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AS and A Level: Macroeconomics

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The macroeconomic objectives

  1. 1 Growth is measured usually by the GDP per capita. Be aware that just looking at GDP as a measure of growth is flawed to some extent and know the criticisms of it e.g. ignores the distribution of income, exchange rate problems.
  2. 2 Full employment – This usually tracks GDP growth to a large extent. Some unemployment in an economy is normal as people change jobs (frictional unemployment) and some would say a little unemployment is useful for preventing big wage rises.
  3. 3 Low inflation – Inflation is a persistent rise in the level of prices. If a country has inflation its prices are likely to rise compared with foreign competitors so the country will become uncompetitive.
  4. 4 The balance of payments needs to be in equilibrium, where the value of imports equals the value of exports.
  5. 5 The most important objective varies – For many years it was the balance of payments and unemployment. Until very recently it was inflation and much more recently, growth has become the most important. Remember that all objectives need to be achieved at the same time.

Macroeconomic Policies

  1. 1 The government tries to regulate the economy, mainly by affecting the level of Aggregate Demand (AD) and Aggregate Supply (AS). There are three main types of policy listed below.
  2. 2 Fiscal policy is using taxation and government spending to regulate AD by, for instance, increasing tax to reduce AD or borrowing more to spend on infrastructure projects to increase AD. Fiscal policy is used less to affect AD recently.
  3. 3 Monetary policy is essentially affecting the amount of money in the economy by changing the money supply, changing the exchange rate or altering the interest rate. In recent years, monetary policy has mainly come to mean just changing the interest rate with the main aim of affecting AD however quantitative easing is also monetary policy.
  4. 4 Supply side policies are designed to increase AS by improving the production potential of the economy. Examples include improving education and training, increasing competition for businesses and tax breaks for research and development.
  5. 5 In practice, governments use all three policies to regulate the economy. Supply side policies are seen as most effective as they also lead to lower inflation but their effects are in the long term.

Keynes versus Friedman

  1. 1 This is regarded as being a key ideological stand off regarding government regulation of the economy.
  2. 2 Keynes believed that the government had a big role to play in the economy by regulating aggregate demand. When AD was too low so there was low growth and unemployment, the government should borrow money and embark on public sector expenditure to stimulate AD and the economy. When AD was too high, the government should increase tax or reduce government spending to reduce AD.
  3. 3 Friedman was a monetarist. He believed that the free market should be left to itself to regulate the economy. He believed that left alone, the economy would provide full employment and growth. The government would only create inflation by injecting money into the economy. The government should regulate the money supply only.
  4. 4 The dominant ideology changes. From 1945 to 1979, Keynes was dominant. During the 1980s monetarism came back. Now there is arguably a more balanced view.
  5. 5 Avoid simplistic analysis. The debate concerning the role of the government in macroeconomics is complex.

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    How can inflation be reduced?

    5 star(s)

    To reduce inflation through monetary policy you must increase interest rates. By increasing interest rates it makes saving more appealing therefore reducing consumer spending, as one of the factors in aggregate demand by reducing consumer spending you ultimately reduce inflation. High interest rates not only reduce consumer spending but also investment, business will be concerned with high interest rates as it becomes more expensive to buy assets, this again reduces aggregate demand. Also people with mortgages will find themselves with lower discretionary income as they are spending more on their mortgage then before.

    • Word count: 2774

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