Exam Revision Unit 2

Question 0

Problems of measuring economic growth?

Answer 0

1. Inaccurate data due to large volume
2. Omissions related to non-marketed activities for which payment is not made (household tasks, DIY)
3. Non-marketed government services need to be valued (health care etc) - zero priced goods
4. Informal economy resulting in omissions
5. Large black markets

Question 1

Limitations of monetary policy

Answer 1

1. Liquidity trap (due to lack of confidence)
2. Difficult to control many objectives with one tool - conflict between macro objectives
3. Affects exchange rate
4. May affect some parts of the economy more than others
5. Time lag - 18 months for rates to affect the economy

Question 2

Benefits of economic growth

Answer 2

1. Increased standards of living as growth of prod capacity permits increased consumption and investment
2. Increased employment opportunities
3. Increased trade competitiveness
4. Increased business confidence - and hence increased investment
5. Increased tax revenue -> higher public spending
6. Expansion of productive capacity decreases risk of inflation caused by ‘overheating’
7. Reduction of poverty

Question 3

Costs of economic growth

Answer 3

1. Imperfect indicator of living standards
2. Fails to take into account externalities such as costs to the environment
3. No indication if the distribution of rising income
4. Consumer society gives rise to social problems

Question 4

What are 2 sustainable economic growth strategies?

Answer 4

1. Investment in technology that reduces negative environmental impacts (i.e “green” technology)
2. Use of expanded tax revenue to redistribute income to those not benefitting from growth.

Question 5

Difference between RPI AND CPI

Answer 5

1. Different composition of prices (12% of RPI items are not included in CPI)
2. Different weighting calculations - CPI includes all households
3. RPI uses an arithmetic mean
4. RPI is usually a higher value as it 1) includes housing costs 2) arithmetic

Question 6

Limitations of measures of inflation

Answer 6

1. Relies on data from the past (backward looking)
2. Imperfect measures of the cost of living
3. Difficult to define “average household”
4. Price changes do not reflect quality of products
5. May overestimate inflation as it doesn’t consider special offers
6. Non unionised workers are not always getting increases in wages by the rate of inflation

Question 7

Name 2 other impacts of monetary policy

Answer 7

1. Low interest rates encourage greater demand for housing and hence property prices rise which increases the wealth effect and induces confidence
2. Low interest rates will induce a low savings ratio meaning that more of the money owned by consumers will be spent.

Question 8

When would expansionary monetary policy be used?

Answer 8

If there are concerns about slow growth and thus lower inflation then interest rates are cut meaning that borrowing becomes more attractive so consumption rises.
Employment is created as AD rises

Question 9

When is contractionary monetary policy used?

Answer 9

If inflation is running above target then interest rates increase to reduce inflationary pressure.
Savings become more attractive
However output decreases

Question 10

Paradox of the thrift

Answer 10

Despite low interest rates, during a recession people save more and consumption decreased due to job uncertainty and fear

Question 11

Limits of the MPCs effectiveness

Answer 11

1. Inflation could be low due to global pressures (globalisation and better technology)
2. Time lag
3. Some sections of the economy do not respond to higher interest rates

Question 12

Limitations of fiscal policy

Answer 12

1. Difficult to estimate how much AD will change due to automatic stabilisers and deliberate changes
2. Time delay and inflexibility
3. Government has imperfect information
4. May have other un intended consequences
5. Disincentive effect (rise in tax)
6. Influenced by fiscal policy of other countries

Question 13

Limitations of monetary policy 2

Answer 13

1. Change in interest rates may have adverse effect - a rise in interest may reduce inflation but it will also reduce output and employment.
2. Imperfect government information
3. Will not effect everyone equally. A rise would benefit savers but harm borrowers
4. Consumer confidence may be a more important factor
   5.

Question 14

Advantages of supply side policies

Answer 14

1. Can help to reduce inflationary pressure due to productivity gains
2. Improve sustainable growth, balance of payments and employment due to increased competitiveness
3. Less likely to create conflict between macro objectives hence why it has been so popular for the last 25 years

Question 15

Disadvantages of supply side policies

Answer 15

1. Policies can take a long time to work
2. Very costly
3. Some policies may be strongly resisted as they reduce the power of interest groups
4. Issue of equity - many policies have negative effect on distribution of income (at least in the short term)

Question 16

Crowding out

Answer 16

As govt runs expansionary fiscal policy (budget deficit), they need to borrow money
- do this by attracting investors to lend by increasing interest rates
- crowds out investment in the private sector as the cost of borrowing increases for firms
– hence firms decrease investment and AD is reduced
DOWNWARD MULTIPLIER