Effectiveness of policy options to meet all macroeconomic objectives · A Level Economics

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Due to the multiplier process, governments conducting an expansionary fiscal policy do not need to increase spending by the full amount of the negative output gap to bring the output of the economy to its full employment level. Evaluate this statement.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 8 marks. AO3 out of 4 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Negative output gap as the condition where actual output is less than potential output.

• The concept of full employment where all available resources in the economy are fully and efficiently used, where there is no cyclical unemployment.

• Aggregate demand is a determinant of the output of an economy.

• Expansionary fiscal policy is when the government decreases taxes and increases government spending, incurring a budget deficit.

• Government spending is an injection into the circular flow of income and is a component of aggregate demand.

• Multiplier = 1 / (1-MPC) = 1/ MPW = 1/ (MPS + MTR + MPM) = Change in National Income/ Change in Injection

• Multiplier process leads to multiple rounds of spending due to an injection

• The increase in income leads to induced consumption and investment spending by households and businesses.

• As households have more disposable income, they increase their consumption of goods and services.

• Similarly, businesses may invest in new capital equipment or expand production capacity to meet the growing demand.

• The initial injection of spending sets off a chain reaction of additional rounds of spending, as the increase in income from one round leads to further increases in consumption and investment, creating a multiplier effect on aggregate demand.

• An injection of government spending leading to a more than proportionate increase in national income.

• Examples of what the government can spend on and the additional rounds of spending that it creates.

• AD/AS diagram showing more than one shift in AD (or 1 shift with written explanation that the amount of increase is more than the amount the government spent)

AO3 Evaluation

• The uncertainty of the existence of the multiplier may lead to government spending being insufficient.

• Uncertainty could also lead to overshooting, leading to higher inflation.

• Government spending is a small part of the aggregate demand of the economy and therefore may have an insignificant impact on the national output levels, even with the multiplier.

• Expansionary fiscal policy could lead to the crowding out effect.

• National debt issues could emerge such as high debt servicing ratio, lower investor confidence, debt crises.

• MPM in the economy might be very large /MPC in the economy might be very small, leading to small multiplier.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Consider whether a high interest rate will ensure that ‘inflation, job creation and economic growth are all moving in the right direction’ in the US economy.

• High interest rates will reduce investment and lower employment (job creation)t 1 and lower growth rate 1

• Increases the exchange rate (hot money inflows) 1 reduces import cost and inflationary effects 1

• Reduce consumer demand 1 and reduces growth rate/inflation 1 3  (1 + 1)

Max 6 Conclusion: Not all the stated aims are likely to be achieved at the same time.1

Knowledge of both the multiplier and the accelerator enable a government to implement effective fiscal policies to close a deflationary gap. Evaluate this statement.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content

AO1 Knowledge and understanding and AO2 Analysis Responses may include:

• Explanation of a deflationary gap in terms of the full employment level of income and the equilibrium level of income.

• Explanation of multiplier, accelerator and fiscal policies

• Formula for the multiplier and accelerator.

• Explanation of the multiplier mechanism after an increase in government spending and/or a decrease in taxation.

• Explanation of the accelerator mechanism after an increase in real gross domestic product leading to an increase in induced investment.

• Analysis of the effects of expansionary fiscal policy on equilibrium level of national income and the level of real output, the price level and employment. Use of AD/AS diagram, showing a deflationary gap, with shifts in AD/AS (and LRAS).

AO3 Evaluation

• Effectiveness depends on accurate calculations of marginal propensity to consume, the potential level (full employment level) of national income, and the present level of national income.

• Government failure can occur if variables change/forecasts are wrong.

• Time lags in implementation.

• Other influences on consumption and investment, such as confidence and interest rates.

• Supply shocks will change planned outcomes

• Effectiveness of an expansionary fiscal policy may be reduced if government needs to borrow funds to finance a budget deficit.

• Marginal propensity to consume may change in the long run.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Compare the additional government spending in Japan and Ghana in response to the COVID-19 pandemic. Japan’s government’s fiscal response was 45% GDP. (1) Ghana’s government’s fiscal response was 2% GDP. (1) Japan’s response was approximately 20+ times the size of Ghana’s response.

