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Evaluation Booster Pack

This booster pack aims to support you develop your evaluation skills across a series of different economic

topics.

We have selected some of the core theories and models across the AQA, EDEXCEL and OCR specifications of the

A-level economics course and identified some of the potential evaluation points that you can use when writing

an essay on this topic in an exam.

For more economics resources to support your A-level studies, visit https://www.ezyeducation.co.uk/ezyeconomicsdetails.html

and find out more about us!

AQA Edexcel OCR

https://www.ezyeducation.co.uk/ezyeconomicsdetails.html

EzyEconomics Interventions

AO1 - KNOWLEDGE AND UNDERSTANDING

Do you know?

Key Terms Main Theories

Models Core Concepts

AO2 - APPLICATION

See our main course EMAs

Theories Concepts

Real World Economy Examples

Discuss Economic Issues

See our Weekly 5 material

AO3 - ANALYSIS

See our Revision Snapshot

Slides

AO4 - EVALUATION

Impact of Economic Events/Policies

Consumers Producers Government

National Economy Global Economy

Questioning Economic Arguments

Does this hold up in the real economy?

Are alternative outcomes possible?

Are these effects likely to be sustained?

See our Evaluation

BoosterPack

AO4 - SUPPORTED FINAL JUDGEMENT

Answer the question – your opinion

Support with an explanation

See our exam resources

Getting Started with Essays

Essay Checklist

Exam Checklist

Sufficient syllabus knowledge

Exam structure familiarity

Have you practiced reading past exam questions carefully?

This helps you avoid significant question misinterpretations

Can you produce answers that are easy to read and mark?

Legible Handwriting Clear Paragraphing Diagram References

Can you rapidly read and understand unfamiliar extract data?

Interpreting Graphs Percentages, Index Numbers and Ratios

Do you know what you’re required to do in each section before sitting the exam?

Marking criteria knowledge

Do you know how you are assessed in an exam?

Are you comfortable with all the topic points in the exam board specification?

Essay Requirements

Exam Checklist

Develop a discussion that

explains, analyses and

evaluates different

perspectives

Make sure you produce a

supported final judgement

Manage time so answers aren’t

rushed or ruined if time

runs out.

Number 1 Number 2 Number 3

How can you integrate evaluation (AO4) into your essays?

Developing Exam Technique

All economics essays should have this general structure…

Introduction

Build answer

Build answer

Build answer

Summary and FSJ

Summary and FSJ

Page 1 Page 2 Page 3 Page 4

Make a point drawing on extract or own

knowledge

Develop with an explanation

Highlight any issues/alternatives and

try to set up a link to the next point

One paragraph per point, no more than 3 sentences

Repeat process through each paragraph – gaps between paragraphs

Refer to extract if extract supports what you have said + use own examples

Question focus always means the answer will be an either/or - you need to state your preference and explain why

Short intro

Make a point Explain Critique

Final Judgment



Summarise & Critique

Summarise & Critique

Work out how many pages you expect to write and where you need to switch from analysis to evaluation and then onto your final judgement

Importance of Evaluation


Evaluation is about casting a critical eye over the assumptions that bind together economic theory and models to come to a supported

conclusion over the effects of an economic event/policy.

Critically important exam tool to use throughout essays after you have initially analysed the economic issue.

Variable changes e.g. demand/supply

Causes other variables to change e.g. price level and real output

When? By How Much? For How Long?

Showcasing some of these evaluation points is crucial to establishing the final impact of an event/policy on an industry or an economy.

Basic Evaluation Process:

Immediate or lagged effects

Magnitude and significance of the

effect

Short-term and long-term effects

Does the result only hold under ‘ceteris paribus’?

Are there any additional factors that affect the final result?

Supported by quantitative or qualitative data?

Is this data or the data source reliable?

What are the net effects of this change?

How does the economy’s original position affect the end result?

What is the level of confidence across the economy?

Are there any further policy changes expected?

What is the wider context of these economic effects?

Who are the winners and losers?

Dynamic v static efficiency

How does elasticity change the outcome?

Are there any policy conflicts?

Integrating AO4 into your Essay


Same Approach, Different Questions!

Equilibrium

Shift in AD

PriceLevel

Real Output

P1

YFE1

SRAS

AD

A

LRAS

PriceLevel

Real Output

P1

YFE1 Y

SRAS

AD

P2

A

LRAS

AD1

B

Unsustainable Sustainable

PriceLevel

Real Output

P1

YFE1 Y

SRAS

AD

P2

A

LRAS

AD1

B

CP3

PriceLevel

Real Output

P1

YFE1Y

SRAS

AD

P2

A

LRAS

AD1

B

LRAS1

SRAS1

C

YFE2

Determine Macro Objectives

Draw AD/AS/LRAS Curves

Pinpoint Initial Equilibrium

Price Level + Real Output

Output Gaps

Level of Unemployment

Basic Evaluations

Magnitude of Shift?

Duration of Shift?

Impacted by…

Size of Multiplier Effect

Presence of Accelerator Effect

Level of Confidence

Net Effect – Policy Conflicts

1

2

3

4

What type of growth does this lead to in the long-run?

OR

Advanced Evaluations Advanced Evaluations

Spare Capacity – Use a Keynesian AS Curve

Role of Inflation Expectations

Inequality – Winners and Losers?

Impact on Aggregate Supply (AS)

Impact on Economy’s Competitiveness

Environmental Effects e.g. Resource Depletion

This leads you into your supported final judgement!

Magnitude of the Shift –How large is in the initial

shift in demand?

Duration of the Shift –How long is the shift expected to last for?

Demand Curves

Demand Curves

Downward sloping curves which display a negative relationship between the price and quantity demanded.

Initial Analysis - Demand Curve Shifts

Inward D Shift Outward D Shift

Decrease in D Increase in D

D curve shifts to the left

D curve shifts to the right

Applies downward pressure on P

(excess supply)

Applies upward pressure on P

(excess demand)

Evaluation Points

Elasticity – How sensitive is demand to price changes?

