Measuring Economic Performance

Before we can fix an economy we have to measure it. This sub-theme covers the four headline indicators — growth, inflation, unemployment and the balance of payments — that governments watch and that every macro essay refers back to.

Learning objectives — by the end of 2.1 you can…

- explain GDP, GNI and the real/nominal, total/per-capita and value/volume distinctions; - use PPP to compare living standards and explain the limitations of GDP; - define inflation, deflation and disinflation, and explain how the CPI is built; - explain the causes and effects of inflation and deflation; - explain how unemployment is measured, its causes and effects; - describe the current account of the balance of payments.

Economic growth & national income

Spec: 2.1.1

Economic growth is the rate of change of real Gross Domestic Product (GDP) — the total value of goods and services produced in an economy over a period (usually a year). Growth is the main measure of rising living standards.

Key Terms — getting the measure right

Real vs nominal: Real GDP is adjusted for inflation; nominal is at current prices. Always use real to judge genuine growth.

Total vs per capita: Per capita = GDP ÷ population. Better for living standards, because it accounts for population size.

Value vs volume: Value is measured in money; volume is the physical quantity of output.

GNI: Gross National Income = GDP + net income earned from abroad — an alternative national-income measure.

To compare countries fairly we use Purchasing Power Parity (PPP), which adjusts for differences in the cost of living — £1 buys far more in India than in Switzerland. A recession is defined as two consecutive quarters of negative economic growth.

Evaluation — why GDP is a flawed measure of living standards

- Inequality: an average hides how income is distributed — GDP per capita can rise while most people gain nothing. - The hidden economy: informal, black-market and unpaid (e.g. household) work is excluded. - Quality of life: GDP ignores pollution, working hours, leisure and health. - Wellbeing: the Easterlin paradox suggests that beyond a certain income, extra GDP adds little to national happiness — hence interest in wellbeing indices.

Inflation, deflation & disinflation

Spec: 2.1.2

Key Terms

Inflation: A sustained rise in the general price level — the purchasing power of money falls.

Deflation: A sustained fall in the general price level.

Disinflation: A fall in the rate of inflation — prices are still rising, just more slowly.

Inflation is measured by the Consumer Price Index (CPI). A representative "basket" of goods and services is tracked, with each item weighted by how much of household spending it makes up, so a rise in the price of essentials matters more than a rise in something rarely bought. The Producer Price Index (PPI) tracks factory-gate prices and acts as an early warning of future consumer inflation.

Deflation can come from falling AD (damaging — linked to recession), rising AS (benign), or a falling money supply. Its danger is the deflationary spiral: people delay purchases expecting lower prices, so demand falls further.

Effects of inflation — who wins and loses

- Consumers & savers: falling real incomes; savings lose value. - Borrowers: can gain — the real value of debt falls. - Firms & investment: uncertainty deters investment; "menu" and "shoe-leather" costs. - Competitiveness & the current account: if inflation is higher than rivals', exports become dearer and the current account worsens.

Exam tip

"Low and stable" inflation (most central banks target around 2%) is healthy — it greases the wheels of the economy. Don't write that "all inflation is bad." The problems come from inflation that is high, volatile or unexpected.

Employment & unemployment

Spec: 2.1.3

Unemployment counts those who are willing and able to work and actively seeking a job, but without one. The main measure is the ILO (Labour Force Survey) measure, based on a survey of the population.

Effects & related ideas

- Effects: lost output (the economy sits inside its PPF), lower incomes and deskilling for workers, lower tax revenue and higher benefit spending for the government, and social costs. - Underemployment: people working fewer hours than they want, or in jobs below their skill level — not captured by unemployment figures. - Net migration adds to the labour supply; its effect on unemployment depends on whether the economy can create enough jobs.

Balance of payments

Spec: 2.1.4

The balance of payments records all transactions between a country and the rest of the world. The part you need here is the current account, made up of trade in goods, trade in services, and income flows.

Key Terms

Current account deficit: The value of money leaving (imports + outflows) exceeds the value entering (exports + inflows).

Current account surplus: Money entering exceeds money leaving.

Trade balance: The value of exports minus imports of goods and services.

A persistent deficit can signal weak competitiveness. The full detail of the balance of payments, exchange rates and how to correct imbalances is covered in Unit 4.

2.1 Recap — nail these

Economic growth = rate of change of real GDP; use per capita & PPP to compare living standards; recession = 2 quarters of negative growth.
GDP has real limitations as a welfare measure (inequality, hidden economy, quality of life).
Inflation (CPI, weighted basket); causes = demand-pull, cost-push, excess money supply; "low & stable" is the goal.
Unemployment: frictional, seasonal, structural, demand-deficient, real-wage — know the causes and effects.
The current account records trade and income flows; deficits vs surpluses.