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Economic Performance

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Economics

Have you ever wondered why some countries have a better economic performance than others? What are the factors that determine a country’s economic performance?

Economic performance is the achievement (or failure to achieve) of economic policy objectives.

Evaluating economic performance

Economic performance refers to how an economy is prospering. As stated above, we can typically assess it in terms of the achievement of economic policy objectives. The objectives are goals set by governments to improve the economic situation of their countries. Economists determine economic performance by the success or failure in achieving those goals.

A government usually has four macroeconomic policy main objectives:

Stable economic growth

Economic growth relates to an increase in the productive potential of an economy. It is both an increase in the potential level of output that the economy can produce and an increase in the income of citizens of a country. The economic growth should be stable as rapid growth may result in issues such as inequality, inflation, current account deficit, and environmental pollution.

Rapid economic growth in Asian countries such as China and India resulted in common problems such as the widening rural-urban income gap and environmental degradation.

Low unemployment

Low unemployment refers to a lower number of economically inactive people. Economists define the economically inactive population in the UK as the unemployed who have not been looking for work within the last four weeks and/or are not able to start work within the next two weeks. If the unemployment increases, the government typically failed in achieving the objective of low unemployment. However, each country can set its own unemployment rate target which is around 3% in the United Kingdom.

The unemployment rate in Lesotho was 22.5% in 2010. This was coupled with high inequality and strong poverty.

Inflation is the increase in the average prices in an economy. If the inflation is high, this can be destabilising for the economy. Even if there is a positive rate of inflation, which is not rising in itself, the prices continue to rise every period. This means that people’s real incomes erode as they don’t necessarily increase with inflation making them unable to afford what they could afford before.

Inflation shouldn’t only be low but also stable as agents make projections about future inflation. If it goes out of control, they will not base their expectations on the stable rate set by a country’s central bank. As expectations about inflation lead to actual inflation in the economy, this can lead to an inflationary spiral where people’s incomes erode and they become poorer in real terms. This contradicts the objective of increasing the standard of living.

High and rapid inflation in Venezuela that began in 2016 forced domestic companies out of business, leading to a lack of products in shops and massive emigration.

The Bank of England sets the inflation target rate at 2% in the UK.

Satisfactory balance of payments

The balance of payments is a record of every transaction in an economy. It measures money flowing into and out of an economy in a specified period of time. A satisfactory balance of payments typically means that there are more inflows than outflows.

However, a large surplus may be destabilising too. A large surplus in the Balance of Payments means a large deficit in another country. That is why economists widely agree that an equillibrated balance of payments or small and sustainable deficits/surpluses are more desirable.

In 2020, the United States had the world’s largest current account deficit, at $647 billion, whereas China had the world’s largest surplus, at $274 billion.

Governments can set secondary macroeconomic objectives suitable to their needs depending on a country’s economic situation. These are some examples:

  • Balancing the budget: a budget is balanced when government expenses equal government revenues. Some governments such as the UK and the USA run budget deficits because they spend more than they earn.
  • Economic development: economic development refers to a standard of living in a particular country. Many African countries such as Sudan and Zambia are less developed and the living standards there are very poor.

It’s important to note that the achievement of any of the main objectives may lead to trade-offs between them. The government needs to balance attainment of the various objectives in the short and long-run. In addition, the achievement of the main objectives may contradict the achievement of the secondary objectives. Thus, a government’s emphasis on various objectives varies over time.

Economic performance indicators

Economists measure economic performance through economic performance indicators. Similarly to the objectives of a government’s macroeconomic policy, there are four main economic performance indicators:

Economic growth

Economic growth is an increase in the productive potential of an economy. It is an increase in the potential level of real output an economy can produce in a specified period (typically one year) compared to another period. Therefore, it is strictly related to GDP and GNI.

GDP (gross domestic product) is a monetary measure of the market value of all the final goods and services produced in an economy in a specific period. It considers factors such as consumption, investment, government spending, exports and imports. There are two sub-categories of GDP:

1. Real GDP: GDP adjusted for price changes (inflation.)

2. Nominal GDP: GDP not adjusted for price changes (inflation.)

GDP = Consumption + Investment + Government Spending + Net Exports

Net Exports is a value of total exports minus the value of total imports.

GNI (gross national income) measures the total amount of money earned by people and businesses in an economy. Compared to the GDP, it measures a nation’s wealth in a specific period.

GNI = GDP + Net Income from abroad

Employment and unemployment

Employment refers to economically active people whereas unemployment refers to those who are economically inactive.

Full employment occurs when the number of workers willing to work equals the number of workers needed.

