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Economic Performance

Macroeconomics

All economies have to perform in order to survive. There are many measures of economic performance all with their advantages and disadvantages, as discussed below.

How is the rate of change of real GDP a measure of economic growth?

GDP is the total value of national output of all of the goods and services produced in an economy over a time period.

The rate of change of GDP can be used to measure the growth of the economy.

When GDP growth is positive, this signals that economic growth is taking place.

What is the distinction between real and nominal?

Real values take into account inflation, whereas nominal values don't take into account the inflation rate.

What is the distinction between total and per capita and what is GDP per capita?

Total refers to the overall sum of a variable, such as total GDP which represents the entire output of an economy. GDP per capita is the total GDP divided by the population. Per capita represents the average amount per person.

What is the distinction between value and volume?

Value measures the monetary value of goods and services produced, whereas volume measures the quantity of goods and services produced.

What is Gross National Income (GNI)?

Gross National Income (GNI) is GDP plus net income from abroad, such as net overseas interest payments and dividends.

Why are rates of growth compared between countries?

Comparing growth rates between countries can help show which countries are performing and which countries aren't performing economically.

What are Purchasing Power Parities (PPP)?

PPP measures how much of a country's currency is required in order to purchase a basket of goods and services relative to how much of another country's currency is required to purchase the same basket of goods and services.

Hence, PPP can be used to compare the cost of living between countries.

For example, if a basket of goods costs $3 in the US and £1 in the UK, the PPP exchange rate would be $3 to £1.

What are the limitations of using GDP to compare living standards between countries?

The quality of data varies greatly. Richer, developed countries are likely to spend a lot of money collecting data compared to developing countries.
Some countries have large informal markets.
National income data has to be adjusted to the population. This is why GDP per capita is typically a better measure than GDP.
GDP per capita does not take into account how incomes are distributed throughout the economy.

What is national happiness and how is it measured?

National happiness is concerned with the overall well-being of a country's population. Many countries have created national well-being programmes to measure the quality of life in a country, instead of just using GDP. The UK created the "National Well-being Programme" in 2010 in order to measure the quality of life of the population. It takes into account factors such as personal finances, health, relationships and education.

What is the relationship between real incomes and subjective happiness?

While an increase in real income is likely to bring about improvements in subjective happiness at lower income levels, at higher income levels it has been suggested that improvements in subjective happiness are likely to be smaller when real incomes rise.

What is inflation?

Inflation is defined as a sustained rise in the general price level over time, which leads to a fall in the purchasing power of money.

What is deflation and disinflation?

Deflation occurs when there is a fall in the general price level over time.

Disinflation is where the rate of inflation decreases. (e.g. from 10% to 5%.)

How is the rate of inflation in the UK calculated using the Consumer Price Index (CPI)?

The CPI measures the changes in the price of a basket of goods and services typically bought by households. Some goods and services represent a larger proportion of typical household expenditure and thus are given a greater weighting, so changes in the price of these goods and services will have a larger effect on the CPI than goods and services with a lower weighting. The CPI measures price levels using a base year which serves as a reference point with an index value of 100.

What are the limitations of the CPI as a method to measure inflation?

The CPI is only an average measure of price levels, so won't take into account the individual experiences of certain regions or demographics.
The CPI does not take into account housing costs, which are typically a large proportion of household expenditure.

What is the RPI?

The Retail Price Index (RPI) is another measure of inflation and includes additional areas of expenditure such as mortgage interest payments.

What are the causes of inflation?

Demand-pull - demand-pull inflation occurs when there is rising aggregate demand which is not met by an increase in supply.

The diagram above uses a Keynesian LRAS (Long Run Aggregate Supply curve). The Keynesian LRAS curve becomes more inelastic as the economy reaches full employment. Keynes believed in government intervention to achieve full employment in order to shift the AD curve outwards. As shown in the diagram, an outward shift in the AD curve from AD to AD1 has resulted in higher real output (increase from Y to Y1) and an increase in the price level (demand-pull inflation) from P to P1.

Demand-pull inflation can also be shown with the classical LRAS. Classical economists believe that in the long run, resources will be fully employed, meaning no matter the change in AD, output stays the same. However, if AD shifts outwards from AD to AD1, there is still a rise in the price level from P to P1 (demand-pull inflation).

Cost-push inflation - cost-push inflation occurs when the cost of production rises for producers, potentially leading to a fall in aggregate supply, leading to an increase in the price level, and thus inflation.
Monetary inflation (growth of the money supply) - if an increase in the money supply is not matched by an increase in the amount of goods and services supplied, excess demand will occur, resulting in a rise in the price level, and inflation taking place.

