Lecture notes
notes Unit 2 - The UK economy - performance and policies
- Institution
- PEARSON (PEARSON)
detailed notes for unit 2 alevel economics A
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Macroeconomics2.1 measures of economic performance
Economic growth:
- “An increase in the long-term productive potential of the country; an increase in the amount of goods and services
produced.”
- Increase in real GDP
- Shift of PPF
- Short run – “the actual annual percentage change in GDP.”
- Long run – “An increase in the potential productive capacity of the economy.”
GDP: Gross domestic product:
- “The value of goods and services produced in a country over a given period of time.”
- Allows us to compare countries:
- Indicator of standard of living in a country
- GDP per capita grows if national output increases faster than population.
- Increases – means country is experiencing increasing incomes, output + spending.
- People can have more goods and services implying they have a higher standard of living.
GDP per capita: total GDP/population:
- Grows if national output grows faster than population, so more goods per person.
Nominal GDP:
- doesn’t take inflation into account, GDP at current prices.
Real GDP:
- values that have been adjusted to remove the effects of inflation.
Volume:
- real values of GDP, quantity of goods and services produced in a country.
Value:
- nominal values, monetary worth of goods and services produced in a country.
% Change for inflation = final-initial/initial x 100 or new/initial x 100
Total national income:
- “Value of all goods and services produced in a country.”
Per capital income:
- Total income divided by population.
GNI: gross national income:
- “The value of goods and services produced by a country over a period of time plus net overseas interest payments and
dividends.”
- Affected by profits from businesses owned overseas and remittances sent home by migrant workers.
- Includes what a country earns from overseas and removes any money that is sent back home by foreigners in that
country.
- Used over GDP as the growing size of remittances and aid.
- Profits and incomes earned overseas from locally owned firms - profits and income that goes abroad from foreign
owned companies
GNP: gross national product:
- “The value of goods and services produced by citizens of a country, whether they live in the country or not.”
- “The value of goods and services produced by domestic businesses both at home and abroad.”
- Value of goods and services produced by citizens of a country, while GDP is the value produced inside the country.
Comparisons about growth:
- Over time: changing national income levels will shows whether the country has grown or shrunk over a period of time:
- Data’s compared to similar countries to put figures into context, growth figures over a set period -> compared
against similar countries -> see if the country’s done well or not.
- Figures also make judgements about economic welfare -> growth in national income means a rise in living
standards as economy’s producing more goods and services so people have access to more things.
- Important to use real per capita figures -> if a county’s population grows, this may case a rise in GDP without a
rise in living standards so provides inaccurate comparison, real to strip out effect of inflation as prices rise so
may give impression of growing GDP without any more goods and services being produced.
- Between countries:
- countries have different populations so different total GDP doesn’t necessarily mean difference in living
standards.
- Use GDP per capita.
- Real figures as inflation’s different in every country.
PPP: Purchasing power parities:
- “An exchange rate of one currency to another which compares the cost of living in different countries through
comparing a typical basket of goods in one country to another.”
- Alternative to using exchange rates for comparisons of GDP.
- Takes into account costs of living so will help better compare living standards between countries.
, - Big mac index.
- Allows to see how much an individual from each country can purchase given the average amount of income they have.
- Real GDP / population when converted to $ allow comparison between all countries around the world.
Problems using GDP to compare standard f living:
- Inaccuracy of data:
- Some countries inefficient at collecting/calculating data so comparisons become less effective.
- Hidden/black market – people work without declaring their income to avoid tax or continue claiming benefits.
So GDP underestimated.
- GDP doesn’t consider home-produced services; in poorer countries many people work sass subsistence
farmers – grow and produce crops without trading so GDP underestimated.
- Errors in calculating inflation rates means real GDP slightly inaccurate.
- Methods used to calculate GDP will change over time and different countries use different methods to
calculate GDP so can be difficult to compare.
- Important to take away transfer payments otherwise money’s paid to a person without any corresponding
increase in output in the economy.
- Inequalities:
- Increase in GDP may be due to an increase in income of just one group of people so growth in national income
may not increase standards of living everywhere.
- Income distribution changes overtime and varies between countries so makes comparisons difficult.
- Quality of goods and services:
- Quality much higher now than 50 years ago but not necessarily shown in real price of goods and services so
living standards may have increased more than GDP suggests as quality improved greatly.
- Improved technology may allow prices to fall, suggesting a fall in living standards but this is not the case.
- Comparing currencies:
- Issues over which unit should be used to compare figures.