The unemployment rate measures unemployment. In the UK, the two unemployment measures are the Claimant Count and the LFS (Labour Force Survey).

The unemployment rate measures the number of unemployed people in relation to the economically active population.

Inflation and deflation

Inflation is a consistent or continuing increase in average prices and a decrease in the purchasing power of money. It is the opposite of deflation: a decrease in the price levels and an increase in the purchasing power of money.

When the inflation rate is falling, but still positive, this is called disinflation. The stability of inflation can be determined by the inflation rate, which is the percentage change of the average prices in a specified period (typically one year.) The inflation measure used in the UK is the CPI (Consumer Price Index.)

Balance of payments

The balance of payments is a record of all transactions made within an economy. It measures money flowing into and out of an economy in a specified period.

Balance of payments = money inflows/money outflows.

Three sub-accounts make up the balance of payments:

  • Current account measures the monetary value of imports and exports. It includes transactions around a country’s capital markets, industries, services, and governments.

  • Capital account measures the national ownership of assets and liabilities. It includes the sources of capital and its utilisation.

  • Financial account measures the monetary movements into and out of the country. A positive figure represents an inflow and a negative figure indicates an outflow.

Imports: goods and services produced by other countries outside the UK and sold to residents of the UK.

Exports: goods and services produced in the UK and sold to residents of other countries outside the UK.

Evaluating the UK’s economic performance

Based on the economic performance indicators mentioned above, we can evaluate the economic performance of the United Kingdom. Below you will find statistics regarding:

  • Economic growth
  • Employment and unemployment
  • Inflation and deflation
  • Balance of payments

Economic performance UK economic growth StudySmarterUK’s GDP, 2010–20 - StudySmarter Originals. Source: UK Office for National Statistics - ons.gov.uk.

As you can see on the graph above, the GDP of the United Kingdom in 2010 equalled just above £1,800,000 million and then it increased to almost £2,300,000 million in 2019. Those nine years were a period of continuous economic growth. Unfortunately, due to the Covid-19 Pandemic, the GDP rapidly decreased to just above £2,000,000 million in 2020.

Economic Performance Uk unemployment rate StudySmarterUK’s unemployment rate, 2010–20 - StudySmarter Originals. Source: UK Office for National Statistics - ons.gov.uk.

As you can see in the graph above, the unemployment rate in the United Kingdom in 2010 was around 8% and then it gradually decreased to just under 4% in 2019. Over those nine years, the UK’s unemployment rate decreased by over 50%. Unfortunately, similarly to the GDP, Covid-19 worsened the situation and caused a rise in the unemployment rate to 4.5% in 2020.

Economic Performance Uk Inflation Rate StudySmarterUK’s inflation rate, 2010–20 - StudySmarter Originals. Source: UK Office for National Statistics - ons.gov.uk.

As you can see in the graph above, the highest inflation rate in the given period occurred in 2011 and equalled almost 4%. Afterward, it decreased steadily to less than 0.5% in 2015. Later on, it increased and decreased again, arriving at 1% in 2020. The inflation rate in the UK has not been particularly stable, but since 2012 it did not reach more than around 2.5%, which is relatively low compared to past years.

Economic Performance UK Balance of Payments StudySmarterUK’s BoP current account, 2010–20 - StudySmarter Originals. Source: UK Office for National Statistics - ons.gov.uk.

As you can see above, the UK’s balance of payments on the current account in the given period was always in the red. A relatively good situation occurred in 2011 when the balance equalled a negative of £30,000 million. Similarly to the inflation rate, after 2011 the balance of payments worsened reaching around -£110,000 million in 2016. Afterward, it fluctuated and reached a little bit less than -£50,000 million in 2020. All in all, although for over half of the given period the UK’s balance of payments on the current account was lowering, after 2016 it started to recover. This can be regarded as a success in achieving a satisfactory balance of payments.

Considering all the statistics that you just saw, think about the overall economic performance of the United Kingdom between 2010 and 2020: was it good, bad, or moderate? Why?

Economic Performance - Key takeaways

  • Economic performance describes the achievement of economic objectives.

  • The economic policy objectives are goals set by governments to improve the economic situation of their countries.

  • The main four economic objectives are growth, low unemployment, low and stable inflation, and a satisfactory balance of payments.

  • Other economic objectives are balancing the budget and economic development.

  • We can measure economic performance by using economic performance indicators such as economic growth, employment and unemployment, inflation and deflation, and the balance of payments.

Economic Performance

Economic performance is important because it indicates if an economy is prospering or not. It measures the degree to which a government achieves its economic policy objectives.

