Questions

Question 1

Explain what is meant by an output gap using AS and AD diagrams

Answer 1

difference between the actual level of output and the potential level of output

measured as a percentage of national output

A negative output gap occurs when the actual level of output is less than the potential level of output. This puts downward pressure on inflation

unemployment of resources in the economy, so labour and capital aren’t used to their full productive potential. This means there is a lot of spare capacity in the economy.

Keynesian economists believe output gaps exist in the SR and LR

LRAS curve, AD to the left of inelastic part, output gap difference between output at output at full employment

Question 2

Relationship between the national debt as a proportion of GDP and the fiscal deficit

Answer 2

A government has a fiscal deficit when expenditure exceeds tax receipts in a financial year

The national debt is the accumulation of the government deficit over time, the total amount the government owes.

The national debt as a proportion of GDP is the government’s debt-to-gdp ratio = the total accumulation of a governments debt as a proportion of the total goods and services produced by the country

Question 3

Impact on NLW on profitability of firms with costs and revenue diagram

Answer 3

National living wage from April 2017 was £7.50 per hour

The national living wage is a minimum age workers over the age of 25 are entitled to

An increase in national minimum wage involves an increase in average variable costs. This will cause an increase in marginal costs and average costs shifting the curves outwards. assuming workers can increase their hours

Diagram: shift MC to the left and AC up, dont curve MC up at the start, C1 should be a lot less than C2 which should be close to P1 and P2

However the effect of this change in revenue depends on the magnitude of the change in the minimum wage and the time scale over which it happens

A NLW may see a rise in the labour which could see a rise revenue and profitability
A NLW may be an incentive to work harder and increase productivity

Question 4

Evaluate the microeconomic and macroeconomic effects of a government policy of cutting public expenditure rather than raising taxes as a means of reducing a fiscal deficit (25)

Answer 4

The fiscal deficit is the difference between government expenditure and government income for both current and capital transactions in any financial year. It is called the Public sector net cash/borrowing requirement. For the fiscal year ending in March 2018, the current budget is estimated to be £18.2bn.

Draw LRAS diagram with decrease in AD

Deflationary pressure - macroeconomic objective, discourage consumer spending as delay purchases as cheaper in future creating more deflationary pressure, real value of money/debt increases increasing burden for governement

However significance depends on type of cut. Public sector investment strongly linked to AD, but weapons is not so in the SR. Cutting pension spending by making people work longer could increase productive capacity and tax revenue

Reduction in economic growth - total income decreases so lower employment and income equality reducing quality of life, higher cyclical deficit in the LR as tax revenue decreases

However depends one elasticity of AS, effects on economic growth minimal if near full capacity

Reduction in living standards - spend around £450bn 50% on welfare pensions and healthcare - more relative poverty, less medicine, bigger hospitals

However if tightening fiscal policy is couples with loosening monetary policy then effects could be negated

Time lag
Reduce international competitiveness