Price

Quantity

D

D-

D+

P

QQ- Q+

+

-P-

P+

S

Price

Quantity

D

P

Q

S

Inelastic Demand Curve Elastic Demand Curve

P+

Price

Quantity

D

S

S+

S-

P-

Q- Q+

Use as an evaluative tool to assess supply curve shifts.

S+

S-

PP+

P-

Q- Q+Q

Large Impact on Equilibrium Price! Large Impact on Equilibrium Quantity!

Any additional factors to consider?

Ceteris paribus assumption? One-off or multiple shifts?

Apart from the general evaluation points, the elasticity of the demand curve can be used to assess the final impact of a supply curve shift on the market.

Permanent Shift

Temporary Shift

Long Lasting Impact on Market

Small Correction in Market

Large Demand Shift

Small Demand Shift

Big Impact on Price

Small Impact on Price

Price Elasticity of Demand (PED)

Measures the responsiveness of demand to a change in price.

When evaluating supply shifts the PED is crucial…

PED can be used as an evaluation tool when assessing the final impact on supply curves. It can also be used to assess the impact of taxes/subsidies on

economic agents.

Firms experience a fall in production costs due to a rise in the value of the exchange rate – imported materials fall in price.

Positive supply curve shift to S+, but final impact will depend on PED…

Inelastic Demand Curve Elastic Demand Curve

S+Price

Quantity

D

S

P

P+

Q+Q

S+

Price

Quantity

D

P

Q

S

P+

S+

Q+

Fall in Revenue – P Falls

Rise in Revenue – Q Rises

Negative Effect on Revenue

Fall in Revenue – P Falls

Rise in Revenue – Q Rises

Positive Effect on Revenue

Assuming ceteris paribus, firms are HURT by shifting production costs

Assuming ceteris paribus, firms BENEFITfrom shifting production costs

PricePED Quantity

Variable Impacts from a Rise in Supply

Inelastic

Unit Elastic

Elastic

Large Fall

Medium Fall

Small Fall

Small Rise

Medium Rise

Large Rise

Negative Impact

Positive Impact

Commodity and agricultural markets often face an inelastic demand curve!

Neutral Impact

Firm Revenue

Price Elasticity of Demand (PED)

Supply Curves

Supply Curve Shifts

Upward sloping curves which display a positive relationship between the price and quantity supplied.

Initial Analysis - Supply Curve Shifts

Inward S Shift Outward S Shift

Decrease in S Increase in S

S curve shifts to the left

S curve shifts to the right

Applies upward pressure on P

(excess demand)

Applies downward pressure on P

(excess supply)

Evaluation Points

Price

Quantity

S-

S+

P

QQ- Q+

S

D

P- -

P+ +

Elasticity – How sensitive is supply to price changes?

Magnitude of the Shift –How large is in the

initial shift in supply?

Duration of the Shift –How long is the shift expected to last for?

Inelastic Supply Curve Elastic Supply Curve

Use as an evaluative tool to assess demand curve shifts.

Large Impact on Equilibrium Price! Large Impact on Equilibrium Quantity!

Any additional factors to consider?

Ceteris paribus assumption? One-off or multiple shifts?

Price

Quantity

D

D-

D+

P

QQ- Q+

+

-P-

P+

S Price

Quantity

D

D-

D+

P

QQ- Q+

+

-P-

P+

S

Permanent Shift

Temporary Shift

Long Lasting Impact on Market

Small Correction in Market

Large Supply Shift

Small Supply Shift

Big Impact on Price

Small Impact on Price

Apart from the general evaluation points, the elasticity of the supplycurve can be used to assess the final impact of a demand curve shift on the market.

Price Elasticity of Supply (PES)

Price Elasticity of Supply (PES)

Measures the responsiveness of supply to a change in price.

When evaluating demand shifts the PES is crucial…

PES can be used as an evaluation tool when assessing the final impact of demand curve shifts. It can also be used to assess the impact of taxes/subsidies

on economic agents.

Consider the impact that an increase in disposable income will have on the demand for cars.

Positive demand curve shift to D+, but final impact will depend on PES…

PricePES Quantity

Variable Impacts from a Rise in Demand

Inelastic

Unit Elastic

Elastic

Large Rise

Medium Rise

Small Rise

Small Rise

Medium Rise

Large Rise

Positive Impact

Positive Impact

Positive Impact

Firm Revenue

Price rise is SMALLER if S curve is elastic (PES > 1).

Inelastic Supply Curve in Short-Run

Price

Quantity

D

P

Q

PSR

QSR

D+

Price rise is LARGER if S curve is inelastic (PES < 1).

Price

Quantity

D

P

Q

SSR

PSR

QSR

D+

SLR

Elastic Supply Curve in Long-Run

PLR

QLR

Supply curve can become more elastic in the long-run because...

The key evaluation points here relate to

This changes the market outcome and allows firms to accommodate extra demand without rapid price increases.

All factors are variable in the long-runSR supply constraints no longer apply

SSR

Public Goods

Public Goods

Goods that are under-provided if left to the market to supply. The government plays a role in supplying this good to the market.

The key area to evaluate in relation to public goods is the extent of under provision which is likely to exist in the market.

Basic Analysis and Evaluation

How big a problem is the issue of unemployment?

Nature of Public Goods

Price

QuantityQ

S

D

P

QSOC

Public good’s demand and supply are deficient (Qsoc – Q) because of…

Non-Excludability

Non-Rivalry

Under-provided or missing market?

The specific level of demand and supply and Qsoc is very difficult to estimate

You might have a scenario where there is less demand and supply (Q) than anticipated (Qsoc)…


Extent of Under-Provision is Greater

Price

QuantityQ

S

D

P

QSOC

The good’s market demand and supply is lower at every given price

The extent of the market failure that exists will grow the greater the

divergence between social optimum and market supply

Every market will have different demand and supply factors - Market for defence

different from the market for flood defences

You might have a scenario where the amount of the public good required is under-estimated…


Under-Estimate Supply Requirements

Price

QuantityQ

S

D

P

QSOC1

The social optimum reflects the required amount that needs to be provided to

maximise welfare

How much defence, crime prevention, justice and flood defences do we actually

need?

