PAPER 2 - MACRO REVISION NOTES
4.2.1.1 The objectives of government economic policy
The government has four main macroeconomic objectives. These aim to provide macro stability.
1. Stable economic growth: In the UK, the long run trend of economic growth is about 2.5%.
Governments aim to have sustainable economic growth for the long run. In emerging
markets and developing economies, governments might aim to increase economic
development before economic growth, which will improve living standards, increase life
expectancy, and improve literacy rates.
2. Low unemployment: Governments aim to have as near to full employment as possible. They
account for frictional unemployment by aiming for an unemployment rate of around 3%.
The labour force should also be employed in productive work.
3. Price stability: In the UK, the government inflation target is 2%, measured with CPI. This
aims to provide price stability for firms and consumers and will help them make decisions for
the long run. If the inflation rate falls 1% outside this target, the Governor of the Bank of
England has to write a letter to the Chancellor of the Exchequer to explain why this
happened and what the Bank intends to do about it.
4. Sustainable balance of payments on current account: Governments aim for the current
account to be satisfactory, so there is not a large deficit. This is usually near to equilibrium. A
balance of payments equilibrium on the current account means the country can sustainably
finance the current account, which is important for long term growth.
Additionally, the government might have the following macroeconomic objectives:
Balanced government budget: This ensures the government keeps control of state
borrowing, so the national debt does not escalate. This allows governments to borrow
cheaply in the future should they need to and makes repayment easier.
Greater income equality: Income and wealth should be distributed equitably, so the gap
between the rich and poor is not extreme. It is generally associated with a fairer society. The
importance of each objective changes over time.
Environmental protection: This ensures environmental sustainability and the reservation of
scarce non-renewable resources. Coal, oil, and gas are all examples of fossil fuels. They are
non-renewable - once we run out of them, they are gone forever. The government is trying
to reduce the use of non-renewable fossil fuels. Instead, they are trying to increase the use
of renewable energy sources such as wind, tidal and solar energy.
Potential conflicts and trade-offs between the macroeconomic objectives (generally in the short
run):
• Economic growth vs inflation: A growing economy is likely to experience inflationary
pressures on the average price level. This is especially true when there is a positive output
gap and AD increases faster than AS.
• Economic growth vs the current account: During periods of economic growth, consumers
have high levels of spending. In the UK, consumers have a high marginal propensity to
import, so there is likely to be more spending on imports. This leads to a worsening of the
current account deficit. However, export-led growth, such as that of China and Germany,
means a country can run a current account surplus and have high levels of economic growth.
,PAPER 2 - MACRO REVISION NOTES
• Economic growth vs the government budget deficit: Reducing a budget deficit requires less
expenditure and more tax revenue. This would lead to a fall in AD, however, and as a result
there will be less economic growth.
• Economic growth vs the environment: High rates of economic growth are likely to result in
high levels of negative externalities, such as pollution and the usage of non-renewable
resources. This is because of more manufacturing, which is associated with higher levels of
carbon dioxide emissions.
• Unemployment vs inflation: In the short run, there is a trade-off between the level of
unemployment and the inflation rate. This is illustrated with a Phillips curve. As economic
growth increases, unemployment falls due to more jobs being created. However, this causes
wages to increase, which can lead to more consumer spending and an increase in the
average price level. The extent of this trade off can be limited if supply side policies are used
to reduce structural unemployment, which will not increase average wages.
4.2.1.2 Macroeconomic indicators
There are four main macroeconomic indicators. Governments use these indicators to monitor how
the economy is doing. These four main macroeconomic indicators can be used to measure a
country’s economic performance:
1) The rate of economic growth - GDP
2) The rate of inflation – CPI/ RPI
3) The level of unemployment - Claimant Count/ ILO LFS
4) The state of the balance of payments -
GDP
GDP measures the quantity of goods and services produced in an economy (national output). In
other words, a rise in economic growth means there has been an increase in national output. Real
GDP is the value of GDP adjusted for inflation may also be used to take inflation into account.
Real GDP per capita is the value of real GDP divided by the population of the country. Capita is
another word for ‘head’, so it essentially measures the average output per person in an economy.
This is useful for comparing the relative performance of countries.
,PAPER 2 - MACRO REVISION NOTES
CPI /RPI
CPI and RPI are the measures of inflation in the UK.
The Consumer Prices Index (CPI) measures household purchasing power with the Family Expenditure
Survey. The survey finds out what consumers spend their income on. From this, a basket of goods is
created. The goods are weighted according to how much income is spent on each item. Petrol has a
higher weighting than tea, for example. Each year, the basket is updated to account for changes in
spending patterns.
RPI is an alternative measure of inflation. Unlike CPI, RPI includes housing costs, such as payments
on mortgage interest and council tax. This is why RPI tends to have a higher value than CPI.
Claimant Count/ ILO LFS
The Claimant Count counts the number of people claiming unemployment related benefits, such as
Job Seeker’s Allowance (JSA). They have to prove they are actively looking for work.
The LFS is taken on by the ILO. It directly asks people if they meet the following criteria:
o Been out of work for 4 weeks
o Able and willing to start working within 2 weeks
o Workers should be available for 1 hour per week.
Part time unemployment is included. Since the part-time unemployed are less likely to claim
unemployment benefit, this method gives a higher unemployment figure than the Claimant Count.
Productivity
Productivity is defined as output per worker per period of time. It measures how efficient production
is. Productivity increases if more output can be produced with fewer units of input. For example,
labour productivity is measured in the UK by output per hour. In the first quarter of 2015, it grew by
0.3%
Balance of payments on current account
The balance of payments is a record of all financial transactions made between consumers, firms,
and the government from one country with other countries. It states how much is spent on imports,
and what the value of exports is.
Exports are goods and services sold to foreign countries and are positive in the balance of payments.
This is because they are an inflow of money. Imports are goods and services bought from foreign
countries, and they are negative on the balance of payments. They are an outflow of money.
The balance of payments is made up of: - The current account - The capital account - The official
financing account. The current account on the balance of payments is the balance of trade in goods
and services.
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4.2.1.3 Use of index numbers
An index number is a figure reflecting price or quantity (usually of different years) compared with a
base value (base year). The base value always has an index number of 100. The index number is then
expressed as 100 times the ratio to the base value.
Note that index numbers have no units e.g. £, Euros or $
For example, if the year 2015 is the base year, the value given to it is 100. If inflation has risen by 5%
between 2015 and 2018, the index number for 2018 will be 105.
Index numbers are a useful way of expressing economic data time series and comparing /
contrasting information, measuring the magnitude of change over time.
How are index numbers used in the calculation of CPI?
In the calculation of CPI, different items in the basket of goods have difference weights. Food will
have a much larger weighting than clothing, since consumers spend more of their income on food.
The index number measures the change in price over time.
The calculation used is: (Pn/P0) x 100
• Where P0 is the price level in the base year
• and Pn is the price in the year being compared.
Weights are assigned using the following method:
• Where Q0 is the quantity of the unit being compared
• and P0 is the original price of the unit.
• The total amount spent in the base year is P0 x Q0.
The amount spent on each unit in a later year is:
4.2.1.4 The uses of national income data
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. In other words, a rise in
economic growth means there has been an increase in national output. Economic growth leads to
higher living standards and more employment opportunities.
