Essay Plans 1

MACROECONOMICS

1. (a) Suggest three possible reasons why a government might measure national
income. [10 marks]
• A definition of national income in terms of increases in total output in the economy,
measured by rises in GDP (gross domestic product) or gross national income (GNI)
calculated by either the output, expenditure or income method.
• A diagram showing that long term economic growth can be illustrated by either a right
shift in PPF (diagram to the left) or an AD / AS curve showing a right shift in the AS
curve, illustrated by a rise in economic activity.
• An explanation of some of the possible reasons for governments measuring national
income include.
o measuring national income is a good indicator of living standards. This is
because even though economists accept that national income is not a perfect
measure of living standards, it does provide a relatively accurate illustration of
the living standards in a nation. Further, the state of the economy is a good
indicator of the government’s own performance. It is not uncommon for
governments to pin their entire reputation on their own competence at
managing the economy and providing a high living standard for its citizens.
o Secondly, GDP data can also provide a good yard stick with which to compare
the economic performance between the nation’s own economy and the
economies of rival nations.
o Thirdly, when a nation is part of a multinational association such as the EU,
NATO or the UN, calculating national income statistics is also compulsory as
the contribution that each nation pays to the organisation is allocated on a %
of their national income. With almost all nations part of the UN this reason
alone dictates that a government should calculate its national income data in
an accurate and consistent manner.
o National income data can also be used as the basis for economic forecasts as
well as the basis of future decisions by businesses and governments, e.g. tax
or interest rate policy. One of the most difficult economic policy decisions that
a nation faces is the control of interest rates and tax policy. In many cases the
level of interest rates or income tax will be set by central banks and the rate of
growth of national income is a key determinant of any decision. For instance,
in periods of time, when there is a slowdown in economic activity, the central
bank will choose to boost their economy by a combination of cutting taxes,
raising government spending or reducing interest rates in the
economy. Similarly, when the economy is facing inflationary pressures then
they are likely to do the opposite, reducing government spending, raising taxes
and / or increasing interest rates in an attempt to reduce inflationary pressures
in the economy and stabilise the currency value.

(b) Using real world examples, evaluate the view that demand-side policies are the most
effective method of increasing the level of national income. [15 marks]
• A definition of demand side policies- A (Keynesian) policy emphasising the importance
of government intervention in managing the level of aggregate demand in the
economy, through fiscal and monetary policies. Use the example- In response to the
Financial Crisis of 2008 and the lower bound of interest rates, the Federal Reserve in
the US opted to use a more extreme expansionary monetary policy, quantitative easing
(QE) involving the purchasing of bonds by the central bank to reduce interest rates
across the economy and thus stimulate lending, borrowing, AD and economic growth.
• A recognition that demand side policies can be divided into fiscal and monetary
policies, with an explanation that expansionary demand-side policies can increase the
Essay Plans 2

level of national income / economic growth by increasing one or more of either C, G, I

or X.
• A diagram representing a right shift in AD as a result of expansionary fiscal or monetary
policy. Examples might include a rise in government spending or a reduction in interest
rates, leading to a rise in AD and an increase in national income from Y1 to Y2
• On the other hand there are considerable disadvantages of governments using
demand-side policies to stimulate economic growth. Examples of problems that may
arise as a result of using demand side policies include time-lags, inflationary pressure,
increased government debt, increased imports or crowding out. It should also be noted
that demand side policies re only effective when there is spare capacity in the
economy. Without available unemployed resources any rise in aggregate demand is
likely to be inflationary only.
• The response also needs to include a discussion of alternative policies that may be
used to increase economic growth - supply side policies. This should start with a
discussion of how national income can rise as a result of supply-side policies, with
examples of supply side policies that may be effective e.g. improvements to
infrastructure, investments in human capital as well as increased spending on research
and development. Use the example of China and draw a diagram showing the
rightward shift of LRAS.
• A discussion of some of the disadvantages of governments using supply-side
policies, e.g. time-lags, the cost of large scale investment projects and the uncertain
effectiveness of lowering taxes.
• Evaluate- significant stimulus policies employed by the US government following the
financial crisis of 2007-8. Such policies were considered to be effective in helping the
American economy revive itself after the recession, although at a considerable cost to
the nation's finances and some criticisms from free market economists.
• A suitable conclusion might be that demand side policies are straightforward to
implement and are relatively effective in the short term, providing there is spare
capacity in the economy. However, they do little to improve long term growth in the
economy, which is best served by the implementation of supply side policies which
have the ability to improve the quantity and / or quality of the available factors of
production.
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2. (a) Explain how deregulation of the labour market can stimulate economic growth. [10
marks]
• A definition of deregulated labour markets and economic growth. This should include
an understanding that greater flexibility in the labour market can lead to economic
growth through rises in aggregate supply, effectively increasing the number of people
willing and able to work in the economy.
• This should be supported by a diagram showing a right shift in the LRAS curve,
illustrating a rise in real GDP from Y1 to Y2 following an increase in LRAS.
• Examples of labour market reforms that may lead to greater economic growth include
reduced unemployment benefit levels, reductions in the power of labour unions, the
removal of a national minimum wage, investments in education and training as well as
financial incentives for firms to recruit unemployed workers.
• A recognition that in the case of policies aimed at reducing labour union powers or
reducing access to out of work benefits, the aim is to encourage more workers to
except low paid work.
• A recognition that labours reforms aimed at improving access to education and
training, the aim is to enable the structurally unemployed to up skill and find work that
was previously unavailable to them. This policy may also improve the productivity and
quality of the work produced.
Essay Plans 3

(b) Using real world examples, discuss why Keynes believed that an economy will
remain stuck in a permanent deflationary gap, without the government using a fiscal
stimulus package. [15 marks]
• An explanation of why, according to Keynesian economists, an economy may be
permanently stuck in recession without government stimulus. For example, according
to Keynesian economists, governments cannot simply wait for an economy to fix itself
as in the long run ‘we are all dead’. Responses should then provide examples such
as Japan in the 1990s:
• In the 1990s, the Japanese economy suffered a prolonged recession that
followed the collapse of the fabled economic bubble of the 1980s. This stretch of
economic stagnation, the “lost decade,” finally ended in 2002; it had taken more than
10 years, punctuated with occasional “false dawns,” to pull up the economy.
• A suitable diagram illustrating the theoretical impact: a rise in AD (closing of the
deflationary gap) as a result of fiscal stimulus measures. For example, a rise in AD
resulting from a fiscal expansion package has led to a narrowing of the recessionary
gap, as increased levels of government spending or other measures have
compensated for the fall in consumption and investment by the private sector.
• A recognition that because of the impact of the multiplier any stimulus package may
end up being self-financing, funded by future rises in economic activity and increased
tax revenues.
• Examples of when governments have adopted such a fiscal stimulus approach, e.g.,
the US economy in 2007 - 2010, which many economists believe was rescued by
Keynesian stimulus policies.
• On the other hand, neo-classical economists do not support this view, arguing that an
economy in recession will automatically correct itself. Responses could use a suitable
diagram to explain that inflationary / deflationary gaps are short term measures only
and that without government intervention the macro economy will naturally clear at a
new equilibrium level.
• This is illustrated by the monetarist LRAS diagram, which illustrates how the
economy's natural stabilisers will automatically correct a deflationary gap. This is
because according to neo classical theory, a fall in aggregate demand will create a
short-term deflationary gap only, represented on the diagram by Y1, Y2. However,
over time, as the price of factor resources falls, indicated by a rise in aggregate supply
from SRAS1 to SRAS2, a new long run equilibrium is established and the economy
clears at P3, Y1.
• An example of a real-life example of government stimulus measures that can be
considered less effective in stimulating economic growth might include the Japanese
stimulus packages that have failed to rescue the economy from persistent recession
and stagflation.
• Responses should also provide a suitable conclusion based on the arguments
above. For example, there is general support for the view that the economy’s
automatic stabilisers may correct a deflationary gap eventually. However, as Keynes
himself said ‘in the long run we are all dead’. Similarly, there is little doubt that
Keynesian policies are effective in the short-term, but the long-term impacts are less
clear, with any fiscal stimulus package likely to result in a larger budget deficit and
inflation.
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3. (a) Describe possible reasons why an economy might go into recession. [10 marks]
• A definition of recession as a period when there is a fall in GDP for two consecutives
three-month periods.
• This should be followed by an explanation of how a fall in any one of the components
of AD could lead to a fall in national income: consumption, investment, government
expenditure or net exports. If national income then falls for two consecutive periods
Essay Plans 4

then this is a technical recession. This is illustrated by the diagram 1, showing a

decline in aggregate demand, illustrated by a left shift in AD and a fall in output equal
to Y1, Y2.
• A recognition that a recession can also be caused by supply factors rather than
demand side factors. For example, a rise in production costs, e.g. an increase in the
price of oil or minimum wage, may cause a fall in GDP through reductions in SRAS,
illustrated on diagram 2 by a fall in SRAS to SRAS2 and a reduction in real output from
Y1 to Y2.
• A recognition that in some cases a recession may stem from external events e.g.
recessions in other countries leading to a fall in export revenues.

