2016 paper 2

Question 1

1. Define the term ‘national income’.(1)

Answer 1

National income refers to the total value of all goods and services produced within a country in a particular period, usually a year.

Question 2

1b. Which one of the following is an injection into the circular flow of income?(1)
A Taxation
B Imports
C Investment
D Saving

Answer 2

C Investment

Question 3

1c. Define the term ‘circular flow of income’. (2)

Answer 3

The circular flow of income shows connections between different sectors of our economic system. It revolves around flows of goods and services and factors of production between firms and households.
- Injections also include government spending,
exports
- Withdrawals are taxation, savings, imports

Question 4

2a. Define the term ‘purchasing power parities’.
(2)

Answer 4

Making a comparison between countries.
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

Question 5

2b The Office for National Statistics estimates that the UK population was 64 million
in 2013. Using the data, what was the UK’s total GDP in 2013?
(1)
A $2 464 000 million
B $2 272 000 million
C $1 662 000 million
D $2 112 000 million

Answer 5

A. $2 464 000 million

Question 6

2c Diagram A shows the aggregate demand and aggregate supply for a country.
Illustrate actual economic growth on Diagram A.
(1)

Answer 6

New AD curve (shifts to the right) and a new equilibrium at
Y2

Question 7

3a Define the term ‘claimant count’.
(1)

Answer 7

Number of people claiming unemployment
benefit/jobseekers allowance

Question 8

3b Calculate the percentage change in the claimant count from August 2014 to
February 2015.
(2)

Answer 8

858,344 – 961,149 = -102,805
(-102,805 / 961,149) X 100 (1) = -10.7%

Question 9

(c) Which one of the following is likely to cause a reduction in the claimant count? (1)
A An increase in the weekly payment for claimants
B A compulsory weekly interview for every claimant
C An increase in the size of the workforce
D A fall in employment

Answer 9

B A compulsory weekly interview for every claimant

Question 10

4a (a) Which one of the following can be inferred from Figure 1 in the period shown? (1)
A The total UK trade deficit was the largest in June 2013
B The trade in goods was always in surplus between January 2013 and
January 2015
C The total UK trade deficit was the smallest in January 2014
D The trade in goods deficit was the smallest in June 2013

Answer 10

D

Question 11

4b Explain one likely reason for the reduction in the total UK trade deficit in
January 2015. (3)

Answer 11

Relatively lower inflation in UK makes exports more competitive
trade deficit was approx. £1 billion in January 2015
Fall in the value of the pound makes exports cheaper and imports more expensive

Question 12

In 2014 the Bank of England estimated the marginal propensity to consume of UK consumers to be 0.5. In 2014 the Chancellor of the Exchequer announced a £15 billion investment
programme into UK road infrastructure.

Answer 12

Multiplier = 1 / (1-MPC)
Multiplier = 1 / 0.5 = 2
£15 billion x 2 = £30 billion

Question 13

Which one of the following is most likely to cause a rightward shift in the
aggregate supply curve?
(1)
A A decrease in real output
B A rise in price level
C A fall in price level
D An increase in productivity

Answer 13

D

Question 14

6 (a) With reference to Figure 1, explain the term ‘real income’.
(4)

Answer 14

Real income indicates earnings that an entity or an individual makes after considering inflation rates.
Real income has fallen
From approximately £675 in 2008 to £615 in 2013

Real income is the amount of money people earn, whether this be from their job, interest on
savings, rent on land etc., adjusted for inflation. Real income was highest in 2008 at £676 and
lowest at £610 in 2012. This does not necessarily mean that nominal income fell, but inflation may
have meant prices rose and if nominal income did not rise at the same amount, real income would
have fell. Real income means the value of the income at prices in that year.

Question 15

6b Assess the likely impact of falling real incomes on UK consumers.
(10)

Answer 15

One effect of falling real income will be lower spending. This is because consumers can simply buy less with their disposable income. and so have less to spend and therefore spend less. Also, it will mean that they have less confidence about their future income and so will save more, meaning even less is spent. On the whole, this will cause a fall in consumption.

