Just how large is the UK’s Gross Domestic Product and how quickly is it growing? Well, the latest Quarterly National Accounts from the Office for National Statistics show that the value of our economy’s output in Q3 2010 was £365.9 million. When measured across the latest four quarters, i.e. from the start of Q4 2009 to the end of Q3 2010, the total value of our economy’s output was £1.440 trillion. Across calendar year 2009 the UK’s GDP is estimated to have been £1.394 trillion.
When analysed in terms of the expenditure on the goods and services produced in the latest four quarters, household final consumption contributed £910.4 billion towards Gross Domestic Product. In other words, household expenditure over these four quarters was equivalent to 63% of GDP, exactly in line with its average since 1948. This only serves to demonstrate just how important the spending by households is for our short-term economic prospects.
Another important expenditure-component of GDP is gross capital formation. This is capital expenditure by the private and public sector and is estimated to have been £202.9 billion over the latest four quarters, equivalent to 14% of GDP. This is an important component because as well as affecting current levels of GDP, it also affects our economy’s potential output. This points to changes in capital expenditure having both a demand-side and a supply-side impact. Interestingly, the long-term average share for gross capital formation in GDP is around 18% and so about 4 percentage points higher than is currently the case.
So we now have a number which reflects the size of our economy: a little over £1.4 trillion. But, what about the rate at which the economy is growing? This time we have to be a little careful as to which GDP numbers we are using. The numbers we have so far considered have been measured at current prices and so at prevailing prices. When analysing the rate of economic growth, rather than analyse GDP at current prices, economists look at GDP at constant prices. By doing this we can immediately see whether the volume of output has increased. This is important because in the presence of price rises, an increase in the value of output could occur even if the volume of output remained unchanged or actually fell. For instance, in 1974 the volume of output or real GDP fell by 1.3%, but because the average price of our domestic output (known as the GDP deflator) rose by 14.8%, GDP measured at current prices rose by nearly 13½%.
The latest ONS figures show that real GDP grew by 0.7% in the third quarter 2010. For the record, GDP at current prices (nominal GDP) grew by 0.9%. The 0.7% increase in GDP in volume terms is down on the 1.1% figure for Q2. While this appears to constitute a reasonable rate of economic growth we can see from the articles below the concern amongst commentators that this third estimate of growth for Q3 had seen a downward revision from the previous estimates of 0.8%. Nonetheless, when compared with Q3 2009, the output of the UK economy in Q3 2010 is estimated to have grown by 2.7%. This is the strongest annual rate of economic growth since the third quarter of 2007.
Despite its relatively low historic share of GDP, gross capital formation was the most rapidly growing expenditure component in Q3, increasing by 5.2% over the quarter and by 16.6% over the latest four quarters. Household spending grew by 0.3% over the quarter and by 2% over the latest four quarters. Meanwhile, government final consumption, i.e. those government purchases not classified as capital expenditures, fell by 0.4% over the quarter and by 1.3% over the latest four quarters. Finally, the volume of exports rose by 1.5% over the quarter and by 7.5% over the latest four quarters, but the volume of imports increased more rapidly rising by 1.7% over the quarter and by 10.3% over the latest four quarters. This has contributed to a UK trade deficit from the start of Q4 2009 to the end of Q3 2010 of a little over £40.5 billion.
Articles
UK recovery weaker than first thought, official data shows Telegraph, Emma Rowley and Philip Aldrick (23/12/10)
Service sector output dips Financial Times, Chris Giles (23/12/10)
UK’s official economic growth estimates revised down Guardian, Graeme Wearden (22/12/10)
UK economic growth revised down BBC News (22/12/10)
Economic growth weaker than thought Press Association (22/12/10)
UK economic growth in 3rd quarter revised downward Bloomberg, Robert Barr (22/10/12)
Economic growth ‘is lower than we thought’ admits ONS Scotsman, Natalie Thomas (23/12/10)
UK GDP growth: analysts view of the revised data Telegraph (22/12/10)
Data
Latest on GDP growth Office for National Statistics (22/12/10)
Quarterly National Accounts, 3rd Quarter 2010 Office for National Statistics (22/12/10)
UK Economic Accounts, Time Series Data Office for National Statistics
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission
Questions
- What do you understand by the terms nominal GDP and real GDP?
