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Economic stability, by preventing fluctuations in output, unemployment and inflation it

is easier for households to plan, firms to invest and governments to change spending
patterns.
(Re)distribution of income, the government aim to ensure everyone has access to the basic
necessities and/or to more equally distribute income. However if done too much, this will
reduce business incentives and working for income.
Potential and Actual growth, by achieving both potential and actual growth, inflation
(caused by a positive output gap) and unemployment (caused by a negative output gap)
are kept low as the output gap is held constant.
Reduction in 'regrettables', increased spending on things such as police to deal with an
increase in crime will lead to negative impacts on standard of living if this spending is
ineffective because of the opportunity cost of the spending

In addition to their major objectives, governments also have several minor objectives:

Minor Objectives of Governments


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Major Objectives of Governments


Most governments have four main macroeconomic objectives:
Low (positive) inflation, meaning that wages and prices will remain stable, therefore firms
are more likely to invest and the value of incomes doesn't erode as fast. Purchasing power
of consumers and firms remains stable.
Low unemployment, meaning that more people have an income, and so will be more likely
to have a better standard of living. Also as the government will be spending less on welfare,
meaning they have more money available for spending on other things.
Positive, sustainable economic growth, this means greater income, more output and better
living standards in the future, but must be sustainable to avoid negative effects later on.
Balance of Payments stability/equilbrium, neither a deficit or a surplus is beneficial in the
long-term - deficits mean the economy is keeping less of its income and so will grow slower,
a surplus will often lead to other countries taking protectionist action, reducing trade.

This uses the ILO definition of unemployment, i.e. people who are able, available and willing
to work at the current wage rate but do not have a job. The ONS interviews the residents of
60,000 households each quarter as a sample of the total population. They ask about the residents'
employment status and nature of employment. Statistics for the entire UK are then extrapolated
from the sample.
The Labour Force Survey is the official measure of unemployment in the UK.

Labour Force Survey


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Parts of the Macroeconomy


In macroeconomics there are 4 main parties:
Households: receive income through wages and salaries from their jobs and from their
investments and then buy the output of firms (this is known as consumer spending and
is labelled as C)
Firms: Businesses hire land, labour and capital inputs when making products for which
they pay wages and rent (income). Firms receive payment from consumers and profitable
businesses may invest (I) a percentage of profits in new producer goods such as
equipment and technology
Government: collect taxes (T) to fund spending on public services such as education,
healthcare and defence. Government spending is given the label (G)
International sector: The UK buys imports from other countries, (M) and overseas
businesses and consumers buy UK products known as exports (X). International trade is
important for the UK.

All those who are registered as claiming Job Seekers Allowance at benefit offices on the day of the
count are counted as unemployed. Therefore to be recognised as unemployed, the individual must
satisfy the conditions for claiming the benefit. This process happens once per month, however is
not the official measure of unemployment for the UK.
The claimant count simply counts the number of people claiming unemployment-related benefits.

Claimant Count
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Problems with Measuring Unemployment 1


By changing the criteria for unemployment-related benefits, the government can influence
the unemployment figures. This means the claimant count is unreliable as a means
of comparison over a long period of time since changes in eligibility have, generally,
decreased the unemployment rate.
By classing people as 'unfit for work' they are not counted in unemployment figures, which
leads to 'hidden unemployment'. If some of these people are actually able to work, the
unempoloyment statistics will be incorrect.
Both the measures are susceptible to fraudulant claims, and so may be too high. Such
fraudulant claims may include people claiming who are not actively seeking work, or those
who claim but work in the informal economy.

The Bank of England target inflation rate is 2%, with a 1% fluctuation allowance either side.
The CPI measures the average level of prices, replacing the RPI in 2003. CPI is based on the
HICP (Harmonised Index of Consumer Prices) used throughut the EU.
Inflation is measured using index numbers. Each month, the average price level is calculated and
recorded as the CPI (Consumer Prices Index). The rate of inflation is calculated by finding the %
change in CPI.

Measuring Inflation
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Problems with Measuring Unemployment 2


The Claimant Count does not include a range of people, including 16-17 year olds, the
sick, disabled and single parents who are looking for work, men over 60 and those who
do not qualify for benefit but do not have a job, for example if the savings of their partner
are too high. Therefore the CC is likely to be an understatement of unemployment.
The LFS includes people who (arguably) should not be included, such as people who are
frictionally unemployed and people with disabilities.
The LFS is based on extrapolation of data from a survey, and so may not be representative
of the population as a whole. If the sample chosen by the ONS is not representative of the
UK as a whole the figure could be either too high or low.