The main economic performance indicators are economic growth, employment and unemployment, inflation and deflation, and balance of payments.

Inflation states whether the increase/decrease in average prices is not too high/low and whether a decrease/increase in the purchasing power of money is too low/high.

Final Economic Performance Quiz

Question

What is the definition of inflation?


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Answer

The progressive increase in prices of goods and services in an economy.


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What are the key types of inflation?


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Answer

Demand pull-inflation and cost-push inflation.

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What is cost-push inflation?


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Cost-push inflation arises due to issues in the supply-side of the economy. It can occur due to the increased union power in the wage bargaining process, or through an increase in either

commodity and energy prices.

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What is the definition of deflation?


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Answer

Deflation is the opposite of inflation. It means that prices of goods and services in an economy fall. 


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What are the key methods used to calculate inflation?


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Answer

Retail price index (RPI) and Consumer price index (CPI).


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Is the retail price index (RPI) method used currently?


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No, it was only used until 2003.


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What is CPI in economics?


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CPI means consumer price index. The CPI method is used to calculate the rate of inflation of the ‘national shopping basket,’ which includes the essential consumer goods.


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What is the main cause of demand-pull inflation? 

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Answer

An increase in the aggregate demand.

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What are the main causes of cost-push inflation?


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Cost-push inflation arises due to issues in the supply-side of the economy such as:

  • Increased union power in the wage bargaining process or
  • Increase in either commodity or energy prices.

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Question

What is stagflation?


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Stagflation is an economic situation that describes a period of slow economic growth, rising unemployment, but also rising inflation.

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What are the main causes of deflation?


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The main causes of deflation are:

  • Shortages of money supply in the economy.
  • The imbalance of supply and demand. The supply is higher than demand. 
  • A sudden increase in productivity influenced by the improvements in technology which makes costs of production less expensive.


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Question

What are the main consequences of inflation?


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The main consequences of inflation are:

  • Decrease in consumer purchasing power.
  • Making debt repayments cheaper for the consumers.
  • If prices of goods increase faster than consumers’ incomes it makes consumers less wealthy.
  • The business may make cuts in employees, due to increased labour costs.
  • An increase in employees' wages result in higher costs of production.
  • Decrease in demand for exports.


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Question

What are the main consequences of deflation?

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Answer

The main consequences of deflation are:

  • Decrease in consumer spending.
  • Decrease in prices of goods along with employees' wages.
  • Causes an overall slowdown in the economy.


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Question

Can you give a real-world example of how inflation was caused?


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For example, the oil prices increased significantly during 2008 and 2011-12, which influenced inflation in the UK. How did that happen? The higher oil prices caused plastic manufacturing costs to increase. Due to this, the plastic production companies passed increased prices of plastic goods onto consumers, and this caused inflation of goods containing plastic. 

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Question

What is the key method used to control inflation?


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Answer

Although there are various ways to control inflation, Monetary Policy is the main tool as it involves the manipulation of the interest rates.

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Question

What are the key methods used to control deflation?


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The key method used to control deflation are:

  • Fiscal policy, which is used by the government to increase spending and escalate the aggregate demand.
  • Monetary policy, used by the central bank to lower the reserve limits and generate more loans for investments and consumption.


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 What is disinflation?


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Disinflation occurs when the rate of inflation is decreasing, in other words, the prices are rising at a slower rate. This applies to a positive inflation rate only.

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Question

Name the four basic components of the current account.

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Answer

Trade-in goods, trade-in services, primary income, and secondary income.

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Under which part of the current account does the remittance fall?

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Secondary income

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Question

What is the natural rate of unemployment?

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The natural rate of unemployment is the lowest unemployment rate that occurs when demand and supply for labour are at the equilibrium rate.

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What types of unemployment does the natural rate of unemployment consists of?

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The natural rate of unemployment consists of two types of unemployment: frictional and structural.

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What does frictional unemployment mean?

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Frictional unemployment indicates a period of unemployment during which people are looking for work.

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What is structural unemployment?

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Structural unemployment means that people are unemployed because they do not have the skills that are needed in the current market, and that there are too many job seekers compared to the jobs available.

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Question

Can the unemployment rate ever be at 0% rate?

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Answer

No, the unemployment rate can never be at a 0% rate. This is due to factors such as the unemployment of recent university graduates and people’s lack of skills required in the current labour market.

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Question

What is the name of the lowest rate of unemployment that can occur in the economy?


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The natural rate of unemployment.

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What is the difference between the natural rate of unemployment and the actual rate of unemployment? 


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The actual rate of unemployment includes both the natural rate of unemployment and the cyclical rate of unemployment.

