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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.

  1. Assess the view that falling unemployment will inevitably lead to an improvement in the standard of living for people in the UK. (25)

    These higher wages can translate into an improvement in the standard of living for people in the United Kingdom as they can now spend more money, to improve their quality of life. This positive impact is exacerbated through the positive multiplier effect. The initial increase in aggregate demand will lead to a proportionately greater increase in national income, which will help other firms as they can benefit from other firms hiring, as they now have more consumers. However, such an improvement could possibly be offset by inflation.

    • Word count: 848
  2. Evaluate the case for and against leaving market forces to provide necessity goods such as water

    Leaving the government to provide necessity goods is arguably more inefficient than if left to the market. The government, in providing the necessity goods, has no incentive to maximize the efficiency and quality of the system. As the government receives no profit from the distribution of necessity goods, there is no pressure upon it to improve the quality of the distribution. No matter how efficient and good the distribution is, the government employees in charge of the distribution will be payed the same amount, and the department of government responsible for the necessity good does not face the threat of bankruptcy in case they do a bad job, thus it does not incentivize its employees to do a good job.

    • Word count: 841
  3. Explain the difficulties of carrying out cost-benefit analysis. [8]

    Then, one the groups in question are determined, the potential costs and benefits start to be identified. In the case of a highway, for example, the benefit of faster and more efficient commutes, transportation and travel will likely be identified together with the potential costs associated with deforestation, such as fewer camping and hiking trails, or the costs associated with building the highway, such as pollution. These costs and benefits are then assigned an appropriate monetary value in order to allow for more objective comparison. The final step before their evaluation is a forecasting of the costs and benefits in the future, which will also be accounted for in the monetary value.

    • Word count: 530
  4. Discuss whether national defence or a public park is the better example of a public good. [12]

    The park is also non-excludable, as, being a public park, nobody can exclude any person from using the park. In terms of marginal cost the park also has virtually no marginal cost as the costs associated with operating a park are almost always fixed; costs such as lighting or water supplies are almost always fixed and do not vary with consumption. However, there are certain aspects of parks that fail to make it a true public good. On the one hand, there is the fact that the park is rejectable, as one can choose whether they wish to take advantage of it, thus the park fails to fulfill at least one of the criteria to be considered a public good.

    • Word count: 909
  5. Structured Response a) + b) on Absolute Advantage, Comparative Advantage and Trade ( [8] + [12] marks, 45 minutes)

    Take the example given in the table where the output of the countries is predicted based on the assumption that they both have the same resources and they are divided evenly between the production of chairs and tables. As can be seen, with the same resources, Country A can produce 40 more tables than country B, while country B can produce 60 more chairs with the same resources. Beyond this, Country A can produce Tables at an opportunity cost to chairs of 5:3 while Country B can only produce them at an opportunity cost of 1:2.

    • Word count: 1290
  6. Discuss whether inflation is necessarily harmful [12 marks] (27 minutes)

    This decrease in the availability of credit resulting from inflation will then go on to lead to a fall in investments and spending as people are no longer able to finance startups, investments and expenditure through credit. This is then likely to cause a fall in the aggregate demand within the economy as two main components, consumer expenditure and investments, fall, thus causing a fall in real output. This will then likely go on to lead to poor long term economic growth prospects and structural unemployment within the economy as industries are unable to sustain themselves due to poor revenue.

    • Word count: 877
  7. Explain the difficulties in measuring inflation accurately [8 marks] (18 minutes)

    In the following years, a similar process of finding a weighted average of the prices of relevant goods and services is carried out, then, the difference between the price level in the current year and the base year is divided by the original price level in the base year, thus measuring the annual inflation rate. Due to the nature of the process required for the measurement of inflation, several potential inaccuracies arise.

    • Word count: 498

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