The percentage changes in the prices of the items are multiplied by their weights, and combined
to give the overall CPI for the month.
Price data for each of the items in the basket is collected every month, using a range of retail
outlets in 180 different areas, with more than one price collected for each item. The average price
of the item is then calculated.

Measuring Inflation 3
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Measuring Inflation 2
The CPI is calculated each month and measures the average change in the prices of consumer
goods and services. Items are weighted according to what consumers spend most of their money
on. Every year the weightings are recalculated and the goods included in the CPI are changed.
It is calculated by the ONS.
The weights are calculated by the Expenditure and Food Survey, which is conduceted every year to
find out the spending patterns of 7,000 households. These households are supposed to represent
a typical cross section of the population.
The 650-700 items that take up the greatest proportion of consumer speding are selected for the
'basket' of goods for the CPI. Each item is given a weighting reflecting their share of total spending
as consumers will be more affected by a price increase in these goods.

If the PPC (Potential output) expands faster than actual output, this creates spare capcity, known
as the output gap.
On a PPC, actual growth is shown by making more and better use of resources, shown by moving
closer to the PPC. Potential growth is shown by an expansion (rightward movement) of the PPC.
This shows an increase in the quality and/or quantity of FoP.
Potential Growth: This is when there is an increase in the productive capacity of a economy.
Actual Growth: This is when an economy produces more goods and services.
Economic growth is the increase in the output of an economy of goods and services. This is
generally considered to be good, as this means more goods and services are being consumed,
which we assume will increase our standard of living.

Economic Growth
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Problems with Measuring Inflation


Measures of price change do not take into account changes in quality, which may increase
at a different rate to prices. The CPI can therefore under- or over-estimate inflation because
of this.
The CPI does not take into account substituion effects in the market. When prices rise,
consumers are likely to substitute purchases of items which are relatively expensive for
those tha are relatively cheaper. This helps reduce the cost of their spending, but means
spending patterns have changed, meaning the CPI not only over-estimates inflation, but
could also be consider irrelavent.
The CPI also does not take into account special offers, or the price of products in when they
are not purchased from new. This also means that the CPI is probably an over-estimate
Trends in consumer spending change very quickly, and so the yearly revision of weightings
is not frequent enough. This mean some of the price changes monitored by the index are
irrelavent.
Lastly, the CPI is prone to ststistical errors. If the sample of households does not represent
the general population, then the inflation figures calcuated will not be useful. The inflation
value calculated will also not apply exactly to any household, because every household is
different, and the average household used to calculate the CPI does not exist.

National income is what is newly produced in an economy in a year, and adds to national wealth.
National wealth is the stock of goods, services and money (assets). However, depreciation reduces
national wealth as assets lose value.
An unsustainable activity is anything that comprimises the ability of future generations to meet their
needs. For example the use of fossil fuels may mean that future generations have limited access
to energy, hindering output. Sustainable growth is when these things do not happen.
Sustained growth is when both potential and actual growth are achieved simultaneously.

Sustained, Sustainable Growth and National Income


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The Circular Flow of Income


This is a two sector model with just two economic agents; Households and Firms. It assumes that
these two agents have the property rights for all FoP.
Households provide firms with factor services, and firms pay for these by providing factor incomes
such as wages. Households then use these incomes to pay for the products firms produce, and
firms provide these products in return for payment.
The flows of products and factor services are said to be real flows, and the flows of expendtiure
and factor incomes are said to be monetary flows.
This means that GDP can be measured in 3 ways; The output method (value of products made by
firms), Income method (Value of earnings of households) and the Expenditure method (Value of
expenditure by households on the products firms provide). In theory, all of these should give the
same answer, as the assumptions are made such as that there is no saving and that all products
made are purchased.

Collectively, these are known as the National Income Statistics (NIS). GDP is used most often, and
GNP is used occasionally. NNP is rarely used as depreciation is almost impossible to measure
accurately.
GDP, the total value of a nation's domestically produced output within a time period
GNP, the value of income accruing to a nation's citizens irrespective of the location of the
FoP tht generated it, within a time period
NNP, value of a nation's income within a time period
Growth is usually measured yearly using the output method, by calculating the % change since
last year. There are 3 different measures of growth:

Measuring Growth
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Income and Output Methods


Income is a total of all factor incomes/rewards, i.e. the total of:
Rent + Wages + Interest + Profit
Although HMRC collect this data for tax purposes, not all incomes are recorded as not all income
is declared. Some is black market or informal activity and so no tax is paid.
Output is the aggregate of the value of all new products produced in an economy over a year. When
products do not have a market price (i.e State provided services), the cost of their provision is used.
This is often inaccurate as the cost of provision will not equal benefit gained from consumption.
Also, double counting can occur if a product is used in the production of another product, and so
is counted twice, although the 'final output' method is designed to counteract this.

