2024 SH1 H2 Econ Ch5 Lecture Notes (Final) PDF
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These lecture notes cover Chapter 5 of the 2024 SH1 H2 Economics syllabus, focusing on national income and standard of living. Topics include introduction to macroeconomics, the circular flow of income, and measures of national income.
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CHAPTER 5 National Income and Standard of Living 1. INTRODUCTION TO MACROECONOMICS 1 2. THE CIRCULAR FLOW OF INCOME AND EXPENDITURE 6 3. NATIONAL INCOME...
CHAPTER 5 National Income and Standard of Living 1. INTRODUCTION TO MACROECONOMICS 1 2. THE CIRCULAR FLOW OF INCOME AND EXPENDITURE 6 3. NATIONAL INCOME 7 3.1 MEASURES OF NATIONAL INCOME 8 4. USES OF NATIONAL INCOME STATISTICS 11 4.1 TO MEASURE THE RATE OF ECONOMIC GROWTH 11 4.2 TO MEASURE THE MATERIAL STANDARD OF LIVING 11 4.3 FOR GOVERNMENTS TO FORMULATE SECTOR-BASED ECONOMIC POLICIES 11 4.4 FOR PRIVATE FIRMS TO PLAN PRODUCTION AND INVESTMENT 12 5. STANDARD OF LIVING 12 5.1 LIMITATIONS OF USING NATIONAL INCOME AS MEASURE OF LIVING STANDARDS 13 5.1.1 LIMITATIONS OF COMPARISON OVER TIME (INTER-TEMPORAL) 14 5.1.2 LIMITATIONS OF COMPARISON OVER SPACE (INTERNATIONAL) 21 5.2 ALTERNATIVE MEASURES OF LIVING STANDARDS 25 5.2.1 HUMAN DEVELOPMENT INDEX (HDI) 25 5.2.2 MEASURE OF ECONOMIC WELFARE (MEW) 25 5.2.3 SOCIAL PROGRESS INDEX 26 6. DECISION MAKING EXAMPLE 27 7. APPENDIX 31 2024 SH1 H1 & H2 Economics Chapter 5 1. INTRODUCTION TO MACROECONOMICS In Microeconomics, we studied how markets rely on the price mechanism to allocate scarce resources to meet the unlimited wants. We analysed the workings of the price mechanism in the context of individual markets such as the market for oil, cars, etc. We also examined the various situations in which the price mechanism results in an inefficient allocation of resources and governments may undertake policies to improve the allocation of resources in such situations. Governments may also intervene for equity reasons. What then is Macroeconomics? It is the study of the economy as a whole, where we look at general price level of output in the economy. We are no longer concerned with an efficient distribution of resources in specific markets, but in the performance of the economy as a whole. We will look at national employment and national output instead of sectoral employment and output of the firm. We will also study the relationship of an economy with the rest of the world economy. This involves, amongst other things, studying the determinants of exports and imports, as well as that of exchange rates. Any slight turbulence in the economy can significantly influence the behaviour of households, firms and governments. Hence, these economic agents are to make the most appropriate decision to react to these changes through a robust economic analysis of the constraints they face, the benefit and cost of the decision and the possible intended and unintended consequences by taking into account the available information and differing perspectives. The next page provides an overview of the various macroeconomic topics that we will be covering. We shall learn about the overarching macroeconomic objective/ aim of governments which is to improve standard of living for their population through policies to correct for economic instability and to promote sustainable and inclusive economic growth. We will also delve into the key macroeconomic aims and their related indicators of economic performance. We will present linkages between topics, as well as the possible tools of government macroeconomic policy intervention. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 1 2024 SH1 H1 & H2 Economics Chapter 5 At the end of the 2-year ‘A’ level course, students are expected to acquire a good knowledge of recent economic trends and developments in Singapore as well as the international economy. Students should also be able to appreciate the possible underlying causes of these trends and developments and to evaluate the effectiveness of government policies in the light of these events. Overarching aim of government: Improving Standard of Living (SOL) of a country’s population Macroeconomic Aims External Stability Internal Stability [H2] Balance of Trade and Economic Growth Inflation Unemployment Exchange Rate Aim Aim Aim Aim Sustainable & Inclusive Price Stability (i.e., low Low Unemployment Favourable Balance of Economic Growth inflation) Trade Position Indicator Indicator Indicator Indicator National Income Inflation Rate & Unemployment Rate Balance of Trade Statistics (GDP/GNI) Consumer Price Index (CPI) National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 2 2024 SH1 H1 & H2 Economics Chapter 5 To achieve one or more of the key macroeconomic aims highlighted above, governments can implement macroeconomic policies including Demand-side (Aggregate Demand management) policies and/ or Supply-side (Aggregate Supply management) policies: Macroeconomic Policies Demand-side Policies Supply-side Policies Interventionist Market Oriented Monetary Policy* Fiscal Policy Policies Policies Interest Rate/ Exchange Rate Money Supply *Students are expected to define monetary policy in the broader context where interest rates and exchange rates are alternative tools/ instruments. However, exchange rate is separately classified, in consideration of its unique case in Singapore’s context. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 3 2024 SH1 H1 & H2 Economics Chapter 5 OVERVIEW OF MACROECONOMICS TOPICS Standard of Living Standard of living refers to the level of economic welfare and social well-being of an individual or household. It includes the material and non-material (qualitative) aspects of living. The material standard of living has to do with the amount of goods and services that individuals within the country have available for consumption. Non-material aspects of living standards involve indicators like the amount of leisure people consume, life expectancy, standard of education, absence of pollution and other social factors. National Income The circular flow of income is an interactive model involving households, firms, government Determination and the foreign sector to explain the flow of income between firms and households and how this flow is affected by withdrawals and injections. The national output and the General Price Level (GPL) of an economy at any given time is determined by the intersection of the Aggregate Demand (AD) and Aggregate Supply (AS) curve, where AD refers to the total demand for all the goods and services produced by a country at a given