UNIT 6

ECONOMIC INDICATORS

The retail price index

Average prices are measured by governments using the Retail price index or Consumer price
index.

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of
a basket of consumer goods and services, such as transportation, food and medical care. It is
calculated by taking price changes for each item in the predetermined basket of goods and
averaging them.

CPI may also be defined as a measure of changes in the purchasing-power of a currency and the
rate of inflation. The consumer price index expresses the current prices of a basket of goods and
services in terms of the prices during the same period in a previous year, to show effect of
inflation on purchasing power.

Use of price indices:

1. As an economic indicator – it is used as an indicator of inflation

2. As a price deflator – rising prices reduce the purchasing power of money. CPI is used to
deflate various economic series (eg. Real value of earnings) to calculate their real or
inflation free value.
3. Indexation – it involves tying certain payments to the rate of increase in price inflation to
keep their real value constant. Eg. Pensions.

Problems with price indices :

Price indices are based on the basket of goods and services a typical household consumes.
Problems occur when over a period of time there are

 Changes in Tastes and fashions

 Introduction of new goods
  Composition of population changes

Inflation : It is a persistent or sustained rise in the general prices over a period of time.

Inflation may also be defined as a quantitative measure of the rate at which the average price
level of a basket of selected goods and services in an economy increases over a period of time.
Often expressed as a percentage, inflation indicates a decrease in the purchasing power of a
nation's currency.

Weighting: It is a figure given to a category of goods according to the percentage of a typical

household’s income that is spent on it.

Calculating average price changes: It will give the rate of inflation. It involves two sets of data

1. The price data

2. The weights

To find the average change in price, we need to take account of each of the items’ price changes
in terms of how much consumers spend on that item (weight).

Problems involved in using a price index :

1. The index doesn’t necessarily show how price changes affect typical consumers.
2. Index makes comparison with a base year (specially if prices were very low or high, it
influences results)
3. Some items like fuel are subject to lot of variations
4. Reliability of index relies on accurate gathering of data

Causes of inflation

1. Cost push factors: As cost rises, business will push them to consumers in the form of
increased prices
a. Food costs – Rising population, use of cereals as alternative fuel has put pressure
on demand of food, hence increasing its price.
b. Raw material costs – eg. Steel, copper, oil, gas
 c. Wage costs – increased food costs lead to demand for higher wages
d. Land costs – Agricultural land increasingly used to meet housing needs
e. Exchange rate costs – changes in exchange rates affect business costs
2. Demand pull inflation: It occurs when rising demand pushes up the price of goods. This
happens when people have more to spend, most likely when economy is near full
employment.

Consequences of inflation

 Mild inflation (1-2%) is not harmful as it encourages producers to supply more to the
market and help to increase profits.
 High inflation can disrupt economic decision making as it becomes to do planning with
constantly rising prices

Benefits of low and stable inflation (1-3%) :

1. Low inflation encourages consumers to buy goods sooner than later

2. Low inflation makes it appealing to borrow money as interest rates are also usually low
during periods of low inflation
3. Increased borrowing by businesses will enable higher rates of economic growth in the
economy
4. Low inflation helps reduce the workers demand for higher wages
5. Exports from the country that has lower inflation will be more competitive
6. Low inflation creates a certain business environment, enabling firms to increase
production by making investments

Effects of inflation on :

 Low income households : They can afford fewer goods, standard of living goes down
 Fixed income (like pensioners) : There is a fall in real income, can afford to save less as
they have to spend greater proportion of their income
 High income : There is less income to spend on Luxury items. They may also save less
and spend more
Who loses out in a period of inflation?

1. The poor – Can afford to consume fewer goods, standard of living goes down
2. People on fixed income
3. Savers – During a period of inflation, savings lose their value
4. Businesses – Inflation hampers economic planning

The costs of inflation to an economy :

1. It imposes additional costs on firms (eg. Printing new price list, putting surcharges on
customers)
2. It reduces the competitiveness of exports
3. It creates economic uncertainty (firms uncertain about costs in future, reluctant to invest)

Deflation : It refers to a general fall in the level of prices.

It is a decrease in the general price level of goods and services. Deflation occurs when
the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value
of currency over time, but deflation increases it. This allows one to buy more goods and services
than before with the same amount of currency. Deflation is distinct from disinflation, later being
a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.

Deflation happens when prices fall because the supply of goods is higher than the demand for
those goods. This is usually because of a reduction in money, credit or consumer spending.

 Fall in consumer spending

 Fall in demand for goods and services
 Fall in prices
 Harmful for economy – businesses make less profits, lay off workers, unemployment
increases, income falls, GDP falls and so on.

The consequences of deflation:

1. Consumers delay spending in expectation of further price falls

 2. Stocks of unsold goods accumulate, firms cut their prices and this reduces profits
3. Firms cut their production, reduce employment
4. With rising unemployment, household incomes fall. This further reduces demand of
goods.
5. Value of debts held rise in real terms as prices fall
6. Firms stop investing in new plant and equipment. This reduces economic growth.
7. Tax revenues fall
8. Eventually economy goes into deep recession. Many firms shut down, unemployment
rises.

Govt policy to deal with deflation :

1. Cut interest rates to induce borrowing (for spending and investment)

2. Print more currency to pump more money into the economy
3. Expansionary fiscal policy – involving tax cuts, which increase disposable income and
may lead to increase in demand

Patterns and levels of employment

Participation rate = number who are prepared to work/number within working age range

Participation rate varies from country to country due to :

1. Social attitudes (women working)

2. Number going to school and university
3. Age at which people retire
4. Facilities enabling disabled or disadvantaged to work

Industrial structure is split in

1. Primary or extractive industries

2. Manufacturing and construction industries
3. Services industries
Causes of unemployment

Unemployment occurs when a person who is actively searching for employment is unable to find
work. Unemployment is often used as a measure of the health of the economy. The most
frequent measure of unemployment is the unemployment rate, which is the number of
unemployed people divided by the number of people in the labor force.

Unemployment is defined by the Bureau of Labor Statistics as people who do not have a job,
have actively looked for work in the past four weeks, and are currently available for work. Also,
people who were temporarily laid off and were waiting to be called back to that job are included
in the unemployment statistics.

Who suffers from unemployment? :

1. People who are unemployed – suffer poverty, etc

2. The communities in which they live – fewer facilities as people can’t afford, social unrest
3. Businesses - reduced sales of businesses, ripple effect
4. The govt – loses tax revenue, have to increase payments to unemployed. Even required to
increase govt spending.
5. The economy – rising unemployment has a downward effect on the trade cycle.

Imperfections in the labour market (that may disrupt free play of market forces)

1. Powerful trade unions may force up wages (higher wages may lead to reduced
employment)
2. Unemployment benefits may reduce incentive to work
3. Other employment costs can reduce the demand for labour (taxes, contribution to CPF)
4. A lack of information can prevent people from finding jobs
5. Minimum wage legislation may reduce labour demand
6. Labour immobility prevents workers from finding new jobs
Gross Domestic Product

GDP is a measure of the total value of goods produced in an economy in a particular period.

Measuring GDP:

1. The output method is also called the “net product” or “value added” approach. The output
approach focuses on finding the total output of a nation by directly finding the total value
of all goods and services a nation produces.
2. The expenditures approach says GDP = consumption + investment + government
expenditure + exports – imports.
3. The income approach sums the factor incomes to the factors of production. (adding
together all the incomes earned for producing outputs are included)

Real GDP : It is a macroeconomic measure of the value of economic output adjusted for price
changes (i.e. inflation or deflation). This adjustment transforms the money-value measure,
nominal GDP, into an index for quantity of total output.

Using GDP statistics:

1. Govt gets better information about allocation of resources, kind of goods produced. It
helps them make better decisions on economic policies (eg. taxes, subsidies to be
provided)
2. It allows comparison in standard of living from one year to another
3. It allows inter-country comparison of standard of living, even within different regions of
one country.

Economic growth :

Economic growth is an increase in the capacity of an economy to produce goods and services,
compared from one period of time to another. It can be measured in nominal or real terms, the
latter of which is adjusted for inflation.

It can be represented on a PPC by an outward shift in the frontier.

How economies grow:

1. The discovery of more natural resources

2. Investment in new capital and infrastructure
3. Technical progress
4. Increasing the amount and quality of human resources
5. Reallocating resources (moving resources from less-productive to more-productive uses)

Negative growth: Sometimes economies can experience negative growth indicating real output
is shrinking. It means fewer goods and services are being produced, standard of living of many is
falling. This may happen during periods of economic recession.

Economic cycle:

The economic cycle is the natural fluctuation of the economy between periods of expansion
(growth) and contraction (recession). Factors such as gross domestic product (GDP), interest
rates, levels of employment and consumer spending can help to determine the current stage of
the economic cycle.

Typically, an economy passes through four phases during one complete economic cycle:

1. Growth (or expansion)

 Rapidly expanding economic activity
 Increased sales and profits
 New business organisations are formed
 Output, income, employment grow
2. Economic boom (peak)
 Aggregate demand, sales and profits peak
 Demand exceeds supply
 Economy ‘overheats’
 May experience rapid inflation
 Unemployment is low
  Govt may raise interest rates to control inflation
 Due to inflation and high interest rates, consumer confidence may begin to
decline
3. Economic recession (or downturn)
 General slowdown in economic activity
 Economic growth may turn negative
 Demand may begin to fall
 Sales and profit decline
 Firms cut production, employment falls
 Rising unemployment, falling incomes reduce aggregate demand
 Rate of inflation declines (disinflation)
 Govt may cut interest rates, cut taxes, increase govt spending to counter recession
 May lead to deflation
4. Economic recovery (or upturn)
 Business and consumer confidence starts to recover
 Spending begins to rise
 Firms increase their output, employment rises
 Unemployment falls, incomes rise
 Economy starts to expand again

Comparing living standards

Standard of living is the level of wealth, comfort, material goods and necessities available to a
certain socioeconomic class or a certain geographic area.

Criticisms of using GDP as an economic indicator:

1. It doesn’t take into account inequality in society

2. GDP simply measures the value of goods produced, but don’t take any harmful effects it
may have on society
3. GDP not good measure for making comparisons between countries
 4. Standard of living (quantity of goods and services) is not the same as quality of life
(feeling of happiness, stress free life, pleasant climate)

Human development index

HDI is a broader method of measuring quality of life. It contains three elements

1. Standard of living (GDP per head)

2. Life expectancy at birth
3. Education
a. Adult literacy
b. Primary, secondary and tertiary enrolment in education

Using HDI, countries are ranked n following categories:

1. Very high (Norway, Australia, Singapore)

2. High (Bahrain, Poland, Argentina)
3. Medium (Thailand, Jamaica)
4. Low (Niger, Senegal)

Criticism of HDI :

 Fails to take into account the impact of economic growth on the environment
 Concentrates on too narrow range of indicators (health, education)

Human Poverty Index (HPI) is an alternative way of looking at development. It was developed
by United Nations as a useful way of measuring human deprivation.

It includes indicators like –

 Proportion of population living below poverty line, and

 Rate of unemployment