1. Economic growth Economic growth measures how much the value of output produced in an economy (known as national income) has grown over a period of
... [Show More] time, usually over one year. It is calculated as the percentage change in national income over a period of time. 2. Price stability This is concerned with how fast the average level of prices of a range of goods and services rises over a period of one year. 3. Balance of pay- ments 4. Balancing the budget 5. Achieving an eq- uitable distribu- tion of income The balance of payments measures the difference be- tween the value of goods and services sold abroad and the value of goods and services bought from abroad. The government would like the value of government ex- penditure and the value of taxation to be the same as each other so that the government's budget is balanced. Incomes are not shared out equally across households in the economy. Achieving an equitable distribution of income means the government would like to ensure that the gap between the richest and poorest does not become excessively wide. 6. Policy conflict A policy conflict that has occurred frequently concerns the conflict between minimising unemployment and achieving price stability. Success in reducing the level of unemployment has often come at the expense of prices rising at a faster rate, and vice versa. The conflicts that exist are often said to exist only in the short term. It is suggested that in the long term, it is possible to achieve all the objectives at the same time, with no policy conflict. Some would argue that there is no conflict even in the short term. This is open to debate. 7. The following are generally seen as the main priorities among the government's economic objectives: Importance of economic objec- tives 8. Real gross do- mestic product (GDP) • economic growth • price stability • minimising unemployment Governments do not view all their economic objectives as equally important. They have priorities for their objectives and these priorities change as circumstances change. For example, after winning the 2015 general election, George Osborne, the Chancellor of the Exchequer at that time, decided to make eliminating the budget deficit less of a priority than it had been in the previous parliament. Gross domestic product (GDP) is a measure of the nation- al income of an economy. It is based on the value of all incomes earned in an economy over a period of time (data are produced every quarter, though the yearly figure is the one that attracts most attention). 9. Real GDP Real GDP measures the value of GDP after removing the effect of price changes from its value. This ensures that an increase in GDP from one year to the next represents increased output of goods and services rather than just increases in prices. 10. Real GDP per capita 11. Consumer price index (CPI) and retail price index (RPI) Real GDP is often used to make comparisons between countries in terms of the standard of living enjoyed by the population. To make comparisons more meaningful, average income per person is often used. This is known as real GDP per capita and it is calculated as follows: One government objective is to achieve price stability. This is where the average level of prices is reasonably stable. An increase in the price level over time is referred to as inflation. High and unstable inflation is something governments wish to avoid. As a result the government has a target rate 12. Measures of un- employment of inflation that it wishes to achieve of 2%. This means that the government wishes to see the average level of prices rising by no more than 2% annually (actually the target allows a margin of error of 1%, which means inflation can still be on target as long as it is no lower than 1% and no higher than 3%). In the UK, two main measures of the price level are used to record the rate of inflation: • consumer price index (CPI) • retail price index (RPI) Both measures include the prices of goods and services typically bought by households in the UK. Although the CPI measure is the 'official' measure used to calculate inflation, the RPI is still used by the government. For example, the prices of tickets set by rail companies are regulated by the government and can rise no faster than the inflation rate based on the RPI. It is the job of the Bank of England (the UK's central bank) to achieve this inflation target. There are plenty of people who are not working in the economy (children, the elderly, those raising families), but people only count as part of the unemployment statistics if they are part of the labour force (i.e. those in work or actively seeking work). In the UK there are two main measures of unemployment: • The claimant count — includes the number of people re- ceiving welfare benefits for being unemployed. The usual benefit received by those unemployed is jobseeker's allowance (JSA). • The Labour Force Survey (LFS) — based on a monthly sample of people, it records those who report they are looking work but cannot find it, regardless of whether they receive benefits or not. This information is used to produce an estimate of the national unemployment level. In the UK, the LFS measure is normally higher than the claimant count measure as it includes all those receiving benefits as well as those who do not qualify for (or do not wish to claim) benefits. Although the level of unemployment (expressed as a num- ber) is published, it is the rate of