6 The measurement

of macroeconomic
performance
The national economy in a global
environment
 6.1
1.1 The
Theobjectives
nature andofpurpose
government
of business
economic policy
This section will develop your knowledge and understanding of:
➔ the main objectives of government macroeconomic policy: economic growth, price stability,
minimising unemployment and a stable balance of payments on current account
➔ conflicts that might arise when attempting to achieve these objectives
➔ how the importance attached to the different objectives will affect the policies adopted by the
government.

This chapter and the chapters that follow are about macroeconomics.
Key terms Macroeconomics looks at the economy as a whole, rather than
Macroeconomics: the study of the individual markets. For example, macroeconomists are interested in
economy as a whole. what determines the total output of the economy rather than what
determines the output of a particular industry. They try to explain why
Policy objectives: what the the average price of all goods and services changes rather than what
government is trying to achieve, or determines the price of one good or service. Macroeconomics studies
its aims. the aggregate or total values of variables such as unemployment,
output, consumption, investment and exports.
Fiscal policy: the use of government
spending and taxation to influence
the economy and help the The main macroeconomic policy objectives
government achieve its objectives. The objectives, or aims, of government economic policy are what the
government is trying to achieve. Governments have microeconomic
Monetary policy: the use of
and macroeconomic policy objectives. It is not always easy
interest rates, the supply of money
to distinguish between microeconomic and macroeconomic
and the exchange rate to influence objectives partly because changes to the microeconomy can affect
the economy and help the macroeconomic performance and the macroeconomy often affects
government achieve its objectives. what is happening in individual markets.
Supply-side policies: measures to Most governments have four main macroeconomic policy objectives.
increase economic incentives, make They are to:
markets work better and increase the
productive capacity of the economy. • achieve a satisfactory rate of economic growth
• keep prices stable
Policy instruments: tools the
• keep unemployment low
government can use to help it
achieve its objectives. • have a stable balance of payments on current account.
Governments have a variety of policies they can use to achieve their
Economic growth: the rate at aims, including fiscal policy, monetary policy and supply-side
which the total output of all goods policies. Each of these policies has several policy instruments that
and services produced by an can be used to help the government achieve its aims.
economy is increasing.
Link
The instruments of government macroeconomic policy are explained in
Chapter 9 “Macroeconomic policy”.

Economic growth
Economic growth is the rate at which the total output of all goods
and services produced by an economy is increasing. If total output
▲ Figure 6.1.1: Unemployment is a falls, the rate of economic growth is negative. It is usually expressed
waste of scarce resources

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 The objectives of government economic policy

as a percentage. For example, India’s economic growth was estimated

to be 7.8% in 2019. Achieving a stable rate of economic growth is a Key terms
fundamental macroeconomic policy objective because an increase in Standard of living: the ability of
output means more needs and wants can be satisfied. This should help people to satisfy their needs and
to improve the standard of living. wants, including health care and
education.
Link
Price level: the average price
Economic growth is discussed in more detail in 8.1 “Economic growth and the
of all goods and services in an
economic cycle”.
economy.
What is judged to be a satisfactory rate of economic growth for one Inflation: an increase in the price
country may not be acceptable for another country. In general, level.
what is viewed to be an acceptable rate of economic growth for an
already developed economy is usually lower than for a less developed
Deflation: a fall in the price level.
economy. Also, if a country’s population is growing rapidly, a higher Inflation rate: the percentage
rate of economic growth is needed to maintain living standards than increase in the price level.
for a country with a population that is only growing slowly.