With some of the most crucial public goods it is impossible to tell what the

level of under provision actually is

Size of the market failure and the level of intervention needed to correct it are unknown

QSOC

Required Supply

Required Supply

Merit Goods

Merit Goods

Goods for which the social benefits associated with consumption are greater than the private benefits.

The key area to evaluate is the fact that market failure exists in the market for merit goods for different reasons and this has policy implications.


Merit Good e.g. Education and Vaccinations

Co

sts

+ B

enef

its

Output

MPC = MSC

MPB

PPRI

QSOC

MSB

QPRI

PSOC

Positive externalities associated with the consumption of this type of good

Societal benefits not captured (DWL)

Good under-consumed as consumers take short term decisions → base decisions on SR private benefits which

can be far less than LR private benefits

Scale of market failure depends on…

Size of Positive Consumption Externalities

Extent of short –termism/imperfect

information

Economic School of Thought – Free Market or Interventionist?

Free Market Economists

Do not define goods as being either merit or demerit -individuals can make rational decisions for themselves

and have freedom of choice.

Interventionist Economists

Use definitions of merit and demerit goods to support the implementation of policies such as taxes, subsidies

and regulations.

Behavioural economists suggest policies that keep freedom of choice, but the state should guide individuals via nudge theory to make the “rational” decision (Libertarian Paternalism).

Advanced Evaluation Points – Effectiveness of Remedial Policies

Subsidies – Museum Visits Policies to Inform – Health Care

Co

sts

+ B

enef

its

Output

MPC = MSC

MPB

PPRI

QSOC

MSB

QPRI

PSOC

MPC + Sub

PSUB

External Benefits Captured

Co

sts

+ B

enef

its

Output

MPC = MSC

MPBNO INFO

PPRI

QSOC

MSB = MPBINFO

QPRI

PSOC

External Benefits Captured

How is the subsidy financed? Higher taxes?

Is the subsidy set at the right level?

Does this need to be applied on a national scale or just select museums?

How accurately are the externalities measured?

Social opportunity cost of subsidy? Alternative projects sacrificed? Impact on growth?

What benefits can supporting cultural venues do for the local economy?


How are these policies financed?

What are the macro benefits associated with greater use of health care systems?

Can you guarantee the effectiveness of policies to inform?

Even with the policies, is there equality of access?

Does this policy need to be supported by supply side measures or regulations?

Danger of government failure in each case of intervention creating unintended consequences

Demerit Goods

Demerit Goods

Goods for which the private benefits associated with consumption are greater than the social benefits.

The key area to evaluate is the fact that market failure exists in the market for demerit goods for different reasons and this has policy implications.


Demerit Good e.g. Alcohol and Cigarettes

Co

sts

+ B

enef

its

Output

MPC = MSC

MSB

PSOC

QPRI

MPB

QSOC

PPRI

Negative externalities associated with the consumption of this type of good

Excessive private benefits perceived (DWL)

Actual benefits are overlooked and overestimated due to imperfect information leading to over consumption

Scale of market failure depends on…

Size of Negative Consumption Externalities

Extent of Imperfect Information

Advanced Evaluation Points – Effectiveness of Remedial Policies

Taxes – Cigarettes Policies to Inform – Obesity Crisis

Qpri reduced to Qsoc by MPC shift & move up the MPB Qpri reduced to Qsoc by MPB shift & move down the MPC

How does the PED value affect the burden of tax?

Is the tax set at the right level?

Could smokers switch to alternative products to satisfy their addiction? Impact on e-cigarette market?


Is the tax fair, equitable and effective in dealing with those affected by addiction?

What benefits could the increased tax revenue have on the growth and competitiveness of the economy?


How are these policies financed?

What are the macro benefits associated with improvements in public health?

Can you guarantee the effectiveness of policies to inform?

How quickly are the effects of these policies going to pass through to the market?

Does this policy need to be supported by supply side measures or regulations?

Danger of government failure in each case of intervention creating unintended consequences

Costs + Benefits

Output

MPC = MSC

MSB

PSOC

QPRI

MPB

QSOC

PPRI

MPC + TAX

PTAX

Costs + Benefits

Output

MPC = MSC

MSB = MPBINFO

PSOC

QPRI

MPBNO INFO

QSOC

PPRI

Increased levels of regulation can also alter the incentives of individuals – restricting or banning consumption

There is always a danger of driving consumption underground i.e. market for drugs and the formation of cartels in the underground economy.

Indirect Taxes

Indirect Taxes

A tax that is applied on producers, but is paid by both consumers and producers.

You need to be able to talk about the factors that alter the effectiveness of applying an indirect tax on a market.


Price

Quantity

D

P1

Q1

S1

S2

Q2

P2

PS

Indirect tax is applied to correct market failure…

Negative Production Externality

Demerit Goods

Need to show you understandthat the impact is variable

Consumer Tax Burden

Producer Tax Burden

How does PED affect the burden of an indirect tax?

Price

Quantity

D

P1

Q1

S1S2

Q2

P2

PS

Inelastic Demand Elastic Demand

Price

Quantity

D

P1

Q1

S1S2

Q2

P2

PS

Consumer Burden

Producer Burden

Output Change

Tax Take

HIGH

LOW

LOW

HIGH

Consumer Burden

Producer Burden

Output Change

Tax Take

LOW

HIGH

HIGH

LOW

Demerit goods are generally characterised by an inelastic demand!

Have to apply high taxes for a long time to have the desired behaviour change!

The Bigger Picture

Taxes can be used to cover the cost of other

interventions BU

T Can distort the spending patterns in other undesirable

directions

Having significant regressive effects on society in the

process

Magnitude and Duration of Tax?

