Unit 2 - The UK economy - performance and policies
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measures of economic performance
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Unit 2 - The UK economy - performance and policies
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Macroeconomics- Measures of economic
performance (2.1)
Economic Growth 2.1.1
Economic Growth: measures the rate of change in a country’s output. An expansion in the productive potential capacity
of an economy. Increase in Real GDP
Short run economic growth: the actual annual percentage change in real national output (real GDP)
Long run economic growth: An expansion in the potential productive capacity of the economy
Gross Domestic Product: the value of the quantity of goods and services produced in the economy over a period of time
Real GDP: the value of the quantity of goods and services produced in the economy over a period of time, adjusted for
inflation (constant prices)
Nominal GDP: the value of the quantity of goods and services produced in the economy over a period of time, NOT
adjusted for inflation (current price)
GDP per capita: the value of total GDP divided by the population of the country
Total GDP: the combined monetary value of all goods and services produced within a country’s borders during a specific
time period
Total national income: the value of all goods and services produced in an economy
Per capita income: the total income divided by the population
GDP: Volume- considers the quantity of goods produced within an economy, GDP adjusted for inflation
GDP: Value-considers the monetary worth of the goods and services produced within an economy, nominal figure.
Gross National Product (GNP): the value of all goods and services produced by domestic businesses both at home and
abroad- includes overseas assets
Gross National Income: GDP plus income paid into the country by other countries for such things as interests and
dividends
Purchasing power parities (PPP): A methods that allows us to look at the relative value of different currencies. It takes
Real GDP and divides it by the number of people within the country. It then converts the income into dollars to allow a
comparison between all countries around the world.
Happiness Economics: looks at how content individuals are with their life from a theoretical and scientific viewpoint
,Macro economics is concerned with issues, objectives and policies that affect the whole economy
rather than individual markets (micro economics) it considers aggregates (totals) of economic
variable.
Possible macroeconomic objectives:
§ Economic growth
§ Reducing inequality greater income quality
§ Low unemployment, it'll never be at 0 due to frictional unemployment
§ Low and stable inflation rate 2%
§ Balanced government budget - ( fiscal policy) use of taxation and government spending to
influence the economy
§ Protection of the environment investment in the green
§ Balance of payments equilibrium on current account- talking about imports and exports.
The UK runs a persistent current account deficit
Macroeconomic Objectives:
T rade- balanced trade between imports and exports
I nflation- low and stable, 2% UK target
G rowth- strong sustained and sustainable economic growth
E mployment- low unemployment/ full employment
R edistribution of income- fair within society
Stability- stable growth
Sectors of the economy:
§ Primary- extraction of raw materials from the Earth e.g. agriculture, fishing, mining, forestry
§ Secondary- transforming or refining the raw materials e.g. manufacturing
§ Tertiary- service industry e.g. retail, entertainment, finance
,Economic Growth:
Measures the ‘rate of change’ in a country’s output. An expansion of the productive potential of an economy, increase in
Real GDP.
§ This is typically measured by the percentage change in real GDP per annum. It can also be shown through the shift
of PPF.
Real GDP – the value of the quantity of goods and services produced in the economy over a period of time adjusted for
inflation, constant prices
Nominal GDP- the value of the quantity of goods and services produced in an economy over a period of time, not adjusted
for inflation, current prices
GDP- the value of quantity of goods and services produced in an economy over a period of time
What can lead to an increase in the productive potential of an economy?
§ Any changes in the quantity or quality of the factors of production (resources) in an economy
Inputs- factors of production
§ Capital- goods that are made in order to produce other goals and services
§ Enterprise- the act of bringing the other factors of production together to create goods and services
§ Land- natural resources that can be used for production
§ Labour- workers
Two types of economic growth:
Short run economic growth
§ The actual annual percentage change in real national output
Long run economic growth
§ An increase in the potential productive capacity of the economy
Economic growth can be measured in a number of ways by looking at a range of economic variables. It is defined as an
increase in Real GDP
§ If real GDP is growing, this means the value of goods and services being produced are rising. So it should mean,
ceteris paribus (everything else equal, that income and standards of living are rising
§ Economic growth leads to higher living standards and more employment opportunities
National income can also be measured by:
§ Gross National Product (GNP) is 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. GDP is within a country’s borders, whilst GNP includes products produced by citizens
of a country, whether inside the border or not.
§ Gross National Income (GNI) is the sum of value added by all producers who reside in a nation, plus net overseas
interest payments and dividends. It includes what a country earns from overseas and removes any money that is
sent back home by foreigners in that country.
Measuring the level and rate of growth of national income (Y) is important for keeping track of:
§ The rate of economic growth
§ Changes to living standards
§ Changes to the distribution of income between groups within the population
, Making comparisons about growth:
Over time: Changing national income levels will show us whether the country has grown or shrunk over a period of time.
