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SECTION A Answer ALL questions. Write your answers in the spaces provided. Use the data to support your answers where relevant. You may annotate and include diagrams in your answers. 1. The diagram shows Euros to the £ between 2005 and 2014. 1a) Define the term ‘exchange rate’. (1) ______________________________________________________________________________ ______________________________________________________________________________ 1b) Explain one factor that might lead an exchange rate to fall in value. (2) ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 1c) Which statement below is the most accurate summary of the data. A. The Euro fell sharply between late 2007 and 2009, but recovered a bit in 2014 B. The £ fell from around €1.45 to €1.10 between 2007 and 2009 but has been recovering since C. The Euro fell from around €1.45 to €1.10 between 2007 and 2009 but has been recovering since D. The £ was stable prior to 2007 and was stable again between 2009 and 2014 State your answer here __________ 2. Look at this data on components of the Consumer Prices Index Jun 2013 Jun 2014 Jun 2015 Food (retail) 143.2 143.2 140.1 Clothing 81.4 83.4 82.8 Restaurants 129.3 132.6 135.1 Source: ONS July 2015: CPI measures of inflation. Index 2005 = 100 2a) Define the term ‘index’. (1) ______________________________________________________________________________ ______________________________________________________________________________ 2b) Calculate the % rate of deflation that took place between June 2014 and June 2015. ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 2c) Which one of the following conclusions is correct based on this data table? A. The price of clothes has fallen nearly 20% in the past ten years B. The cost of eating out rose by 5.8% in the two years to June 2015 C. The indexed data shows that, in June 2015, people spent more on restaurants than clothing D. Food prices fell by 3.1% between 2014 and 2015 State your answer here __________ 3a) An injection of £10,000 into the economy eventually leads to £5,000 in extra saving, £35,000 of extra consumption and £40,000 of extra income. Therefore the multiplier can be calculated as: A. 8 B. 0.5 C. 4 D. 3.5 State your answer here __________ 3b) Define the term ‘injection’. (1) ______________________________________________________________________________ ______________________________________________________________________________ 3c) Explain one circumstance in which the multiplier may fail to work in an economy. (2) ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 3a) The rate of growth in prices 3b) The rate of growth in productivity 3c) UK income measured against major rivals such as America 3d) The rate of exchange, e.g. $s to the £ 4. This UK data shows the rate of private sector investment in manufacturing (1998-2015) £ms Private sector investment in manufacturing (Quarterly figures in £m constant prices and seasonally adjusted, ONS) 8000 7396 7000 5930 6000 5000 4000 4232 3000 2000 2015 Q1 2014 Q3 2014 Q1 2013 Q3 2013 Q1 2012 Q3 2012 Q1 2011 Q3 2011 Q1 2010 Q3 2010 Q1 2009 Q3 2009 Q1 2008 Q3 2008 Q1 2007 Q3 2007 Q1 2006 Q3 2006 Q1 2005 Q3 2005 Q1 2004 Q3 2004 Q1 2003 Q3 2003 Q1 2002 Q3 2002 Q1 2001 Q3 2001 Q1 2000 Q3 2000 Q1 1999 Q3 1999 Q1 1998 Q3 1998 Q1 4a) Define the term ‘investment’. (1) ______________________________________________________________________________ ______________________________________________________________________________ 4b) Calculate the % decline in investment spending between the peak and the trough in 2008/09. ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 4c) Which of the following is the best summary of the data presented in the graph? A. The pattern shown is typical of the standard economic cycle. B. The data has broken out of a broadly downward trend and is rising healthily. C. Investment is still below the 1998 level, which is especially disappointing given inflation over this time. D. Between the 2009 trough and the most recent period, investment spending has risen by 42.8%. State your answer here __________ 5a) A setback to economic growth caused by deteriorating infrastructure would be represented as: A. A rightward shift in the long run aggregate supply curve B. A rightward shift in the short run aggregate supply curve C. A leftward shift in the short run aggregate supply curve D. A leftward shift in the long run aggregate supply curve State your answer here __________ (1) 5b) Define the term ‘aggregate supply’. (1) ______________________________________________________________________________ ______________________________________________________________________________ 5c) Explain what an economist means by the term ‘long run’. (2) ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ End of Section A SECTION B Read Figures 1 and 2 and extract (A) before answering Question 6. Answer ALL Questions 6(a) to (e), and EITHER Question 6(f) OR Question 6(g). Q6. UK economy in 2015 Extract A Main points from Office of National Statistics Press Release on latest GDP figures Change in gross domestic product (GDP) is the main indicator of economic growth. GDP is estimated to have increased by 0.7% in Quarter 2 (Apr to June) 2015 compared with growth of 0.4% in Quarter 1 (Jan to Mar) 