GPL, comprising the components consumption (C), investment (I), government expenditure (G) and net exports (X-M), and AS refers to the total output of goods and services produced by an economy for a given GPL. Economic Growth There are two types of economic growth: 1) Actual economic growth – A sustained increase in the real national output of a country which can be the result of greater and better utilisation of existing resources (i.e. a rise in employment) 2) Potential economic growth – An increase in the capacity of the economy to produce goods and services (i.e. an increase in full-employment GDP). Governments aim to achieve sustainable and inclusive economic growth where the economy grows at a strong and stable rate without resulting in significant environmental degradation, resource depletion, and the worsening of income or wealth inequality. National Income refers to the income generated from the production of goods and services by a country within a specific period, normally a year. It measures the overall level of economic activity in a country. Measures of national income include GDP and GNI. Inflation Inflation refers to a sustained rise in the general level of prices (i.e. average price level of all goods and services) in an economy. Inflation rate is commonly measured using the Consumer Price Index (CPI), which measures the market price of a basket of goods and services. The major groups in this basket are food, clothing, housing, fuel, transportation, and medical care. Usually, retail prices are used in its computation and it is generally used as indicator of the cost of living. Unemployment Unemployment is the condition of the economy where some of the factors of production are not utilised in the production of goods and services. More specifically, our focus will be on the unemployment of labour, which refers to the number of people of legal age who are willing and able to work but are unable to find suitable employment. Unemployment rate = Number unemployed ÷ Labour force x 100% where labour force = number employed + number unemployed National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 4 2024 SH1 H1 & H2 Economics Chapter 5 Balance of Payments The balance of payments records the receipts from and payments for all economic transactions (H2 only) between a country and the rest of the world over a period of time, usually over a year. There are 2 main accounts: 1. Current account records a country’s trade in goods and services with the rest of the world as well as income flows and current transfers to and from other countries. 2. Capital and Financial account records both short and long-term capital inflows and outflows as well as capital transfers and acquisition or disposal of non-produced, non-financial assets. Note: Syllabus focuses on Balance of Trade as a macroeconomic aim, which is a component under the current account in the balance of payments. Monetary Policy It is the discretionary control of the money supply or interest rate by the Central Bank to (Interest Rate/Money influence the level of economic activity. Supply) Monetary Policy It is the discretionary control by the Central Bank to influence the movement of the foreign (Exchange Rate) exchange rates by buying and selling foreign currencies in the foreign exchange market. Foreign exchange rates of a currency imply the exchange value of the currency (its price) in terms of other national currencies. Fiscal Policy It is the discretionary management of government spending and/or taxation designed to influence the level of economic activity. Supply-side Policy It involves the implementation of various measures to improve quantity, quality and mobility of factors of production to increase the productive capacity of an economy. Conflicts between Possible conflicts in macroeconomic aims may occur when governments’ pursuit of one aim may macroeconomic aims be at the expense of another. Such conflicts include those that arise between inflation vs and policies unemployment, inflation vs growth, growth vs trade balance, strong and stable growth vs inclusive and sustainable growth. Globalisation and the The basis of free trade and specialisation is due to differences in comparative advantage International Economy between countries. (H2 only) Globalisation leads to benefits and costs from the perspectives of consumers, producers, and the government. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 5 2024 SH1 H1 & H2 Economics Chapter 5 2. THE CIRCULAR FLOW OF INCOME AND EXPENDITURE Learning Objectives: ✴ Recognise the relationship between national income, national expenditure and national output through the circular flow of income. We will begin our macroeconomics journey by looking into the foundation NOTE: The concept of circular flow of modern macroeconomic analysis – which is the circular flow of income of income and expenditure is not required for students and expenditure. taking the H1 syllabus. The circular flow of income and expenditure shows the sources of spending flow and the uses of income generated by the spending flow. It is useful as a model for understanding the workings of an economy. For a basic understanding of the circular flow of income, we assume a simple 2-sector economy made up of the household sector and the firm sector (see Figure 1 below). (2) Income [Firms’ factor payments to households] Firms (Producers) Households (Consumers) (1) Production (output) of final goods and services NOTE: The 4-sector model is an (3) Expenditure extended circular flow [Households’ payment for final goods and model that includes the services] government sector and the international sector. This Figure 1: Circular flow of Income in a simple 2 -sector economy model paints a more realistic picture of the real world. You will be analysing it Firms produce goods and services. To do so, they hire factors of further in Chapter 6. production (labour, land, capital, and enterprise) from households and these factor services will generate their respective income payments (wages, rent, interest, and profits). Households (who are the consumers of goods and services as well as the suppliers of labour and other factors of production) in turn spend their factor income on the consumption of goods and services. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 6 2024 SH1 H1 & H2 Economics Chapter 5 From this analysis, we can see that for an economy as a whole, all expenditure on the final output of a nation (which is equal to the money value of that output) ends up as someone’s income. Expenditure on output translates into incomes (wages, profits, interest, and rent) and incomes are spent on consumption. Assuming that there is no savings here, when expenditure equals to output, there is no change in the circular flow of income i.e., the circular flow of income is in equilibrium. Hence, the three values are equal due to the circular flow of national income. National Output = National Income = National Expenditure 3. NATIONAL INCOME Learning Objectives: ✴ Differentiate between GDP and GNI ✴ Differentiate between national income measured in real and nominal terms To measure economic performance and compare standard of living across time and space, we make use of various macroeconomic NOTE: indicators. One of the key macroeconomic indicators is the National Other indicators (inflation rate, unemployment rate, Income. First, we need to learn about the different national income balance of trade position) are also necessary to statistics. measure the economic performance and standard DEFINITION: of living. These will be NATIONAL INCOME refers to the income generated from the production covered in later chapters. of all final goods and services by a country within a specific period, normally a year. It is often used as a measure of the overall level of economic activity in a country. National income accounting is a set of rules and techniques for measuring the total flow of output during a period of time. It provides a comprehensive framework for recording, presenting and analysing macroeconomic statistics. It also records the actual and not the desired level of national income. With information on the actual level of national income, governments will be able to measure the current state of the economy. More appropriate policies will be then implemented to achieve the desired state of the economy. In this chapter, we will analyse the usefulness of various national income statistics and evaluate the use of it as a measure of living standards and economic growth. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 7 2024 SH1 H1 & H2 Economics Chapter 5 Given the understanding of the circular flow of income, there are thus three approaches to measure the national income: Expenditure Approach Output Approach Income Approach The three approaches theoretically give us the same value for national income where consumption expenditure (Expenditure Approach) equals the total receipts collected by firms (Output Approach). The national income estimates from the previous two approaches is also equal to the total income received by factors of production for services rendered in production (Income Approach). These three approaches will be further elaborated under Chapter 6: National Income Determination. 3.1 MEASURES OF NATIONAL INCOME There are various indicators used to reflect the total value of output produced by an economy. Some commonly used indicators of national income include Gross Domestic Product (GDP) and Gross National Income (GNI). DEFINITION: GROSS DOMESTIC PRODUCT (GDP) refers to the total money value of all final goods and services produced within the geographical boundary of the country, regardless of the ownership of the factors of production, within a specific period, normally a year. DEFINITION: GROSS NATIONAL INCOME (GNI) refers to GDP plus factor incomes earned by residents from overseas sources minus factor incomes earned by non-residents from the domestic economy. a. Domestic vs. National ✴ The term domestic refers to income/expenditure/output gained within the country. For instance, gross domestic product (GDP) shows the total money value of goods and services produced within the country. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 8 2024 SH1 H1 & H2 Economics Chapter 5 ✴ The term national refers to income/expenditure/output of residents of a country, regardless of where the economic activity occurred. For instance, gross national product (GNI) shows the total income accruing to factors of production owned by residents of the country (thus belonging to the country) even if they are located abroad. GNI is thus a better reflection of the standard of living of the residents of the country compared to GDP. ✴ In countries where foreigners own a large part of the production, the value of GDP may be high but the value of GNI will be very low. This is so because a large part of income (e.g. interest, profit, and rent earned) in this country will be remitted abroad. ✴ On the other hand, some of the incomes earned by residents in the country will come from abroad (e.g. interest, profit, and rent earned). Hence, we have to take into account the ‘net income flows from abroad’, known as Net Factor Income from Abroad (NFYA). ✴ Many developing countries have negative NFYA. The factor income to abroad is greater than that from abroad because of the massive foreign investments within the country. Hence, GNI = GDP + NFYA THINK ABOUT IT [REFER TO APPENDIX]: As Singapore becomes increasingly globalised and local firms are venturing abroad, is GDP or GNI a better measure of Singapore’s national income? Hint: Refer to the definitions of GDP and GNI above. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 9 2024 SH1 H1 & H2 Economics Chapter 5 b. Nominal Income vs. Real Income ✴ Nominal national income is national income measured at current prices. ✴ Real national income is national income after accounting for inflation, i.e. national income measured in constant prices and this means that it is measured in terms of the prices ruling in a chosen base year. ✴ If we are to make a sensible comparison of one year’s national income with another, we must take into account inflation. For example, if this year’s national income is 10 percent higher than last year, but at the same time, prices are also 10 per cent higher, then the average person will be no better off at all. There has been no real increase in income. ✴ Real GDP is obtained by deflating current nominal GDP using the current price index, known as the GDP deflator. ✴ The formula for estimating growth in real national income is as follows: ✴ % Change in Real Income = ✴ % Change in Nominal Income – % Change in General Price Level National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 10 2024 SH1 H1 & H2 Economics Chapter 5 4. USES OF NATIONAL INCOME STATISTICS Learning Objectives: ✴ Explain the rationale of measuring national income from the government and firms’ perspective. 