§ The data is compared to other countries to put figures in a context. Growth figures over a set period of time can be
compared against similar countries to see whether the country has done well or not.
§ The figures can also make judgements about economic welfare as growth in national income means a rise in living
standards as the economy is producing more goods and services so people have access to more things.
§ It is important to use real, per capita figures.
§ If a country’s population grows over time, then this may cause a rise in GDP without a rise in living standards and so
provide inaccurate comparisons.
§ We use real GDP in order to strip out the effect of inflation. Inflation is rising prices and therefore can give the
impression of GDP growing without any more services and goods being produced.
Benefits of using GDP to measure living standards:
Between countries:
§ Allows countries to see aggregate output of production
When countries
§§ Compare againsthave a difference
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§ It is possible for GDP to increase simply because of an increase in prices in the country and inflation is different in every
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enables GDP figuresofneed
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SOL - simple and out
easyGDP per capita
to use. Therefore it allows for some
comparison on SOL as countries can compare their data and see how and where they differ. Additionally, it allows for a
comparison over time which can be extremely useful when comparing living standards between the UK and developing
countries
§ In the UK the informal economy only accounts to 7% of GDP so it allows for a good comparison to an extent in
comparison to developing countries. Furthermore, GDP is a widely recognised measure here and internationally, it is
simple and easy to use and understand hence giving some comparison between the UK and developing countries.
Consequently, this means that countries can compare output values, growth or decline of their economy.
§ For a country that is mainly based around tangible goods, GDP is a good measure as it’s quite simple and effective to
use. Rising income levels and an increase in GDP indicates an increase in material well-being and living standards.
Therefore, this shows an increase in living standards making a good comparison between the UK and developing
countries through GDP measurable.
Limitations of using GDP as a measure of economic growth
1. A large amount of data needs to be collected- comes from varied sources. – inaccuracies to exist in the data
leading to final figures not being perfect- GDP figures often revised
2. Informal economy- country’s official GDP figures are lower than should be. Can lead to u/e figures being
overstated and tax revenue collection being lower- potentially impacting gov spending
3. Problem of double counting- using output method to calculate Real GDP = prone to error.
,Limitations of Using GDP to measure living standards:
National income statistics can be used to compare between countries and overtime to give some indication of the relative
living standards: the quality of life enjoyed by people in a country. However, there can be problems with this.
1. Real GDP- single measure of living standards- measures changes in income. Big flaw. Composite indicators- more
appropriate measure HDI
2. GDP only account for the quantity of output produced provides no information regarding the quality. – Production
can lead to severe negative production externalities air pollution, resource degradation. These externalities drastically
reduce living standards
3. Fails to recognise debt and nature of economic growth, there could be unsustainable growth
§ Firms live beyond their means
§ E.g. USA housing market 2000-2007 created an asset bubble
4. Fails to recognise the shadow economy. There is a ‘ hidden’ or ‘black’ market in which people work without declaring
their income to avoid tax or to continue claiming benefits, and so GDP is underestimated because these incomes
aren’t taken into account. This varies hugely between countries and may change overtime.
5. GDP can lead to inaccurate data when collected as it includes foreign assets- makes no allowance for depreciation of
capital
§ Shadow economy at 7% GDP
§ Sub Saharan 60% GDP under estimates real GDP
6. GDP is an average in absolute terms however fails to recognise regional imbalances, regional inequality. Increases
in Real GDP may only benefit one group elite. Growth may only be in one sector. Corrupt gov may prevent effective
redistribution of income from higher levels of GDP, increases in tax rev promoting income inequality. Poor see no
improvements – relative and absolute poverty may remain or increase
7. Comparing different currencies: There are issues over which unit should be used to compare figures: they are usually
converted into US dollars because of the size of the American economy. Some people argue that Purchasing Power
Parity should be used to take into account the impact of differences in the cost of living in different countries.
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8. Spending: Some types of expenditure, such as defence, does not increase standard of living but will increase GDP. For
example, the GDP of the UK was higher during the Second World War than in the 1930s because a lot of money was
spent on defence which increased GDP but it is difficult to argue that standard of living was higher in the Second
World War. This therefore makes comparisons difficult as spending varies overtime and between countries
9. Fails to recognise growth in the digital economy
§ MIT estimate USA misses 0.7% GDP through not including the digital economy
§ Service utility isn’t accounted for in GDP – David Piling growth illusion
§ David Piling- now we’ve moved from analogue to digital it’s not that useful
10. Real GDP doesn’t take account of remittance incomes. Remittance does boost living standards – no account for it in
GDP calculations. Given the globalised nature of the world economy, remittances- significant finance for developing
countries.