Price stability Link

For most countries, having price stability as an objective means they
want to prevent the price level rising too fast and to avoid the price What determines living standards
level falling. The price level is the average price of all goods and is covered in the A2 part of the
services in an economy. A persistent rise in the price level is known course.
as inflation. A fall in the price level is known as deflation. Most
governments’ objective is to achieve a low, stable rate of inflation
rather than no change in the price level. In Vietnam, the target for the Link
inflation rate in 2019 was 4% and in South Korea it was 2%.
The effects of inflation and
High rates of inflation can be harmful for an economy as people have deflation are covered in the A2 part
to pay more for the things they buy and inflation can make exports of the course.
uncompetitive. Unstable prices make it difficult for economic agents to
plan and can damage an economy.
Key term
Low unemployment
Unemployment is the total number of people who are willing and
Unemployment: the number of
able to work but who cannot to find a job. In an economy where the people who are willing and able to
demand for different products is changing, some unemployment is work but who cannot to find a job.
unavoidable. The aim for most governments is to keep unemployment
as low as possible. Unemployment is a waste of scarce resources
and means the economy is producing fewer goods and services Link
than it could. More needs and wants could have been satisfied. The use of production possibility
Diagrammatically, unemployment can be illustrated by a point inside a
diagrams is explained in 1.4
country’s production possibility boundary (PPB).
“Production possibility diagrams”.
Unemployment is not only a waste of scarce resources, it also causes
other economic and social problems. People who are unemployed
for a long time may be unable to afford basic necessities and their Link
families may live in poverty. High levels of unemployment can lead to
an unequal and inequitable distribution of income. However, many The causes of unemployment are
people who lose their job soon find another job. It is not just the explained in 8.2 “Employment and
number of people who are out of work that matters, it is also for how unemployment”.
long they are unemployed.

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 6 The measurement of macroeconomic performance

The balance of payments on current account

The balance of payments records all the financial transactions
between one country and the rest of the world. The current account
is part of the balance of payments. For most countries, exports and
imports of goods and services are a large part of the current account
of the balance of payments.

Activities
▲ Figure 6.1.2: Exports and imports Identify four products that you or your family buys that have been imported
transported by ship from abroad.
1 In which country was each of these products made?
2 For each product, explain why you, or your family, bought a product made
abroad rather than from your own country.

A country has a balance of payments deficit when the value

Link of imports is greater than the value of exports and a balance of
What is included in the current account payments surplus is when the value of exports is greater than
is explained in 8.4 “The balance of the value of imports. Value means the total amount spent on either
payments on current account”. exports or imports. For most countries, their balance of payment on
current account is stable if they run either a small surplus or a small
deficit. However, some countries are able to run large surpluses or
Key terms deficits without any serious problems.
Balance of payments: a record of If a country has a large balance of payments deficit on current
a country’s financial transactions account, it is not earning enough money from its exports to pay
with the rest of the world. for the imports it is buying. This is likely to result in an increase in
borrowing from abroad so that it can get the foreign currency it needs
Exports: goods and services that to pay for its imports. It can also lead to a fall, or depreciation, in its
are sold to other countries. exchange rate, which makes imports more expensive. However, if
Imports: goods and services that the country is able to attract investment from foreign companies, or
are bought from other countries. if it receives foreign aid, a large current account deficit may not be a
serious problem, provided it does not last too long. A large surplus
Balance of payments deficit: can lead to a rise, or appreciation, in its exchange rate. This makes
when the value of imports is its products less competitive compared to foreign goods in both its
greater than the value of exports. home and export markets. As a result, there may be an increase in
unemployment.
Balance of payments surplus:
when the value of exports is Link
greater than the value of imports.
The effects of a balance of payments deficit or surplus on an economy are fully
Exchange rate: the price at which explained in the A2 part of the course. The effects of changes in the exchange
one currency can be converted rate are explained in 9.4 “Monetary policy”.
into another currency.

Progress questions
Get it right 1 What is meant by “an objective of economic policy”?
Do not confuse a balance of 2 What are the four main objectives of macroeconomic policy?
payments deficit with a budget 3 Explain the difference between macroeconomics and microeconomics.
deficit. The balance of payments 4 What is a policy instrument?
is about exports and imports. 5 What is meant by “economic growth”?
The budget is about government 6 What is meant by “inflation”?
spending and taxation. 7 What is a balance of payments deficit?

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 The objectives of government economic policy

