2.6 Macroeconomic objectives

Question 1

What are demand side policies

Answer 1

Demand-side policies are policies designed to increase consumer demand, so that total production in the economy increases.

Question 2

What is the treasury

Answer 2

The treasury is the govt department responsible for developing and executing the govt public finance and economic policy.

Question 3

aim to decrease AD

Contractionary monetary policy involves…

Answer 3

Increase I.R.
Restrictions on money supply
Stronger E.R.

Question 4

How will a decrease in bank rate affect exchange rates

Answer 4

The exchange rate is likely to fall (because Capital Inflow will fall i.e.less inwards hot money).
This is likely to increase export sales – since exports are now relatively cheaper – and imports should decrease – since they are now more expensive
Investors move £ out of UK increasing supply of £

Question 5

How does expansionary fiscal/ monetary policy leads to cost-push inflation

Answer 5

• More pressure on competition for existing FoP
• Increases price level which CoP
• Passed to consumer in form of increased prices= cost push inflation

Question 6

How can contractionary monetary policy rectify a current account deficit and what does this depend on

Answer 6

Increase I.R.
Decrease money supply so bank is less willing to loan out so I.R. increases to deter people who cant afford to pay back
Decrease import expenditure
Drawbacks- depends on size of multiplier, conflict of low growth and high unemployment

Question 7

Explain the transmission theory quantitative easing

Answer 7

1. Central bank created money electrically
2. That £ is used to buy bonds from financial institutions e.g. banks
3. P of govt bonds increase= yield (I.R.) falls for investors = increase in D for govt bonds
4. Banks/ investors either loan this £ out or invest in riskier coorporate bonds or shares
5. P of coorporate bonds increase and yield falls= reduces cost of borrowing - cheaper to raise finance and easier to issue loans out
6. This encourages banks to make credit more widely available at a cheaper cost to firms and housholds so general I.R. falls (market rates falls)
7. This will discentive savings and should encourage consumption of luxury goods like cars, electronics as its cheaper to borrow
8. Rate of return upon investment will be higher for firms and will encourge them to invest in capital
9. Increase AD as I, C (which are key components of AD) so demand-pull inflation increases

Question 8

Why would QE create the positive wealth effect

Answer 8

QE created positive wealth effect due to a rise in bond P’s and share P’s and lower mortgages costs increase demand for houses =higher house P’s (8% rise in house P’s in 2021) More wealth, more savings via Harod Domar so more investment, overcome liquidity trap

Question 9

Cons of monetary policy

Answer 9

• Can over inflate asset P’s causing asset bubbles (higher bond P’s)
• Inequality due to positive wealth effect (only bond holders benefit)
• Liquidity trap: fall in I.R. stops working
• Globalisation creates external shocks and so its difficult to predict inflation
• I.R. are a blunt instrument (affecting trade)
• Takes 18 months to have an effect
• Over do QE or QT (some of the 11% of inflation was due to too mich QE)
• Can only control demand- pull inflation
• QE: lower I.R. mortgages, causing housing bubbles

Question 10

Why is a liquidity trap a disadvantage of expansionary monetary policy

Answer 10

• I.R. have lower bound
• Even if central bank cut I.R. futher, there wont be an increase in consumer spending or investment because firms/ households are hoarding money due to pessimistic view on the future of the economy

Question 11

Why would a reduction in income tax not lead to an increase in consumer expenditure (Rational choice theory/ permanent income hypothesis)

Answer 11

Expectations amongst consumers regarding future economic conditions and the longevity of the income tax cut will also influence consumption decisions. For example, pessimism over the future of the economy or the length of time the rate cut will last will lead to lower levels of increased consumer expenditure, following a cut in the income tax rate

Question 12

Aim of supply side policies

Answer 12

Designed to increase the productive capacity of the economy, shifting LRAS to the right

Question 13

Define Market based supply side policies

Answer 13

Designed to remove anything thats prevents the free market system working efficiently.

Question 14

What are 5 free market based supply side policies

Answer 14

Deregulation, income tax, corporation tax, privatisation and trade union power

Question 15

How could supply side policies improve the balance of payments

Answer 15

If output increases (Quantity and quality of labour)
There is a decrease on inflationary pressure, this could make G+S more competitive. This may cause consumers to buy more domestic goods and cause foreigners to buy more UK goods. This may reduce imports and increase exports which leads to an improvement on the current account deficit.

Question 16

Define interventionist supply side policies

Answer 16

Designed to correct market failure

Question 17

What is meant by trade union power and how does it improve LRAS?

Answer 17

Trade union power reduces restrictions and legisalation on workers. This means that firms have more control over who they hire and fire as workers are less protected. This could incentivise productivity because of the increased risk of unemployment.
Increases quantity of labour

Question 18

What is meant by deregulation and how does it improve LRAS.