(1)

Max 2 marks Explain one possible reason for the difference between their responses. Japan will have had greater ability to access to credit markets to increase its debt levels. (1) Therefore, Japan may have been more willing to spend on COVID-19 responses. (1) Ghana’s government may not have had the ability to spend on COVID-19 responses. (1) This might be due to Ghana’s being a relatively low-income country. (1)

Max 2 marks for one developed point.

Accept any valid alternative response.

With the help of an aggregate demand and aggregate supply diagram, explain the impact of an increase in ‘direct income support’ on real output and the price level. Correct labelling of axes and correct labelling of curves (1) Changes in co-ordinates correctly labelled and correct identification of shift in AD curve (1) (Max 2 marks) An increase in government spending will shift AD to the right because G is a component of AD. (1) This will cause an increase in real GDP/ real income/output. (1) Price level is likely to increase (1) The effect on the price level will depend upon initial the equilibrium position.

(1) (Max 2 marks)

Using the information regarding government policy tools, assess the advantages and disadvantages of two policies used by governments during the COVID-19 pandemic to protect their economies. The policies: Direct income support (grants, ‘furlough’ money) Debt write-offs (lender forgives all/some outstanding debt) Asset purchases (quantitative easing) (Max 1 mark for identifying at least 2 policies) Advantages

• Government provides support for any fall in income and allows families to survive drop in income.

• Reduces costs to allow firms to avoid bankruptcy helps to maintain employment.

• Reduce interest rates so that families/firms can reduce size of debt obligations

• Reduces costs of government borrowing

• Promotes the growth of the circular flow of income. up to 2 marks for each developed point – Max 3 marks Disadvantages)

• Income support is a significant cost to the government and, in the long run, the taxpayer.

• Will have a significant long-term negative impact on government debt.

• Potential for exploitation/fraud regarding the use of government financial support

• Debt write-offs might have a negative impact on the government’s borrowing requirement, in the long run.

• Quantitative Easing might have a potentially negative effect on the rate of inflation in the long run up to 2 marks for each developed point – Max 3 marks

The Bank of China has a target inflation rate of around 3%, the Bank of India has a target inflation rate of 4%, the Federal Reserve, the European Central Bank and the Bank of England all have a 2% target inflation rate. Consider whether central banks should have a target inflation rate of 0%?

Use Table A: AO1 Knowledge and Understanding, AO2 Analysis, and Table B: AO3 Evaluation, to mark candidate responses to this question

AO1 and AO2 are out of 14 marks. AO3 is out of 6 marks.

Indicative Content Responses may include:

AO1 Knowledge and Understanding and AO2 Analysis

• definition of a target inflation rate

• explanation of the process by which a central bank attempts to meet a target inflation rate – including changes in central bank lending rate/open market operations/quantitative easing

• explanation why central banks state target inflation rates – main reasons would include the aim to achieve price stability and to support sustainable growth

• a 0% inflation target might help businesses and household to make long term spending plans

• very low rates of inflation will allow real wages to adjust without cutting nominal wages

• very low rates of inflation will help a government to reduce its expenditure on debt repayment/help to reduce a public sector fiscal deficit

• a very low target rate of inflation might eventually lead to a reduction in menu/shoe leather costs.

AO3 Evaluation

• if the inflation target set i.e. 0% is too low, consumer spending might fall due to expectations of further price falls

• a very low inflation target will reduce profit expectations and a subsequent fall in the level of investment is likely

• a 0% inflationary target based on low interest rates, might result in an outflow of short-term capital and a negative effect on the overall balance of payments

• 0% inflationary targets will remove the ability of a central bank to use interest cuts to stimulate the economy/ liquidity trap

• due to index linking, a very low inflationary target is likely to lead to a re- distribution of income from savers to borrowers

• a 0% inflationary target might trigger falling prices and cause a deflationary outcome/ ultimately linked to lower economic growth and higher levels of unemployment

• a conclusion should be attempted based on the statement in the question

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Evaluate the effect ofa rise in the exchange rate on the achievement of the macroeconomic aims of a country.

