Paper 2 - Macroeconomic

Question 1

Reasons for Falling SRAS (7)

Answer 1

1. ↓ Labour Productivity
   
   • Average Worker produces less output than previously in a given time period
   • Worker produced 10 units an hour and paid £20 → Labour Cost £2
   • Productivity Falls = Only produce 8 units → Labour cost ↑ £2.50
   • Production less Profitable = More firms leave market due to less incentive to supply → SRAS shifts leftwards
2. ↑ Wages
   
   1. ↑ Firms cost of production = ↓ Incentive to Supply Good = Real National output Falls from Y1 to Y2
3. ↑ Price of Raw Material / Commodity Price
   
   1. ↑ Price of Raw material = ↑ Production cost = ↓ Profit = SRAS Shifts Left
4. Oil Price = Transport costs
   
   1. ↑ Oil price AFFECTS ALL FIRMS IN MARKET
5. Business Tax = VAT
   
   1. ↑ Tax = ↓ Profit = ↓ Incentive to Supply → SRAS shifts left
6. Import Price = WIDEC + SPICED
   
   1. WIDEC = Imports more Expensive = Need for production = ↑ Cost of production = ↓ Profit = Less incentive to Supply
   2. SPICED = Import Cheaper, Exports Dearer → Imports Cheaper = ↓ Cost of Production BUT Less Internationally Competitive
7. Restriction on Firms ability to produce
   
   1. Lockdown shut down factories in China = Shortage of Microchips = Needed in Manufacture of finished goods i.e. Cards
   2. UK Manufacturers unable to Source = Less Production = SRAS ↓ → SRAS Shift left

Question 2

Reason for Rising LRAS = LRAS Shift RIGHT (6)

Answer 2

<aside>
💡 Q2CELL = Quantity + Quality of Capital, Enterprise, Land and Labour

</aside>

1. ↑ Quality + Quantity of good produced
   
   1. ↑ Productive Efficiency = ↓ LR costs of Production
2. ↑ Labour Productivity
   
   1. Average Worker produces more output than previously in a given time period
      - Worker produced 10 units an hour and paid £20 → Labour Cost £2
      - Productivity Rises = Only produce 12 units → ↓ Labour cost = £1.50
      - Production More Profitable = More firms Join market due to More incentive to supply → LRAS shifts Right
3. ↑ Investment = Tech and R&D
   
   1. Firms Spend more money on Capital = ↑ Quality + Quantity of Capital = ↑ Productive Efficiency
4. ↑ Infrastructure = Roads, Bridges, Airports ect
   
   1. ↓ LR costs = ↓ Cost of Transport + Services
   2. Quicker Transport = ↑ Productivity = LRAS SHIFT RIGHT
   3. Quality + Quantity of Capital Stock improve
5. ↑ Quantity of Labour
   
   1. ↑ Size of Labour Force
      
      1. ↑ Migration
      2. ↓ Benefits + ↓ Income Tax = Gives Economically Inactive to become Active → Gives people incentive to join Labour force
6. Competition
   
   1. Firms must ↓ Costs to beat rivals = Cut cost of production themselves
   2. ↑ Productive Efficiency

##

Question 3

Reason for Falling/Leftward shift of LRAS (5)

Answer 3

1. ↓ Labour Productivity
   
   1. Average Worker produces less output than previously in a given time period
      - Worker produced 10 units an hour and paid £20 → Labour Cost £2
      - Productivity Falls = Only produce 8 units → Labour cost ↑ £2.50
      - Production less Profitable = More firms leave market due to less incentive to supply → SRAS shifts leftwards
2. Mass of Capital Depreciation
   
   1. ↓ In Capital Available
3. Wars, Natural Disaster, Conflict
   
   1. Destroys Infrastructure = ↓ Quantity + Quality of Capital
   2. Deaths = ↓ Labour Force
4. Pandemic
   
   1. ↓ Productivity of Labour = People Dont work their hardest at Home
   2. Deaths = ↓ Labour Force = ↓ Quantity of Labour
5. Hysteresis
   
   1. Long Term Unemployment Causes Workers to become discouraged so leave Labour force

Question 4

Reasons for AD Shifting = Increase / Extension (3)

Answer 4

• Wealth Effect (C)
  
  • As Price level decreases from P1 to P2 → ↑ Purchasing Power of Income = People have more disposable income so will consume more
• Trade Income ( X - M)
  
  • Price Level decreases Exports become more competitive ( ↑ Demand for exports = ↑ X ) and Imports become Less competitive ( ↓ Demand for Imports = ↓ M)
  • Depends on Exchange Rate
• Interest Rates = C, I, (X-M)
  
  • Price level decreases, Interest rates kept LOW because Inflation is Low at new price at P2
  • ↑ Consumption = ↑ Investment because cost of borrowing Lower = ↓ Exchange Rate = Makes Exports more internationally Competitive = (X-M)

Question 5

Consumer Spending and AD increasing (6)

Answer 5

• Independent of Price Level
• MPC = Willingness of households to spend extra Income

<aside>
💡 Consumer Spending = Total Spending by households on Good and Services in an Economy

</aside>

1. ↑ Level of Real Disposable Income
   
   1. ↓ In Income Tax = ↑ Level of Real Disposable Income = ↑ MPC = ↑ Consumption
2. ↓ Interest Rates =
   
   1. ↓ Cost of Borrowing = ↑ Incentive to Borrow = ↑ Consumption
   2. ↓ Reward for Saving = ↑ Incentive to Consume
   3. ↓ Mortgages repayment on Variable mortgages = ↑ disposable income = ↑ Consumption
      
      1. Also ↑ Incentive to buy houses due to low Interest Rates
   4. Availability to Credit = Low reduced impact of ↓ Interest Rates = Banks not willing to Lend
   5. Consumer Confidence
      
      1. Job Prospects = People more likely to get promotion = ↑ Consumption = ↑ MPC
      2. Low Level of Unemployment = ↑ Consumption + Decreased Saving
   6. Asset Prices = House prices, Bonds ect
      
      1. If Consumers Hold these Assets and ↑ Asset prices = Consumer more likely to spend = Feel richer
   7. Household Indebtedness
      
      1. Huge debt = Individuals more likely to Save incase money needed to pay back debt

Question 6

Saving Spending and AD increasing (4)

Answer 6

<aside>
💡 Disposable income which is not Spent = ↑ Saving = ↓ AD

</aside>

1. Level of Real Disposable Income
   
   1. ↑ Incomes = ↑ Consumption but so does Savings
2. Intrest Rates
   
   1. ↑ Interest Rates = ↑ Reward for Saving = ↑ Return
3. Consumer Confidence
   
   1. Low due to Recession or job losses = Likely to Save for that
4. Tax Incentive
   
   1. Government Policy to increase Savings = Don’t need to pay Tax on Saving

Question 7

Investment and AD increasing

Answer 7

<aside>
💡 Investment is when firms spend money on capital goods to increase their productive capacity

</aside>

1. Intrest Rates
   
   1. ↓ Interest Rates = ↓ Cost of borrowing = Greater incentive to Borrow and invest
   2. Reaching Hurdle Lower
2. Business Confidence
   
   1. ↑ Expected Profit = ↑ Incentive to Invest = ↑ MPI = Ensure keep up with demand in future
   2. Expected Further Demand in Economy
3. Corporation Tax
   
   1. ↓ Corporation Tax = ↑ Retained Profit = ↑ Profits to invest
4. Spare Capacity
   
   1. If Spare Capacity = No reason to Invest
5. Level of Competition
   
   1. Increased Competition = ↑ Investment to keep up with rivals
6. Price of Capital
   
   1. Low price = Investment less costly = ↑ MPI = ↑ Investment
7. Accelerator Effect
   
   1. ↑ GDP = ↑ Investment

Question 8

Government Spending (4)

Answer 8

• Current Spending = Maintenance of Public Services → Injection = AD shift right
• Capital Spending = Infrastructure → Injection = AD shift right
• Welfare = Benefits + Pensions → Injection = AD shift right
• Debt Interest payment

