Chapter 5. Revision.

Government economic policy objectives and indicators of national economic performance.

Key performance indicators.
One of the most important is economic growth. Short-run, or actual, economic growth is said to occur when an economy increases its output. Long-run,or potential, economic growth take place when the productive capacity of the economy increases. When a country’s output increases, usually unemployment falls. Some people between 16 and 65 are not in the labour force, because, for example, they are homemakers, disabled or have retired early. These people are said to be economically inactive and are not regarded as unemployed. A country also can experience deflation which is a sustained fall in the price level, although this is less common. A country’s external performance can be assessed by examining its balance of payments.

Definitions:
Economic growth: in the short run, an increase in real GDP, and in the long run an increase in productive capacity, that is the maximum output that the economy can produce.
Unemployment: a situation where people are out of work but are willing and able to work.
Labour force: the people who are employed and unemployed ,that is ,those who are economically active.
Economically inactive: people of working age who are neither employed nor unemployed.

Current trends.
In the UK stable economic growth has been combined with low unemployment and low and stable inflation. This has led some economists to suggest that the shape the UK’s aggregate supply curve may have changed, becoming more elastic up to the full capacity level. There are thought to be a number of reasons why the inflation rate has fallen and stayed relatively low. These include a reduction in inflationary expectations resulting from the success of the government’s monetary policy, a high value of the pound and increased global competition putting pressure on firms to keep their prices low.

Definitions:
Elastic: responsive to a change in market conditions.
Inflation rate: the percentage increase in the price level over a period of time.
Objectives of government economic policy.
Governments have always had general policy objectives for the macroeconomy but in recent years many have set more specific targets.
Economic growth.
Governments want to achieve economic growth because of the benefits it brings, including increasing material living standarts.
Definitions:
Sustainable economic growth: economic growth that can continue over tome and does not endanger future generations’ ability to expand productive capacity.
Trend growth: the expected increase in potential output over time. It is a measure of how fast the economy can grow without generating inflation.
Employment and unemployment.
Another government policy objective is high employment and low unemployment. Some governments state that their objective is full employment.
Definition:
Full employment: a situation where those wanting and able to work can find employment at the going wage rate.
Inflation.
A third macroeconomic policy objective is low and stable inflation.
Balance of payments.
In the past,governments placed considerable emphasis on achieving a satisfactory balance of payments position, particularly with respect to trade in goods and services.
Definition:
Current account deficit: when more money is leaving the country than entering it, as result of sales of its exports, income and current transfers from abroad being less than imports and income current transfers going abroad.
Economic stability.
While a satisfactory balance of payments position has been somewhat downgraded as an objective, economic stability has become more significant as an objective.

Income redistribution.
At any particular time, a government may also seek to redistribute income. This may be done in order to ensure everyone has access to basic necessities and/or to correct what is seen as an inequitable distribution of income.
Definition:
Hyperinflation: an inflation rate above 50 per cent.
GDP and real GDP.
Economists first calculate what is called money or nominal GDP. This is output measured in terms of the prices in the year in question. Then they convert nominal into real GDP(GDP adjusted for inflation). For example 800 pounds in 2008 and 880 pounds in 2009. This would appear to suggest that output has risen by: 80/8000*100%=10%
So to calculate the rise in the volume of output, the effects of changes in the price level are taken out by multiplying GDP by the base year index divided by the current year price index. So if the price index in 2008 was 100 and 104 in 2009,real GDP was 880*100/104=846.15. In real terms GDP has risen by 46.15/800*100%=5.77 per cent.
Definitions:
Nominal GDP: output measured in current prices and so not adjusted for inflation.
Labour productivity: output per worker hour.
Measuring economic growth.
Economic growth is usually measured by the annual percentage change in real GDP. As just mentonied,this is the change in the country’s output.
Production and productivity.
Production is what is produced. So,when real GDP increases, it means that output has risen.
Difficulties in interpreting changes in real GDP.
On the surface, an increase in real GDP suggests that living standarts are improving, as more goods and services are being produced.
Measuring unemployment.
Economists measure the number of people who are unemployed and from this find the unemployment rate. The unemployed*100%/labour force.