4.1 TO MEASURE THE RATE OF ECONOMIC GROWTH Economic growth is best measured by the percentage change in real GDP. ✴ Nominal GDP is not suitable since it does not account for inflation. Nominal GDP can rise even when the quantity of output produced falls because prices have increased. ✴ Real National output or real GDP is more suitable since it is measured in constant dollars to eliminate the effects of rising prices. ✴ The rate at which real GDP is changing is taken as a measure of the rate of economic growth. ✴ By comparing national income statistics over the years, we can see whether the economy is growing, stagnating or declining. Such information allows the government to monitor the progress of the economy and take appropriate actions to promote economic growth. 4.2 TO MEASURE THE MATERIAL STANDARD OF LIVING Standard of living (SOL) is covered more in the following section. Note that the economic growth of a country is not the only measure of the material standard of living. Other non-national income indicators such as inflation rate, unemployment rate, and balance of trade positions can also be a measure of material standard of living. 4.3 FOR GOVERNMENTS TO FORMULATE SECTOR-BASED ECONOMIC POLICIES National income statistics announced quarterly are regarded as a good short-term indicator of economic prospects, while average GDP figures (over four quarters) are useful for forecasting purposes over a longer period. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 11 2024 SH1 H1 & H2 Economics Chapter 5 The government uses these national income statistics and estimates to formulate future economic plans and developments for different sectors, and implement policies to achieve a targeted level of economic growth. National income statistics of subsequent years will then be used to gauge the progress of the economy and to evaluate the effectiveness of the policies implemented. 4.4 FOR PRIVATE FIRMS TO PLAN PRODUCTION AND INVESTMENT Firms also make use of national income statistics to make predictions on level of demand for goods and services in a country. When the GDP of a country is rising, it signals to firms that the level of demand (for normal and luxury goods) is rising. Hence, firms might increase production levels to meet the rising demand. In addition, if private firms are planning their overseas production and investments, it will be useful for them to consider the economic performance of the countries they are planning to venture to. 5. STANDARD OF LIVING Learning Objectives: ✴ Define material and non-material standard of living ✴ Explain how national income can be a measurement of the material standard of living ✴ Explain the limitations of using national income to measure standard of living across time and space (between countries) ✴ Explain the alternative measures available to measure standard of living ✴ Compare and evaluate the appropriateness of measures to determine standard of living In microeconomics, we are concerned with the social welfare resulting from an individual market. In macroeconomics, we look at the country’s overall standard of living that indicates the level of material and non- material aspects of life that a typical citizen experiences. DEFINITION: STANDARD OF LIVING refers to the level of economic welfare and social well-being of an individual or household. It includes the material and non-material (qualitative) aspects of living. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 12 2024 SH1 H1 & H2 Economics Chapter 5 Two aspects of Standard of Living (SOL) ✴ Material SOL is related to the amount of goods and services that individuals within the country have available for consumption. ✴ Non-material (qualitative) SOL will involve indicators like the amount of leisure people consume, life expectancy, standard of education, absence of pollution and other social factors. National income statistics provide an indication of a country’s material standard of living as they provide some indication of the amount of goods and services available for consumption in a country. With higher national income, the average household has greater purchasing power (assuming no change in population size) to consume more goods and services, attaining a higher material standard of living. The most widely used statistic to indicate standard of living is real per capita GNI. Ceteris paribus, there is a correlation between national income and the standard of living. Countries with high national income such as USA, UK and Japan also have high standard of living. Conversely, countries with very low national income such as Myanmar and Ethiopia have correspondingly lower standard of living. An increase in real per capita GNI within a country over a period of time is taken as an indication of an improvement in the material standard of living of its population, ceteris paribus. 5.1 LIMITATIONS OF USING NATIONAL INCOME AS MEASURE OF LIVING STANDARDS National income figures are commonly used as indicators of the living standards of countries. This section will discuss the limitations of national income as an indicator of living standards. It has to be noted however, that despite its limitations, national income figures are still useful and necessary as an indicator of living standards. It is thus still the most commonly used indicators of living standards. The limitations come in the following forms. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 13 2024 SH1 H1 & H2 Economics Chapter 5 5.1.1 LIMITATIONS FOR COMPARISON OVER TIME (INTER-TEMPORAL) National income statistics are used as a basis for estimating changes in the standard of living of a country over time. It is also commonly referred to as inter-temporal comparisons. ✴ GNI is essentially a measure of a country’s production and is thus more of an indicator of the material aspect of living standards. Since production may be a poor indicator of the well-being of people in the society, it is usually noted that GNI does not give any indication of the non-material aspects of standard of living. ✴ There are also several limitations when estimates of national income, such as GNI, are used to compare a country’s change in standard of living over time. The reasons are as follows. a. Nominal GNI does not take into account changes in prices over time Nominal GNI is measured in nominal or money terms, as this is the most obvious yardstick. However, as a rise in the money value of GNI does not necessarily mean a rise in the volume of goods and services produced. This could have been due largely to rising prices. Suppose nominal GNI rises by 10% but the prices of all goods and services also rise by 10%, i.e. the rate of inflation is 10%, the real GNI has not changed. In fact, real GNI can be negative if the rate of inflation is higher than the nominal economic growth rate. The population might not