(b) Using real world examples, evaluate the effectiveness of a keynesian demand-side
stimulus package in solving a recession. [15 marks]
A definition of recession and keynesian demand side policies. A (Keynesian) policy
emphasising the importance of government intervention in managing the level of
aggregate demand in the economy, through fiscal and monetary policies.
• An explanation of how aggregate demand can be raised through a combination of
expansionary fiscal and monetary policy e.g. a reduction in interest rates or lower
taxes. This explanation should include the impact of the multiplier on AD. Example: In
response to the Financial Crisis of 2008 and the lower bound of interest rates, the
Federal Reserve in the US opted to use a more extreme expansionary monetary policy,
quantitative easing (QE) involving the purchasing of bonds by the central bank to
reduce interest rates across the economy and thus stimulate lending, borrowing, AD
and economic growth.
• Responses should note that in circumstances where a fall in national income is the
result of low AD, then filling the output gap by fiscal or monetary policy can be
effective. This is illustrated on diagram 1 by a closing of the output gap and a rise in
real output from Y1 to Y2.
• A recognition that Keynesian demand side policies have sometimes proven effective
at least in the short term, of lifting an economy out of recession (e.g. USA in 2009 /10),
where the economic recovery began after a Keynesian style fiscal package
implemented by the American government.
• On the other hand, Keynesian demand side policies have limitations which need to
be considered. Some of the problems associated with expansionary fiscal policy
include:
• That any expansionary fiscal policy is likely to lead to an increase in a country’s budget
deficit, which is likely to be financed through increased government borrowing. This
may ultimately lead to a rise in interest rates, cancelling out some of the effectiveness
of the original Keynesian measure. between 2008 and 2015, three rounds of QE led to
$3.7 trillion worth of bonds bought up by the Fed in a bid to boost the economy.
• A recognition of the time lags associated with fiscal policy, leading to eventual rises in
inflation. Overall Keynesian policies are considered more effective in the short run,
rather than the long run.
• A discussion of the problems associated with using monetary policy to raise
AD. Examples include:
• The unpredictable reaction of households to cuts in interest rates, for example many
households may choose to use lower interest rates to reduce their debts rather than
increasing their spending.
• The reluctance of banks to lend and pass on interest rate cuts. There was evidence
of this happening in the UK: In response to the economic crisis from Coronavirus, the
Monetary Policy Committee (MPC) of the Bank of England enacted a dual
expansionary monetary policy, reducing interest rates from 0.75% to 0.1% and
pumping an extra £450bn of money into the UK economy through quantitative easing.
The intention of this policy move was to promote economic growth and employment
Essay Plans 5

thus reducing the overall impact of the recession on UK macro performance. However
as interest rates were already very low before the cuts took place, this avenue of
monetary policy has been limited in its effectiveness forcing huge Increases in
quantitative easing to provide further stimulus to the economy.
• Another weakness is the expected rises in inflation as the country approaches its
production possibility frontier and the risks of crowding out. This could be illustrated
on a keynesian curve. It is relatively simple for governments to increase national
income, given the amount of spare capacity in the economy, but this gets progressively
more difficult as the economy reaches full capacity. If, there is no spare capacity as
the economy is at full employment and any attempts to raise AD further will simply be
inflationary.
• Lastly, the most effective responses will also include an explanation of alternative
policies that might be more effective in solving a recession such as supply-side
policies. Examples of supply side policies should be included as well as a recognition
that supply side policies are more effective in raising national income in the long run,
rather than solving a short term recessionary gap.
• A conclusion should provide a summary of the overall arguments and provide a
consideration of the short-term versus long-term consequences of both demand side
policies as well as the impact on different stakeholders. For example a suitable
conclusion maybe that in the short term, keynesian policies have proven to be effective
but when employing them, a government is potentially storing up difficulties for the long
term.
_________________________________________________________________________

4. (a) Explain how changes to the relative size of injections and leakages determine
changes to the size of the circular flow of national income. [10 marks]
• Definitions of the key terms - circular flow: A simplified model of the economy that
shows the flow of money through the economy. Injections: The investment,
government expenditure and export revenues that add spending to the circular flow of
income. Leakages: The savings, taxes and import expenditure that remove spending
from the circular flow of income.
• A diagram illustrating a circular flow diagram with both injections and leakages.
• A recognition that when leakages from imports, savings and taxes are greater than
injections into the circular flow from exports, investment and government spending,
then the circular flow will reduce in size making the economy smaller.
• Similarly, when injections into the circular flow are greater than leakages out of the
economy then the circular flow will increase in size and the economy will expand.
• Provide examples of situations where injections are greater than withdrawals or
examples of the opposite situation. An example of situations where the circular flow is
growing, might be when the government is looking to add stimulus to the economy by
cutting taxes / interest rates and raising government spending levels.
• Similarly, a situation when the size of the circular flow is shrinking might be when their
government (or another government) is employing an austerity package and raising
taxes as well as cutting back on public spending.

(b) Evaluate the use of national income statistics in making comparisons of the
standard of living over time. [15 marks]
• A definition of national income, measured by GDP and the standard of living, measured
by HDI: A composite index that brings together three variables that reflect the three
basic goals of development, a long and healthy life, improved education, and a decent
standard of living. The variables measured are life expectancy at birth, mean years of
schooling and expected years of schooling, and GNI per capita (PPP US$).
Essay Plans 6

• Arguments in support of the argument that national income statistics do provide an

accurate reflection of the standard of living in a nation. Examples might include a note
that countries with high levels of GDP normally also have a high HDI.
• The human development index has three components and national income per capita
is one of these. Countries with a high GDP also have greater resources to invest in
infrastructure and improvements to health and education, the other two components
of HDI.
• Examples of nations such as Singapore or Rwanda that have made significant strides
in both GDP and HDI.
• Arguments illustrating the weaknesses of using GDP as a measure of HDI. Examples
might include the need to consider the impact on living standards of changing output,
changing price levels and the need to use real values, as well as disparities in the
distribution of income e.t.c. Example- China is the second largest economy but ranks
really low in other indicatirs such as Gini coefficient (approx. 0.481) or HPI (72).
• A recognition that countries use slightly different methods of recording national income
data. This means that there will always be a margin of error in any national income
data.
• An explanation that GDP does not always reflect non-economic indicators of the
standard of living. For example GDP / GNI data does not reflect changes in working
conditions, increased life expectancy and other quality of life indicators, new products,
environmental conditions, defence expenditure, the size of underground economy or
the value of non-marketed output e.t.c.
• The higher mark band responses should also provide examples of the above, for
example some LEDCs that have experienced high rates of economic growth but have
also seen sharp rises in economic degradation or significant gaps in wealth and income
inequality as a result.
_________________________________________________________________________

5. (a) Explain two factors that might lead to increased levels of economic growth in an
economy. [10 marks]
• A definition of economic growth in terms of a rise in GDP or national income. Economic
growth maybe a result of increases in aggregate demand in the economy or
improvements to the quantity and quality of the factors of production which will increase
aggregate supply.
• Two diagrams, one showing a rise in economic growth as a result of a rise in AD curve
and the other illustrating growth caused by a rise (right shift) in the LRAS curve
• An explanation that diagram 1 illustrates a rise in aggregate demand from AD1 to AD2
and the new equilibrium illustrates a rise in real GDP. Diagram 2 shows a rise in real
GDP from Y1 to Y2 brought about by a rise in the long run aggregate supply curve
from LRAS to LRAS2.
• Examples of factors that can increase economic growth through rises in aggregate
demand include a rise in government spending or private consumption, investment or
an increase in net exports.
• Examples of factors that increase economic growth through rises in aggregate supply
include rises in investment and / or improvements to physical, human and natural
capital; rises in productivity or an increase in the size of the labour force through
changes to labour laws.

