chains

Question 1

Economic Growth (2.1)

Answer 1

Point: An increase in investment can lead to long-run economic growth.
Chain:
1. Higher investment increases capital stock (e.g. new machinery).
2. This raises productivity, meaning more output is produced per worker.
3. Higher productivity shifts the LRAS to the right.
4. This increases the economy’s potential output (trend growth).
5. Over time, this supports sustained growth without inflationary pressure.

Question 2

Unemployment (2.2)

Answer 2

Point: A fall in aggregate demand may increase cyclical unemployment.
Chain:
1. A fall in AD reduces firms’ revenues.
2. Firms cut production to match lower demand.
3. To reduce costs, they lay off workers.
4. This increases cyclical (demand-deficient) unemployment.
5. Higher unemployment leads to reduced incomes and consumption, deepening the slowdown.

Question 3

Inflation (2.3)

Answer 3

Point: A rise in wages can cause demand-pull inflation.
Chain:
1. Higher wages increase household disposable income.
2. This boosts consumer spending (C), which increases aggregate demand (AD).
3. If the economy is near full capacity, the increase in AD pushes up the price level.
4. Firms may also raise prices to protect profit margins.
5. This results in demand-pull inflation, reducing purchasing power.

Question 4

Balance of Payments (2.4)

Answer 4

Point: A depreciation of the pound can reduce a current account deficit.
Chain:
1. A weaker pound makes UK exports cheaper abroad and imports more expensive.
2. Demand for exports rises while demand for imports falls.
3. Net exports (X – M) increase, improving the current account balance.
4. Over time, this raises aggregate demand and output.
5. However, the Marshall-Lerner condition must hold and PED of exports/imports must be elastic.

Question 5

Fiscal Policy (2.6)

Answer 5

Point: An increase in government spending can stimulate economic growth.
Chain:
1. Government spending is a component of aggregate demand (AD = C + I + G + X – M).
2. Higher G shifts AD to the right, increasing output and employment in the short run.
3. Higher incomes lead to more consumer spending (multiplier effect).
4. With higher output, tax revenue rises and unemployment benefits fall.
5. This can reduce the budget deficit over time and improve fiscal sustainability.

Question 6

Supply-Side Policy (2.6)

Answer 6

Point: Investment in education and training can increase potential growth.
Chain:
1. Improved education and skills raise labour productivity.
2. Workers can produce more output with the same inputs.
3. This increases the productive potential of the economy (rightward shift of LRAS).
4. In the long run, this supports sustainable economic growth.
5. Higher productivity also improves international competitiveness.

Question 7

. Monetary Policy (2.5)

Answer 7

Point: A cut in interest rates can boost consumption and investment.
Chain:
1. Lower interest rates reduce the cost of borrowing and mortgage repayments.
2. This increases household disposable income and business investment.
3. Consumption (C) and investment (I) rise, boosting aggregate demand.
4. The AD curve shifts right, increasing real GDP and reducing unemployment.
5. However, the strength of the effect depends on consumer and business confidence.

Question 8

inflation (2.3)
cost-push

Answer 8

• When wages rise, the cost of production for firms increases, especially in labour-intensive industries.
• Higher production costs force firms to increase prices in order to maintain profit margins.
• As firms across the economy raise prices, this leads to an overall increase in the general price level — known as cost-push inflation.
• If wage increases are not matched by productivity gains, unit labour costs rise, making goods and services more expensive.
• This inflationary pressure can become persistent if it triggers a wage-price spiral, where workers demand further pay rises to keep up with rising living costs, pushing inflation even higher