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Exam-style questions (multiple choice and short answer)


1 D. (1 mark) Explanation: it will reflect a fall in X or an increase in M. Both represent a fall in AD. NB Explanation is not required for mark.

2 A. (1 mark) Explanation: a decrease in imports will reduce withdrawals so boost X – M and hence the expenditure measure of GDP. NB Explanation is not required for mark.

3 The exchange rate is the price of one currency in terms of another. (1 mark)

4 24%. Calculation: 100 x ((2 – 1.52)/2)) (2 marks)

5 Outline:

  • Define exchange rate: the price of one currency in terms of another. Application: the value of the pound has fallen by 24% between July 2008 and January 2009.

  • A decrease in the value of the pound means that the price of UK goods falls in foreign markets; hence demand for them increases, meaning increased volume of falls X and hence a rise in AD.

  • A decrease in the value of the pound means that the price of imported goods rises; hence there is a decrease in demand for imports which may be substituted for UK-produced goods, leading to a decrease in M and a rise in AD.

Evaluation: two separate points needed with relevant use of context:

  • Long-term contracts between companies mean that a fall in export earnings will not happen straight away. Export earnings may rise in the short run or stay the same.

  • Exporting companies may choose to keep prices unchanged and receive higher profit margins.

  • PED for exports and imports may be highly price inelastic. So some foreign countries/firms may take the hit of having to pay a higher price due to a better quality of goods. So export earnings may remain stable.

6 Possible answers include:

  • Define economic growth: increase in real GDP.

  • Define balance of payments: record of transactions between the UK and the rest of the world. Current account includes exports minus imports of goods and services plus net income from abroad plus net transfers between residents.

  • If growth is accompanied by an increase in domestic demand (C + I + G) then the increase in growth may be accompanied by a rise in imports as households, firms and government use their rising income to purchase more goods from abroad. In this case, the balance of payments might deteriorate.

  • If growth is export led then the balance of payments might improve. (This could count as evaluation depending on how analysis is developed.)

Evaluation (1 x 4 or 2 x 2 marks): to score 3 or 4 marks the evaluation must be put in the context of the question/extract. For example:

  • Impact depends on the changes in the exchange rate over the time period. Since sterling depreciated sharply between 2008 and 2009, this will offset some of the effect.

  • Extent of the change depends on the relative growth rates in UK vs trading partners. If UK grows by more than trading partners, it is likely that balance of payments will deteriorate. In 2009 major trading partners were going into recession.

  • Effect of increase in domestic demand depends on the marginal propensity to import. In the UK this has remained very high despite the recession. The MPM means the effect of an increase in UK growth on the current account deficit will be magnified.

Exam-style questions (data response)


7 Nominal GDP is GDP measured in terms of money values, and so it is influenced by the price level or inflation in an economy. GDP figures are converted to ‘constant price’ numbers to remove the effects of inflation.

‘UK nominal GDP rose by 1.3% in 2010 Q2, reflecting a 1.2% increase in real output and a 0.1% rise in inflation’. Here, real GDP has actually risen by 1.2%, but nominal GDP has risen by 1.3% as it includes inflation, which increased by 0.1%. (4 marks)



8 A recession is when there are two consecutive quarters of falling real GDP. GDP is the total value of goods and services produced by the factors of production in an economy in a given time period. Real GDP is GDP adjusted for inflation.

In the extract we are told that GDP fell by a total of 6.5% during the recession, suggesting that at some point there were at least two consecutive quarters of negative GDP growth. (4 marks)

Topic 3

Aggregate supply



Short-run aggregate supply

1

The SRAS is upward sloping because as prices rise firms find it more profitable to increase production and thus will be incentivised to do so. This is because, in the short run, wages and other input prices are assumed to be fixed. With fixed cost inputs and higher-priced outputs, companies can increase profit by increasing production. Thus, as the price level increases in the short run, then real wages (and other real costs) fall, giving the SRAS an upward slope. (4 marks)



2 The initial SRAS is SRAS1.

a SRAS3 (2 marks)

b SRAS3 (2 marks)

c SRAS2 (2 marks)



3 AD/AS diagram showing:

  • initial AD/AS curves and axes correctly labelled (1 mark)

  • initial equilibrium correctly labelled (1 mark)

  • contraction (leftwards/inward shift) in SRAS (1 mark)

  • new equilibrium correctly labelled showing a fall in the equilibrium level of real national output and an increase in the equilibrium average price level (1 mark)

Further explanation (not needed to score marks in exam): firms use oil for many purposes and it has few substitutes so demand is likely to be price inelastic. Oil price increases will also add to transport costs, pushing up costs of production for all firms. This means the increase in AS may be substantial. In the long run, households are also likely to see an increase in key costs of living (petrol and other goods prices). This may lead to a wage–price spiral, pushing up SRAS even further.

Long-run aggregate supply

4 The short run is the period in which at least one factor of production is assumed to be fixed. Labour is usually assumed to be variable. In the long run, all factors of production are variable. (4 marks)

The Keynesian and classical LRAS curves



5 AD/AS diagram showing:

  • initial AD/AS curves and axes correctly labelled (1 mark)

  • initial equilibrium correctly labelled (1 mark)

  • increase (rightward shift) in LRAS (1 mark)

  • new equilibrium correctly labelled showing an increase in the equilibrium level of real national output and a fall in the equilibrium average price level. (1 mark)



6 C. (1 mark)

7 At low levels of output (real GDP) the LRAS curve is horizontal. With a high level of unemployment and a lot of ‘spare capacity’ in the economy, output can be increased without a rise in wages as more workers can be employed at the current wage rates and a rise in the demand for raw materials and capital will not raise their price. Then at higher levels of output the LRAS starts to slope up as firms begin to experience rises in costs as they have to compete for increasingly scarce resources (e.g. raw materials and labour). The price level will rise to compensate for the higher costs. At the full employment level (maximum potential output), there is no spare capacity and the LRAS curve becomes perfectly inelastic. (4 marks)


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