be better off as the amount of goods and services available for consumption remains unchanged. To accurately compare one year with another, the figures must be adjusted so that we are using a common price level. To do this, we deflate the data by a suitable price index such as the Consumer Price Index (CPI). Thus: Base Year Index Real GNI = Current Year GNI × Current Year Index National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 14 2024 SH1 H1 & H2 Economics Chapter 5 An example: Year Nominal GNI GNI deflator (e.g. CPI) Real GNI 1990 $66.9 billion 98.4 $68.0 billion 1995 $118.9 billion 100.0 $118.9 billion 2003 $159.1 billion 103.3 $154.0 billion Thus, the real GNI in 2003 was $154.0 billion (in terms of 1995 prices), rather than its current value of $159.1 billion. In other words, between 1995 and 2003 real GNI increased by 29.5% while its money value increased by 33.8%. Changes in real GNI can be approximated to be the difference between % change in nominal GNI and % change in general price level, i.e. % ∆ in real GNI ≈ % ∆ in nominal GNI – % ∆ in general price level Therefore, compared to nominal GNI, the real GNI is a better reflection of the standard of living as it eliminates increases in value of national output due to an increase in prices. b. Changes in the size of population over time are not considered Standard of living concerns the individuals within a country. Real GNI, as an aggregate figure, does not take into account changes in the size of the population. For example, the real GNI of a country may have increased. However, if the population of this country has also increased by an equal or greater proportion, then standard of living has not improved. Therefore, the real per capita GNI is a better measure of standard of living as it takes into consideration the population size. Real GNI Real per capita GNI = Total Population Changes in real GNI per capita can be approximated to be the difference between % change in real GNI and % change in population size. % ∆ in real GNI per capital ≈ % ∆ in real GNI – % ∆ in population size National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 15 2024 SH1 H1 & H2 Economics Chapter 5 c. Changes in income distribution over time are not considered Real per capita GNI is a crude indicator of standards of living as it measures the average availability of resources per person in the economy. It does not reflect income distribution (or the way in which these resources are distributed between members of society). For example, the rich minority in a country could be receiving a larger proportion of the GNI while the poor majority could be receiving a smaller share of GNI. In this case, it is difficult to say in general that the standard of living has improved even though real per capita GNI may have increased. Hence, it is necessary to consider how income is distributed within a country. If the income gap widens over time, then living standards may not have improved for the lower income group. DEFINITION: Income Inequality refers to the extent of the uneven distribution of income among a population. To measure income inequality, Gini Coefficient is used as it is universally accepted as a summary measure of income inequality in a given country. The coefficient ranges from zero to one. In a country where each member receives exactly the same income, the coefficient is zero (0 = perfectly equal income distribution). However, for a country where only one member receives all the income and the rest receive nothing, the coefficient is equal to one (1.0 = maximum inequality). In other words, the higher the coefficient, the more unequal is the income distribution. NOTE: Gini Coefficient=Area A/Area A+ Area B Calculation of Gini coefficient is not required. Figure 2: Lorenz Curve National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 16 2024 SH1 H1 & H2 Economics Chapter 5 The Lorenz Curve is a graph with the horizontal axis showing the cumulative proportion of households ranked according to their household income and the vertical axis showing the corresponding cumulative proportion of household income. Lorenz curve shows the proportion of national income earned by any given percentage of the population. Gini coefficient is the area between the Lorenz curve and the 45-degree line divided by the total area under the 45-degree line. Thus, the Gini coefficient will be between 0 and 1 where 0 corresponds to perfect equality and 1 corresponds to perfect inequality. The further the Lorenz curve is from the Perfect Equality Line, the more unequal the income distribution. According to the latest data retrieved from World Bank Organisation in 2021, countries with the highest inequalities were South Africa (0.63) and Namibia (0.59) while countries with the lowest inequalities were Slovenia (0.25) and Czech Republic (0.25). Before adjusting for government transfers and taxes, Singapore’s Gini coefficient was 0.478 in 2012, and hovered about 0.463 from 2013 to 2015. It fell to 0.433 in 2023. Singapore’s Gini coefficient after government transfer and taxes was 0.371 in 2023. THINK ABOUT IT: Singapore’s Gini coefficient was 0.478 in 2012, hovered around 0.463 from 2013 to 2015 and fell to 0.433 in 2023. Explain whether this suggests an improvement in the living standards of an average Singaporean over time? National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 17 2024 SH1 H1 & H2 Economics Chapter 5 An important limitation of Gini coefficient is that it is a relative measure that fails to capture absolute changes in incomes. It is possible for a country to have a higher Gini coefficient even when the number of people living in absolute poverty is declining. Thus, even with an absolute increase in income for all groups, Gini coefficient could still become greater. Likewise, even with an absolute decrease in income for all groups, Gini coefficient could still become smaller. d. Some productive activities are excluded but may have changed over time GNI figures do not record the output of some goods and services. Hence, national income statistics will understate the true living standards in the economy. There are 2 cases where productive activities are not recorded. ✴ Non-marketed items Many products are not transacted in the market. Examples include the services of housewives and subsistence farming. As an economy develops, previously non-marketed items may now be transacted through the market. The increase in GNI due to such monetisation of transactions will not show improvement in welfare. This is so since the increase is not due to the production of more goods and services. ✴ Underground economy Changes in the size of the underground economy will not be reflected in the national income figures. The transactions that occur in the underground economy include: Transactions where the goods and services are illegal (e.g. drugs and prostitution) Transactions that are illegal because they are not declared for tax purposes (e.g. private tuition in Singapore) ‘Moonlighting’ is where people do extra work outside their normal job and they do not declare the income for tax purposes. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 18 2024 SH1 H1 & H2 Economics Chapter 5 e. Externalities incurred over time (non-materials aspect) are ignored GNI figures do not take into account the negative externalities that reduce welfare. Production and consumption of some economic goods could entail harmful side effects to 'third parties' and are not recorded in national income statistics. Examples of such negative externalities include polluted air and rivers, congestion, the ozone layer depletion and global warming. There is a danger that an all-out pursuit of economic growth may lead to deterioration in environmental conditions. This would perhaps be most apparent if growth was concentrated in manufacturing sectors that may increase pollution levels, or run down stocks of non-renewable resources at too rapid a rate. Even growth in financial or service sector activity may accelerate environmental degradation by its effect on commuting activity, congestion, or energy use. It may be difficult to quantify the value and extent of the negative externalities but it remains true that if production generates negative externalities, the net benefits of such increased production will be much less. Hence, even if real GNI per capita increases over time, living standards may not have improved if environmental conditions have deteriorated severely. f. Leisure is not taken into account (non-material aspect) An intangible factor, which influences standard of living, is the amount of leisure time enjoyed by the population. If everyone worked more hours, output would have increased but welfare might not have increased to the same extent. The gain is increased output, but the cost is a reduction in leisure time. In this case, a growth in national income will overstate the improvement in human welfare. g. Changes in the composition of output over time ✴ National Income does not reflect changes in the quality and type of goods and services National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 19 2024 SH1 H1 & H2 Economics Chapter 5 GNI is a quantitative rather than qualitative measure. Even if GNI remains the same from one year to the next, standard of living would have increase if there are improvements in the quality of output or development of new products. In the past 20 years, there have been substantial changes in the quality and availability of products sold and exported by Singapore (e.g. new computers today are more technologically efficient than new computers sold 10 years ago). Some goods like satellite TV receivers, video recorders and personal laptops, were simply unavailable a few years ago. Hence, when the bundle of goods available each year and its quality differ substantially, the significant of national income comparison over time diminishes. ✴ Production does not equal consumption National income measures a country’s level of production but may be a poor indicator of the consumption level by a country’s residents. This is because a country’s output includes both consumption and investment goods but current living standards depend only on consumption goods. If national income rises because of a rise in the production of investment goods (as opposed to consumer goods) it will not lead to a rise in current living standards, although it will help to increase future consumption and future living standards. A rise in national income due to increases in government expenditure on arming for war does not imply a rise in living standards. Similarly, a rise in national income that stems from increase in exports will not contribute to a rise in living standards if the income generated from exports is not spent on consumer imports. Likewise, a fall in national income due to an increase in consumer imports does not necessarily lead to a fall in living standards. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 20 2024 SH1 H1 & H2 Economics Chapter 5 h. Changes in the statistical coverage and reliability of data over time Data collection will become more comprehensive and reliable over time. For example, the use of computers has allowed for more information input and more accurate analysis. Differences in the reliability of data over time have thus made comparisons more difficult. 5.1.2 LIMITATIONS FOR COMPARISON OVER SPACE (INTERNATIONAL) National income statistics, such as real per capita GNI, is frequently used for international comparisons of living standards. This is commonly referred to as spatial comparison. a. Comparisons between countries are made in terms of a common currency A major problem arises because different countries have different currencies. Therefore, it is necessary to convert the GNI figures to a common currency to make realistic comparisons. The most widely used currency for this purpose is the US dollar. The problem with using the official exchange rates for conversion is that the official exchange rates often do not reflect the relative purchasing power of the currencies. This is because the official exchange rates could be the result of speculative activities, movements in the relative prices of only traded goods and of government interventions in the currency market. For example, the per capita GNI in both countries A and B, after conversion using the official exchange rate, may be US$1000. The two countries therefore seem to have the same standard of living. However, if general prices in country A are much higher than that in country B, then US$1000 in country A will buy a smaller amount of goods and services. To overcome this problem, economists use Purchasing Power Parity (PPP). PPP measures the amount of foreign currencies needed to buy the same basket of goods and services in the 2 countries. Purchasing power parities are the rates of currency conversion that equalise the purchasing power National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 21 2024 SH1 H1 & H2 Economics Chapter 5 of different currencies by eliminating the differences in price levels between countries. E.g. If a basket of goods in Singapore costs S$100 and the same basket of goods costs US$150 in