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Edexcel IAL Economics Unit 2 (WEC12) – Complete Study Notes

2.3.1 Measures of Economic Performance

Economic Growth

• a) The rate of change of real Gross Domestic Product (GDP) as a measure of economic growth and living standards.

  • Q: What is economic growth and how is it measured?
  • A: Economic growth is the increase in a country's real national output over time. It is measured by the rate of change of real Gross Domestic Product (GDP).
    • Real GDP: The value of GDP adjusted for inflation.
    • Example: If the economy grew by 4% since last year, but inflation was 2%, real economic growth was 2%.
    • An increase in economic growth indicates an increase in national output, typically leading to higher living standards and increased employment opportunities.
  • Why is real GDP used?
  • Using real GDP eliminates the distorting effect of inflation, enabling economists to determine if the economy is producing more goods and services or if the price increases are merely nominal.

• b) Gross National Income (GNI) as an alternative measure of national income.

  • Q: What is GNI and how does it differ from GDP?
  • A: Gross National Income (GNI) is the sum of value added by all producers residing in a nation, including product taxes (minus subsidies not included in the output value) and receipts of primary income from abroad (compensation of employees and property income).
    • Key Distinction:
    • GDP: Measures output within a country's borders.
    • GNI: Measures output produced by a country’s citizens, regardless of whether it occurs inside the country's borders.
  • GNI accounts for:
    • Remittances: Money sent home by citizens working abroad.
    • Foreign aid received.
    • Income from overseas investments.
    • Example: A UK firm operating a factory in China contributes to China's GDP but to the UK's GNI.

• c) The distinction between the following measures of GDP/GNI: real and nominal; total and per capita; value and volume.

  • Q: What are the differences between real and nominal, total and per capita, and value and volume measures?
  • A:
    • Distinction
    • Real vs Nominal:
      • Real values: Adjusted for inflation.
      • Nominal values: Not adjusted for inflation.
      • Example: GDP grew by 4% while inflation was 2%.
        • Nominal growth = 4%, real growth = 2%.
    • Total vs Per Capita:
      • Total GDP: The joint monetary value of all goods and services produced.
      • GDP per capita: Total GDP divided by population, allowing fair comparisons between countries of different sizes.
    • Value vs Volume:
      • Value: The monetary worth of goods and services.
      • Volume: The quantity of goods and services produced.
      • Example: If prices rise but quantity remains constant, value increases while volume does not.

• d) Comparison of GDP/GNI rates of growth between countries and over time.

  • Q: How can we compare growth rates between countries and over time?
  • A: Comparisons can be made by:
    • Calculating annual percentage changes in real GDP or GNI.
    • Using index numbers to track changes from a base year.
    • Comparing per capita figures to adjust for population differences.
    • Utilizing purchasing power parity (PPP) to account for differences in cost of living.
  • Limitations of direct comparisons:
  • Different countries may employ various calculation methods.
  • Fluctuations in exchange rates can distort comparisons.
  • Informal economies (black markets) are often excluded.

• e) The concept of Purchasing Power Parities (PPPs) in making international comparisons of real GDP/GNI.

  • Q: What are PPPs and why are they important?
  • A: Purchasing Power Parity (PPP) is a theory that estimates needed adjustments to the exchange rate so that exchanges between countries are equivalent according to each currency's purchasing power.
    • Example: If a car costs £15,000 in the UK and the exchange rate is 1.5 £/$, then it should cost $10,000 in the US to maintain equality.
  • Why use PPP?
    • Simple exchange rate conversions do not accurately reflect purchasing power.
    • Prices of identical goods (e.g., Big Mac) vary in different countries.
    • PPP offers a more reliable comparison of living standards and real income across nations.

• f) The distinction between positive economic growth rates and negative economic growth rates.

  • Q: What is the difference between positive and negative growth rates?
  • A:
    • Positive Economic Growth:
    • Real GDP is increasing.
    • Economy is expanding.
    • Typically associated with rising employment and living standards.
    • Example: UK growth of 2.5%.
    • Negative Economic Growth:
    • Real GDP is decreasing.
    • Economy is contracting.
    • Typically associated with declining employment and living standards.
    • Example: UK growth of -1.5%.

• g) The concept of 'recession' as two consecutive quarters of negative economic growth.

  • Q: What defines a recession?
  • A: In the UK and most developed economies, a recession is defined as two consecutive quarters of negative economic growth.
    • Characteristics of a recession:
    • Negative economic growth.
    • High level of spare capacity and negative output gaps.
    • Demand-deficient (cyclical) unemployment.
    • Low inflation rates (or deflation).
    • Deteriorating government budgets due to increased welfare spending and decreased tax revenues.
    • Reduced consumer and firm confidence resulting in decreased spending and investment.

• h) The limitations of using GDP/GNI to compare living standards between countries and over time.

  • Q: What are the limitations of GDP/GNI as measures of living standards?
  • A:
    • Limitation
    • Income distribution: GDP per capita does not reflect income distribution; countries with similar GDP per capita may show significant inequality.
    • Non-market activities: Excludes household work, volunteering, and subsistence farming.
    • Informal economy: Black market transactions and undeclared income are not recorded.
    • Negative externalities: GDP may increase from spending to address issues like pollution but does not factor in the negative impacts.
    • Quality of goods: GDP records quantity produced but not quality improvements (e.g., healthcare or education upgrades).
    • Leisure time: Longer working hours might boost GDP but detract from wellbeing.
    • Environmental costs: Depletion of natural resources is not accounted for in GDP figures.

• i) National happiness and wellbeing: indicators of national happiness and wellbeing; the relationship between real incomes and subjective happiness.

  • Q: How can we measure national happiness and wellbeing?
  • A: Several alternative indicators exist alongside GDP:
    • Human Development Index (HDI): Combines three dimensions:
    • Education – mean years of schooling and expected years of schooling.
    • Life expectancy – ranges from 25 to 85 years.
    • Standard of living – real GNI at PPP per capita.
      • A value close to 1 signifies high development; close to 0 indicates low development.
    • Human Poverty Index (HPI):
    • HPI-1 for developing countries: Measures probability of not living to age 40, adult literacy, and the percentage of underweight children and individuals without