Unit 2: Economic Issues and Living Standards
Core concepts to master
Unit 2 shifts to macroeconomic issues and living standards. You must understand the business cycle (expansion, peak, contraction, trough), the measurement of GDP, and the difference between nominal and real values. Learn the causes and types of unemployment (cyclical, structural, frictional, seasonal, hidden) and how the unemployment rate is calculated. Understand inflation - demand-pull, cost-push - and how the CPI is constructed, including the difference between the headline and underlying rate. Know the distribution of income (Lorenz curve, Gini coefficient) and poverty (absolute vs relative). Finally, distinguish material from non-material living standards and the limitations of GDP as a welfare measure.
Traps examiners set
- Counting discouraged workers. They are not in the labour force, so they are excluded from the unemployment rate - a fall in participation can flatter the headline figure.
- Confusing real and nominal GDP. Real GDP adjusts for inflation; nominal does not.
- Treating all inflation alike. Cost-push inflation can coincide with falling output - a policy dilemma.
- Assuming GDP equals welfare. GDP ignores leisure, inequality, environmental damage and unpaid work.
- Mixing absolute and relative poverty. Absolute refers to a fixed standard; relative refers to position within a society.
Worked rule of thumb
To find real GDP from nominal GDP, divide by the price index and multiply by 100. If nominal GDP is $500 billion and the CPI is 125, real GDP is $500 ÷ 1.25 = $400 billion. This shows whether growth is genuine or merely price-driven. Always identify the base year when interpreting index numbers.