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What is the cyclical rate of unemployment?


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Cyclical unemployment is the unemployment caused by business cycles. For example, if there is an economic recession the unemployment rate will increase. But if the economy grows, the unemployment rate will decrease.

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What are the main causes of natural unemployment rate?


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Answer

The main causes of the natural rate of unemployment are:

  • Changes in labour force characteristics.
  • Changes in labour market institutions. 
  • Changes in government policies.

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Question

How do the changes in the labour force characteristics affect the natural rate of unemployment?


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Answer

With the increase in skilled and experienced labour, the natural rate of unemployment is likely to decrease. This is because skilled labour is able to perform more tasks on the current labour market than inexperienced labour.  

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Question

 How do the changes in government policies influence the natural rate of unemployment?


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Answer

Government policies such as increasing the minimum wage can increase the natural unemployment rate.  Due to the higher staff costs, it may become expensive for businesses to keep a lot of employees, therefore companies may lay off some of the employees or will hire fewer workers than previously. On the other hand, policies such as the introduction of employment training can help people to acquire skills that are needed in the current labour market, thus the natural rate of unemployment will decrease.

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Question

What type of policies does the government use to reduce the natural rate of unemployment?


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The government uses supply-side policies.

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Question

 What are the key types of supply-side policies that are used to reduce the natural rate of unemployment?


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The key types of supply-side policies are:

  • Improving education and employment training. 
  • Making relocation easier for both labour and companies.
  • Introducing policies that allow to hire and fire workers more easily. 
  • Reducing minimum wage and trade union power.
  • Reducing welfare benefits.


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Question

How to calculate natural unemployment?

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Answer

To calculate natural unemployment you need to add frictional and structural unemployment together.
It should look like this:

Frictional unemployment + Structural unemployment = Natural employment 

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Question

How to calculate the natural unemployment rate?


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Answer


  1. Frictional unemployment + Structural unemployment = Natural employment 
  2. (Natural unemployment/ Total unemployment) X 100 = Natural rate of unemployment

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Question

Define financial accounts.

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Answer

Financial accounts are the records of financial transactions across countries between its residents and non-residents. The financial transactions result in a change of ownership of financial assets or liabilities.

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Question

State the three components of financial accounts.

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Answer

Long-term direct investments, long-term portfolio investments, and short-term ‘hot-money’ capital flows. 

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 ______________________ involve the acquisition of different physical assets in other countries. 

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Long-term direct investments

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_________________ involve the purchase of securities issued by foreign governments or shares from companies abroad.


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Long-term portfolio investments

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What are capital accounts?


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Answer

It is the part of the Balance of Payments that records all international transactions of the country. They also help in understanding the country’s relative level of economic stability or future stability and identify whether the country is a net importer or exporter. 

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Question

Define economic performance.

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Answer

Economic performance is the achievement of economic policy objectives. 

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Question

What are the four main objectives of a government’s macroeconomic policy?

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Answer

  • Stable economic growth
  • Low unemployment
  • Low and stable inflation
  • Satisfactory balance of payments

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Question

Why should economic growth be stable?


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Answer

The economic growth should be stable as rapid growth may result in issues such as inequality, inflation, current account deficit, and environmental pollution.

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Question

What is the economically inactive population?


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Answer

The economically inactive population in the UK is the unemployed who have not been looking for work within the last four weeks and/or are not able to start work within the next two weeks.

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Question

What happens to people’s real incomes when prices rise?


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Answer

People’s real incomes erode as their incomes do not necessarily rise by the same amount. They are able to afford less and less.

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What is the balance of payments?

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Answer

The balance of payments is a record of all transactions made in an economy. It measures money flowing into and out of an economy in a specified period.

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Question

Besides the four main economic objectives, what other objectives can governments set?


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Answer

Balancing the budget and economic development.


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Question

What is economic growth?

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Answer

Economic growth is an increase in the productive potential of an economy. It is an increase in the potential level of real output an economy can produce in a specified period (typically one year) compared to another period.

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Question

What is the difference between GDP and GNI?


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Answer

GDP (gross domestic product) is a monetary measure of the market value of all the final goods and services produced in the economy in a specific period whereas GNI (gross national income) is a measure of the total amount of money earned by people and businesses in an economy. Compared to GDP, GNI measures a nation’s wealth in a specific period and is calculated by adding GDP and income from abroad.

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Question

What are the two unemployment measures in the UK?

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Answer

Claimant Count and LFS (Labour Force Survey.)

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Question

What is full employment?


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Answer

Full employment occurs when the number of workers willing to work equals the number of workers needed.

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