6.

(a) Explain how a government can use fiscal policy to reduce the level of aggregate
demand in an economy? [10 marks]

Command term: Explain

Key terms to define: AD, fiscal policy

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.

Responses in this section should be graded according to the following mark bands:

Maximum mark 10

Criteria Mark
There is no clear answer to the question but some limited: 1-2
• Use of economic terms – fiscal policy, AD
• Application of economic theory
• Use of diagrams – AD/AS, PPF diagram
There is a vague answer to the question with limited: 3-4
• Use of economic terms – fiscal policy, AD
• Application of economic theory
• Use of diagrams – AD/AS, PPF diagram
There is an answer to the question with satisfactory: 5-6
• Use of economic terms – fiscal policy, AD
• Application of economic theory
• Use of diagrams – AD/AS, PPF diagram
There is a clear answer to the question with good: 7-8
• Use of economic terms – fiscal policy, AD
• Application of economic theory
• Use of diagrams – AD/AS, PPF diagram
There is clear answer to the question with excellent: 9-10
• Use of economic terms – fiscal policy, AD
• Application of economic theory
• Use of diagrams – AD/AS, PPF diagram

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InThinking www.thinkib.net/Economics 1
(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]

Command term: Evaluate

The command term asks candidates to evaluate whether demand or supply-side policies are
more effective in increasing the level of national income. Candidates must consider
arguments in support of this statement followed by counter-arguments, followed by a suitable
conclusion based on the evidence provided.

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.

Responses should also include the

following:

A definition of national income and demand-side policies. If this has already been defined in
part (a) of the response then there is no need to repeat this definition. However, candidates
are required to refer to this definition at the beginning of the section, in order to gain credit
for it.

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

© Mark Johnson,
InThinking www.thinkib.net/Economics 2
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.

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 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.

This can be illustrated by an AD/AS

diagram (diagram 3), illustrating a shift in
the AS curve and a rise in national income
from Y1 to Y2

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.

Real-world examples that might be used

could include Japan and USA. Following
the financial crisis of 2007-9, the USA adopted very aggressive expansionary demand-side
policies and the economy benefited as a result. By contrast, Japan has adopted similar
expansionary demand-side policies but their economy remains stuck in a recessionary cycle -
and with significantly higher national debt levels as a result.

A conclusion with an evaluation of the above arguments in terms of short-term versus long-
term consequences and the impact on different stakeholders.

© Mark Johnson,
InThinking www.thinkib.net/Economics 3
Responses in section (b) should be graded according to the following mark bands:

Maximum mark 15

Criteria Mark
There is no clear answer to the question but some limited: 1-3
• Use of economic terms - national income and demand-side policies
• Application of economic theory
• Use of diagrams
• Evaluation
• Real-world examples
There is a vague answer to the question with limited: 4-6
• Use of economic terms - national income and demand-side policies
• Application of economic theory
• Use of diagrams
• Evaluation
• Real-world examples
There is an answer to the question with satisfactory: 7-9
• Use of economic terms - national income and demand-side policies
• Application of economic theory – appropriate demand-side policies
• Use of diagrams
• Evaluation - recognition that demand-side policies are only effective in
closing a recessionary gap caused by falling AD
• Alternative (supply side) policies included
• Real-world examples
There is a clear answer to the question with good: 10-12
• Use of economic terms - national income and demand-side policies
• Application of economic theory - appropriate demand-side policies
• Use of diagrams
• Evaluation - recognition that demand-side policies are effective in
closing a recessionary gap, caused by falling AD, but not in bringing
long-term benefits to the economy
• Alternative (supply side) policies addressed and applied appropriately
• Real-world examples
There is a clear answer to the question with excellent: 13-15
• Use of economic terms - national income and demand-side policies
• Application of economic theory - appropriate demand-side policies
• Use of diagrams
• Evaluation - recognition that demand-side policies are effective in
closing a recessionary gap, caused by falling AD, but not in bringing
long-term benefits to the economy
• Alternative (supply side) policies addressed and applied skillfully
• Real-world examples

© Mark Johnson,
InThinking www.thinkib.net/Economics 4