20 markers Flashcards
Supply side policy in achieving economic growth
Define - influence quantity or quality of factors of production and the level of AS and potential economic activity. True economic growth = increase in productive potential
KAA 1 - increase government spending on education and training e.g. Labour government’s expansion of higher education to increase people under 30 to have undertaken higher education to 50% by 2012. This makes workers more highly skilled and productive resulting in a higher level of AS, higher potential output and economic growth. (AD AS DIAGRAM)
EV 1 - considerable time lags in their implementation e.g. expansion of higher education will take years to improve productivity and will result in fewer workers available in the labour market in the short run. Also effectiveness of policy depends upon types of training/education provided; young people need to be trained in areas of need within the skills market. Because of this time lag, predicting the future needs of the labour market can be difficult - especially with high tech markets changing at such a rapid pace
KAA 2 - Reduction in unemployment benefit or tax rate. These reduce poverty trap (where workers are financially better off on benefits than working) and enables greater incentives to work encouraging an increase in the supply of labour which causes an outward shift in the AS curve and increase real output
EV 2 - Laffer curve: if tax rate is too high dis-incentivises workers causing tax revenue to fall – and it is extremely difficult to determine the correct tax and benefit rate for a government. Also reducing the poverty trap might increase poverty levels for those out of work – which is at detriment of wider government objecting
KAA 3 – Privatisation (selling off of state owned industries to private sector e.g. British Gas and BT). This shifts to an objective of profit maximisation causing the firm to become more efficient and productive increasing AS increasing real output
Ev 3 – However not always successful e.g. privatisation of British Rail has been problematic where accusations of private sector profit maximisation at the expense of safety perhaps the failure of the free market might have reduced potential output in the long term
Evaluate the demand side policy responses to the global financial crisis 2008
Define – demand side policies refer to the use of fiscal and monetary policy by the government and monetary authorities to change the demand for goods and services and therefore alter economic activity
Cut indirect** tax VAT to 15% lowering price of goods increasing real income increasing consumption increasing AD and resulting in a multiplied increase in real output. **Increase government expenditure** increasing growth and reducing unemployment rate_. Cut interest rates_ to 0.5% to increase consumption and investment increases AD reducing deflationary pressure. **Increase QE to increase investment and AD
However use of expansionary demand side policies was limited due to running of budget deficit** at a time when the national debt had grown threatening the financial credibility of the government. This caused the government to promise an **austerity based fiscal policy** making it harder to use demand side policies. Also the ability of the Bank of England to stimulate the economy was limited by the 18 month **time lag** from the decision to change rates to the change in consumer behaviour and because they **couldn’t further cut interest rates from 0.5%.
(Conflicting objectives with increase output and environment, commercial banks passing on interest rates to consumers)
Evaluate the use of monetary policy to achieve price stability in the UK economy
KAA 1 - A reduction in the interest rate** should reduce mortgage rates resulting in consumers having a higher effective disposable income allowing them to increase spending. Also leads to an increase in borrowing of money **increasing consumption resulting in an increase in aggregate demand, real output and price level increasing the inflation rate back to target
EV 1 – cutting interest rates particularly significant as effects consumption which represents almost 70% of AD total causing a large change in real output and price level. However this depends on the size of the cut in interest rates, current rates are 0.25% so very difficult to reduce further.
KAA 2 –a reduction in interest rates will also influence investment levels. Lower interest rates mean that the rate of return on investments financed through credit will increase. Thirty percent of all investment is financed this way and so a significant increase in capital investment by firms might be expected. This increases AD, real output and the price level
EV 2 – However might be a time lag as commercial banks do not necessarily pass on the reduction in the official interest rates in their commercial lending rates to consumers and firms straight away (especially when a reduction in interest rates rather than an increase). Furthermore changes in interest rates may not be felt quickly given the level of fixed rate loans that exist – estimated that it takes up to 18 months for the full effect of an interest rate rise to be felt by borrowers in their loan repayments
KAA 3 – changes in interest rates also influence the exchange rate – reduction in interest rates likely to depreciate the value of the pound making UK exports more competitive and increase while imports appear more expensive so will fall resulting in an increase in the level of net exports, an increase in AD and an increase in real output and price level
EV 3 – however the impact on the price level may be larger than anticipated as we must know the size of the output gap in the economy (difference between equilibrium output and that of maximum potential output i.e. spare capacity). When there is no spare capacity, resources are not available to increase output in response to rising AD so expansionary monetary policy might result in a very significant increase in inflation (initial equilibrium found on inelastic part of Keynesian long run AS curve – representing full employment within the economy – AD3 – AD4 rather than AD1 – AD2 showing a larger increase in the price level.
KAA 4 – an alternative expansionary monetary policy is quantitative easing – money created electronically to buy financial assets (gilts) from businesses thus increasing liquidity in the financial markets which can be used to loan out to investors thus increasing investment, AD…
EV 4 – however when taken money out of economy cause deflationary pressure MV=PY and if too much QE can cause hyperinflation
Evaluate the effectiveness of fiscal policy in meeting the UK government’s macroeconomic target
KAA 1 - Expansionary fiscal policy to achieve higher levels of GDP growth and employment e.g. reducing income tax to increase consumption, AD, GDP growth and employment
EV 1 - Significant as influences consumption representing 70% of total, cutting top rate of tax less impact as bottom income groups as higher incomes have less marginal propensity to consume
KAA 2 - Reduce corporation tax increasing size of retained profits increasing investment expenditure (70% of investment financed this way) increases AD (however inflationary pressure)
EV 2 –depends on size of output gap, when no spare capacity expansionary fiscal policy results in high levels of inflation but no increase in growth. However in current economic climate (high under-unemployment, empty shops) represents a sizeable output gap so would be effective. (Environment)
KAA 3 – increase government spending to increase GDP growth and employment (Labour pledged to increase spending on health and education in 2017 general election). These injections into circular flow would increase government spending increasing AD, real output and employment levels. However inflationary pressure and difficult to meet Government’s aim to reduce the budget deficit.
EV 3 – more significant than first thought due to multiplier effects (increase government spending increases employment thus increasing consumption resulting in further increases in investment). Shown in diagram of multiple increases in AD. The size of each shift reduces due to leakages such as taxation.
