The measurement of macroeconomic performance
Macroeconomic performance is judged against a small set of official measures: real GDP and its growth rate (economic growth), the rate of inflation (CPI and RPI), the unemployment rate (claimant count and Labour Force Survey/ILO measures) and the current account balance of payments.
Before you start
Make sure you're comfortable with these topics first:
Method
- Distinguish nominal values (measured in the prices of the year in question) from real values (adjusted for inflation, measured in constant prices of a chosen base year).
- Learn the real GDP formula: real GDP = (nominal GDP / price index) x 100, using the GDP deflator as the price index.
- Learn how an index number is constructed: choose a base year, set it to 100, then express every other year as a percentage of the base year value.
- Practise converting a percentage change into an index number and back, and calculating a percentage change between two years using index numbers.
- Learn the UK's main headline measures: real GDP growth (economic growth), the CPI/CPIH and RPI (inflation), the Labour Force Survey unemployment rate and the claimant count (unemployment), and the current account balance (external performance).
- For any data-response question, always state whether a change is nominal or real, and convert to real terms (or use a given index) before comparing across years.
- Evaluate the limitations of a headline measure, e.g. GDP ignores the informal economy, income distribution and negative externalities, while CPI uses a basket that may not match every household.
Worked example
A country's nominal GDP was 400bn in Year 1 and 440bn in Year 2. The GDP price deflator (Year 1 = 100) was 100 in Year 1 and 108 in Year 2. Calculate real GDP in Year 2 in Year 1 prices, and the real percentage change in GDP between Year 1 and Year 2.
- Real GDP in Year 1 equals nominal GDP in Year 1, since the deflator is 100 in the base year: 400bn.
- Real GDP in Year 2 = (nominal GDP / price index) x 100 = (440 / 108) x 100.
- Calculate: 440 / 108 = 4.074 (to 3 decimal places), then x 100 = 407.4bn (to 1 decimal place).
- Find the percentage change in real GDP: (407.4 - 400) / 400 x 100.
- Calculate: 7.4 / 400 x 100 = 1.85%, so real GDP grew by approximately 1.9% between Year 1 and Year 2, even though nominal GDP grew by 10%.
Practice questions
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Q1What does CPI stand for?Show answer
Answer: Consumer Prices Index.
Q2State one difference between the CPI and the RPI as measures of inflation.Show answer
Answer: The RPI includes housing costs such as mortgage interest payments and council tax, which the CPI largely excludes, and the two use different formulae, so the RPI tends to give a higher reading (known as the formula effect).
Q3A price index is 100 in the base year and 115 four years later. What is the percentage change in prices over the four years?Show answer
Answer: 15 percent - a rise from 100 to 115 is a 15 percent increase.
Q4Name the two main UK measures of unemployment.Show answer
Answer: The claimant count (people claiming unemployment-related benefits) and the Labour Force Survey/ILO measure (a survey of people who are jobless, actively seeking work and available to start).
Q5If nominal GDP rises but the price level rises faster, what happens to real GDP?Show answer
Answer: Real GDP falls, because output measured in constant prices has fallen even though the money value of output has risen.
Q6Why do economists prefer to use real GDP rather than nominal GDP to compare living standards over time?Show answer
Answer: Because real GDP removes the effect of inflation, so changes reflect actual changes in the volume of goods and services produced rather than just rising prices.
Q7Give one limitation of using real GDP as a measure of a country's living standards.Show answer
Answer: It ignores how income is distributed, so a rise in GDP could mask rising inequality; it also excludes non-market activity and negative externalities such as pollution.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
A country's price index was 100 in 2020 and 106 in 2021. Its nominal GDP was 500bn in 2020 and 520bn in 2021. Calculate the real GDP in 2021 in 2020 prices, and state whether real GDP rose or fell between 2020 and 2021.
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Assess the reliability of real GDP as a measure of a country's macroeconomic performance.
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