Section C: Tutorial Package

SUGGESTED ANSWERS TO
CHAPTER 7: STANDARD OF LIVING AND ITS INDICATORS

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SECTION A: SHORT STRUCTURED QUESTIONS

1. The able bel h me a i ic ela ing ac n na i nal inc me.

$ million

Consumption expenditure 100

Gross investment 120

Government spending 75

Exports 20

Imports 30

Net factor income from abroad 10

Depreciation 5

Subsidies 2

Indirect taxes 3

Using the expenditure method, what is the value of

(i) Gross Domestic Product at market prices? $285m (100 + 120 + 75 + 20 30)
(ii) Gross National product at market prices? $295m (above, + NFIA)

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2. The table below shows some statistics relating to the national income of a country.

$ million

Income from employment and self-employment 20

Rental income 12

Interest earnings 5

Dividends 15

Corporate taxes 8

Undistributed profits 15

Household savings 10

Transfer payments 7

Personal income tax 4

(i) Using the income method, how much is Gross Domestic Product at factor cost? $67m (20 +
12 + 5 + 15 + 15)

3. Complete the following equations:

i. GNP at market prices = GDP at market prices + Net Property Income from Abroad.
ii. GNP at factor costs = GNP at market prices taxes + subsidies.
iii. NNP = GNP depreciation.

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CSQ1: Cambridge IGCSE Economics 0455, 2014 Paper (Edited)

Extract 1: Economic problems in Bulgaria

Bulgaria is the poorest of the 27 countries (as of May 2013) in the European Union (EU). It joined
the EU in January 2007. Average wages are only US$4.50 an hour and average monthly salaries
are only US$465. The rate of unemployment in Bulgaria in 2012 was estimated at 12%, compared
to an EU average of 9.4%. This level of unemployment, however, was much less than that in
some EU countries, such as Greece, where the rate of unemployment was twice as high.

The population of Bulgaria is 7.5 million and yet over a million Bulgarians have left the country in
recent years to work abroad, especially in Spain and Greece. The value of the money they have
sent back home, known as migrant remittances, has risen from US$900 million in 2008 to US$990
million in 2012. Much of the work that these people do in Spain and Greece is seasonal and so
there have been particular problems of seasonal unemployment, with some of the migrants losing
their jobs and having to return home.

Within Bulgaria, a lot of workers have lost their jobs in the construction industry. It had been
lanned ha a la ge n mbe f h el and h lida fla ld be b il al ng B lga ia Black Sea
coast. Since 2008, there has been a dramatic fall in the demand for these properties and many
construction firms have gone out of business, having failed to obtain sufficient funds from financial
institutions.

The Gross Domestic Product (GDP) of Bulgaria has only been growing by 1.7% per year in recent
years. In 2012 the GDP was US$48.0 billion. One of the problems in measuring GDP in Bulgaria
is that it has been estimated that as much as 30% of the economy goes unrecorded. There is a
great deal of activity in what has been termed the hidden or informal economy. Not all income
earned is declared for tax purposes, there is some smuggling (illegal importing) and much of
agricultural output is subsistence farming.

It is noticeable that the death rate in Bulgaria is considerably higher than the birth rate (see Table
2 for details). A survey of Bulgarians found that about 70% of them expected the economic
situation in the country to worsen in the next 12 months, not something that would be likely to
bring about an increase in the birth rate. This has meant that Bulgaria now has the second most
rapidly declining population in the world, as shown in Table 1.

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Questions

(a) Using information from the extract, calculate what would have been the estimated size of the
informal economy in Bulgaria in 2012 in US$. [1]

(b) With reference to the extract, explain why such a large percentage of the Bulgarian Gross
Domestic Product goes unrecorded. [2]

(c) With the aid of a diagram(s), e lain he im ac f declining la i n n B lga ia ec n m .