What are the effects of inflation on the consumer?

A fall in the real income of consumers if their income doesn’t rise in line with inflation.
A fall in the real value of savings of consumers if the interest rate on their money is lower than the rate of inflation.
During periods of high inflation, consumers may incur shoe leather costs which are the time and resources spent trying to minimise the negative effects of inflation on their money.

What are the effects of inflation on the producer?

A fall in animal spirits due to potential uncertainty which may arise when inflation is high.
During periods of high inflation, producers have to update prices, leading to increased menu costs.
Firms are likely to have more flexibility in the pricing of their goods and services when the rate of inflation is high.
The cost of raw materials is likely to rise during periods of high inflation, leading to an increase in the costs of production.

What are the effects of inflation on the government?

Government spending is likely to rise in periods of high inflation in order to protect households which are likely to be affected by the rise in the price level.
As government spending is likely to rise during periods of high inflation to protect households affected by the rising prices, this may lead to a fiscal deficit.
The real value of government debt is likely to fall during periods of high inflation.

What are the effects of inflation on workers?

Unionised workers may go on strike during periods of high inflation, in order to attempt to persuade their employer to increase wages in line with inflation.
During periods of high inflation, real wages are likely to fall if wages aren't raised in line with inflation.

What is the workforce?

The workforce is the number of individuals of working age who are willing and able to work. Individuals in the workforce can either be employed or unemployed.

How is unemployment measured?

The two main measures of unemployment are:

Consumers - consumers who become unemployed are likely to suffer from a large fall in their income. This means they can't spend as much on goods and services, potentially leading to a fall in living standards.
Firms - firms are likely to benefit from unemployment. This is because when there are large amounts of unemployment, trade unions are unlikely to have much bargaining power, resulting in less pressure on wage rates to appreciate, likely leading to low wage rates. As wage rates are a large proportion of the costs of most firms, firms may thus experience an improvement in profitability.
Workers - workers are likely to suffer from a large fall in their income if they become unemployed. Moreover, if workers are unemployed for a long time period, this may lead to deskilling, resulting in it becoming harder for workers to find future employment.
The government - during periods of high unemployment, the government is likely to spend more on unemployment-related benefits. The government is also likely to see a reduction in income tax revenue, as workers who lose their income as a result of having lost their jobs don't have to pay income tax. This may lead to a fiscal deficit for the government.
Society - rising unemployment may lead to reduced levels of social cohesion. This is because unemployment usually leads to rising inequality which can fuel social tensions.

What is the balance of payments?

The balance of payments (BOP) records all of the economic transactions that are made between one country and other nations.

What is the balance of payments made up of?

It’s made up of the current account and the capital and financial account.

What are the components of the current account?

Trade balance in goods. The trade balance in goods records the difference between the value of imported and exported goods for a specific country.
Trade balance in services. The trade balance in services records the difference between the value of imported and exported services for a specific country.
Net investment income. Net investment income records the difference between the value of payments into the country from the earnings from investments abroad and the value of payments made to foreign investors who have invested in domestic assets within the country.
Net money transfers. Net money transfers represent the difference between the value of transfers of money flowing out of a country and the value of transfers of money flowing into a country (e.g. aid and remittances).

What is a current account deficit and a current account surplus?

A current account deficit is where the value of exports plus the inflow of investment income and money transfers is less than the value of imports plus the outflow of investment income and money transfers.

A current account surplus is where the value of exports plus the inflow of investment income and money transfers is greater than the value of imports plus the outflow of investment income and money transfers.

What is the relationship between current account imbalances and other macroeconomic objectives?

A current account deficit may form as a result of firms importing large amounts of raw materials from abroad. These raw materials may be used in order to produce large quantities of output, likely resulting in large levels of economic growth.

A current account surplus is normally symbolic of large amounts of demand for a country's exports. Thus, large amounts of demand for a country's exports are likely to lead to large amounts of job opportunities in exporting industries in order to produce these exports, thus potentially reducing unemployment and increasing employment in the country.

A current account deficit is normally due to greater imports than exports. This results in a worsening of the trade balance, which is a component of aggregate demand. This is likely to lead to a fall in aggregate demand, which is likely to lead to a fall in the price level, leading to falling inflation and potentially deflation.