AO1 Knowledge and understanding and AO2 Analysis

• Explanation of the effect of a rise of the $US on the US’s exports and imports OR any other currency

• Analysis of exchange rate rise on the price of exports (X) and imports (M) and the consequences fortheir demand, links to aggregate demand (AD) through the balance of payments effect (X–M). A decrease in exports and an increase in imports, potentially worsening the trade balance

• Candidates may refer to this change in terms of injections and leakages and their effect on AD.

• The use of AD and AS diagram to show this effect on the level of national income and economic growth.

• Alternatively, the analysis of the increased injection may be through the multiplier effect and/or the 45° diagram.

• A clear link should be made between the effect of the rise in exchange rate and economic growth, reference to the type of economic growth: actual or potential should be made.

• Ignore $US on the US’s exports

• Minimum of 2 aims developed for L3

AO3 Evaluation

• Why the US$ rate rose and how that might have affected economic growth.

• The nature of exports fromthe USto the rest of the world: oil, agricultural produce etc. and the price elasticity of demand for that produce.

• Extent the effects of a rise in ER on employment and inflation.

• The effect of the $US being a reserve currency.

• The size of the marginal propensity to export/import on the multiplier and its affect on the change in AD

• The impact of inflow of capital in terms of MNC and the effect on US output and growth.

• The percentage of US GDP represented by (X–M)

• Accept all valid responses

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Evaluate the effect ofa fall in the exchange rate on the achievement of the macroeconomic aims of a country.

AO1 Knowledge and understanding and AO2 Analysis

• Knowledge and understanding of the effectof depreciation/devaluation on the exchange rate (ER), and economic growth.

• Analysis of Ex R fall on the price of exports (X) and imports (M) and the consequences for their demand, links to aggregate demand (AD) through the balance of payments effect (X–M).

• Candidates may refer to this change in terms of injections and leakages and their effect on AD.

• The use of AD and AS diagram to show this effect on the level of national income and economic growth.

• Alternatively, the analysis of the increased injection may be through the multiplier effect and/or the 45° diagram.

• Identification of at least two macroeconomic aims of a country: e.g. balance of payments, economic growth, inflation, employment.

• Analysis of the impact of the change in ER on at least 2 macroeconomic aims to comment on their likely achievement.

AO3 Evaluation

• The ability of supply capacity in the country to react to the effectof the fall in the exchange rate.

• The nature of exports from many countries where exports of agricultural commodities are price inelastic in supply.

• The short run effect on employment (positive) and inflation (negative), reference to the Phillips curve.

• Effect on a country’s ability to service international debt positive if denominated in domestic currency but negative if borrowings are in a foreign currency.

• The impact of the inflow of capital in terms of FDI/MNC and the effect on output, employment and growth.

• The proportion of international trade in relation to GDP.

Accept all valid responses.

With the help of a diagram, evaluate the effectiveness of usingmonetary policy to increase the rate of economic growth in an economy.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• A clear outline of different types of monetary policy, including changes to the money supply, changes in interest rates and exchange rate policy.

• A detailed explanation of what is meant by ‘economic growth’ and why it is important.

• An accurate, clearly labelled diagram indicating the link between an increase in aggregate monetary demand and an increase in real GDP/output.

• Analysis can be used to show how a government will be able to increase the money supply, which in turn might reduce interest rates, increase investment and ultimately increase aggregate demand and GDP, thus achieving economic growth.

• Central banks might directly reduce interest rates which would be expected to increase borrowing and consumer expenditure and ultimately lead to an increase in real GDP.

• Alternative analysis might focus upon the impact of changes in the exchange rate and how a devaluation of the currency might lead to an export led growth of income, employment and real GDP. No diagram Max L3

AO3 Evaluation

• The immediate impact of monetary policy on income, output and growth will depend upon the existing state of the economy when the policy is introduced. The policy will have a greater impact when the economy has significant spare capacity.

• An increase of the money supply might be relatively ineffective due to the existence of the liquidity trap or due to a low elasticity of the MEC curve.

• Negative expectations would also determine the extent to which a decrease in interest rates is likely to increase consumer expenditure, which will then reduce the impact on output.

• Currency devaluation will only be effective if this results in a net increase in trade. This will be determined to some extent by the Marshall-Lerner condition.

• Increase in money supply might cause high inflation.