Definitions:
Informal economy: economic activity that is not recorded or registered with the authorities in order to avoid paying tax or complying with regulations,or because the activity is illegal.
Economy of scale: the advantage of producing on large scale, in the form of lower long-run average cost.
Unemployment rate: the percentage of the labour force who are out of work.
Labour force survey: a measure of unemployment based on a survey using the ILO definition of unemployment.
International labour organization: a member of organization of the united nations that collects statistics on labour market conditions and seeks to improve working conditions.
Claimant count: a measure of unemployment that includes those receiving unemployment-related benefits.
Consumer price index: a measure of changes in the price of a representative basket of consumer goods and services .Differs from the retail price index in methodology and coverage.
Difficulties of measuring unemployment.
There is no perfect measure of unemployment. Both the LFS measure and the claimant count measure have their advantages and disadvantages.
Measuring inflation.
there are number of measures of inflation. The main measure of inflation is the consumer price index(CPI). It forms the basis for the inflation target that the government requires the bank of England’s Monetary Policy Committee to achieve.
The CPI and other measures of inflation.
another measure of inflation used in the UK is the retail price index. This measure is the one used for adjusting pensions and other benefits to take account of changes in inflation and is frequently used in wage negotiations.
Difficulties of measuring inflation.
the CPI and the other measures of inflation mentioned aim to give a representative picture of what is happening to prices in a country.



The structure of the current account of the balance of payments.
The current account receives the most media attention. It includes trade in goods, trade in services, income and transfers.
The capital and financial accounts show the movement of direct investment.
The last section. Net errors and omissions, is added to ensure that the balance of payments does balance.
The causes of economic growth.
In the short run, an economy with spare capacity can experience economic growth as a result of an increase in aggregate demand. For an economy to experience economic growth in the long run its productive capacity has to increase.
The causes of unemployment.
Cyclical unemployment: unemployment arising from a lack of demand.
Structural unemployment: unemployment caused by the decline of certain industries and occupations due to changes in demand and supply.
Frictional unemployment: short term unemployment occurring when workers are in-between jobs.
The causes of inflation:
Cost push: increases in the price level caused by increases in the costs of production.
Demand pull: increases in the price level caused by increases in aggregate demand.
The causes of a deficit on the current account of the balance of payments.
A deficit on the current account occurs when the country’s expenditure abroad exceeds its revenue from abroad.
The causes of a surplus on the current account of the balance of payments.
A surplus on the current account is experienced when a country’s revenue from abroad is greater that its expenditure abroad.
The consequences of unemployment.
Unemployment can have a number of consequences for the economy, for the unemployed and for other economies.
1) Lost output: one of the most significant costs of unemployment is lost output.
2) Lost tax revenue: unemployment results in tax revenue being lower than possible. If more people were in work, incomes. Spending and possible profits would be higher.
3) Government spending on unemployment benefits: if unemployment rises, the government will have to spend more on unemployment related benefits, principally job seeker’s allowance.
4) Pressure on other forms of government spending: as well as affecting the amount the government spends on unemployment-related benefits, rising unemployment can put upward pressure on a variety of other forms of government spending.
5) Costs to the unemployment: as mentioned above, the unemployment may suffer from poor health and family break-ups. They are also likely to experience a loss of income.
6) Hysteresis: one of the costs of the unemployment can be unemployment itself. This is known as hysteresis.
Definitions:
Hysteresis: unemployment causing unemployment.
Long-term unemployment: unemployment lasting more than one year.

