Advantages and disadvantages of real GDP per head and HDI as indicators

Cambridge IGCSE Economics (0455) – Complete Syllabus Notes

Contents

1. The Basic Economic Problem
2. Allocation of Resources
3. Micro‑economic Decision‑makers
4. Government and the Macro‑economy
5. Economic Development – Living Standards
6. International Trade & Globalisation

1. The Basic Economic Problem

1.1 The Three Basic Economic Questions

• What goods and services should be produced?
• How should they be produced?
• For whom are they produced?

1.2 Scarcity, Choice and Opportunity Cost

• Resources are limited; human wants are unlimited → choices must be made.
• Opportunity cost: value of the next best alternative foregone.
• Key terminology: needs, wants, resources (land, labour, capital, entrepreneurship).

1.3 Factors of Production and Their Rewards

1.4 Production Possibility Frontier (PPF)

• Shows the maximum possible output combinations of two goods when all resources are fully and efficiently employed.
• Key features

  • Efficient points – on the curve.
  • Inefficient points – inside the curve.
  • Unattainable points – outside the curve.

• Shifts

  • Outward shift – economic growth (more resources or better technology).
  • Inward shift – war, natural disaster, loss of resources.
  • Change in shape – reallocation of resources between sectors.

Diagram suggestion: Draw a PPF for “Cars” vs “Clothing”. Mark a point inside (inefficiency), a point on the curve (efficient), and an outward shift after a technological improvement in car production.

Evaluation of the PPF Model

• Strengths: Simple visual of scarcity, choice, efficiency and growth; illustrates trade‑offs and opportunity cost.
• Limitations: Only two goods are shown; assumes all resources are homogeneous; ignores quality changes, distribution of income and non‑market activities.

2. Allocation of Resources

2.1 Economic Systems

2.2 Demand and Supply

• Demand: Quantity buyers are willing & able to purchase at each price (law of demand).
• Supply: Quantity sellers are willing & able to offer at each price (law of supply).
• Market equilibrium: Where D = S; determines equilibrium price (P_e) and quantity (Q_e).

2.3 Price Elasticity of Demand (PED)

2.4 Price Elasticity of Supply (PES)

2.5 Other Elasticities

2.6 Market Failure

• Public goods – non‑rival & non‑excludable (e.g., street lighting).
• Merit goods – under‑consumed if left to market (e.g., education, vaccinations).
• Demerit goods – over‑consumed if left to market (e.g., tobacco, alcohol).
• Externalities

  • Positive – benefits to third parties (e.g., immunisation).
  • Negative – costs to third parties (e.g., pollution).

• Monopoly power – single seller can restrict output and raise price.

2.7 Government Intervention – Tools & Brief Evaluation

Evaluation of Intervention

• Advantages: corrects market failures, promotes equity, protects consumers and workers.
• Disadvantages: can create shortages or surpluses, impose administrative costs, distort incentives, and may lead to unintended consequences (e.g., black markets).

3. Micro‑economic Decision‑makers

3.1 Households

• Decide on consumption, saving and borrowing.
• Factors influencing consumption: income, interest rates, expectations, tastes and preferences.
• Savings – part of disposable income not spent; provides capital for investment.
• Borrowing – influences aggregate demand; interest rates affect willingness to borrow.

3.2 Money and Banking (required for the syllabus)

• Functions of money: medium of exchange, unit of account, store of value, standard of deferred payment.
• Forms of money: commodity money, fiat (paper) money, electronic money.
• Banking system

  • Central bank – controls money supply, sets policy interest rates, acts as lender of last resort.
  • Commercial banks – accept deposits, provide loans, create money through the multiplier effect.

• Money supply (M1, M2) – definition and relevance to monetary policy.

3.3 Workers (Labour Market)

• Labour supply determined by wage rates, population, education, expectations, and non‑wage factors (working conditions).
• Labour demand derived from the marginal product of labour (MPL); firms hire until MPL = real wage.
• Wage‑determination diagram – labour supply & demand curves; illustrate the effect of a minimum wage above equilibrium (creates unemployment).
• Additional topics:

  • Trade unions – collective bargaining can raise wages above market‑determined level.
  • National Minimum Wage – statutory floor to protect low‑paid workers.
  • Wage differentials – skill, sector, geographic, gender and discrimination.