• In a situation of ‘stagflation’ when unemployment is high and prices are high the use of monetary policy might solve one problem at the expense of the other. A more appropriate long-term policy might be supply-side based. For example, investment in skills training/education

• A conclusion should attempt to assess the relative effectiveness of each type of policy approach and consider which approach is likely to be the most effective in the short run and then compare this with possible outcomes that might be achieved in the long run.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

A countryimposes a tariff of 20% on imported goods and restricts the number of immigrants entering the country. Evaluate, with the aid of a diagram(s), the impact of these two policies on the rate of inflation in that country. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Definition of a tariff and analysis of the effect of a tariff on the price of goods and a development of this in terms of the direct effect on the price of goods bought by consumers.

• The analysis may also be in terms of the cost of imported raw materials and cost push inflation.

• Analysis of impact on macroeconomy in terms of leftwards shift of aggregate supply (AS) promoting cost push inflation.

• A similar analysis of the effect of restricting the supply of labour and reducing any potential decrease in the general wage rate.

• A relevant diagram to show either the effect of a tariff on cost/prices, the restriction of immigrants and the effect on wages and the impact on AS

AO3 Evaluation

• The elasticity of supply of domestically produced goods subject to the tariff.

• The availability of domestic labour force prepared to do jobs.

• The rate of inflation will also depend on the level of aggregate demand (AD). The restriction on immigrants will reduce the level of demand and hence demand pull inflation.

• Limited migration may allow domestic workers to claim higher wages and contribute to cost push inflation.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Evaluate whether an increase in a government’s budget deficit will always lead to economic growth. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

AO1 Knowledge and understanding and AO2 Analysis

• Definitions of budget deficit, economic growth.

• Use of AD/AS models or 45o model to analyse government budget deficit.

• Use of the circular flow of income to explain the effect of an increase in government spendingincreases the level of aggregate demand within the economy.

• Reference to the short run and long run economic growth.

• Reference can be made to employment, inflation, the balance of payments

• Impact of supply side expenditure of budget deficit on education/investment

AO3 Evaluation

Evaluation may be by individual measure or by comparing the measures.

• Closeness of economy to full employment.

• Use of Phillips’ Curve to reflect inflationary impact.

• Commentary on the size of marginal propensity to consume and its effects on the size of the multiplier.

• The role of expectations in determining the reactions to expansionary fiscal policy

• Reference to the multiplier being an analysis of the trade cycle which exists for only a short run and that the accelerator effect is needed to increase investment and an outwards shift in the production possibility curve for the long run effects.

Accept all valid responses

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

To keep unemployment low, one government used fiscal policy. Analyse how this policy can affect unemployment rates. Explanation of meaning of fiscal policy (Government spending and Taxation).

(2).

Up to 4 marks for a correct diagram explained. Comment on how it could affect output and unemployment – up to 2 for comment on each example. Fully developed point up to 4 marks.

Assess whether the article provides sufficient evidence to justify its conclusion that the intervention of governments has little effect on economic outcomes. Evidence. – War in Ukraine disrupted supplies, but the Russian government was responsible for the war and they stopped the flow of natural gas. So, some evidence against the conclusion that governments have little effect on outcomes.

• banks raised interest rates to stop rise in inflation.(1) Some evidence against the conclusion. (1)

• governments decided to concentrate on growth and did not direct finances to encourage ‘green energy’. (1) This is some evidence against the conclusion as this did affect the economic outcome. (1)

• article mentions billions of private transactions. (1) Not clear whether this supports or contradicts the conclusion. (1)

• Article does not give evidence that supply-side policies were the reason for low unemployment in Germany. (1) Some evidence supports the conclusion. (1)

• evidence about link between unemployment and fiscal policy does support the conclusion. (1)

• No clear conclusion (1)

Up to 2 marks for explanation of any of above points, maximum 7 Reserve a mark for conclusion.

A country is experiencing stagflation, when there is a high rate of inflation at the same time as a negative output gap. With the help of a diagram, evaluate the effectiveness of using fiscal policy to solve this problem.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• A clear definition of inflation and why inflation might cause problems.

• A detailed explanation of what is meant by a ‘negative output gap’.