- Can you think of any other contexts in which we might wish to distinguish between nominal and real changes?
- The following are the estimates of GDP at constant 2006 prices:
Q3 2009= £322.655bn, Q2 2010= £328.881bn, Q3 2010= £331.222bn Show how you would calculate both the quarterly rate of change and the annual rate of change for Q3 2010.
- What would happen to our estimates of the level of constant–price GDP in (3) if the base year for prices was 1986 rather than 2006? What would happen to the quarterly and annual growth rates you calculated? Explain your answer.
- Explain how gross capital formation could have both demand-side and supply-side effects on the economy? How significant do you think such supply-side effects can be?
- How important for short-term economic growth do you think household spending is? What factors do you think will be important in affecting household spending in the months ahead?
The government’s plan for the UK economy is well known. Reduce the public-sector deficit to restore confidence and get the economy going again. The deficit will be reduced mainly by government spending cuts but also by tax increases, including a rise in VAT from 17.5% to 20% on 1 January 2011. Reductions in public-sector demand will be more than offset by a rise in private-sector demand.
But what if private-sector demand does not increase sufficiently? With a fall in government expenditure, reduced public-sector employment and higher taxes, the danger is that demand for private-sector output may actually fall. And this is not helped by a decline in both consumer and business confidence (see, for example, Nationwide Consumer Confidence Index). What is more, consumer borrowing has been falling (see Consumer borrowing falls again) as people seek to reduce their debt, fearing an uncertain future.
So does the government have a ‘Plan B’ to stimulate the economy if it seems to be moving back into recession? Or will it be ‘cuts, come what may’? The Financial Times (see link below) has revealed that senior civil servants have indeed been considering possible stimulus measures if a return to recession seems likely.
Over in Threadneedle Street, there has been a debate in the Bank of England’s Monetary Policy Committee over whether an additional round of quantitative easing may be necessary. So far, the MPC has rejected this approach, but one member, Adam Posen, has strongly advocated stimulating demand (see The UK inflation outlook if this time isn’t different, arguing that the current high inflation is the result of temporary cost-push factors and is not indicative of excessively strong demand.
So should there be a Plan B? And if so, what should it look like?
Articles
Gus O’Donnell’s economic ‘Plan B’ emerges BBC News, Nick Robinson (14/12/10)
Sir Gus O’Donnell asks ministers to consider possible stimulus measures Financial Times, Jim Pickard (14/12/10) (includes link to article by Philip Stephens)
Gus O’Donnell urges Treasury to prepare ‘Plan B’ for economy Guardian, Patrick Wintour and Nicholas Watt (14/12/10)
Unemployment, and that ‘Plan B’ BBC News blogs, Stephanomics, Stephanie Flanders (15/12/10)
Inflation wars (cont’d) BBC News blogs, Stephanomics, Stephanie Flanders (16/12/10)
Don’t overreact to UK inflation – Bank’s Posen Reuters, Patrick Graham (16/12/10)
Bank of England’s Adam Posen calls for more quantitative easing The Telegraph, Philip Aldrick and Emma Rowley (29/9/10)
Don’t overreact to above-target UK inflation rate, cautions Posen Herald Scotland, Ian McConnell (17/12/10)
Posen calls for calm as inflation fears rise Independent, Sean O’Grady (17/12/10)
Data
OECD Economic Outlook OECD (see, in particular, Tables 1, 18, 27, 28 and 32)
Forecasts for the UK economy HM Treasury
UK Economic Outlook PricewaterhouseCoopers
Employment and Unemployment ONS
Inflation Report Bank of England
Questions
- What are likely to be the most important factors in determining the level of aggregate demand in the coming months?
- What are the dangers of (a) not having a Plan B and (b) having and publishing a Plan B?
- Why is inflation currently above target? What is likely to happen to inflation over the coming months?
- What are the arguments for and against having another round of quantitative easing?
- What else could the Bank of England do to stimulate a flagging economy?
It is the Bank of England’s responsibility to ensure that inflation remains on target. They use interest rates and the money supply to keep inflation within a 1% band of the inflation target set by the government = 2%. However, for the past 12 months, we have had an inflation rate above the 3% maximum and this looks set to continue. Official figures show that the CPI inflation rate has risen to 3.3% in November, up from 3.2% in October 2010 – above the inflation target. There was also movement on the RPI from 4.5% to 4.7% during the same months. The ONS suggests that this increase is largely down to record increases in food, clothing and furniture prices: not the best news as Christmas approaches. It is not just consumers that are facing rising prices, as factories are also experiencing increasing costs of production, especially with the rising cost of crude oil (see A crude story). Interest rates have not changed, as policymakers believe prices will be ‘reined in’ before too long.