Answer 18

• The removal of restrictions
• It can increase competitivness because it removes barriers to entry for new companies to enter a market
• This could decrease P and firms are profit maximisers and so want D to increase

Question 19

What is meant by privatisation and how can it improve LRAS?

Answer 19

• When a public sector assets become privately owned
• Increases efficiency of the allocation of resources as well as waste minimisation
• However people argue NHS are publicly owned and remain the market leader for healthcare

Question 20

How might infrastructure shift LRAS outwards?

Answer 20

Increase in investments such as HS2, cross rails and broadband projects allows better transportation of goods and services as well as transporting labour more efficiently reducing geographical immobility
Reduces delays in transporting G+S

Question 21

Interventionist policy

Effects of infrastrucutre spending (building more homes)

Answer 21

Home building increases supply of houses due to reduced scarcity
Increases affordability of housing
Allow people to move across UK
Decreases geographical mobility
Increases mobility of labor
Increases available workers
Decreases unemployment
Increases productivity
LRAS shifts right real GDP increases, price level falls
Firms maximized profit= happy businessmen and women Consumers living conditions improved as homelessness reduced + positive wealth effect (own more stock of assets as price of houses may increase in future)

Question 22

Effects on transport infrastructure spending

Answer 22

• People can access jobs further away from where they live, reducing unemployment and geographical immobility of labour
• Improved ability to transport goods around the country or abroad quicker/cheaper
• Greater injections into the circular flow leading to a multiplier effect
• Helping to reduce inequality across the country by focusing spending on poorer areas of the
  country, e.g., new train station in Wales, leading to new businesses, jobs, etc

Question 23

Effect of government spending on healthcare

Answer 23

Reduces abseentism
Healthier nation
People live longer
More G+S produced

Question 24

if economy is close to full capacity…

How can increased government spending lead to crowding out

Answer 24

By borrowing money to spend on infrastructure the government is increasing demand for loanable funds for land, labour and capital
=increases price for each factor of production
=more expensive for private sector to borrow and invest= crowded out (increase in CoP for firms)
Shifts SRAS left= decreasing real GDP
Firms may pass on higher prices to consumers= expensive goods and services

Question 25

# 3 marks Explain how an increase in direct taxation may help the govt move towards its objective of greater income equality

Answer 25

Direct taxation is a tax on profit or income Increase income tax= targetted at high income earners Rich have less disposbale income

Question 26

# Market based policy Effects of lowering income tax

Answer 26

Consumers will receive a greater proportion of disposable income to be able to spend. Additionally, decrease in demand deficient unemployment, means more people are employed, earning a stable income. Inactive are more likely to join labour force as they earn more Productivity will increase as workers strive for promotions  Firms, who are profit maximisers, will invest more as they expect increased demand, given consumers MPC increases, MPI increase= accelorator effect, high animal spirits, confidence increases  long-run growth as quantity of labour increases. LRAS shifts right. PL falls = consumers are happy as goods and services are cheaper More people employed, firms are investing on capital goods increasing productivity= more choice for conumers and firm increases revenues

Question 27

How does flexibility of labour improve productivity

Answer 27

* Improving the flexibility of labour to be able to adapt to changes in the demand for labour. * Education can help this, as can incentives to retrain, and subsidies and grants to firms to engage in training. * Labour mobility is a key component of flexibility. * When labour is geographically immobile, government may subsidise public transport or provide re-location assistance. * In the case of occupational immobility, improving education and skills, and providing better information to job-seekers can help. * Reducing barriers to entry into the labour market can also help improve mobility and flexibility, such as encouraging more part-time work.

Question 28

Effect of reforming the labour market

Answer 28

***Attempts to decrease unemployment to prevent a waste of resources in the market*** * ↑ retirment age- ↑ workers= ↑G+S produced * Reducing benefits- incentivises people to work and help reform labour market through schemes e.g. universal credit... Also incentivises economically inactive to enter labour force in order to find work This ↑ quantity of factors of production, increasing size of capital stock and amount of capital per worker employment * Reducing minimum wage law incentivises firms to fire more as it reduces CoP as there less of their retained profit are spent on wages and more can be spent on capital This encourages workers to work harder to remain in jobs

Question 29

Effect of increased government spending on education

Answer 29

* Incentivises people to get an education, which increases skills of people * Less likely to suffer from structural unemployment as they have greater occupational mobility and a broader range of skills

