H1 Econ Revision Lecture Oct 2018

Transcription

1 H1 Econ Revision Lecture 6 19 Oct 2018

2 Recall Case Study Skill You have to guess the breakdown of mark allocation so that you do not overwrite (by now, you should know what is the opportunity cost). You should make reference to extract if applicable. If you run out of time, strategise whether you want to do the questions with low mark weightage (low order questions) or with high mark weightage (high order questions) based on your strength.

3 Selected part questions from DHS Mid Year Paper 2018: Question 1 Policy Approaches in the Euro Area (d) Using AD/AS diagrams, explain how the stimuli of a fall in oil prices (Extract 1) and a weakening Euro (Extract 1) could contribute to economic recovery in the euro area and comment on likely reasons why the pace of recovery remains disappointing. [8] (e) Explain how still high unemployment (Extract 3) and aging of the population (Extract 3) may impact a country s productivity. [4] (f) Evaluate the appropriateness of policy approaches governments in the euro area may adopt or have adopted to address economic stagnation (Extract 3) and below target inflation (Extract 2). [12] (g) Driven by robust domestic demand and supported by growth in government expenditure, GDP growth in the German economy in 2016 was 1.9%, the best year of annual expansion since [Source: Financial Times, ] Discuss whether economic growth will always reduce unemployment. [10]

4 (d) Using AD/AS analysis, explain how the stimuli of a fall in oil prices (Extract 1) and a weakening Euro (Extract 1) could contribute to economic recovery in the euro area and comment on likely reasons why the pace of recovery remains disappointing. [8] Guess the breakdown of mark allocation Explain 5m Must explain fall in oil prices AND weakening Euro (Extract 1), link to economic recovery Comment 3m Provide comment why pace of recovery is disappointing i.e. recovery is very slow or weak

5 Lower oil prices reduce firms costs of production in the economy, thereby resulting in an increase in short run aggregate supply (SRAS). This leads to an economic expansion as real GDP increases and unemployment falls. This expansion results in a falling general price level [2].

6 A weakening Euro against other currencies makes exports out of the euro area cheaper in terms of foreign currency. Assuming price of exports remains unchanged in domestic currency, demand of export would increase resulting in a rise in export revenue in Euro. The imports into the euro area has become more expensive in terms of the domestic currency (Euro). This results in a fall in the quantity demanded of imports assuming demand for import is price elastic. Hence import expenditure in Euro fall. Net exports (X M) would increase and the aggregate demand of the euro area increases. An increase in aggregate demand causes real GDP and employment to increase via the multiplier effect [2].

7 Use AD/AS diagram to illustrate above explanation. Should make reference to diagram when explaining the answer. [1]

8 Up to 3 further marks for valid and relevant explanation of two possible reasons why the stimuli did not contribute to strong recovery. There are many possible reasons that can be provided. Preferred answer is to provide comments that are linked to AD and AS.

9 Weak external demand due to economic problems faced by emerging countries, including China, might have nullified the effect of a weakening Euro hence AD might increase by a small extent only. A weakening Euro would also contribute to cost push pressures that would cause short run aggregate supply to fall, in which case, equilibrium real national income would fall with higher unemployment and general price level, effectively reversing the stimulus of lower oil prices. Other reason include weak consumer and business sentiments as well as unemployment remaining high in the euro area that might also have dampened domestic demand hence nullified the effect of a weakening Euro.

10 (e) Explain how still high unemployment (Extract 3) and aging of the population (Extract 3) may impact a country s productivity. [4] Guess the breakdown of mark allocation 2m for each explanation

11 Recall the meaning of productivity Productivity refers to the output per man hour. You need to infuse this definition in your answer. Still high unemployment will likely result in the erosion or deterioration of skills since those who are without work over an extended period of time do not have opportunities to utilise their skill sets. Motivation levels will also wane. Consequently, the average output contributed by each worker per man hour will reduce, lowering the productivity.

12 Aging of the population means that people in higher age groups will gradually form a larger proportion of the workforce. Beyond a certain age, health issues and the obsolescence of skillsets, as well as lower levels of motivation and adaptability may reduce the productivity of workers, notwithstanding the higher levels of experience older workers may have.

13 (f) Evaluate the appropriateness of policy approaches governments in the euro area may adopt or have adopted to address economic stagnation (Extract 3) and below target inflation (Extract 2). [12] Guess the breakdown of mark allocation Analysis 9m Must explain how policies work to achieve rise in AD and/or AS to achieve economic growth and rise in general price level (to counter the possibility of deflation) Evaluative Comment 3m Provide comment whether the policies are relevant and/or effective to address economic stagnation (slow growth) and below target inflation

14 Suggested approach to write the answer Due to time constraint, focus on 2 policies with coverage on AD and AS Explain how each policy is used to achieve the objective/goal then explain the strength/weakness. Provide an overall conclusion on whether the policies are relevant and/or effective.

15 Monetary stimulus as a policy approach (Explain how it works) Extract 2 mentioned that European Central Bank cut interest rates (to an all time low) and provided new ultra cheap credit (very low cost of borrowing) to commercial banks which they are obliged to lend to companies. This is an expansionary monetary policy aimed to increase AD to achieve economic growth and rise in general price level. Show AD/AS diagram. The increase in AD spurred by higher private consumption and investment spending will allow for idle resources to be utilised and the output gap to be narrowed as real national income increases towards the full employment level of real GDP (economic recovery). At the same time, domestic price pressures will build up as previously unutilised resources are now reemployed in production (competition for factor inputs will bid up resource prices that eventually feed into product prices) and, if sustained, will facilitate a robust return of inflation back to a level closer to the target.

