Preparing for the May 2011 AQA AS Unit 2 Economics

Macro PaperGeoff RileyMay 2011

Recent AQA Unit 2 Papers• January 2009:

– Productivity growth and importance for macro performance– Household savings and importance for macro performance

• June 2009:– Inflation and monetary policy, Inflation and AD– Growth and consumption

• January 2010:– Exchange rate, Balance of Payments– Economic cycle and unemployment

• June 2010:– Causes and consequences of a fall in investment spending– Economies in recession, policies to help the UK recover from recession

• January 2011:– Demand and supply side policies to generate higher economic growth– Role of fiscal and monetary policy in maintaining economic stability

Some possibilities for May 2011• Causes of economic recovery, stimulus policies and multiplier/accelerator

• Why is inflation persistently above target, achieving growth without inflation

• Demand and supply-side shocks including oil & food prices

• Difficulties in achieving macro aims (policy “trade-offs”)

• Output gap, unemployment and inflation / deflation

• Saving and consumer spending and real disposable incomes

• Demand and supply-side causes of unemployment

• Demand and supply-side policies to reduce unemployment

• Policies to improve balance of payments in recent years (current account only)

• Interest rates & their impact on the macro-economy / credit supply and cost

• Cuts in government spending and their possible economic effects

• Changes in the exchange rate and their macro impact (AD and SRAS)

Reminder about timing

• 75 minute paper• 25 Q multiple choice paper – 20 mins• Data response question

– (1) Key term definition (5 marks) – 2 min– (2) Data description (8 marks) – 5 min– (3) Explanation question (12 marks) – 15 min– (4) Evaluation question (25 marks) – 30 min

What is core?

• Determinants of macroeconomic performance– Understanding of AD-AS analysis– Using this analysis to explore recent and current economic

behaviour and events• Analysing and critically evaluating a range of

macroeconomic policies (e.g. MP, FP and SS-P)– How do policies work? The transmission mechanism– What are the limitations / constraints of each policy?

• Understanding the external environment and how it impacts on the British economy

• Being aware of how the different macroeconomic topics link together e.g. Inflation and unemployment

Macroeconomic performance and stability

• Domestic objectives:– GDP: Real economic growth (short and long term)– CPI: Price stability (low stable positive inflation)– Achieving higher employment / less unemployment– Higher living standards (i.e. GDP per capita and other

measures of well-being and social welfare)• External objectives

– Sustainable position on the current account of the BoP– Maintaining competitiveness in the global economy

• Restoring and then maintaining economic stability– Smoothing some of the volatility in key macro objectives

such as inflation, growth and unemployment

Trying to achieve macro stabilityTracking three key macroeconomic objectives

Choppy Times! - UK Growth, Jobs and Prices

Source: Reuters EcoWin

90 92 94 96 98 00 02 04 06 08 10

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Pe

rce

nt

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

CPI Inflation

GDP growth

Unemployment Rate

The output gap is negativePercentage, since May 1997 base rates have been set by the Bank of England

Interest rates, growth and the UK output gap

00 01 02 03 04 05 06 07 08 09 10 11

-6

-5

-4

-3

-2

-1

0

1

2

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6

Pe

rce

nt

-6

-5

-4

-3

-2

-1

0

1

2

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5

6

Output Gap

Real GDP growth

Base interest rates

Annual balances for each component, £ billion

UK BoP on Current Account

Source: Statistics Commission BoP Statistics

00 01 02 03 04 05 06 07 08 09 10

bill

ion

s

-100

-75

-50

-25

0

25

50

75

£ (

bill

ion

s)

-100

-75

-50

-25

0

25

50

75

Trade in Goods

Current account

Transfers

Investment income

Trade in Services

Exchange rate - US dollars per £1

The pound (sterling) against the US dollar

Source: Reuters EcoWin

06 07 08 09 10 11

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

2.2

US

do

llars

pe

r £1

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

2.2

Annual % change in UK GDP at constant prices,% of labour force unemployed

Real GDP Growth and UK Unemployment

Source: UK Statistics Commission

05 06 07 08 09 10 11

Pe

r ce

nt

of

the

lab

ou

r fo

rce

-8.0

-6.0

-4.0

-2.0

0.0

2.0

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10.0

Pe

rce

nta

ge

gro

wth

of

GD

P

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Real GDP (Annual % Change)

Unemployment (% of the labour force, LFS)

Oil prices affect AD and SRASDaily closing price for Brent crude oil

World Crude Oil Price - $ Per Barrel

Source: Reuters EcoWin

03 04 05 06 07 08 09 10 110

20

40

60

80

100

120

140

160

US

do

llars

pe

r b

arr

el

0

20

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60

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120

140

160

Jobs and pricesAnnual percentage change in consumer prices, unemployment rate (%)

Prices and Jobs - a Shifting Phillips Curve?

Source: Reuters EcoWin

98 99 00 01 02 03 04 05 06 07 08 09 10 110

1

2

3

4

5

6

7

8

9

Pe

rce

nt

0

1

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3

4

5

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9

Unemployment Rate (LFS)

Inflation Rate (CPI)

Trend growth is falling – why?Source: OECD World Economic Outlook

UK - Potential GDP and Trend Growth

Source: OECD World Economic Outlook

00 01 02 03 04 05 06 07 08 09 10 11 12

tho

usa

nd

bill

ion

s

1.10

1.20

1.30

1.40

Re

al G

DP

£ (

tho

usa

nd

bill

ion

s)

1.10

1.20

1.30

1.40Potential GDP

0.00

1.00

2.00

3.00

4.00

Pe

r ce

nt

pe

r ye

ar

0.00

1.00

2.00

3.00

4.00

Estimated UK Trend Growth Rate

How much borrowing can the UK take?Governemnt debt (top pane) and annual budget balance (bottom pane)

UK Government Borrowing and Debt

Source: OECD World Economic Outlook

00 01 02 03 04 05 06 07 08 09 10 11 12

-12.0

-10.0

-8.0

-6.0

-4.0

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0.0

2.0

4.0

% o

f G

DP

-12.0

-10.0

-8.0

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Annual government budget balance

Budget deficit

Budget surplus

0

20

40

60

80

100

% o

f G

DP

0

20

40

60

80

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Gross Government Debt (% of GDP)

Govt Spending has macro & micro effects

Taxes also have microeconomic effects!