[6]

Declining population: C likely to fall Surplus --> accumulation of stocks reduce production
trigger reverse K process multiplied fall in Real GDP and fall in derived demand for workers,
unemployment rise.

No. of workers fall, productive capacity falls LRAS likely to fall potential growth fall

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(d) Discuss whether the Human Development Index is a perfect measure to compare living
standards in different countries. [8]

Living standards comprise of material and non-material standard of living. HDI is a composite
index that takes into account achievements in these three dimensions, the ability to live a long
and healthy life (life expectancy), knowledge (mean years of schooling and expected years of
schooling) and a decent material standard of living (GNI/capita(PPP$). These three basic
dimen i n a e incl ded a i i h gh ha e le elfa e i infl enced n nl b he g d
and services available to them but also by their ability to lead a long and healthy life and to acquire
knowledge. It is expressed as a value between 0 and 1. The higher the score (i.e closer to 1) the
better will be the quality of life.

The material standard of living dimension is measured by PPP-adjusted Gross National Income
(GNI) per capita. This indicator provides a good comparison of material SOL across countries as
it measures the level of purchasing power after adjusting for differences in cost of living between
countries. When a country has higher GNI/capita (PPP$), on average, the residents will higher
purchasing power and they can consume more goods and services. This would result in higher
material standard of living.

HDI also provide information on non-material standard of living, for example, the acquisition of
knowledge. When the residents have higher years of schooling, or they are more education
compare to other countries, they will be more confident and assured. They can also better
understand the information available. As a result, the quality of life will be higher as compared to
other countries. Life expectancy could also be an indicator for the quality of life. When a country
has longer life expectancy, we can interpret that the residents are healthier and suffered less
physical and emotional distress from being sick. Thus, the quality of life can also be said to be
higher.

As HDI measures different aspects of SOL, it can be said to be a good indicator.

However, it is not the perfect indicator. GNI/capita in PPP$ only measures the average income
per person in that country. It does not considered the income distribution which is measured by
gini coefficient. While a country may have higher GNI/capita(PPP$) than the rest, if the country
also experiences very high income inequality, then HDI may not be able to help us to make an
accurate comparison of standard of living between two countries.

Moreover, non-material SOL is not just about the education level or the longevity of the people.
Other elements such as quantity of leisure time, pollution level, access to internet etc are also
important to quality of life. For example, a country may have high income in terms of GNI/capita
in PPP$ and higher level of education. However, the residents may have little leisure hours as
they experience long working hours or stressful education. As such, their overall SOL may not be
as high as what HDI suggested.

SOL has many different aspects and HDI only measures a few aspects. However, the three
elements of income level, education and life expectancy are three of the most important aspects
of standard of living. It is hard to argue that one can be considered to be enjoying a good level of

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standard of living without attaining certain level of income level, education and health life.
Moreover, these indicators are objective and the information is easily available to be used as a
form of comparison of standard of living across countries. As such, HDI can be considered as a
very good indicator.

Level Descriptor

L2 (4-6) A good understanding of HDI and how it can be used to compare SOL across
countries. Students also explain the limitations of HDI and why these limitations are
important.

L1 (1-3 One sided explanation of how HDI is a perfect indicator. Some awareness of HDI, its
uses and limitations but explanations are incomplete.

E1(1-2) Up to a further 2 marks for valid evaluative judgement.

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CSQ2: 2007 A Level CSQ (modified)

OECD report on China, Brazil and the Russian Federation, 2005

Extract 1: China

Asian economic growth stabilised in 2004 i h he ligh inc ea e in China g h being ff e

el e he e in he a ea. The inc ea e in China g h came de i e igh e fi cal lic and
strengthened controls over investment. The latter were only partially effective as profitability
continued to drive investment expenditures in the ever more important private sector. Looking at
the demand side of growth, investment has long been a major driver. Even though per capita
capital stock in China is still lower than in more advanced economies, a gradual rebalancing from
investment to consumption is needed as it spends on economic investment, leaving less for
consumption. The strength of exports and the economy as a whole were also related to the
depreciation of the exchange rate. In the future, domestic demand may slacken. However, rapid
export growth will limit this slowdown and produce a marked increase in the current account
surplus.

