Sample Answer (Unit 2 - Managing the Economy)

Managing the Economy

Unit 2 (Previously Unit 3) - January 2006 - Question 1 - parts (b) and (d)

b) Using an aggregate demand and aggregate supply diagram, examine the likely implications for the UK economy of imposing ‘more regulations on businesses’ (7)

• Diagram with AS shifting left
• Imposition of increased regulations means an increase in COP, e.g. businesses have to hire extra people or work longer hours to make sure they are complying with regulations, extra costs to change production methods if they are not.
• AS shifts left, prices rise, output falls.
• Evaluation (2 marks)
• Businesses may increase attempts to enhance productivity levels. This results in a fall in costs since each unit of input is now more productive, and thus AS may eventually shift right, offsetting the effects of the regulation.
• Increased regulations may cause confidence levels to fall, causing investment and therefore AD to fall as well.

d) To what extent might ‘shifting resources… into the public sector’ (line 10) assist the government in achieving its macroeconomic objectives? (15)

• Shifting resources into the public sector implies expanding fiscal policy and spending more in the public sector, e.g. higher budgets to government offices
• This attempts to stimulate AD, which should lead to an increase in price and output levels. Can draw diagram here.
• Increase in employment
• By spending more the government will expand the public sector, which will involve more jobs being created, higher employment levels
• However this may be offset if there is a decline in the private sector job opportunities. Government spending alone will not be enough to carry a sustained rise in job opportunities.
• Economic growth
• If government investment is towards infrastructure, e.g. roads and telecommunications, productivity in the country may be increased.
• This would stimulate confidence and investment in the economy, which would lead to higher growth rates.
• However productivity in the government sector itself is very low, e.g. 10.2% increase in spending à only 1.7% increase in output
• Inflation
• Increased government spending leads to a danger of demand pull inflation. That is, as spending power rises, C and I begin to rise, causing AD to increase, thus increasing the price level.
• Evaluation: There is an inherent conflict between expansionary fiscal policy and inflation rates; the extent of the problem depends on the level of increase in the government’s spending. Also, depends on whether there is potential growth, i.e. whether AS shifts out.
• BOP deficit
• If government spending encourages productivity, and thus make UK products more competitive, then exports will increase.
• Evaluation: But as incomes increase due to more job opportunities, the additional income may simply be spent on more imports. This would worsen the BOP.

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