Question 9

Draw Tariff Diagram and Analyse (8)

Answer 9

1. In an open economy there would be international trade causing domestic producers to be forced to accept the prevailing world price of PW which is less than their domestic equilibrium of P1.
2. The domestic equilibrium price is now at point C where QD1 of goods are bought
3. Of this, QS1 will be supplied domestically at the global price of Pw therefore the amount of imports will be QD1-QS1 causing total consumer surplus to increase by PWP1BD to PWAC, where PWP1BC comes from domestic surplus and DBC is the net welfare gain.
4. With the introduction of a tariff T, global prices would increase from PW to PW+T, resulting in a contraction of domestic demand to QD2 reducing consumer surplus to PW+TAH.
5. Domestic firms will have more incentive to produce increasing process causing an extension of supply from QS1 to QS2 increasing producer surplus from OPWD to OPW+TE which is an increase of PWPW+TED.
6. The difference between the quantity demanded and supplied domestically decreasing to QD2 – QS2 which is a fall of QD1-QD2 and QS1-QS2.
7. The government receives a tariff of T for each unit imported making total government revenue FEHG.
8. However, consumer surplus is still lost with EDF and GHC being unaccounted for resulting in there being a deadweight loss of welfare to society.

Question 10

Tariff Disadvantages (4)

Answer 10

**Tariff = Form of Protectionism = Use of trade barriers to protect domestic industry + employment###
**
1. Market distortions
1. Free market messed around = no longer efficient in allocation of resources
1. ↑ Price from PW → PW+T = ↓ Consumer Surplus = Deadweight loss of welfare = ↓ in choices available = Goes from QD1 → QD2
2. Production Inefficiency
1. May lead to worsening efficiency = Deadweight loss of welfare = EDF = through tariff ↓ in allocative efficiency
1. Domestic suppliers producing extra supply is wasteful = Need higher prices to produce = Inefficiency due to world suppliers producing at lower costs
1. Resources should not be used to increase supply domestically = Instead supply should be used by World SUppliers = ↓ Product Costs = ↑ Consumer Surplus
3. Retaliation - From people of Nation + Other countries
1. Hurts Consumers = ↓ CS = ↑ inefficiency = Distorted benefit gained from free trade
2. Cost of Retaliation may be higher than benefit received by Tariff
4. Regressive - Consumers bear burden of Tariff
1. May go on necessary items = Low income households unable to buy such goods i.e. house prices ↑ = unable to afford shelter = Absolute Poverty
2. Worsens distribution of incomes = Worsens issue of Equity

Question 11

Tariff Advantages (7)

Answer 11

1. Infant Industry Argument - Short term Protectionism<aside>
   💡 Infant Industry = New industry = Not fully developed + Not as Grown as global industrial Rivals
   
   </aside>
   1. Allows Domestic Firms to grow
   2. Allow for EOS to develop = Gives leverage to compete against International Firms
   3. DISADVANTAGE - Allows room for inefficiency = Distorted Market
2. Protection against Dumping<aside>
   💡 Dumping - Countries decide to sell goods or services below production costs = ↓ Domestic Industry Competitiveness
   
   </aside>
   1. Hard to prove = Caused by Subsidies + Minimum Price = If false accusation you bare fault
3. Protect Domestic Employment
   
   1. Declining Industry = Saves Jobs
   2. BUT If already declining industry + Tariff used = May cause more damage than good by longing out process = Tariff cant be used forever = Should allow Natural Disintegration argument?
4. Protects against unfair Low Cost Labour
   
   1. Countries can’t compete against Low Cost countries
      
      1. Protects against Low quality good + Firms linked with “Sweatshops” = ↑ CS
5. Raise GOV Revenue
   
   1. ↑ Tax = ↑ Revenue = funds important sectors e.g. Health + Education
   2. Tariff easy to collect = May lead to reliancy
6. Improve Current Account Deficit
   
   1. Weak Argument = Retaliation expected
   2. Large imports = ↑ Spending
      
      1. Tariff restricts spending on Imports = ↑ Economic Growth = ↓ Import Expenditure = May lead to severe retaliation by other countries
7. Avoid over Specialisation
   
   1. Allows you to delve into other industries + create other industries = ↑ Employment = ↑ Income = ↑ Spending = ↑ Economic Growth
   2. Allows you to create new industries = Good when old industries going out of businesses

Question 12

Draw and Analyse Long Run + Short Run Phillips Curve (9)

Answer 12

1. In the Diagram Above, the economy is initially in equilibrium at Point A.
2. Households base their expectation of future Inflation rates solely on the Current rate of Inflation, thus as Inflation is 0 there expect it to remain that way
3. When the Government Undertakes Expansionary Policy, there is a trade off along SRPC1. However, point B (Positive Output Gap) is Unsustainable
4. Workers Initially are More willing to work as there is an increase in their Money Wages as Firms are Forced to pay more to attract additional workers, causing them to Initally suffer from Money Illusion
5. However when they realise their Real Wages have not Increased ( Inflation has also Risen to I2) they return to Voluntary Unemployment, but with higher Expectations of Future inflation
6. This Shifts the Short Run Phillips Curve Outwards. So if the Government Doesn’t Pursue further Expansionary policy the Economy will Return to its Natural level of Unemployment UN, but with a Higher rate of Inflation at C
7. There is NO WAY for the Government to keep Unemployment below Natural rate without Accepting an ever Increasing rate of Inflation
8. The LONG RUN PHILLIPS CURVE is therefore Vertical as the economy will not Remain at Point B and D, But Instead revert to NRU at A,C and E
9. Thus if the Government Wishes to Increase output in an Economy with no Involuntary Unemployment it is Necessary to Reduce Natural Rate of Unemployment

Question 13

Explanation of Phillips Curve (4)

Answer 13

1. On the Phillips Curve above UN represents the Natural Rate of Unemployment which is the rate of Unemployment when Aggregate Labour market is in EQ, meaning Demand + Supply of labour are Equal
2. This Doesnt not mean Everyone has a Job as there will still be Voluntary Unemployment (Frictional) as workers look for better pay or conditions
3. However everyone who wishes to have a job at the prevailing wage rate will have a job
4. This is the same as the Non-Acceleration Inflation rate of Unemployment

Question 14

Draw and Analyse Laffer Curve (3)

Answer 14

1. Laffer Curve shows that it is Possible for a Government to increase Revenue by Reducing Tax rates = Cutting Tax Rate from T3→ T2 will increase Tax Revenue from R3 → R2
2. However Cutting Tax Rates will Only Increase the Tax Revenue if the current tax rate is Above optimal Tax rate ( T2 in this example)
3. Lower Tax Rate Incentivises Work, due to it giving incentive to the Economically Inactive to find jobs, as they will earn more decreasing Unemployment. Furthermore it gives incentive for Current Workers to Work Harder and Work Overtime as they get to keep more of their money which incentives consumption as Disposable Income increases, Promoting Economic Growth + Disincentivizes Tax Avoidance

Question 15

Explanation of Laffer Curve (3)

Answer 15

1. Theory Suggest ↑ Rate of Tax ONLY↑ Revenue collected until Certain point, after which it disincentives working, Earning Profit and Consuming and in the Long run this will become too great for some people, stopping them doing thing that attract Tax
2. Some people Argue Some taxes will Yield more Revenue to the Government if they were Cut
3. In Practice = Difficult to identify high point on curve would be (limitation of Social Science) due to them being Limited Empirical Evidence

Question 16

Draw and Analyse J curve (4)

