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Measuring Economic Growth

Measuring Economic Growth

  • Economic growth is usually measured by the annual percentage change in real GDP
  • Due to the circular flow of income, real GDP can be calculated by either totalling output, income, or expenditure.
    • Economic growth can therefore be measured by changes in any one of these
  • However, each method of measuring real GDP/growth can have problems
    • For output, it is important not to count the output of raw materials (e.g. flour), and then count them again in a finished product (e.g. bread)
    • For income, only money earned via the market (i.e. in return for goods and services) should be included, and not things like pension funds or JSA
    • With expenditure, imports cannot be counted (as they are made by producers from other countries), and so only exports must be.

Production and Productivity

  • Production is what is produced (output), so when real GDP rises it means output has too
  • Labour productivity is output per worker hour
  • Productivity can be an indicator of a country’s economic performance
    • If productivity rises by more than wages, then labour costs will fall, and a country can become more price competitive
  • Production can increase and productivity can fall simultaneously
    • So this can indicate while an economy’s doing well, its ability to maintain this growth in the long run could be in doubt.

Difficulties in Interpreting Changes in Real GDP (Why GDP Isn’t a Reliable Figure For Determining Living Standards)

  • There isn’t a definite link between real GDP and improved living standards
    • For example, although real GDP can be increasing for a country, the population can also be increasing at a greater rate
    • Economist often measure GDP per capita to counter this
  • Another problem with GDP depicting an accurate representation of an economy is the existence of informal economies
    • These are economic activities that are not recorded or registered with the authorities, in order to avoid paying tax or complying with regulations, or because the activity is illegal
    • The existence of the informal economy means that
      • Inflation would be overstated
      • Employment and output would be understated.
      • Tax revenue would be lower
      • Productivity would be lower – firms in the informal economy would want to stay small, and hence wouldn’t have the capital to invest in productivity-boosting measures such as machinery and economies of scale
    • The composition of GDP will also impact the extent to which changes in GDP impact on peoples’ lives.
      • If output increases, but this output consists of capital goods, people won’t feel instantly better off – although they’ll be better off in the long run
      • Also, if output rises because of ‘regrettables’ – things like spending more money on the police force to combat crime – people may feel worse off.
    • GDP figures do not include externalities, so pollution may rise, but GDP wouldn’t fall.
    • An Increase in GDP could also mean people were just working longer hours, or working in poorer conditions.
      • GDP doesn’t include negative externalities either, so people can experience worse living conditions but have a higher GDP
    • People may not feel richer in a growing economy for two reasons
      • People get quickly used to an increase in living standards, e.g. 20 years ago a computer was a luxury, now it’s seen as a necessity.
      • People value their worth relative to others, so would prefer £50k a year when everyone else is getting £40k rather than £100k when everyone else is earning £150k
    • The rich are generally happier than the poor, but rich countries do not seem to get happier as they get richer.

Measuring Unemployment

  • The unemployment rate is the percentage of the labour force who are out of work
    • (The unemployed x 100%)/labour force
  • The government’s preferred method of measuring unemployment is the Labour Force Survey
    • This just utilises a survey of the labour force to gather this information
  • There is also the claimant count, which is basically just how many people are receiving unemployment-related benefits.

Difficulties of Measuring Unemployment

  • The LFS measure is seen to capture more people who are unemployed
    • This is because some people are seeking work, but are not eligible to claim benefits
  • LFS is also quite expensive to undertake, and it can also result in sampling errors
  • The claimant count is cheap to carry out, and also quick
  • However, the claimant count will also factor in benefit frauds
  • The claimant count also isn’t able to allow international comparisons, as the categories of people allowed to claim unemployment benefits varies over countries.

Measuring Inflation

  • The main measure of inflation is the consumer price index (CPI)
    • This is a measure of changes in the price of a representative basket of consumer goods and services
    • A price is calculated for the base year, and then the price of a current year’s basket of goods can be compared to that to work out inflation

The CPI and Other Measures of Inflation

  • There is also the retail price index (RPI)
    • This is a measure of inflation that is used for adjusting pensions and other benefits to take account of changes in inflation and is frequently used in wage negotiations
  • Both the RPI and CPI are measures of the average change from month to month in the prices of consumer goods and services
    • However, the CPI excludes things like housing costs, mortgage interest payments, council tax, etc.
    • CPI does include things like uni accommodation fees and stockbrokers’ charges, which are not included in the RPI.
  • RPIX is RPI minus mortgage interest payments
    • It is important to do this, as when the BoE raises the rate of interest to reduce inflation, according to the RPI, inflation will actually increase
  • Inflation can also be measured by constructing a core prices index, which excludes energy and food prices
    • This is because the price of both of these can be subject to seasonal changes or one-off shocks.

Difficulties of Measuring Inflation

  • Both the RPI and CPI measure the price of one good changing over time to gauge inflation

However, consumer goods often improve in quality, and so these figures may not be totally accurate of the change in the price level.