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Exam-style questions


1 Knowledge and analysis: (8 marks)

  • Definition of imports.

  • Explanation that imports are a leakage from the circular flow of income.

  • Explanation that fall in imports leads to increase in (XM) so a rise in AD.

Diagram showing AD shift to the right (1 mark) and changes in the equilibrium points (1 mark). Growth and price level effects:

  • Increase in AD. (1 mark)

  • Via (X – M). (1 mark)

  • Multiplier effects. (1 mark).

Effects on national income (Y) and price level (P) must be clearly explained and marked on a diagram as below.

Significance of export-led growth. (1 mark) Further analytical marks for consequences for growth, e.g. through damaging effects of inflation. (2 marks)



Evaluation: (4 marks). Factors might include:

  • Discussion of the size of the multiplier (size and types of leakages, e.g. applied to UK which has low MPS but high MPM).

  • Time-lag effects.

  • Depends on the shape or the AS curve (vertical LRAS versus flatter LRAS).

  • Other things might not be equal, for example interest rates might increase or exports might also fall at the same time.

2 Knowledge and analysis: (8 marks)

Definition of investment. Recognition that investment is part of AD (AD = C + I + G + X – M)

Short-run effects: diagram showing AD shift to the right (1 mark) and changes in the equilibrium points. (1 mark)



AD analysis: increase in I, as a component of AD; expansionary impact – real output AND price level.

Long-run effects: diagram showing AD shift to the right (1 mark) and LRAS shift to the right (1 mark) and changes in the equilibrium points for P and Y labelled. (1 mark)





AS analysis: increase in I leads to an expansion of capital stock and increases productive capacity. Hence LRAS increases. Expansionary impact on real output. Price level may increase, decrease or stay the same.

Evaluation: (1 x 4 or 2 x 2 marks). Factors might include:

  • Multiplier/accelerator effects.

  • Relative size of effect on AD/LRAS. Has important effect on whether real output and price level increases or just output.

  • The spending might not affect quality of capital stock, in which case will LRAS shift out (e.g. wasteful investment in obsolete technology)?

  • Short/long-run effects.

  • There are many other determinants of AD, e.g. exchange rates might change.

Topic 4

What are the macroeconomic objectives of governments?

The four main macroeconomic objectives

1 Actual economic growth is measured by the change in real national output. National output is measured by gross domestic product (total output of goods and services produced in an economy within a given time period). GDP growth may be measured in money (or current price) or real (adjusted for inflation) terms.

Long-term growth is shown by the increase in trend or potential GDP and this is illustrated by an outward shift in a country’s long-run aggregate supply curve (LRAS).



2 KAA: (8 marks)

Inflation might reduce consumer confidence, causing a fall in consumption and therefore a fall in businesses’ potential sales. This in turn can cause uncertainty for businesses and a fall in investment. This will cause a fall in AD and hence national income. Export demand might also suffer as inflation increases costs and reduces competitiveness, which can lead to falling demand for exported goods and rising demand for imports.

Inflation can also create ‘shoe leather’ and ‘menu’ costs. Shoe leather costs are where firms and businesses need to make an additional effort to seek out the best deals. These costs are also called search costs, reflecting the increased time spent attempting to find the lowest available prices. Menu costs are costs associated with having regularly to re-price products to bring them into line with general inflation.

Evaluation: (4 marks)

In evaluation of this, provided the inflation is anticipated by firms, they might be able to plan ahead for its effects by hedging their costs (buying the goods at pre-agreed prices or purchasing futures contracts). They might also not suffer any loss of competitiveness in the short run if the exchange rate falls to compensate for the increase in domestic prices.

In addition, the internet has increased the availability of information and considerably reduced the problem of search costs. Search engines and comparison sites have also made it much easier to access the cheapest product even at times of rapidly rising prices.

3 Knowledge and analysis: (8 marks)


  • Definition of inflation (sustained increase in the general price level measured by the annual percentage change in an index such as the CPI or RPI).

  • Understanding of distribution of income: how the GDP of a country is distributed amongst different groups (the highest percentile earners and the lowest percentiles, or other identified groups) of a country.

  • Identification of groups of beneficiaries from an increase in inflation, e.g. borrowers, mortgage holders (as inflation reduces the real value of the debt).

  • Identification of losers: those on fixed incomes; savers (inflation erodes the real value of savings), especially if nominal interest rates increase by less than inflation; pensioners; benefit recipients (if benefits are not indexed to inflation).

  • Further analysis, e.g. savers are likely to be the higher-income groups; monthly mortgage interest payments may rise, if interest rates also rise possibly affecting lower-income groups more as a proportion of their income; link between inflation and house prices.

Evaluation: (2 x 2 or 1 x 4 marks). Factors might include:

  • Lower-income groups are often least able to protect themselves against increasing inflation by hedging or buying assets that can protect them. They are also worst hit as they are often already close to subsistence.

  • Higher-income groups might arguably have larger mortgage interest payments as a proportion of their income if they have been able to borrow heavily to buy large houses.

  • Inflation changes may take time to have an effect, especially if workers have just received wage increases or if interest rate changes do not happen right away. Effects on income might take longer than wealth effects or other wealth issues.

4

Summary of causes: an increase in AD particularly when the economy is close to full employment. This might be caused by loose fiscal policy, higher house prices, greater confidence, increased credit availability, depreciation in the exchange rate. (4 marks)



Summary of causes: caused by substantial increase in costs of production, resulting in SRAS shifting to the left. Causes might be rising oil prices, higher indirect taxes, rising wages, depreciation in the exchange rate. Hence price level rise from P1 to P2, but real output falls from Q1 to Q2. (4 marks)



5 a When EXPORTS exceed IMPORTS the country has a current account surplus.

b When IMPORTS exceed EXPORTS the country has a current account deficit.

6 KAA: (8 marks)

The balance of payments is a record of the extent of international transactions between one country and the rest of the world. The current account is the largest part of the balance of payments, the main elements of which are the balances of exports and imports in goods and services.

The exchange rate is the value of one currency expressed in terms of another – for example, £1 = $1.45. A decline in the value of the currency (depreciation) will, ceteris paribus, lead to import prices rising but export prices falling. This should boost demand for UK exports whereas rising import prices will reduce demand for imports. As a result the trade deficit should narrow.



Evaluation: (4 marks)

However, if the price elasticity of demand for imports were relatively inelastic, then a rise in the price of imports would lead to a less than proportionate fall in demand, in which case total expenditure on imports would rise. This would, ceteris paribus, lead to a deterioration in the trade deficit. Equally, if the demand for exports were price inelastic then a fall in the price of exports would result in very little increase in the demand for UK exports. Total sterling export earnings will nevertheless increase in this case.

We can also relax the ceteris paribus assumption. For example, when global growth is weak there will be a low level of demand for UK exports, so exports might actually not increase despite the decline in price. At the same time, foreign firms may try to access UK markets by keeping their prices low despite the fall in the exchange rate. The net effect of this could be for exports to remain unchanged and imports to rise, thus contributing to a widening of the deficit.

Additional macroeconomic objectives


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