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Key Economic Indicators and why are they important

Theme 5: Introduction to Macroeconomics

Topic: Key Economic Indicators and Performance of an Economy

Relevance: H1 and H2 Economics

Introduction:

Economists measure economic performance of a country using economic indicators. Among the many indicators, there are 4 key economic indicators that economists usually use either to compare the changes in economic performance of a country over time or to compare the economic performance of different countries. The 4 key economic indicators are:

1) National Income Statistics

2) Inflation rate

3) Unemployment rate

4) Balance of Payment

National Income Statistics

National income statistics is not just one indicator, but a range of indicators associated with gross domestic product (GDP). GDP is defined as the total value of final goods and services produced within the geographical limit of a country over a period of time. GDP can also be understood as the measurement of the total value of income generated or earned in the economy over a period of time.


To measure the overall performance of an economy, Real GDP is usually used as its GDP taking changes in general price level (inflation) into account, making it more accurate for comparison. Comparison of real GDP can be done in two methods.


The first method is comparison of the absolute value, where the higher the absolute value of GDP, the better the performance of an economy. For example, USA is the 1st with the largest real GDP, China is 2nd while Singapore is about 38th.


The second method is the comparison of the relative value, which is the percentage change in real GDP, this is where the larger the increase of real GDP, the better the performance of an economy. The smaller the decrease in real GDP, we can also argue the performance of an economy being good.


To measure the wealth, income or standard of living of individuals in an economy, real GDP per capita is usually used, real GDP divided by the population, or the average Real GDP per person in the economy. With higher income earned on average per person, living standards of the population would have increased as they are wealthier and able to consume more goods and services which increases standard of living, ceteris paribus. This is a more accurate measurement as it divides the total income generated by the economy by the population size, China might be 2nd on the real GDP ranking, however on the Real GDP per capita, China is now ranked about 100th. On the other hand, Singapore might be about 38th on the real GDP ranking, however on the Real GDP per capita, Singapore is now ranked top 10. Real GDP per capital can also be understood as the measurement the average productivity level of per person in an economy.


To increase the accuracy of measurement and comparison, real GDP or real GDP per capita can also be measured using purchasing power parity (PPP) terms. It is real GDP per capita but converted into a common currency with each dollar having the same purchasing power.

Inflation Rate

The second key economic indicator is Inflation rate. Inflation can be defined as a persistent increase in the general price level. Inflation rate is commonly measured by the percentage change in consumer price index over two period of time.


Inflation rate and consumer price index are commonly linked to the cost of living in a country. An increase in consumer price index would mean that the inflation rate is positive percentage change and the cost of living is now higher.

  • Inflation is defined as positive inflation rate and increase in consumer price index.

  • Deflation is defined as negative inflation rate and decrease in consumer price index.

While a positive inflation rate is usually associated with good economic performance, however, it could also have negative impact on the economy. On the other hand, a negative inflation rate is usually associated with bad economic performance, however, it could also have positive impact on the economy. This is because inflation rate will affect the, expectation of economic performances, cost of production and export competitiveness


Inflation rates also affects the standard of living as inflation will decreases the real income as well as the purchasing power of households and the amount of goods and services they can consume.


A country with positive inflation rate is usually deemed to be better performing economy compared to another country with negative inflation rate.


A country with a larger positive inflation rate is usually deemed to be better performing economy due to an increase in demand for goods and services, however, too high of an inflation is associated with unsustainable economy growth.

Unemployment Rate

The third key economic indicator is unemployment rate. Unemployment can be defined as a situation when a person of legal working age, willing and able to work but unable to find jobs or employment. Unemployment is commonly measured by the percentage population of legal working age, willing and able to work but unable to find jobs or employment. The population of legal working age in a country is also known as the labour force.


Unemployment rate measures the economic performance of a country as it signals the amount of labour that is unutilised. High or higher unemployment rate suggests poor economic performance as labour is a factor of production, therefore which high or higher unemployment rate, it means that less goods and services are being produced.


Unemployment rate also suggests the amount of goods and services that could have been produced by the economy instead if these unemployed are utilised. Lower unemployment rate suggests good economic performance as more goods are services are being produced.


An economy with high unemployment rate is likely to face other issues or problems as high unemployment rate usually leads to higher crime rates and social instability. Governments are also expected to tackle unemployment rate by devoting more resources and effort in terms of spending to promote employment or welfare benefits for the unemployed. These spending will negatively affect the country’s fiscal position. Also, these resources would incur opportunity cost as they could have been spend elsewhere like national defence or education. Higher unemployment would also mean lesser income tax collected by the government, which will also negatively affect the country’s fiscal position.

Balance of Payments

The fourth key economic indicator is the Balance of payments. Balance of payments can be defined as a summary record of all economic transactions between residents of a country and the rest of the world over a period of time, ceteris paribus. Balance of payments is commonly measured by subtracting payments to abroad from payments into the country. It can be measured in terms of absolute value or percentage of the national income.


The two main accounts of Balance of payments are “Current Account” and “Capital and Financial Account”. Current account is associated with the trading of goods and services in terms of imports and exports while capital and financial account is associated with the trade short- and long-term investment in and out of the country.


Balance of payments surpluses suggests good economic performance as the money flowing into the economy is more than the money flowing out of the economy. This will increases the income of the population as well as the amount of money circulating the economy. This is usually caused by a Balance of Trade surplus as exports revenue exceed imports expenditure. Balance of payments will also have an impact on the economy as it will affect the exchange rate of the country. Balance of payments surpluses is likely to lead to an appreciation of the currency and this will improve the standard of living of population as imports become cheaper to consume.

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