Question 30

# SSP Investment in education and training KAA

Answer 30

* Education and Training would increase levels and quality of human capital. This would provide more skilled workers and decrease occupational immobility of workers as they can gain new skills and apply the new skills in new jobs. This should decrease level of structural unemployment and increase productivity of economy as output per worker increase * Higher demand for goods and services as structural unemployment decreases and people have disposable income instead of being unemployed * Decrease in structural unemployment also reduce the financial burden of govt spent on unemployment benefits/ welfare payments. It should reduce the opportunity cost and could spend it elsewhere like healthcare (to increase life expectancy of people, or provide more productive workforce with less absences for the economy). This should increase output per worker, increase LRAS an stimulate economic growth

Question 31

Disadvantages of supply side policies

Answer 31

* Time lags: lengthy time lags between SSP's being applied and the effects becoming visible which means, the identified problem persists over an extended period. * Govt budget deficit & national debt make it difficult to pay for large investments or offer significant grants/ tax breaks. * Depends if there's spare capacity

Question 32

Define time lag

Answer 32

Time lag- large infrastructure projects take a long time from initial planning to being completed

Question 33

# PLLEBBGH Macroeconomic objectives

Answer 33

**P**rotection of the environment **L**ow unemployment **L**ow and stable rate of inflation **E**conomic growth **B**alance of payments equilibrium on current account **B**alanced government budget **G**reater income equality **H**appines

Question 34

Conflicts between objective of economic growth and other macroeconomic objectives

Answer 34

* Inflation rising as full capacity is approached – bottlenecks may arise where some restrictions in the supply chain cause cost and wage pressures * Balance of payments position may deteriorate as incomes rise and more imports are demanded as UK has a high marginal propensity to import * Growth should result in higher average living standards, but may not deliver a more fair or equitable distribution of income and wealth as rich tend to get rich faster than the poor do * Increased growth tends to lead to high external costs / deterioration of the environment from congestion and pollution

Question 35

Explain why the govt has a low rate of inflation as a macroeconomic objective

Answer 35

1. To encourage long term investment by firms- increase capital spending - increase G+S produced in an economy- increases internationl competitiveness 2. Increases confidence in govt control of economy- If high PL- increase govt spending on welfare benefits - govt budget deficit (gov spending> govt revenue) If low PL- consumers may hold off purchases as PL may fall again = Consumption falls 3. Help reduce income inequality as inflation damages those on fixed incomes (pigou wealth effect)

Question 36

Why would quality of G/S reduce the extent of the conflict with the government’s objective of maintaining the standard of living when the balance of payments moves from a deficit to equilibrium on the current account.

Answer 36

It is also possible that the living standards within the domestic economy may be compensated for by improvements in the standard of goods produced domestically or still imported, such that despite the loss of the additional goods exported the net welfare of domestic consumers is not adversely affected.

Question 37

# Philips curve Why does the trade off between unemployment and inflation exist

Answer 37

Philips curve- as rate of unemployment decreases, the rate of inflation increases This is because a reduction in unemployment leads to a shortage of labour that encourages an increase in wages and subsequent increases in prices.

Question 38

Why might the balance of payments moving from a deficit to equilibrium on the current account lead to a fall in living standards

Answer 38

There could also be a fall in living standards as more goods are exported (or less imported) than previously, so domestic consumption could be falling as exports account for an increasingly large proportion of AD, which will lead to a further conflict in macroeconomic objectives

Question 39

Why would lower interest rates decrease income inequality

Answer 39

Lower interest rates tend to redistribute income from savers to borrowers, which would tend to improved income distribution

Question 40

Explain the phillips curve

Answer 40

The trade-off between the unemployment and inflation exists because a reduction in unemployment leads to a shortage of labour that encourages an increase in wages and subsequent increases in prices.

Question 41

Trade off with low unemployment and inflation

Answer 41

When unemployment is low: * There are fewer unemployed workers available. * Firms compete for labour by offering higher wages. * Higher wages increase consumer income and spending. * Businesses pass on higher wage costs as higher prices — leading to inflation.

Question 42

Why is the Long-Run Phillips Curve Vertical?

Answer 42

* The vertical LRPC means that there is no long-run trade-off between inflation and unemployment. * This is because, over time, workers and firms adjust their expectations about inflation. * If the government tries to push unemployment below its natural rate (u*), workers will demand higher wages as they anticipate rising prices. * This erodes real wage gains, and firms pass the costs onto consumers → leading to higher inflation but no lasting fall in unemployment.

Question 42

# Milton Friedman and monetarists Trade off between low unemployment leads to high inflation LR view

Answer 42

* Milton Friedman and the monetarists argued that in the long run, the economy always returns to the natural rate of unemployment (NRU), also known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU). * This means that unemployment is determined by structural factors (skills mismatch, mobility, etc.), not demand. * Hence, only supply-side policies (e.g. T-levels, infrastructure investment) can shift the LRPC to the left, reducing the NRU and achieving low unemployment without triggering inflation.