A current account deficit is likely to put pressure on the currency of a country to depreciate. This is because a current account deficit is normally reflective of a country importing more than it is exporting.

How have economies become more interconnected through international trade?

International trade has resulted in countries becoming more interdependent upon one another. This has led to increased interconnectedness.

The claimant count. The claimant count measures unemployment according to the number of individuals who are claiming unemployment-related benefits. The claimant count measure of unemployment is arguably limited as it is likely that not all unemployed individuals are claiming unemployment-related benefits.
The International Labour Organisation (ILO) and the UK Labour Force Survey (LFS). The UK LFS surveys individuals in the UK population about their employment status. The survey asks the individual whether they fit the ILO definition of unemployment. Unlike the claimant count, the LFS includes those not claiming unemployment-related benefits.

What is the distinction between unemployment and under-employment?

Unemployment occurs when individuals who are willing and able to work at the current wage rate are unable to find employment. Whereas, underemployment occurs where individuals would prefer to work longer hours, or the job that they are in does not fully utilise their skill set.

What is the significance of changes in the rates of employment, unemployment and inactivity?

The rate of employment is the percentage of the workforce that is employed. An increase in the rate of employment likely indicates that the economy is growing, as there is more derived demand for labour when the economy is growing.

The rate of unemployment is the percentage of the workforce that is unemployed. An increase in the rate of unemployment likely indicates that the economy is stagnating and potentially in a decline, as there is less derived demand for labour when the economy is contracting.

The rate of inactivity is the percentage of the working-age population that is neither employed nor seeking employment. Rising inactivity rates may potentially indicate a structural decline and may indicate that discouraged workers are leaving the workforce.

What are the causes of unemployment?

Structural unemployment - structural unemployment is unemployment as a result of a long-term decline in industry/industries.
Frictional unemployment - frictional unemployment is the temporary period of unemployment that occurs when individuals move between jobs.
Seasonal unemployment - seasonal unemployment is unemployment which occurs as a result of falling demand during a particular season.
Demand deficient and cyclical unemployment - this unemployment occurs as a result of economic downturns which leads to falling demand in the economy, thus leading to falling derived demand for labour and unemployment.
Real wage inflexibility and classical unemployment - this unemployment occurs as a result of a higher real wage rate being preserved above the equilibrium wage rate. This is normally a result of labour market imperfections.

What is the significance of migration and skills for employment and unemployment?

Migration can lead to improved labour market flexibility. This is because migration facilitates the movement of workers from areas where their skills may be of low demand to areas where their skills are in high demand, helping to improve employment and reduce unemployment. A workforce comprised of highly skilled workers is likely to lead to higher employment. This is because their labour productivity is likely to be high, likely leading to an increase in economic growth which creates job opportunities.

What are the impacts of unemployment on different economic agents?

Consumers - consumers who become unemployed are likely to suffer from a large fall in their income. This means they can't spend as much on goods and services, potentially leading to a fall in living standards.
Firms - firms are likely to benefit from unemployment. This is because when there are large amounts of unemployment, trade unions are unlikely to have much bargaining power, resulting in less pressure on wage rates to appreciate, likely leading to low wage rates. As wage rates are a large proportion of the costs of most firms, firms may thus experience an improvement in profitability.
Workers - workers are likely to suffer from a large fall in their income if they become unemployed. Moreover, if workers are unemployed for a long time period, this may lead to deskilling, resulting in it becoming harder for workers to find future employment.
The government - during periods of high unemployment, the government is likely to spend more on unemployment-related benefits. The government is also likely to see a reduction in income tax revenue, as workers who lose their income as a result of having lost their jobs don't have to pay income tax. This may lead to a fiscal deficit for the government.
Society - rising unemployment may lead to reduced levels of social cohesion. This is because unemployment usually leads to rising inequality which can fuel social tensions.

What is the balance of payments?

The balance of payments (BOP) records all of the economic transactions that are made between one country and other nations.

What is the balance of payments made up of?

It’s made up of the current account and the capital and financial account.

What are the components of the current account?

Trade balance in goods. The trade balance in goods records the difference between the value of imported and exported goods for a specific country.
Trade balance in services. The trade balance in services records the difference between the value of imported and exported services for a specific country.
Net investment income. Net investment income records the difference between the value of payments into the country from the earnings from investments abroad and the value of payments made to foreign investors who have invested in domestic assets within the country.
Net money transfers. Net money transfers represent the difference between the value of transfers of money flowing out of a country and the value of transfers of money flowing into a country (e.g. aid and remittances).