Edexcel Economics (A) A-level Theme 2: The UK Economy - Performance and Policies 2.1 Measures of Economic Performance Summary Notes

Economic Growth

Economic growth is a rise in the value of Gross Domestic Product (GDP).
GDP measures the quantity of goods and services produced in an economy; a rise in economic growth signifies increased national output.
Economic growth leads to:
- Higher living standards
- More employment opportunities
Real GDP:
- Value of GDP adjusted for inflation.
- Example: 4% economic growth with 2% inflation means real economic growth is 2%.
Nominal GDP:
- Value of GDP without adjusting for inflation.
- Example: 4% nominal economic growth can be misleading because it doesn't account for inflation.
Total GDP:
- Combined monetary value of all goods and services produced within a country’s borders during a specific time period.
GDP per capita:
- Value of total GDP divided by the country's population.
- Measures the average output per person in an economy.
- Useful for comparing the relative performance of countries.
Volume of GDP:
- GDP adjusted for inflation.
- Represents the real level of GDP.
Value of GDP:
- Monetary value of GDP at current prices.
- Nominal figure, calculated by volume times current price level.
National income can also be measured by:
- Gross National Product (GNP):
  - Market value of all products produced annually by labor and property supplied by citizens of one country.
  - Includes GDP plus income earned from overseas assets minus income earned by overseas residents.
  - GNP includes products produced by citizens of a country, whether inside the border or not.
- Gross National Income (GNI):
  - Sum of value added by all producers who reside in a nation, plus net overseas interest payments and dividends.
  - Includes what a country earns from overseas and removes any money sent home by foreigners.
Purchasing Power Parity (PPP):
- Theory estimating how much the exchange rate needs adjusting for exchanges between countries to be equivalent in purchasing power.
- Example: If a car costs £15,000 and the exchange rate is 1.5 £ per $, the car should cost $10,000 in the US.
- Helps minimize misleading comparisons between countries.
Limitations of using GDP to compare living standards:
- GDP doesn't indicate income distribution; similar GDPs per capita can mask different living standards.
- GDP may need recalculation in terms of purchasing power to account for international price differences.
- Large hidden economies (e.g., black market) are not accounted for in GDP, making comparisons misleading.
- GDP gives no indication of welfare; other measures like the happiness index might be used.
National happiness (statistics from the ONS):
- UK national well-being:
  - The Office for National Statistics develops ways to measure national well-being, giving a wider picture of society and living standards.
  - The UN happiness report found that six factors affect national well-being:
    - Real GDP per capita
    - Health
    - Life-expectancy
    - Having someone to count on
    - Perceived freedom to make life choices
    - Freedom from corruption
    - Generosity
- The UK 'Measuring National Wellbeing' report includes questions about life satisfaction, anxiety, happiness, and worthwhileness.
- The relationship between real incomes and subjective happiness:
  - The UK economy grew by 5% in GDP per capita between 2007 and 2014 but showed no change in life satisfaction.
  - Generally, higher GDP per capita correlates with higher average life satisfaction.
  - Happiness and income are positively related at low levels of income, but higher income does not lead to increased happiness once basic needs are met.

Inflation

Inflation is the sustained rise in the general price level over time, increasing the cost of living and decreasing purchasing power.
Deflation is the opposite, with the average price level falling and a negative inflation rate.
Disinflation is the falling rate of inflation, where the average price level still rises but more slowly.
Calculating the inflation rate in the UK uses the Consumer Prices Index (CPI):
- Measures household purchasing power with the Family Expenditure Survey.
- A basket of goods is created based on consumer spending patterns.
- Goods are weighted according to income spent on each item (e.g., petrol has a higher weighting than tea).
- The basket is updated annually to account for changing spending patterns.
The UK government aims for inflation to be at 2%, ±1%, to maintain price stability.
Key points when answering an exam question on CPI:
- A survey is used.
- Weighted basket of goods.
- Measures average price change of the goods.
- Updated annually.
Limitations of CPI when measuring inflation:
- The basket of goods is only representative of the average household.
- Different demographics have different spending patterns.
- CPI is slow to respond to new goods and services.
- Hard to make historical comparisons due to vastly different technology quality.
Retail Price Index (RPI):
- Alternative measure of inflation.
- Includes housing costs like mortgage interest and council tax, resulting in a higher value than CPI.
- Excludes the top 4% of earners and low income pensioners.
- RPI doesn't account for consumers switching to cheaper products when prices rise, unlike CPI.
Causes of inflation:
- Demand-pull inflation:
  - From the demand side of the economy.
  - Occurs when aggregate demand is growing unsustainably, pressuring resources.
  - Producers increase prices and earn more profits.
  - Main triggers:
    - Depreciation in the exchange rate, causing imports to become more expensive and exports cheaper, raising AD.
    - Fiscal stimulus (lower taxes or more government spending) increasing consumer spending.
    - Lower interest rates making saving less attractive and borrowing more attractive, increasing consumer spending.
    - High growth in UK export markets increasing UK exports and AD.
- Cost-push inflation:
  - From the supply side of the economy.
  - Occurs when firms face rising costs.
  - Triggers:
    - Raw materials becoming more expensive (e.g., oil prices).
    - Labor becoming more expensive (e.g., through trade unions).
    - Expectations of inflation leading to demands for higher wages.
    - Indirect taxes increasing the cost of goods (e.g., cigarettes or fuel).
    - Depreciation in the exchange rate, increasing the price of imported raw materials.
    - Monopolies exploiting consumers with high prices.
- Growth of the money supply:
  - Excessive increases in the money supply can cause hyperinflation.
  - Only inflationary if the money supply increases faster than real output.
Effects of inflation:
- Consumers:
  - Those on low and fixed incomes are hit hardest due to its regressive effect.
  - Purchasing power of money falls.
  - Borrowers benefit as the real value of debt decreases.
- Firms:
  - High inflation leads to higher interest rates, increasing the cost of investing.
  - Workers may demand higher wages, increasing production costs.
  - Firms may be less price competitive globally.
  - Unpredictable inflation reduces business confidence and investment.
- Government:
  - The government must increase the value of state pensions and welfare payments.
- Workers:
  - Real incomes fall, reducing disposable income.
  - Firms may implement redundancies to cut costs.