The fall in consumption is likely to mean that AD will fall (ceteris paribus) and therefore this will cause a fall in unemployment causing consumers’ real income to fall even further. This will also mean some businesses close down and so, therefore, consumes have fewer choices. This will be a particular problem in areas where the fall in AD has caused local unemployment and so many shops and businesses have to close down, meaning consumers have to travel long distances.

On the other hand, one positive effect may be that businesses put on sales and lower prices in order to encourage people to buy. As a result, consumers will be able to get goods and services
cheaper than before.

Another effect on consumers may be that they buy different goods. It may have a microeconomic effect as consumers switch to goods with a negative YED. The impact on consumers may depend on government decisions. For example, the government may decide to lower tax and so therefore, real disposable income may rise, meaning consumers can buy more goods. The MPC may decide to lower interest rates in order to prevent deflation and unemployment. As a result, consumers may have increased confidence and spend more, particularly on durable goods which are often bought on credit. They could also benefit from positive wealth effects when the value of their assets rises.

The impact will also depend on the size of the fall in income and who is most hit. If rich individuals with a lower marginal propensity to consume, are most affected, t is likely to make no difference to them as they have lots of excess income. Overall, it is likely to have mainly negative effects on the consumers as they have less to spend and less choice.

Question 16

6c With reference to Extract A, explain the likely effect of a rise in the value of the pound on aggregate demand. (5)

Answer 16

A rise in the value of the pound is likely to mean AD will fall. A strong pound makes imports cheap and exports dear. As a result, more people will buy imports and less people will buy UK exports, causing net trade to fall. Net trade is a component of AD and so a fall in net trade will cause AD to fall. Extract A shows how a rise in the value of the pound can be caused by a rise in interest rates and so therefore the effect of a rise in interest rates will cause AD to fall even further.

Question 17

6d With reference to the data, explain two likely reasons for the UK’s falling inflation rate. (6)

Answer 17

Inflation peaked at 5.2% in October 2011 and since then has fallen to 0.5% in October 2014. One cause of this fall in inflation may be due to lower levels of demand, reducing the problems of
demand-pull inflation. Demand is likely to have fallen due to the Global Financial Crisis since consumption will have fallen due to a fall in consumer confidence and real incomes (Extract A
shows it fell by about £65 in 2008 to 2012) and investment would have fallen due to lower business confidence.

Moreover, it may be due to lower rises in costs. The main business cost in the UK is wages and so therefore a fall in real wages (shown in Extract A) would have led to lower costs for businesses.
Therefore, there is a reduction in cost push inflation and so businesses do not have to keep putting up prices to match rising wages in order to maintain profit. Instead, they can keep prices low and
so inflation is lower.

Question 18

6e With reference to Extracts A and B and your own knowledge, discuss whether the MPC
should be concerned about the risk of deflation in the UK economy. (15)

Answer 18

Deflation is the general fall of prices. If it occurs, it can cause major problems as consumers continue to put off spending and so demand falls even further and therefore prices continue to fall. It is also often associated with negative economic growth and rising unemployment as businesses have to sack workers as sales are too low.

One reason the MPC should be concerned because if it does occur, they have few tools they can use in order to fix the problem. Once it has started, it is difficult to get rid of, seen in Japan which had deflation in 9 years between 1999 and 2012. Therefore, they should be concerned as if the UK
experience deflation, there is likely to be high unemployment etc for a long period of time.

Moreover, they should be concerned because inflation has fallen by almost 5% in 2011 and 2014 and is now below 1%, already much lower than the UK’s target of 2%. This is despite the policies
of quantitative easing and extremely low-interest rates, at 0.5%, which have been attempting to rise AD. There is little more they can do to raise inflation, so they should be concerned as the threat is quite possible. Extract A says deflation is expected.

However, some may argue they shouldn’t be concenred as the Bank of England governor, Mark Carney, said that in the “medium term” there is likely to be higher inflation in the UK and so the MPC shouldn’t be concerned about deflation as it will only be short term. Forbes argue that the pound is likely to get weaker, which will increase exports and decrease imports, causing a rise in
AD. Imports will be more expensive and so if people still have to buy them, it will cause inflation. Therefore, they should not be concerned as experts argue that, whilst there may be deflation in the
short term, in the long/medium term there will even be inflation. This increased inflation will even warrant a possible rise in interest rates.

