Theme 2

• Purchasing Power Parity (PPP)


  Used when assessing relative living standards between countries. Real GDP needs to be converted into the same currency for comparison, but the market exchange rate does not reflect differences in the cost of living/purchasing power of income in the countries.
• Calculating PPP


  Compare the price of a basket of comparable goods and services in different countries. PPP measures the total amount of goods and services that a single unit of a country's currency can buy in another country.
• GDP


  Value of national output produced in an economy
• Gross National Product (GNP)


  GDP + net property income from abroad
• Gross National Income (GNI)


  Similar to GNP = final value of income flowing to a country's owned factors of production in a given year. GNI = Gross Domestic Product + net income from abroad of compensation of employees and property income.
• GNI could be higher than GDP if there is income from worker remittances, income from interest on bonds and savings held overseas, income from dividends on profits from overseas investment, or overseas aid transfers (inflows) for poorer countries.
• GNI can be lower than GDP if these flows are reversed.
• Economic growth


  Increase in the potential output of an economy or in the real value of goods & services produced, measured by the % change in real GDP.
• Nominal GDP


  The monetary value of all goods and services produced in the economy (GDP at current prices).
• Real GDP


  The nominal value of GDP adjusted for inflation (GDP at constant prices).
• Real GDP per capita


  National income per person often used a proxy measure for the standard of living.
• Value vs volume


  The value of goods and services shows what they are worth; the volume shows the number that are produced.
• Economists use real GDP per capita as a proxy/rough guide for the standard of living, but it has limitations.
• Limitations of using GDP to compare living standards

  • The distribution of income
  • The value of unpaid work (housework, child care, DIY, voluntary work)
  • Environmental degradation and depletion/impact on natural capital
  • Negative externalities of consumption of goods that are bad for us (eg tobacco, alcohol) and production (eg pollution, congestion)
  • Shadow market activity/unofficial work
  • Impact on standard of living of changing working hours/conditions/leisure time/quality of jobs
  • The changing quality of goods/services over time
  • Impact of technological improvements on the standard of living
• GDP data is not necessarily accurate - difficulties collecting data and making accurate calculations, GDP measures look backwards, GDP data often needs to be revised, and some countries are likely to have more accurate data than others.
• Subjective happiness


  'Self-reported' levels of happiness with one's life, usually determined using questionnaires which consider emotions, rather than asking about material well-being.
• Factors that affect happiness


  • Personality and genetics
  • Social influences (e.g. friends)
  • Income and wealth (to a smaller degree than you might expect)
  • Health
  • Leisure time
• Easterlin Paradox: life satisfaction does rise with average incomes but only up to a point beyond that the marginal gain in happiness declines.
• Human Development Index (HDI)


  An indicator of economic development and broader measure of the standard of living, looking at health, education, and living standards (GNI per capita).
• Advantages of using HDI


  • Broader measure
  • Better measure of development
  • Better measure of standard of living and wellbeing
• Aggregate demand (AD)


  Shows the relationship between the level of real planned expenditure and the general price level in an economy

  
• Disadvantages of using HDI


  • Still does not take all aspects of wellbeing into account
  • Weighting of the three categories is arbitrary
• A fall in the general price level (PL)

  Causes an extension of AD (movement along the AD curve, higher real Y)
• Other measures of living standards


  • Happy Planet Index
  • Social Progress Index
  • ONS Well-being dashboard
  • OECD Better Life Index
• A rise in the PL

  Causes a contraction of AD (movement along AD curve, lower real Y)
• Real GDP per capita often 'tracks' these broader measures of living standards with varying degrees of accuracy.
• Relationship between AD and PL


  • Inverse because:
  • Real income effect: As the price level falls, the real value of income rises, consumers can buy more; higher consumption C (the real money balance effect)
  • Balance of trade effect: A fall in the relative price level of a country could make foreign-produced goods more expensive, causing a rise in exports, X and a fall in imports, M
  • Interest rate effect: If price inflation is low this might lead to a reduction in interest rates and so there is less incentive to save and consumption C rises; the exchange rate could also depreciate and improve net exports (X-M)
• Consumer Price Index (CPI)


  The 'headline' rate of inflation is the annual % change in the CPI. The CPI tracks changes in the prices of a basket of goods and services purchased by an average household.
• AD slopes downwards to the right
• Calculating CPI inflation


  CPI Inflation Rate = [(Current CPI - Previous CPI) / Previous CPI] × 100
• Any change that causes AD to increase other than a change in the PL

  Shifts AD to the right from AD1 to AD3
• Basket of goods and services


  Things a typical household buys; updated each year to keep it relevant. Price survey – prices of the goods and services in the basket are monitored each month. The price of each representative good/service in the basket is weighted according to the proportion of income a typical household spends on it.
• Any change that causes AD to decrease other than a change in the PL


  Shifts AD to the left from AD1 to AD2
• Factors that shift the AD curve

  Changes in real income and employment

  Changes in consumer & business confidence (Keynes' 'animal spirits')

  Changes in household wealth – the 'wealth effect'

  Changes in monetary policy

  Changes in fiscal policy

  Changes in the exchange rate and in the global economy
• CPIH


  Similar to CPI but also monitors owner occupier housing costs (OOH), in its basket.
• Short run aggregate supply (SRAS)


  Total planned output when the general price level can change but the prices and productivity of factor inputs are held constant

  
• RPI


  Retail Price Index - the basket of goods/services includes some items not in the CPI, such as council tax & mortgage interest payments; it is often used to calculate increases in welfare benefits, pensions, index-linked bonds and wage negotiations; in a period of rising interest rates it typically gives a higher rate of inflation than the CPI.
• In the short run, the SRAS curve is assumed to be upward sloping
• A change in the price level brought about by a shift in AD


  Results in a movement along the short run AS curve
• Core inflation


  Sustained increase in prices of goods in the basket, excluding goods such as energy, food, alcohol and tobacco which can have volatile prices.