• An accurate, clearly labelled aggregate supply and aggregate demand diagram to identify a ‘negative output gap’.

• An explanation of what is meant by fiscal policy and how it is used to control inflation or close an output gap.

• Analysis might use a diagram to indicate how fiscal policy might be used to close a negative output gap.

• Analysis might use a diagram to indicate how fiscal policy might be used to reduce the level of inflation.

• Analysis using aggregate demand and aggregate supply curves could be used to show why it is possible to have high inflation and a negative output gap at the same time.

Accept Keynesian Cross diagram

Maximum 8 marks if no relevant diagram

AO3 Evaluation

• The use of fiscal policy to reduce aggregate demand might help to reduce the level of inflation, it will simultaneously increase the negative output gap and vice versa.

• An alternative approach to fiscal might be the use of supply side measures which would increase aggregate supply, reduce the rate of inflation and help to close the negative output gap in the long run.

• Long run supply-side policies are likely to focus on attempts to increase productivity. This frequently involves significant investment in new technology which might lead to a rise in unemployment in the short run.

• Fiscal policy may be inappropriate or ineffective unless paired with supply-side reforms. More suitable policies might include reducing regulation, cutting production costs, or encouraging productivity.

• May lead to crowding out A conclusion should attempt to assess the relative effectiveness of each type of policy approach and consider which approach is likely to be the most effective in the short run and then compare this with possible outcomes that might be achieved in the long run.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

A country with an open economy has falling demand for exports. Consider the view that monetary policy alone will solve this problem.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks.

AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• A definition of an open economy in terms of its foreign trade sector in the aggregate demand equation.

• The effects of the falling exports on the level of aggregate demand.

• The candidate should show the intended effect of monetary policy on the demand for exports – A choice is made of reducing the exchange rate to boost exports through increasing external demand and the effect of this on aggregate demand.

• Governments can directly devalue the exchange rate.

• Government can indirectly reduce the exchange rate by increasing the money supply/decreasing interest rates.

AO3 Evaluation

• The elasticity of demand for exports and the short-run, long run implications.

• An explanation of whether the aims can be achieved in the short run or long run.

• Governments might use supply-side policies e.g. subsidies.

• Comments on other aims of the government which may be affected and how they may be affected by the policy/policies suggested.

• The government impact through directly reducing the rate of interest and the effects of this through the monetary transmission mechanism can be traced.

• Comments on the negative impact on other government aims e.g. Inflation.

Accept all valid responses

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation

With the help of a diagram, assess the effectiveness of government policies that might be used to reduce demand-pull inflation. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2Analysis

• A clear outline of different causes of demand-pull inflation and why inflation might cause problems.

• A more detailed analysis of the causes of demand-pull inflation, can use either a monetarist or Keynesian approach, supported by an accurately labelled diagram

• A description of alternative policies that a government might use to reduce demand-pull inflation, can focus upon either a Keynesian or monetarist perspective

• Analysis can be used to show how a government will be able decrease aggregate demand, by appropriate fiscal policy. For example, by increasing direct taxation. This analysis might also be supported by a relevant diagram

• Alternatively, a government might focus on the use of different types of monetary policy. For example, increasing interest rates, re-valuing the currency or open market operations. Accept alternative supply side policies.

L2 Max if no relevant diagram provided

AO3 Evaluation

• Increasing the use of direct taxation might have a negative impact on long term economic growth and/or unemployment

• Decreasing government expenditure might mean key sectors such as education and health care having a long-term negative impact on social welfare

• The overall impact of contractionary fiscal policy will depend upon the state of the economy when the new policies were introduced.

• Exchange rate policies which promote a re-valuation of the currency might have a negative impact on an economy’s balance of payments, depending upon the Marshall-Lerner condition. This might also cause unemployment in the export producing sector.

• The use of high interest rates might lead to lower levels of investment which, in turn, will have a negative impact on economic growth in the long term

• A contractionary monetary might also produce additional economic outcomes. For example, a rapid fall in house prices due to the high cost of borrowing for house purchase.

• A conclusion should attempt to assess the relative effectiveness of each type of policy approach and consider which approach is likely to be the most effective in the short run and then compare this with possible outcomes that might be achieved in the long run.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation