Provided by Vedant Batra and Shivam Jain
1. (a) Using suitable examples, explain the difference between the multiplier and the accelerator. [10 marks]
Emphasis will normally be placed on the multiplier. This is acceptable as long as you display a basic understanding of the accelerator. Candidates should appreciate the interaction between them that the multiplier is investment led and the accelerator is income led.
(b) Evaluate the proposition that the most effective way to reduce unemployment is through the use of demand-side policies. [15 marks]
Demand side policies explain, equilibrium and disequilibrium unemployment, demand side cyclical, its limitations, AD/AS analysis supply side for others its limitations
Points for discussion might include:
Candidates may take a different approach.
2. (a) Explain the difference between demand-side and supply-side economic policies. [10 marks]
(b) “Higher economic growth can only be achieved through the implementation of supply-side policies.” Discuss. [15 marks]
Answers may include:
This is potentially a big question for you to tackle. Do not expect answers to be able to cover the greater part of the above. Good candidates should be able to show how supply side policies can increase economic growth. You also need to be able to discuss this in the context of alternative demand side policies.
3. (a) Identify the components of aggregate demand and briefly explain two factors which might determine each of these components. [10 marks]
Answers may include:
– consumption e.g. real income, consumer confidence, interest rates and availability of credit, attitudes to saving, wealth, etc.
– investment factors e.g. business expectations, interest rates, level of profit, available finance(level of savings)
– government spending e.g. political priorities (improve public services, defense etc.) rate of economic growth, unemployment/inflation, tax revenue
– exports minus imports e.g. rate of economic growth, exchange rate changes, domestic producer efficiency, foreign producer efficiency, changes in the terms of trade, protectionism.
It is important that you show an understanding of the factors that affect AD rather than just listing factors.
(b) Evaluate the likely impact on an economy of a substantial rise in the level of interest rates. [15 marks]
Answers may include a discussion of the impact of a rise in interest rates on:
– reducing AD(reducing C, I, etc.)
– reducing AS(increasing costs of production)
– costs and benefits of higher interests rates
– the short and long term consequences higher interest rates
– the significance of the impact of higher interest rates on different factors
4. (a) Explain how interest rates can be used to bring about an increase in economic activity. [10 marks]
Candidates may include any of the following:
(b) Discuss the strengths and weaknesses of demand-side policies. [15 marks]
Explain how demand side cure inflation and unemployment, trade off, limitations deflationary fiscal fine-tuning, time lags. Contractionary monetary increase in interest rates slows economic growth and negatively affects exports due to increase in exchange rate, limitations of expansionary fiscal and monetary inflation, time lags, export competitiveness, crowding out, diagrams,
Candidates may include any of the following:
To have an effective argument always include:
5. (a) Using one or more diagrams, explain the difference between the equilibrium level of national income and the full employment level of national income. [10 marks]
Provide the following information for an effective argument:
– maximum level of national output, or – all factors of production are fully utilized, or – AS = AD on LRAS curve
You could also show both the equilibrium level of national income and the full employment level of national income on one diagram using the 3-range AS curve intersected by an AD curve on the upward bending range and by another AD curve intersecting the AS curve on its vertical range. Diagrams showing equilibrium level of national income with a 45 degree diagram are equally acceptable.
(b) Evaluate the policies a government may use to increase the full employment level of national income. [15 marks]
Include the following information:
You should be able to explain a range of supply-side policies and the possible implications of the policies. Appropriate policies may include:
The evaluation of the policies requires a critical approach, particularly the reduction of welfare benefits and the flexibility of labour markets. Explain that demand-side policies are not appropriate because they do not expand the quantity and quality of factors of production.
Effective evaluation include:
6. (a) Explain how fiscal policy can be used to increase aggregate demand. [10 marks]
Answers should include:
Answers may include:
(b) “In the long-run, a country’s economic performance can only be improved through the implementation of supply-side policies.” Evaluate this statement. [15 marks]
Answers may include:
7. (a) Aggregate demand consists of consumption, investment, government spending and net exports (exports minus imports). Explain two factors that may influence consumption and two factors that may influence government spending. [10 marks]
Answers should include:
OR
Answers should include:
(b) Evaluate the effectiveness of an increase in investment expenditure on the performance of an economy. [15 marks]
Answers may include:
8. (a) Explain how supply-side improvements to an economy may be achieved through the use of taxes and government spending. [10 marks]
Answers should include:
– greater government spending on healthcare, education and training
– less government spending on benefits
– a reduction in income tax to increase work incentives
– lower corporation tax to encourage investment
– lower indirect taxes to reduce business costs.
Answers may include:
distinction between SRAS and LRAS.