(b) Using real world examples, evaluate the argument that economic growth is always
good? [15 marks]
• A definition of economic growth: The growth of the real value of output in an economy
over time. Usually measured as growth in real GDP.
• Arguments in support of the view that economic growth is always good. For example,
countries with high levels of GDP normally also have a high HDI such as China- second
Essay Plans 7

largest economy and high HDI of 0.761. (China's rapid economic growth has played a
critical role towards its progress in human development). This maybe because nations
that experience economic growth, will normally have greater resources to invest in
infrastructure and improvements in health and education. In many cases economic
growth also leads to rises in income levels and employment opportunities.
• Examples of nations that have made significant improvements to their quality of life as
a result of significant rises in economic growth. China has experienced sharp falls in
poverty (in 2020 they declared they have 0 absolute poverty) and improvements to
HDI, following a significant rise in economic growth.
• A recognition of the alternative perspective, that why economic growth will often lead
to improvements in the HDI, that this is not always the case. For example it could be
noted that the collection of GDP / GNI data contains weaknesses. For instance
changes to GDP / GNI do not necessarily take account of disparities in the distribution
of income or the quality of other non economic indicators of development - e.g. working
conditions, life expectancy and other quality of life indicators such as the availability of
new products, environmental conditions, defence expenditure, the size of underground
economy or the value of non-marketed output e.t.c. Refer to China’s high gini
coefficient (0.48) and low HPI (72).
• A relevant diagram illustrating the costs and benefits of economic growth, such as the
private and social costs of increased consumption of demerit goods, as well as the size
of the welfare loss and the externalities associated with unregulated
markets. Examples of this might be a sharp rise in pollution or traffic congestions
within fast growing cities or the fact that some LEDCs, that have experienced high
rates of economic growth but have also seen sharp rises in economic degradation or
significant gaps in wealth and income inequality. For example, Beijing, one of China’s
most important cities is also extremely polluted. The result is an increase in welfare
loss, resulting from the increase in consumption of some demerit goods.
• A short conclusion weighing up the relative merits of both arguments and the impact
upon different stakeholders, as well as the short-term as well as long-term
consequences upon sustainability. For example, a conclusion might recognise that
while the net welfare effect of economic growth is likely to be positive, some
stakeholders, typically the young and skilled will benefit more than others. The
conclusion might also recognise that in some cases the positive effects of sustained
economic growth, might not lead to higher living standards for a period of time.
_________________________________________________________________________

Q6. (a) Explain how a government can use fiscal policy to reduce the level of aggregate
demand in an economy? [10 marks]
• Key terms to define: AD: The total spending in an economy consisting of
consumption, investment, government expenditure and net exports;
fiscal policy: A demand-side policy using changes in government
spending and/or direct taxation to achieve economic objectives relating
to inflation and unemployment.
• AD is made up of C+G+I+(X-M) and a fall in any of these components will reduce
aggregate demand levels.
• By raising taxes and or reducing government spending aggregate demand will fall
because of a direct fall in private consumption and government spending.
• Indirectly a third component, investment may also fall if firms feel less incentivized due
to a reduction in economic activity.
• A distinction should also be made between the immediate direct impact on AD and the
secondary indirect impact on the level of AD, through the reverse multiplier: The
negative multiplier effect occurs when an initial withdrawal of spending from the
economy leads to knock-on effects and a bigger final fall in real GDP. The negative
multiplier effect suggests that a fall in spending causes a negative spiral but in practice,
Essay Plans 8

we don't see a permanent decline. Economies can bounce back and the negative
multiplier effect is limited.
o People dip into savings to maintain income.
o Inventories fall. In a recession, firms may run down stocks, but after a while,
they need to restock creating new orders.
o Not all business will fail at the same time. In a recession, there may be
increased demand for inferior goods/ normal goods, which maintains demand.
o Welfare state. Unemployed received benefits from the government to maintain
spending

(b) Using real-world examples, evaluate the view that demand-side policies are the most
effective method of increasing the level of national income. [15 marks]
• Real-world examples might include Japan and USA. Following the financial crisis of
2007-9, the USA economy benefited as a result of expansionary demand-side policies,
while Germany also recovered from recession, despite not adopting the same
measures. Equally, Japan, over a long period adopted a series of expansionary
demand-side policies (through increased government spending and quantitative
easing) but their economy remains stuck in a recessionary cycle - and with significantly
higher national debt levels as a result.:
• A definition of national income and demand-side policies
• A recognition that demand-side policies can be divided into fiscal and monetary
policies, with an explanation that expansionary demand-side policies can increase the
level of national income / economic growth by increasing one or more of either C, G, I
or X.
• A diagram that represents a right shift in AD as a result of expansionary fiscal or
monetary policy. Examples might include a rise in government spending or a reduction
in interest rates, leading to a rise in AD and an increase in national income from Y1 to
Y2. Alternatively, candidates may draw a PPF diagram showing a movement towards
a point closer to the PPF maximum, shown on diagram two by a rise from point A to
B.
• Examples of different monetary and fiscal demand-side policies which can increase
either consumption, government spending, investment or net exports: USA 2008.
• On the other hand, there are considerable disadvantages of governments using
demand-side policies to stimulate economic growth. Examples of problems that may
arise as a result of using demand-side policies include time-lags, inflationary pressure,
increased government debt, increased imports or crowding out. It should also be noted
that demand-side policies are only effective when there is spare capacity in the
economy. Without available unemployed resources any rise in aggregate demand is
likely to be inflationary only.
• The response also needs to include alternative policies that may be used to increase
economic growth - supply-side policies. National income can rise as a result of supply-
side policies, with examples of supply-side policies that may be effective e.g.
improvements to infrastructure, investments in human capital as well as increased
spending on research and development. Eg China
• A discussion of some of the disadvantages of governments using supply-side
policies, e.g. time-lags, the cost of large-scale investment projects and the uncertain
effectiveness of lowering taxes.
• A suitable conclusion might be that demand-side policies are straightforward to
implement and are relatively effective in the short term, providing there is spare
capacity in the economy. However, they do little to improve long-term growth in the
economy, which is best served by the implementation of supply-side policies which
have the ability to improve the quantity and/or quality of the available factors of
production.
Essay Plans 9

Macroeconomic Indicators

1. (a) Explain two possible reasons why the rate of inflation may rise in an economy.
[10 marks]
• Inflation refers to a sustained increase in the general price level in an economy
generally measured by the change in the consumer price index- a fixed basket of
goods and services consumed by an average household of a country. There are two
major types of inflation- Demand pull and Cost push inflation caused by different
factors discussed below.
• Firstly, demand pull inflation is the type of inflation that occurs when aggregate demand
rises at a faster rate than the economy’s ability to produce those goods and services
represented by the short run aggregate supply curve. The impact of the increase in AD
has been shown below by the rightward shift of the AD curve. This shift is caused by
a plethora of factors namely any factor that increases any of the components of
aggregate demand (consumption spending, investment spending, government
spending or net exports) such as the rise in the disposable incomes of the citizens
causing an increase in consumption spending, or a reduction in income/business taxes
increase C and I, or even an increase in government spending. It can also be driven
by central bank policy of low interest rate or a fall in the value of the exchange rate of
domestic currency making exports more competitive, causing an increase in net
exports.
• Draw a diagram: the increase in AD causes an increase in price levels from PL1 to
PL2 which is caused by an increase in the money supply in the economy often
measured by the fisher equation MV = PT. This type of inflation is also considered as
good inflation as its evident from the diagram above that apart from an increase in
price level, it also increase real GDP from Y1 to Y2 indicating an increase in economic
activity.
• The second type of inflation is referred to as cost-push inflation and is caused by a fall
in the aggregate supply due to increasing cost of production as shown below.
• This is illustrated on the diagram where average prices have risen from PL1 to PL2,
as a result of an increase in production costs. Unlike demand pull inflation, this is
sometimes called bad inflation because the rise in prices is accompanied by a fall in
economic activity causing a dangerous situation called stagflation– illustrated on the
diagram by a fall in real GDP from Y1 to Y2.
• Some of the possible causes of cost push inflation include lower productivity, wage
increases (higher than the corresponding rise in productivity) and the impact of external
shocks on the economy, e.g. a rise in oil prices or a fall in the exchange rate which
makes importing raw materials expensive forcing domestic firms to reduce supply.
• Thus, the two types of inflation are demand-pull inflation and cost-push inflation caused
by an increase in aggregate demand and a fall in aggregate supply respectively.
Although the former is accompanied with rising economic activity and the latter is
accompanied with falling real GDP as well as an inflation leading to stagflation, in
reality, no high inflation is never good as it causes future price uncertainty, reduced
business confidence and in some cases, trade-off with important macroeconomic
objectives at least in the short term such as with unemployment.

