CH31 Economic growth

Question 1

what is the most commonly used measure of national income?

Answer 1

it is Gross Domestic Product GDP

Question 2

what is one of the most important economic statistics and what does it measure?

Answer 2

one of the most important economic statistics is national income, which measures the size of an economy

Question 3

is calculating national income difficult?

Answer 3

yes, calculating national income is difficult and no measure of national income exactly captures the size of an economy and how it is changing

Question 4

what is the accounting standard used in the UK today based on?

Answer 4

it is based on European System of Accounts 2010, which in turn is based on the United Nations’ System of National Accounts 2008

Question 5

what is GDP?

Answer 5

it is the total market value of all goods and services produced over a period of time.
-GDP is measured at market prices, which means it is a measure of national income that includes the value of indirect taxes (taxes on expenditure) like VAT.

Question 6

are indirect taxes (like VAT) part of the output of the economy? and what affect does this have on the actual value of national income?

Answer 6

no.
-so this measure (using GDP) inflates the actual value of national income.

Question 7

what are the other 3 measures of national income?

Answer 7

-Gross value added (GVA) at basic prices: this is GDP minus indirect taxes plus subsidies on good. Indirect taxes minus subsidies is called the basic price adjustment.
-Gross national product (GNP) and gross national income (GNI) at market prices: these are very similar measures of the domestic output of the country (as measured by GDP) plus earnings from overseas. More precisely, gross national income (GNI) is the value of the goods and services produced by a country over a period of time (GDP) plus net overseas interest payments and dividends (factor incomes). Gross national product (GNP) is the market value of goods and services produced over a period of time through the labour or property supplied by the citizens of a country, both domestically (GDP) and overseas.
-Net national income at market prices: each year, the existing capital stock or physical wealth of the country depreciates in value because of use. This is like depreciation on a car as it gets older. If individuals run down their savings to finance spending, their actual income must be their spending minus how much they have used from their savings. Similarly with a country, its true value of income is gross (i.e. before depreciation has been taken into account) national income minus depreciation. This is net national income

Question 8

what is GNI?

Answer 8

gross national income: it is the value of goods and services produced by a country over a period of time (GDP) plus net overseas interest payments and dividends (factor incomes)

Question 9

what is GNP?

Answer 9

gross national product: it is the market value of the goods and services produced over a period of time through the labour or property supplied by the citizens of a country, both domestically (GDP) and overseas.

Question 10

why is GDP at market prices the main headline figure for national income?

Answer 10

because the data to calculate it is most quickly available.

Question 11

when comparing over time and between countries, movements in GDP at market prices are broadly similar to what?

Answer 11

are broadly similar to movements in other measures of national income. So it is a good guide to what is happening in the economy and can be used to judge the performance of the economy.
-in particular, the rate of growth of real GDP is the main indicator of the economic growth of an economy

Question 12

when measuring national income, the real value of national income can also be described as measuring what?

Answer 12

can also be described as measuring the volume of national income. It is the basket of goods and services that can be bought with a given amount of money

Question 13

so when comparing national income in 1900 with that of today in real terms, what is it that is being measured?

Answer 13

what is being measured is the relative size of that basket of goods and services.

Question 14

what does the value of national income measure?

Answer 14

it measures the monetary cost of the basket of goods and services at a given level of price. The value is the equal to the volume times the current price level.

Question 15

what is the national income of the USA compared to that of China and the UK? what is better to use to compare living standards or the productivity of workers?

Answer 15

the national income of the USA is approximately the same as that of China today and seven times that of the UK
-however, this measure compares total national income of those economies. To compare living standards or the productivity of workers, it is better to compare national income per person or per head or per capita. This means dividing national income by the size of the population.

Question 16

are all types of income included in the final calculation of national income? which are not included?