3.4 Firms

• Goal: maximise profit (or loss‑minimise in the short run).
• Cost concepts: fixed, variable, total, average (AC), marginal (MC).
• Revenue concepts: total, average, marginal.
• Profit = Total Revenue – Total Cost.
• Types of market structures – competitive market vs monopoly (required for the syllabus):

  • Competitive market – many sellers, homogeneous product, price‑taker.
  • Monopoly – single seller, unique product, price‑setter.

• Mergers

  • Horizontal – firms at the same stage of production.
  • Vertical – firms at different stages (e.g., manufacturer & retailer).
  • Conglomerate – firms in unrelated industries.

• Economies of scale – average cost falls as output rises (diagram of ATC falling). Causes: bulk buying, specialised labour, spreading of fixed costs.
• Diseconomies of scale – average cost rises after a certain size (management inefficiency, coordination problems).
• Labour‑intensive vs capital‑intensive production – examples: garment factories (labour‑intensive) vs automobile plants (capital‑intensive).

3.5 Evaluation of Firm‑level Decisions

• Profit maximisation may conflict with long‑run sustainability, environmental concerns, or social responsibility.
• Scale economies improve efficiency but can lead to market power and reduced competition.
• Government policies (taxes, subsidies, regulation) can alter cost structures and affect firm behaviour.

4. Government and the Macro‑economy

4.1 Macro‑economic Aims

• Economic growth
• Low unemployment
• Price stability (low inflation)
• Equitable distribution of income
• External balance (stable current account)

4.2 Fiscal Policy

• Components: Government spending (G) and taxation (T).
• Aggregate demand equation:
  \$AD = C + I + G + (X - M)\$
• Expansionary fiscal policy – increase G or cut T → AD shifts right → higher output (Y) and price level (P).
• Contractionary fiscal policy – decrease G or raise T → AD shifts left.
• Budget outcomes:

  • Deficit = G − T (when G > T).
  • Surplus = T − G (when T > G).
  • Public debt accumulates when deficits are persistent.

• Effect on each macro‑aim (brief table):

  Policy	Growth	Unemployment	Inflation	Distribution
  Expansionary	↑	↓	↑ (risk of demand‑pull inflation)	Can be progressive if spending is on welfare
  Contractionary	↓	↑	↓ (helps control inflation)	Can be regressive if tax cuts favour high earners

4.3 Monetary Policy

• Controlled by the central bank (e.g., Bank of England, Federal Reserve).
• Key tools:

  • Policy interest rate (Bank Rate) – influences commercial bank rates.
  • Open‑market operations – buying/selling government securities to change the money supply.
  • Reserve requirements – proportion of deposits banks must hold.

• Money supply (M) – total amount of money circulating in the economy (M1, M2). Expansionary monetary policy increases M, lowering interest rates and shifting AD right.
• Liquidity trap – when interest rates are already near zero, further monetary easing has little effect on AD.

4.4 Supply‑side Policies

• Aim to increase productive capacity (potential output) without increasing demand.
• Examples:

  • Investment in education & training (human capital).
  • Deregulation – removing unnecessary red tape.
  • Tax incentives for research & development.
  • Infrastructure development (roads, ports).
  • Privatisation of inefficient state enterprises.

• Evaluation: long implementation lags; benefits accrue in the medium‑ to long‑run; may cause short‑run disruption (e.g., job losses from privatisation).

4.5 Unemployment

4.6 Inflation

• Measured by the Consumer Price Index (CPI) – weighted basket of goods and services.
• Demand‑pull inflation: AD > AS (economy overheating) → price level rises.
• Cost‑push inflation: rising production costs (e.g., oil price shock) shift AS left.
• Policy mix: contractionary fiscal/monetary policy to curb demand‑pull; supply‑side measures to alleviate cost‑push.

Evaluation of Macro Policies

• Fiscal policy effectiveness limited by high public debt and long implementation lags (recognition, decision, execution).
• Monetary policy can be implemented quickly but may be ineffective at the zero‑lower bound.
• Supply‑side policies improve long‑run growth but require time, political will and may face opposition from affected groups.

5. Economic Development – Living Standards

5.1 Real GDP per Head (Real GDP per Capita)

Real GDP per head measures the average value of goods and services produced per person, adjusted for inflation.

Formula:

\$\text{Real GDP per head} = \frac{\text{Real GDP}}{\text{Population}}\$

Advantages

• Simple, single monetary figure – easy to compare countries and to track change over time.
• Inflation‑adjusted, so it reflects real changes in output rather than price movements.
• Data are widely published by national accounts and international organisations (World Bank, IMF).
• Provides an indication of the economy’s capacity to generate income for its residents.