(b) Using real world examples, evaluate the possible impact of a government decision
to bring inflation under control on the other economic indicators. [15 marks]
• In an event of high inflation, governments often use fiscal policy to achieve the
macroeconomic objective of achieving low and stable inflation. This is because high
inflation has a plethora of negative consequences on other key macroeconomic
objectives such as the level of exchange rate, balance of payment, and unemployment
which will be explained below. An example of a similar situation is the Turkey debt
Essay Plans 10

crisis that is characterised by high inflation to which the Government responded with
contractionary fiscal policy.
• Although inflation is of two types as discussed above, fiscal policy is a demand-side
policy and is only effective in the event of a demand-pull inflation caused due to a shift
in AD to the right and beyond potential GDP. The plan includes a reduction of
government expenditures by $10 billion. Since government spending is a component
of aggregate demand, reducing it will bring down aggregate demand. This is shown in
the diagram below.
• The decrease in aggregate demand would lead to a fall in the price levels and decrease
in the inflationary gap from Y1 to Y2. During inflation, unemployment would fall below
NRU as firms would hire more workers who are structurally/ frictionally unemployed at
higher wages. This is evident from Turkey’s projection that the contractionary fiscal
policy would potentially lower economic growth substantially in the short term.
• However, this decision has implications and must be discussed. The fall in aggregate
demand will make unemployment in Turkey equal to NRU as firms will lay-off workers
in NRU if price-level falls due wage-price downward inflexibility at least in the short run.
This is shown by the Phillips curve that illustrates the trade-off between unemployment
and inflation. However, in the long run, as shown by the vertical line at the natural rate
of unemployment in the long run Phillips curve, inflation rate is unlikely to have an
impact on the natural unemployment rate. Moreover, Turkey has also used supply side
policies to create 2 million jobs in two-three years by focusing on increasing the
country’s productive capacity by promoting export-led industries.
• The promotion of export led industry will only be helped with the contractionary fiscal
policy as the reduction in price level from PL1 to PL2 would make Turkey’s exports
more internationally competitive, as, exports would become cheaper, and increase the
cost of imports improving Turkey’s net trade. On the other hand, an increase in the
cost of imports may have inflationary pressures (cost-push) as cost of imported factors
of production will increase but since Turkey is employing supply-side policies to
promote domestic industries and be more self-reliant in the long term. Although in the
short run firms that import raw-materials may suffer in terms of high production cost.
• Another point to note is that, in contractionary fiscal policy, the reduction in government
spending would make exports more competitive. If the consequence is an increase in
balance of trade, then AD would shift to the right again causing demand-pull
inflationary pressure rendering the fiscal policy ineffective. However, Turkey is
burdened with a huge amount of fiscal deficit, thus, it is unlikely that net exports would
overtake the effect the contractionary fiscal policy is trying to achieve and the fiscal
deficit will likely reduce. This will also improve the country’s credit ratings and the cost
of repayment will reduce now making them unlikely to default on payments.
• There are other benefits to reducing inflation using contractionary fiscal policy as well.
By bringing inflation under control, uncertainties about future price expectations would
decrease. This, in turn, would increase spending by attracting investments which
Turkey has been lacking due to the heavy debt crisis. It would also help stabilise the
currency as low inflation would make exports competitive, increasing demand of the
currency causing appreciation- this will help Turkey’s Lira which has lost over 44% of
its value in a single year helping it stabilise.
• Thus, overall there are a plethora of benefits for Turkey to reduce inflation. Although
there may be trade-offs in the short run such as increase in unemployment or cost
push inflationary pressures; in the long run they are unlikely to have any major impact
especially since the country is also using supply side policies. Moreover, it will also
help Turkey stabilise its exchange rate and improve business and consumer
confidence.
_________________________________________________________________________
Essay Plans 11

Q.2 (a) Explain why many governments pursue the macroeconomic goals of low
inflation and low unemployment. [10 marks]
• Inflation refers to a sustained rise in the average price level in an economy and
unemployment refers to the people in the workforce (labour force) who are willing and
able to work, are unemployed but are seeking a job.
• Low unemployment is one of the macroeconomic objectives of a government due its
economic benefits. Firstly, high employment in the economy means that the
government would have a larger tax base which would lead to a high tax revenue. This
would allow the government to achieve other macroeconomic objectives such as
maintaining a sustainable level of debt as they would be less likely to default on loans
with a , and even allow them to spend on merit goods or public goods such as
healthcare, education and infrastructure growing the living standards of the economy
as well. Secondly, it would also reduce the expenditure on unemployment benefits by
the government. Clearly, the increase in tax revenue, and the reduction in
unemployment benefits would reduce the government’s budget deficit or increase the
budget surplus. Besides, high levels of unemployment can be extremely detrimental
for the economy especially due to the increase in government expenditure on
unemployment benefits, or the social and personal costs of increased crime rate,
depression or even suicide.
• Similarly, a low and stable rate of inflation is also one of the macroeconomic objectives.
Firstly, if inflation is low and stable, firms will be more confident and optimistic to invest,
this will lead to an increase in productive capacity and enable higher rates of economic
growth in the future. Moreover, low and stable rate of inflation would also lead to a
greater competitiveness in the export market as exports will be cheaper. Furthermore,
a low and stable rate of inflation would prevent boom and bust cycles in the economy,
and this price stability would also lead to higher investment levels in the economy.
• Thus, in the long term, there is no trade-off indicating that unemployment is
independent of inflation rate.

(b) Using real world examples, discuss the view that the use of monetary policy is the
most effective in reducing the rate of inflation? [15 marks]
• Monetary policy is a set of actions available to a nation's central bank to achieve
macroeconomic objectives by adjusting the interest rate and money supply.
Contractionary monetary policy is often used to reduce the rate of inflation, which is
the sustained increase in the general price level of an economy.
• Central banks can use a range of contractionary monetary policies such as a
contraction in the money supply or higher interest rate to reduce the aggregate demand
in an economy and bring down the rate of inflation. The USA’s central bank- Federal
Reserve increased interest rates numerous times from 2016 to 2019 and had been
tapering back Quantitative Easing (to reduce money supply) to protect against
demand-pull inflationary pressure. The effects of this are shown in the diagram below-
• The reduction in money supply and an increase in interest rate in the USA made
borrowing expensive. This reduced the aggregate demand from AD1 to AD2 in the
economy as consumption spending and investment spending fell- this effectively
brought inflation under control from PL1 to PL2l. This is a simple remedy to the problem
of inflation, although it should be recognised that there are disadvantages of using
contractionary monetary policies to reduce inflationary pressures in the economy.
• Firstly, there is the possibility of the ratchet effect. In reality, the price level increases
easily when there is strong aggregate demand, but does not easily fall as aggregate
demand decreases due to sticky wage theory caused due to labour market rigidities.
This makes it hard for firms to lower their prices as cost of labour would remain
constant. Therefore, despite using contractionary monetary policy, the price level may
remain constant at PL1. This may have been detrimental for the American economy
Essay Plans 12

