Theme 2.6 - Macroeconomic objectives and policies

Question 1

2.6.2 - What are demand side policies?

Answer 1

polices designed to manipulate consumer demand

• Expansionary policy aims to increase AD to bring about growth
• Deflationary policy attempts to decrease AD to control inflation

Question 2

2.6.2 - What is monetary policy?

Answer 2

Where the central bank or regulatory authority attempts to control the level of AD by altering base interest rates or the amount of money in the economy

Question 3

2.6.2 - What is fiscal policy?

Answer 3

The use of borrowing, government spending and taxation to manipulate the level of AD and improve macroeconomic performance

Question 4

2.6.2 - How does interest rates cause a change in the level of AD? (monetary)

Answer 4

• Rise of interest rates will increase the cost of borrowing for firms and consumers - fall in I and C = fall in AD
• Fall in price of assets eg stocks share and gov bonds
• Less confidence = AD to fall as less C and I
• Incentive for foreigners to hold money in British banks = value of the pound to rise = cheaper imports dearer exports - reduced AD
• Problems - full effect takes up to 2 years - lack of confidence, discourage investment, balance of trade deficit

Question 5

2.6.2 - How does asset purchases (QE) change levels of AD? (monetary)

Answer 5

when BoE buy assets in exchnage for money in order to increase money supply and get money moving around the economy

• rise in demand = asset prices rise = positive wealth effect = C goes up
• Money supply increases = increase in I or C therefore AD increases
• Commercial banks may lower interest rates - encourage borrowing = increase in I and C so increase in AD
• Problems - very risky, can cause hyperinflation if not controlled properly, no guarantee that higher asset prices lead to higher consumption, can becomes too dependent

Question 6

2.6.2 - How does government spending lead to a change in AD?

Answer 6

• Spending = increase in AD

Question 7

2.6.2 - How does indirect and direct taxation change AD?

Answer 7

a rise in income tax = fall in disposable income = reduction in C and AD
a rise in corporation tax = reduction in I and AD
Problems - spending’s impacts LRAS, taxes have impact on inequality, worry about political issues, impact depends on the multiplier

Question 8

2.6.2 - What are the evaluations of demand side policies?

Answer 8

• Significant time lags
• Expansionary - inflationary
• Deflationary - unemployment
• Depend on where the economy operate - Keynesian LRAS

Question 9

2.6.2 - What is the role of the Bank of England?

Answer 9

MPC - keep inflation +/-2%

independent for roughly 25 years

Question 10

2.6.2 - How were demand side policies used in the Great Depression and the Global Financial Crisis of 2008?

Answer 10

UK:

• Raised income tax to 25%
• Cut public sector wages and unemployment benefits
• Cut interest rates
• Nationalised banks and building societies and guarantee savers
• Expansionary monetary policies

US:

• Expansionary fiscal policy
• New Deal

Question 11

2.6.3 - What are supply side policies?

Answer 11

government polices aimed at increasing the productive potential of the economy and moving the supply curve to the right

Question 12

2.6.3 - What are market based policies?

Answer 12

Policies which are designed to remove anything that prevents the free market system working efficiently causing lower output and higher prices
- free market economists tend to argue for market-based policies - want gov to have as small a role as possible

Question 13

2.6.3 - What are interventionist methods?

Answer 13

Policies designed to correct market failure eg provision of education

Question 14

2.6.3 - What are some supply side polies?

Answer 14

• Increase incentives
• Promote competition
• Reform the Labour Market
• Improve skills and quality of labour force
• Improve infrastructure

Question 15

2.6.3 - How does increasing incentives affect supply?

Answer 15

increasing the incentive for people to go to work through the reduction of benefits/taxes/minimum wage will increase the size of the workforce - however small changes in tax has little impact

Question 16

2.6.3 - How does promoting competition affect supply?

Answer 16

through privatisation/deregulation + competition policy’s = efficiency firms to arise - however can lead to poorer quality service

Question 17

2.6.3 - How does reforming the Labour Market affect supply?

Answer 17

increasing retirement age, weakening unions, change employment contracts eg 0 hour contracts = reduction in unemployment however trade unions already weak so little impact in the UK

Question 18

2.6.3 - How does improving skills and quality of the labour force affect supply?

Answer 18

Increase in spending on education and training = educated and skilled workforce - increase in high skilled migrants, regulation to force training - however no effect if skills irrelevant and opportunity cost incurred

Question 19

2.6.3 - How does improving infrastructure affect supply?

Answer 19

tax incentives/subsidies on investment, spend more money however effect on budget may lose tax rev and not invest successfully

Question 20

2.6.3 - What are some evaluations of supply side polices?

Answer 20

• able to increase output and decrease prices
• more long term + lead to long term econ growth
• can be directed at increasing exports - improve balance of payments
• both free market economists and interventionist will accept and use supply side polices
• no impact when LRAS is elastic so demand-side policies needed
• not all supply side polices work
• take long to have an effect
• often need to spend more = budget deficit
• undesirable impacts on AD = unemployment/higher inflation