Economics | Measures of economic performance

Welcome to Measures of Economic Performance!

Hi future economists! This chapter is essential because it teaches you how to read the vital signs of an economy. Think of the economy like a patient in a hospital: we need specific, reliable measurements—like heart rate, temperature, and blood pressure—to know if they are healthy, improving, or getting sick.
In this module, we will explore the four main economic indicators that policymakers (like the government and central bank) use to assess the health of the macroeconomic environment.

Why are these measures important?

• They allow governments to set appropriate goals (macroeconomic objectives).
• They help businesses make investment decisions.
• They provide a basis for international comparison.

Section 1: Measuring National Output (GDP, GNP, GNI)

The most common way to measure the size and overall performance of an economy is through its National Income or Output.

Key Measure 1: Gross Domestic Product (GDP)

Gross Domestic Product (GDP) is the total value of all final goods and services produced within a country's geographical borders over a period of time, usually one year.
Domestic means "inside the house" (the country). It doesn't matter who owns the factory, as long as the production happens physically within the country's borders.

The Three Ways to Calculate GDP

Don't worry, you don't usually have to calculate this yourself, but you must know the three methods used, as they should, theoretically, yield the same result (because every bit of production generates income and expenditure):

1. The Output Method: Summing the value added by all firms in the economy.
2. The Income Method: Summing all incomes earned (wages, rent, interest, profit).
3. The Expenditure Method: Summing all spending on final goods and services (this is often the most useful for analysis).

The Expenditure Approach (A useful way to remember the components)

We often use the components of aggregate demand to represent GDP:
$$ \text{GDP} = C + I + G + (X - M) $$
Where:

• C = Consumption (Spending by households)
• I = Investment (Spending by firms on capital goods)
• G = Government Spending (Spending by the state on public services)
• (X - M) = Net Exports (Exports minus Imports)

Understanding Nominal vs. Real GDP

When GDP rises, how do we know if the country is genuinely producing more stuff, or if prices have just gone up? We need to separate the effect of price changes from the effect of volume changes.

1. Nominal GDP (Money GDP):
This uses current prices (the prices actually paid today). If prices rise, Nominal GDP rises, even if the quantity produced hasn't changed. (It's misleading!)

2. Real GDP:
This uses prices from a fixed base year (e.g., 2015 prices). This allows economists to see if the actual volume of goods and services produced has increased. This is the figure used to measure economic growth.

Analogy: Imagine you sell 10 ice creams for \$1 each (GDP=\$10). Next year, you still sell 10 ice creams, but now they cost \$2 each (GDP=\$20). Your Nominal GDP doubled, but your Real GDP stayed the same (10 ice creams).

From GDP to GNI (Gross National Income)

While GDP measures what is produced inside the country, Gross National Income (GNI) measures the income owned by the country's residents (citizens and companies owned by citizens), regardless of where the production took place.

The Key Difference: Net Property Income from Abroad (NPIA)

GNI is calculated by taking GDP and adjusting for NPIA:

$$ \text{GNI} = \text{GDP} + \text{Net Property Income from Abroad (NPIA)} $$

• NPIA Explained: This is the difference between income flowing *into* the country (from assets owned abroad, like profits from a British factory in India) and income flowing *out* of the country (like profits sent back to the USA from an American factory operating in the UK).
• If a country has many companies operating successfully overseas, its GNI will be higher than its GDP.

GDP vs. GNI per Capita

To understand the average living standards of people within a country, we use GDP per capita or GNI per capita.

$$ \text{GDP per capita} = \frac{\text{Total GDP}}{\text{Population}} $$

Why is 'per capita' important? A country like China might have a much higher total GDP than Switzerland, but Switzerland's GDP per capita (income per person) is much higher, suggesting that the average Swiss resident enjoys a higher standard of living.

Section 2: Measuring Price Stability (Inflation)

Price stability (keeping inflation low and steady) is one of the primary macroeconomic objectives.

Key Measure 2: Inflation

Inflation is defined as the sustained increase in the general level of prices in an economy over a period of time, leading to a fall in the purchasing power of money.

Common Mistake to Avoid: A price rise in one item is NOT inflation. Inflation is when prices are rising *across the entire economy*.

How Inflation is Measured: The Consumer Price Index (CPI)

The standard measure used by the UK government and most major economies is the Consumer Price Index (CPI).

1. The "Basket of Goods": Economists select a representative sample (a "basket") of thousands of goods and services commonly bought by households (e.g., bread, petrol, cinema tickets, rental payments).
2. Weighting: Each item in the basket is given a weight based on how much the average family spends on it. (E.g., housing costs have a far bigger weight than stamps).
3. Price Collection: Prices for all these items are tracked monthly.
4. Calculation: The weighted average price change is calculated. The inflation rate is the percentage increase in the CPI compared to the same month the previous year.