Employment and Unemployment

Measures of unemployment:
- Difficult to measure accurately because some employed may claim benefits, and some unemployed may not reveal this in surveys.
- The Claimant Count:
  - Counts people claiming unemployment-related benefits like Job Seeker’s Allowance (JSA).
  - Claimants must prove they are actively looking for work.
  - Evaluation:
    - Underestimates unemployment because not all unemployed are eligible or claim JSA.
- The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS):
  - Directly asks people if they meet the criteria:
    - Been out of work for 4 weeks.
    - Able and willing to start working within 2 weeks.
    - Available for 1 hour per week (includes part-time unemployment).
  - Gives a higher unemployment figure than the Claimant Count.
Distinction between unemployment and underemployment:
- Unemployed:
  - Able and willing to work but not employed.
  - Actively seeking work and looking to start within two weeks.
- Underemployed:
  - Have a job, but their labor is not used to its full productive potential.
  - Those in part-time work looking for full-time jobs.
Significance of changes in the rates of and effects of employment and unemployment:
- Consumers:
  - Unemployment reduces disposable income and living standards.
  - Psychological consequences affect mental health.
- Firms:
  - Higher unemployment increases the labor supply, causing wages to fall.
  - Consumer spending falls, reducing profits.
  - Firms may need to retrain workers.
- Workers:
  - Waste of workers’ resources and loss of skills.
  - Those in jobs may see a fall in wages.
- Government:
  - Increased spending on JSA entails an opportunity cost.
  - Reduced revenue from income tax and indirect taxes.
- Society:
  - Opportunity cost due to lost production.
  - Potential negative externalities in the form of crime and vandalism.
- Inactivity:
  - Economically inactive are not actively looking for jobs.
  - Includes carers, retirees, and discouraged workers.
  - Increases in inactivity can decrease the labor force size and the productive potential of the economy.
Causes of unemployment:
- Structural unemployment:
  - Long-term decline in demand for goods and services in an industry, causing job losses.
  - Worsened by geographical and occupational immobility of labor.
  - Globalisation and technological change contribute.
- Frictional unemployment:
  - Time between leaving a job and looking for another job.
  - Temporary and not particularly damaging.
  - Inevitable due to people moving between jobs.
- Seasonal unemployment:
  - Occurs during certain points in the year (e.g., summer and winter).
  - Tourist industry employment increases in summer.
- Demand deficiency (cyclical unemployment):
  - Lack of demand for goods and services during economic declines or recessions.
  - Firms close or make workers redundant due to falling profits.
  - Can be caused by increases in productivity where fewer workers are needed.
- Real wage inflexibility:
  - Wages above market equilibrium may cause unemployment.
  - Minimum wage can cause unemployment.
  - Classical economists argue that flexible wages would eliminate unemployment.
  - However, cutting wages during weak consumer spending could further decrease consumer spending.
Significance of migration and skills for employment and unemployment:
- Migrants increase the labor supply at all wage rates.
- Migrants bring high-quality skills, which can increase productivity and global competitiveness.
- Migrant labor affects the wages of the lowest paid in the domestic labor market.
- Higher-skilled workforce is more employable.
- Skills of the workforce need to continuously improve.
- Structural unemployment occurs if individuals don't have the right skills.

Balance of Payments

Components of the balance of payments:
- A record of all financial transactions between consumers, firms, and the government from one country with other countries.
- Records how much is spent on imports and the value of exports.
- Exports: goods and services sold to foreign countries (positive inflow of money).
- Imports: goods and services bought from foreign countries (negative outflow of money).
- Made up of:
  - The current account
  - The capital account
  - The official financing account
- The current account is the balance of trade in goods and services.
Current account deficits and surpluses:
- A current account surplus: net inflow of money into the circular flow of income.
- A current account deficit: the UK spends more on imports than it earns from exports.
Relationship between current account imbalances and other macroeconomic objectives:
- UK government’s macroeconomic objectives:
  - Full employment
  - Low, stable inflation
  - A sustainable current account on the balance of payments
  - Sustainable economic growth
- Selling more exports increases AD and improves the rate of economic growth.
- During economic declines, the current account deficit falls; during periods of economic growth, the deficit increases.
- Expensive imported raw materials can cause cost-push inflation.
Interconnectedness of economies through international trade:
- The sum of all countries’ trade balances should be zero.
- Economic downturns in the UK’s main export market will cause demand for UK goods and services to fall.
- International trade has meant countries have become interdependent.