Links to Price Elasticity of Demand

Answer 16

1. This shows that the Impact of Devaluation on the Current account balance may vary overtime
2. Demand for Imports + Exports is more Likely to be Price Inelastic in the SR, Especially as Firms may already have Contracts in Place that Specify a Price + Quantity
3. If the Currency Depreciates and Firms can’t reduce the amount they Imports, they will end up paying more for them Initally worsening their Current Account Deficit
4. As the Contracts Expire and Trade Adjusts, the Current Account position will Improve but eventually the Impact of Rising Import Prices (Potentially increasing Value of net Exports) where Expenditure is not Switched increases Domestic Inflation, Reducing International Competitiveness which will worsen the Current Account Position ( Ceteris Paribus)

Question 17

Draw and Analyse Reverse J Curve - Correcting Current Account Surplus (3)

Answer 17

**Current Account Surplus - an economy is exporting a greater value of goods and services than it is importing
**
1. In the Short Run, the Existence of Contracts wil make Demand for Imports and Exports Price Inelastic
2. When the Exchange rate Appreciates, this will make imports cheaper and Exports more Expensive
3. If Quantity can’t be adjusted due to the Contracts, the value of Imports will Fall while the Value of Exports will Rise, thus Increasing the Size of the Current Account Surplus in the SR
Overtime, demand for the Country’s Currency will Fall, causing the Exchange Rate to Depreciate, Causing the Country’s goods to become more Internationally Competitve and Improving its Current Account Position

Question 18

Draw and Analyse Monetary Policy + Exchange Rate (8)

Falling Aggregate Demand

Answer 18

1. Rising Interest Rates increase the reward for Saving in the UK ( Banks and Rising bond Coupons ect in response)
2. This Attracts “Hot Money” into the UK as Overseas investors pursuing Higher rates of Return, buy UK assets increasing the Derived Demand for Sterling, shifting the Demand curve Rightward from D1 to D2
3. This causes the Value of the Pound to Appreciate from £1 = $1.20 to £1 = $1.25
4. Foreign Goods will become Cheaper in terms of Sterling while Buyers Overseas will have to Give up More of their Currency to Buy UK goods
5. This will give UK consumers more Incentive to Buy Imports, causing Imports to Rise and Exports to Fall ( Less foreigners able to Afford them) due to the Law of Demand
6. Ceteris Paribus Net Exports will Fall, causing AD to shift Leftward from AD1 to AD2
7. This Causes Real National Output to fall from Y1 to Y2, indicating Falling in Economic Growth
8. Falling AD reduces the Derived Demand for Labour Increasing Cyclical Unemployment, causing the General Price Level to Fall from P1 to P2, showing Falling Inflationary Pressures reducing the Chances of Demand Pull Inflation (Period of inflation which arises from rapid growth in aggregate demand)

Question 19

Draw Diagrams for and Analyse Quantitative Easing (11)

Answer 19

1. With permission from Treasury, Bank of England credits its own accounts with newly created (digital) money → Increases the money supply ceteris paribus
2. Bank of England uses newly created money to buy financial assets (mostly government bonds) in Secondary Capital markets from Banks + Financial institutions
3. Bank of England makes profit which gives other banks incentive to join the market causing demand of bonds to shift Rightward from D1 for bonds to D2 for bonds
4. Causes price to rise from £1000 to £1200 resultining in quantity of bonds increasing from Q1 to Q2
5. Government bonds have a fixed coupon (the amount of interest on coupon does not change) the more expensive bonds are the lower the value of the coupon is relative to the price of bonds causing Bond Yield to fall
   1. £1000 has £50 coupon → worth 5% of bond
   2. Same bond now resold for £1200 with £50 coupon → Yield decreased to 4.17%
6. Yield decreases = gives firms incentive to move out of the market into more profitable markets decreasing the cost of borrowing due to investors no longer having incentive to hold bonds → This drives down the yield in the new markets investors join as well
7. Banks having the ability to attract new savers with low interest rates = relatively competitive.
   
   1. Bonds decreasing in price it gives people more incentive to save making it less rewardable → increases the banks deposits from S1 of loans to S2 of loans.
   2. Increase in quantity of loans from Q1 to Q2 resulting in a decrease in interest rates from R1 to R2 showing why it is less rewardable to
      save
8. Firms within the private sector have incentive to buy these bonds from the central bank increasing the private sector assets
   increasing their liquidity. This increases their ability to buy goods + services
9. Banks have more loanable funds making it easier for them to lend money out increasing consumption + Investment
   
   1. Might also lead to the creation of new jobs
10. As interest rates fall consumer and business confidence increases making it cheaper to borrow resulting in increased debt based financed consumption and investment
11. Shown by the AD curve shifting rightward from AD1 to AD2, increasing Real GDP from Y1 to Y2 = increase in price from P1 to P2
    
    1. Increased spending and employment due to borrowing
       becoming more accessible will return inflation rates in the UK back to 2% in theory

Question 20

Causes of AD shifting Rightwards (4)

AD Increasing

Answer 20

• Lower Interest Rates = Decreases cost of borrowing
  
  • Gives firms more incentive to borrow =. More investment
  • Consumers more likely to take out mortgages
  • Weaker Exchange rate = ↑ Export (lower priced for foreigners) = ↓ Cyclical Unemployment
• Lower Income + Corporation Tax
  
  • ↑ Disposable income for consumers to spend
  • ↑ Profits for Firms to re invest = Investment
• Higher Business Confidence
  
  • ↑ Consumption
• Increased Government Spending

Question 21

Draw and Analyse Demand Pull Inflation (3)

Answer 21

**Demand-pull inflation is aperiod of inflation which arises from rapid growth in aggregate demand
**1. Rising Investment causes Aggregate demand to increase causing a rightward shift of the AD curve from AD1 to AD2
2. Real National Output will Increase from Y1 to Y2 however there will be Greater Pressure on Firms Existing factors of production due to them having to produce more, causing these resources to become scarcer
3. This causes the Cost of Production to increase, causing the general price level to increase from P1 to P2,due to firms passing on their higher production costs

Question 22

Causes of Cost Push Inflation (7)

Answer 22

**Occurs when the cost of production increases, leading to higher prices for goods and services.
**
1. ↓ Labour Productivity
- Average Worker produces less output than previously in a given time period
- Worker produced 10 units an hour and paid £20 → Labour Cost £2
- Productivity Falls = Only produce 8 units → Labour cost ↑ £2.50
- Production less Profitable = More firms leave market due to less incentive to supply → SRAS shifts leftwards
2. ↑ Wages
1. ↑ Firms cost of production = ↓ Incentive to Supply Good = Real National output Falls from Y1 to Y2
3. ↑ Price of Raw Material / Commodity Price
1. ↑ Price of Raw material = ↑ Production cost = ↓ Profit = SRAS Shifts Left
4. Oil Price = Transport costs
1. ↑ Oil price AFFECTS ALL FIRMS IN MARKET
5. Business Tax = VAT
1. ↑ Tax = ↓ Profit = ↓ Incentive to Supply → SRAS shifts left
6. Import Price = WIDEC + SPICED
1. WIDEC = Imports more Expensive = Need for production = ↑ Cost of production = ↓ Profit = Less incentive to Supply
2. SPICED = Import Cheaper, Exports Dearer → Imports Cheaper = ↓ Cost of Production BUT Less Internationally Competitive
7. Restriction on Firms ability to produce
1. Lockdown shut down factories in China = Shortage of Microchips = Needed in Manufacture of finished goods i.e. Cards
2. UK Manufacturers unable to Source = Less Production = SRAS ↓ → SRAS Shift left

Question 23

Draw Diagram for and Analyse Cost Push Inflation (2)

Answer 23

**Inflation that occurs when the cost of production increases, leading to higher prices for goods and services.
**1. As the price of raw materials increases, this increases firms cost of production, resulting in them having less incentive to supply due to them earning less profit causing the SRAS curve to shift Leftward from SRAS1 to SRAS2
2. Real National output will fall from Y1 to Y2, causing the General price level to increase from P1 to P2, making it harder for lower income households to buy specific good = losing out on key macro objective