16 Monetary stimulus as a policy approach (Explain the strength/weakness) The strengths of monetary policy include relative ease of implementation with the ability to fine tune the economy through incremental adjustments of interest rates. If the interest rate is already very low (near to zero), such policy will not be effective unless the ECB implements negative interest rate policy. Such MP does not face the problem of budget constraint or crowding out effect.

17 Supply side policy as a policy approach (Explain how it works) Monetary policy may not be able to improve the business climate and create favourable economic conditions for investment and enterprise. This could be due to structural issues such as labour market rigidities, high cost of doing businesses, low productivity level (Extract 3), excessive protection for workers etc. Implementing market orientated supply side policies in the form of labour market reforms or deregulation may be relied upon to create conditions that allow competitive market forces to function well. This not only encourages investment, enterprise and spending by firms but also support potential growth. Governments could also introduce interventionist measures in the form of incentives (e.g. tax cuts or subsidies) to encourage investment spending in research and development. If policies are implemented successfully, higher productivity coupled with lower business cost will make exports more price competitive leading to increase in AD. In addition, the increase in potential output in the long run prevents overheating.

18 Supply side policy as a policy approach (Explain the strength/weakness) Structural reforms through market orientated and interventionist SSP may help to solve the root cause of the problem which is aging population and low productivity level. The policy takes very long to take effect and depends on whether the workers are willing and able to acquire higher knowledge and new skills.

19 (Conclusion Evaluative Comment on the AD) AS shown in Table 1, inflation has been very low from 2013 to 2016, real GDP growth rate is below 2% during this period with high unemployment rate of greater than 8%. Lowering interest rates and provision of ultra cheap credits would raise AD to achieve higher economic growth and higher inflation rate. However if households and firms are very pessimistic that the economy will not do well (such as unfavourable economic effect from Brexit), they may choose to save than to spend. While this policy is considered appropriate, the demand management policy implemented alone is not sufficient. It should be complemented by expansionary fiscal policy where government play an important role to pump prime the economy by spending.

20 (Conclusion Evaluative Comment on the AS) SSP to lower business cost and raise productivity is appropriate as it tackle the problem of aging population in the euro area. However it does not solve the problem in the short run as it is a long term policy. In the short run, the government in the euro area should consider providing subsidies or rebates on rentals and utilities to temporarily lower the business cost in the economy. [Provide an overall stand] The policies of expansionary MP and SSP as explained above are appropriate but they ought to be complemented with expansionary FP and short term measure to lower business cost.

21 (g) Driven by robust domestic demand and supported by growth in government expenditure, GDP growth in the German economy in 2016 was 1.9%, the best year of annual expansion since [Source: Financial Times, ] Discuss whether economic growth will always reduce unemployment. [10] Guess the breakdown of mark allocation Analysis 7m Must explain how economic growth may OR may not lead to lower unemployment. Thesis, Anti thesis approach Evaluative Comment 3m Provide comment whether the economic growth ALWAYS reduce unemployment.

22 Thesis: Economic growth will reduce unemployment Economic growth due to the expansionary phase of the business cycle will cause cyclical unemployment to fall. Suppose an economy is experiencing an output gap due to insufficient aggregate spending, economic expansion through increased private consumption and government spending will allow the economy to move closer to its full employment level of real GDP. As firms increases output to meet rising demand, more resources including labour will be utilised. The creation of employment opportunities makes it possible for previously unemployed workers to find jobs. Thus economic growth can reduce cyclical unemployment. Show AD/AS diagram to illustrate. If economic growth makes available resources with which government is able to introduce interventionist measures that invest in human capital, then structural unemployment may reduce.

23 Anti thesis: Economic growth may not reduce the level of unemployment In certain situations, economic growth may itself lead to increase in structural unemployment. This could occur when growth results from technological utilisation leading to a fall in the demand for certain labour skills or innovation that reduces the intensity of labour in production. In developing countries, growth could result from the introduction of technologies (such as capital intensive technologies), which would cause unemployment to rise. Marketoriented policies that governments implement to introduce greater productivity or efficiency in markets may also cause unemployment to rise. This is more relevant when the power of trade unions are greatly reduced. Depending on the main causes of unemployment (labour market rigidities or structural changes) in an economy, economic growth may not reduce the level of unemployment.

24 (Conclusion Evaluative Comment) In addition, up to 3 further marks for evaluative comment. This may be to focus on the always term in the stem of the question. Depending on how growth is pursued by a government, and the policy response to help the workforce cope with the effects of growth, as well what may be the main causes of unemployment in a country, economic growth may not always reduce the level of unemployment

25 (Conclusion Evaluative Comment) Economic growth may create job opportunities in certain expanding industries while causing retrenchment in some sunset industries so the overall effect on unemployment will depend on the number of jobs created compared to the number of jobs lost. While more jobs could be created, if workers do not have the necessary knowledge and skills, they would still face the problem of structural unemployment. If government is able to provide subsidies to encourage workers to acquire the necessary skills, the problem of structural unemployment would be reduced over time. [Provide an overall stand] If the pace of economic growth is moderate and the workers are motivated to acquire new skills and knowledge relevant to the booming industries, economic growth should reduce unemployment.

26 Learn from Dumbo Believe that you can do it!

27 Your actual ability is higher than your perceived ability!