Extract 2: Brazil

Economic growth in Brazil was above 5% in 2004, the strongest in almost 20 years. Growth
continued to be driven by strong consumer demand, pushed by the recovery in employment and
wages, and in investment. Export growth also remained robust, owing to strong demand from
OECD markets, as well as from China. Imports surged on the back of robust private consumption
and investment. The Brazilian exchange rate appreciated over the year. Growth was set to
continue in 2005-06, but at a slower pace than in 2004.

Extract 3: Russian Federation

In 2005 Russia and other commodity exporters in the region are expected to continue to benefit
from very high prices for hydrocarbons and metals. However, Russian economic activity should
slow, as the growth rates of both investment and export volumes have fallen and are unlikely to
pick up again in the absence of steps to restore shaken business confidence. Nevertheless,
R ia e an i n a e c n in e, a ne ec ed inc ea e in il e en e a e inc ea ingl
used to finance expansionary fiscal policy by increasing government expenditure on infrastructure
and to fuel household consumption.

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Table 1: Macroeconomic Indicators: China

2003 2004 2005 2006

Annual rate of growth in real GDP 9.5 9.7 9.0 9.2

Rate of inflation 1.2 3.9 4.0 4.2

Government budget balance -1.9 -0.9 -0.4 -0.2

Current account balance (US$ Billion) 45.9 68.7 100.00 101.0

Current account balance (% of GDP) 3.1 4.0 5.2 4.6

Table 2: Macroeconomic Indicators: Brazil

2003 2004 2005 2006

Annual rate of growth in real GDP 0.5 5.2 3.7 3.5

Rate of inflation 9.3 7.6 6.3 5.0

Government budget balance -5.1 -2.7 -3.8 -2.8

Current account balance (US$ Billion) 4.2 11.7 6.5 2.0

Current account balance (% of GDP) 0.8 1.9 0.9 0.3

Table 3: Macroeconomic Indicators: Russia

2003 2004 2005 2006

Annual rate of growth in real GDP 7.3 7.1 6.0 6.0

Rate of inflation 12.0 11.7 13.0 12.0

Government budget balance 1.2 4.5 2.0 1.5

Current account balance (US$ Billion) 39.5 58.2 92.0 80.0

Current account balance (% of GDP) 8.3 10.0 12.0 8.5

Source: OECD Outlook Vol 77

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Table 4: GDP per capita (current US$)

2006

Brazil $ 5,860

China $ 2,099

Russian Federation $ 6,920

Source: World Bank, accessed Nov 2018

Questions
(a) (i) Describe the trend in the government budget balance in China between 2003 and
2006. [2]
(ii) Compare this trend with he change in he R ian g e nmen b dge balance in
the same period. [2]
(b) (i) What is the difference between real GDP growth and nominal GDP growth? [1]
(ii) Identify the economy which is projected to have the highest growth in nominal GDP in
2006. [1]
(c) Explain how current and future living standards can be affected by the allocation of
resources between private consumption and gross fixed investment. [3]
(d) Using AD/AS analysis,
(i) Explain the possible effects of an appreciation of Brazilian currency on the real
national output and general price level of Brazil. [6]
(ii) Explain the effect of expansionary fiscal policy on the Russian economy. [4]
(e) Discuss and compare the likely impact of an unexpected decline in world economic
activity on any two of these economies. [8]
(f) Comment on the usefulness of the data in table 4 to compare the standard of living
across Brazil, China and Russia in 2006. [6]
(g) Discuss whether the data provided are sufficient to assess changes in the standard of
living in these economies over the period. [12]

[Total: 45]

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Suggested Answers

OECD Report on China, Brazil and the Russian Federation, 2005

(a) (i) Describe the trend in the government budget balance in China between 2003 and
2006. [2]

The g e nmen b dge balance in China was in a deficit and the deficit was declining
between 2003 and 2006.