Question 24

Cost & Benefits of Inflation

7 Cost + 5 Benefits

Answer 24

Costs

1. Lower Purchasing Power
   
   1. Incomes not rising in line with Inflation = decreases consumption + increases incentive to Save
   2. Lower Incomes = Unable to afford basic necessities = Poverty
2. Erosion of Savings
   
   1. Interest Rates not rising in line with Inflation = decreases value of saving ( bad for pensioners + unemployed) = poorer living standards = ↑ Inequality
   2. ↓ Consumption in the LR
3. Lower Export = Competitiveness
   
   1. Inflation increases of Exports = Foreign Countries have less incentive to buy UK goods = ↓ Competitiveness = Worsens Current account deficit + ↓ Revenue = ↑ Cyclical Unemployment
4. Wage Price Spiral
   
   1. Workers anticipate increasing inflation = Bargain for ↑ Wages → ↑ Firms cost of production = ↑ Costs passed on to consumers causes price level to rise from P1 to P2
5. Consumer Price Spiral
   
   1. Anticipate ↑ Prices
   2. Consumers buy when prices seem lower to protect themselves = ↑ consumption = ↑ AD = ↑ Price level = Demand Pull Inflation (period of inflation which arises from rapid growth in aggregate demand)
6. Fiscal Drag
   
   1. When inflation is rising and workers are receiving higher inflation but is only inline with inflation = Don’t actually receive more money
   2. May cause people to enter new Tax bracket = ↑ Government Revenue
7. Inflationary Noise
   
   1. Signally function loses value = Uncertainty = ↓ Consumption + Investment
      ## Benefits
8. Workers able to bargain for ↑ Wages
   
   1. ↑ Disposable Income = ↑ Consumption = ↑ Productivity
9. Firms encourages to increase output
   
   1. Inflation Stable = ↑ Output due to them knowing they will earn revenue = ↑ Revenue = ↑ Government Revenue
10. Keep Unemployment low in recession
    
    1. Gives people incentive to join work force due to them knowing prices are increasing = ↑ Gov Revenue
11. Reduces Value of debt
    
    1. ↑ Profits + ↑ Wages = More debt payed off = ↓ Debt
12. Improvement in Gov Finance
    
    1. ↑ VAT = ↑ Gov Revenue

Question 25

Evaluation For Inflation (3)

When are Cost of Inflation greater than Benefits

Answer 25

1. Rate = Low and stable inflation higher benefits but Higher inflation = Cost more significant
   
   1. Demand Pull inflation more favourable than Cost push Inflation
      
      1. Demand Pull = ↑ Growth + ↓ Unemployment = Easier to solve by using Contractionary Demand Policies
      2. Cost Push Inflation = ↓ Growth + ↑ Unemployment = Stagflation - Stagnant growth along side increasing inflation
2. Duration
   
   1. Long Term = Anticipated = Hyper inflation
   2. Risking Spirals
3. Stability
   
   1. More Volatile = More fisk of Inflationary Noise

Demand pull - period of inflation which arises from rapid growth in aggregate demand
Cost push - occurs when the cost of production increases, leading to higher prices for goods and services

Question 26

Causes of Demand Side / Malignant Deflation (2)

Answer 26

• Causes Lower growth
• Long Term and anticipated

Question 27

Draw and Analyse Diagram for Demand Side / Malignant Deflation (2)

Answer 27

**Deflation - Persistence fall of prices in an economy in a year - Occurs when Inflation is negative = ↑ Purchasing Power = ↑ Consumption = ↑ Firms Profits = Cost of production decreases
**1. Fall in investment causes a leftward shift of Aggregate demand causing it to decrease from AD1 to AD2, causing Real National Output to Fall from Y1 to Y2, causing prices to decrease from P1 to P2
2. As a result of this some firms may be forced out of the market increasing unemployment within the economy, decreasing growth causing deflation to worsen

Question 28

Causes of Supply Side / Benign Deflation (2)

Answer 28

• Comes with Higher Growth
  
  • ↑ Profits = ↑ Employment = ↑ Investment = ↑ Gov Revenues
• Short term and Unanticipated
  
  • Cost of Production i.e. Cost of Raw materials could increase any time
  • Exchange Rates could change

Question 29

Analysis + Diagram for Supply Side / Benign Deflation (2)

Answer 29

1. As Firms cost of production decreases, it gives firms more incentive to supply causing the SRAS curve to shift Rightward from SRAS1 to SRAS
2. Real National Output will increase from Y1 to Y2, causing the General Price level to decrease from P1 to P2 causing increased Growth in the UK

Question 30

Analysis and Diagram for Expansionary Fiscal Policy and what it does (4)

Answer 30

1. As Taxation on Corporation it gives firms more incentive to invest in the economy, generating more jobs causing Aggregate Demand to increase causing a rightward shift of the AD curve from AD1 to AD2
2. This causes the Price level to increase from P1 to P2, causing Real National output to increase from Y1 to Y2
3. As a result of this unemployment decreases, increasing the disposable income of consumers especially the poor, increasing their MPC which increases their consumption causing the Aggregate demand curve to shift again from AD2 to AD3, showing a multiplier effect.
4. The general price level increase from P2 to P3, with Real National Output increasing from Y2 to Y3, boosting growth within the UK, allowing GDP to rise
   **What does it do:
   **1. Boost Growth
   
   1. ↑ AD = ↑ Growth
5. Reduce Unemployment
6. Increase Demand Pull Inflation = period of inflation which arises from rapid growth in aggregate demand
   
   1. Central Banks Job
7. Redistribute Incomes
   
   1. ↓ Inequality = Gov Spending on Welfare benefits + ↓ Taxation

• Multipler = Increase in AD = ↑ in Incomes = ↑ Spending = Cycle

Question 31

Expansionary Fiscal Policy Examples (3)

Answer 31

1. Reduction Income Tax
   
   1. ↓ Income Tax = ↑ Disposable Incomes = ↑ Consumption = ↑ MPC
2. Reduction Corporation Tax
   
   1. ↓ Tax = ↑ profits = ↑ Investment =
   2. ↓ Regressive Taxes = VAT ( Take greater % Income of poor than rich) = ↑ Disposable Income for Poor = ↑ MPC for Poor = ↑ Consumption
3. Increase Gov Spending
   
   1. Healthcare, Eduction ect

Question 32

Side effect of Expansionary Fiscal Policy - Use Diagram (4)

Answer 32

• LRAS shifts rightward from LRAS 1 to LRAS 2. Real National output increases from YFE 1 to YFE2 = ↑ Productive potential of economy
  1. Reduction Income Tax
  
  1. Gives incentive for inactive to become active = Make people enter Labour force = ↑ Quantity of Labour Force
  2. ↑ Incentive to Work harder + Earn More = ↑ Productivity
     
     2. Reduction Corporation Tax
  3. ↑ Investment = ↑ Quantity and Quality of Capital = ↑ Productive Efficiency
     
     3. Increased Gov Spending
  4. ↑ Spending on Health and Education = ↑ Productivity of Labour force = ↑ Productive Efficiency = Infrastructure

Question 33

Cons of Expansionary Fiscal Policy (6)

Answer 33

1. Causes Demand Pull Inflation - Period of inflation which arises from rapid growth in aggregate demand
2. ↑ Current Account Deficit
   
   1. ↑ Economic Growth = ↑ Incomes for Households = ↑ Spending on Incomes = ↑ Current Account Deficit
3. Worsening of GOV Finance
   
   1. ↑ Budget Deficit
   2. ↑ National Debt = Unproductive Gov Spending
   3. How will these Policies be funded = ↓ Benefits = ↑ Taxation = ↓ Growth
   4. Ricardian Equivalence → Consumers know Gov can’t afford Expansionary Fiscal Policy = Consumers Save Tax Cut now expecting Tax Rise
4. Crowding out Effect
   
   1. GOV spending is debt fueled = Reduces Private Sector investment
   2. ↑ Demand for Loanable funds = ↑ EQ Interest Rates = More Expensive for Private Firms to Borrow = ↓ Investment = ↓ Growth = ↑ Unemployment
5. Gov Spending X Inefficient
   