unemployment which will often be seen as more significant. The unemployment rate is calculated as: 13. Productivity Productivity measures how much output is being pro- duced by each unit of labour (such as per worker, or per hour worked). Labour productivity measures the output of workers, whereas capital productivity looks at the efficien- cy of machinery and equipment. Economic growth in the long run mainly comes from im- provements in productivity (i.e. getting more output from existing resources). Improvements in productivity will come from making work- ers more efficient (either faster or better) in producing output and also improving the efficiency of the economy's capital equipment (machines etc.) 14. Current account on the balance of payments 15. Uses of index numbers The balance of payments is divided into three sections: the current account, the capital account and the financial account. However, at AS level we are concerned only with the current account. The main section of the current account relates to foreign trade, i.e.: • exports of goods and services (produced in the UK but sold to foreigners) • imports of goods and services (produced overseas but purchased by the UK) The difference between these two values (exports minus imports) is referred to as the balance of trade. Index numbers are frequently used to illustrate economic variables when data are presented. Index numbers are useful when making comparisons over periods of time. They are particularly useful when it is the size of changes in variables that need 16. Consumer price index (CPI) to be highlighted (rather than the actual values of the variables themselves). Index numbers will start off with a value of 100 and this value is known as the base year value. The change in the index number will show how far the variable has moved away from its starting value. For example, an index number of 120 would indicate that the variable's value had increased by 20% since the base year starting value. Presenting these index numbers as a line graph increases the ease with which the changes in values can be understood and inter- preted. Controlling inflation is a major macroeconomic objective. In the UK, the inflation rate is measured through the an- nual percentage change in the CPI — an index number measuring the average level of prices for the UK. The CPI is calculated by combining price data for the UK as a whole for a variety of different products bought by an imaginary 'typical' family. This means the CPI is meant to represent the spending patterns of a typical, average UK household. The range of goods and services included in the calcula- tion is often referred to as a basket of goods and services. This inflation 'basket' includes over 700 items and the prices of these are checked in thousands of shops across the UK each month. The basket of goods and services is updated annually as new products emerge and old ones decline in popularity. For example, in 2015, E-cigarettes were added to this inflation 'basket' whereas frozen pizza was removed (we still like eating pizza, but largely prefer chilled ones!). The CPI is a weighted price index. 'Weights' are attached to items in the CPI according to their relative importance to an average family in their spending patterns. For example, a doubling of the price of light bulbs 17. Issues with the CPI 18. Distribution of in- come 19. Composition of GDP 20. Shadow econo- my will have less impact on the CPI number than a doubling of the price of cars, or holidays, or restaurant meals because light bulbs are a less significant item in our average spending plans. As it is based on an 'imaginary' typical family, the CPI never really reflects anyone's exact spending patterns — how representative it is depends on how close an individual's spending patterns are to those on which the CPI is based. The inflation 'basket' has to include many goods and ser- vices that not everyone buys: for example, most people don't smoke but cigarettes are still included within the basket to account for those who do. Regular updates to the basket mean we are not always comparing like with like (i.e. the 2016 basket will differ from the 2015 basket), though the updated items are small in number. How income is shared out will matter. A country with high income inequality, i.e. a greater gap between the incomes of the rich and the poor, will have more people with in- comes significantly below the average GDP per capita compared with a country with a more equal distribution of income. This means greater income inequality makes GDP per capita less reliable in measuring the country's living standards. How national income is generated matters. In some coun- tries, military expenditure is a very important contributor to GDP. It will create some jobs and will contribute to GDP, but military expenditure does not add much to the general living standards of the population, which could have been improved if the money had been spent on, say, health or education. The shadow economy refers to income generated from unrecorded transactions (also known as the black or un- derground economy). These may include: 21. Non-marketed output 22. Negative exter- nalities 23. Non-financial factors • income from transactions that are legal but unrecorded (often to avoid tax charges), or • transactions which are both illegal and unrecorded (trade in drugs being an obvious example) Unrecorded transactions add to the living standards of the