2016 AS paper

Question 1

define ‘national income’

Answer 1

total spending on goods and services

Question 2

define ‘circular flow of income’

Answer 2

 Money flows around the economy between
consumers/households and firms.
 withdrawals from the circular flow: savings, tax (TP), imports
 Injections: government spending, exports, investment
 Consumption and income flows as financial flows for factors of production and goods and services.
 g/s to households, consumption expenditure to firms
 FOP to firms, income (rent, wages, interest, profit) to households

Question 3

define ‘purchasing power parities’

Answer 3

 The rate at which the currency of one country
would have to be converted into that of another country to buy the same amount of goods and services in each country
 Comparison between countries, taking into account different cost of living.

Question 4

define ‘claimant count’

Answer 4

number of people claiming unemployment/jobseekers allowance

Question 5

cause a reduction in the claimant count

Answer 5

compulsory weekly interview for every claimant

Question 6

likely reason for the reduction in total UK trade deficit in Jan 2015

Answer 6

Knowledge
 Falling oil price reducing cost of imports
 Relatively lower inflation in UK makes exports more competitive
 Improvement in quality of UK exports increases demand for them
 Depreciation of the exchange rate.

Application
 trade deficit was approx. £1 billion in January 2015

Analysis
 Fall in the value of the pound makes exports
cheaper and imports more expensive.

Question 7

explain ‘real income’

Answer 7

Knowledge
 Income is money received as payment for work
 Real means adjusted for inflation/purchasing power of income

Application
 Real income has fallen
 From approximately £675 in 2008 to £615 in 2013

Question 8

likely impact of falling real incomes on UK consumers (KAA)

Answer 8

 Lower incomes means lower consumption
 Consumer confidence falls
 Aggregate demand therefore falls
 Fall in standard of living
 Falling demand for firms means lower profits; rising unemployment
 Less ability to save & possible consequences of this, e.g. mortgage deposit; confidence
 AD/AS diagram showing AD decreasing

Question 9

likely impact of falling real incomes on UK consumers (Ev)

Answer 9

 Depends on other factors in the economy, such as government spending or demand for exports
 Changes in benefits and/or tax allowances may offset fall in real income
 Only short-term fall (Figure 1 shows slight increase in 2013)
 Inflation falling recently, improving likelihood of real income rises
 Could be due to firms keeping wages low rather than making redundancies, thus people’s standard of living higher than it would be if they lost their job

Question 10

likely effect of a rise in the value of the pound on AD

Answer 10

Knowledge/understanding
 Definition of aggregate demand (total spending on g/s in the economy)
 Understanding of a rise in value of the pound

Application
 Aggregate demand will fall
 Lagged effect
 Declining imported food and commodity prices

Analysis
 Imports become cheaper so aggregate demand
falls
 Exports become expensive so aggregate demand falls

Question 11

likely reasons for the UK’s falling inflation rate

Answer 11

1. fall in AD 2. rightward AS
Knowledge
 Falling energy prices
 Falling telecommunication prices
 Falling shipping costs
 Falling non-energy industrial goods prices
 Slowdown in world economic growth
 Slowdown in consumer spending
 Slowdown in house construction

Application
2 relevant pieces of application from Extract B
 inflation at 0.3%

Analysis
 falling oil prices makes transport of goods cheaper

Question 12

inflation

Answer 12

• situation of a sustained increase in the general price level in an economy. Inflation means an increase in the cost of living as the price of goods and services rise.
• rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time
• inflation indicates a decrease in the purchasing power of a nation’s currency

Question 13

calculating CPI

Answer 13

• measures the average household cost of living, excluding housing costs and is used as the target for monetary policy
  1. assign weights to different categories of consumer spending - uses “national accounts” to assign weights, cross check against Family Expenditure Survey, annually checked and trade for new trends
  2. price collection - every month, regionally, over 100,000 prices collected
  3. calculate price indices for each category - base year, compare the month’s data with the previous year
  4. calculate CPI - multiply each index number by its weighting, sum to give CPI

Question 14

MPC should be concerned about risk of deflation in UK economy

Answer 14

 Risk of deflationary spiral; hard to ‘escape’ from such a situation
 Example of Japan (the root cause of deflation was slow growth and a high level of spare capacity that was driving prices lower.)
 Consumer expectations of very low/falling prices
become embedded
 Limited ability of the MPC to get the economy out of
deflation (interest rates already only 0.5%)
 Harder for MPC to react to/influence supply-side
factors such as falling oil prices

Question 15

MPC should not be concerned about risk of deflation in UK economy

Answer 15

 Likely to be only short-term/caused by one-off factors that will disappear from the statistics after one year
 Caused by supply-side factors rather than demand-side, so less of a problem for the UK economy
 Caused by falls in just a few significant items (e.g. oil), fall in prices not widespread across the whole economy
 Economic growth and incomes are still rising in the UK economy, suggesting inflation is not affecting consumer demand
 May benefit economy as it leads to increasing AS due to falling commodity prices, rather than being caused by falling AD

Question 16

deflation

Answer 16

persistent fall in the general price level of g/s - the rate of inflation becomes negative

Question 17

causes of deflation - demand-side

Answer 17

• deep fall in AD causing a persistent recession/depression (a more severe recession, e.g. decline in output for over 2 years, drop in output of 10% or greater, unemployment rate touch 20% rather than 10% with a recession
• large negative output gap (high level of spare capacity)

Question 18

causes of deflation - supply-side

Answer 18

• improved productivity
• technological advances
• significant fall in wage rates
• high exchange rate causing import prices to fall

Question 19

why deflation is damaging for an economy

Answer 19

• consumers holding back on spending
• real value of debt rises (higher real debts big drag on consumer confidence)
• real cost of borrowing increases (real interest rates will rise if nominal rates of interest don’t fall in line with prices)
• lower profit margins (lower prices -> reduced revenue & profits -> higher u/e as seek to reduce costs
• confidence/saving (falling asset prices such as price deflation in housing market hits personal sector wealth and confidence
• income distribution (redistribution from debtors to creditors)
• deflation can make exporters more competitive eventually (but often comes at a cost, i.e. higher u/e in shot term)

Question 20

MPC has been successful in controlling the UK’s inflation rate since 2011

Answer 20

 Changing interest rates and quantitative easing/asset purchases to influence money supply as monetary policies
 AD/AS diagram could be used to aid effective analysis

MPC has been successful at controlling inflation:
 According to Figure 2 highest inflation rate was only just over 5%, good by historical standards
 Independent of government
 Regular monthly MPC meetings implies flexibility
 Willingness to use other unorthodox tools such as
QE and forward guidance to additionally control
inflation
 QE helped to avoid risk of deflation during global
economic crisis
 Powerful transmission mechanisms
 Contrast with Japan.

Question 21

MPC has not been successful in controlling the UK’s inflation rate since 2011

Answer 21

 Figure 1 shows inflation has often been outside of
range of +/- 1% from the 2% target
 MPC struggles to respond to supply-side factors, e.g. rising food/commodity prices in 2008/9 and
now falling prices in 2014
 Interest rates have stayed at 0.5% for a long
time so there is limited scope to reduce further in
response to falling inflation/risk of deflation
 Banking failure
 In the period shown, interest rates have been
0.5% but inflation has continued to fall

Question 22

evaluate demand-side policy responses to the Global Financial Crisis of 2008 (KAA)

Answer 22

 Understanding of demand-side policies to include monetary and/or fiscal policy
 Understanding of Global Financial Crisis of 2008 in UK and/or other countries
 AD/AS diagram may be used to aid effective analysis

Examples of demand-side policies:
 Reduction of interest rates to boost aggregate demand in a recession.
 Quantitative easing to increase liquidity
 Bailout of banks
 Increase in government spending e.g. infrastructure
 Cut in taxation

Question 23

evaluate demand-side policy responses to the Global Financial Crisis of 2008 (Ev)

Answer 23

 Short run/long run issues, e.g. interest rates take at least a year to have a full effect
 Interest rates cannot be cut much further; relative interest rates are important
 The uncertainty of the impact of QE, e.g. do banks pass on the credit, is it inflationary?
 Size of the multiplier
 Problems in financing government deficit/fiscal
austerity issues
 Impact of different tax cuts, e.g. income tax vs. VAT
 Relative success of US or other country’s policies
in response to the crisis compared to the UK

Question 24

demand-side policy

Answer 24

policy that stimulates AD