(b) Evaluate the use of supply-side policies to reduce unemployment. [15 marks]
Answers may include:
– tax cuts
– cuts in welfare benefits
– education and training/retraining
– privatization/deregulation
– trade union policies
9. (a) Using appropriate diagrams, explain the difference between demand-side and supply-side economic policies. [10 marks]
Answers should include:
(b) Evaluate the use of supply-side policies to improve the performance of an economy. [15 marks]
Answers may include:
A distinction between market-oriented and interventionist supply-side policies and advantages of supply-side policies in terms of their impact on:
Use the AD/AS diagrams to illustrate the above
Disadvantages of supply-side policies in terms of:
10. During the global financial crisis of 2008–2009, there was a fall in consumer spending in many countries.
(a) Explain the factors which might be responsible for causing consumer spending to fall. [10 marks]
Answers should include:
an explanation of “consumer spending” in the context of aggregate demand and some of the factors which may cause it to fall such as:
Two or three factors explained fully or more factors explained in less detail would be sufficient for full marks.
(b) Evaluate the possible consequences of falling consumer spending for a country’s macroeconomic performance. [15 marks]
Answers may include:
11. (a) Using appropriate diagrams, explain how a reduction in income tax could affect both aggregate demand and aggregate supply in an economy. [10 marks]
Answers should include:
(b) “The lower the level of both direct and indirect taxation, the better.” Evaluate this view. [15 marks]
Answers may include:
12. (a) Using appropriate diagrams, explain how an increase in government spending could affect both aggregate demand and aggregate supply in an economy. [10 marks]
Answers should include:
(b) “The lower the level of government spending, the better.” Evaluate this view. [15 marks]
Answers may include:
Arguments in favour of lower government spending:
Arguments against lower government spending:
13. (a) Explain why a government might find it difficult to maintain a low rate of inflation as the economy approaches full employment [10 marks]
Answers may include:
(b) Evaluate the proposition that the priority in economic management should be the maintenance of low unemployment. [15 marks]
Answers may include:
14. (a) Explain why a country may wish to reduce its rate of inflation. [10 marks]
Answers should include:
This may include the impact on:
Answers may include:
b) Evaluate the likely effects on the economy of relying on higher interest rates to reduce the rate of inflation. [15 marks]
Answers may include:
15. (a) Explain why a country may wish to reduce its unemployment rate. [10 marks]
Answers should include:
This may include the impact on:
(b) Evaluate the likely effects on the economy of relying on demand-side policies to reduce the unemployment rate. [15 marks]
Answers may include:
16. (a) What are the causes of inflation? [10 marks]
(b) Evaluate the possible effects of a persistently high inflation rate on a country’s current account balance and its exchange rate. [15 marks]
17. (a) Explain the possible causes of a rise in the rate of inflation in an economy. [10 marks]
Answers should include:
Answers may include:
(b) Evaluate the possible impact on economic performance that may result from a government decision to bring inflation under control. [15 marks]
Answers may include:
18. (a) Explain the difference between progressive taxation and regressive taxation. [10 marks]
Responses should include:
(b) Evaluate the possible effects of a decrease in direct taxation on a country’s inflation rate, unemployment rate and balance of payments. [15 marks]
Responses may include:
19. (a) Using one or more diagrams, explain the difference between the equilibrium level of national income and the full employment level of national income. [10 marks]
Your answer may include the following information:
– all factors of production are fully utilized, or
– AS = AD on LRAS curve
(b) Evaluate the policies a government may use to increase the full employment level of national income. [15 marks]
You may include the following information:
– increased expenditure on education and training to increase productivity of labour
– increased spending on R&D to increase the quality of capital
– reducing trade union power to encourage greater flexibility in both wages and working
– practices and to allow labour markets to clear
– reducing welfare benefits to encourage greater self-reliance and to increase the quantity of labour in the market
– reducing “red tape” and bureaucracy to encourage investment and risk taking
– privatization to encourage competition
– abolishing the minimum wage to reduce labour costs to employers thus increasing their profits and encouraging and enabling more investment.
20. (a) Explain the relationship between the Lorenz Curve and the Gini Coefficient. [10 marks]
Lorenz Curve
Gini Coefficient
(b) Evaluate the effectiveness of the various methods that governments may use to redistribute income. [15 marks]
Different forms of taxation are to be seen as one method. In the same way different forms of transfer payment, subsidies, merit goods and public goods are to be each seen as one method.
21. (a) Explain two policies a government might use to redistribute income. [10 marks]
Answers should include:
Plus any two of the following:
Answers may include:
(b) “Measures to promote greater income equality should be a key feature of government economic policy.” Evaluate this proposition. [15 marks]
Answers may include:
In attempting evaluation you might point to the fact that arguments for greater or less equality coexist within economics and that notions of income equality and fairness are not the same.
- · explanation of multiplier
- · use of numerical examples
- · explanation of accelerator
- · use of examples
- · key differences. E.g. multiplier is autonomous, accelerator is induced
Emphasis will normally be placed on the multiplier. This is acceptable as long as you display a basic understanding of the accelerator. Candidates should appreciate the interaction between them that the multiplier is investment led and the accelerator is income led.