Answer 16

no. Some incomes are received without there being any corresponding output in the economy. For instance:
-the government pays National Insurance and Social Security benefits to individuals, but the recipients produce nothing in return
-children receive pocket money and allowances from their parents
-an individual selling a second hand car receives money, but no knew car is created

Question 17

what is the name of the incomes which are excluded from final calculation of national income?

Answer 17

transfer payments.
-for instance, government spending in national income is public expenditure minus spending on benefits and grants

Question 18

what are the 4 ways national income statistics are used?

Answer 18

-Academic economists use them to test hypothesis and build models of the economy. This increases our understanding of how an economy works
-governments, firms and economists use the figures to forecast changes in the economy. These forecasts are then used to plan for the future. Government may attempt to direct the economy, making changes in its spending or its taxes at budget time. Groups such as trade unions or the CBI will make their own recommendations about what policies they think the gov should pursue
-they are used to make comparisons over time and between countries. For instance, national income statistics can be used to compare the income of the UK in 1950 and 2016, or they can be used to compare Frances income with that of the UK. Of particular importance when making comparisons over time is the rate of change of national income (i.e. the rate of economic growth)
-they are used to make judgements about economic welfare. Growth in national income, for instance, is usually equated with a rise in the standard of living.

Question 19

what are the 4 reasons why national income statistics are inaccurate? (give the first 2)

Answer 19

-statistical inaccuracies: national income statistics are calculated from millions of different returns to the government. Inevitably mistakes are made: returns are inaccurate or simply not completed. The statistics are constantly being revised in the light of fresh evidence. Although revisions tend to become smaller over time, national income statistics are still being revised decades after first publication
-the hidden economy: taxes such as VAT, income tax and National Insurance Contributions, and government regulations such as health and safety laws, impose a burden on workers and businesses. Some are tempted to evade taxes and they are then said to work in the hidden, black or informal economy. In the building industry, for instance, it is common for workers to be self-employed and to under-declare or not declare their income at all to the tax authorities. Transactions in the black economy are in the form of cash. Cheques, credit cards, etc. could all be traced by the tax authorities. Tax evasion is the dominant motive for working in the hidden economy but a few also claim welfare benefits to which they are not entitled.

Question 20

what are the 4 reasons why national income statistics are inaccurate? (give the last 2)

Answer 20

-home produced services: in the poorest developing countries in the world, GDP per person is valued at less than £100 per year. It would be impossible to survive on this amount if this were the true value of output in the economy. However, a large part of the production of the agricultural sector is not traded and therefore does not appear in national income statistics. People are engaged in subsistence agriculture, consuming what they produce. Hence the value of national output is in reality much higher. In the UK, the output of the services of housewives and househusbands is equally not recorded. Nor is the large number of DIY jobs completed each year. The more DIY activity, the greater will be the under-recording of national output by national income statistics
-the public sector: valuing the output of much of the public sector is difficult because it is not bought and sold. This problem is circumvented by valuing non-marketed output at its cost of production. For instance, the value of the output of a state school is the cost of running the school. This method of valuation can yield some surprising results. Assume that through more efficient staffing the number of nurses on a hospital ward is reduced from 10 to 8 and the service is improved. National income accounts will still show a fall in output (measured by a drop in the two nurses incomes). In general, increased productivity in the public sector is shown by a fall in the value of output. It looks as though less is being produced when in fact output remains unchanged.

Question 21

what is the estimated size of the hidden economy in the UK?

Answer 21

it is difficult to estimate, but in the UK estimates have varied from seven to 15 percent of GDP (i.e. national income statistics underestimate the true size of national income by at least seven percent)

Question 22

what are the 8 problems with comparing the national income of the UK today with national income in the past? (give the first 2)

Answer 22

-prices: prices have tended to increase over time. So an increase in national income over the period does not necessarily indicate that there has been an increase in the number of goods and services produced in the economy. Only if the rate of increase of national income measured in money terms (the nominal rate of economic growth) has been greater than the increase in prices (the inflation rate) can there be said to have been an increase in output. So when comparing over time, it is essential to consider real and not nominal changes in income
-the accuracy and presentation of statistics: national income statistics are inaccurate and therefore it is impossible to give a precise figure for the change in income over time. Moreover, the change in real income over time will also be affected by the inflation rate. The inevitable errors made in the calculation of the inflation rate compound the problems of inaccuracy. The method of calculating national income and the rate of inflation can also change over time. It is important to attempt to eliminate the effect of changes in definitions.

