Paper 2

Question 1

what occurs in a financial market

Answer 1

financial liquid assets are exchanged .g stock or bond market

Question 2

role of the financial market

Answer 2

to facilitate saving - provide somewhere for consumers + firms to store their funds, savings are rewarded with interest rates
lend to businesses + individuals - allows consumption and investment , sometimes referred to as financial intermediary
facilitate the exchange of goods + services - by creating a payments system : cheques, paper money, credit card services, bank transaction, banks buy + sell foreign currencies
provide forward markets - firms are able to buy and sell into the future at a set price e.g. farmers selling the produce that they are growing in a month time at a guaranteed price
provide a market for equities - involves the trade of shares

Question 3

impacts of a tax change

Answer 3

incentive to work
tax revenue
income distribution
real output and employment - effects income and therefore AD, higher indirect taxes effects SRAS, higher income taxes + disincentive to work
price level change - due to shifts in LRAS and AD
trade balance - consumers spend less on imports –> in the long run less AD decreases a business need to invest and this could reduce competitive FDI
lower corporation tax encourages firm to more production to your country –> this results in a “ race to the bottom “ = lower revenue for all countries

Question 4

national debt definition

Answer 4

is the sum of all the government debts built up over many years

Question 5

fiscal debt definition

Answer 5

is when government spends more than it receives in a given year

Question 6

structural deficit definition

Answer 6

the fiscal deficit that occurs when the cyclical deficit is zero, it is not related to the state of the economy

Question 7

cyclical deficit definition

Answer 7

is the deficit that occurs because government spending and tax fluctuate around the trade cycle

Question 8

factors increasing the size of the fiscal deficit

Answer 8

trade cycle - during a downturn government tax revenue reduces
unforeseen events - natural disaster / recession
interest rates - IR on national debt (£82 billion)
privatisation - one off payment to the government
government aims - does the government care about the debt
factors such as number of dependants
high revenue from oils = budget surplus

Question 9

factors influencing the size of national debts

Answer 9

if the governments is continuously running a fiscal deficit national debt will increase
ageing population = pension programs + lack of people working therefore a reduction in income tax

Question 10

significance of high fiscal deficit and national debt

Answer 10

• high levels of borrowing may raise interest rates in the economy as it increases the demand for money therefore the price of money increases
• countries have to pay a large amount servicing their national debt through interest repayments –> high opportunity cost –> debt interest is £82 billion
• high levels of debt reduce the credit rating for the government so the UK looks like a “risky choice “ for lenders leading to higher interest rates –> realistically it is not the size of the debt that loses credit rating, it is whether the country has defaulted on payments before e.g Russia
• could cause demand pull inflation AD –> if government is unable to borrow money they will have to print their own which will cause hyperinflation, as seen in Germany in 1923
• if government borrowed from abroad it may struggle getting enough of that currency to make its repayments
• government borrowing can increase growth if it is used for capital spending since this will improve the supply side of the economy

Question 11

market failure in the financial sector - speculation and market bubbles

Answer 11

• buy assets at low prices and sell at higher prices
  –> what if deals are leveraged then prices fall
  –> excessively high estimates of future price increases can create a market bubble and over paying for assets
  —> eventually people realise this so demand and therefore price plummet –> people realise prices are falling + begin to sell faster further decreasing the price
  ^ this is an even bigger problem for the banks as they now have no money as people cannot pay back their loans
  –> they also may not be able to give their costumers their money = financial crash ( liquidity crisis )

Question 12

market failure in the financial sector - asymmetric information

Answer 12

• when the buyers are most likely those who the seller does not want to sell to due to imperfect information
• e.g health insurance
• premium is based on who they think will buy the insurance
• healthy people don’t buy it, sick people do
• only unprofitable buyers are buying, meaning the company could struggle
• premium increases only make the problem worse

Question 13

market failure in the financial sector - negative externalities

Answer 13

• cost to the taxpayer of bank bailouts ( “ too big to fail”)
• loss of savings - of individuals in the bank
• loss of jobs, income , growth –> potential collapse of the whole economy, as a result of their overproduction and over risk taking

Question 14

market failure in the financial sector - moral hazard

Answer 14

” too big to fail “

bankers make risky decisions knowing if they fail the burdens do not fall on them

Question 14

market failure in the financial sector - market rigging

Answer 14

• where traders / bankers / intermediates collude to manipulate markets and make huge profits
• e.g. libour and forex markets
• heavy fines + regulation but can still occur if punishment + enforcement is weak

Question 15

macroeconomic polices in a global context : reduce fiscal deficit and national debt

Answer 15

• government has been using a policy of austerity since 2010 where they attempt to decrease spending –> they could also increase taxes but this would be highly unpopular
• opposition parties advocate for demand stimulus by high spending which will eventually bring about higher tax revenues –> allowing for a budget surplus and then a reduction in national debt
• rely on automatic stabilisers –> shown by the US’ response to the financial crisis and their economy recovered fairly quickly –> by 2015 the fiscal deficit as a % of GDP was the same as the uk
• could default on loan