UK exposed to external demand shocks

1. A big rise or fall in the exchange rate2. Recession in major trading partners which

affects the demand for exports3. A prolonged slump in the housing market4. The credit crunch – squeezing the supply of

loans – impact on businesses and consumers5. Unexpected (large) changes in interest rates

or taxes

Y1 Y2

Price Level

LRASAD2

Real National Output

SRAS

AD1

An initial change in AD can have a much greater final impact on equilibrium national income. This is known as the multiplier effect

A fall in aggregate demand

Supply-side shocks

• Supply side can be affected by shock effects• Some of these are negative for growth and inflation – other

supply-side shocks can have a positive impact• SRAS:

– Changes in global food prices– Volatility in the prices of imported raw materials / energy– Changes in import tariffs and other import controls– Changes in indirect taxes on businesses and subsidies

• LRAS– Impact of new technologies on costs and productivity– Long term impact of innovation and invention– Unexpected changes in the size of net labour migration

Price Level

LRAS

AD1

Y1National Output

SRAS1

Yfc

SRAS2

Y2

A fall in SRAS might be caused by higher costs of production – leading to lower supply at each price level

A fall in short run aggregate supply

Price Level

LRAS

AD1

National OutputYfc

SRAS1

Y1

An increase in the supply-side capacity of the economy is shown by shift in LRAS

LRAS2

Yfc2

An increase in productive potential

Macro Evaluation (1)

1. Most macro problems have multiple causes2. No single macro policy works in isolation3. Combination of policies needed for short & longer term

1. Demand side policies and supply side policies2. Be clear on the main ideas behind Keynesian macro theory

4. Remember – economics is a social science – we can never be certain about how people will respond

5. Expectations and confidence are crucial – e.g. Weak animal spirits during the early stages of a recovery

6. Policy time lags are uncertain e.g. The time lag between economic recovery and falling unemployment

7. Use data to support or reject a point of view8. Question reliability of the data – especially if out of date

Macro Evaluation (2)

• Importance of macro awareness / knowledge1. It is crucial that you show an awareness of what is actually

happening in the British economy2. Use extracts in your answer to Q (3) – make at least three explicit

data references in your final answer (from charts, table and text)3. Also show awareness of events / issues in other countries – useful

for comparative illustrations e.g. Events in the USA, Europe, China

• AD-AS analysis must always be used as foundation to show impact on output, prices, employment

• The UK is an open economy vulnerable to external events • Remember to offer a clear final conclusion in the 25 mark Q

– this is essential to get a level 5 answer in the 25 marker

Evaluation phrases

• However• Hence• Nevertheless• Although• It is likely that• With the benefit of hindsight• On the other hand• In the short run …….. but in the long run• It depends upon (e.g. price elasticity of demand, what happens to

the exchange rate, etc.)• The data suggest that ... But the data in the extract is out of date• According to the article the writer argues that …… but

Remember the Wee-Steps Approach

W Wider context – consider the bigger picture in an issue and use it to weight your arguments

E Efficiency – Does this achieve a more/less efficient allocation of resources?

E Equality – Do some parties benefit more/less than others from a policy change?

S Scope – How many people are affected by the point? Is it wide reaching or narrow?

T Time – How long will it last, SR or LR or both?

E Effectiveness – does it solve the issue it was intended to solve? Are there better alternatives?

P Prioritisation – which of your points is the strongest and why. Be specific about the context of the question – use this in your final paragraph

S Scale or Magnitude – where people are affected how strong is the impact?

% change unless stated 2009 2010 2011

Consumer spending -3.3 1.3 -0.5

Government consumption 1.0 1.2 -1.0

Investment -15.4 3.5 5.5

Stock-building (% GDP) -1.2 0.1 0.5

Domestic demand -5.5 2.7 0.8

Exports -10.1 5.3 6.5

Imports -11.9 8.0 3.5

GDP -4.9 1.7 1.5

UK economy at a glance

% change unless stated 2009 2010 2011

Manufacturing output -10.7 3.8 4.0

Company profits -7.5 1.0 3.0

Unemployment LFS measure (%) 7.6 7.9 8.6

Unemployment CC measure (%) 4.9 4.8 5.3

Average earnings (inc. Bonuses -0.1 2.2 1.0

RPI Inflation -0.5 4.5 3.2

CPI Inflation 2.1 3.3 3.2

Productivity (output per worker) -3.5 1.5 1.7

At a glance (2)

% change unless stated 2009 2010 2011

BoP Current Account Balance (% GDP) -1.7 -2.3 -2.0

Government Budget (Fiscal) Balance (% GDP) -11.8 -10.1 -7.7

Gross government debt (% of GDP) 71.3 77.9 82.6

US Dollar /£ exchange rate (annual average) $1.62 $1.55 $1.40

Sterling / Euro exchange rate (annual average) Euro 1.13 Euro 1.19 Euro 1.22

Monetary policy: Base (policy) interest rate (%) 0.5 0.5 0.50

10-year UK government bond yield (%) 4.1 3.7 2.75

World economic growth -0.8 4.5 3.5

At a glance (3)