The performance of the economy can have a major impact upon people’s lives. It will influence the type of jobs people have and the goods and services available to them, and whether they can afford to buy them.

The government has 4 macro-economic objectives:

• low unemployment
• low and stable inflation
• sustainable Economic growth
• balance of payments equilibrium

A number of key indicators can be used to illustrate the success of an economy:

• the level of output, and Economic growth
• the inflation rate
• level and rate of unemployment
• the Balance of Payments

If the economy is growing it can normally be judged as successful. But economic growth must be measured in real terms, in other words, inflation must be removed from the measure to give real GDP growth. Currently the target for real GDP per annum in the UK is 2%.

Economic Growth

An economy’s growth can be measured in terms of its Gross Domestic Product (GDP) or its Gross National Product (GNP). GDP is the sum of all output of goods and services in the UK over a period of time usually 1 year. It can be measured using 3 methods.

• output method
• income method
• expenditure method

Output Method

This measures the value of output by industries, for example the manufacturing and catering businesses. It is important to avoid Double Counting when using the output approach. For example if the value of a computer were added to the value of the processor, then the final output will be overstated. Thus only the final value is calculated.

So, the final value of the table, i.e. the amount added to the economy’s output is £450 not £925.

Income Method

The income measures the aim of all rewards to the factors of production: i.e. rent for land, wages for labour, interest for capital and profit for entrepreneurship.

This payment only includes payments for which there is a corresponding output, thus we exclude transfer payments which are just payments from those in work to those not employed, such as social security. There is no output related to transfer payments.

Expenditure Method

The amount produced in a year, i.e. output is either sold or held as stock therefore the sum of that sold and held in stock must equal the level of output. This is the expenditure method, taking spending by consumer (C), government spending (G), spending by firms (I) and the net trade the UK enters into (X-M).

The Expenditure Method: C + I + G + (X – M)

For this method to be accurate the value of subsidies must be added and taxes on goods deducted. This converts the product’s value from market prices to factor cost.

Converting from Nominal to Real

Nominal GDP is GDP measured in terms of money values, and so is influenced by the level of inflation. This can give a misleading impression of a country’s performance. If inflation is running at 20%, then at the end of a year, GDP will have risen by 20%, this will suggest that output has remained the same but the value of the output has risen as prices rise. Thus to overcome such calculation difficulties GDP figures are returned to a base year to remove the affects of inflation. This is known as converting to real GDP.

Real GDP is Nominal GDP x price index in base year.

Nominal GDP £1048 x  100/120 = Real GDP = £873m

Economic Growth

If a country’s output is rising, this suggests that a country’s citizens are experiencing higher living standards. The most common indicator of economic growth is a rise in real GDP.

Actual and Potential Growth

An increase in the productive capacity of an economy increases the potential growth, whilst an increase in output results in an actual increase in output. A shift in the PPF illustrates an increase in productive potential.

However a movement in the actual amount of output from A to B illustrates an increase in economic growth. There is however still potential to increase actual output from B to the boundary of PPF² by employing previously unemployed sources.

Production and Productivity

A country’s output can increase either because greater resources are employed or because of a rise in productive potential. However an increase doesn’t necessarily result in an increase in output, this will depend upon whether this increase in productive capacity is matched by an increase in actual output or a great level of employment.

Measurement Problems

1. Shadow Economy: This exists because when the output of some goods and services is deliberately not declared. This can be for 2 reasons, to avoid tax, for example ‘cash in hand’ deals with plumbers etc. In addition some people may not declare economic activity if that activity is illegal, for example drug dealers will not declare their income.As people will spend any income they might receive in this undeclared way, a gap will tend to exist between the final figures for the expenditure method and income method of calculating GDP. The gap that exists will give an indication as to the size of the black economy.

2. Non-Marked Goods and Services: GDP figures only include those goods that are bought and sold and so have a price attached to them. Services which are produced and which either are not traded, or which are exchanged without money being exchanged. For example homegrown products, DIY or voluntary work are not included in the official figures.

3. Government Spending: Some government spending goes on financing some services which are not sold, such as Defence, and the Police. The cost of production is therefore used, however this can be misleading. If productivity in the Police Force were to rise as a result of the introduction of some new technology, staff numbers and so cost could be reduced. This overall reduction will result in a fall in the Police services contribution to the final GDP figures.

To overcome this problem the government has introduced a method for estimating output based on key performance indicators.