosion of skills (depending on how long unemployed)

• Tax revenue shrinks - fiscal costs to govt. (welfare spending increases) - budget deficit (divert money from elsewhere)

• Firms selling luxury goods - lower revenue

• Operating below PPF - decrease in confidence

Potential benefits of UE

• Leads to lower cost of production for firms (paying less in wages) so more revenue (esp. if labour replaced by capital)

• Higher bargaining power for firms - can reduce wages

• More leisure time

• Less imports (less demand for luxury goods)

• At level of 3-5%, it causes lower inflation and spare capacity is needed in economy to open new firms

• “Natural unemployment”

Net migration

Net total of migrants during period (citizens + non-citizens)

Policies to reduce UE

1) Macro stimulus policies - causing positive multiplier effects (firms)

• Low interest rates + improving credit supply to businesses

• Infrastructure investment policies

2) Cut firms’ cost of employing more workers

• Lower National insurance contribution rates

• Financial support for apprenticeships

3) Stronger work incentives

• Higher minimum wage

• Lower welfare payments - reform to system to prevent poverty trap

• Increased tax-free allowance

Net migration in 1990s

0

Since when has net migration been positive?

1994

Net migration today

204,000

Benefits of migration

• Increase AD

• Fiscal contribution

• Helps w/ demographics (countries with ageing populations)

• Increase in GDP

• Greater skill base in certain industries - hospitality, construction

Drawbacks of migration

• Pressure on public services

• Overcrowding

• Congestion

• Housing shortage

• Social disharmony

• Pushes down wages (only in low income)

Evaluation for effects of migration

• Depends on:

Demographic + skillset

Ease w/ which they settle

Dynamic effects - innovation + research

Does rise in labour migration stimulate capital spending of firms + govt.?

Duration of their stay

Recession

2 consecutive quarters of negative economic growth

Boom

Rate of growth of GDP is fast and higher than long term trend

Depression

GDP falls by at least 10%

Prolonged downturn in economy

Recovery

• Phase after recession - real GDP starts increasing, UE falls