Other macroeconomic policy objectives Key terms

Many governments will also have other macroeconomic policy
objectives and these may change over time. Examples of other policy Balanced budget: when
objectives include: government spending is equal
to the amount the government
• balancing the budget to prevent the national debt growing too fast receives from taxation.
• achieving an equitable, or fair, distribution of income
Budget deficit: when government
• protecting the natural environment.
spending is greater than the
amount the government receives
Balancing the government’s budget from taxation.
Some governments aim for a balanced budget to prevent the
national debt growing too fast. The national debt is the amount of Budget surplus: when the
money the government owes, it is the sum of past borrowing. The amount the government receives
government’s budget is concerned with government spending and from taxation is greater than
taxation. A balanced budget is where government spending equals tax government spending.
revenue. If the government has a budget deficit, where government
expenditure is greater than the money gained through taxation, it National debt: the total amount
will have to borrow. This will increase the national debt. A budget the government owes. It is the
surplus is where taxation is greater than government spending. The accumulated total of the amount
surplus can be used by the government to repay some of the money borrowed by the country’s
it owes. This will reduce the national debt. A balanced budget, or a governments in previous years.
budget surplus, often becomes a macroeconomic policy objective when It is the stock of outstanding
the country’s national debt has been growing quickly. For example, government debt.
the global financial crisis of 2007–2008, which led to a large increase
in the national debt of some countries, persuaded the governments of
several of these countries to aim to balance their budgets. Link
The government’s budget and the
Achieving an equitable distribution of income and wealth national debt are discussed in
Most governments intervene in the economy to influence the distribution
more detail in 9.2 “Fiscal policy”.
of income and wealth. The aim is to achieve an equitable, or fair,
distribution of income and wealth. This can be viewed as an objective
of both microeconomic and macroeconomic policy. The government Link
can use microeconomic policies to affect the distribution of income and
wealth. However, if the government is able to reduce unemployment, a
The distribution of income and
macroeconomic policy objective, this will also help to reduce inequality. wealth is considered in more detail
in 5.6 “An inequitable distribution
Protecting the natural environment of income and wealth”, and in
Protecting the natural environment is another objective of most 5.7 “Government intervention in
governments. Both microeconomic and macroeconomic policies can markets”.
help to achieve this aim. With growing concern about global warming,
climate change and the destruction of the natural environment, this Key terms
has become a much more important aim for most governments.
Conflict between policy objectives:
when an improvement in one
Possible conflicts between macroeconomic policy policy objective leads to a worse
objectives outcome for a different policy
A conflict between policy objectives exists when the government objective.
uses measures that lead to an improvement in one policy objective but
Aggregate demand: total planned
result in a worse outcome for a different policy objective. For example,
if the government increases its spending to boost aggregate demand spending on all goods and
and this reduces unemployment but leads to higher inflation, there services produced in the domestic
is a conflict between reducing unemployment and the objective of economy.
price stability. An increase in aggregate demand will encourage firms
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6 The measurement of macroeconomic performance

to produce more and employ more workers. However, rising demand

Key terms may also encourage firms to raise prices. In this example, there is a
Policy trade-off: the opportunity policy trade-off between unemployment and inflation. The cost of
cost of achieving an improvement lower unemployment is higher inflation.
in a policy objective. There is not always a conflict between policy objectives. There are
Compatible policy objectives: compatible policy objectives. For example, measures to reduce
an improvement in one policy unemployment are likely to be compatible with reducing inequality.
objective is accompanied by an Some policy objectives may conflict in the short run but may be
improvement in a different policy compatible in the long run. Rising economic growth may lead to an
objective. increase in imports in the short run. To produce more goods, firms
may import more raw materials and rising incomes may allow people
Recession: when total output
to buy more foreign products. Rising imports will lead to a larger
of the economy is falling and
deficit on the current account of the balance of payments.
unemployment is rising.
However, in the long run, economic growth may mean that home-
produced goods replace imports and the country may be able to export
Link more. This will reduce the current account deficit, or perhaps lead
to a surplus. This is likely to happen if economic growth is caused by
The effects of government improvements in efficiency.
policy on its macroeconomic
objectives are explained in Whether policy objectives conflict or are compatible with each other
8 “Economic performance” and may also depend on the present state of the economy. For example, if
9 “Macroeconomic policy”. the government adopts policies to increase aggregate demand to reduce
unemployment when the economy is recession, there is spare capacity
and firms may not raise prices until the economy has recovered.
Get it right
There is not a conflict between How the importance attached to different
all policy objectives, some are objectives will affect economic policy
compatible with each other. How much importance a government attaches to each policy objective
will vary depending on the government in power. Some governments
may attach more importance to achieving high economic growth than
Link keeping inflation low. Another government may believe that price
The characteristics of a depression stability is more important than other policy objectives.
are explained in 8.1 “Economic How much importance a government attaches to a particular
growth and the economic cycle”. objective will be affected by many factors, including the problems
facing the economy and the beliefs and values of the government.
If the economy has been suffering from high unemployment for
several years, the government may make its main objective to reduce
unemployment. Some governments, and economists, believe that
unless inflation is kept low and stable, other policy objectives will not
be achieved in the long run. This has led some governments to have
low inflation as their most important policy objective.
Key term
During the 1930s, the world economy was in a depression with high
Depression: when the economy
unemployment. After the Second World War, many governments of
has very high unemployment and the more economically developed economies adopted achieving full
total output is much lower than employment as their main policy objective. However, in the 1970s, in
the productive capacity of the some of these economies, inflation reached high and worrying levels.
economy. There is a large amount Keeping inflation low became the main objective for many of these
of spare capacity that continues governments.
for a number of years.
When living standards are low, the government may consider that
achieving a high rate of economic growth is the most important

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 The objectives of government economic policy

objective. If living standards improve, the importance attached to

the different policy objectives may change. Although a high rate Link
of economic growth helps to improve living standards and reduce Macroeconomic policies are
poverty, it may damage the natural environment. Increasing pollution explained in Chapter 9
and environmental problems may lead to more importance being “Macroeconomic policy”. Value
attached to this objective. The government and the population may judgements are explained in
be willing to accept a lower rate of economic growth to protect the 1.5 “Economic methodology”.
environment.
Some people believe that rich economies should aim for zero growth.
As the effects of global warming have become more obvious and well
known, the importance many governments attach to protecting the
environment has increased. However, it is not only economic events
that affect the importance attached to the different macroeconomic
policy objectives, it is also influenced by value judgements. Different
governments may have different priorities because they have different
views about what is right. The importance attached to each policy
objective will affect the policies used to manage the economy.

Case study: Economic growth and inflation in Malaysia, 2014–2018

▼ Table 6.1.1: Economic growth and inflation in Malaysia
2014–2018
Year Growth Rate (%) Inflation (%)
2014 6.01 3.14
2015 5.09 2.10
2016 4.22 2.08
2017 5.90 3.80
2018 4.72 0.97
Source: www.statista.com; accessed 4 October 2019
1 Draw a bar chart to show the growth rate and the rate
of inflation in Malaysia between 2014 and 2018. ▲ Figure 6.1.3: Kuala Lumpur, capital of Malaysia
2 Explain why the data in the table show that there is
a trade-off between the growth rate and inflation in
Malaysia between 2014 and 2018.

Progress questions
8 What is meant by “a trade-off between policy objectives”?
9 If two policy objectives are compatible with each other, what does that
mean?
10 Explain why an increase in aggregate demand is likely to reduce
unemployment.
11 Why might a high rate of economic growth harm the environment?

153
6.2 Macroeconomic indicators

This section will develop your knowledge and understanding of:

➔ data that is commonly used to measure the performance of an economy: real GDP, real GDP
per capita, the Gini coefficient, the Consumer Price Index, measures of unemployment,
productivity and the balance of payments on current account
➔ how index numbers are calculated including the base year and weights.

Statistics that are used to measure the current or past performance

Key terms of an economy are known as economic indicators. Governments
Economic indicators: statistics publish data that measure an economy’s performance in relation
that are used to measure the to each of the main macroeconomic objectives. They also publish
current or past performance of an a variety of other data to show what is happening to other aspects
economy. of economic performance. As well as helping to assess how well an
economy is performing, such data are also used to test and develop
Gross domestic product (GDP): economic theories that aim to explain how an economy works.
is a measure of national income,
it measures the monetary value
Measuring economic growth
of the total output of an economy
over a given period of time, for The most commonly used indicator of economic growth is the
percentage change in real gross domestic product, usually
example, a year.
shortened to real GDP. GDP is a measure of national income. National
Real terms: when the effects of income measures the monetary value of the total output of an
inflation have been removed from economy. It is measured over a period of time, for example over one
the economic variable. year or a quarter of a year. If GDP is measured in real terms, it means
that the effects of inflation have been removed from the figures.
Nominal GDP (or money GDP):
the monetary value of the total Over time, GDP can increase because the total output of the economy
output of the economy without any has increased and/or because prices have risen. Changes in nominal
adjustment for inflation. GDP (or money GDP) show the change in the monetary value
of total output, including the effects of inflation. Since economic
growth is the change in the total output of the economy, to calculate
economic growth the effects of inflation must be removed. If real GDP
has risen, this means the volume, or quantity, of goods and services
Link produced by the economy has increased.
National income is explained in 7.1 If the real GDP of an economy increased from $250 billion in 2018 to
“The circular flow of income”. $260 billion in 2019, the growth rate in 2019 is calculated as follows.

Economic growth in 2019 = Change in real GDP × 100

Original real GDP
Activity 260 − 250 × 100
=
Find out the GDP of your country 250
last year and the rate of economic = 4%
growth over the past five years.
Real GDP per capita
The change in real GDP per capita is the most frequently used measure
Key term of changes in living standards. Real GDP per capita is the average
Real GDP per capita: the average, amount of real GDP per person. It is calculated by dividing real GDP
by the size of the country’s population. An increase in real GDP per
or mean, real GDP per person.
capita means that average output per person has increased. Therefore,

154
 Macroeconomic indicators

on average, there are more goods and services for each person to
consume. Real GDP per capita is also known as real GDP per head. Get it right
If a country’s population increases more quickly than its real GDP Make sure you know the difference
increases, real GDP per capita will fall. Even though the country has between nominal or money GDP
experienced economic growth, average output per person has fallen, and real GDP.
indicating a fall in living standards.

The Gini coefficient

The Gini coefficient is used to measure inequality in income. A
Gini coefficient of zero means that the income is distributed equally Link
between individuals: everyone has exactly the same income. A Gini The measurement of living
coefficient of 1 represents the largest degree of inequality possible. standards is covered in the A2 part
The higher the value of the Gini coefficient the more unequal the of the course.
distribution of income. The Gini coefficient is also used to measure
inequality in wealth.
The Gini coefficient is sometimes shown as a percentage ranging from
0 to 100, where the higher the percentage the greater the inequality.
▼ Table 6.2.1: World Bank estimates of the Gini coefficient for selected countries
Country Gini coefficient Year estimated
Australia 35.8 2014
Chile 46.6 2017 Link
France 32.7 2015
The Gini coefficient is explained in
Indonesia 38.1 2017
more detail in the A2 part of the
Norway 27.5 2015
course.
South Africa 63.0 2014
USA 41.5 2016
Source: World Bank; https://data.worldbank.org; accessed 4 October 2019

Measuring unemployment
An individual is unemployed when he or she is out of work and
actively seeking work. Not everyone who is out of work is included in Key terms
the unemployment figures. For example, measures of unemployment Unemployed: people who are out of
do not include people who stay at home to look after their children
work and actively seeking work.
and those who are retired. Measuring unemployment accurately
is difficult in countries where many people work in the informal Informal economy: part of the
economy, often in rural areas. economy that is not regulated or
protected by government. People
There are two main ways of measuring unemployment. Many
and firms operating in the informal
countries use the International Labour Organisation (ILO) measure
of unemployment. This method estimates unemployment by asking economy rarely pay taxes and
a large sample of the population to complete a survey. People are barter may be used to exchange
counted as unemployed if they are out of work, have been looking for goods and services.
work and are able to start work within the next two weeks.
The other main method of measuring unemployment counts people
claiming unemployment benefits. This method usually underestimates
the true level of unemployment because some people who are
unemployed are not eligible to claim unemployment benefits.

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6 The measurement of macroeconomic performance

Unemployment is often measured as a percentage of the total labour

Key terms force. This is the unemployment rate. The labour force includes
Unemployment rate: the people who are working and those who are unemployed and looking
percentage of the labour force that for work. It is the number of people who are available for work.
is unemployed.
Labour force: the number of people
Measuring productivity
available for work. It is the sum of Productivity is a measure of efficiency. It measures how much is
those who are employed, self- produced by a unit of a factor of production in a given time. Labour
employed and unemployed. productivity is how much is produced by one worker in a given time,
for example each hour or each day. It is the most commonly used
measure of productivity. Labour productivity is calculated by dividing
total output produced, in a given time, by the number of workers. For
Case study: Unemployment
example, if a factory produces 50 chairs in an hour and employs
and the labour force 20 workers, labour productivity in this factory is 2.5 chairs per hour.
The population of a country is
Productivity should not be confused with production. Production
30 million. The number of people in
is the amount produced in a given time. In the previous example,
employment is 18 million, 2 million
production was 50 chairs per hour.
are self-employed and 1 million are
looking for work. Productivity is an important indicator of the performance of an
economy. An increase in labour productivity means that more
1 Calculate the size of the output can be produced by the same labour force. Improvements
country’s labour force. in productivity usually lead to economic growth. Improvements in
2 What is the unemployment productivity, and efficiency, will make the country more competitive
rate for this country? Give your in its home and export markets and should improve the balance of
answer to two decimal places. payments.