as contractionary monetary policy would shift real GDP from Y1 to Y2 but inflationary
pressures would remain.
• There are other negative impacts of using tighter monetary policy as well. After the US
Central Bank began to taper quantitative easing, the US dollar appreciated sharply as
higher interest rates tend to attract foreign investment, increasing the demand for and
value of the American dollar. This meant that the emerging market currencies
depreciated against the dollar, making U.S. goods and services expensive to buy,
adding to the balance of payments pressures.
• Further, there could also be short term impacts as according to the Phillips Curve, in
the short term the fall in inflation could be met with high levels of unemployment due
to falling economic activity. But this is only a short term phenomena as in the long run
this trade-off breaks down and the rate of unemployment will return to the natural rate.
This is what happened in the United States as the unemployment levels during this
period did not rise substantially.
• Lastly, if the inflation is not demand side and is due to an increase in cost of factors of
production (cost-push inflation), such as the recent inflationary pressures in the USA
due to increase in oil-prices caused by the Russian invasion of Ukraine, contractionary
monetary policy would become ineffective as monetary policy cannot be used for
supply-side measures showing its limitations.
• The US government can also use alternative measures to battle inflation such as using
contractionary fiscal policy which works similarly to the use of tight monetary policy,
except that a government would raise taxes and or reduce public spending. Such
policies would come with the additional advantage of helping a government balance
its budget, but can be unpopular politically especially since the US is a strong advocate
for a free economy and increases in taxes are rather orthodox policies in the country.
Another point to note is that, in contractionary fiscal policy, the reduction in government
spending would make exports more competitive. This is the opposite of what happened
in the USA due to contractionary monetary policy which made exports less competitive
due to appreciation. However, If the consequence is an increase in balance of trade,
then AD would shift to the right again causing demand-pull inflationary pressure. This
would render the fiscal policy ineffective.
• It is evident from the above analysis that in the United States Contractionary Monetary
Policy is a better option compared to Fiscal policy when dealing with demand-side high
inflation. Despite downsides such as balance of payment pressures due to reduced
export competitiveness and a short term trade-off with unemployment, in the long run
there are no significant downsides. Other approaches to reducing inflation can be
undertaken such as the use of contractionary fiscal policy, however that may make the
government very unpopular as high taxes and strong government intervention are not
desired and cause political unpopularity. Clearly, contractionary monetary policy is a
significantly better option.
_________________________________________________________________________

3. (a) Explain why deflation may be a significant a threat to an economy. [10 marks]
• A definition of deflation: Responses should also note that deflation is not the same as
disinflation. Deflation is a sustained fall in average prices while disinflation is merely a
fall in the rate of inflation.
• Deflation can be illustrated with two AS / AD diagrams, one illustrating cost push (good)
deflation and the other demand pull or bad deflation. The cost push deflation diagram
is illustrated by a rise in the AS curve leading to lower average prices. The diagram of
demand pull deflation is illustrated by a fall (or left shift) in the AD curve, leading to a
deflationary gap, represented by a fall in national income from Y1 to Y2.
• A description of some of the problems associated with deflation, e.g. price reductions
leading to reduced profit margins and companies then forced to reduce staffing levels,
leading to unemployment.
Essay Plans 13

• A recognition that a sustained period of deflation is also likely to lead to a fall in

consumption levels as many consumers delay certain purchases in the expectation of
further price falls - deferred consumption. Debtors, including those with mortgage
payments will see their debts increase in relative terms, as the size of the loan grows
in relation to the value of the asset secured on it. This in turn leads to falling real wealth
and further reductions in consumption and investment. In this situation many creditors
will not be repaid leading to further job losses and loss of output. (Deflationary Spiral)
• The impact of deflation on low investment and economic growth, including an
explanation of the use of the reverse multiplier. Candidates should also explain why
governments may be powerless to prevent deflation simply by expanding the monetary
supply - interest rates cannot fall below zero for example.

(b) Using real-world examples, evaluate the view that deflation is more harmful than
inflation to an economy. [15 marks]
• A definition of deflation and inflation: A sustained decrease in price vs a sustained
increase in price
• An explanation of the negative costs of deflation.
o Reduced AD as consumers defer their purchases in the expectation of lower
prices in the future, the impact on debtors and creditors and reduced
investment levels as businesses are less likely to invest when prices are falling.
May even cause a deflationary spiral
o A recognition that deflation, caused by falling production costs, cost push
deflation, is considered good deflation, where as falling prices as a result of
falling aggregate demand levels, demand pull deflation, is considered bad
deflation.
o This is illustrated in two diagrams, illustrating a fall in average price levels, as
a result of either demand pull deflation or cost push deflation (diagram 2, left).
o Responses should conclude this section by describing examples of some of
the difficulties associated with deflation, for example Japan, during its
deflationary period and how difficult it is to battle: Deflation in Japan started in
the early 1990s. On 19 March 2001, the Bank of Japan and the Japanese
government tried to eliminate deflation in the economy by reducing interest
rates. Despite having interest rates near zero for a long period, this strategy did
not succeed. In July 2006, the zero-rate policy was ended. In 2008, the
Japanese Central Bank still had the lowest interest rates in the developed world
and deflation continued.
• On the other hand, nations have also suffered from excessive inflation. While it is
generally accepted that a little inflation, perhaps 2 – 3% is good for an economy,
excessive inflation also causes a range of economic costs. Example: The 2018–2022
Turkish currency and debt crisis is an ongoing financial and economic crisis in Turkey.
It is characterised by the Turkish lira plunging in value, high inflation, rising borrowing
costs, and correspondingly rising loan defaults:
o While the crisis was prominent for waves of major depreciation of the currency,
later stages were characterised by corporate debt defaults and finally by
contraction of economic growth. With the inflation rate stuck in the double digits,
stagflation ensued.
o After a period of modest recovery in 2020 and early 2021 amid the COVID-19
pandemic, the Turkish lira plunged to all-time lows after interest rates dropped
from 19% to 14%. The lira lost 44% of its value in 2021 alone.
o The crisis was exacerbated as the central bank claims that by cutting interest
rates. Turkey is focused on growing the economy rather than controlling
inflation, which economists think is highly questionable at this point because
you are going to see more contraction coming as a result of the panic and
uncertainty and escalating costs coming from this crisis. This shows-
Essay Plans 14

o Uncertainty for firms brought on by constantly rising prices making investment

decisions more difficult. Menu and shoe leather costs associated with constant
rising prices, reduced real incomes especially on households with fixed
incomes, e.g. pensioners.
o Reduced international competitiveness as domestic prices riser at a faster rate
than a nation’s trading partners.
o A recognition that inflation, caused by a left shift in AS (cost push inflation), is
considered bad inflation where as rapidly rising prices caused by
aggregate demand levels rising at a faster rate than the economy’s ability to
produce them, demand pull inflation, is considered good inflation.
• This should be illustrated by appropriate diagrams, illustrating a rise in average price
levels as a result of either demand pull factors or cost push inflation
• The response should conclude with an evaluation of the above arguments in terms of
the short-term and long-term effects as well as the impact on different
stakeholders. For example debtors will benefit from inflation while creditors will be
more likely to benefit from deflation. Candidates should also note that while excessive
inflation has a negative impact on the economy a relatively low level of inflation, say 2
- 3% is considered positive. It should also be noted that a small level of deflation,
caused by falling production costs (cost push deflation) may also have a relatively
positive impact on the economy.