US, then the PPP rate is S$1:US$1.5. This can also be expressed as S$0.67 per US$. This means that S$0.67 can buy as many units of goods in Singapore as what US$1 can buy in America. By converting the GNI figures into a common currency using the PPP rate, we eliminate the differences in purchasing power of different currencies used in the computation of the GNI. Hence, PPP-adjusted GNI figures is preferred to GNI figures converted using official exchange rates because it reflects the relative costs of goods and services in various countries. However, there are still some limitations in the use of PPP-adjusted GNI figures. One major problem is that the qualitative differences of products in different countries have not been taken into account. Another problem is the differences in the basket of goods consumed, given that countries differ in climate and culture. There are differences in the way individuals live in different countries because of differences in the physical environment, social and cultural norms. For example, people who live in cold climates will spend more of their incomes on heating and lighting. People living in wide and sparsely populated countries will spend more on transportation and communication. Therefore, different needs have to be satisfied and thus certain countries may differ in the composition of the basket of goods consumed. b. Countries differ in the size of population Standard of living is concerned with individuals within a country. GNI, as an aggregate figure, does not take into account differences in the size of the population. For example, the GNI figures for 2 countries could be the same but with country A having a much larger population size than country B, the GNI per head in country A will thus be much lower compared to country B. GNI per capita is thus a better measure of standard of living as it takes into consideration the population size. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 22 2024 SH1 H1 & H2 Economics Chapter 5 c. Countries differ in their distribution of income GNI per capita is an average figure. It does not show the actual income earned by an individual in a country. A higher per capita GNI in a country may not mean that the average individual will be better off compared to another country. For example, the rich minority in a country could be receiving a larger proportion of the GNI while the poor majority could be receiving a smaller share of GNI. In this case, it is difficult to generalize that the standard of living in this country is the same as another country with similar per capita GNI. d. Countries differ in the amount of externalities generated The higher output in some countries may be accompanied by higher levels of crime, pollution, congestion, depletion/ damage of natural resources. The higher output could actually mean lower welfare for such countries. e. The ‘black economy’ differs between countries GNI figures do not record the output of some goods and services. Hence, national income statistics will understate the true living standards in the economy. There are two cases where productive activities are not recorded: ✴ Non-marketed items In developing countries, there is a major problem of omission of non-marketed transactions (e.g. imputation of a value to self-consumed output in the calculation of GNI). Developed countries, on the other hand, have a higher degree of specialisation of production. This means that such items, as omitted by the developing countries, will be included in the developed countries’ calculation of GNI. ✴ Underground economy Developing countries tend to have a larger underground economy. The transactions that occur in the underground economy include: ✴ Illegal transactions (e.g. drugs and prostitution) are not declared for tax purposes ✴ ‘Moonlighting’ National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 23 2024 SH1 H1 & H2 Economics Chapter 5 f. Countries differ in amount of leisure time enjoyed An intangible factor, which influences standard of living, is the amount of leisure time enjoyed by the population. A country could have a higher GNI at the expense of reducing the amount of leisure time enjoyed. g. Countries differ in their composition of national output Countries with similar per capita GNI may produce a substantially different range of goods and services. Some countries devote relatively large amounts of resources to military expenditure. Other countries may have a larger proportion of GNI consisting of goods and services for household consumption. Countries that devote a larger proportion of resources to investment may have a lower level of current consumption although it can enjoy a higher future standard of living (idea of trade off). h. Accuracy and reliability of data collection differ between countries There is no internationally agreed method of measuring National Income. Hence, not every country uses the same basis for their calculations. Some countries may exclude the output of entertainers but include the monetary value of work done by homemakers. Thus, we are frequently not making comparisons on the same platform. Accuracy in data collection also differs. Statistical services are better developed in high-income countries compared to those in low-income countries. Therefore, national income figures are more complete and reliable in the high-income countries. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 24 2024 SH1 H1 & H2 Economics Chapter 5 5.2 ALTERNATIVE MEASURES OF LIVING STANDARDS As mentioned earlier, national income figures are useful and necessary indicators of living standards. However, due to their limitations, they are imperfect and insufficient. Alternative measures have been designed to provide us a better indication of living standards. 5.2.1 HUMAN DEVELOPMENT INDEX (HDI) NOTE: Calculation of HDI is not HDI is a composite measure developed by the United Nations to provide required. a broader view of a country’s standard of living, including material and non-material aspects. It is used to rank countries by level of human development, which usually also implies whether a country is a developed, developing, or underdeveloped country. HDI = GNI per capita + knowledge (measured by the adult literacy rate and the mean years of schooling received by adults 25 years and above) + health (measured by life expectancy and infant mortality rates). 