How the Macroeconomy Works (AQA A Level Economics): Exam Questions

Extract D

Figure 3: UK household gross debt to income, 2006 to 2020

Figure 4: Household saving ratio, 2006 to 2016 

 Extract C: Free market, supply-side labour market reforms Free market supply-side reforms often focus on either encouraging individuals to take up work by making it more attractive, or by making it more difficult for people to remain on unemployment-related benefits. A feature of recent government supply-side policy has been to create and maintain flexible working practices. The Confederation of British Industry (CBI) argues that “the UK’s flexible labour market is an invaluable strength of our economy which should be protected”. The UK’s employment rate is the highest since recent records began in 1971, and 97% of firms say the UK’s flexible labour market is vital to improving firms’ competitiveness.

Having a flexible workforce, which can respond quickly to changes in demand, may benefit both businesses and workers. There is a growing need for workers to have more flexibility, whether to allow them to balance work with such things as childcare, study commitments or as an alternative income when work in their preferred occupation is unavailable. Some labour market analysts also point to flexible labour markets as one of the key reasons that, after the recession of 2008–09, unemployment did not reach the levels it did in the recessions of the 1980s and 1990s.

Some point to the fact the UK has the least-regulated labour market in Europe. Hiring and firing staff is easier than in countries such as France, where the difficulty of getting rid of unproductive workers makes firms more cautious about employing someone in the first place. Improving workers’ productivity is the key to increasing real GDP and real wage rises. Having a flexible workforce allows the UK to meet the challenges of a dynamic global economy. It not only helps keep unemployment low, but also helps achieve other macroeconomic objectives.

Source: News reports, 2018

Extract E: Deficit reduction

In 2017, the Chancellor of the Exchequer claimed that the government was on course to create a budget surplus by 2025. However, the Office for Budget Responsibility (OBR) has suggested that the budget deficit will not be wiped out until 2031. This is 16 years later than originally forecast.

The Government borrowed £52bn in 2016–17, a fall of £20bn compared to the year before, as the long struggle to eliminate the deficit moved closer towards its goal. However, the OBR has forecast a ‘weaker’ economy than it did just nine months ago; it expects economic growth to slow and government borrowing to rise as a result. The OBR also delivered the biggest downgrade to productivity growth in its history, with output per hour expected to be 4.6% lower in 2022 than originally forecast.

The financial crisis of 2007–08 led to a budget deficit of almost 11% of GDP in 2009–10; the deficit has now fallen to 2.6% of GDP, the lowest level of borrowing since 2007–08. If growth could be increased, the budget deficit would fall much faster.

Why is deficit reduction so important in the first place? Firstly, there are the negative effects of larger interest repayments caused by a higher national debt. There is also the argument that public spending crowds out the private sector. Some economists point to the effects on future generations and the possibility that the government’s credit rating may fall if borrowing is high.

Source: News reports, 2017

Extract B: Is India still a developing country?

Every region of the world has seen improvements in its HDI and India, in particular, has seen major changes. Job creation is a key aspect of development. However, 95% of all workers in India are in informal employment where there is no monitoring or taxation. Nearly 120 million more workers will enter the Indian labour force over the next 10 years seeking manufacturing jobs but, so far, these jobs have not appeared. Manufacturing still counts for less than 20% of all jobs and more than half of all workers are in low productivity agriculture. The large amount of informal employment also reduces tax receipts, which limits the amount the Indian government can spend to improve the economy.

India is still a very poor country with low per capita income, widespread destitution, hunger and malnutrition. Moreover, it has poor health facilities, housing and infrastructure as well as slowly expanding education and a strong reliance on foreign aid. Despite the emergence of a rising middle class, inequality is growing and the majority of the population lack basic social and economic rights. The Indian government must find a way to do more to provide for its citizens. However, when the government has intervened in the economy, it has often resulted in failure. Some say the Indian government should adopt the Chinese model of export-led industrialisation.

Until the early 1990s, India was a closed economy: average tariffs exceeded 200%, quotas on imports were extensive and there were restrictions on foreign investment. India still protects its economy with anti-dumping measures and export subsidies that are designed to promote economic growth. In the past, nearly all advanced economies have benefited from protectionist policies, why should India be any different?

Source: News reports, 2016

Extract B: What is GDP?

Imagine £50 notes stacked on top of each other, stretching almost 4500 kilometres into the sky. This fantastically large amount of money (more than £2 trillion) is the current estimated value of the UK’s Gross Domestic Product (GDP).

GDP is the standard measure of the size and health of a country’s economy but it is important to distinguish between nominal and real GDP. It’s the way we measure and compare how well or badly countries are doing. In other words, it is the total value of the output of goods and services produced in an economy over a period of time. The higher the value of GDP, the bigger the economy. If injections into an economy’s circular flow of income increase, then this may generate multiple increases in GDP, depending upon the size of the marginal propensity to consume.

Why is the measurement of GDP important? Well, it’s a way of keeping track of how the economy is doing, and whether it is growing. We can also use it to measure one economy against other economies using purchasing power parity exchange rates. If real GDP goes up, the economy is doing well; this is associated with higher incomes, more jobs and higher spending. If real GDP goes down, the economy is not doing so well; this is associated with falling incomes, lower consumption and a lower standard of living.

In November 2022, the UK government announced large public spending cuts and tax rises in order to reduce the budget deficit. Some economists worry that this may cause a negative multiplier effect and damage economic activity.

Throughout 2021 and 2022, the UK suffered from supply-side problems which caused prices to rise. Within an economic cycle, there are often trade-offs between different macroeconomic objectives. However, many economists argue that the government should do more to reduce the likelihood of these trade-offs persisting in the long run.

Extract B: Government debt: a Greek tragedy

In 2018, after years of tough government spending cuts (austerity), the Greek government emerged from its third and final international financial rescue package, although economists warned that the country still had a “long way to go”. The European Union (EU), the European Central Bank (ECB) and the International Monetary Fund (IMF) have loaned Greece a total of €289bn (£240bn) since 2010.

The EU and IMF insisted that, in return for help, economic reforms were necessary to reduce Greece’s structural budget deficit. For many Greeks, especially the young, the years of economic hardship were severe. Higher taxes and reduced salaries and pensions led to riots on the streets. The government spending cuts also severely damaged private-sector jobs. In 2012–13, the unemployment rate peaked at 27.5%, but for those under 25 it was 58%. Eight years after austerity began, GDP was 25% below its 2010 level.

How did Greece find itself in this position in the first place? In 2007–08, the global financial crisis caused a worldwide recession. Many countries had huge government debts, but Greece was the worst affected with an unsustainable budget deficit following years of high government spending. In 2010, the country revealed the size of its huge budget deficit which led bond yields to soar and to a sovereign debt crisis. International lenders labelled Greek debt as ‘junk’ and the Greek Government was unable to borrow on financial markets. Greece was forced to ask for financial help.

But what now? In 2019, the Greek economy grew by 1.9%. It had a budget surplus (excluding interest payments on its debt) and the unemployment rate had fallen below 20%. However, the pandemic has harmed the Greek economy and the Greek government’s budget is again in deficit.

Source: News reports, 2020

The savings ratio is the proportion of national income that is saved. The UK savings ratio reached 10.6% in 2015 but fell to 3.9% in 2017. This indicates rising consumption and a fall in savings across the economy. Economists debate whether or not this change in consumption and savings is beneficial.

The savings ratio is the proportion of national income that is saved. The UK savings ratio reached 10.6% in 2015 but fell to 3.9% in 2017. This indicates rising consumption and a fall in savings across the economy. Economists debate whether or not this change in consumption and savings is beneficial.