Balance of payments on current account

Link The size of the deficit or surplus on a country’s balance of payments
The effects of productivity on other on current account is another important indicator of the performance
macroeconomic policy objectives is of the economy. For example, if a country has a large deficit, it might
explained in more detail in Chapter 8 mean that it is less competitive than other countries. However, there
“Economic performance”. might be other reasons for the deficit. When assessing the significance
of the deficit, or surplus, it is best to measure it as a percentage of GDP.
An annual current account deficit of $5 billion for a country with a
small economy might be a serious problem. However, a deficit of $5
Link billion might not be a problem for a much bigger economy.
The current account of the balance
of payments is explained in 8.4 “The Progress questions
balance of payments on current
account”. The significance of 1 What does GDP measure?
balance of payments deficits and 2 A country’s nominal GDP increased by 15% but, over the same time period,
surpluses is covered in the A2 part its real GDP only increased by 8%. Explain why this is possible.
of the course. 3 Over a period of 10 years, the Gini coefficient showing the distribution of
income in a country increased from 30.5 to 37.1. Has inequality fallen or
risen?
4 State the two main methods of measuring unemployment.
5 Explain the difference between production and productivity.
6 If a firm employs 200 workers and produces 3,600 baskets each day,
calculate the average labour productivity of each worker.

156
 Macroeconomic indicators

Index numbers Key terms

Index numbers are used to measure changes in, or to compare, a
selection of related variables. The starting point for an index number Index number: a statistic, with a
has a base value of 100. Economists often use index numbers when base value of 100, that is used to
making comparisons over time. measure changes in a selection of
related variables.
Changes in the price level, and hence inflation, are measured using
index numbers. The most commonly used measure of inflation is the Consumer Price Index (CPI): a
Consumer Price Index (CPI). The CPI measures changes in the measure of the price level and
average price of a weighted basket of consumer goods and services inflation.
purchased by households.
Basket of goods: the goods and
The first stage is to determine which goods and services should be services that are included in a price
included in the index. This is usually done by getting a selection of index.
households to record their expenditure over a period of time. The
Weight: a way to reflect the relative
products on which people in the average household spend most of
their money are included in the basket of goods.
importance of each item in an
index.
The products included in the basket will change over time. For
example, 20 years ago compact discs (CDs) were the main way in
which many people bought music but today many people download
their music from the internet. Therefore, CDs have been replaced in
Activity
the basket by music downloaded from the internet. Choose six goods and services that
you would include in a basket of
The pattern of consumer spending also determines the weight
goods used to calculate the rate of
attached to each item in the basket. The greater the percentage of total
inflation for yourself or your family.
spending on an item, the larger its weight. The sum of the weights
attached to all items is often set at 1000, therefore if the typical Estimate the weight that you would
household spends 12.3% of its total income on an item, it will be attach to each of the items.
given a weight of 123.
Weights are used to ensure that the relative importance of the
different items in the index is taken into account. For example, food is
likely to have a higher weight than petrol. The use of weights means
that a given percentage increase in the price of food would have a
greater impact on the overall price index than the same percentage
increase in the price of petrol.
The base year is the starting point for an index. The price of each item Key term
is given a value of 100 in the base year. This means that the average
price of all items, the overall price index, will also have a value of 100
Base year: the starting point for an
in the base year. As the price of each item changes, the index for that index, where its value is 100.
item is recalculated. For example, if the base year was 2017 and the
price of a chicken increased from $3.00 in 2017 to $3.60 in 2020, the
index for the price of chicken in 2020 would be calculated as follows.
New price index = new price × 100 Quantitative skills
original price
Make sure that you know how to
= 3.60 × 100
3.00 calculate the new price index for
= 120 an individual item after a change in
the price of that item.
The following example shows how a simple price index for four items
might be calculated. In the example, Year 1 is the base year. Average
monthly expenditure on each of the items is as follows: coffee $15,
milk $10, sugar $5 and tea $20. Since total expenditure on coffee is