11. Real GDP can misguide an increase in living standards by including profit made by MNC’s. MNC profit is repatriated
back to the home country. MNC’S – may impose poor working condition. MNC – increase Real GDP- not noticeable
impact of SOL
12. Fails to recognise life expectancy and health. Leisure time sacrificed is not accounted for. Voluntary work isn’t
included (informal sector)
§ 1% of GDP is involuntary work
13. Depletion of natural resources- Sustainability of growth
14. GDP is quite simple and effective with tangible goods .g manufacturing.
§ With intangible gods GDP isn’t effective. Service gains through productivity aren’t accounted for.
§ GDP doesn’t encapsulate the social output
,Purchasing Power Parities: is a method that allows us to look at the relative value of different currencies. It takes Real GDP
and divides it by the number of people within the country. It then coverts the income into dollars to allow a comparison
between all countries around the world
§ It is a theory which suggests that exchange rates are in equilibrium when they have the same purchasing power in
different countries.
§ The difference between the highest and lowest GDPs will be smaller when PPP is used as poorer countries have a much
lower cost of living than richer ones. For example, in Kenya £2 a day in their own currency is enough to survive on,
whilst it isn’t in the UK. One example of this is the Big Mac Index, comparing the cost of the Big Mac throughout the
world.
§ The PPP exchange rate remains fairly constant year round, so it can be easily compared
§ Exchange rates will often get closer to the PPP as time passes
§ Knowing the PPP will allow you track and predict exchange rate relationships
§ PPP can help you examine the relative living conditions of different countries
Arbitrage
§ If at a certain exchange rate, it is cheaper to buy goods in one country than another, businesses will buy goods in
the cheaper country and sell in the other for a profit
§ This is arbitrage. It forces price and exchange rates to align over time. E.g. increased demand in the cheaper
country might lead the price there to eventually increase, closing the ‘gap’
The Big Mac index:
§ The Big Mac Index is a bit like PPP. It compares how much a Big Mac would cost in different countries.
§ According to the Big Mac index, the British Pound was 23% undervalued vs the US Dollar in July 2018. A Big Mac
costs £3.19 in the UK and $5.51 in the US. The implied exchange rate is 0.58, but the actual exchange rate is 0.75
Subjective Wellbeing and the Easterlin Paradox:
National happiness (statistics from the ONS):
UK national well-being The Office for National Statistics is trying to develop more ways of measuring national well-being. It
should give a wider picture of society and the standard of living within the UK.
The UN happiness report found that the six factors which affect national wellbeing are:
§ real GDP per capita,
§ health, life-expectancy
§ having someone to count on
§ perceived freedom to make life choices,
§ freedom from corruption and generosity
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.
However, generally, the higher the GDP per capita, the higher the average life satisfaction score. One finding is that
happiness and income tend to be positively related at low levels of income but, once basic needs are met, higher income
does not lead to increased happiness.
, Measuring economic wellbeing
Wellbeing indicators include the following:
§ Real disposable income per head
§ Average ratings of life satisfaction and happiness
§ Feeling that things done in life are worthwhile
§ Feelings of anxiety
§ Unemployment rate and job expectations
§ Household debt to income ratio
§ Income inequality (Gini coefficient)
What is subjective happiness?
§ Refers to self – reported levels of happiness with one’s life, usually determined using questionnaires
§ Measuring subjective happiness usually involves considering emotions
§ Factors that affect your happiness: personality, genetics, social influences, income and wealth, leisure
What is the Easterlin Paradox?
§ The Easterlin Paradox concerns whether we are happier and more contented as our real living standards improve.
§ Within a society, richer people tend to be happier than poor people.
§ Richard Easterlin argued that life satisfaction does rise with average incomes but only up to a point. Beyond that
the marginal gain in happiness declines
§ One of his conclusions was that someone’s relative income can weigh heavily on people’s minds. Several papers
(including Wolfers, 2008) have contested the findings of the Easterlin Paradox
The Easterlin Paradox is a contested idea. In the long term, there is no trend between happiness and increase in Real GDP
doesn’t exist.
GDP:
§ Smooth transition away from GDP, intangible goods and service= analogue to digital economy
§ A broader and inclusive measure (benefits are widely spread)
§ Look at distribution rather than wealth
The measure needs to be globally accepted and simple taking into consideration 4 variables to replace GDP; Income,
education, health, sustainability
The Human Development Index (HDI) is a measure of economic development and economic welfare. The Human
Development Index examines three important criteria of economic development (life expectancy, education and income
levels) and uses this to create an overall score between 0 and 1.
The HDI combines:
1. Life Expectancy Index. Average life expectancy compared to a global expected life expectancy.
2. Education Index
§ mean years of schooling
§ expected years of schooling
3. Income Index (GNI at PPP)
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