Theme 2: Macroeconomic Objectives and Policies

Question 1

What are supply-side policies?

Answer 1

Government policies which aim to influence aggregate supply.

Question 2

What are demand-side policies?

Answer 2

Government policies and monetary policies which aim to influence aggregate demand.

Question 3

What is fiscal policy?

Answer 3

When the government uses tax and government spending to influence the economy.

Question 4

What is contractionary fiscal policy?

Answer 4

When the government increases tax and decreases government spending in order to decrease aggregate demand.

Question 5

What is expansionary fiscal policy?

Answer 5

When the government decreases tax and increases government spending in order to increases aggregate demand.

Question 6

What is one advantage and disadvantage of lowering the income tax rate for high earners?

Answer 6

One advantage is that a lower income tax rate will increase disposable incomes for the rich. This will increase consumption and aggregate demand, and lead to the multiplier effect.

One disadvantage is that this will reduce the government’s revenue from income tax, which will decrease government spending and decrease aggregate demand.

Question 7

What is one advantage and disadvantage of raising the income tax rate for high earners?

Answer 7

Raising the income tax rate for high earners decreases their disposable income. This will decrease consumption and aggregate demand, which will help to bring the price level down and control inflation. Also, a higher income tax rate will increase income tax revenue and help the government to balance its budget.

However, a reduction in aggregate demand will reduce real GDP. Also, an increase in income tax may increase tax evasion and avoidance which could even mean that income tax revenue decreases.

Question 8

What is one advantage and disadvantage of the government increasing spending on benefits?

Answer 8

Increasing benefits means more money is transferred to unemployed workers. This will increase their consumption, which will increase AD. Also, increasing benefits will help to reduce income inequality.

However, if benefits are too high, there is a significant disincentive for unemployed people to find a job, because they may earn more by claiming benefits. This is known as the benefits trap.

Question 9

What is benefits trap?

Answer 9

When benefits get too high and unemployed workers are actually better off staying unemployed and claiming benefits than working.

Question 10

What is one advantage and disadvantage of the government reducing spending on benefits?

Answer 10

One advantage in reducing benefits is that the budget deficit will improve as the government is paying out less. Lower benefits may get the unemployed out of the benefits trap by increasing the incentive to work - this will reduce unemployment.

However, poor households will have less to spend, so consumption will fall, which will decrease AD. Also, income inequality will worsen as the poor get poorer.

Question 11

What is one advantage and disadvantage of the government increasing corporation tax?

Answer 11

Increasing corporation tax should increase tax revenue for the government, helping to improve the budget. Or, the increased tax revenue could be used to increase government spending, which will lead to economic growth.

However, increasing corporation tax means that firms make less profit and are likely to reduce their investment in capital, which causes depreciation in productivity. This makes them less productive and reduces LRAS.

Question 12

What is one advantage and disadvantage of the government decreasing corporation tax?

Answer 12

One advantage of decreasing corporation tax is that it should lower costs for firms. This will shift SRAS to the right and increase real GDP in the short run. Also, firms can keep more of their profit, so they are likely to increase investment, which will increase AD. Increasing investment will increase the productivity of capital and shift LRAS to the right, leading to economic growth.

However, decreasing corporation tax means that the government will receive less tax revenue. Also, the extra profit from reducing corporation tax might just be kept by the owners instead of being used for investment.

Question 13

What is one advantage and disadvantage to the government spending more on healthcare and education?

Answer 13

An increase on government spending is an increase in G, which increases aggregate demand and, therefore, real GDP. Specifically, spending on healthcare and education will make the workforce healthier and more productive, so the LRAS will shift right.

However, this spending will worsen the government’s budget deficit. Furthermore, spending on schools and education could go towards unproductive bureaucracy or useless degrees.

Question 14

What is one advantage and disadvantage to the government spending less on healthcare and education?

Answer 14

A reduction in spending on education means a higher labour supply which can lower wages and therefore lower real costs for firms. This will shift SRAS to the right and increase real GDP.

However, a reduction in spending on healthcare and education means that the workforce is less productive, so LRAS will shift left, reducing real GDP.

Question 15

What is one advantage and disadvantage to the government increasing VAT?

Answer 15

An increase in VAT will increase tax revenue for the government, which will improve the budget deficit.

However, an increase in VAT will increase costs for firms, which will shift SRAS inwards. This can reduce economic growth and leads to cost push inflation.

Question 16

What is one advantage and disadvantage to the government decreasing VAT?

Answer 16

A decrease in VAT will decrease costs for firms, which will increase SRAS. This will increase real GDP and economic growth, and also bring the price level down.

However, a decrease in VAT will also decrease tax revenue and worsen the budget deficit.

Question 17

What is infrastructure?