Question 23

what are the 8 problems with comparing the national income of the UK today with national income in the past? (give the 3rd and 4th one)

Answer 23

-changes in population: national income statistics are often used to compare living standards over time. If they are able to be used in this way, it is essential to compare national income per capita. For instance, if the population doubles whilst national income quadruples, people are likely to be nearer twice as well of than four times.
-quality of goods and services: the quality of goods may improve over time due to advances in technology but they may also fall in price. For instance, cars today are far better than cars 80 years ago and yet are far cheaper. National income would show this fall in price by a fall in national income, wrongly implying that living standards had fallen. On the other hand, pay in the public sector has tended to increase at about 2 percent per annum faster than the increase in inflation. This is because pay across the economy tends to increase in line with the rate of economic growth rather than the rate of inflation. Increased pay would be reflected in both higher nominal and real national income but there may well be no extra goods or services being produced

Question 24

what are the 8 problems with comparing the national income of the UK today with national income in the past? (give the 5th and 6th one)

Answer 24

-defence and related expenditures: the GDP of the UK was higher during the Second World War than in the 1930s, but much of GDP between 1940 and 1945 was devoted to defence expenditure. It would be difficult to argue that people enjoyed a higher standard of living during the war years than in the pre-war years. So the proportion of national income devoted to defence, or for instance to the police, must be taken into account when considering the standard of living of the population
-consumption and investment: it is possible to increase standards of living today by reducing investment and increasing consumption. However, reducing investment is likely to reduce standards of living from what they might otherwise have been in the future. As with defence, the proportion of national income being devoted to investment will affect the standard of living of the population both now and in the future

Question 25

what are the 8 problems with comparing the national income of the UK today with national income in the past? (give the 7th and 8th one)

Answer 25

-externalities: national income statistics take no account of externalities such as pollution produced by the economy. National income statistics may show that national income has doubled roughly every 25 years since 1945. However, if the value of externalities has more than doubled over that time period, then the rate of growth of the standard of living has less than doubled. There has been some work on developing a measure called green GDP which takes away the environmental costs of production from GDP. Environmental costs include loss of biodiversity, pollution and resource depletion
-income distribution: when comparing national income over time, it is important to remember that an increased national income for the economy as a whole may not mean that individuals have seen their income increase. Income distribution is likely to change over time, which may or may not lead to a more desirable state of affairs.

Question 26

what are the difficulties with comparing national income between economies (countries)?

Answer 26

-countries may use different accounting conventions to calculate national income
-the quality of national income data gathered varies enormously. E.g. a poor country like Tanzania spends far less on gathering data than a rich country like the UK
-the size of the unrecorded part of the economy differs between countries. Italy and Greece, e.g. have much larger hidden economies than Sweden or the UK
-national income figures must be adjusted for the size of the population. So GDP per capita rather than GDP itself is the variable which must be used to make comparisons.
-the quality of goods and services differs. E.g. countries differ significantly in the speed and coverage of broadband and yet national income statistics will only record how much is being spent on broadband.
-countries spend different proportions of their GDP on defence and related expenditures but these expenditures do not necessarily contribute to the standard of living of citizens.
-national income statistics take no account of externalities created by different economies
-income distributions differ between economies and so, e.g. low income earners are likely to be better off in Denmark or Sweden than in the USA, which has a much higher GDP per capita
-geography distorts comparisons. E.g. Italians have lower heating bills than Swedes. So the fact that more is spent per capita on domestic fuel in Sweden does not indicate they have a better standard of living. Equally, France is four times the size of England with a similar population. The fact that France has to build and maintain more roads doesn’t give them a better standard of living than the English.
-market exchange rates dont reflect purchasing power. So simple comparisons using the market exchange rates may give a distorted picture of living standards between countries. A way round this is to use purchasing power parities.