(ii) Com a e hi end i h he change in he R ian go e nmen b dget

balance in the same period. [2]

The R ian g e nmen b dge balance a in a l hile China b dget balance was
in a deficit. H e e , he R ian g e nmen b dge l ii n a ening, j a
China g e nmen budget deficit was improving generally.

(b) (i) What is the difference between real GDP growth and nominal GDP growth? [1]

Real GDP growth is the percentage change in real output, adjusted for inflation whereas
nominal GDP growth is the percentage change in nominal output, without adjustment for
inflation.

(ii) Identify the economy which is projected to have the highest growth in nominal
GDP in 2006. [1]

Russian Federation

(c) Explain how current and future living standards can be affected by the allocation
of resources between private consumption and gross fixed investment. [3]

*Can use PPC diagram with current and capital goods on the axis to illustrate this.

With a reallocation of resources from private consumption to fixed investment, current standards
of living will fall as fewer goods and services are made available for current consumption fall
in current material living standards.

On the other hand, with more resources being diverted to gross fixed investment, there will be a
rise in potential growth in the economy and more goods and services will be made available for
consumption in the future rise in future material SOL.

Hence, there is a trade-off between current and future SOL where diverting resources from private
consumption to gross fixed investments leads to higher future SOL at the expense of a fall in
current SOL.

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(d) Using AD/AS analysis,

(i) Explain the possible effects of an appreciation of Brazilian currency on the real
national output and general price level of Brazil. [6]

Appreciation causes a fall in net (X M) as prices of exports rise in foreign currency while
imports become cheaper in domestic currency. Exports lose competitiveness. Assume ML
condition holds where sum of PEDx + PEDm >1, (X-M) falls AD falls, so assume
economy was near full employment surplus of goods and services firms will cut
production due to lower prices GPL and real national output falls.

The price of imported FOP will also fall. The cost of production will fall. SRAS will rise.
This will lead to a surplus of goods and services. As prices fall, there will be a rise in
consumer spending and that will lead to an increase in real national output.

Overall, brazil will experience a fall in general price level. Since Brazil current account
accounts for a small proportion of AD, then overall, the AS effects will be stronger, an
overall rise in real national output.
(ii) Explain the effect of expansionary fiscal policy on the Russian economy. [4]

Rise in G and fall in taxes

Fall in income tax rise in disposable income C rise
Fall in corporate tax post tax profits rise more funds available for investment I
rise
overall AD rises as AD=C+I+G+(X-M)
Assume economy was not near full employment / at excess capacity rise in AD leads
to a depletion of stocks firms increase production triggers the multiplier effect
multiplied rise in real national output with no rise in GPL.

(e) Discuss and compare the likely impact of an unexpected decline in world economic
activity on any two of these economies. [8]
An unexpected decline in world economic activity would generally affect both China and Brazil
adversely. A decrease in worldwide incomes due to a decline in world economic activity would
have caused demand for exports from both China and Brazil to decline. This may lead to a fall in
export revenue and hence losses and eventual closure of businesses. In the face of declining
business, firms cut down on investment spending and workers put off unnecessary consumption
for fear of getting retrenched. Such events have a contractionary effect on aggregate expenditure
and, through the multiplier process, lead to a multiple fall in national output and higher demand-
deficient unemployment.

However, how adverse the impact would be depended on many factors such as the degree of
reliance of the economy on international trade, size of the multiplier and the exchange rate.

China ec n m i m e elian n in e na i nal ade han B a il. He c rent account surplus is

ab 6 ime ha f B a il . A a i n f GDP, China c en acc n balance i al

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much higher. Hence, a decline in world economic activity is likely to impact China more than
Brazil. Moreover, given that Brazil is facing relatively higher rates of inflation, a contraction in
agg ega e e endi e ma be a g d a c l ff he ng c n me demand in i h me
ma ke a men i ned in E ac 2 and hel alle ia e infla i n in B a il ec n m .