Answer 17

Items needed for businesses to operate such as roads and telecommunications networks.

Question 18

What is crowding out?

Answer 18

When government spending increases, the government demands more borrowed money, land, labour and capital. The price and interest rate increases which increases costs for firms and reduces supply.

Question 19

What is monetary policy?

Answer 19

When the central bank changes the base interest rate or the money supply in order to influence aggregate demand within an economy.

Question 20

What is base interest rate?

Answer 20

The interest rate, set by the Bank of England, showing the rate at which they will lend money to highstreet banks.

Question 21

What is expansionary monetary policy?

Answer 21

Decreasing the base interest rate or increasing the money supply in order to increase aggregate demand and increase the rate of inflation.

Question 22

What is contractionary monetary policy?

Answer 22

Increasing the base interest rate or decreasing the money supply in order to decrease aggregate demand and decrease the rate of inflation.

Question 23

What can the BoE do in terms of demand-supply policies?

Answer 23

Change the interest rates

Question 24

What are the 4 things that are affected by the change in the interest rates?

Answer 24

1) savings
2) mortgages
3) investment
4) net trade

Question 25

What is meant by quantitative easing?

Answer 25

Central bank buys financial assets from high street banks in order to increase their money supply and encourage lending

Question 26

What lead to the Great Depression in the US economy?

Answer 26

A commitment to the gold standard led to a fall in the Money supply in the US economy.

Question 27

What are the 3 responses the US made which lead to the Great Depression?

Answer 27

1) Restrictive trade policies: The US government enabled the Wall Street Crash to turn into the Great Depression because, first, it introduced Restrictive policies which increased the price of imports and caused the collapse of world trade. 2) Contractionary fiscal policy: It engaged in a policy of contractionary fiscal policy because of a belief in balanced budgets. 3) Increased interest rates: Finally, it increased interest rates to protect itself from negative consequences of belonging to the gold standard

Question 28

What are the 3 responses the US made which lifted them up from the Great Depression?

Answer 28

1) New Deal: Roosevelt implemented Expansionary fiscal policy by introducing a series of policies known as the new deal. 2) Expansionary monetary policy: In addition, he left the gold standard, which enabled policy makers to decrease interest rates and increase the money supply. 3) Removal of import restrictions: Finally, he encouraged the growth of world trade by removing import restrictions.

Question 29

What is different about the UK’s responses to the Great Depression in contrast to the US?

Answer 29

- The UK made the economic downturn worse by implementing a policy of contractionary fiscal policy. - However, it was able to see a return to economic growth because of the decision to leave the gold standard. - This enabled policy makers to enact an expansionary monetary policy.

Question 30

How did the UK respond to the 2008 financial crisis?

Answer 30

1) In response to the 2008 Financial Crisis the UK engaged in expansionary monetary policy. It did this by reducing interest rates from 5% - 0.5% and implementing a radical programme of quantitive easing 2) The UK also implemented expansionary fiscal policy. It unleashed a package of tax cuts and government spending equivalent to 2.2% of GDP.

Question 31

How did the US respond to the 2008 financial crisis?

Answer 31

- In response to the 2008 Financial Crisis, the US engaged in expansionary monetary and fiscal policies. For instance, interest rates were lowered from 5.25-0%. In addition, 4.5 trillion of quantitative easing was pumped into the economy. - Finally, a tax and spending programme equivalent to 6% of GDP was introduced.

Question 32

What are the 2 types of supply-side policies?

Answer 32

1) interventionist 2) market-based

Question 33

What are interventionist supply-side policies?

Answer 33

Policies where the government is actively involved in increasing aggregate supply.

Question 34

What are market-based supply-side policies?

Answer 34

Policies where the government aims to increase aggregate supply by decreasing intervention in the economy and allowing the market to operate efficiently.

Question 35

Explain 2 advantages of increased government spending on infrastructure as a supply side policy. (Give 3 chains of reasoning for each)

Answer 35

1) -> Infrastructure projects such as HS2 improve the geographical mobility of Labour -> increasing the productivity of labour -> causing the LRAS to shift out. 2) -> Another advantage is that it increases aggregate demand as employment increases -> this will increase consumption. -> Both the increase in LRAS and AD will lead to economic growth.

Question 36

Explain one disadvantage of increased government spending on infrastructure as a supply side policy. (Give 4 chains of reasoning)

Answer 36

-> However, a disadvantage is that government spending on infrastructure might crowd out private firms -> By borrowing money to spend on new infrastructure, the government is increasing the demand for borrowed money, land, labour and capital. -> This increases prices for each factor of production, increasing costs for firms. -> This shifts the SRAS in and reduces real GDP.

