Measures of Economic Performance

Economic growth and national income measures

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Purchasing power parity matters because the same dollar buys far more in a low-cost economy. Without a PPP adjustment, cross-country comparisons systematically understate living standards in poorer countries.

Limitations of GDP as a welfare measure: it is an average that ignores distribution; it excludes unpaid work and the informal economy; it ignores what is produced (weapons count the same as hospitals); it ignores externalities (pollution does not subtract, and cleaning it up adds); it ignores leisure and working conditions; and data is subject to revision.

Alternatives: national wellbeing measures, the HDI (4.3), and subjective happiness surveys. The Easterlin paradox, that beyond a certain income, further GDP growth does not raise reported happiness, is a strong evaluative point Edexcel rewards.

Inflation, deflation and disinflation

• Inflation: a sustained rise in the general price level, so money loses purchasing power.
• Deflation: a sustained fall in the price level.
• Disinflation: inflation that is still positive but falling. Prices rise more slowly; they do not fall.

Measurement:

• CPI: a weighted basket of around 700 goods and services, weighted by their share of household spending. The UK target is 2% CPI. It excludes housing costs such as mortgage interest.
• RPI: an older measure that includes mortgage interest payments and council tax, and uses a different averaging formula, so it usually runs above CPI. No longer a national statistic but still used in some contracts and index-linked bonds.

Limitations of price indices: they are averages, so different households face different inflation rates; quality improvements are adjusted for imperfectly; the basket is updated only annually, so it lags changes in spending; and sampling error and the informal economy affect accuracy.

Causes:

• Demand-pull: AD rises faster than capacity, typically with a positive output gap.
• Cost-push: rising costs (wages, imported raw materials, energy, indirect taxes, a depreciating currency) shift SRAS left, raising prices and lowering output.
• Growth in the money supply: in the quantity theory (MV = PQ), if money grows faster than real output, the price level rises.
• Expectations: anticipated inflation is built into wage claims and prices, producing a self-sustaining wage–price spiral.

Effects: eroded purchasing power, especially on fixed incomes; loss of international competitiveness; menu and shoe-leather costs; uncertainty deterring investment; arbitrary redistribution from savers and lenders to borrowers; and fiscal drag as nominal incomes cross tax thresholds.

Deflation is more dangerous than it looks: consumers delay purchases expecting lower prices, so demand falls further; the real value of debt rises; and nominal interest rates cannot fall far below zero, so monetary policy loses traction. This is why the target is 2% rather than 0%.

Employment and unemployment

Measures:

• The Labour Force Survey (LFS): the internationally comparable ILO measure: those without a job who are available to work and have actively sought work in the past four weeks. The preferred measure.
• The claimant count: those claiming unemployment-related benefits. Timely and cheap, but distorted by every change to benefit rules and it excludes unemployed people who are ineligible.

Both understate labour market slack because they miss discouraged workers who have stopped searching and underemployment, part-time workers wanting full-time hours. The participation rate and inactivity figures are therefore essential context.

Types of unemployment: frictional, structural (skills or geographical mismatch), cyclical/demand-deficient, seasonal, and real-wage. The natural rate, frictional plus structural, cannot be reduced by raising AD; only supply-side policy lowers it.

Significance: lost output (the economy operates inside its PPF); lost tax revenue and higher benefit spending, widening the deficit; hysteresis, where long-term unemployment erodes skills and permanently lowers potential output; and the personal and social costs of poverty and ill health.

Migration affects both sides: it raises the labour supply and can fill skills gaps, easing wage pressure and raising potential output, while adding to demand for housing and public services.

The current account of the balance of payments

The current account records trade in goods, trade in services, primary income, profits, interest, dividends, wages from abroad, and secondary income (transfers, aid, remittances).

Causes of a deficit: loss of international competitiveness through higher relative inflation or weak productivity; a strong exchange rate; strong domestic growth pulling in imports; a narrow export base; and structural decline in exporting industries.

Significance: a deficit is a leakage from the circular flow, reducing AD and employment; it must be financed by borrowing or selling assets, creating future income outflows. But its meaning depends on the cause: a deficit financed by inward FDI, or caused by importing capital goods that raise future capacity, is very different from one funding consumption on credit.

Worked example

An economy reports 4% nominal GDP growth, CPI inflation of 3%, population growth of 1%, and unemployment falling from 5% to 4.2%.

1. Real GDP growth = 4% − 3% ≈ 1%
2. subtracting population growth of 1% leaves real GDP per capita roughly unchanged
3. so despite headline growth of 4%, average living standards have not improved at all.

Falling unemployment alongside near-zero per-capita growth suggests weak productivity: more people are working, but output per worker is flat.

Evaluation.

• GDP per capita is an average and says nothing about distribution, if the gains went to the top decile, most households are worse off in real terms.
• The unemployment figures may understate slack, since they exclude discouraged workers and underemployment; the participation rate is the necessary check.
• Falling unemployment with weak growth may reflect a shift to low-productivity, insecure work rather than genuine improvement.
• GDP ignores unpaid work, the informal economy and externalities, so it is an incomplete welfare measure regardless of the arithmetic.
• Data is revised, sometimes substantially, so policy based on first estimates is risky.

Judgement: the headline growth figure is misleading. Once inflation and population are stripped out, the economy has stagnated in per-capita terms, and the improvement in unemployment is better explained by weak productivity than by genuine strength.

Common exam mistakes

• Using nominal GDP to discuss growth. Always specify real.
• Forgetting to adjust for population when discussing living standards.
• Confusing deflation (falling prices) with disinflation (slowing inflation).
• Saying CPI includes housing costs; it does not; RPI includes mortgage interest.
• Treating all inflation as demand-pull; the diagram and the policy differ for cost-push.
• Confusing cyclical with structural unemployment.
• Treating a current account deficit as automatically harmful.

Exam technique

With data-response material, do the arithmetic: convert nominal to real, then to per capita. Edexcel's context questions frequently hinge on exactly that adjustment.

For inflation, use AD/AS and let the direction do the work, demand-pull shifts AD right, cost-push shifts SRAS left.

For evaluation, question the reliability of the data (revisions, what the measure excludes, whether it is an average) before questioning the economics. That is a distinctive and reliable evaluation route in 2.1.

Quick revision

• Growth = % change in real GDP; use per capita for living standards and PPP for comparisons.
• GDP ignores distribution, unpaid work, the informal economy, externalities and leisure. Easterlin paradox.
• Inflation / deflation / disinflation: know the difference.
• CPI excludes housing costs; RPI includes mortgage interest and runs higher.
• Causes: demand-pull, cost-push, money supply (MV = PQ), expectations.
• Deflation: delayed spending, rising real debt, ineffective monetary policy.
• LFS (ILO) is the preferred unemployment measure; the claimant count is narrower.
• Both miss discouraged workers and underemployment.
• Hysteresis: long-term unemployment lowers potential output permanently.
• Current account: goods, services, primary income, secondary income.

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