   1. Gov Lack profit Motive
   2. Waste of Gov Spending
6. Time Lags
   
   1. Tax cuts take time to feed through into economy

Question 34

Evaluation of Expansionary Fiscal Policy - Use Diagram (8)

Answer 34

1. Size of Output Gap
   
   1. Effectiveness depends on Output GAP
   SMALL Negative Output GAP
   1. If Economy close to Full employment shown in the diagram above at Y1, AD1 with a small Negative output Gap = Expansionary Fiscal policy less Effective at Boosting Growth and Reducing Unemployment
   2. AD shift from AD1 to AD2, Demand Pull Inflation more likely to Occur
   LARGE Negative Output Gap
   1. Economy Deep recession at AD3 with Growth of Y3, Large Negative output Gap, expansionary fiscal policy likely to be effective at boosting growth + increase employment without demand pull inflation
2. Size of Multiplier
   
   1. Large Multiplier Value = Greater Impact = Less Need for Heavy Expansionary Fiscal policy = Multiplier will do majority work = ↓ Need for Higher Gov spending
   2. Economy at AD3, boost AD to AD4, further growth to AD2 = Greater risk of Demand pull Inflation
3. Consumer/ Business Confidence
   
   1. ↓ confidence = Tax Cuts saved and not spent
4. State of Gov Finance
   
   1. High Budget Deficit = Unable to do Expansionary Fiscal policy
5. LR Returns to the GOV
   
   1. Lead to LR Returns to GOV due to ↑ Tax Returns in LR due to education
   2. Tax Cuts generate LR ↑ Revenue for GOV
6. Laffer Curve Idea
   
   1. Income Tax cut = ↑ Revenue for GOV
   2. People in Jobs work harder + ↑ Productivity to earn more income to keep ↑ disposable income
   3. Enterpernaters take more risks
7. Role of Automatic Stabilizers
   
   1. Automatic Stabilizers ↓Need for Expansionary Fiscal Policy
   2. Automatic Stabilizers Helps support output during Recession
8. Classical view of Self-Correcting Economy in a RECESSION
   
   1. Economy self heal = Wages will decrease = Leave economy on its own

Demand pull - period of inflation which arises from rapid growth in aggregate demand
Cost push - occurs when the cost of production increases, leading to higher prices for goods and services.

Question 35

Draw Diagram for and Analyse Supply Side Policies (3)

Answer 35

<aside>
💡 Policies designed to increase productive Capacity of the Economy shifting LRAS to the Right

</aside>

→ If Successful ALL 4 MAcroeconomic Objectives will improve
1. LRAS will shift Rightward from LRAS 1 to LRAS 2 because
1. ↑ Quantity of Factors of Production
2. ↑ Quality of Factors of Production
3. ↑ Productive Efficiency = ↓ Firms LR Cost of Production
2. Real National Output to increase from Y1 to Y2, Showing rising Economic Growth
1. ↓ Unemployment more Specifically Frictional + Structural
2. ↓ Long Term Rates of Inflation
3. Improves Current Account Position = Exports More Competitive
3. The General price Level will decrease from P1 to P2

Question 36

Interventionist SSP (3)

Answer 36

<aside>
💡 Promote More of a role for government to increase LRAS

</aside>

1. Gov Spending on Education / Training
   
   1. Boost Skills of Work Force = ↑ Productivity of Work Force = Quality of Labour
   2. Spending on Hospitals = ↑ Productivity of Labour = ↑ Quality of Labour
2. Gov Spending on Infrastructure
   
   1. Upgraded Roads, bridges ect = Decreases Firms LR Cost of Production = Easier to Access Raw Materials = Cheaper to sell Goods + Services
   2. Building New Schools + Hospitals = ↑ Capital Stock of the Economy = ↑ Quantity of Factors of Production (Capital)
3. Subsidies to Firms to Promote Investment
   
   1. Investment - firms spend on Capital
   2. Investment increases = Quantity, Quality of Factors of Production = ↑ Productive Efficiency → Decreases Firms LR COst of Production

Question 37

Market Based SSP (8)

Answer 37

<aside>
💡 Decreases GOV Intervention in Market

</aside>

Tax Reforms

1. Lower Income Tax
   
   1. Incentive for Unemployed /Inactive to Become employed / Active = ↑ Quantity of Labour force from Y1 to Y2
   2. People in Work = ↑ Incentive to Work Harder + Work Over Time = Able to Earn More + Keep More of it = ↑ Quality of Labour + productivity
2. Lower Corporation Tax
   
   1. Firms have ↑ Retained Profit = More incentive to invest = Investment increases = Quantity, Quality of Factors of Production = ↑ Productive Efficiency → Decreases Firms LR COst of Production

Labour Market Reforms

1. Reduces benefits
   
   1. Strong Incentive for Economically Inactive (Unemployed) to find Employment = ↑ Quantity of Labour = ↑ Size of Labour Force from Y1 to Y2
2. Reduces Min Wages
   
   1. ↓ Firms Long Run Cost of Production = ↑ Productive Efficiency = Boost LRAS
3. Reduces Trade Union Power
   
   1. ↑ Productive Efficiency = Boost LRAS

Competition Policy

1. Privatisation
   
   1. ↑ Competition = Firms have to ↓ Their Long Run Cost Of Production = ↑ Productive Efficiency = Boost LRAS
2. Deregulation
   
   1. ↑ Competition = Firms have to ↓ Their Long Run Cost Of Production = ↑ Productive Efficiency = Boost LRAS
3. Trade Liberalisation
   
   1. ↑ Competition = Firms have to ↓ Their Long Run Cost Of Production = ↑ Productive Efficiency = Boost LRAS

Question 38

Cons / Evaluation for Supply side Policies (6)

Answer 38

1. No Guarantee of Success
2. Cost
   
   1. Policies are Costly especially Gov Policies = May Fail = Waste of Money
   2. Debt Interest
   3. Opportunity Cost
3. Time Lags
   
   1. Takes Decades for Infrastructure programmes to be completed
   2. Impact of Gov spending on Education takes Years before Benefits can be seen
   3. Tax Cuts take while before they increase Investment
4. Negative Stakeholder Impact
   
   1. Reducing NMW = ↓ Living Standards of poor + Increases Inequality
   2. Deregulation = What Laws are Taken away or Relaxed?
      
      1. Are they productive Safety Laws, environmental Laws?
      2. Impact on Environment, Worker Safety ect
      3. Relaxed Laws may not be in interest of Society = Harming consumers
5. Output Gap
   
   1. Depends on Size of Output Gap + Stage of Economy
   2. In Recession = Supply Side Policies Wont Boost growth
   3. Economy booming at Full Employment = Increases Growth
6. Need for Targeted Supply side Policies
   
   1. Supply Side policies need to be targeted to chronic supply side issues in economy
      
      1. I.e. Infrastructure Low = Spend on Infrastructure

Question 39

Policies to Reduce Cyclyical Unemployment = Draw and Analyse Diagram for it + Evaluation and Cons of Policies (12)

Draw and Analyse Diagram

Answer 39

<aside>
💡 Occurs in a Recession when AD is Low

</aside>

1. Aggregate Demand will increase Causing a Rightward shift of the AD curve from AD1 to AD2
2. Rising in Real National Output from Y1 to Y2 indicates a Rising in Economic Growth
   
   1. Y1 to Y2 = Increase in Short Run Growth = Using up More Spare capacity= Economy moving Towards Full employment
3. As AD Rises it Increases the Derived Demand For Labour decreasing Cyclical unemployment
4. General price level will Rise From P1 to P2 showing increasing inflationary Pressures

Expansionary Fiscal Policy

• ↑ Gov Spending
• Lower Income Tax
  
  1. Incentive for Unemployed /Inactive to Become employed / Active
  2. People in Work = ↑ Incentive to Work Harder + Work Over Time = Able to Earn More + Keep More of it
• Lower Corporation Tax
  