(b) Evaluate the proposition that the most effective way to reduce unemployment is through the use of demand-side policies. [15 marks]
Demand side policies explain, equilibrium and disequilibrium unemployment, demand side cyclical, its limitations, AD/AS analysis supply side for others its limitations
Points for discussion might include:
- · explanation of demand-side policies
- · explanation of monetary and fiscal policies
- · different types of unemployment: equilibrium/disequilibrium and “traditional” types
- · evaluation of the appropriateness of demand-side policies to combat types of unemployment, e.g. appropriate to cyclical and demand deficient, but not to seasonal and structural.
- · AD/AS analysis
- · problems of demand side policies
- · benefits of supply-side policies
- · drawbacks of supply-side policies
- · overall evaluation
Candidates may take a different approach.
2. (a) Explain the difference between demand-side and supply-side economic policies. [10 marks]
- explanation of demand-side policies in terms of monetary and fiscal policy
- explanation of supply-side policies in terms of particular policies, e.g. tax cuts, welfare cuts, privatization, deregulation and an outward shift of the LRAS curve
- use of AD/AS diagram to illustrate the difference
- References to the Keynesian/Monetarist debate should also be included for higher marks.
(b) “Higher economic growth can only be achieved through the implementation of supply-side policies.” Discuss. [15 marks]
Answers may include:
- · definition of economic growth
- · illustration of economic growth in terms of an outward shift of the PPC/LRAS curve
- · distinction between actual and potential growth
- · explanation of linkages between supply side policies and growth
- · importance of AD
- · Reward references to the Keynesian Monetarist debate
- · demand side policies and the multiplier effect
- · interdependence of supply side and demand side policies
This is potentially a big question for you to tackle. Do not expect answers to be able to cover the greater part of the above. Good candidates should be able to show how supply side policies can increase economic growth. You also need to be able to discuss this in the context of alternative demand side policies.
3. (a) Identify the components of aggregate demand and briefly explain two factors which might determine each of these components. [10 marks]
Answers may include:
- · a definition of aggregate demand(AD)
- · a definition of the components of AD: Consumption, Investment, Government Expenditure, Exports – Imports(net Exports), (candidates may use C+I+G+X which is rewarded in the same way)
- · an explanation of any two factors that determine:
– consumption e.g. real income, consumer confidence, interest rates and availability of credit, attitudes to saving, wealth, etc.
– investment factors e.g. business expectations, interest rates, level of profit, available finance(level of savings)
– government spending e.g. political priorities (improve public services, defense etc.) rate of economic growth, unemployment/inflation, tax revenue
– exports minus imports e.g. rate of economic growth, exchange rate changes, domestic producer efficiency, foreign producer efficiency, changes in the terms of trade, protectionism.
It is important that you show an understanding of the factors that affect AD rather than just listing factors.
(b) Evaluate the likely impact on an economy of a substantial rise in the level of interest rates. [15 marks]
Answers may include a discussion of the impact of a rise in interest rates on:
- · consumption spending
- · saving rates
- · investment spending
- · government spending(government borrowing costs increase)
- · rate of inflation
- · level of unemployment
- · rate of economic growth
- · balance of payments
- · current account (imports and exports)
- · capital account (capital flows)
- · exchange rates
- · use of AD/AS analysis to illustrate impact of shifts of AD/AS:
– reducing AD(reducing C, I, etc.)
– reducing AS(increasing costs of production)
- · or an evaluative approach candidates may discuss:
– costs and benefits of higher interests rates
– the short and long term consequences higher interest rates
– the significance of the impact of higher interest rates on different factors
4. (a) Explain how interest rates can be used to bring about an increase in economic activity. [10 marks]
Candidates may include any of the following:
- · explanation of interest rates as a tool of monetary policy
- · explanation that a cut in interest rates reduces the cost of borrowing
- · consumption will increase for a number of reasons
- · investment will increase for a number of reasons
- · possible effect on net exports
- · diagram showing increased spending shifting out AD curve and leading to an increase in national income
- · possibility of a supply-side effect
(b) Discuss the strengths and weaknesses of demand-side policies. [15 marks]
Explain how demand side cure inflation and unemployment, trade off, limitations deflationary fiscal fine-tuning, time lags. Contractionary monetary increase in interest rates slows economic growth and negatively affects exports due to increase in exchange rate, limitations of expansionary fiscal and monetary inflation, time lags, export competitiveness, crowding out, diagrams,
Candidates may include any of the following:
- · explanation of demand-side policies: fiscal policy and monetary policy
- · explanation of how demand-side policies can be used to reduce inflation or unemployment
- · discussion of a possible trade-off between inflation and unemployment
- · discussion of the problems associated with deflationary fiscal policy e.g. unemployment, time lags
- · discussion of the problems associated with contractionary monetary policy: an increase in interest rates slows economic growth and negatively affects exports due to increase in exchange rate.
- · discussion of the problems associated with expansionary fiscal and monetary policy e.g. inflation, time lags, export competitiveness, crowding out
- · use of an appropriate diagram
To have an effective argument always include:
- · consider short run versus long run consequences
- · examine the impact on different stakeholders
- · discuss advantages and disadvantages
- · prioritize the arguments
5. (a) Using one or more diagrams, explain the difference between the equilibrium level of national income and the full employment level of national income. [10 marks]
Provide the following information for an effective argument:
- · definition of national income
- · equilibrium level of national income as AS = AD
- · diagram showing equilibrium level of national income full employment level of national income described as:
– maximum level of national output, or – all factors of production are fully utilized, or – AS = AD on LRAS curve
- · diagram showing full employment level of national income
- · identification and explanation of the difference between the two concepts
You could also show both the equilibrium level of national income and the full employment level of national income on one diagram using the 3-range AS curve intersected by an AD curve on the upward bending range and by another AD curve intersecting the AS curve on its vertical range. Diagrams showing equilibrium level of national income with a 45 degree diagram are equally acceptable.
(b) Evaluate the policies a government may use to increase the full employment level of national income. [15 marks]
Include the following information:
- · definition of full employment
- · an increase in the full employment level of national income means a shift to the right of the LRAS curve
- · explanation that supply-side polices are the most appropriate policies to be implemented in order to increase the full employment level of national income
You should be able to explain a range of supply-side policies and the possible implications of the policies. Appropriate policies may include:
- · direct tax cuts to increase incentives to work and invest
- · increased expenditure on education and training to increase productivity of labour
- · increased spending on R&D to increase the quality of capital
- · reducing trade union power to encourage greater flexibility in both wages and working practices and to allow labour markets to clear
- · reducing welfare benefits to encourage greater self-reliance and to increase the quantity of labour in the market
- · reducing “red tape” and bureaucracy to encourage investment and risk taking
- · privatization to encourage competition
- · abolishing the minimum wage to reduce labour costs to employers thus increasing their profits and encouraging and enabling more investment.
The evaluation of the policies requires a critical approach, particularly the reduction of welfare benefits and the flexibility of labour markets. Explain that demand-side policies are not appropriate because they do not expand the quantity and quality of factors of production.
Effective evaluation include:
- · consider short run versus long run consequences
- · examine the impact on different stakeholders
- · discuss advantages and disadvantages
- · prioritize the arguments
6. (a) Explain how fiscal policy can be used to increase aggregate demand. [10 marks]
Answers should include:
- · definition of fiscal policy
- · definition of AD
- · identifying the components of AD: C+I+G+X
- · an explanation of how expansionary fiscal policy can be used to increase
- · aggregate demand in terms of: increases in government spending and/or reduction in tax.
Answers may include:
- · how expansionary fiscal policy could lead to a budget deficit
- · increases in transfer payments, such as pensions, and the impact on consumption
- · the use of subsidies to boost exports
- · reductions in direct and indirect taxation and the impact on consumption and investment
- · use of AD/AS diagrams to illustrate how fiscal policy will increase AD
- · explanation of how expansionary fiscal policy can lead to economic growth and inflation.
(b) “In the long-run, a country’s economic performance can only be improved through the implementation of supply-side policies.” Evaluate this statement. [15 marks]
Answers may include:
- · definition of supply-side policies
- · examples of supply-side polices, e.g. reducing direct tax to encourage worker incentives, privatization, strong competition policy, etc.
- · explanation of “economic performance” in terms of the main indicators, i.e. employment, price stability, growth, development, the balance of payments, income distribution and efficiency
- · explanation of the importance of demand-side policies for improved economic performance, e.g. through impact on the above indicators
- · use of AD/AS diagrams and analysis involving shifts of AD
- · possible drawbacks of demand-side policies e.g. higher inflation
- · distinction between SRAS and LRAS
- · significance of shifts in LRAS for the main indicators of economic performance
- · use of AD/AS analysis involving shifts of SRAS and LRAS
- · possible drawbacks of supply-side policies e.g. the time it takes for supply-side policies to work, difficulties of reducing inflation using supply-side policies.
7. (a) Aggregate demand consists of consumption, investment, government spending and net exports (exports minus imports). Explain two factors that may influence consumption and two factors that may influence government spending. [10 marks]
Answers should include:
- · a definition of consumption
- · a definition of government spending
- · an explanation of any two factors which may influence consumption such as the distribution of income, changes in wealth, the availability of credit, social attitudes, interest rates, changes in personal taxes, confidence in economy, expectations of future income. Reference to disposable better than just income
- · an explanation of any two factors which may influence government spending such as the population structure (e.g. an aging population), the rate of interest/cost of government borrowing, unexpected events, e.g. a credit crunch, war, the economic cycle (government spending usually rises in the downturn), political decisions, unemployment.
OR
Answers should include:
- · a definition of investment
- · a definition of net exports
- · an explanation of any two factors which may influence investment such as the interest rate, business expectations, increased consumer demand, cost, economic stability and efficiency of capital equipment
- · an explanation of any two factors which may influence net exports such as increases in foreign incomes increases a country’s exports, increases in a country’s national income leads to an increase in imports, decreases in foreign incomes results in less exports from a country, decreases in a country’s national income results in a decrease in imports, a fall in relative prices (if a country’s goods and services fall in price relative to those of other countries) will result in a country selling more exports and buying less imports and improvements in the relative quality of a country’s goods in comparison to other countries will result in it selling more exports and buying less imports.
(b) Evaluate the effectiveness of an increase in investment expenditure on the performance of an economy. [15 marks]
Answers may include:
- · a definition of investment
- · an explanation of the “performance of an economy” in terms of growth, employment, price stability and the balance of payments
- · consideration of an increase in investment leading to an increase in real GDP (economic growth)
- · Multiplier effect
- · diagrams showing a movement from a point within to a point on the PPF or a shift of the AD to the right
- · the supply-side effects of increasing investment on price and real output levels
- · diagram to show shift in LRAS
- · the possibility of demand-pull inflation, depending on where the economy is operating
- · an explanation that it could adversely affect the current account of the balance of payments if investment expenditure is on import
- · impact of different types of investment in terms of sustainable development
- · a comparison with potential growth
- · the supply-side effects of increasing investment on price and real output levels
- · short-run versus long-run effects
- · an overall assessment of the impact.
8. (a) Explain how supply-side improvements to an economy may be achieved through the use of taxes and government spending. [10 marks]
Answers should include:
- · an explanation of “supply-side improvements”
- · use of AD/AS diagrams
- · an explanation of how taxes and government spending may be used to affect AS, e.g. through:
– greater government spending on healthcare, education and training
– less government spending on benefits
– a reduction in income tax to increase work incentives
– lower corporation tax to encourage investment
– lower indirect taxes to reduce business costs.
Answers may include:
distinction between SRAS and LRAS.
(b) Evaluate the use of supply-side policies to reduce unemployment. [15 marks]
Answers may include:
- · a definition of unemployment
- · a definition of supply-side policies
- · examples of supply-side policies
- · the concept of a natural rate of unemployment
- · the importance of the different types of unemployment, e.g. demand deficient, frictional and structural
- · an explanation of how supply-side policies may work to reduce unemployment in the longer term
- · use of AD/AS analysis, showing LRAS shifting to the right
- · an assessment of the effectiveness of such measures
- · unemployment beyond the control of national governments, e.g. arising from demand-side shocks or international recession
- · consideration of the use and effectiveness of alternative short-term demand-side measures to reduce unemployment, i.e. fiscal and monetary policies
- · an evaluation of the effectiveness of particular supply-side policies, e.g.:
– tax cuts
– cuts in welfare benefits
– education and training/retraining
– privatization/deregulation
– trade union policies
9. (a) Using appropriate diagrams, explain the difference between demand-side and supply-side economic policies. [10 marks]
Answers should include:
- · a definition of monetary policy
- · a definition of fiscal policy
- · an explanation of demand-side policies
- · an explanation of fiscal policy as a demand-side instrument
- · an explanation of monetary policy as a demand-side instrument
- · use of an AD/AS diagram to illustrate the likely impact on AD
- · an explanation of supply-side policies
- · an explanation of the impact of supply-side policies
- · use of an AD/AS diagram to illustrate the likely impact on AS
- · examples of supply-side policies.
(b) Evaluate the use of supply-side policies to improve the performance of an economy. [15 marks]
Answers may include:
A distinction between market-oriented and interventionist supply-side policies and advantages of supply-side policies in terms of their impact on:
- · productivity
- · economic growth
- · employment
- · inflation
- · current account
- · distribution of income
Use the AD/AS diagrams to illustrate the above
Disadvantages of supply-side policies in terms of:
- · welfare benefits
- · cost of funding them
- · public services
- · exploitation of labour
- · time it takes them to work.
10. During the global financial crisis of 2008–2009, there was a fall in consumer spending in many countries.
(a) Explain the factors which might be responsible for causing consumer spending to fall. [10 marks]
Answers should include:
an explanation of “consumer spending” in the context of aggregate demand and some of the factors which may cause it to fall such as:
- · a fall in disposable incomes
- · a change in the distribution of income
- · the wealth effect e.g. of falling property and share values
- · an increase in unemployment or the threat of unemployment
- · less availability of credit
- · an increase in the cost of credit
- · a decrease in consumer confidence.
Two or three factors explained fully or more factors explained in less detail would be sufficient for full marks.