Question 27

what are purchasing power parities?

Answer 27

an exchange rate of one currency for another which compares how much a typical basket of goods in one country costs compared to that of another country
-for instance, if a typical basket of goods cost 2euros in France and £1 in the UK, then national income should be converted at an exchange rate of 2euros to £1, even if the market exchange rate gives a very different figure

Question 28

when do purchasing power parities often differ significantly from market exchange rates?

Answer 28

purchasing power parities often differ significantly from market exchange rates when comparisons are made between rich and poor countries.
-e.g. it might be possible to survive on £2 a day in Kenya or Vietnam when £2 is converted at the market exchange rate into the local currency. In contrast, it is not possible to survive on £2 a day in the UK. However, £2 buys far more in Kenya or Vietnam than £2 would buy in the UK. The market exchange rate undervalues the value of the local currency in Kenya or Vietnam when it comes to buying a basket of goods on which people can survive

Question 29

what does national income tend to be correlated with?

Answer 29

national income tends to be correlated with national wealth

Question 30

what is wealth?

Answer 30

wealth is a stock of assets which produce a flow of income over time.

Question 31

what do countries with high levels of wealth tend to produce higher levels of ?

Answer 31

countries with high levels of wealth, which includes both human wealth and non-human wealth, tend to produce higher levels of income than countries with low levels of wealth.
-the wealthiest nation in the world, the USA, also has the highest national income. A poor country like Tanzania with relatively little wealth also has a low national income.

Question 32

is there a perfect correlation between wealth and income?

Answer 32

no there isn’t. Wealth can be mismanaged and used poorly.

Question 33

are happiness and income positively related?

Answer 33

using surveys from across the world, it was found that happiness and income are positively related at low levels of income but higher levels of income are not associated with increases in happiness.
-this is called the Easterlin Paradox, after Richard Easterlin, an economist, identified this problem in a 1974 research paper

Question 34

what was the conclusion from Richard Easterlin’s paper on happiness and income?

Answer 34

the conclusion from his research is that an increase in consumption of material goods will improve well-being when basic needs are not being met, such as adequate food and shelter. But once these are being met, then increasing the quantity of goods consumed makes no difference to well-being.
-having a new high-definition tv, or a new car when you already have a reasonable functioning tv and car doesn’t increase your well being in the long term.
-what this means is that average levels of happiness in the UK, which already enjoys a high standard of living, will not increase if GDP doubles

Question 35

however, what do some disputing economists say about the Easterlin Paradox?

Answer 35

-reworking survey evidence, they suggest there is a correlation between income and happiness.
-Even if they are correct, the idea that happiness is caused by a wide variety of factors and not just income would suggest that GDP and happiness are likely to be only weakly correlated.

Question 36

what is the caveat to the debate about changes in absolute incomes and happiness?

Answer 36

-survey evidence suggests that within a population, there is a positive correlation between relative income and happiness.
-surveys across countries consistently show that those with above average incomes tend to have higher levels of happiness than those with below average incomes.
-so if incomes for every individual in the UK doubled, there would be no increase in happiness. But if an individual worker had their pay doubled, they would be happier because their income relative to everyone else has increased.

Question 37

what are the 2 suggested explanations for the correlation between relative income and happiness?

Answer 37

-one is that income is a symbol of social status. Psychologically, we are happier if we feel we have more status. This competitive streak is ‘hard-wired’ into our brains and comes from our biological roots.
-the second explanation is that above average incomes are correlated with a number of other factors which are associated with happiness. E.g. those on above average income tend to enjoy better health and live longer. They have more control over their environment and are less likely to perform short repetitive tasks. They are less likely to be unemployed.