However, the government expects inflation to remain above target over the next year, especially with the approaching increase in VAT from 17.5% to 20%. As this tax is increased, retail prices will also rise and hence inflation is likely to remain high. There is also concern that retailers will use the increase in VAT to push through further price rises. A report by KPMG suggests that 60% of retailers intend not only to increase prices to cover the rise in VAT, but to increase prices over and above the VAT rise.
Despite the planned VAT rise spelling bad news for inflation, it could be the spending cuts that offset this. As next year brings a year of austerity through a decrease in public spending, this could deflate the economy and hence bring inflation back within target. However, there are suggestions that more quantitative easing may be on the cards in order to stimulate growth, if it appears to be slowing next year. The Bank of England’s Deputy Governor, Charles Bean said:
“It is certainly possible that we may well want to undertake a second round of quantitative easing if there is a clear sign that UK output growth and with it inflation prospects are slowing,” Bean told a business audience in London.”
The following articles consider the rising costs experienced by firms, the factors behind the inflation and some of the likely effects we may see over the coming months.
Articles
UK inflation rises to a surprise six-month high The Telegraph, Emma Rowley (14/12/10)
UK inflation rate rises to 3.3% in November BBC News (14/12/10)
Inflation unexpectedly hits 6-month high in November Reuters, David Milliken and Christina Fincher (14/12/10)
Food and clothing push up inflation Associated Press (14/12/10)
Retailers ‘to increase prices by more than VAT rise’ BBC News (14/12/10)
VAT increase ‘will hide price rises’ Guardian, Phillip Inman (14/12/10)
Slower growth may warrant more QE Reuters, Peter Griffiths and David Milliken (13/12/10)
Factories feel squeeze of inflation The Telegraph, Emma Rowley (13/12/10)
Figures show rise in input prices The Press Association (13/12/10)
November producer input prices up more than expected Reuters (13/12/10)
Data
Inflation ONS
Inflation Report Bank of England
Questions
- What is the difference between the RPI and CPI? How are each calculated?
- Why are interest rates the main tool for keeping inflation on target at 2%? How do they work?
- Is the inflation we are experiencing due to demand-pull or cost-push factors? Illustrate this on diagram. How are expectations relevant here?
- Explain why the rise in VAT next year may make inflation worse – use a diagram to help your explanation.
- Explain the process by which rising prices of crude oil affect manufacturers, retailers and hence the retail prices we see in shops.
- How are the inflation rate, the interest rate and the exchange rate linked? What could explain the pound jumping by ‘as much as 0.2pc against the dollar after the report’ was released?
- Explain why the public spending cuts next year may reduce inflation. Why might more quantitative easing be needed and how could this affect inflation in the coming months?
Happiness and unhappiness are central to economists’ analysis of consumer behaviour. If we define ‘utility’ as perceived happiness, standard consumer theory assumes that rational people will seek to maximise the excess of happiness over the costs of achieving it: i.e. will seek to maximise consumer surplus. In fact, this analysis can be traced back to the work of the utilitarians, Jeremy Bentham and John Stuart Mill. Bentham reffered to it as hedonic or felicific calculus (see also and also).
Now, of course, whether people actually behave in this way is an empirical question: one that behavioural and experimental economists have been investigating over a number of years. Nevertheless, it remains central to neoclassical analysis of ‘rational behaviour’.
But if happiness is central to a large part of economic analysis, how is happiness to be measured? At a micro level, this has proved problematic as it is virtually impossible to have inter-personal comparisons of utility. As a result, consumer theory uses indifference analysis, characteristics analysis, revealed preference and other approaches to analyse consumer demand.
But what about at the macro level? How is a nation’s happiness or well-being to be measured? There is general acceptance that GDP is a relatively poor proxy for national well-being and is more a measure of production. There have been various indices developed over the years (see, for example, Box 14.7 on ISEW in Economics, 7th edition) as alternatives to GDP. None has been adopted by governments, however, with the exception of a Gross National Happiness index in Bhutan.