(b) Evaluate the possible consequences of falling consumer spending for a country’s macroeconomic performance. [15 marks]
Answers may include:
- · an explanation/definition of macroeconomic performance
- · the use of AD/AS diagrams
- · the use of a PPC diagram
- · linkages to the level of investment and possible accelerator/multiplier effects
- · the impact on the level of employment
- · the impact on economic growth (processing, depression, the business cycle)
- · the impact on the rate of inflation
- · the impact on the balance of payments and the exchange rate
- · the impact on government revenues and expenditures.
11. (a) Using appropriate diagrams, explain how a reduction in income tax could affect both aggregate demand and aggregate supply in an economy. [10 marks]
Answers should include:
- · a definition of income tax
- · a definition of aggregate demand
- · a definition of aggregate supply
- · an explanation of a reduction in income tax increasing disposable income, consumption and thus AD
- · use of an AD/AS diagram showing shift of AD to the right
- · an explanation of the possible linkage between a reduction in income tax, incentives to work and the level of output
- · use of an AD/AS diagram showing shift of an AS curve to the right (upward sloping or vertical AS curve is acceptable).
(b) “The lower the level of both direct and indirect taxation, the better.” Evaluate this view. [15 marks]
Answers may include:
- · a distinction between direct and indirect taxation
- · lower taxation and greater use of market forces to allocate resources
- · lower taxation and greater consumer choice
- · lower indirect taxation and lower prices
- · an explanation of what is meant by “better” in an economy
- · supply-side arguments in relation to lower direct taxation (company and personal), incentives and LRAS
- · relative international rates of taxation and investment by MNCs
- · taxation as a means of raising revenue and financing government spending, e.g. on merit and public goods
- · problem of budget deficits if taxes are low
- · taxation as a means of discouraging consumption of demerit goods/dealing with the problem of negative externalities
- · taxation as a means of influencing the distribution of income/consideration of progressive and regressive taxation
- · taxation as a means of regulating AD, e.g. use of higher taxes to reduce AD and demand-pull inflation.
- · multiplier effect
12. (a) Using appropriate diagrams, explain how an increase in government spending could affect both aggregate demand and aggregate supply in an economy. [10 marks]
Answers should include:
- · a definition of government spending
- · a definition of aggregate demand own: Multiplier effect
- · a definition of aggregate supply
- · an explanation of an increase in government spending influencing AD
- · use of an AD/AS diagram showing shift of AD to the right
- · an explanation of the possible linkage between an increase in government spending affecting the supply-side of the economy, e.g. education and training, government spending on infrastructure
- · use of an AD/AS diagram showing shift of LRAS to the right.
(b) “The lower the level of government spending, the better.” Evaluate this view. [15 marks]
Answers may include:
Arguments in favour of lower government spending:
- · lower government spending and greater use of market forces to allocate resources leading to greater economic efficiency
- · lower government spending leading to lower taxation
- · lower government spending reduces government borrowing
- · the importance of reduced government spending as a means of reducing AD, to reduce inflation and a current account deficit.
Arguments against lower government spending:
- · the importance of government spending for the supply-side of the economy
- · the importance of government spending on merit goods, public goods and infrastructure
- · the importance of government spending as a means of influencing the distribution of income through public services and state benefits
- · the importance of government spending as a means of regulating AD, e.g. use of higher government spending to increase AD to encourage growth and to reduce unemployment.
13. (a) Explain why a government might find it difficult to maintain a low rate of inflation as the economy approaches full employment [10 marks]
Answers may include:
- definition of inflation and full employment
- use of the Phillips Curve (PC) to illustrate the trade off between full employment and
- price stability (short-run and/or long-run). A relevant diagram referring to AD/AS is
- also acceptable
- explanation of the PC relationship in terms of possible demand pull factors
- explanation of the PC relationship in terms of possible cost push factors
- explanation in terms of AD/AS analysis
- explanation in terms of the natural rate of unemployment
(b) Evaluate the proposition that the priority in economic management should be the maintenance of low unemployment. [15 marks]
Answers may include:
- explanation of economic management in terms of fiscal and monetary policies
- support of the proposition in terms of the costs of high unemployment, e.g. the economic,
- social, financial and personal costs
- use of long run PC and the concept of the natural rate of unemployment to illustrate the possible inflationary implications
- other possible policy conflicts, e.g. with the balance of payments and economic growth
- the importance of the other goals of economic policy, i.e. low inflation, economic growth and a satisfactory balance of payments
- significance of the use of supply-side policies
14. (a) Explain why a country may wish to reduce its rate of inflation. [10 marks]
Answers should include:
- an explanation of the term rate of inflation
- an explanation for wishing to reduce the inflation rate in terms of the various costs of inflation.
This may include the impact on:
- international competitiveness
- the distribution of wealth and income
- savers and borrowers
- fixed income recipients suffer reduced real income
- certainty/uncertainty and the willingness of businesses to invest
- government finances
- government interest rate policy
- purchasing power, pressure on wages and industrial relations
- “shoe leather” and “menu” costs.
