Theme 2: Measures of Economic Performance Summary Notes

Measures of Economic Performance: Economic Growth

• Economic growth occurs when there 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 an increase in national output.
• Benefits of economic growth include higher living standards and more employment opportunities.
• Real GDP: This is the value of $GDP$ adjusted for inflation. For example, if the economy grew by $4\%$ since last year, but inflation was $2\%$, then real economic growth was $2\%$.
• Nominal GDP: This is the value of $GDP$ without being adjusted for inflation. In the same example, nominal economic growth is $4\%$. This can be misleading, as it can make $GDP$ appear higher than it actually is.
• Total GDP: The combined monetary value of all goods and services produced within a country’s borders during a specific time period.
• GDP per Capita: Calculated as the value of total $GDP$ divided by the population of the country. "Capita" means "head," so this measures the average output per person. It is useful for comparing the relative performance of different countries.
• Volume of GDP: This refers to $GDP$ adjusted for inflation. It represents the size of the "basket of goods" and the real level of $GDP$.
• Value of GDP: This refers to the monetary value of $GDP$ at the prices of the day. It is the nominal figure and can be calculated as: $\text{Volume} \times \text{Current Price Level}$.

National Income and Comparison Theories

• National income can be measured using the following variants:     - Gross National Product (GNP): The market value of all products produced in an annum by the labour and property supplied by the citizens of one country. It includes $GDP$ plus income earned from overseas assets minus income earned by overseas residents. While $GDP$ is restricted to a country’s borders, $GNP$ includes products produced by citizens regardless of geography.     - Gross National Income (GNI): The sum of value added by all producers who reside in a nation, plus net overseas interest payments and dividends. It includes earnings from overseas and removes money sent home by foreigners residing in the country.
• Purchasing Power Parity (PPP): This theory estimates how much an exchange rate needs adjusting so that an exchange between countries is equivalent according to each currency’s purchasing power.     - PPP Example: If a car costs $£15,000$ and the exchange rate between the UK and the US is 1.5\,£ \text{ per } \, then in the US, the car should cost $\$10,000$. This ensures the car costs the same number of US dollars and pounds Sterling in real terms.     - PPP helps to minimize misleading comparisons between countries regarding wealth and costs.

Limitations of GDP for Measuring Living Standards

• Income Distribution: $GDP$ does not indicate how income is distributed. Two countries could have similar $GDP$ per capita but vastly different living standards if income inequality is high in one.
• Price Differences: $GDP$ may need recalculation in terms of purchasing power to account for international price differences, cost of living, and inflation rates.
• Hidden Economies: Large hidden economies, such as the black market, are not accounted for in $GDP$. This makes comparisons difficult and often misleading.
• Welfare and Happiness: $GDP$ provides no indication of human welfare. Other measures, like the happiness index, are used in conjunction with $GDP$ to evaluate standards of living.

National Happiness and Well-being

• UK National Well-being: The Office for National Statistics (ONS) is developing ways to measure well-being to provide a wider picture of society and standards of living. The UK "Measuring National Wellbeing" report includes queries on life satisfaction, anxiety, happiness, and worthwhileness.
• UN Happiness Report Factors: The six factors affecting national well-being are identified as:     - Real $GDP$ per capita.     - Health.     - Life expectancy.     - Having someone to count on.     - Perceived freedom to make life choices.     - Freedom from corruption and generosity.
• Income vs. Happiness: Between $2007$ and $2014$, the UK economy grew by $5\%$ in $GDP$ per capita, but there was no change in life satisfaction.     - Generally, higher $GDP$ per capita correlates with higher average life satisfaction.     - A key finding is that happiness and income are positively related at low income levels; however, once basic needs are met, higher income does not necessarily lead to increased happiness.

Inflation, Deflation, and Disinflation

• Inflation: A sustained rise in the general price level over time, resulting in an increase in the cost of living and a decrease in the purchasing power of money.
• Deflation: The opposite of inflation, where the average price level in the economy falls, resulting in a negative inflation rate.
• Disinflation: A falling rate of inflation. Prices are still rising, but at a slower pace. The purchasing power of money increases relative to previous high-inflation periods.
• Example of Price Changes:     - A $4\%$ increase in the price level between $2014$ and $2015$ is inflation.     - A change from $4\%$ to $2\%$ is disinflation (price rise slowed down).     - A change in the price level to $-3\%$ is deflation.