X - M (Exports - Imports) equals net exports


GDP = C + I + G + X - M

Consumption (C) - Expenditure by consumers on domestic products


Investment (I) - Expenditure by firms in new capital goods
Government (G) - Expenditure by government on the provision of products
Exports (X) - Expenditure by foriegn individuals/organisations on domestic products
Imports (M) - Expenditure by domestic individuals/organisations on foriegn products

This method aggregates expenditure made in a year by both individuals and organisations on new
products. There are 5 main types of expenditure:

Expenditure Method
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GNP and NNP


GNP (Gross National Product) = GDP + Net property income from abroad.
Net property income from abroad is income made by individuals and organisations that is
repatriated to the countyr of origin. This adds profits made by British firms overseas, and removes
money sent back to countries of origin by immigrants.
NNP (Net National Product) = GNP - Depreciation
This takes into account that wealth and capital stocks depreciate over time as they become out of
date. The effect of depreciation on standard of living has to be taken into account to give a true
representation of how the economic welfare of the citizens of an economy has changed.

Divide by population size to get GDP per capita for fair representation of the population.
Convert to $ using the Purchasing Power Parity exchange rate to easily compare GDP in
relation to costs of living in different economies.
Real GDP accounts for rises in prices during the period of production, nominal GDP is
adjusted to remove inflationary price rises. Real GDP is calculated by measuring GDP at
constant prices from a selected base year.
The NIS are used to calculate growth, compare living standards and compare economic
performance. To accurately compare data, three adjustments are made:

Uses of and adjustments to NIS


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Problems with NIS 1


Although they are probably the best (and indeed only) measure of economic performance that we
have, NIS have several problems:

Composition of Output - a nation may have a high GDP p/c, but living standards may
be relatively low if the products made are not for current consumption, for example an
economy based largely on military expenditure will generally not have high living standards
Distribution of Income - a nation may have a high GDP p/c, but this may not reflect how
the income is distributed, and so may not reflect the relative living standards of its citizens.
Middle Eastern countries are a good example of this.
Poor Data - In LEDCs, data is often incomplete, unreliable or simply not available. There
are no sophisticated recording mechanisms in place, and the governments do not have
either the resources or expertise to record or share data.
Illegal activities - The black market, tax evasion and benefit fraud all increase standard of
living, but are not recorded or are recorded when they should not be.

Current Account
Capital Account
Financial Account
There are 3 categories to the BoP:
If inflows are greater than outflows, there is a BoP surplus, if ouflows are greater than inflows there
is a deficit.
The BoP is a record of all the inflows and outflows of money in a country. It is calculated by
subtracting outflows from inflows (debits from credits).

Balance of Payments
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Problems with NIS 2


Inaccuracies and guesstimates when calculating productivity and value of government
workers
Non-marketed economic activities also contribute to improvements in economic welfare,
such as DIY and housework. We do not value these things as they are unpaid, but makes
up a significant sector of LEDC economies as subsistence farmers are not paid for their
work, they work to survive.
There are also other factors that affect economic welfare that are not quantifiable, such as:

Leisure
Political freedoms
Quality of products made
Pollution and envionmental quality

Combined, these two factors make up net exports.


Trade in services is calculated by service exports minus service imports, and is also called the
balance of trade in services.
The trade in goods is calculated by exports minus imports, and is also called the balance of trade.

(Balance of) Trade in Goods


(Balance of) Trade in Services
Income
Current Transfers

This is split into 4 main sections:

The Current Account


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Capital and Financial Accounts


Capital
The capital account shows transfers of capital/money, such as government investment and the
purchase and sale of intangible fixed assets (such as patents and trademarks). For example,
spending by government on an embassy or a firm buying a patent to a particular idea
Financial
This shows flows of investment such as FDI from MNCs and international borrowing. For example
the investment by Japanese car firms in the north of England.

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The Current Account 2


Income is flows that come from international lending and investment. It is made up of 3 main
categories:
Profits from MNCs that are repatriated
Dividends from shares bought in other countries
Interest paid on international loans or ganied on bonds
Current transfers are when money changes hands without the taking place of an economic
transaction, for example:
Aid flows from government or charities sent abroad
Remmitances from people from another country sending their earnings home