Subsidies

Subsidies

Payments made by the government to producers to help facilitate the production of goods and services.

You need to be able to talk about the factors that affect the effectiveness of applying a subsidy to a market.


Subsidies are applied to correct market failure…

Positive Production Externality

Merit Goods

Need to show you understandthat the impact is variable

Consumer Subsidy Benefit

Producer Subsidy Benefit

Magnitude and Duration of Subsidy?

Positive Consumption Externality

Price

Quantity

D

P1

Q1

S1

S2

Q2

P3

P2

The Bigger Picture

Taxes can be used to cover the cost of

subsidies BU

T This can distort economic activity elsewhere in the

economy

Higher rates of income tax can damage incentives and

hurt econ. growth

How does PED affect the benefit of a subsidy?

Price

Quantity

D

P1

Q1

S1

S2

Q2

P3

P2

Inelastic Demand Elastic Demand

Price

Quantity

D

P1

Q1

S1

S2

Q2

P3

P2

Consumer Benefit

Producer Benefit

Output Change

Subsidy Cost

HIGH

LOW

LOW

REDUCES

Consumer Benefit

Producer Benefit

Output Change

Subsidy Cost

LOW

HIGH

HIGH

INCREASES

A danger that market failure converts into government failure!

Regulations

Regulations

Rules created and enforced within a market to control externalities.

Type of Regulations

Employment Laws Product StandardsHealth and Safety

Regulations

Financial Regulation Environmental RegulationCompetition Regulation

Role of Regulations in Externality Markets

Co

sts

+ B

enef

its

Output

MPC

MPB = MSB

PPRI

QSOC QPRI

PSOC

MSC

Negative Production Externalities

Overproduction results in high levels of industrial pollution → Negative Production

Externality

Legislation to control pollution levels to fix output levels at QSOC

Eliminates DWL triangle and social welfare improves

Excessive legislation constrains economic

activity

Insufficient levels of regulation and

market failure still persists

Government must fully understand the problems

Difficult to calculate the exact externality value

Success of regulation may have unintended consequences

The following evaluation points can be applied to specific forms of regulation…

What type of firms is the regulation imposed on?

Some firms may find it easier to reduce costs compared to others

Self-defeating to impose regulations on those firms that cannot cope

Effectiveness of Enforcement?

Regulatory capture – regulators do not act in the best interests of the market

Economic agents may withhold information e.g. car emissions tests

What type of economist are you?

Free Market – Unnecessary burden on firm costs

Interventionist – Can freshen up the market

Enforcement Issues?

Financial punishments – do they really deter behaviour of large firm?s

Drives certain firms to anti-competitive practices e.g. collusion.

As there are many different varieties of regulations you need to be able to apply some general evaluative points to the industry that you are considering.

Supply Limit

Price Controls

Price Controls

Restrictions governing the price a market can sell a product at.

Price controls are examples of intervention strategies that quite often create a different variety of market failure. Is it best to leave the market unchallenged or

intervene to improve the market outcome?

Effectiveness of Price Controls?

Minimum Price Maximum Price

Price

Quantity

D

P

Q

S

QS

PMIN

QD

Binds

Price

Quantity

D

P

Q

S

QD

PMAX

QS

Binds

PMIN ABOVE P causes excess supply PMAX BELOW P causes excess demand

The government has to set the right level – same logic for the minimum wage!

What are the welfare implications?

Minimum Price Maximum Price

Price

Quantity

D

P

Q

S

QS

PMIN

QD

Price

Quantity

D

P

Q

S

QD

PMAX

QS

Consumer Surplus

Producer Surplus

FALLS

RISES

DWL LOST DEMAND

RISES

FALLS

Consumer Surplus

Producer Surplus

DWL LOST SUPPLY

Where does this excess demand go?

Forms the creation of a black market

Either market supply increase or demand is forced lower

Where does this excess supply go?

Surplus stock gets sold in a separate market

Government can intervene to purchase stock and maintain minimum price

Excess Supply

Excess Demand

Buffer Stocks (Edexcel + OCR Only)

Buffer Stocks

A programme run by an agency which buys and sells a commodity in order to stabilise its price.

How does it work?

Agency monitors market price movements

against target price

If the price falls below the target price the agency

buys the commodity

If the price rises above the target price the agency sells

the commodity

Agency purchases causes + D shift and prices rise

Agency sales cause + S shift and prices fall

Evaluation – Challenging the effectiveness of these schemes…

You need to be able to assess the factors which affect the effectiveness and sustainability of these types of policies.

Scheme Design

The effectiveness of the scheme will depend on price that is set – single price or upper and lower price range?

Easier to maintain agricultural prices within a price range than a specific level, but the price range cannot be too large

Operational Issues

This has consequences for the frequency and scale of intervention and ultimately determines whether the scheme is a success or a failure

Greater levels of intervention requires a significant of capital to be taken on and utilised

This carries an opportunity cost due to funds, equipment and facilities not being able to be used for alternative purposes

High storage costs associated with preserving the value for goods when re-intervention is required.

Physical Requirements – Storage Space e.g.

Technical Requirements – Preserve Product Quality e.g. food

Storage Costs

Policy Suitability – Details of the Scheme

Type of Product? More appropriate for storable agricultural products compared to consumer goods

Market characteristics? Does the market suffer from price volatility?

What about demand and supply elasticities?

Do not be afraid of putting forward alternative policy proposals such as price controls, subsidies and government support programmes to improve storage and

irrigation facilities!

Perfect Competition

Perfect Competition

A theoretical model that describes the conditions required for intense competition to take place between firms.

Due to its application limitations, the model of perfect competition should be used as a benchmark to evaluate the outcomes of other market structures.

Perfect Competition Outcomes

Short-Run PC Firms Long-Run PC FirmsHow Does Market Respond?