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6 The measurement of macroeconomic performance

three times the total expenditure on sugar, the weight attached to

coffee must be three times the weight attached to sugar. In this simple
example, the sum of the weights is fixed at 100, but it could have been
some other value, for example 50 or 1000. What matters is that the
weights reflect the relative importance of each item. In a price index,
this is determined by the relative amount spent on each item.
▼ Table 6.2.2: Constructing a weighted price index
Price in Index in Price in Index in Index in Year 2
Item Weight
Year 1 Year 1 Year 2 Year 2 × Weight
Coffee $2.00 100 $2.20 110 30 3300
Milk $0.80 100 $1.00 125 20 2500
Sugar $1.20 100 $0.96 80 10 800
Tea $1.50 100 $1.95 130 40 5200
Total 100 11800
Overall price index 118

For each item, the figure in the final column of the table is calculated
by multiplying the “Index in Year 2” by its “Weight”. The overall price
index is calculated by dividing the sum of the final column of the
table, by the sum of the weights: 11800 ÷ 100 = 118.
The initial stages in constructing a price index, such as the CPI, can be
summarised as follows.
• Decide which goods and services should be included in the basket.
• Decide on the base year, the starting point for the index.
• Find out the price of each item in the base year.
• Find out the percentage of income that a typical household spends
on each item.
• Use the pattern of expenditure to determine the weight attached to
each item.
• Give a value of 100 to the base year price of each item.
• For each item, multiply the base year index by the weight attached
to the item.
• Add up the resulting totals and divide by the sum of the weights,
this must result in a base year index of 100.
This is how to calculate the new price index for the current year.
• Find the price of each item in the current year.
Quantitative skills • Calculate the new index for each item.
Make sure you can calculate a • Multiply the new index by the weight.
weighted price index for a small • Add up the totals and divide by the sum of the weights.
number of items. • This will give the weighted index for the current year.

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Case study: Changing patterns of expenditure in China affect the CPI

“food, tobacco and alcohol”. The income elasticity of
demand for food is much lower than for many other
products. As a result, rapid economic growth in China
has meant that the proportion of income spent on food
has fallen, even though more food is being consumed.
However, the weights given to “housing” and to “transport
and communication” rose. At the same time, the base
year for the index was changed from 2010 to 2015.
1 How might the National Bureau of Statistics decide
which products to include in the basket of goods that
are used to calculate inflation?
2 Explain why the weight given to “transport and
communication” has risen.
▲ Figure 6.2.1: Food prices have less effect on the CPI 3 How might a change in the weights given to different
products affect the rate of inflation, as measured by the
In 2016, the National Bureau of Statistics (NBS) in China CPI?
made changes to the basket of goods used to calculate 4 How will changing the base year from 2010 to 2015
inflation. It reduced the weight given to the category affect the CPI?

Using a price index to remove the effects Progress questions

of inflation
7 What is meant by the “base
Data that is given as a monetary value can be expressed in either year”?
nominal (money) terms or real terms. Changes in the price level
can make it difficult to interpret what is happening to an economic
8 Explain why items in an index
variable. For example, if the nominal value of government spending are often given a weight.
has risen by 20%, this might be because prices have risen and/ 9 What does the CPI measure?
or because the government is providing more goods and services
to people. Data measured in real terms has the effects of inflation
removed and shows what has happened to the quantity, or volume, of
goods and services. The following example illustrates how data can be
converted from nominal to real terms. Table 6.2.3 shows government
spending in nominal terms and a price index showing the change in
the prices of the goods and services the government buys.
▼ Table 6.2.3: Changes in government spending, 2017–2019
Year Government spending Price index
2017 $500 million 100
2018 $560 million 108
2019 $600 million 112
To remove the effects of inflation it is necessary to measure the
variable, in this case government spending, using the same year’s
prices. For example, government spending in 2018 and 2019 could be
measured in 2017 prices.
The following formula can be used to calculate the value of a variable,
for example government spending, measured using the prices in the
base year.

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6 The measurement of macroeconomic performance

Spending in current year at base year prices

= Spending in the current year × Base year price index

Current year price index

Using the figures in Table 6.2.3, the value of government spending in

2018 at 2017 prices is calculated as follows.
Government spending in 2018 at 2017 prices
= Government spending in 2018 × 2017 price index
2018 price index

= $560 × 100
108

= $518.52 million
Quantitative skills
In nominal terms, government spending increased by $60 million
Make sure you can convert a (12%) between 2017 and 2018 but in real terms it only increased by
variable measured in nominal or $18.52 million (3.7%). The value of government spending in 2019
money terms to real terms. in 2017 prices is $600 million × 100 = $535.71 million, showing an
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increase of 7.14% in real terms since 2017.