Disadvantages

• Ignores income distribution – a high average can mask severe inequality (e.g., oil‑rich countries with large wealth gaps).
• Excludes non‑market activities such as unpaid household work, volunteer work and informal sector output.
• Environmental neglect – does not subtract the cost of pollution, resource depletion or loss of ecosystem services.
• Quality‑of‑life factors omitted – health, education, personal safety, political freedom and cultural satisfaction are not reflected.
• Can be distorted by exchange‑rate fluctuations when expressed in a common currency.

5.2 Human Development Index (HDI)

The HDI combines three key dimensions of human development: health, education and standard of living.

Component indices (each normalised 0–1):

• Health – Life expectancy at birth.
• Education – Mean years of schooling (MYS) and Expected years of schooling (EYS).
• Income – GNI per capita (PPP $) (logarithmic transformation to reflect diminishing returns).

Simplified formula:

\$\text{HDI} = \frac{I{\text{health}} + I{\text{education}} + I_{\text{income}}}{3}\$

Advantages

• Broadens assessment beyond pure economic output, incorporating health and education – core aspects of well‑being.
• Allows simultaneous comparison of income, health and education progress.
• Highlights cases where income growth does not translate into improved human welfare (e.g., high GDP but low schooling).
• Encourages policy focus on “human” development rather than “economic” development alone.

Disadvantages

• Relies on limited indicators – many aspects of quality of life (e.g., political freedom, gender equality, environmental quality) are omitted.
• Data quality varies; some countries have outdated or incomplete statistics, especially for education.
• Aggregation can mask internal disparities (regional, gender, urban‑rural).
• Weighting is equal for all three dimensions, which may not reflect a country’s specific development priorities.
• Uses GNI rather than GDP, which can be affected by remittances and income from abroad, potentially overstating domestic welfare.

5.3 Comparison of Real GDP per Head and HDI

Evaluation – Which is a Better Indicator of Living Standards?

• Context matters – For a quick snapshot of economic growth, real GDP per head is useful; for policy aimed at improving health, education and equality, HDI is more informative.
• Complementarity – Most economists recommend using both indicators together to obtain a fuller picture.
• Potential bias – Relying solely on GDP can lead to “growth‑without‑development” policies; relying solely on HDI may under‑emphasise the importance of sustainable economic growth.
• Future trends – Emerging measures (e.g., Genuine Progress Indicator, Sustainable Development Goals indices) aim to combine economic, social and environmental dimensions.

6. International Trade & Globalisation

6.1 Reasons for Trade

• Comparative advantage – countries specialise in goods with lower opportunity cost.
• Economies of scale – larger markets allow lower average costs.
• Variety of goods – consumers gain access to a wider range of products.
• Access to resources – imports of raw materials not available domestically.

6.2 Balance of Payments (BOP)

Surplus = Exports > Imports; Deficit = Imports > Exports. Persistent deficits may lead to borrowing and exchange‑rate pressure.

6.3 Trade Protection Measures

6.4 Evaluation of Trade Policies

• Advantages: Protects infant industries, safeguards jobs, can improve trade balance.
• Disadvantages: Raises prices for consumers, invites retaliation, can lead to inefficiency and reduced export competitiveness.
• Long‑run consensus: free trade promotes growth, but strategic protection may be justified for sectors with strong potential (e.g., high‑tech).

6.5 Globalisation – Benefits and Costs

• Benefits: Faster technology transfer, increased foreign investment, greater consumer choice, lower production costs.
• Costs: Job losses in uncompetitive industries, widening income inequality, cultural homogenisation, environmental pressure.

6.6 Exchange Rates

• Nominal vs real exchange rate – real adjusts for price level differences.
• Factors influencing exchange rates: interest rates, inflation differentials, political stability, speculation.
• Depreciation makes exports cheaper and imports more expensive; appreciation has the opposite effect.

Key Revision Tips

• Use diagrams (PPF, demand‑supply, AD‑AS, labour market, ATC) and label all curves, shifts and equilibrium points.
• Memorise the formulas for elasticity, real GDP per head, and the HDI component indices.
• For evaluation, always present at least two advantages and two disadvantages, and consider short‑run vs long‑run effects.
• Practice past‑paper questions that ask you to compare indicators (GDP per head vs HDI) and to evaluate policies.