population but do not show in the official GDP data. This means that official GDP generally understates living standards. Estimates suggest that the UK's shadow economy is worth around 10% of actual GDP. Plenty of goods and services add to people's wellbeing and their standard of living but do not show up in official GDP data. Services such as DIY and childcare can be obtained as paid-for services but are often conducted by families for free as normal parts of household life. These will add to the family's welfare with- out ever showing up in the official data. Additions to GDP often generate negative externalities which reduce the standard of living of those who suffer the externalities generated. Pollution and traffic congestion usually arise out of increased activity but reduce people's quality of life. Therefore increases in GDP often exaggerate the improvements to people's standard of living by ignoring the negative aspects of these increases. The standard of living may be derived primarily from in- come, but there are plenty of other factors which add to people's general quality of life. These include: • the quality of health provision (and whether or not it is made available freely for the population) • education provision (how many years' schooling does the average person typically receive? Is the quality of the provision of a high standard?) • individual freedoms (of speech, of travel and so on) 24. Purchasing pow- er parity (PPP) • the amount of leisure time enjoyed on average (are there paid-for holidays? Limits on working hours?) Making comparisons of living standards between coun- tries means we need to convert GDP into a common exchange rate. If exchange rates are volatile then it becomes harder to make meaningful comparisons between countries once converted into the same currency. A currency may remain 'over-valued' or 'under-valued' for a long period of time, which may give us misleading infor- mation once converted into a common currency. The purchasing power parity exchange rate is a way of avoiding the problem of using inappropriate ex- change rates. The PPP exchange rate is the rate where goods and services in different countries would appear as the same price once converted into common currencies. For example, a basket of goods and services priced at £1,000 in the UK but priced at $1,500 in the USA gives us a PPP exchange rate of £1 = $1.50 ($1,500/£1,000) — where the price of the basket of goods is the same in each country once converted into a com- mon currency. 25. National income We know that national income refers to the income of an economy (a country) earned by all workers and business- es over a period of time. Income is a flow variable that is measured over time. A stock variable, such as household wealth, is measured at a point in time. National income can be calculated in three ways: 1 expenditure method 2 income method 3 output method 26. National income - Expenditure method This involves adding up all the spending over a period of time: • Consumption (C) • Investment (I) 27. National income - Income method 28. National income - Output method 29. Real national income versus nominal national income 30. GDP and real na- tional income • Government expenditure (G) (not including welfare ben- efits paid out) • Net exports (X M) This involves adding up all incomes earned over a period of time: • wages and salaries earned by those in work • rent earned by those who allow their land and property to be used by others • interest earned by those who invest capital in financial assets • profits earned by companies trading goods and services This involves totalling the value of all output produced in the economy for a period of time for each sector of the economy. Steps need to be taken to avoid double counting: for example, the output of the steel indus- try may be used in the production of cars and this should appear only once. For the non-traded sectors, such as state education and the NHS, a value of their output is based on the cost of their provision, i.e. how much the government spends on these sectors over a period of time. Real national income measures national income after re- moving the effect of price changes from its value. This means that any increase in real income refers to increases in output (or income) and does not merely represent higher prices charged for the same amount of production. National income that is unadjusted for changes in prices is known as nominal national income or money national income. Real national income is one of the most used macroeco- nomic variables. It is often referred to as gross domestic product (GDP). Technically, real national income and real GDP are not the same variable, as some UK national income comes from incomes earned outside the UK but still belonging to UK 31. Uses of real na- tional income citizens. Gross national income (real GNI) includes incomes from overseas assets. However, the difference between GDP and GNI is small and these terms are often used interchangeably. Real national income provides useful information: • It is a measure of how successful the economy is — countries are often ranked in importance by the size of their national incomes. • It shows how well off the population is — through mea- suring national income per person. • It allows a government to estimate how much can be collected in taxation (most taxes are placed on incomes and expenditure — both measures of national income). [Show Less]