Question 16

macroeconomic polices in a global context : reducing poverty and inequality

Answer 16

free market forces will make poverty + inequality
–> however most agree that some level of redistribution of income is necessary but the degree to which is continuous as high incomes in society provide an incentive
progressive tax –> depends on how effective government are at redistributing USA vs Finland
inheritance tax which means wealth cannot be passed on
government expenditure: universal benefits , means tested benefits
- government can provide goods and services such as school , education, healthcare meaning people are given a more + start in life
- max wage minimum wage
- equal pay legislation ( men , women , ethnicity )
- trade union friendly legislation
- employers could provide benefits to their workers : sickness pay , medical care, pensions
- price controls however thus may create a black market for the excess supply
- trickle down effect
- redistribution of income increases marginal utility
- improvement in education and training opportunities will prevent children from under privilege backgrounds achieving less than others –> e.g. lower university requirements

Question 17

macroeconomic polices in a global context : changes in interest rates and the supply of money

Answer 17

• domestic reasons such as to control inflation –> or global issues such as exchange rate or a change in world commodity prices
• there is no simple relationship between money supply and inflation because :
  CB cannot simply control the money supply because they cannot control the ability of the financial system to create credit
  –> globalisation of the financial market has also made it harder to control the money supply

Question 18

macroeconomic polices in a global context : international competitiveness

Answer 18

• supply side measures will improve productivity and flexibility, can involve taxes and deregulation
• -> encourage competition competition = innovation + competitiveness
• -> education will improve the skills of the workforce
• exchange rate policies e.g. china devalues their currency to increase exports
• join WTO or sign trade agreements

Question 19

macroeconomic polices in a global context : transnational companies

Answer 19

• huge gains for the economy through job creation and the tax revenue they raise –> they also innovate and invest
• however negative economic and social impact by destroying local culture, affecting the environment –> withdrawing more profit than they invest –> history of influencing politicians = illegal
• some developing countries only allow this to set up if they partner with a local company > meaning some profit is retained within the country > government also use contracts to ensure some of the value is retained in the country

Question 19

macroeconomic polices in a global context : transnational companies

Answer 19

• huge gains for the economy through job creation and the tax revenue they raise –> they also innovate and invest
• however negative economic and social impact by destroying local culture, affecting the environment –> withdrawing more profit than they invest –> history of influencing politicians = illegal
• some developing countries only allow this to set up if they partner with a local company > meaning some profit is retained within the country > government also use contracts to ensure some of the value is retained in the country

Question 20

macroeconomic polices in a global context : regulation of transfer pricing

Answer 20

• tax avoidance
• in the uk companies which don’t make sufficient profits are challenged by HMRC
• it is difficult to control global companies so they get away with lots of tax avoidance
  they use countries like Luxemburg to get away with it, every £1 Luxembourg makes in corporation tax another country loses 1000
• worldwide solution would benefits those such as the uk or USA

Question 21

macroeconomic polices in a global context : problems facing policy makers

Answer 21

inaccurate information > trends change , government is always behind with the stats
risks + uncertainty > cannot accurately predict the future
external shocks . government aim to lessen their impacts

Question 22

Reasons for restriction of free trade

Answer 22

Infant industries - newly established so unable to compete in global markets due to: reputation, costumer base, sunk costs, high AC and lack of economies of scale
Job protection - concern that by allowing imports domestic producers will lose out to international firms = job loss
Protection from potential dumping - excess supply being sold at extremely low prices internationally harming domestic producers > in China tariffs were placed on stainless steel tubes from the EU and Japan
Protection from unfair competition - different health and safety rules allow some firms to have much lower costs. Heavy subsidisation from governments > harms domestic producers
Dangers of over specialisation - no country should be totally reliant on another

Question 23

Types of restriction on free trade

Answer 23

Tariffs placed on imported goods making them more expensive to buy
Quotas, a limit placed on the level of imports allowed into a country forcing people to buy domestic goods
Subsidies to domestic producers lowering their costs and helping them be more competitive
Non tariff barriers : embargo , import licenses , legal and technical standards, voluntary export restraint agreements ( where countries agree they won’t export to each other to promote domestic buying)

Question 24

Impacts of protectionist policies on : consumers, producers , workers, government

Answer 24

Consumers : higher prices and less choice
Producers : domestic producers gain as they have less competition and therefore can raise prices —> however may suffer from higher costs due to controls placed on imports needed for their production
Foreign producers will lose out
Workers: very little effect, could be argued that allowing inefficient firms to close would be better for the workers in the LR as market would re allocate the resources + create more jobs
Governments - in the SR gov benefits as they gain tariff revenue + they are politically popular
- however could lead to an inefficient economy which slows growth
Living standards - deadweight loss in consumer surplus
- can cause trade wars ( USA vs China )
Equality - raise in price is regressive