Recently, however, there has been renewed interest in developing an index of well-being. In France, President Sarkozy commissioned two Nobel economists, Joseph Stiglitz and Amartya Sen, to examine the issues in developing such a measure. In the light of the Stiglitz/Sen report, David Cameron has asked the Office of National Statistics to measure the UK’s general well-being. The articles below look at the difficulties that could arise in producing an index of well-being, of meauring the elements and in using it for policy.
Articles
UK Prime Minister Cameron Moves on UK Happiness Index Triple Pundit, Kristina Robinson (17/11/10)
David Cameron’s happiness index finds support despite impending decade of austerity Daily Record, Magnus Gardham (16/11/10)
How can we measure happiness? Telegraph, Philip Johnston (16/11/10)
David Cameron aims to make happiness the new GDP Guardian, Allegra Stratton (14/11/10)
An unhappiness index is more David Cameron’s style Guardian, Polly Toynbee (16/11/10)
Happiness is a warm baguette? The Economist (13/1/08)
‘Stiglitz-Sen Moving in the Right Direction, but Slowly’ IPS, Hazel Henderson (18/9/09)
The Rise and Fall of the G.D.P. New York Times Magazine (13/5/10)
Happiness doesn’t increase with growing wealth of nations, finds study Guardian, Alok Jha (13/12/10)
Should governments pursue happiness rather than economic growth? The Economist (25/11/10)
M&S’s Sir Stuart Rose among UK’s expert happiness panel BBC News (27/1/11)
The Stiglitz/Sen/Fitoussi report
Report by the Commission on the Measurement of Economic Performance and Social Progress, Joseph Stiglitz, Amartya Sen, Jean-Paul Fitoussi (September 2009)
Questions
- What are the shortcomings of using GDP as a measure of a nation’s well-being?
- Summarise the main findings of the Stiglitz/Sen/Fetoussi report.
- What items would be included in a happiness or well-being index that (a) are not included in GDP; (b) not included in Stiglitz and Sen’s proposed net national product measure? How would such an index be compiled?
- Would it be satisfactory to compile such an index purely on the basis of survey evidence? Why might such evidence prove unreliable?
- What are the political advantages and disadvantages of using such an index?
- Is utilitarianism the best basis for judging the progress of society?
If ever there was something to make you clean out your house and sort out your ‘rubbish’, this has got to be it!! A Chinese vase found gathering dust in an attic has just sold for £43 million at auction. The buyer will pay around £53 million after paying the buyer’s 20% commission to the auction house and VAT. The seller will get around £40.75 million, after deduction of the seller’s commission by the auction house. The auction house itself will make over £10 million – not a bad day to be an auctioneer!
With the price starting at £500,000, onlookers could hardly believe it as the price began to increase by £1 million at a time. The buyer is thought to be a Chinese person or a state-backed company. And, just in case you didn’t realise, the FT article does make special mention that the person is likely to be ‘wealthy’!
The Chinese vase sold for over 40 times its estimate, with speculation that the price was forced up by a Chinese cultural agency owned by the state. As China aims to regain many of its lost artefacts, prices for objects such as this have been pushed up: although perhaps £53 million is a little expensive for the everyday consumer! However, unstable financial markets and rising inflation may also be partly to blame for the surge in prices for objects such as this. We’ve seen how gold and other commodities have increased in value throughout the recession, as investors look for more stable investments – and the same appears to be happening in the world of art. I’ll certainly be keeping a look out for any dusty artefacts!
House clearance vase fetches £53 million Financial Times, Jan Dalley, Peter Aspden and Justine Lau (12/11/10)
Chinese vase: the suburban auction house that made £12m Telegraph, Andy Bloxham and Martin Evans (12/11/10)
Qianlong Chinese porcelain vase sold for £43m BBC News (12/11/10)
Chinese vase fetches record $69 million in UK auction Reuters (12/11/10)
Questions
- Why are auctions a good way of selling and buying a product?
- The auction house has made over £10 million from this sale, despite only employing 8 people. Does this income guarantee the success of this business?
- Using a demand and supply diagram, explain the factors that have fuelled the price increase in artefacts, such as this Qianlong porcelain vase.
- Why are people investing in assets, such as art and commodities, rather than in more traditional financial assets?
- Could an auction be an example of price discrimination?