4. (a) Explain some of the difficulties associated with measuring the rate of inflation in
the economy. [10 marks]
• A definition of the key terms –inflation rate: A sustained increase in the general or
average level of prices and a fall in the value of money and the consumer price
index: A measure of the average rate of inflation which calculates the change in
the price of a representative basket of goods and services purchased by the
“average” consumer.
• Explanation of how the consumer price index is constructed: using fixed basket of
goods, highlighting the difficulties involved in the accurate collection of data.
• The different consumer patterns of high / low income earners, as well as between
different age groups. An example might be the cost of rented housing. For older,
particularly wealthier households who own the property that they live in, a rise in
rental prices has no bearing on their cost of living. By contrast, a young worker
paying a large % of their net income on rent will be greatly impacted by a rise in
rental prices. Similarly a change in the price of car fuel is relevant only to those
individuals who own and use a car, yet both items would still be included in the
basket of goods and services measured.
• Another difficulty of measuring inflation is the result of changes to consumption
patterns over time; as well as the introduction of new products, which then have to
be added to the basket, while at the same time other goods and services becoming
obsolete and needing to be removed. For example a product such as video or
DVD rentals were once a regularly purchased item in the basket but have now
disappeared from the shelves. Similarly the price of a rental mobile contract did
not exist even 10 years ago but has since been added.
• Another difficulty results from changes in the quality of goods and services, making
a comparison of changes in price irrelevant, e.g. new technology products. An
example would be the Apple smart phone, which is impossible to compare with
earlier models, that were vastly inferior and therefore difficult to compare in terms
of price movements.
• Responses should end with a concluding statement that for the reasons included,
making an accurate calculation of the rate of inflation is difficult and requires an
element of guess work to arrive at a measurement.
Essay Plans 15

(b) Using real world examples, evaluate the view that the best result for an economy is
a low and stable rate of inflation. [15 marks]
• A definition of a low and stable rate of inflation, for example many central banks try to
keep inflation within the range 2 - 2.5%.
• An explanation of how a low and stable inflation rate causes greater certainty for a
business. This encourages entrepreneurs to investment in new plant and machinery
and also encourages overseas investment. Consumption and economic activity are
also likely to flourish.
• The impact of a low inflation rate on exporters, for example a low rate of inflation makes
domestic goods more competitive in overseas markets and imported goods less
competitive.
• A recognition that fixed income earners, including those retired people dependent on
a pension income, are less at risk from falling real wage levels and that saving is also
encouraged. A low rate of inflation also has social benefits because trade unions are
less likely to go on strike because low inflation means that real wage levels are better
protected.
• On the other hand, the response needs to recognise that low inflation can also have a
negative impact on some of the other economic indicators such as unemployment and
economic growth. For example as the AD / AS diagram illustrates, when low inflation
is the result of falling AD, there can be accompanied by a reduction in real output
levels from Y1 to Y2. Similarly, according to some economists there is an inverse
relationship between inflation and unemployment, at least in the short term,
represented by the Phillips curve, making it difficult to combine both low and stable
inflation with low unemployment.
• This implies that rather than maintaining a low and stable rate of inflation, however
desirable this might be, might not be possible if governments choose to instead to
focus on policies aimed at growth and higher employment.
• Examples of nations that have benefited from maintaining a low and stable rate of
inflation include USA, EU, UK e.t.c. - nations with independent Central banks
prioritising low inflation.
• An example of a nation driving a different policy can be witnessed in modern day
Turkey, a nation with one of the highest rates of inflation in the world, as the
government has abandoned any attempt to control average prices and instead
prioritise growth policies.
• The response should conclude with a consideration of both the long-term and short-
term consequences of a sustained period of low inflation, as well as the impact on
different stakeholders - creditors, debtors, businesses, customers, exporters and the
government, to reach an effective conclusion.

5. (a) Explain two consequences of a central bank decreasing interest rates. [10 marks]
Command term: Explain - Give a detailed account including reasons or causes.
Answers may include:
• Definition(s): interest rates, central bank
• Explanation: of how deceasing interest rates might increase consumption,
decrease savings, increase investment and depreciate the exchange rate
• Diagram: money market diagram to show interest rates decreasing or an AD/AS
diagram
(b) Using real-world examples, evaluate the effectiveness of monetary policy to reduce
the rate of inflation. [15 marks]
• Definition(s): monetary policy, inflation.
• Explanation: of how contractionary monetary policy might reduce inflation by
reducing aggregate demand and the average price level.
Essay Plans 16

• Diagram: AD/AS diagram to show how contractionary policy reduced aggregate

demand and the average price level.
• Synthesis (evaluate): strengths and limitations of monetary policy in reducing the
rate of inflation. The strengths of monetary policy: it is incremental, it can easily
adjusted, it is flexible, quick to implement and it does not increase the budget
deficit. The weaknesses of monetary policy are: it is less effective when interest
rates are close to zero, may not be effective if household and businesses do not
reduce consumption and investment and it may not be as effective with costs push
inflation.
• Examples: real-world examples of where governments and the central bank have
tried to reduce the rate of inflation using contractionary monetary policy: The
Federal Reserve in the US increased interest rates numerous times from 2016 to
2019 and had been tapering back QE.
o Interest rates were 0.25% in 2016 reaching 2.5% at the start of 2019. The
reason for rate rises was twofold; to protect against demand-pull inflationary
pressure, cooling down a booming US economy and also to normalise interest
rates after a uniquely long period of near-zero rates.

6. (a) Describe some of the problems associated with measuring the level of
unemployment. [10 marks]
• A definition of unemployment: The state of being eligible for work, actively looking for
work, but without a job.
• A discussion of some of the difficulties that governments have with calculating
unemployment accurately.
o One example could be the existence of underemployment and hidden
unemployment. Hidden unemployment includes categories of workers such as
housewives actively looking for work, but who may not be included in the official
unemployment figures, as well as those considered too sick to work. In other
words the difficulty of assessing people’s willingness and ability to work.
o A recognition that another problem associated with calculating unemployment
rates includes small differences in methods of measuring unemployment.
o A recognition that the unemployment rate represents an average figure and
ignores regional, ethnic, age and gender disparities.
• Examples of differences in the way that unemployment is calculated in different
countries: For instance, China measures it unemployment through a registered
database. It does not take into account those who are unregistered and it does include
those workers who have been laid-off which is not included in United States or
European statistics.

(b) Using real-world examples, evaluate the argument that the maintenance of a low
level of unemployment should be the primary macroeconomic objective for any
government. [15 marks]
• A definition of unemployment: The state of being eligible for work, actively looking for
work, but without a job.
• An explanation of the economic and social costs of unemployment. Examples of
economic costs include a loss of potential national output resulting from
unemployment, a reduction in tax revenue collected, the increased cost of
paying unemployment benefits, loss of income for households and disparities in the
distribution of income.
• Examples of social costs associated with unemployment include increased crime
levels and stress, indebtedness, family breakdown e.t.c. Many African countries face
very high numbers of unemployment rates and many Latin American countries fall
between 6 and 10 percent.
Essay Plans 17

o The reason that there is high unemployment in much of Africa and throughout
Latin America is due to under developed infrastructures and economies.
• Relevant diagrams showing the impact of unemployment on the economy, for instance
a PPF diagram with an economy operating below its capacity.
• On the other hand, maintaining a policy which prioritises low unemployment also has
its weaknesses. For example, many free market / laissez faire economists suggest
that while low unemployment may well be desirable, it is actually difficult to
control. Therefore, any attempt by governments prioritise this with the use of demand
side policies will be counterproductive, with no long term gains in output and higher
inflation. This is because free market economists argue that a rise in public sector
spending simply crowds out private sector consumption and investment, rather than
creating new employment opportunities. This is illustrated by the following free market
LRAS curve.
• On the diagram Y1 represents the equilibrium level of national income. Following the
implementation of an expansionary demand policy, AD rises to AD2 and initially
national income rises and creates new employment opportunities – represented by a
rise from Y1 to Y2. However, over time the economy adjusts and with factor resources
now more scarce, the price of those resources increases and the markt clears at point
B. This is illustrated by a fall in SRAS to SRAS2 and the level of real GDP falls back
to its equilibrium level, but with higher average price levels.

• In terms of supply side policies aimed at lower unemployment, responses should

recognise that attempts by governments to reduce unemployment by promoting
greater flexibility of labour may also present costs to the economy / society, in terms
of lower levels of job security and working protection.
• As a conclusion responses should discuss the importance of maintaining low
unemployment in terms of the short and long term impact on the economy and society
as well as the impact on the other economic indicators e.g. inflation. For example
candidates should recognise that some measures to reduce unemployment, such as
an expansionary demand side policy, may come at a cost in terms of higher inflation,
which may present difficulties for an economy long term, in terms of a loss of
international competitiveness.