Using index numbers to show changes in

economic variables
Index numbers are used to show changes in a wide selection of
economic indicators. For example, they can be used the show changes
in production, the value of exports, and consumer spending. Most
economic variables can be presented as index numbers.
Index numbers do not have units. For example, even if the original
data is expressed in $ million or tonnes, when converted into index
number form, there are no units.
Using index numbers can make it easier to understand and compare
the changes that are taking place. Table 6.2.4 shows the real GDP for
the UK economy between 2014 and 2018 in £ million and as index
numbers, with a base year of 2015. It is much easier to interpret the
changes in the index numbers than the figures shown in £ million.
▼ Table 6.2.4: Real GDP for the UK, 2014–2018
Year Real GDP (£ million) Index of real GDP
2014 1,912,866 97.70
2015 1,957,920 100.00
2016 1,995,478 101.92
2017 2,033,234 103.85
2018 2,061,408 105.29
Source: Office for National Statistics (UK); www.ons.gov.uk; accessed 10th October 2019

However, care is still needed when using the figures. It is correct to

say that real GDP increased by 1.92% between 2015 and 2016, or by
5.29% over the period 2015 to 2018. However, although the index
of real GDP increased by 1.44 between 2017 and 2018, this is not the
percentage change in real GDP. The percentage change is only the

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same as the difference between the two figures when starting from the
base year, when the original value is 100. The percentage change in
real GDP in 2018, or the growth rate, is calculated as follows.
Percentage change in real GDP
= Change in the index of real GDP × 100
Index of real GDP in the original year Quantitative skills
Percentage change in real GDP in 2018 Make sure you understand how to
= Index in 2018 – Index in 2017 × 100 interpret data presented as index
Index in 2017 numbers.
= 1.44 × 100
103.85
= 1.39%
Index numbers can also be used to make comparisons at a point
in time. For example, they might be used to compare productivity Activity
between countries. Find out what has happened to
▼ Table 6.2.5: Index of labour productivity in four countries, 2020 the value of goods exported by
your country over the past five
Country A Country B Country C Country D years. Put the figures in a three-
90 100 113 127 column table showing: the year, the
monetary value of exports and the
In this example, the base value is given to a country rather than a
date. In Table 6.2.5, it is easy to compare productivity in Country B index of the value of exports. When
with the other three countries. For example, it can be seen that labour calculating the index, use the third
productivity in Country A is 10% lower than in Country B but labour year as the base year.
productivity in Country D is 27% higher than in Country B.

Progress questions
10 What is the formula for converting the money, or nominal, value of a
variable to its real value?
11 Between 2015 and 2020, consumer spending in an economy increased
from $240 billion to $380 billion. If the base year for the index of consumer
spending is 2015, what is the index of consumer spending in 2020?
12 Using the figures in question 11, state the percentage increase in
consumer spending between 2015 and 2020.

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6 The measurement of macroeconomic performance

Exam-style questions
1 Which one of the following is an objective of government macroeconomic policy?
A A high Gini coefficient
B High interest rates
C Low labour productivity
D Stable economic growth (1 mark)
2 The unemployment rate is
A the number of people claiming unemployment benefits.
B the number of people out of work.
C unemployment as a percentage of the labour force.
D unemployment as a percentage of those who are working. (1 mark)
3 The weight given to housing in a country’s Consumer Price Index (CPI) has increased. This means that
A house prices are increasing faster than the prices of other products.
B spending on housing as a percentage of total spending has increased.
C the price of houses has increased.
D the total amount spent on housing has risen. (1 mark)
4 (i) Define “base year”. (3 marks)
(ii) Define “inflation rate”. (3 marks)
5 The table below shows the imports of a country in $ billion and the index of import prices for that
country between 2016 and 2019.
Year Value of imports Index of import prices
($ billion) (2018 = 100)
2016 754 92
2017 790 97
2018 842 100
2019 915 109

You are advised to show your working for the calculations below.
(i) Calculate, to one decimal place, the percentage increase in the average price of imports
between 2016 and 2017. [2 marks]
(ii) Calculate, to the nearest $ billion, the real value of imports in 2019 in 2018 prices. [4 marks]

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