Five criteria by which different economies can be judged

By | June 26, 2013

1.1    Inflation rate

 

1.1.1            Introduction of Inflation rate

 

According to Patrick J. Welch and Gerry F. Welch (2010, p. 113), inflation occurs when there is an increase in the general level of prices. It does not mean that prices are high, but rather that they are increasing. Since inflation refers to an increase in the general level of prices, the price of every good and service need not increase. For example, if the inflation rate is 10 per cent, it means the on average the price are increasing by 10 per cent but the increase of the prices of some individual goods would probably vary. And inflation rate could take the form of Core inflation, CPI (Consumer Price Indices) and WPI (Wholesale Price Index). And in the following we will talk about the usefulness of these inflation rates.

 

1.1.2            Benefits of using Inflation rate in measuring the performance of economies

 

1.1.2.1      Benefits of using Core inflation: Anticipating the price and production growth trend

 

Figure 1 The Euro zone inflation and core inflation

 

Core Inflation is a measure of inflation which excludes certain volatile and seasonal prices. It will be based on the Consumer price index but exclude prices such as  petrol (subject to oil price variations) and food (subject to seasonal variations). Core inflation will also exclude the impact of government excise duties. It is seen as important guide to long term inflation trends (economicshelp.org 2011). For example, by removing the impacts of energy, food and alcohol and tobacco, the original fluctuating inflation rate could be stabilized and we can easily witness the changing trend of the inflation in the Euro zone. Therefore, the core inflation index could be understood as a seasonally-adjusted index which allows us to observe deeper trends in the changes in prices. It presents the fundamental growth of production costs and the relationship between supply and demand by removing prices which are subject to government intervention (electricity, gas, tobacco etc.) and products whose price is highly volatile (petrol, seasonal produce, dairy products, meats, flowers and plants etc.) which experience high variability due to climatic factors or tensions on the global markets (insee.fr 2009). By anticipating the price and production growth  trend using the core inflation index, we will be able to predict the price stability performance of an economy compared to the average level and other economies.

 

1.1.2.2      Benefits of using CPI (Consumer Price Indices): Reflecting the buying habits of different groups

 

Consumer Price Index is an inflationary indicator that measures the change in the cost of a fixed basket of products and services, including housing, electricity, food, and transportation. The CPI is published monthly usually and it is also called cost-of-living index (investorwords.com 2010). CPI (Consumer Price Indices) besides measuring the price changes of the consumer goods also reflects the buying habits of different groups of buyers. For example in the United States, the CPI reflects spending patterns for each of two population groups: all urban consumers (CPI-U) and urban wage earners and clerical workers (CPI-W). The CPI-U represents about 87 percent of the total U. S. population. It is based on the expenditures of almost all residents of urban or metropolitan areas, including professional, the self-employed, the poor and the retired and so on. And CPI-W based on the expenditures of households that are included in the CPI-U definition that also meet two requirements: more than on half of the household’s income must come from clerical or wage occuptions (González 2003, p. 391). By monitoring the change of the CPI in two different groups, the government could monitor the buying habits of different groups.

 

1.2    Gini coefficient

 

1.2.1            Introduction of Gini coefficient

 

The Gini coefficient was developed to measure the degree of concentration (inequality) of a variable in a distribution of its elements. It comprises the Lorez curve of a ranked empirical distribution with the line of perfect equality. This line assumes that each element has the same contribution to the total summation of the value of a variable. The Gini coefficient ranges between 0, where there is no concentration (perfect equality), and 1 where there is total concentration (perfect inequality).

 

Figure 2 The Lorenz curve

Source: Rodrigue, Comtois & Slack 2009

 

 

 

 

1.2.2            Benefits of using Gini coefficient in measuring the performance of economies

 

1.2.2.1      Anonymity

 

In term of the calculation of the Gini coefficient, Suppose that n incomes have been supplied. The Lorenz curve may then be described by n+1 points. Call these (x1,y1),…,(xn+1,yn+1). To determine these points, first reorder the supplied incomes smallest to largest. Next, determine cumulative totals for the incomes. Call these c1,…,cn+1. We then have xi=100(i-1)/n and yi=100(ci/cn+1) for i=1,…,n+1. Note, of course, that (x1,y1)=(0,0) and (xn+1,yn+1) = (100,100). Also note that cn+1 is the sum of all incomes. The Gini index equals 100 + (100 – 2S)/n where S=y1+…+yn+1. The Gini coefficient is the Gini index divided by 100 (peterrosenmai.com 2011). From this calculation we can see that there are several key benefits of using the Gini coefficient in measuring the performance of economies: first of all, the Gini coefficient calculation is irrelevant to who are the rich and who are the lower income people. What it cares is the income structure and how concentrated the fortune is in the economy.