5.2.2 MEASURE OF ECONOMIC WELFARE (MEW) MEW is another composite economic indicator developed by Nordhaus and Tobin to adjust GDP or GNI figures to provide a better measure of a country’s standard of living (SOL) rather than only its production, with adjustments for leisure, environmental degradation, income distribution and other economically unsustainable costs such as depletion of natural resources. MEW = GNI – capital depreciation – regrettables (e.g. expenditure on defence and pollution) + allowance for leisure + non-marketed activities (e.g. housework and underground activities) + public amenities (e.g. parks and roads) + private durable goods (e.g. furniture and jewellery). While more direct and useful, MEW is difficult to compute because valuation of leisure, pollution and other regrettables is not easy. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 25 2024 SH1 H1 & H2 Economics Chapter 5 5.2.3 SOCIAL PROGRESS INDEX This is an index to measure national progress. The Social Progress Index offers a rich framework for measuring the multiple dimensions of social progress, benchmarking success, and catalysing greater human wellbeing. This index measures: ✴ Basic human needs Nutrition and basic medical care Water and sanitation Shelter Personal safety ✴ Foundations of well-beings Access to basic knowledge Access to information and communication Health and wellness Ecosystem and sustainability ✴ Opportunity Personal rights Personal freedom and choice Tolerance and inclusion Access to advanced education National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 26 2024 SH1 H1 & H2 Economics Chapter 5 6. DECISION-MAKING EXAMPLE THIMPHU, Bhutan — This secluded Buddhist kingdom uses a unique barometer to measure economic progress. And the message of the 2015 Gross National Happiness Index is a troubling one: Money isn’t buying enough contentment. Tucked high in the Himalayas between India and China, Bhutan was poor and largely closed to foreigners when its fourth king declared, in the 1970s, that “gross national happiness” was more important than gross domestic product, or GDP. Never mind that tourism and hydropower have more recently lifted incomes and fueled development or that Bhutan’s economy is growing at a healthy annual rate of nearly 7%. Officials here worry that modern life tends to throw things off-balance. So Bhutan’s happiness surveyors think it’s worth asking a few questions. Among them: “How much do you trust your neighbours?” “Is lying justifiable?” “Do you feel like a stranger in your family?” The index also surveys knowledge of artisan skills such as embroidery, carpentry and papermaking. If “we are increasing in richness but we’re not doing so well overall in well-being, and people are not as content, then something definitely is wrong,” Prime Minister Tshering Tobgay said in this serene capital, 7,700 feet above sea level. Bhutan, population 750,000, still feels like a place out of time. Traditional architecture and dress prevail: Men wear knee-length robes, tied at the waist, with over-the-calf socks. An early-morning prayer session is among the state-run television network’s most popular programs. “Life is very slow here,” said Tshewang Norbu, the Asian Development Bank’s resident representative in Bhutan. The fourth monarch’s pronouncements about national happiness were only pronouncements until 2010, when Bhutan computed its first happiness index. Bhutanese officials say the happiness index is about finding balance between modernity and tradition, between prosperity and ecological conservation, between material advancement and its National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 27 2024 SH1 H1 & H2 Economics Chapter 5 discontents. Some wish the country could stop releasing conventional economic indicators altogether. “Personally, I would not want GDP data from Bhutan,” said Norbu Wangchuk, the economy minister, wearing the customary sword of Bhutanese officialdom. But “we need to seem to be belonging to the world community,” he said, laughing. “We cannot isolate ourselves from the world.” In response to declining spirituality, Prime Minister Tobgay said he is looking to strengthen Buddhist education in schools. He wants to reinvigorate the rural economy and stem the exodus of young people into towns and cities, where youth unemployment is around 25%. Novelist Kunzang Choden, however, worries that economic progress has made simple living a harder sell. “We’ve gone this far,” said Ms. Choden. “How do you tell the people, ‘No, we’ve made a mistake. Let’s go back and start over again?’” Source: Adapted from Wall Street Journal, 16 Dec 2015 1. Key concepts: ✴ National income statistics ✴ Economic performance ✴ Standard of living 2. Decision to be made (by the government) ✴ Whether the use of Gross National Happiness Index is a better measure of a country’s standard of living as compared to the use of the conventional Gross Domestic Product. 3. Constraints ✴ Reliability and accuracy of data, since samples are only partially representative of the target population. ✴ Happiness is subjective and affected by social and cultural factors. This could affect the validity of comparison across countries. National Junior College Economics Department H1 Economics (8843) & H2 Economics (9570) 28 2024 SH1 H1 & H2 Economics Chapter 5 4. Benefits and costs ✴ Benefits: The use of Gross Happiness Index as a measure of a country’s standard of living is an attempt at providing a balance between prosperity and ecological conservation, and between material advancement and its discontents. Allows to track changes of a country’s economic performance and standard of living. Allows for a comparison of economic performance and standard of living between countries. ✴ Costs Monetary costs of collecting data Opportunity cost in resources, time and effort spent to compile and process data is the capacity expansion of Bhutan’s hydropower system forgone. 5. Relevant information support Decision Making ✴ To ask questions that focuses on the populace’s contentment and overall well-being as the economy prospers. Questions such as “How much do you trust your neighbours?” “Is lying justifiable?”, “Do you feel like a stranger in your family?” ✴ Exclusion of productive activities, non-market activities in the calculation of national income statistics that may understate or overstate a country’s standard of living. 6. Perspectives on the Decision/Issue ✴ A more comprehensive set of indicator or indicators that measure both material and non-material standard of living given the differing perspectives on the appropriate index to use. Some preferred the use of Gross Happiness Index, while others felt that the conventional GDP index used could be complemented with the Gross Happiness Index since both indices measure different aspects of a country’s standard of