  1. Firms have ↑ Retained Profit = More incentive to invest = Investment increases = Increases Derived Demand for Labour = Reduce Unemployment

Monetary Policy

1. Cut In Interest Rates
2. Boost In Money Supply by QE

Evaluation

1. Conflict of Objectives
   
   1. Higher Economic Growth + Employment
   2. BUT WIll Cause Demand Pull Inflation = Inflation Over shooting target = Not Desirable
   3. Size of Output Gap
      
      1. If Size of Output Gap Small = Risk of Inflation is High
      2. If Size of Output Gap is Big = Small risk
   4. Widens Current Account Deficit
      
      1. Incomes Rise = ↑ Spending On Imports

Question 40

Policies to Reduce Real Wage Unemployment = Draw and Analyse Diagram and Evaluate (5)

Answer 40

<aside>
💡 Occurs when wages are above equilibrium

</aside>

1. Reduce Min Wages
   
   1. ↓ Firms Long Run Cost of Production = ↑ Productive Efficiency
2. Reduce Strength of Trade Unions

Analysis

1. The Gov will realise that increased unemployment maybe as a result of wages causing them to decrease wages from W1 to WE
2. This will give firms more incentive to hire workers, increasing employment, causing the Demand for Labour curve to Shift Rightwards from Qe to Qs = Extension of Demand
3. This causes wages to decrease from W1 to WE, causing a contraction of Supply from Qs to QE due to workers earning less, giving them a lower incentive to supply their labour at the new lower wage rate, potentially causing a increase of voluntarily unemployed by inevitably increasing inequality within the market
   ### Evaluation
4. Impact on Workers
5. Inequality
   
   1. Decreases Income for Poorer Workers = Decreases their Disposable Income = Increases Income Gap

Question 41

Policies to Reduce Structural Unemployment (9)

Answer 41

<aside>
💡 Immobility of Labour - Geographical and Occupational

</aside>

Interventionist SSP

1. Gov Spending on Education / Training
   
   1. Boost Skills of Work Force = ↑ Productivity of Work Force = Decreasing Occupational Immobility
   2. Spending on Hospitals = ↑ Productivity of Labour = ↑ Quality of Labour
2. Gov Spending on Transport Infrastructure
   
   1. Upgraded Roads, bridges ect = Decreases Geographical Immobility of Labour = More Transport Links so workers can look further out for jobs
3. Subsidies For in work training
   
   1. Workers still being trained = Able to transfer if lose job = Decreases Occupational immobility
4. Grants or Low cost housing
   
   1. Gives incentive for Workers to move out of their current Location to places further away = Decreases geographical Immobility

Market Bases SSP

1. Reduces benefits
   
   1. Strong Incentive for Economically Inactive (Unemployed) to find Employment = ↑ Incentive for workers to skill themselves up in order to find work = Reduces Occupational Immobility and Also Geographical Immobility as workers can’t be picky about area = Low benefits = Forced to Take job
2. Deregulation Hiring / Firing Laws
   
   1. Reduces occupational Mobility
   2. More incentive to Hire Low Skilled Workers + Train them up = Paid Low wages
   3. If Workers not good able to Fire them

Question 42

Policies to Reduce Frictional Unemployment (11)

Answer 42

<aside>
💡 Workers are between jobs

</aside>

Interventionist SSP

1. More or Better Resources for job centers
2. Subsidise Private Job Agencies
   
   1. Have Better Resources = More able to find job for Frictionally Unemployed
3. Gov Spending on Transport Infrastructure
   
   1. Upgraded Roads, bridges ect = Decreases Geographical Immobility of Labour = More Transport Links so workers can look further out for jobs

Market Based SSP

1. Reduce Benefits
   
   1. Gives workers more incentive to find job = Unable to Fall back on Benefits if unable to find work before savings run out

Evaluation

• Not Guaranteed to Work
• Maybe Policies not needed if at Natural rate = Consequences worse than Benefits
  
  • But if natural Rate high then NEEDED
• Time Lags
  
  1. Takes Decades for Infrastructure programmes to be completed
  2. Impact of Gov spending on Education takes Years before Benefits can be seen
  3. Tax Cuts take while before they increase Investment
     
     1. Negative Stakeholder Impact
  4. Reducing NMW = ↓ Living Standards of poor + Increases Inequality
• Need targeted Policies depending on type of Unemployment
• Difficult to isolate what type of Unemployment is out of control
• Some Type of Unemployment better than Others
  
  • Frictional Unemployment = Good as workers looking for next best job
  • Cyclical not good

Question 43

Policies to Reduce Demand Pull Inflation (10)

Contractionary Monetary Policy

Answer 43

**Demand Pull Inflation - occurs when economic growth occurs too rapidly.
**AD SHIFTS TO THE RIGHT
### Contractionary Monetary Policy

1. ↑ Interest Rates
2. More suited to Target Inflation = Monetary Policy transmission has more impact
3. Central Banks independence of Gov = More trust worthy

Contractionary Fiscal Policy - Unlikely as Central Banks Job = Monetary Policy used

1. ↓ Gov Spending
2. ↑ Taxation

Evaluation

1. Conflict of Objectives
   
   1. ↓ Economic Growth + ↑ Unemployment
2. Impact on Investment
   
   1. High interest Rate = Detract Investment = ↓ Economic Growth = ↓ Competitiveness + Productivity
3. Impact on the Indebted
   
   1. Increases Monthly debt repayment = If default on Loan Businesses go Bankrupt + Consumers may become homeless
4. Strong Exchange Rate + Current Account Deficit
   
   1. “Hot Money” Inflows into UK = Widens Trade Deficit

Question 44

Policies to reduce Cost Push Inflation + Evaluate (7)

Answer 44

**Occurs when the cost of production increases, leading to higher prices for goods and services.

1. Implement / Reduce Inflation Target
   
   1. Reduces Wage Increases
2. Reduces VAT / Subsidies to Firms
   
   1. BUT
   2. Opportunity Cost
3. Intervene in Forex Market to Strengthen Exchange Rate
   
   1. Central banks Intervene
   2. Stronger Exchange Rate → Imports Cheaper
   3. BUT WON’T HAPPEN IN REAL LIFE

Evaluation

1. Cost Push Inflation = Usually Short Term
2. Raw Material Prices decrease or increase with time
3. Exchange Rate change with time
4. Can’t do anything about them
   
   1. Can’t Do anything if Raw Materials Are high

Question 45

Policies to Reduce High Long Term Inflation Rates + Evaluation (5)

Answer 45

<aside>
💡 Economy Does not Have enough Spare Capacity

</aside>

1. Need to Use Supply Side Policies = ↑ Productive Capacity of Economy = Reduce Pressure on Factors of Production = ↓ Inflation

Evaluation

1. No Guarantees Success
2. Cost
   
   1. Policies are Costly especially Gov Policies = May Fail = Waste of Money
   2. Debt Interest
   3. Opportunity Cost
3. Time Lags
   
   1. Takes Decades for Infrastructure programmes to be completed
   2. Impact of Gov spending on Education takes Years before Benefits can be seen
   3. Tax Cuts take while before they increase Investment
4. Negative Stakeholder Impact
   
   1. Reducing NMW = ↓ Living Standards of poor + Increases Inequality
   2. Opportunity Cost

Question 46

Policies to Reduce Inflation Key Evaluation point (3)

Answer 46

1. Need to consider which type of Inflation is Occurring to use Specific Policies to target it
   
   1. Hard to Know which type of inflation is dominating
   2. Maybe range of policies needed
2. Cant do much for Cost Push
3. Low & Stable Inflation = 2%
   
   1. If inflation rate around this number than fine

Question 47

Current Account Deficit = Cause & Consequences (15)

Answer 47

<aside>
💡 Current account Deficit means that the value of imports is greater than the value of exports