Question 37

Explain two advantages of reducing corporation tax. (Give 4 chains of reasoning)

Answer 37

1) A reduction in corporation tax will reduce the cost of production -> This will encourage new firms and expansion of existing firms -> which will shift the SRAS to the right -> and leads to economic growth -> and a reduction in the price level. 2) Firms can keep more of their profit -> and so they are more likely to invest. -> This will increase the productivity of capital and shift LRAS to the right leading to economic growth and a reduction in the price level. -> Investment is a component of AD -> and so an increase in investment will increase AD which will lead to economic growth.

Question 38

Explain one disadvantage of reducing corporation tax. (And one chain of reasoning)

Answer 38

A reduction in corporation tax may reduce tax revenue. -> There is an opportunity cost as there is now less money available to spend in other areas, such as healthcare or infrastructure.

Question 39

Explain one advantage of reducing the national minimum wage. (Give one chain of reasoning)

Answer 39

A decrease in wage costs will decrease the cost of production for firms, -> which will increase short run aggregate supply.

Question 40

Explain two disadvantages of reducing the national minimum wage. (Give 1 chain of reasoning)

Answer 40

1) a reduction in the minimum wage will reduce disposable income for many households. ->This will reduce consumption and decrease aggregate demand, which will lead to a reduction in real GDP. 2) a reduction in the minimum wage may mean that workers emigrate from the UK in search of higher wages. ->This will reduce LRAS and reduce economic growth.

Question 41

What is deregulation?

Answer 41

When regulations are removed from markets to lower barriers to entry

Question 42

What is privatization?

Answer 42

When the government transfers ownership of a public sector firm to the private sector

Question 43

Explain one advantage of subsidising university education. (Give 4 chains of reasoning)

Answer 43

-> subsidies allow universities to offer their courses at a lower price -> which will encourage more students to pursue higher education. -> Over time, this will make workers more productive and lead to an increase in labour supply. -> The LRAS shifts to the right and the economy grows.

Question 44

Explain one disadvantage of subsidising university education. (Give 2 chains of reasoning)

Answer 44

in the short run, education subsidies lead to a decrease in the supply of labour as more people spend their time studying instead of working. -> This leads to an increase in wages which increases the cost of production and reduces SRAS, -> leading to a reduction in economic growth in the short run.

Question 45

Explain the impact of a reduction in income tax on aggregate supply. (Give 5 chains of reasoning)

Answer 45

Reducing income tax means that workers get to keep more of their earnings -> and so disposable income increases. -> This is likely to increase the number of hours they choose to work ->and so there will be an increase in labour supply. -> This will decrease wages which will decrease the cost of production. ->This will shift the SRAS to the right, increasing real GDP.

Question 46

Evaluate the impact of a reduction in income tax on aggregate supply. (Give 3 chains of reasoning)

Answer 46

However, an increase in disposable income could cause some workers to decrease their labour supply as they now need to work less to earn the same amount of money. -> This might lead to a decrease in labour supply. -> This will increase wages which will increase the cost of production. -> This will shift the SRAS to the left, limiting economic growth.

Question 47

Explain one advantage of reducing benefits. (give 2 chains of reasoning)

Answer 47

A reduction in spending on benefits will increase the incentive to work. -> This will increase labour supply and reduce wages which in turn will reduce the cost of production. -> SRAS will increase leading to an increase in economic growth and a decrease in the price level.

Question 48

Explain one disadvantage of reducing benefits. (Give 2 chains of reasoning)

Answer 48

A reduction in spending on benefits means that less money is transferred to unemployed workers and low income households. -> This means that they will have less disposable income and must reduce their spending. -> This will decrease consumption which will lead to a decrease in AD.

Question 49

Explain one advantage of increasing spending on healthcare (Give 1 chain of reasoning)

Answer 49

increasing spending on healthcare will increase the productivity of labour. -> This will shift the LRAS to the right, increasing economic growth.

Question 50

Explain one disadvantage of increasing spending on healthcare (Give 2 chains of reasoning)

Answer 50

spending on the NHS may be inefficient and of poor quality. -> If funding is increased, it is not given that all the extra funds will go towards increasing productivity -> and so the effects on LRAS will be limited.

Question 51

What is Phillips Curve?

Answer 51

A curve which shows the trade off between unemployment and inflation.

Question 52

Draw a short-run Phillips curve

Answer 52

Question 53

Give an evaluation of the Phillips curve

Answer 53

However, some economists argue that in recent years the Phillips curve has flattened. For example, in 1975 and 2019 the UK’s unemployment rate was 3.9 But, in 1975, inflation was 24.24 whereas, in 2019 inflation was 1.8 This change is because of adaptive expectations. In 1998 the UK established an independent central bank to control inflation. Since then, inflation has remained low and steady, mostly between 0 and 3 Consumers and producers expect inflation to be low, because it has been for so long.