However, this argument that China is impacted more than Brazil may be limited as the impact on
capital account is not given in the data to allow a more accurate assessment of the impact of a
recession on the balance of payments, for an effective comparison between the two countries.
Also, information on the size of the multiplier was not given. China may eventually be impacted
less with a small multiplier due to high leakages caused by an expanding affluent middle-class
keen to consume imported goods.

China would be also be le ad e el im ac ed b a ld ide ece i n a China e change

a e i ela i el eake and he a e f infla i n i l e ela i e B a il . De ecia i n f he
Chinese Yuan (Extract 1)and a lower rate of inflation combined with lower wage costs would help
China ff e he im ac ne m ch be e han B a il a China e ma ibl ill
be m e c m e i i e in he ld ma ke han B a il .

In conclusion, the impact of the decline in economic activity on China and Brazil depended upon
the strength of a range of factors some of which are not presented by the data. Hence, it is difficult
to ascertain the impact explicitly.

(f) Comment on the usefulness of the data in table 4 to compare the standard of living
across Brazil, China and Russia in 2006. [6]

SOL refers to both material and non-material SOL.

GDP per capital (in USD) is a good measure for comparing material SOL across 3 countries as it
tells the amount of goods and services enjoyed by an individual in each country. Russia ranked
highest, followed by Brazil and China, so Russia can be considered to have the highest material
SOL. Each individual in Russia enjoys about 3 times more goods and services than an individual
in China Higher material SOL on average in Russia than China.

However, data does not considered the differences in cost of living. Different countries have
different cost of livings, and we should consider the level of income, and the cost of living to have
a better understanding of purchasing power.

Data in Table 4 also does not take into account measurements of non material SOL which
includes leisure time, level of pollution and the environment or healthcare standards, hence not
useful in telling holistic picture on SOL need to supplement with more indicators.

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(g) Discuss whether the data provided are sufficient to assess changes in the standard
of living in these economies over the period. [12]

Standard of living includes the material and non-material aspects, whereby the material aspect
relates to the amount of goods and services that the individual has available for consumption and
the non-material aspect relates to the quality of life and this involves the amount of leisure
available, the standard of education, degree of pollution, etc.

The data provided i.e. the annual rate of growth in real GDP indicates whether the material
standard of living is rising/ declining. The positive growth rates in real GDP in both China and
Brazil in 2003 and 2004 for instance, indicates that the standard of living in both countries are
rising i.e. the amount of goods and services available to the people in respective economies are
rising.

However, the data on annual rate of growth in real GDP does not indicate the amount of goods
and services available for each individual in the country. For instance, standard of living may
appear to be rising but does not indicate the average amount of goods and services available to
each individual in these economies; whereby availability to each individual may be lower the
greater the size of the population. Hence, the data provided may not be entirely sufficient to
assess the changes in the standard of living in these economies. Additional data that would give
a more accurate assessment of changes in average standard of living would be absolute figures
on real GDP and total population figures for each economy to calculate changes in real GDP
per capita to better assess changes in standard of living in these economies.

In addition, a limitation of the data is that the annual rate may not provide an accurate assessment
of the distribution of the increase in the material standard of living. For instance, the increase in
the availability of the goods and services may only be applicable to a minority of the population.
The data on Gini coefficient can be added as a measure of income distribution for the respective
economies.

The data given is insufficient in assessing the changes in the non-material standard of living i.e.
data does not reveal changes in pollution levels and level of mortality rates. Hence, additional
data can be used to assess the non-material standard of living; for instance, the HDI a composite
index would provide an assessment of changes in life expectancy and education levels that add
to non-material standard of living not revealed in the data provided.

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