 

1.2.2.2      Scale independence and Population independence

 

Secondly, the calculation is not relevant with the scale of the economy because it is only relevant to the income and fortune distribution. In some economic indicator such as GDP, large country such as the US and EU would always be ranked on the top of the GDP list. But Gini coefficient would not have such disadvantage. Thirdly, similarly the volume of the population would also not have major impacts over the calculation of the Gini coefficient. One of its main advantages is that it is a measure of inequality by means of a ratio analysis, rather than a variable unrepresentative of most of the population, such as per capita income or gross domestic product (GDP) (scribd.com 2011). And because it is a ratio analysis, Gini coefficient could be used to make comparisons through a long range of periods without being impacted by the price fluctuation and interest rates changes.

 

1.3    Gross Domestic Product (GDP)

 

1.3.1            Introduction of GDP

 

The Gross Domestic Product (GDP) is the most widely used indicator to measure the performance of national economies. In practice, the GDP is equivalent to the sum of the products of the quantities by values, of each respective good and services, within a given country or region over a one year period (365 days). It measures the performance of the economy in relation to the goods and services produced in the country, both the production factors owned by native citizens of the country and those owned by foreigners (Goldemberg & Lucon 2010, p. 67). In detail, the measuring of GDP could also take several forms such as real GDP growth rate and per capita GDP which would be elaborated in the following.

 

1.3.1.1      Benefits of using real GDP in measuring the performance of economies

 

While nominal GDP measures all final goods and services produced in a given period, valued at the prices existing during the time period of production, real GDP measures all final goods and services produced in a given period, valued at the prices of the existing in a base year. Based on the calculation of nominal GDP both the raise of price and increase of aggregate output would contribute to the growth of nominal GDP (Tucker 2011). And because of the fact that changing prices could have a huge impact over the nominal GDP calculation, the usage of the real GDP could better reflect the value creation during the given period of time.

 

1.3.1.2      Benefits of using GDP growth rate in measuring the performance of economies

 

There are three major benefits of using the GDP growth rate in measuring the performance of the economies: first of all, the GDP growth rate GDP growth rate measures how fast the economy is growing. By comparing the GDP growth rate, one can easily come out with the conclusion regarding how whether an economy is growing faster than it was one year before or its growing trend is slowing down; secondly, because the GDP growth rate is measured in the form of percentage, it enables an economy to be evaluated in comparison with other economies no mater there is a difference between these two economies in term of size of economy; thirdly, the GDP growth rate is the most important indicator of economic health. If it’s growing, so will business, jobs and personal income. If it’s slowing down, then businesses will hold off investing in new purchases and hiring new employees, waiting to see if the economy will improve. This, in turn, can easily further depress the economy and consumers have less money to spend on purchases. For example if the GDP growth rate actually turns negative, then it means that an economy is heading towards or is already in a recession (Amadeo 2010).

 

1.3.1.3      Benefits of using per capita GDP in measuring the performance of economies

 

While GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. GDP per capita is gross domestic product divided by midyear population. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources (worldbank.org 2012). The use of per capita GDP to measure to performance of an economy has two advantages: first of all, it measure the life quality of the common people. For example, the GDP volume in China is large, but the per capita GDP is still low because of the large population, this in another word, the low per capita GDP reflects that people’s life is difficult because there are too many people there and the production capacity is still relatively low.

 

1.4    Unemployment rate

 

1.4.1            Introduction of Unemployment rate

 

Unemployment occurs when a person is available to work and currently seeking work, but the person is without work. The prevalence of unemployment is usually measured using the unemployment which is defined as the percentage of those in the labour force who are unemployed. It is a major macroeconomic indicator measuring the health of the economy (Goel 2009, p. 2).

 

1.4.2            Benefits of using Unemployment rate in measuring the performance of economies

 

There are two major advantages of using the unemployment rate in measuring the performance of economies: first of all, the measurement of the unemployment is important because higher unemployment rate would result in a number of social issues such as demonstrations and also unemployed people would be a large burden of the society and economy; on the other hand, as people become unemployed, they would have less money to spend which results in the decrease of the aggregate demand in the economy. And this will finally result in the slow growth or recession of the economy.

 

1.5    Government debt to GDP

 

1.5.1            Introduction of Government debt to GDP

 

In economics, the debt-to-GDP ratio is one of the indicators of the health of an economy. It is the amount of national debt of a country as a percentage of its Gross Domestic Product (GDP) (Gautam 2003).

 

1.5.2            Benefits of using Government debt to GDP in measuring the performance of economies

 

There are at least two major advantages of using the Government debt to GDP in measuring the performance of economies: first of all, the debt to GDP ratio measures the efficiency of a country in term of making use of the domestic or external debt in creating value; secondly, with the outbreak of the Euro zone debt crisis in which several country had been severely hit by the crisis. But long before the crisis, there had already been warnings signals in term of continual high debt to GDP rate. Therefore, the second significance of using Government debt to GDP in measuring the performance of economies is that it could act as a warning indicator suggesting the risks hidden in the national economy.

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