- Spending:
- Dome types of expenditure such as defence doesn’t increase living standards but increases GDP.
- Makes comparisons difficult as spending varies overtime and between countries.
- Consumer + capital spending:
- Spending on investment goods may mean standard of living increases in future but at the expense of living
standards today.
- Quality life issues:
- Rising real incomes may be associated with factors which may reduce living standards such as different levels
of air and noise pollution or different levels of stress or number of hours worked.
National happiness: other factors then GDP affect welfare:
- Real GDP per capita
- Health
- Life expectancy
- Having someone to count on
- Perceived freedom to make life choices
- Freedom from corruption
- Generosity
Real incomes and subjective happiness:
- Happiness and income positively related at low incomes but higher levels of income aren’t associated with increases in
happiness.
- Easterlin paradox – an increase in consumption of material goods will increase happiness if basic needs aren’t met but
once these are met, an increase in consumption won’t increase long-term happiness.
Conclusion for GDP as. Measure of standard of living:
- Accuracy of stats.
- Shadow economy not included.
- Transactions without monetary value.
- Negative externalities.
- Economic growth can cause inequalities in income and wealth.
Problems of comparison between developed and developing countries:
- Accuracy of stats can vary dramatically.
- Developing often consume what they produce and don’t sell. So no monetary value.
- Developed increase incomes at expense of quality of life.
- Developed may wish to achieve growth at expense of health and safety.
- Alternative methods of measuring quality of life available.
Inflation:
- “a sustained increase in the general price level for goods and services.”
- CPI – consumer price index
, - UK gov want it to be 2%.
Deflation:
- “a persistent fall in the general price level of goods and services.”
- Problem for people with debts as the real payments will become larger.
- Stops any firm wanting to invest in a country from abroad as value of outputs likely to fall relative to initial costs, and
deflation likely to cause AD to fall.
Disinflation:
- “a fall in the rate of inflation.”
- Sign inflation if coming under control but investment and confidence are low in the economy.
CPI:
- Measures household purchasing power with the family expenditure survey – finds out what consumers spend their
income on, from this a basket of goods is created, goods weighted according to how much income is spent on each
item.
- Survey used.
- Weighted basket of goods.
- Measures average price change of the goods.
- Updated annually.
- Takes into account when prices rise people will switch to a different product, RPI doesn’t.
Limitations of CPI:
- Basket of goods is only representative of the average household so not accurate for households who have mortgage
interest repayments or rent or households who don’t own cars.
- Different households have different spending patterns.
- Measure for an average household – top and bottom 4% and pensioners not included.
- Sampling problems – not everyone responds to the survey or may not give accurate information about spending.
- List of the 650 items changes one each year but tastes and fashion change more regularly.
- People with atypical spending patterns – vegetarians and non-drivers – unrepresentative.
- Slow to respond to new goods and services.
RPI: retail price index:
- Alternative measure of inflation.
- Includes housing costs, unlike CPI, such as payments on mortgage interest and council tax so has a higher value than
CPI.
- Excludes top and bottom 4% earners and low-income pensioners.
- Not reliable for international comparisons.
Cause of inflation:
- Demand pull: an increase in the general level of prices caused by increase consumption, investment, government
spending or net exports.
- AD growing unsustainably so pressure on resources, so producers increase prices and earn more profits.
- Usually occurs when resources are fully employed.
- Too much money for too few goods and services, excessive demand.
- Causes:
§ Reduced taxation – fiscal stimulus – consumers have more disposable income.
§ Lower interest rates.
§ A general rise in consumer spending.
§ Improved availability of credit.
§ A weak exchange rate – imports become more expensive while exports become cheaper, so AD rises.
§ Fast growth in other countries – UK exports increase so AD increases.
§ General rise in confidence/expectations of future growth.
§ Certainty.
- Cost push: an increase in the general level of prices raised by increased production costs, such as rise in wages or fall in
exchange rate – imports more expensive.
- Occurs when firms face rising costs:
§ Raw materials become more expensive – oil.
§ Labour becomes more expensive.
§ Expectations of inflation – consumers may ask for higher wages if they expect prices to rise, causing
more inflation.
§ Indirect taxes could increase cost of goods if producers choose to pass costs onto consumers.
§ Depreciation in exchange rate – imports become more expensive so price of raw materials more.
§ Monopolies – use dominant market position to exploit consumers with high prices.
§ Wage increase.
§ Natural disasters.
- Growth of money supply: increased money supply – may cause hyperinflation – rate of inflation very high and
uncontrollable.
- Only a problem when money supply increases faster rate than real output.
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