Calculating and Measuring Inflation in the UK

• Consumer Prices Index (CPI): The primary measure of household purchasing power. The process involves:     - Family Expenditure Survey: A survey to determine what consumers spend their income on.     - Basket of Goods: A representative group of goods is created based on the survey.     - Weighting: Goods are weighted by the proportion of income spent on them (e.g., petrol has a higher weight than tea).     - Annual Updates: The basket is updated yearly to reflect changes in spending patterns.
• Government Objective: In the UK, the macroeconomic objective is for inflation to be $2\%$, with a tolerance of $1\%$ on either side ($1\%$ to $3\%$), to maintain price stability.
• Limitations of CPI:     - It represents only the "average" household; for example, it is inaccurate for households without cars who do not spend $14\%$ of income on motoring.     - Different demographics have different spending patterns.     - Retrospective quality changes: CPI is slow to respond to new goods and struggles with historical comparisons because technology quality from $20$ years ago is vastly different from current products.
• Retail Price Index (RPI): An alternative measure that includes housing costs (mortgage interest, council tax) and tends to be higher than CPI. It excludes the top $4\%$ of earners and low-income pensioners. Unlike CPI, RPI does not account for the fact that people switch to cheaper alternatives when prices rise.

Causes and Effects of Inflation

• Demand-Pull Inflation: pressurized by the demand side when Aggregate Demand ($AD$) grows unsustainably. Triggers include:     - Depreciation of the exchange rate (exports cheaper, imports expensive).     - Fiscal stimulus (lower taxes or higher government spending).     - Lower interest rates (less saving, more borrowing/spending).     - High growth in UK export markets.
• Cost-Push Inflation: pressurized by the supply side when firms face rising costs. Triggers include:     - Expensive raw materials (e.g., oil price rises).     - Higher labour costs (e.g., via trade unions).     - Expectations of inflation (workers asking for higher wages in anticipation).     - Indirect tax increases (cigarettes, fuel).     - Monopolies exploiting market positions.
• Growth of the Money Supply: Occurs if the Bank of England prints more money. This is inflationary only if the money supply grows faster than real output. Extreme growth can cause hyperinflation.
• Economic Impacts of Inflation:     - Consumers: Low/fixed-income households are hit hardest due to the regressive effect on necessities. However, the real value of debt decreases for those with loans.     - Firms: High inflation often leads to higher interest rates, making investment more expensive and reducing business confidence. Firms may also become less globally price-competitive.     - Government: Must increase spending on state pensions and welfare to match the rising cost of living.     - Workers: Real incomes fall. Higher costs for firms may lead to redundancies.

Employment and Unemployment Measures

• Claimant Count: Measures the number of people claiming unemployment-related benefits, such as Job Seeker’s Allowance (JSA).     - Limitation: Generally underestimates unemployment because not everyone is eligible (e.g., those with high-earning partners) or chooses to claim.
• International Labour Organisation (ILO) / Labour Force Survey (LFS): A survey asking if individuals meet three criteria:     1. Been out of work for $4$ weeks.     2. Able and willing to start work within $2$ weeks.     3. Available for at least $1$ hour of work per week.     - This usually yields a higher figure than the Claimant Count because it includes part-time workers looking for more work.
• Unemployment vs. Underemployment:     - Unemployed: Able, willing, and actively seeking work.     - Underemployed: Those with a job whose labour is not used to full potential (e.g., part-time workers wanting full-time positions).

Types and Causes of Unemployment

• Structural Unemployment: Long-term decline in demand for a specific industry (e.g., coal, shipbuilding). Worsened by geographical and occupational immobility. Globalisation and technological change (machinery replacing labor) are major contributors.
• Frictional Unemployment: The temporary time spent between leaving one job and finding another (e.g., university graduates).
• Seasonal Unemployment: Occurs at specific points in the year (e.g., tourism industry peaks in summer).
• Demand Deficiency (Cyclical): Caused by a lack of demand for goods and services during a recession. Can also be caused by productivity increases where fewer workers are needed for the same output.
• Real Wage Inflexibility: Unemployment caused by wages being held above market equilibrium (e.g., due to National Minimum Wage or trade unions).     - According to classical economists, the gap between $Q_1$ and $Q_3$ on a labor supply/demand diagram represents this unemployment. They argue removing the NMW would reduce unemployment to zero, though this might further depress consumer spending.

Migration, Skills, and the Balance of Payments

• Migration: Increases the supply of labour. Migrants often bring high-quality skills that increase productivity and global competitiveness. While it can slightly depress wages for the lowest-paid, there is little evidence of this for medium and high-income households.
• Skills: A higher-skilled workforce is more employable. Structural unemployment persists if individuals do not have the right skills for a progressing economy.
• Balance of Payments (BoP): A record of all financial transactions between a country and the rest of the world.     - Current Account: Focuses on the balance of trade in goods and services.     - Exports: Inflows of money (positive).     - Imports: Outflows of money (negative).
• UK Status: The UK typically runs a current account deficit (spending more on imports than earning from exports). It has a surplus in services but a deficit in goods.
• Macroeconomic Interconnectedness:     - A deficit usually falls during a recession because consumer spending on imports drops.     - Economic growth often leads to a larger current account deficit.     - International trade creates interdependence; for example, if the EU (a major UK export market) faces a downturn, demand for UK exports falls.