Did you know?

The "basket of goods" is updated annually to reflect changing consumer habits. For example, in recent years, items like "smart watches" or "meat-free sausages" might be added, while items like "CDs" might be removed.

The Alternative UK Measure: RPI

In the UK, you might also hear about the Retail Price Index (RPI). RPI is similar to CPI but includes housing costs (like mortgage interest payments and council tax) that CPI excludes. While CPI is the official target measure for the Bank of England, RPI is often used for calculating things like rail fare increases or student loan interest.

Section 3: Measuring the Labour Market (Unemployment)

A high level of employment is another key macroeconomic goal. Unemployment represents wasted potential resources (labour) and causes social and personal hardship.

Key Measure 3: Unemployment Rate

The Unemployment Rate is the percentage of the labour force who are currently without a job, but are willing, able, and actively seeking work.

The Two Main Ways to Measure Unemployment

Different countries and policymakers use different methods, which can make international comparisons tricky.

1. The ILO/Labour Force Survey (LFS) Method

• This is the international standard set by the International Labour Organisation (ILO).
• It involves surveying a large sample of households and asking them about their employment status and job-seeking activity.
• Advantage: It is internationally comparable and generally considered the most accurate measure of actual joblessness, regardless of whether someone is claiming benefits.
• Definition: Unemployed people are those who have been actively seeking work in the last four weeks and are available to start work in the next two weeks.

2. The Claimant Count Method

• This measures the number of people claiming unemployment-related benefits from the government (e.g., Jobseeker’s Allowance in the UK).
• Advantage: It is quick, easy, and cheap to calculate, as the data is collected administratively by the benefits system.
• Disadvantage: It excludes many unemployed people who are not eligible for or choose not to claim benefits (e.g., certain students, or those whose partner earns too much). It often understates the true level of unemployment.

Types of Unemployment (Causes)

Understanding the type of unemployment helps the government decide which policy to use (e.g., training or cutting interest rates).

1. Frictional Unemployment: Short-term unemployment that occurs when people are moving between jobs (e.g., a graduate looking for their first role, or someone who just quit to find a better fit).
2. Structural Unemployment: Long-term unemployment caused by a mismatch between the skills workers possess and the skills employers demand (often due to technological change or industrial restructuring, like factory closures).
3. Cyclical (Demand-Deficient) Unemployment: Caused by a lack of aggregate demand (AD) in the economy, typically during a recession. Firms lay off workers because sales are falling. (This is the main concern during a downturn.)

Section 4: Measuring International Trade (Balance of Payments)

A country’s relationship with the rest of the world is tracked using the Balance of Payments.

Key Measure 4: The Balance of Payments (BoP)

The Balance of Payments (BoP) is a record of all financial transactions made between a country and the rest of the world over a set period (usually a year).

Principle: The BoP always balances overall (like double-entry bookkeeping). However, we are primarily interested in one component for performance measurement: the Current Account.

Focus: The Current Account

The Current Account records the flow of money arising from trade (goods and services) and income transfers. It shows whether a country is earning enough from abroad to pay for all its imports.

The Four Components of the Current Account:

1. Trade in Goods (Visible Trade): Exports minus Imports of physical products (e.g., cars, oil, clothing).
2. Trade in Services (Invisible Trade): Exports minus Imports of services (e.g., tourism, banking, insurance, education).
3. Primary Income (Investment Income): Net flows of profit, interest, and dividends resulting from investments made abroad (this is the same NPIA we used to calculate GNI).
4. Secondary Income (Current Transfers): Net payments of money not related to trade or investments, such as foreign aid, military contributions, and remittances (money sent home by migrant workers).

Current Account Balance: Deficit vs. Surplus

• Current Account Surplus: Occurs when the value of exports of goods, services, and net income flowing in is greater than the value of imports and net income flowing out. (A positive balance).
• Current Account Deficit: Occurs when the value of imports and net income flowing out is greater than the value of exports and net income flowing in. (A negative balance). Persistent deficits can be a sign of long-term economic structural problems.

Summary and Final Tips

Congratulations! You now understand the four main barometers of macroeconomic performance:

1. Growth: Measured by Real GDP.
2. Prices: Measured by the CPI (Inflation Rate).
3. Employment: Measured by the Unemployment Rate (ILO method preferred).
4. External Trade: Measured by the Current Account Balance.

These measures often conflict! For instance, trying to reduce unemployment by boosting AD (Aggregate Demand) often causes a rise in inflation. Understanding this trade-off is key to the rest of your macroeconomics course!