Supernormal Profits + Productively Inefficient

Normal Profits + Productively Efficient

Firms Enter → Supply Shift

PC firms unlikely to be dynamically efficient, but also unlikely to create X-inefficiencies

Using the model of PC as an evaluation tool

Regardless of whether firms leave or enter over time, total surplus is

maximised in the market

Perfectly Competitive Market

Pri

ce

Market Output

P

Q

S

D

Pure Monopoly

Co

sts/

Rev

.

Output

P

QM

MC = S

D=ARMR

QPC

Deadweight loss due to reduced production and lower consumption –

monopoly power reduces surplus

P1

S1

D

Q1

Pri

ce

MC

AR = MR

q1

Quantity

Pri

ce Pri

ce

P1

AC

C1

S2

P2

MC

AR1 = MR1

q1

Pri

ce

P1

AC

AR2 = MR2

P2

Q2q2

Quantity

Pri

ce

Quantity

Pri

ce

Monopoly

Monopoly Market

A market structure where one firm exerts dominant control of the market.

The key area to evaluate the monopoly market structure is to take a look at the dynamic efficiency benefits these firms can potentially bring.


MC

AR

Q Quantity

Pri

ceP

rice

P

AC

C

MR

Monopoly Firm Diagram

Firm maximises profit at the output where MR = MC

The firm does not produce at the bottom of the AC curve →

productively inefficient

The firm does not produce at MC = AR where surplus is maximised →

allocatively inefficient

Price is higher compared to PC

Output is lower compared to PC

What the firm chooses to do with those profits is your area of

evaluation here!

Industry Application

The key to evaluating the effectiveness of monopoly is discussing when these dynamic efficiency impacts are important

The appropriateness of monopoly varies from industry to industry depending upon the importance of innovation and invention

Dynamic Effects Not Important Dynamic Effects Important

Monopoly market structure is worse than perfect competition

Monopoly potentially better than perfect competition

Grocery Retailers Self-Driving Cars

How important is dynamic efficiency?

Firm supports dynamic efficiency

Firm does not support dynamic

efficiency

Supernormal profits reinvested

Results in innovation and

invention

Supernormal profits enjoyed

today

Results in slack and x-

inefficiencies

May result in creative destruction

Results in higher costs and prices and

reduces welfare

Monopolistic Competition


A market that contains a large number of firms selling differentiated products.

The key area to evaluate in this market structure is to consider the degree to which firms differentiate their product offerings and the wider implications

this has for the market.

Product differentiation involves a firm establishing a prominent product feature that makes it stand out from the rest of the market.


Branding

Customer Service

Packaging

Specialism of Service

Quality

Functionality

Main Evaluation Area


MC

D = AR

Q Quantity

Pri

ceP

rice

P

AC

C

MR

Short-Run – Supernormal Profits

MC

D3 = AR3

Q Quantity

Pri

ceP

rice

AC

P = C

MR

Long-Run – Normal ProfitsIndividual Firm Demand Curve

D

Quantity

Pri

ceP

rice

D2D3

Supernormal profits encourage entry by new firms to produce substitute products – takes away demand from existing firms. Only normal profits are made in the long-run.

The level and type of competition between firms depends on the extent of product differentiation

If the scale of product differentiation is SIGNIFICANT

Good Welfare Implications

Consumer buys product variety that appeals to them – price becomes

less of a factor

Each firm invests to produce a differentiated

product version

Increases range of products available to

consumers

Bad Welfare Implications

Firm(s) becomes a monopoly of its product

version = inefficiencies of a monopoly

Firms may differentiate their product offerings significantly from the

rest of the market

This opens up a new market segment for those firms to sell to

Enables firms to raise their profits in the LR due to inelastic demand curve

Consumers are willing to pay more due to a product that is better suited to their needs

Re-defining the market may result in a series of unintended monopolies in their own niche product

Could dynamic efficiency benefits from each of these monopolies offset the SR inefficiencies?

Oligopoly

Oligopoly Market

A market structure where a small number of very large firms control the market.

The key area to evaluate here is the likelihood of cooperation strategies and assessing whether that is good or bad for the market and society.


Kinked Demand Curve ModelFirm produces at the point where MR

= MC

Firms are encouraged to charge a price of P due to high levels of

interdependency

MC

AR

Q Quantity

Pri

ceP

rice

MR

PThe market outcomes of an oligopoly depend greatly upon individual firm

behaviours

High levels of product differentiation → monopoly outcome

Firms compete over prices → perfectly competitive outcome

Competitive Pricing Strategies (Price Wars)

Price is forced down until only normal profits are made

If firm cuts price further, it will make an

economic loss

So price remains where firms make only normal

profits (Perfect competition outcome)

Good for Consumers Bad for Firms

You might argue that in the LR, product quality and choice will drop off if little profit incentive!

Non-Competitive Pricing Strategies (Collusion)

Leading firms agree to set a fixed price that is

unattractive for entrants

All firms make lower profits in the short-run but discourages entry

over time

Colluding firms can consolidate their

position with higher prices in the long-run

Firms need perfect information, predictable demand changes and significant entry barriers. How realistic is this?

No guarantee that collusion will be effective – firms may break promise or competition authorities may intervene

Negatives - Collusion increases prices faced by consumers and removes efficiency and innovation incentives of competition

Positives - Agreements to work together create supernormal profits for innovation and

efficiency projects

Not all co-operation between firms should be viewed with suspicion…

Job of competition regulators to distinguish damaging collusion from positive co-operation!

Contestability

Contestability

Using economic theories and models to assess how easily firms can enter and exit a market over time.

Similar to the model of perfect competition, you need to use the factors that underpin a contestable market in theory to assess the ease and cost of new entry

of firms into a market.

