Measuring Economic Performance

Economic performance needs to be measured in practice otherwise….

How will we know how close the government and central bank have stuck to their objectives? Moreover, how will people be better informed to solve the economic problem of resource allocation

Whether it be an investor, a worker looking to back a trade union boss or a bum off the street, these figures of GDP growth, inflation etc are of some value to everyone as they allow people to make better informed and more planned decisions….

So let’s get stuck in! The main focus here will be:

Inflation

Remember, this is the main policy focus of most central banks, particularly the BoE and European Central Bank.

Figures are published monthly and are annualised.

So that means when you see a news article saying  inflation has risen 4.2% in June it does not mean prices have risen 4.2 % in one month. That’d be a yearly rate of 64%! Mental.

Anyway, there are two main ways it’s measured…….

Consumer Price Index(CPI)

Takes the price changes of a basket of consumer goods…

Uses the Household Expenditure Survey and weights each good accordingly. All goods which correspond to less than 1% of total expenditure are excluded, until a few are selected by a panel which should be included.

The sample is meant to represent the cost of living for the everyday Joe Bloggs, and does include consumers in institutions. To avoid skewing the average two groups are excluded:

  1. Households in the top 4% of earners
  2. Households with state pension+benefits being 75+% of income
So if Bugatti won’t let their new supercar go for less than £1m, or there is a shortage of escargot the CPI won’t be affected…

Retail Price Index(RPI)

The government surveys 60000 people via the Expenditure and Food Survey to see the various components of their spending. They then build ‘a basket of goods’, seen as the average households costs, and tracks price changes in those goods.

RPI includes mortgage and other interest payments. It is used by the government in the UK for adjusting welfare benefits in line with inflation.

Weighting is important, and difficult to do on a large scale. The index is more sensitive to price changes of the goods most frequently bought and vice versa.

How Do You Do Weighting?You take each good recorded on the survey as a percentage of expenditure. You then multiply each good by the % of spending it recieves. Add all of those figures together and then divide the whole lot by 100.

Example: So if we have two goods, phones at £50 and glasses £10 which are 60%,40% of spending. Multiply price of phones, £50 by 60 to get £3000. Do same with glasses, £10 multiplied by 40 for £400. Total is £3400.

Average price level found by £3400/100, £34 per good.

Other Measures of Inflation

RPIX

Is the retail price index but excluding changes in mortgage interest payments. It is felt that interest on repayments should not be a part of inflation.

RPIY

Adjusts the prices of goods for taxes and subsidies which has been imposed on them.

So we can take off excise duties and VAT, and just account for the factors of production’s share of earnings per good.

Difficult to calculate in most cases because when we think of gross value added by factors of production, how does direct and indirect taxes on labour, components and materials excise duties and more affect the final goods price?

Why Hyperinflation is Bad

The legendary boxing trainer Cus D’Amato once said that fear is like fire, and the same can be thought about inflation….

A little is good and necessary. When it’s out of control it’s devastating.

Inflation can in fact devastate an economy when it gets up in the figures of ‘hyperinflation’, academically defined as prices rising at a rate of 50% per month.

Here’s how:

Shoe Leather Costs

When prices surge uncontrollably, people become less aware of what a good price is for a product. They then have to spend more time ‘shopping around’ , thus wearing out their shoe leather round the malls and markets.

Nowadays though price information can be obtained instantly on the internet, making it less of an issue…

Menu Costs

Another strange, academically correct name.

Because prices change frequently, shop owners have to consistently reprice their stock, taking up time and using resources when it has already been priced. Restaurant owners have to replace their menus.

Again, slightly less of an issue with the growth of e-business, but a major one in the high street…

Rising Inequality and Poverty

Unemployment

For ways of measuring, see the Unemployment page.

Standards of Living

As we can see in the Development Economics page, advances in purchasing power per person can be misleading. A higher level does not always mean better standards of living and welfare.

To give a better estimate, other indices are used.

Human Development Index (HDI)

Used worldwide as a better proxy to living standards. Uses

GDP per Head As purchasing power still has a strong correlation

Life Expectancy measured at birth. The better living standards, the longer people usually live considering healthcare and sanitation.

Literacy and Numeracy. Shows how eductated the workforce is. Goes hand in hand with the quality of government and inequality, as a high rate means that the wealth is likely to be shared out amongst competent workers.

Check out the world order in Human Development here: http://hdr.undp.org/en/statistics/

Human Poverty Index (HPI)

Looks at how many citizens are below the poverty line, used by the United Nations.

Happiness Index

Used in Scandinavian economies and others, basically a survey seeing the contemptment of people. Based on how they find their job, commute, government services and more.

One Response to Measuring Economic Performance

  1. Pingback: Thinktank « Zahablog's Economic Page

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