7. (a) Explain the different types of unemployment that may arise in an economy. [10
marks]
• A definition of unemployment: The state of being eligible for work, actively looking for
work, but without a job.
Essay Plans 18

• An explanation of different types of unemployment - structural, frictional, seasonal,

demand deficient (cyclical). Ideally responses should also state that structural,
frictional and seasonal unemployment are examples of equilibrium unemployment
(NRU) while cyclical unemployment are examples of unemployment when the labour
market is not in equilibrium.
o Structural: Equilibrium unemployment that exists when in the long-term the
pattern of demand and production methods change and there is a permanent
fall in the demand for a particular type of labour. There is a mismatch between
skills and the jobs available.
o Frictional: Equilibrium unemployment that exists when people have left a job
and are in the process of searching for another job.
o Seasonal: Equilibrium unemployment that exists when people are out of work
because their usual job is out of season, for example, a ski instructor in the
summer.
o Cyclical: Disequilibrium unemployment that exists when there is insufficient
demand in the economy and wages do not fall to compensate for this.
• Draw a diagram to show structural unemployment/all types of unemployment in AD/AS

(b) Unemployment is most effectively reduced through the use of demand-side

measures. Using real-world examples, discuss the merits of this view. [15 marks]
• A definition of unemployment: The state of being eligible for work, actively looking for
work, but without a job as well as demand side policies: A policy emphasising the
importance of government intervention in managing the level of aggregate demand in
the economy, through fiscal and monetary policies.
• An explanation that expansionary demand-side policies can be effective in raising the
level of national income / economic growth by increasing one or more of either C, G, I
or X. This in turn reduces cyclical unemployment by increasing the demand for
labour. Illustrated by diagram where the rise in real GDP is represented by Y1 − Y2.
Example: In the fiscal year ending March 2021, the UK government financed a huge
fiscal stimulus to fight one of the deepest recessions in Europe.
o The UK economy shrunk by 11% throughout 2020 prompting the government
to increase spending on wage subsidy schemes, grants and business loans to
protect employment and welfare benefits, making it easier to claim benefits and
raising the amounts claimants could claim to help the unemployed.
o Though growth rates are some of the lowest in Europe, unemployment rates
remain far below levels seen in other European nations suggesting the job
support policies, in particular, have prevented a large spike in unemployment,
though the burden of such large borrowing and increases in the national debt
will be felt for many years to come.
• A discussion of the weaknesses of demand-side policies in reducing
unemployment. For example, time-lags, inflationary pressure, higher levels of
government debt, increased import levels or crowding out.
• A recognition that another significant weakness of demand side policies is that they
are only effective in reducing cyclical unemployment levels. Demand side measures
are not effective, for example, in reducing levels of equilibrium unemployment- it is only
inflationary.
• A discussion of alternative policies that may be used to reduce unemployment, i.e.
supply-side policies.
• Examples of supply-side policies can may be used to reduce long term unemployment
include measures to improve the nation's infrastructure, investments in human capital
as well as increased spending on research and development.
• A recognition that supply side measures, unlike demand side policies, are also
effective in reducing structural unemployment rates. Example China
Essay Plans 19

• An AD/AS diagram illustrating a right shift in the LRAS curve or an outward shift in the
PPF curve, following an improvement to either the quantity and / or quality of the
factors of production in the economy. Diagram 2 illustrates that following a rise in
LRAS, real GDP rises to Y2 and unlike the use of demand side policies there is no rise
in inflation.
• A discussion of some of the disadvantages of governments using supply-side policies,
e.g. time-lags and the costs associated with large scale investment and government
training projects.
• A recognition that supply-side policies aimed at increased labour market flexibility or a
reduction in access to unemployment benefits may also come at a social cost in terms
of a reduction in labour protection or employment security.

8. (a) Explain the difference between demand-deficient (cyclical) and structural

unemployment. [10 marks]
• Definition(s): demand-deficient (cyclical) and structural unemployment
• Explanation: of the difference between demand-deficient (cyclical) and structural
unemployment
• Diagrams: AD/AS diagram illustrating a deflationary gap and an appropriate
diagram showing structural unemployment.
(b) Using real life examples, discuss the view that unemployment can be reduced
through the use of supply-side policies [15 marks]
• A definition of unemployment: The state of being eligible for work, actively looking for
work, but without a job and supply-side policies: Government policies designed to shift
the long run aggregate supply curve to the right, thus increasing potential output in the
economy.
• A discussion of how interventionist supply-side policies can be effective in reducing
unemployment, with examples of supply side policies that may be effective e.g.
improvements to infrastructure (cyclical unemployment), investments in human capital
as well as increased spending on research and development (structural
unemployment). Example- China’s five year plans.
• A discussion of the effectiveness of market based supply-side policies in reducing
unemployment e.g. privatisation to increase competition.
• This can be illustrated by an AD/AS (LRAS) diagram, illustrating a shift in the LRAS
curve and a rise in national income from Y1 to Y2, leading to a likely fall in
unemployment levels.
• A discussion of some of the disadvantages of governments using supply-side
policies, e.g. time-lags, the cost of large scale investment projects and the uncertain
effectiveness of lowering taxes, as well as the social costs associated with reducing
welfare benefit levels.
• A recognition of the effectiveness of alternative policies that might be used to reduce
unemployment e.g. demand side policies. However, discuss its limitations namely its
effectiveness only in short term or cyclical unemployment. (Otherwise its inflationary)
• A conclusion with an evaluation of the above arguments in terms of short-term versus
long-term consequences and the impact on different stakeholders. A suitable
conclusion might be that unlike demand side policies, which are only effective in the
short term, long term falls in unemployment are best served by the implementation of
supply side policies which have the ability to improve the quantity and / or quality of
the available factors of production.
9. (a) Explain two expansionary monetary policy tools available to a government or
central bank. [10 marks]
Command term: Explain - Give a detailed account including reasons or causes.
- Open Market Operations: Open market operations refer to the selling and
purchasing of the treasury bills and government securities by the central bank
Essay Plans 20

of any country in order to regulate money supply in the economy. When the
central bank wants to increase the money supply in the market, it will purchase
securities from the market. This step is taken to reduce the rate of interest and
also to help in the economic growth of the country. This policy is known as the
expansionary monetary policy.
- Minimum Reserve Requirement: A reserve requirement is a central
bank regulation that sets the minimum amount that a commercial bank must
hold in liquid assets. This minimum amount, commonly referred to as
the commercial bank's reserve, is generally determined by the central bank on
the basis of a specified proportion of deposit liabilities of the bank. Monetary
authorities increase the reserve requirement only after careful consideration
because an abrupt change may cause liquidity problems for banks with low
excess reserves; they generally prefer to use open market operations (buying
and selling government-issued bonds) to implement their monetary policy.
- Quantitative Easing: Quantitative easing (QE) is a form of unconventional monetary
policy in which a central bank purchases longer-term securities from the open market
in order to increase the money supply and encourage lending and investment. Buying
these securities adds new money to the economy, and also serves to lower interest
rates by bidding up fixed-income securities. It also expands the central bank's balance
sheet. Quantitative easing increases the money supply by purchasing assets with
newly-created bank reserves in order to provide banks with more liquidity.
(b) Using real-world examples, evaluate the effectiveness of monetary policy in
maintaining a low rate of unemployment. [15 marks]
• A definition of monetary policy: A demand-side policy using changes in the money
supply or interest rates to achieve economic objectives relating to inflation and
unemployment.
• and low unemployment: The state of being eligible for work, actively looking for work,
but without a job.
• RWE: In response to the economic crisis from Coronavirus, the Monetary Policy
Committee (MPC) of the Bank of England enacted a dual expansionary monetary
policy, reducing interest rates from 0.75% to 0.1% and pumping an extra £450bn of
money into the UK economy through quantitative easing. The intention of this policy
move was to promote economic growth and employment thus reducing the overall
impact of the recession on UK macro performance.
o However as interest rates were already very low before the cuts took place,
this avenue of monetary policy has been limited in its effectiveness forcing huge
Increases in quantitative easing to provide further stimulus to the economy. But
with extremely weak consumer and business confidence the idea of lower
interest rates promoting greater borrowing spending and investment was
unlikely. In reality, businesses have used borrowed funds to protect jobs and
continue paying bills thus preventing mass bankruptcy and skyrocketing rates
of unemployment.
• An explanation of some of the impacts of monetary policy on the economy e.g.
employment, growth, inflation and trade
• A relevant AD/AS diagram
• An evaluation of the strengths and weaknesses of monetary policy in achieving low
unemployment

10. (a) Illustrate using a suitable diagram how a period of recession can increase levels
of poverty in the economy. [10 marks]
• A definition of poverty: The scarcity or the lack of a certain amount of material
possessions or money as well as recession: The situation where total spending
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(aggregate demand) is less than the full employment level of output, thus causing
unemployment- last more than 6 months.
• The definition of recession should then be complemented by an AD / AS diagram
illustrating a recession, defined as a two consecutive periods of declining economic
activity, measured by a fall in GDP. A suitable diagram could show an AD / AS curve,
indicating a deflationary gap, represented on the diagram by the gap between Y1 and
Y2.
• An explanation of how a recession may cause poverty in terms of lower incomes and
higher unemployment. In circumstances where a recession leads to a long term rise
in structural unemployment the rise in poverty for some individuals may be
indefinite. In recession many firms may look to cut real wage levels, forcing some
workers, previously on the margins of poverty below the poverty line.