2015. Output increased in 2 of the main industrial groupings within the economy in Quarter 2 (Apr to June) 2015. Services increased by 0.7% and production increased by 1.0%. Construction growth was flat. In contrast agriculture decreased by 0.7%. GDP was 2.6% higher in Quarter 2 (Apr to June) 2015 compared with the same quarter a year ago. In Quarter 2 (Apr to June) 2015, GDP was estimated to have been 5.2% higher than the preeconomic downturn peak of Quarter 1 (Jan to Mar) 2008. From the peak in Quarter 1 (Jan to Mar) 2008 to the trough in Quarter 2 (Apr to June) 2009, the economy shrank by 6.0%. The preliminary estimate of GDP is produced using the output approach to measuring GDP. At this stage, data content is less than half of the total required for the final output estimate. The estimate is subject to revision as more data become available, but these revisions are typically small between the preliminary and third estimates of GDP. Extract B. UK economy powers ahead by 0.7% Britain’s economic growth bounced back in the second quarter of the year, fanning the debate about the timing of the first rise in interest rates since the financial crisis. Growth in the three months to June stood at 0.7%, according to official figures, following a below-par rise of 0.4% in the first quarter. The second-quarter number was in line with City expectations, but the services sector fuelled the growth as manufacturing declined, prompting warnings from economists that the recovery is being powered by a two-speed economy. There were signs, however, that living standards are returning to their pre-crisis levels after the Office for National Statistics said GDP per head was now “broadly equal” to the first quarter of 2008, before the banking crisis drove the UK into recession. Britain’s GDP-per-head is finally back to its pre-crisis levels, but factories are struggling to grow. Vicky Redwood, chief UK economist at Capital Economics, said growth was unbalanced. “The services sector drove the rise in GDP, while construction output was flat and manufacturing output fell. But at least it looks as though productivity growth is continuing to pick up,” she said. Economists were looking for clues for the timing of change to interest rates, which have been at a low of 0.5% since March 2009, after the warning earlier this month from Mark Carney, the governor of the Bank of England, that a rise in interest rates was “moving closer”. The Bank’s monetary policy committee will be giving its view on rates on 6 August, amid expectations that there could be a split among its nine members. “We suspect that two members of the MPC may well vote for a rate hike in August although there may not be critical mass until February next year,” said James Knightley, an economist at banking group ING. The strength of sterling was blamed by some economists for the 0.3% fall in the manufacturing sector, and after the data was released the pound rose again against the dollar and the euro as investors continued to bet on an interest rate rise perhaps as soon as the end of the year. “Sterling strength has clearly been a key driver behind the re-emergence of the two-speed economy, making life more difficult for export focused UK manufacturers,” said Victoria Clarke at stockbrokers Investec. Source: The Guardian July 28th 2015 Extract C Data extracted from ONS July 2015 report on latest GDP preliminary estimates Distribution of UK GDP output by sector Source: ONS 2011 weights Agriculture 0.6% Government services, 23.4% Other private services, 41.1% Industrial production 14.6% Construction, 6.4% Hotels & Restaurant s, 13.9% UK GDP Index based on 2011 = 100 2011 2nd Q 2015 Agriculture 100 99.2 Industrial production 100 101.1 Construction 100 104.3 Hotels/Restaurants 100 114.4 Other private services 100 112.0 Government services 100 103.5 6a) Explain why ‘sterling strength’ might be especially difficult for ‘export-focused UK manufacturers (Extract B). [5 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 6b) From the data in Extract C, calculate the ratio between agricultural output and the value of the output of government services. [4 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 6c) In 2010 George Osborne announced a plan to rebalance the economy towards manufacturing and industrial production. Using Extract C, explain two features of the data that relate to this objective. [6 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 6d) Assess whether the fall in manufacturing output should be blamed on ‘the strength of sterling’. [10 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________________ 6e) Using the data in the extracts and your economic knowledge, discuss the possible effects on the U.K.’s macroeconomic performance of a rise in interest rates. [15 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ 6f) Evaluate whether economic policies adopted by the UK government or the Bank of England can prevent a future recession. [20 marks] OR 6g) Evaluate whether economic policies adopted by the UK government or the Bank of England can boost significantly the long-term growth rate of the British economy. [20 marks] ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ ______________________________________________________________________________ End of questions ANSWERS 1a) The value of a currency measured by how much foreign currency it can buy. 1b) A sharp fall in export sales would mean a fall in demand for the currency on the foreign exchange markets – which would push its value down (ceteris paribus) 1c) B 2a) An index means taking one period within a time series, letting it equal 100, then relating all the other data to that figure of 100. 