</aside>

Causes - Demand Side

1. Strong Domestic Growth
   
   1. Incomes High = More incentive to buy Imports = ↑ Demand for Imports = ↑ Money leaving UK
2. Recession Overseas
   
   1. Incomes Abroad Falling = ↓ Incentive for Foreigners to buy UK Exports = ↓ Revenue from UK Exports
3. Strong Exchange Rate
   
   1. SPICED
   2. Imports Cheaper + Exports Expensive = Consumers have more incentive to buy Imports as Cheaper = ↓ Export Revenue

Causes - Supply Side

<aside>
💡 More Disruptive than Demand side → Has Long Term Effect + Hard to Resolve

</aside>

1. Lower Investment
   
   1. Less Competitive
2. Low Productivity
   
   1. ↓ Growth = Less Competitive
3. Higher Relative Inflation
   
   1. ↓ Investment = ↓ Growth = Less Competitive as Higher prices than international competition
4. High Unit of Labour Cost
   
   1. More Expensive to produce compared to international competition = Less Competitive
5. Poor Quality Goods
   
   1. Less Competitive = ↓ Incentive for people to buy your good = ↓ Revenue
6. Depreciation of resources
   
   1. ↓ Exports as unable to produce more = ↓ Revenue from Exports

Consequences

1. Lower Investment or Strong Exchange Rate will cause AD to shift Leftward from AD1 to AD2, causing Real National Output to decrease from Y1 to Y2 indicating falling Economic Growth
2. Falling AD reduced the Derived Demand for Labour increasing Cyclical Unemployment within the economy
3. The General price level will decrease from P1 to P2, showing falling inflationary pressures

**AD = C+I+G+(X-M)$
**
- X - M decreases if Deficit caused by trade = ↓ AD = ↓ Growth = ↑ Unemployment
- ↓ Derived demand for labour

Question 48

Evaluation for Current Account Deficit (4)

Answer 48

1. Depends on Size of Deficit
   
   1. If Deficit is small % of GDP = Little Effect as AD decreases a little = Reason why UK still in Deficit
2. Strong Growing Economy
   
   1. Caused by Demand Side Current Account deficit = Good = Increased Growth
3. Caused by Demand Side or Supply Side
   
   1. Demand Side = Good = Increased Growth
   2. Supply Side = Deadly = Long Term + Not Easy to Fix
4. Maybe Government Spending or Incomes has caused Deficit = Might not be due to Trade

Question 49

Policies to rectify Current Account Deficit + Evaluation (20)

Answer 49

Contractionary Monetary Policy ↑↓

1. High Incomes = ↑ Depend for Imports = Use Monetary Policy = ↑ Interest Rates = ↓ AD

BUT

1. ↓ Economic Growth + ↑ Unemployment
2. Success
   
   1. Depends on Consumer Confidence, Multiplier, Initial Economic Activity

Protectionist Measures

1. Import Prices too Low + Export Prices too High
2. USE TARIFF = Reduce Price of Imports
3. Quota = Limits Imports

BUT

1. Retaliation
   
   1. Reduces Overall trade
2. Increases Cost of production for Firms who Rely on Imports = ↑ Prices and may Cause inflation
   
   1. Firm may also go Bankrupt = Increases Unemployment
3. Reducing Imports into Country = reducing Competition for Domestic firms = Domestic Firms keep prices high instead of cost cutting

Currency Depreciation - WIDEC = ↑ X-M

1. Depend for Exports increases + Imports Fall = Reduce Current account deficit

BUT

1. Depends on PED
2. Imported Inflation

Supply Side Policies

1. ↑ Productive Capacity on Economy = Downward Pressure on Prices, reducing Cost push inflation
2. Exports more Competitive = Increase Demand for Exports → Reduce Current Account Deficit

BUT

1. No Guarantees Success
   
   1. Reduce Inflation depends on initial Economic Efficiency
2. High Cost
   
   1. Policies are Costly especially Gov Policies = May Fail = Waste of Money
   2. Debt Interest
   3. Opportunity Cost
3. Takes long time

Evaluation

1. Gov may not need to get involved
   
   1. If they have Small Deficit
2. Current Account Deficit not Huge Issue for economy
3. Bigger Problems e.g. Unemployment, Growth

Question 50

Absolute + Comparative advantage + Source of Comparative Advantage (7)

Answer 50

<aside>
💡 Absolute advantage occurs when a country can produce a good or service using fewer resources than another nation allowing them to produce more resources from the same factor of production.

</aside>

<aside>
💡 Comparative advantage occurs when a country can produce a good or service at a lower opportunity cost than another country

</aside>

Source of Comparative advantage

• Institutional Framework
  
  • Regulation
• Capital Stock
• Demographic + Human Capital
• Natural Resources
• Climate
  
  • Agriculture
• Innovation

Question 51

China VS Japan - Absolute + Comparative advantage (10)

Answer 51

• 2 Countries Japan + China have same factor endowment + produce 2 goods Robots + Steel
• Table shows max possible output of 2 goods countries can produce if they devout all factors of production to that good

                    | China | Japan | | Steel (tonnes) | 100 | 150 | | Robots (units) | 60   | 50 |

• Both countries have same quantity of resources
• Japan = more technically efficient at producing Steel = 50% more steel produced from input
• Japan = Absolute advantage in production
• China = Absolute advantage in production of Robots = More technically efficient too
• Split production equally total production of steel = 125 toones with 55 units of robots
• Specialised in goods they have absolute advantage in China produce Robots + Japan produce Steel = Total production is 220 units of output
• Assume double coincidence of wants = 2 countries trade until they exhaust gains from trade + arrive at Pareto Optimum

<aside>
💡 Pareto Optimum - No one can be made better off without someone being made worse off

</aside>

<aside>
💡 Opportunity Cost Of Producing Tobacco = 200/500 = 2.5 Tons Of Sugar

</aside>

Question 52

Absolute + Comparative advantage = Jamaica Vs Dominica (11)

Answer 52

• Jamaica has Absolute advantage in BOTH Sugar + Tobacco
• If Jamaica switches to producing just Tobacco = produces 200 tonnes of Tobacco at Opportunity cost of 500 tons of sugar
• Opportunity cost of producing unit of Tobacco = 2.5 tonnes of Sugar
• If Jamaica produces just Sugar = produces 500 tonnes of Sugar + Gives up 200 tonnes of Tobacco
  
  • Opportunity cost of producing unit of sugar is 0.4 tonnes of Tobacco
• If Dominica switches to producing just tobacco = 150 tonnes tobacco + Opportunity Cost of 200 tons of Sugar
  
  • Opportunity cost of producing unit of Tobacco = 1.33 tonnes of Sugar
• Dominica Produces just Sugar = Opportunity cost is 150 tonnes of Tobacco for 200 Units of Sugar
  
  • Opportunity cost of producing unit of sugar - 0.74 Tonnes of Tobacco

Jamaica | Dominica |
Sugar (tonnes) | 500 | 200 |
Tobacco ( tonnes) | 200 | 150 |

Question 53

Pros & Cons of Globalisation (11)

Answer 53

Pros

1. Lower prices = increase inter competition
   
   1. Benefits consumers = ↑ Consumer surplus = Greater choice + quality of goods
   2. Businesses benefit = able to access more raw materials from diff countries at lower price
2. Benefits of trade - WTO
   
   1. Countries = Greater growth + Greater tax Revenue
   2. Developing countries = Promotes economic development
3. Greater employment
   
   1. ↑ Market size = Firms grow in size = able to get cheaper prices = Quality of trade increasing
      
      1. Firms need to hire more workers = ↑ Incomes = ↑ Living standards
4. Firms benefit from large Economies of Scale
   
   1. ↑ Market Size = ↑ Output + ↓ Costs = Increased Profit = Stimulates Investment + Innovation
5. Free Movement of Labour + Capital
   
   1. Businesses able to offshore elsewhere = ↑ Profits
   2. Able to hire workers elsewhere through online = Outsourcing

Cons

1. Growing inequality
   
   1. ↑ Over last 20 years
   2. 2015 - Top 1% of earners in World Economy own 55% of total Global Wealth
   3. ↑ Profits + incomes but not spread equally = Poor stay Poor and Rich stay Rich
      