Also, they should not be concerned because, even though inflation has been falling since 2011, there has still been increased economic growth. This could mean that deflation may not even have its usual negative consequences and it may just lead to a further reduction in prices, which helps to
make UK exports more competitive and could improve the balance of payments. Overall, the MPC should be concerned about deflation as it is quite probable that it will occur and
there is little action they can take if it does.

Question 19

Evaluate whether the MPC has been successful in controlling the UK’s inflation rate since
2011. (20)

Answer 19

The MPC (marginal propensity to consume) in economics refers to the proportion of an increase in disposable income that is spent on consumption rather than saving. It measures the sensitivity of consumer spending to changes in income and helps predict the effect of changes in income on the economy. As shown in figure 2 from 2011 to 2014 the UK’s inflation rate rapidly decreased from 4.0 % to 0.5%. A rapid decrease in the inflation rate can signal weak demand in the economy, reducing economic growth and potentially leading to deflation, a sustained decrease in prices and economic activity. But this may also lead to lower interest rates, making it cheaper for households and businesses to borrow and consumers can buy more with their income, improving their purchasing power. The Bank of England has used interest rate changes to influence consumer spending and dampen inflationary pressures. On the other hand, the MPC’s monetary policy measures may have had unintended consequences on the economy. For example, low-interest rates may have fueled a housing market boom, increasing inequality and creating financial stability risks. However, in the UK inflation has remained persistently above the target for significant periods, partly due to external factors such as global oil price increases and Brexit-related supply chain disruptions.

Moreover, it can be argued that they are unsuccessful as inflation has been falling consistently since October 2011 and the bank has done nothing successful at stopping this. They are unable to cut interest rates any further and quantitative easing still does not have a strong enough effect to increase inflation. If the MPC was successful, it would have prevented inflation from continuing to fall, particularly at such a rapid rate.

Question 20

20 marker 2

Answer 20

inflation has many economic disadvantages. For example, it reduces the purchasing power of money. This means people can’t buy much with their income, leading to a fall in their income, leading to a fall in standard of living. In particular, those with fixed income (such as pensioners) will have to lower their real income. Moreover, inflation also erodes the value of savings. In addition, as price increases, Uk exports are more expensive compared to other foreign firms. This reduces the UK’s international competitiveness, which is also reduced by the Uk’s existing productivity gap; therefore inflation worsens this situation. However, many economists would argue there are many benefits to inflation. Moreover, lower interest rates stimulate borrowing, therefore high levels of aggregate demand. This then leads to economic growth, usually in periods of boom, if accompanied by advances that shift the LRAS curve otherwise it’s unsustained growth. For workers, rising prices mean companies can afford to increase real wages. This also increases morale, recruitment and productivity. The Phillips curve ( as shown below) suggests there is a trade-off between inflation and unemployment. This means in the short term high inflation is accompanied by low levels of unemployment.

For example, inflation is still falling but the economy is growing (which is unusual, as seen in the Phillips curve). They have been successful in preventing extremely high or extremely low inflation. The diagram shows that the price level decreases from P1 to P2. But also the real GDP decreases from Y1 to Y2. This causes exports to be cheaper to foreign consumers. This increases the Uk’s international competitiveness, a benefit to firms that export internationally and could lead to unemployment.

Question 21

20 marker 3

Answer 21

However, when the economic situation is taken into account, the MPC has been successful. Firstly, despite the Global Financial Crisis in 2009, there has not yet been any deflation. This can be seen as a success as it is very likely this could have occurred. The bank’s decision to drop interest rates to 0.5% encouraged AD and prevented this from occurring. The decreased rate has made borrowing cheaper, ensuring consumers spent and businesses invested, as most rates in the economy are dependent on the bank’s rates. It has also caused a fall in the value of the pound since fewer people want to store their money in British banks and so, therefore, exports would have been more competitive which increases net trade and increases AD.

Overall, while the MPC has been successful in controlling inflation to some extent, it has faced challenges in achieving its target consistently and its actions have had unintended consequences on the economy. Although normal targets have not been met, the MPC has ensured that there has not been extreme inflation on either end of the scale.