2b) 2.2% (i.e. prices fallen by 2.2%) 2c) A 3a) C 3b) An economic factor that pushes spending power into an economy, such as an export boom or an investment boom; it adds to the circular flow of national income 3c) If the withdrawals from the circular flow are considerable (too many imports or too big a tax take) the multiplier would be very low, i.e. have very little impact 4a) Investment is spending today on assets that will return an income stream in the future 4b) The decline is 28.6% (5930 – 4232 / 5930 x 100) 4c) B 5a) D 5b) The sum total of all the items produced by all the companies within a market sector over a period of time. 5c) The long run is how long it takes for all the factors of production to become variable; this might be 12 weeks for a restaurant and 12 years for a nuclear power plant UK economy in 2015, question 6 6a) Explain why ‘sterling strength’ might be especially difficult for ‘export-focused UK manufacturers’ (Extract B). [5 marks] Sterling means the British pound; strength means that its value is highly rated on the foreign exchange markets, allowing each pound to buy more of any foreign currency (ceteris paribus) For many manufacturers a stronger £ means export pain cancelled out by importer gain (tougher export prices cancelled out by cheaper import costs) For ‘export-focused’ manufacturers, the import cost benefits are probably outweighed by the export difficulties in keeping export customers on-side 6b) From the data in Extract F, calculate the ratio between agricultural output and the value of the output of government services. [4 marks] The ratio is 1:39, i.e. 0.6% is 1/39th of 23.4% 6c) In 2010 George Osborne announced a plan to rebalance the economy towards manufacturing and industrial production. Using Extract C, explain two features of the data that relate to this objective. [6 marks] The most striking thing is that in this period of supposedly unparalleled government austerity, even government spending has risen faster than industrial production since 2011 And private sector services such as hotels & restaurants have enjoyed hugely greater growth than industrial production, growing by 14.4% since 2011 compared with 1.1% for industrial production 6d) Assess whether the fall in manufacturing output should be blamed on ‘the strength of sterling’. [10 marks] Exports are a huge element in the income of UK manufacturers (manufacturing is 10% of UK GDP but 50% of UK exports), so the exchange rate will have a powerful effect on UK producers’ profits and output levels When sterling is strong exporters face a choice between two evils: hold overseas prices constant to maintain sales volumes and market share – but suffer lower sterling income per unit after the foreign currency has been converted into £s; or push overseas prices up to maintain UK profit margins per unit, but suffer a loss of sales volume that will be determined by the size of the price rise, the PED of the export, and the actions of your competitors If UK manufacturing output has fallen as a result of the £’s strength, presumably companies have been pushing up their overseas prices and suffering a sales decline as a result In fact, though, a 0.3% decline in manufacturing in one month is no basis for drawing conclusions; in economics, one month’s data is never enough to draw firm conclusions 6e) Using the data in the extracts and your economic knowledge, discuss the possible effects on the U.K.’s macroeconomic performance of a rise in interest rates. [15 marks] A rise in interest rates has the potential to dampen business investment (which affects AD in the short term, but AS in the long term) and to dampen consumer spending; higher interest rates push up the cost of mortgages and the cost of buying goods such as cars on credit; so consumers have less disposable income for other things such as posh watches or exotic holidays In recent years a great concern has been the disappearance of productivity growth; the longterm performance of the economy hinges on the return to historic levels of growth (2% a year); higher interest rates would logically be a hindrance to productivity growth (though the worst-ever run of productivity growth has coincided with the lowest-ever interest rates); most economists would still assume that higher interest rates would mean lower business investment leading to lower productivity growth and therefore weaker GDP growth/economic performance Extract F shows that UK economic growth is being stimulated mainly by quite rapid increases in sales of private sector services; as this is the largest sector of the economy (and the main element of consumption [C]) this growth is very important; higher interest rates are unlikely to dampen this type of spending much if at all; so real GDP would be largely unaffected by this issue By contrast construction might be hit quite hard; rising interest rates will choke off the rising demand for houses and a flatter housing market will