Answers may include:
- mention of lower inflation for general economic performance, e.g. the growth rate
- mention of the various ways in which inflationary pressures may be reduced
- a distinction between moderate inflation and hyper-inflation.
b) Evaluate the likely effects on the economy of relying on higher interest rates to reduce the rate of inflation. [15 marks]
Answers may include:
- · an explanation of the use of interest rates to tackle inflation
- · an explanation of the linkage between higher interest rates and AD
- · the impact of higher interest rates on costs/AS
- · the impact on output, growth, employment, the balance of payments and the exchange rate
- · use of AD/AS diagrams
- · the implications of using higher interest rates in dealing with cost inflation
- · other measures to deal with inflation, e.g. supply-side policies
- · the problem of time lags
- · interest rates as a highly flexible tool of economic policy
- · the distributional impact of higher interest rates on savers and borrowers
- · overall assessment.
15. (a) Explain why a country may wish to reduce its unemployment rate. [10 marks]
Answers should include:
- · an explanation of the unemployment rate
- · an explanation of the types or components of unemployment
- · an explanation for wishing to reduce unemployment in terms of the various costs of unemployment.
This may include the impact on:
- · the unemployed themselves e.g. reduced income, stress levels, self-esteem
- · society e.g. poverty, crime, vandalism
- · economy as a whole e.g. actual output is less than potential output (to the left of the LRAS curve); or economy is at a point inside the PPC
- · opportunity cost of government spending on unemployment benefits, less tax revenues available for other purposes
- · a government might wish to reduce unemployment in order to raise tax revenue.
(b) Evaluate the likely effects on the economy of relying on demand-side policies to reduce the unemployment rate. [15 marks]
Answers may include:
- · an explanation of the use of interest rates to reduce the unemployment rate
- · an explanation of the use of increased government spending/lower taxation levels to reduce the unemployment rate
- · an explanation of the linkage between lower interest rates and AD
- · an explanation of the “crowding out” effect resulting from government borrowing to increase government spending
- · an explanation of the linkage between increased government spending and lower taxation and AD
- · a consideration of the suitability of demand-side policies for different types of unemployment
- · the impact on output, growth, inflation and the balance of payments
- · use of AD/AS diagrams
- · AD moving to the right causes inflation on the vertical part of the AS curve
- · the inappropriateness of lower interest rates/higher government spending/ lower taxation in dealing with real-wage or natural unemployment
- · demand-side measures effective against demand-deficient unemployment
- · supply-side measures to deal with unemployment
- · the problems associated with increased government spending (running a budget deficit)
- · the problem of inelastic response of consumption and investment to lower interest rates
- · the problem of time lags.
16. (a) What are the causes of inflation? [10 marks]
- define inflation
- explanation of demand pull inflation
- explanation of cost push inflation
- reference to monetary growth
(b) Evaluate the possible effects of a persistently high inflation rate on a country’s current account balance and its exchange rate. [15 marks]
- define current account balance
- define exchange rate
- exports become less competitive while imports become more competitive
- impact on current account balance depends on relative elasticities of demand for exports
- and imports. Reference to the Marshall-Lerner condition to be rewarded
- the likely impact of the current account balance change on the exchange rate
17. (a) Explain the possible causes of a rise in the rate of inflation in an economy. [10 marks]
Answers should include:
- definition of inflation
- explanation of a rise in the rate of inflation
- explanation of the rise in terms of an increase in aggregate demand (AD)
- explanation of the rise in terms of an increase in costs (AS).
Answers may include:
- explanation of the rise in terms of an increase in the money supply (accept
- reference to MV = PT)
- use of an AD/AS diagram to illustrate the rise in AD
- use of an AD/AS diagram to illustrate the rise in costs
- factors which may cause AD to rise, e.g. lower taxation, higher government
- spending
- factors which may cause AS to rise, e.g. lower productivity, wage increases
- the impact of external shocks such as a rise in oil prices
- reference to other relevant factors such as expectations and a depreciating exchange rate
(b) Evaluate the possible impact on economic performance that may result from a government decision to bring inflation under control. [15 marks]
Answers may include:
- explanation of “economic performance”
- different types of inflation according to the rate, e.g. hyperinflation
- importance of the distinction between demand-pull and cost-push inflation
- implications of the use of demand-side policies
- implications of the use of supply-side policies
- impact on employment
- use of Phillips curve
- impact on balance of payments
- impact on growth
- use of AD/AS diagrams.
18. (a) Explain the difference between progressive taxation and regressive taxation. [10 marks]
Responses should include:
- definition of progressive taxation and example
- definition of regressive taxation and example
- progressive taxes may be used to redistribute income from rich to poor
- regressive taxes result in a more inequitable distribution of income.
(b) Evaluate the possible effects of a decrease in direct taxation on a country’s inflation rate, unemployment rate and balance of payments. [15 marks]
Responses may include:
- definitions of direct taxation, inflation rate, unemployment rate and
- balance of payments
- explanation that taxation is a tool of fiscal policy
- explanation of how a decrease in direct taxation is likely to increase
- aggregate demand
- if the economy is near full employment, this will cause inflationary pressure
- if the economy is below full employment, this may lead to a fall in
- demand-deficient unemployment
- the incentive effect of lower taxes may shift LRAS
- higher disposable incomes may result in increased demand for imports
- inflationary pressure may result in decreased competitiveness of exports
- the current account may worsen.
19. (a) Using one or more diagrams, explain the difference between the equilibrium level of national income and the full employment level of national income. [10 marks]
Your answer may include the following information:
- definition of national income
- equilibrium level of national income as:
- diagram showing equilibrium level of national income
- full employment level of national income described as:
– all factors of production are fully utilized, or
– AS = AD on LRAS curve
- diagram showing full employment level of national income
- identification and explanation of the difference between the two concepts
- level of national income on one diagram using the 3-range AS curve intersected by a AD curve on the upward bending range and by another AD curve intersecting the AS curve on its vertical range.
- Diagrams showing equilibrium level of national income with a 45 degree diagram are
(b) Evaluate the policies a government may use to increase the full employment level of national income. [15 marks]
You may include the following information:
- definition of full employment
- an increase in the full employment level of national income means a shift to the right of the LRAS curve
- explanation that supply-side polices are the most appropriate policies to be implemented in order to increase the full employment level of national income
- implications of the policies.
- Appropriate policies may include:
– increased expenditure on education and training to increase productivity of labour
– increased spending on R&D to increase the quality of capital
– reducing trade union power to encourage greater flexibility in both wages and working
– practices and to allow labour markets to clear
– reducing welfare benefits to encourage greater self-reliance and to increase the quantity of labour in the market
– reducing “red tape” and bureaucracy to encourage investment and risk taking
– privatization to encourage competition
– abolishing the minimum wage to reduce labour costs to employers thus increasing their profits and encouraging and enabling more investment.
- The evaluation of the policies requires a critical approach, particularly the reduction of welfare benefits and the flexibility of labour markets.
- Explanation that demand-side policies are not appropriate because they do not expand the quantity and quality of factors of production.
20. (a) Explain the relationship between the Lorenz Curve and the Gini Coefficient. [10 marks]
Lorenz Curve
- · a curve showing the proportion of national income earned by any given percentage of the population
- · used to show the degree of inequality of income in a society
- · the farther from the 45o line is the curve, the greater the degree of inequality
Gini Coefficient
- · a statistical measure of the degree of income inequality
- · measures the area between the 45o line and the Lorenz Curve as a proportion of the entire area under the 45o line
- · ranges between 0 and 1
- · a Gini Coefficient of 0 represents complete equality; coefficient of 1 represents complete inequality
(b) Evaluate the effectiveness of the various methods that governments may use to redistribute income. [15 marks]
- · explanation of the different forms of taxation and how they can be used to redistribute income
- · discussion of the issues associated with using taxes to redistribute income
- · explanation of transfer payments made by government
- · discussion of the issues associated with transfer payments
- · subsidies
- · merit and public goods
Different forms of taxation are to be seen as one method. In the same way different forms of transfer payment, subsidies, merit goods and public goods are to be each seen as one method.
21. (a) Explain two policies a government might use to redistribute income. [10 marks]
Answers should include:
- · a definition of income distribution, as one of the goals of macroeconomic policy.
Plus any two of the following:
- · progressive, regressive and proportional taxation (a diagram may be used)
- · switching the burden of taxation between direct and indirect (more regressive) taxes
- · transfer payments, minimum wage
- · use of property or wealth taxes for redistributive purposes.
Answers may include:
- · a method of describing or measuring income equality or inequality such as the Lorenz curve and/or Gini coefficient
- · the redistributive effects of merit goods in an economy which provides them extensively
- · reference to the redistributive effects of government subsidies.
(b) “Measures to promote greater income equality should be a key feature of government economic policy.” Evaluate this proposition. [15 marks]
Answers may include:
- · a definition of income equality
- · reference to the difficulty and disagreement over “fair” distribution
- · consideration of benefits of greater income equality such as reduction of poverty, increase in consumption of the poor, greater incentives for low income groups, attainment of economic development
- · definitions of the four objectives of government economic policy, with an explanation that income equality is a fifth and not always considered as important
- · consideration of the Laffer curve
- · consideration of the presumed disincentive effects of taxation
- · reference to the positive externalities of merit goods such as education and health care for lower income groups
- · consideration of the normative nature of the statement in the question
- · the positive multiplier effects resulting from transferring income from sectors with high MPS to sectors with high MPC
- · a reference to where the economy is in the business cycle, as an influence on whether greater income equality would be a key feature of government economic policy.
In attempting evaluation you might point to the fact that arguments for greater or less equality coexist within economics and that notions of income equality and fairness are not the same.