(b) Using real-world examples, discuss the view that greater income equality, in the
economy, will reduce efficiency. [15 marks]
• A definition of income equality: A measure of how evenly income is distributed
throughout a population and economic efficiency: Efficiency is a quantifiable
concept, determined by the ratio of useful output to total input.
• A discussion of different policies that can be employed to reduce income inequality.
Examples include a greater use of progressive taxes and transfer payments. In other
words governments can reduce income inequality by increasing progressive taxes, the
burden of which falls primarily on high income households as well as increasing
government spending on transfer payments on pensions, sickness payments and out
of work benefits.
o Belgium has one of the most progressive taxation system. Top progressive tax
rate is 50%. Income from property, work, investments, and miscellaneous
sources is all taxable. Capital gains tax rates depend on the type of capital.
The government social contributions, and 80% of alimony payments, and there
is a personal allowance based on filing status.
o Has one of the lowest Gini coefficient- 0.27
• Such policies will improve income equality but may well reduce efficiency in the
economy by providing a disincentive to work or set up a business. This is because the
burden of progressive taxes will fall heaviest on those who benefit from working hard
to increase their disposable income. At the same time transfer payments, paid out of
taxation, will often benefit households on low incomes disproportionately.
• This is illustrated by the Lorenz curves for two different nations. One for Belgium which
implements a range of policies aimed at poverty and income inequality reduction,
including a rise in progressive taxes and transfer payments. One for the USA which
does not – leaving this up to the free market with a Gini coefficient of
0.41. Unsurprisingly Belgium experiences lower levels of inequality, represented by a
smaller Gini coefficient.
• The second diagram should shows a production possibility frontier, with point A drawn
on the edge of the PPF curve and representing an economy running efficiently and
point B lying within the boundary of the PPF. The loss of economic efficiency, resulting
from a rise in progressive taxes and transfer payments, is represented by a move from
point A to point B on the diagram.
• On the other hand, some economists argue that income inequality may harm a
country’s economic performance and efficiency in other ways. For example, income
inequality can reduce efficiency because of ill health. If people are not healthy they
will not be able to work to their full productive capacity. Even though ascertaining
Essay Plans 22

whether inequality is a direct cause of ill health, as opposed to merely being correlated
with it is difficult to assess.
o Example: The Belgian health system is based on the principles of equal access
and freedom of choice, which covers the whole population and has a very broad
benefits package. This is why the health status of the Belgian population
is generally good, with an increasing life expectancy of 81 years
o In the USA on the other hand, without health insurance coverage, a serious
accident or a health issue that results in emergency care and/or an expensive
treatment plan can result in poor credit or even bankruptcy. Its average life
expectancy is only 78 years.
• Similarly, in most countries there are diminishing marginal returns to an individual’s
expenditure on health, so a transfer of funds from treating the rich to treating the poor
would both reduce inequality and improve the total health of the population.
• This can also be applied to education, where the more the income inequality in a
country the greater the difference of education level of poor and rich. If children from
poor families receive little education, they are less likely to become highly skilled
workers. Their productive capacity, and therefore the productive capacity of the
economy, is diminished. Therefore, policies to improve high school and tertiary
education completion rates also improve efficiency and GDP per capita.
o Belgium has extremely subsidised education- until high school its free and
university is very cheap. Belgium literacy rate for 2018 was 99.00%
o USA too has free public school but university is very expensive. Literacy rate
in 88%
• The essay should finish with a comparison of the positive and negative impacts of
different policies designed to promote income equality. This should include an
evaluation on the impact on different stakeholders. Relevant stakeholders might
include entrepreneurs, low paid workers, high paid workers as well as the recipients of
social benefit payments.

11. (a) Explain why free market economic systems have a less equal distribution of
income. [10 marks]
• A definition of a free market system: An economy where the means of production
are privately held by individuals and firms. Demand and supply (market forces)
determine what/how much to produce, how to produce, and for whom to produce
and income distribution: income distribution covers how a country's total GDP is
distributed amongst its population
• The problem of income distribution arises because ownership of factors of
production is highly unequal, and because the prices of factors of production
determined in the market vary enormously. Most people have labour resources that
they provide in labour markets, for which they receive wages. Yet some people are
able to receive very high wages because of special skills and education or natural
talents, while others who are less skilled, educated or talented may receive wages
so low that they may be unable to cover the most basic needs for themselves and
their families.
o Further, there may be people who would like to work but cannot do so
because they lack the kinds of skills firms want to hire (Structural
unemployment) or because they are sick, or old. Then there are some
individuals who possess some of the additional factors of production of
land, capital and entrepreneurial abilities, for which they receive rental,
interest and profit income. These additional factors of production are
generally highly unequally distributed.
• As a result, the market determined distribution of income in an economy is likely to
be very unequal, with some people receiving far larger shares than others.
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It follows that markets cannot ensure that everyone in a population will secure
enough income to satisfy their basic needs. Most societies consider this to be a
disadvantage of the free market economy, because of the belief held by most
people that everyone in a population should be able to satisfy a minimum of basic
human needs.
• A suitable diagram such as a Lorenz curve, showing a less equal distribution of
income in market economic
• A recognition that income inequality is measured by the Gini co-efficient. We would
expect to see a higher Gini co-efficient within free market economic systems.

(b) Using real-world examples, evaluate different government policies, which promote
greater income equality, in terms of their effects on efficiency in the allocation of
resources. [15 marks]
• A measure of how evenly income is distributed throughout a population and
economic efficiency: Efficiency is a quantifiable concept, determined by the ratio of
useful output to total input.
• A discussion of different policies which may be employed to reduce income inequality
levels. Examples include a greater use of progressive taxes and transfer
payments. Governments can reduce income inequality by increasing progressive
taxes, the burden of which falls primarily on high income households, as well as
increasing government spending on transfer payments. Example of Belgium (Also in
question 10) Dealing with high taxes first, particularly progressive taxes such as
income or corporation tax, economic theory dictates that raising the rate of income tax
will be effective in reducing income inequality, but it may not be effective in improving
economic welfare.
o When level of tax rises past its optimum point, tax revenue will fall as individuals
will simply work less, reducing the effectiveness of any income inequality
reduction policy.
• Similarly, while increasing the level of transfer payments e.g. public sector wages,
pensions, sickness payments and out of work benefits, is likely to improve
income equality, with the recipients of such payments more likely to be from low
income households, the policy may also provide a disincentive to work. This is
because some recipients may simply choose to collect benefits, rather than looking for
employment.
• In other words policies which are effective in reducing income equality may also reduce
economic efficiency by providing a disincentive to work or set up a business as the
burden of progressive taxes will always fall heaviest on those who benefit from working
hard to increase their disposable income.
• This is illustrated by the next two diagrams. The first on the left, illustrates the Lorenz
curve for two different nations. One of Belgium, which implements a range of policies
aimed at poverty and income inequality reduction, including a rise in progressive taxes
and transfer payments. The other represents the USA which does not – leaving this
up to the free market. Unsurprisingly Belgium experiences lower levels of inequality,
represented by a smaller Gini coefficient, but as a consequence may experience from
a loss of efficiency.
• The second diagram illustrates a production possibility frontier, with point A drawn on
the edge of the PPF curve and representing an economy running efficiently and point
B lying within the boundary of the PPF. The loss of economic efficiency, resulting from
a rise in progressive taxes and transfer payments, is represented by a move from point
A to point B on the diagram.
• The essay should finish with an evaluation on the impact of income equality policies
on a range of different stakeholders. Relevant stakeholders might include
entrepreneurs, low paid workers, high paid workers as well as the recipients of social
benefit payments.
Essay Plans 24