For a market to be defined as contestable, the following need to be present…


Few barriers to entry or exit

Few sunk costs upon entry into

market

Entrants need to have similar tech.

capabilities as incumbents

Entrants need close to perfect

information about the market

Most incumbent firms have the protection of

artificial and natural barriers due to

long-term market presence

Technologically driven industries will require large

start-up investment compared to

traditional industries

Incumbents have efficiency and scale advantages sourced from the knowledge of learning-by-doing and have integrated

tech. over time

Market and cost information difficult to extract without operating closely

with target market

Let’s now apply these concepts to the four main market structures…


MONOPOLY OLIGOPOLY MONOPOLISTIC PERFECT COMP.

In reality, some market structures may resemble the outcome of perfect competition if they are highly contestable as they have to stand ready for contestable entry (hit-and-

run-entry) anyway

Long-lasting effects of contestable markets is that they blur the theoretical lines between

the definitions of different market structures – number of firms in the market can become

irrelevant!

The level of contestability in a market is a moving feast…


Competition policies prohibit predatory and

dominant market behaviour

Deregulation has opened up

markets to make entry more

feasible

Changes in consumer and

market sentiment e.g. financial crisis

and the rise of discount retailers

Rapid pace of tech. change

fosters entrepreneurial innovation and

invention

HIGH BARRIERS

HIGH SUNK COSTS

PERFECT INFO. FOR ONE FIRM ONLY

LARGE ECONOMIES OF SCALE

HIGH BRAND LOYALTY

NOT CONTESTABLE

NO BARRIERS

NO SUNK COSTS

PERFECT INFO. FOR ALL

NO ECONOMIES OF SCALE

NO BRAND LOYALTY

CONTESTABLE


Price Discrimination

Price Discrimination

The ability of firms to segment the market and charge consumers different prices to reflect their willingness and ability to pay for a good or service.

You need to be able to evaluate the factors that make price discrimination possible and the effectiveness of this pricing strategy in boosting revenue.

To engage in price discrimination, firms need to be able to…


Identify different market segments

i.e. consumer groups based on

PED

Prevent re-sale across different

market segments i.e. block low price selling to high price

Have some degree of market power in order to be a price

maker

Maintain low admin costs when

separating markets

PED values may change

These pricing policies can exploit certain ends of the

market and contribute to rising

inequality

Consumers are likely to face higher

prices above MC

Collecting market intelligence such as consumer data can

be costly and require significant levels of expertise

to mine the important pieces of

info. required

Not easy to calculate PED in the

real world

PED dependent on rival actions and market trends

Some industries where this isn’t

possible to enforce

Firm may be destabilised if it

exists in a market that is contestable

but not competitive

Basic Analysis and Evaluation – Third Degree Price Discrimination

Customers can be segregated

Segments have different D curves

Opportunity to discriminate

Causes changes in P and Q

Consumer surplus converted into producer revenueConsumer surplus higher,

revenue lower

How important is revenue and profit to the firm as a business objective?

Benefits of third degree

price discrimination

to the firm and possibly

the wider market…

Overall impact on goodwill not

necessarily positive if consumer

experience is poor?

Segmented pricing increases total revenue

Segmented pricing increases total profit

Segmented pricing increases scale

Increased scale reduces costs and increase profit

Raises investment potential for better products

Generates pathway for lower prices in future

Labour Markets: Minimum Wage

Minimum Wage

Legislation that prohibits firms from paying an hourly wage rate to workers below a certain threshold.

You need to be able to evaluate the effects of the minimum wage on overall employment levels and different economic stakeholders.

Traditional View – MW results in unemployment

Traditional View

WageRate

Labour

DL

W

L

SL

LS

WMIN

LD

Minimum wage (WMIN) applied above the prevailing equilibrium wage rate (W)

Assuming ceteris paribus, results in less firms wishing to demand labour, but more workers

wishing to supply their labour

Creates a disequilibrium in the labour market – employment falls from L to LD

Unemployment = Ls – LD = Number of people looking to work who can’t find work

Assumes labour market is perfectly competitive – most likely labour imperfections

will exist

If demand for labour is relatively inelastic – MW

creates a lot less unemployment

Industries where labour costs represent a greater

percentage of total costs will feel the effects more

Is this applied on a national scale or on a regional basis to

protect local living standards?

Can firms absorb higher wages with subsequent improvements in human capital and productivity?

Firm are likely to be able to absorb higher wages during

strong economic times compared to bad ones

Alternative View – MW improves employment

Traditional View

WageRate

Labour

DL

W2

L2

SL = ACL

L1

If firms face skill or quantity of labour restrictions such as migration barriers, it could

encourage firms to continue to hire despite higher MW

If the economy is in or heading towards recession

firms might prefer to take on workers regardless of MW

level

The effect of MW on inequality and poverty

depends on living costs –Living Wage likely to be more

effective

MCL

W1

W3

We assume that the labour market has imperfections which results in an imperfectly competitive labour market e.g. monopsony

A minimum wage applied above the market equilibrium wage rate of W1 but below W3

will result in an increase in employment

Anything above W3 and the monopsony firm can no longer accommodate higher wages

and higher employment levels

However, an artificially high minimum wage might force firms to invest rather than take on workers = long run benefits for economy

The NMW is likely to only affect a small collection of low-paid occupations

AD Curves

Aggregate Demand (AD)

The total expenditure on an economy’s goods and services at any given price level.

In most macro essay questions you will need to analyse an AD curve shift and therefore being able to evaluate these shifts are crucial.

Basic Evaluation – Timing and Size

PriceLevel

Real Output

P1

YFE Y2

SRAS

AD1

P2

AD2

LRAS

Small Shift – Insignificant Impact

Advanced Evaluation Points

Will this shift take place immediately, tomorrow, next year or never?

Will the economy’s automatic stabilisers bring the economy back to its original

position?

Is this shift going to result in further curve shifts? Accelerator or Multiplier Effects?

Initial Analysis – AD Shift

PriceLevel

Real Output

P1

YFE Y2

SRAS

AD1

P2

AD2

LRAS Macro Objectives

Economic Growth

Inflation

Unemployment

Budget Deficit

Trade Deficit

Income Equality

Positive

Accelerating

Falling

Reducing

Increasing

Improving

Do any of these macro objectives conflict with each other?

