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Macroeconomics Notes
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A short (ish) document covering in detail the contents relating to macroeconomic topics. Excellent guide when revising just before exams.
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1. Measures of economic performanceMEASURING GROWTH
Economic growth measures a change in real gross domestic product (GDP). Real/’constant
prices' means inflation has been taken into account, as opposed to nominal/‘current’.
Economic growth is not just GDP, it is the change.
GDP is the total amount of goods and services produced within a country’s borders in one
year.
Potential economic growth is a measure of the increase in capacity in an economy, shown
by an outward PPF shift. It measures how efficiently the economy utilises its resources.
If an economy experiences two consecutive quarters of negative economic growth, this is a
recession. This means there has been less spending, income and output in the economy. The
consequences are firms closing, increased unemployment and a fall in living standards.
‘Falling growth levels’ could mean growth is still positive, just at a lower rate than before.
Rising incomes don't always make living standards rise, since it depends how it’s distributed,
how high inflation is, how much is being spent on long-term socially-beneficial projects, and
population change.
When the size of population changes, GDP per capita is more useful. GDP per capita is total
GDP divided by the population.
Quality of life is a measure of living standards that takes into account more than just
income/GDP.
An increase in GDP causes an increase in the standards of living. This is a measure of the
quality of life, which includes physical assets and consumption, but also: happiness; stress
levels; work day length; pollution levels; and house capacity. It means people can afford
more goods and services, or feel their lives are better since they needn’t work as hard to
achieve their aims.
GROWTH IN DIFFERENT COUNTRIES
An increase in GDP of one country by 10% doesn’t mean the country is doing better than
one with an increase of 5%. It depends on: how much of the output is self-consumed
(therefore not appearing on GDP); methods of calculation and reliability of data; relative
exchange rates (do they show the purchasing power of just the local currency); type of
government spending (if money is spent on warfare, quality of life issues such as health are
being sidelined).
An increase in the volume of output doesn’t indicate an increase in the value of output.
Volume is just the number of goods produced, but if they’re falling in price (maybe because
many countries produce it), then value might fall alongside volume rising.
Exchange rates are the prices of one currency in terms of another.
Purchasing power parities are used to compare GDP between countries, by taking into
account the cost of a ‘basket of goods’ that can be bought in each country being compared.
The PPP exchange rate is the rate where the basket of goods costs the same in each
country, as opposed to normal exchange rates.
,An album costs $10 in USA but €10 in France, and exchange rates are $1=€1.50, while PPP
rate is $1=€1, it implies the pound is overvalued on the currency markets.
Gross National Income measures income received by a country both domestically (GDP) and
net incomes from overseas. So GNP<GDP if much income flows to foreign people/firms.
Gross National Product measures GDP plus the value of output from sales abroad that
residents have received, minus the value of output claimed by non-residents.
The difference between GNI and GNP is the perspective of income rather than output.
NATIONAL HAPPINESS
An alternate measure of living standards is ‘national happiness’: a measure of national
wellbeing. Surveys attempt to measure subjective happiness, which takes into account how
people feel about themselves. This includes friendship, social interactions, alongside
traditional measures such as incomes. This is an unreliable indicator since subjective
happiness depends on thousands of variables and changes many times within one day.
Therefore, asking this survey every day for years could improve its accuracy.
INFLATION
Inflation is the sustained rise in the general price level.
Deflation is the sustained fall in the general price level.
Disinflation is a fall in the rate of inflation, so prices are rising more slowly.
The Consumer Price Index measures inflation changes and is used for inflation targeting in
the UK. It doesn’t include housing costs such as mortgage interest repayments or rent. It is a
weighted average of things on which people spend their money, given as an index number.
An index number is a number shown relative to another number in percentage terms, so the
actual figures are removed and just the relative difference is shown.
A base year is used for comparison between price levels in different time periods. It is given
the number 100.
E.g, inflation if CPI changes from 125-130: 5/125 x 100%.
The Retail Price Index (also called the headline rate) measures inflation changes just as CPI,
but includes housing costs, so can also be used for comparison with the CPI. It can be used
to set the state pension and for price capping (i.e capping rail fares if rising too fast). When
housing costs>costs of all other goods in the economy, RPI>CPI.
CPI/RPI isn’t inflation. It is changes in these levels which indicate inflation.
Weights show the proportion of income spent on items, so are used to ensure that the %
change in price reflects the impact on the average family’s spending.
Calculating inflation => Weights are assigned to each item bought by the average household.
The Living Costs and Food Survey collects info from a sample of nearly 7000 households in
the UK using self-reported diaries for purchases. A price survey is conducted by civil servants
that collect data every month about changes in price of the 650 most commonly used goods
and services in a variety of retail outlets.
The price changes are multiplied by the weights to give a price index; inflation is measured
from this by calculating the % change in this index over years.
, CAUSES OF INFLATION
1: Demand-pull inflation: When a variable of aggregate demand (i.e lower interest rates,
higher govt spending) means a multiplier effect which causes an upward pressure on prices.
2: Cost-push inflation: When aggregate supply decreases (i.e total costs of production go up
due to oil prices rising or minimum wages rising), which makes firms push prices up.
3: Growth in the money supply: Monetarists argue inflation is caused by an increased
money supply.
Monetarism is the economic school of thought, on the idea that inflation is due to too much
money supply.
EFFECTS OF INFLATION
The UK inflation target, set by the Bank of England’s Monetary Policy Committee, is a rise of
2% in CPI with a tolerance of + or - 1%. So a rise in the average level of prices at 2% is ideal.
It implies that the costs of living will rise by 2%, but since CPI doesn’t include housing costs,
and since only some people in the survey don’t show the wider picture of spending patterns,
the CPI’s accuracy is questionable; though it is more or less correct.
Inflation is damaging because:
1. It damages international competitiveness - Exports become expensive in foreign
markets and so the balance of payments worsens.
2. It damages those on fixed incomes, since it won’t rise with inflation, despite earning
the same wage in nominal terms.
3. It damages those on any wages if inflation exceeds their nominal wage rises, because
real income will be falling. If wages rise faster than inflation though, real incomes
rise.
4. High inflation can make the MPC decide on tight monetary fiscal policy, which is
damaging because firms invest less and households have more debt payments.
5. It makes the government look unstable, but if national debt is high then inflation is
actually good. This is because debt doesn’t change in nominal value when there’s
inflation, so in real terms it’s cheaper to finance and to pay back.
EMPLOYMENT
Employment can be measured as a level (num of people in work) or as a percentage (num of
people in work divided by the total num of people that are economically active, x100%). The
same calculation is for unemployment, except of those people looking for work but can’t
find it.
Economically active people are those who are at work or are willing to work. Also called the
workforce, and includes unemployed people.
Economically inactive people, such as students or people caring for others without pay, or
those who aren’t of working age.
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