      1. Higher incomes only for elite of World economy
         
         1. Trickle down effect not see
2. Higher structural unemployment
   
   1. More integration = Domestic firms may struggle to compete = Businesses lose out to International Competition
      
      1. ↑ Structural Unemployment
3. Environmental Cost
   
   1. More Pollution = Foreign firms taking advantage of depleting resources ( Nestle in Pakistan)
      
      1. Degraded resources = dumping wastes
4. Trade imbalance
   
   1. ↑ Globalisation = Countries rely on export led growth is lucrative e.g. China
      
      1. But if revenue of growth slows down or Shock limiting growth potential of Exports
         
         1. Results in Trade War + Protectionism activity to rectify trade imbalance
5. Greater risk to external countries
   
   1. If shock in one country’s industry = shock in another industry in another country = 2008 financial crisis
      
      1. Linked with Banks + Raw materials
6. Countries lose Uniqueness
   
   1. Lose Cultural Diversity
   2. E.g. Multinational firms such as Mcdonalds autocomplete local firms due to tourists desires (ignorance)

Question 54

Trade Restriction / Barriers (5)

Answer 54

Question 55

Arguments in Favour of Trade Restrictions (9)

Answer 55

Question 55

Arguments in Favour of Trade Restrictions (9)

Answer 55

Question 56

Price Elasticity of Demand and the Marshall-Lerner Condition - Also used to show effect of Current Account Deficit (4)

Answer 56

• Change in Exchange Rate = Changes foreign currency price of domestic goods + domestic price of Foreign goods
• Demand for both import + Export = Price Elastic = Change in Exchange Rate = More impact
• Overall Impact unclear if Elasticities are different

<aside>
💡 Marshall-Lerner Condition - In order for a devaluation to have a positive impact on a country's current account balance the sum of the PEDs for imports and exports must be greater than unity/one (ignoring the minus signs). *** = Sum of magnitude of PED for imports + Exports must be greater than unity / 1 = $| PED exports | + | PED imports| > 1 / Unity$
**
</aside>

• Marshall-Lerner Condition = Necessary = Not sufficient condition that a devaluation Can’t Improve Current Account Balance without it BUT Domestic economy MUST have enough additional capacity to either Replace imported goods or produce Additional export goods

PED + Total Revenue

• EOIS = Elastic Opposite Inelastic Same ↑↓
• Elastic = ↑ P = ↓ TR
• Elastic = ↓ P = ↑ TR
• Inelastic = ↑ P = ↑ TR
• Inelastic ↓ P = ↓ TR

**Analysis of J Cure
**1. This shows that the impact of devaluation on the Current Account Balance may Vary Overtime
2. Demand for Import + Exports = Likely to be Price Inelastic in SR = Especially if Firms are Already in Contracts that specify a Price + Quantity
3. If Currency Depreciates + Firms can’t reduce amount they Import = End up paying more for them = Worsening Current Account deficit Initially
4. As Contracts expire + trade adjusts = Current Account Position will improve = Eventually impact of ↑ Import prices (and potentially increase the value of Net exports) and where expenditure not switched increases Domestic Inflation
5. Reduces International competitiveness = Worsen Current Account position Ceteris Paribus

Question 57

Correcting a Current Account Surplus (9)

Answer 57

Why might a government want to tackle a (particularly large) current account surplus?

• Could be sign of Weak Domestic Demand
• In Germany case ( Benefit disproportionately from their competitiveness = due to weakness of eurozone) to help other members of Currency Bloc

Policies to Correct Current Account Surplus

‘Reflation’

• Expansionary Macroeconomic Policy = ↑ National Incomes = ↑ Demand for Imports
• Potentially Demand Pull Inflationary = Cause Exports to lose International Competitiveness

Revaluation

• Deliberate Appreciation of Country’s Exchange rates
• In Order to be Effective Marshall-Lerner Condition = Necessary Condition
• Reverse J curve may be

**Reverse J Curve - Analysis
**1. In SR Existence of Contracts makes Demand for Imports + Exports Price Inelastic
2. When Exchange Rate appreciates = Makes Imports Cheaper + Exports More Expensive
3. If Quantity Can’t Adjust due to Contracts = Value of Imports ↓ + Value of Exports ↑ = Increasing Size of Current Account Surplus in SR
4. Overtime demand for Country’s Currency ↓ = Exchange Rate Weakens = Country’s goods = More Internationally Competitive, Improving Current Account Position

Question 58

Write a Paragraph analysing the impact of an increase in interest rates on the performance of the UK economy referring ONLY to exchange rates (8)

Answer 58

1. Rising Interest Rates increases Reward for saving in the UK (Banks + rising bond coupons ect in response)
2. This attracts “HOT MONEY” as Overseas investors pursue Higher rates of return increasing Derived Demand for sterling, shifting the demand curve rightward from D1 to D2
3. This causes the value of the £ to Appreciate from £1 = $1.25 to £1=$1.30
4. Foreign goods will become cheaper in Sterling while buyers Overseas will gave to give up more of their Currency to buy UK goods
5. Imports will Rise + Exports will Fall due to Law of demand. Ceteris Paribus Net Exports will Fall causing leftward shift of the AD curve from AD1 to AD2
   
   1. Import prices decrease = ↑ demand for imports = ↑ Expenditure of Imports
   2. Exports More expensive = ↓ Demand + Revenue
      
      1. May be bad for Domestic Firms = More money leaving the country = ↓ Revenue from Exports
6. Fall in Real national output from Y1 to Y2 indicates a Fall in Economic Growth
7. Falling AD decreased the Derived Demand for labour increasing Cyclical unemployment
8. Falling Price level from P1 to P2 shows falling inflationary pressures

Question 59

Trade Creation & Diversion - Buying from France before and after joining EU (9)

Answer 59

-### Trade Creation

<aside>
💡 Movement from buying from a high cost country (high cost domestic producer) to a low cost country (low cost domestic producer) - e.g. joining the EU + buying more goods from EU cus no longer subject to Tariff

</aside>

1. UK outside EU = France exports goods with Tariff on them
2. Q1 - Q2 = Num of imports from UK to France
3. Uk Joins EU = All tariffs removed
4. UK supply shifts downwards from PW+T to PW = extension of Supply in France of Q4 + Contraction of domestic supply in France to Q3
5. French Consumer benefit = ↑ CS = Cheaper products from UK
   
   • ↑ Competitiveness = increase efficiency of French firms
6. France ↑ Imports from UK
7. French domestic firms produce higher amount of Q1 = Were producing between Q3 → Q1 = Inefficient
8. UK join + free trade goes from high cost domestically to low cost internationally
9. France able to sell goods to Uk without taxes = ↑ Exports Market = ↑ Revenue = ↑ employment = ↑ Income Tax

Trade Diversion

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💡 Buying from a low cost producer to a high cost country - e.g. buying more from within EU because previous cheap sources now subject to Tariff

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Question 60

Benefits and Costs of International Trade (10)

Answer 60

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💡 Closed economy = Does Not take part in International trade

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💡 Open economy = Completely open to trade with rest of world. If there is no Trade Barriers = Free Trade

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Benefits of International Trade
1. Welfare gain + ↑ availability of goods
2. Rising Living Standards (for some)
3. Economies of Scale for producers
◦ ↑ Scale of operation = Bring EOS
4. Increased Competition = Increased efficiency in Domestic Markets
5. Spur to innovation + Dynamic efficiency
6. Source of Economic Growth

Costs of International Trade
1. Gain for trade are overall, individuals + Specific industries made worse off e.g. british Steel
2. Negative externalities _ depletion of natural resources (Especially through transport)
3. Some argue prices become more stable BUT countries are still vulnerable to exchange rate fluctuation
4. Can make countries reliant on other countries + reliant on exports ( e.g. Ukraine + Russia gas)