Lower Unemployment → Higher Inflation

Faster Growth → Increases Demand for Imports (Higher Trade Deficit)

Uncertainties of the wider economy – these effects might not happen!

Initial Analysis – AD Shift

AS

Price Level

Real OutputYFE

AD1 AD2

P1

Y2Y1

Use a Keynesian AS Curve to evaluate impact on an economy with spare capacity…

Growth

Inflation

Unemployment

Budget Deficit

Trade Deficit

Income Equality

Positive

Neutral

Falling

Reducing

Neutral

Improving

AS Curves

Aggregate Supply (AS)

The aggregated supply for all goods and services produced within a country at any given price level over a limited period of time.

In most macro essay questions you will need to analyse an AS curve shift to explain how an economy rebalances itself back towards full employment.

Initial Analysis – SRAS Shift

Changes in Production Costs

PriceLevel

Real Output

P1

YFE Y2

SRAS1

AD

LRAS

SRAS2

P2

Reduction in the Price of Oil

Basic Evaluation – SRAS Shift

Outwards Shift in the SRAS Curve

Size of Shift?

Depends on overall size of the oil price drop

Duration of Shift?

Depends on whether this is a one-off change or part of a downward trend

Commodity prices do change every day!

Initial Analysis – LRAS Shift

Changes in Quantity and Quality of Inputs

PriceLevel

Real Output

P1

YFE Y2

AD

LRAS1

P2

Improvement in Productivity

Basic Evaluation – LRAS Shift

LRAS2 Outwards Shift in the LRAS Curve

Size of Shift?

Does the change relate to one input or multiple inputs?

Timing of Shift?

How immediately are the productivity improvements going to pass through the

economy?

Influx of Skilled Immigration = Quick

Capital Investment = Slow


Offsetting Factors Spare Capacity Wider Issues

Immigration and new births can be offset by individuals leaving the

workforce

The greater the level of spare capacity in the

economy, the less significant an impact AS

shifts have

Uncertainty about the economy can hold back

targeted investment and can cause effects to

lag

PriceLevel

Real Output

P1

YFE

SRAS1

AD1

AD2

A

LRAS1

YFE2

Economic Growth

Economic Growth

The rate at which the value of an economy’s good and services are increasing by over time.

Any question that requires you to draw an AD-AS diagram will require you to evaluate the growth implications that come with it.

Evaluate the impact of the Government running an expansionary fiscal policy?

Key Evaluation Point – How Sustainable is the Growth?

Unsustainable Growth – AD Shift Only Sustainable Growth – AD + LRAS Shift

PriceLevel

Real Output

P1

YFE Y2

SRAS1

AD1

P2

AD2

A

LRAS

B

Productive Capacity Unchanged in LR

Inflationary Pressures

Productive Capacity Increases in LR

No Inflationary Pressures

LRAS2

Big Picture

More jobs

Control over inflation

Improved competitiveness

Improved living standards

Improved government finances

Economic growth tends to be positive as real output

grows and applies

downward pressure on inflation….

It is important to highlight

some limitations as this is where you capture

your evaluation

marks!

Population growth dilutes the impact as

economic growth will be shared among more

people

Unequal distribution of

economic growth between factor

owners may widen income

inequalities

Growth rate may be too fast and

reduce resources available to

sustain economic growth in the

future

Unregulated production has

negative environment

impacts

CP3

SRAS2

D

SRAS2

Inflation

Inflation

The rate at which prices across the economy increase at over a given period of time.

Inflation is one of the central macroeconomic objectives and can often be used as an evaluation tool of growth to assess the consequences of unsustainable

growth.

When do we need to talk about inflation? Basic Evaluation

AD

SRA

S

Positive Output GapNegative Output Gap

Inward Shift Outward Shift

Falling output with falling inflation

Falling output with rising inflation

Rising output with rising inflation(Demand-Pull

Inflation)

Rising output with falling inflation

(Cost-Push Inflation)

Magnitude of Inflation– Depends on size shift

Persistency of Inflation – Short-run or long-run

problem?

Severity of Inflation Issue – Depends on

original position of the economy (How much

spare capacity?)

Impact on Competitiveness Source of Inflation

If domestic inflation increases, this makes domestic goods more expensive…

If prices increase quicker domestically than abroad the impact on trade competitiveness

will be negative.

Will the fall in trade help bring inflation back down with a negative AD shift?

Short-run inflation can be instigated by an increase in business investment…

If the investment is effective and the benefits are captured, it may contribute to an

improvement in LRAS.

This helps reverse the process and bring inflation back down to a more sustainable

level.


What are the net effects of inflation?

This depends on the economic school of thought you belong to…

Does high inflation encourage a period of lower unemployment?

Inflation Psychology – Winners and Losers?

Property owners and asset holders benefit from inflation

Do people have benign or malign inflation expectations?

Optimal inflation level for society?

CPI inflation target (2%) protects real incomes and maintains confidence across the

economy

Central banks MAY accommodate higher inflation if there are imminent economic

problems forecast down the line (inflation overshooting)

If wages in the economy are growing quickly, the pressure for central banks to control

inflation is reduced (inflation not viewed as an imminent problem)

Deflation

Deflation

The rate at which prices across the economy are decreasing by over a given period of time (negative inflation rate).

A good understanding of deflation is required to ensure that you evaluate the case for or against periods of low inflation.

Reasons for the Deflation?


Bad Deflation Good Deflation

PriceLevel

Real Output

P1

YFEY2

SRAS

AD1

P2

AD2

LRAS

Term Definition

Deflation Price levels consistently falls, value of money rises

Disinflation Falling inflation rate, but prices still overall increasing

ReflationAn increase in economic activity and output stimulated by a policy which

brings inflation back to target

PriceLevel

Real Output

P1

YFE1 YFE2

SRAS1

AD

P2

LRAS1

SRAS2

LRAS2

You need to be careful with handling the different inflation terms before you evaluate…

Supply Side Improvements

Lower Employment

Lower Real Output

Contraction in Economic Activity

Higher Real Output

Higher Employment

Either way, the economy receives a competitive boost!