The costs for other economies.
Unemployment is a country’s trading partners is likely to reduce demand for its exports. This ,in turn, will reduce the country’s aggregate demand and may cause some unemployment.
The benefits of unemployment.
There are few possible benefits of unemployment. For a few people, it may give them time to search for a more rewarding job. The existence of unemployment makes it easier for firms, wishing to expand, to recruit workers, it can also reduce demand-pull and cost-push inflation.
The overall effect.
It is generally agreed that the costs of unemployment above a certain level exceed any benefits. This is why low unemployment or full employment is one of the main macroeconomic objectives pursued by governments.
The significance of unemployment.
How significant the consequences of unemployment are depends on how much unemployment there is, how long on average people are unemployed, the benefits provided to the unemployment, the type of the unemployment and the distribution of the unemployment.
The consequences of inflation.
1) Fall in the value of money: the one certain consequence is a fall in the value of money.
2) Menu costs: the costs of changing prices due to inflation.
3) Shoeleather costs: costs in terms of the extra time and effort involved in reducing money holdings.
4) Administrative costs: as well as shoe leather and menu costs, inflation can impose other administrative costs on firms.
5) Inflationary noise: the distortion of price signals caused by inflation.
6) Random redistribution of income: inflation increases the cost of living, as people have to pay more to buy the same basket of goods and services.
7) Fiscal drag: people’s income being dragged into higher tax bands as a result of tax brackets not being adjusted in the line with inflation.
8) Uncertainty: one of the most serious disadvantages of inflation, especially if its unexpected, is the uncertainty it creates.
9) Inflation causing inflation: the experience of inflation can lead people to behave in a way which causes inflation to continue.
10) Loss of international competitiveness: inflation can have a harmful effect on a country’s international trade position.
Definition:
Real interest rate: the nominal interest rate minus the inflation rate.
The benefits of inflation.
There is a possibility that inflation can bring benefits to an economy.
The significance of inflation.
The impact of inflation on an economy and its households, firms and government will depend on a number of factors. These are the rate of inflation, its cause, whether it is fluctuating, whether it was correctly anticipated and its rate relative to that of other countries.
The consequences of a deficit and a surplus on the current account of the balance of payments.
A deficit means that a country is consuming more than it is producing. The income from this extra output is going to people abroad. If a deficit increases, it will reduce the aggregate demand in the economy.
The significance of a current account deficit.
How significant a current account deficit is depends on its size, duration, cause and what is happening in the capital and financial account.
The costs of economic growth.
Economic growth can have costs. If an economy is currently using all of the resources, and thus producing on its production possibility curve, the only way it can increase its output is to switch resources from making consumer goods to making capital goods.

The benefits of economic growth.
Although there can be costs of economic growth, most governments believe thet the benefits of economic growth outweigh the costs. This is why economic growth is a key macroeconomic objective.
The sustainability of economic growth.
One of the crucial factors that has to be taken into account in deciding whether economic growth is beneficial or not is whether it is sustainable.
Determination of exchange rates.
An exchange rate is the price of one currency in terms of another currencies. the bank of England Monetary Policy Committee’s main indicator of the pound’s value is the Bank’s trade-weighted index.
A number of factors influence the demand for and supply of a currency and so its exchange rate.
1) Demand for pounds is likely to be high and supply is likely to be low if UK products are internationally competitive.
2) Changes in income abroad influence the exchange rate.
3) Rising incomes at home may put downward pressure on the value of the pound.
4) A rise in UK interest rates, relative to other countries’ interest rates, will be likely to increase demand for pounds.
5) Pounds are also bought and sold by those wishing to undertake foreign direct investment(FDI).
6) Speculation is now an important influence on the exchange rate.
Definitions:
International monetary fund(IMF): an international organization that helps co-ordinate the international monetary system.
World trade organization(WTO): an international organization that promotes free international trade and rules on international trade disputes.
Exchange rate: the price of one currency in terms of another currencies.
Monetary policy committee(MPC): a committee of the Bank of England with responsibility for setting the interest rate in order to meet the government’s inflation target.
The relationship between the exchange rate and the interest rate.
Changes in the exchange rate and interest rate are closely linked. If for instance, the UK’s exchange rate rises, exports prices expressed in terms of foreign currencies will rise.
The effect of a change in exchange rate on export and import prices.
A fall in the exchange rate, called a depreciation if caused by market forces, will reduce the price of exports in terms of foreign currencies.
Changes in the exchange rate and the macroeconomy.
A reduction in the exchange rate is likely to improve the current account position of the balance of payments. A fall in the price of exports will result in a rise in export revenue if demand is elastic. A rise in import prices will reduce the expenditure on imports, again if demand is elastic.