lead to a reduction in housebuilding; higher interest rates will also hit the building of house extensions, lofts and other quite major projects; fortunately construction only represents 6.4% of the whole economy, so its impact will be limited in relation to economic performance One other measure of economic performance is the rate of inflation; any upward pressure on prices would be eased by a rise in interest rates, most obviously it will cut demand-pull inflation, but it will also – in the medium-long term – cut cost-push pressures as well; higher interest rates tend to push up the value of the currency, and a stronger pound will cut the prices of imports – so cost-push pressures will be eased Overall, a rise in interest rates by perhaps 0.5% would have little impact on the economy, but because families are still highly indebted, a bigger rise might have a severe effect on consumer spending and therefore – ultimately – UK economic performance 6f) Evaluate whether economic policies adopted by the UK government or the Bank of England can prevent a future recession. [20 marks] A recession is widely defined as two successive quarters of negative growth, i.e. falling real GDP Recessions can come from within or without; perhaps internally-generated recessions can be avoided, but it’s very hard to see how an economy as international as the UK’s can avoid recessions started elsewhere In the UK, recessions have nearly always come from within – usually as a result of excessive expansion leading to an unsustainable boom; government fears about the inflationary or the balance of payments effect of the boom might lead to a sharp tightening of economic policy – which would precipitate the downturn; in the lead-up to the 2009 financial crisis the government could be blamed for inaction, but the real problem was the hubris, greed and faulty financial incentives within financial markets Could these problems have been prevented by all-seeing, wise governments plus the Bank? Perhaps yes in theory, but in practice it’s very hard to imagine. Governments have their eyes set firmly on the electoral cycle rather than the economic one – so their approach is compromised; but let’s stick with the thought that an all-wise government is conceivable in theory – without doubt the government plus Bank have the levers to prevent booms and subsequent recessions. But what if economic problems in China spilled over to a recession in the United States which would in turn affect Germany and Britain? Could the UK government prevent a UK recession? The issue here is the international basis of our economy. Whereas America is relatively selfcontained (foreign trade is a small part of GDP) the UK is less so. Therefore a dip in export demand takes quite a bite out of UK GDP; even if UK government tried to counteract that by tax cuts or boosts to public spending, the time lags involved would make it unlikely that the downward pressure of falling exports could be overcome. So an externally-caused recession is something that could always happen. Overall, it would be fair to say that a wisely-run Treasury and Bank could do a huge amount to make recessions relatively unlikely and – if they happen – relatively mild. But ‘prevent’ is probably a step too far. 6g) Evaluate whether economic policies adopted by the UK government or the Bank of England can boost significantly the long-term growth rate of the British economy. [20 marks] Since 1956, every Chancellor has had it in mind to boost long-term growth prospects. The graph below shows how unrealistic it is to believe that economic policy has magic solutions. Indeed the thin black linear trend line shows that growth has been slowing. Interestingly, it is only in the relatively recent past that economists have decided that to boost long-term growth requires supply-side measures. In the period in which the use of fiscal policy has been pushed aside in favour of the supply-side, growth has slowed. % ch % change in quarterly GDP v previous year UK Q1 1956 - Q2 2015 Source: ONS 2015 12 10 8 6 4 2 -2 -4 1956 Q1 1958 Q2 1960 Q3 1962 Q4 1965 Q1 1967 Q2 1969 Q3 1971 Q4 1974 Q1 1976 Q2 1978 Q3 1980 Q4 1983 Q1 1985 Q2 1987 Q3 1989 Q4 1992 Q1 1994 Q2 1996 Q3 1998 Q4 2001 Q1 2003 Q2 2005 Q3 2007 Q4 2010 Q1 2012 Q2 2014 Q3 0 -6 -8 The first problem is to identify the policies that could boost long-term growth for such a mature economy as ours; in effect, there are two areas to consider: how to smooth the path for growth for large businesses; and how to encourage new business to start up and flourish; George Osborne believes that cutting corporation tax is the most important thing to do; in effect, he wants firms to see and be able to use as much as possible of their own profit – and therefore reinvest more and grow faster. This has been tried before by Tory Chancellors, with no success, but George Osborne would argue that never before have the cuts been as great and the timescale been so long. Then comes the issue of whether anything can really make a difference; perhaps being in or out of the EU may be an important matter; and certainly the growth rates in China and India will be of importance to us; but the UK economy has grown by a long-term average of 2-2.5% for centuries; it is hard to think that any government policy decisions will make much difference.