Additional Evaluation Points


Extent of Deflation

Size of Shift?

Spare Capacity?

National or Worldwide?

Duration of Deflation

SR v LR?

Deflation may discourage further consumption = More

Deflation!

Persistency of Deflation

Period of short-relief on real incomes or is this part of a

deflationary spiral?

Consider case of Japan

Unemployment

Unemployment

The number of people who despite actively searching for work are unable to find a job.



Cyclical Frictional Structural

Pri

ceLe

vel

Real Output

P1

YFEY2

SRAS1

AD1

P2

AD2

LRAS

SRAS2

P3

Demand Side - SR

Pri

ceLe

vel

Real Output

P1

YFEY2

SRAS1

AD1

P2

AD2

LRAS SRAS2

Supply Side - SR

Pri

ceLe

vel

Real Output

P1

YFEY2

AD1

P2

LRAS1LRAS2 SRAS1SRAS2

Supply Side - LR

All part of the business cycle All part of the labour marketLong-term decline in an

industry

Policies restore lost demandWorkers take up new

positions quicklyWorkers need re-training –

how feasible is this?

Can unemployment figures always be trusted?


Hoarding Firms help unemployment numbers by retaining staff in downturn

Under-employed Workers help unemployment numbers by working part time

Over-qualified Workers help unemployment numbers as have taken less skilled work

Discouraged or marginally attached

Workers help unemployment numbers by not seeking employment

Behaviours likely to suppress unemployment levels

Assessing the unemployment rate

March 2019 - The number of people employed is at its highest level recorded at 76.1%, whilst the unemployment rate is at its lowest level since 1974 (3.9%).

This is despite the UK economy recording its worst annual growth rate since 2009

Good News

Resilience of the UK economy and labour market

Bad News

Firms employing rather than investing due to BREXIT

Important remember that there are time lags between business and employment cycle!

Evaluating the unemployment rate concerns the credibility of the numbers being reported and what they tell us about the economy.

The Phillips Curve

Phillips Curve

An economic model that depicts an inverse relationship between the inflation and unemployment rate.

The Phillips Curve can be used as an evaluation tool to approve or disprove the use of an economic policy.



Phillips Curve

Unemployment Rate (%)

Infl

atio

nR

ate

(%)

A

C

ED

B

UNU1

P1

P2

LRPC

SRPC1

SRPC2

SRPC3

Basic Evaluation

Historical evidence contradicts the PC

Are there any measurement errors or bias?

Policy trade-off contradicted by monetarists

Original PC data related to wage inflation not price

inflation

Economic agents may have rational expectations

Phillips curve is a good reference point for macro objective conflicts but there are some application issues in the real economy.

Advanced Evaluation Points – Factors that question the relevance of the PC in 2019


Gig economy and other labour market movements have reduced the pricing power of workers – weakening relationship between inflation and

unemployment.

The level of spare capacity in the economy may be greater than officially reported i.e. rise of self-employment numbers means that the economy might be able to

grow at a faster rate without generating inflationary pressures.

The financial crisis may have psychologically altered some workers and their overall appetite for risk. Workers may be less likely to push for higher wages even

during a tighter labour market.

The source of inflationary pressures may not come from domestic factors i.e. currency depreciation. This means that the relationship between inflation and

wages may not always be relevant.

Globalisation and increased MNC activity has contributed to a global supply chain and a global labour market. Has this contributed to a global Phillips Curve?

Inequality and Poverty

Inequality and Poverty

Measuring the number of people who cannot afford to meet their basic life-sustaining needs and wants because of a lack of equality over the distribution of

income and wealth.

In most cases you will have to use this as an evaluation tool to assess the overall effectiveness of certain economic policies to achieve greater levels of equality.

It is always assumed that higher levels of growth result in higher living standards, but just how evenly distributed are the benefits of growth within society?

In most cases the wealthy have instigated the growth and therefore stand to gain the greatest benefit = widening levels of inequality!

COUNTER ARGUMENT – Concept of the circular flow of income redistributes that wealth back down to society – Trickle Down Economics!

Are Poverty measures reliable and relevant? Are inequality measures too general?

Monetary Policy Fiscal Policy

Supply Side Policy Trade Policy

Exchange Rate Changes Globalisation

Monetary Policy Monetary Policy



Expansionary monetary policy measures boost asset prices

Results in those having the greatest wealth stocks getting even wealthier!

Difficult for individuals to close wealth gap

Does money in stock markets get reinvested back down so that workers feel the effects?

Lower corporation taxes provide stimulus from greater MNC activity

This results in firms making higher profits and dividend payments likely to increase

Do the extra profits get re-invested resulting in dynamic efficiency benefits?

This may depend on competitiveness of market structure

Labour market reforms make it easier for firms to hire and fire

Increases opportunities available to certain workers, but raises job insecurity amongst

others

Are firms likely to give sustained real wage increases to workers they can easily remove

from their wage bill?

Imposition of import tariffs to protect sunset industries

Protects some employment channels but raises prices

Hurts the poorest families that cannot afford higher prices

Could government use tax rev. from tariffs to subsidise those left worse off

A depreciation in the value of the pound results in higher imported prices

Will firms pass on those prices and hurt the poorest or absorb higher costs and cut

dividends to the richest?

Is this even an issue to worry about in the first place when firms hedge against currency risk?

Increased goods choice and cheaper prices

How many individuals in the UK have been left structurally unemployed as a consequence?

Are there sufficient support programmes available for workers to re-train?

Could a Basic Minimum Income help facilitate these programmes?

The interpretation of poverty levels in Sub-Saharan Africa are different to the interpretation of poverty levels in the

developed world.

You need to adapt your economic reasoning depending whether you’re looking at a developed or developing

economy.

Monetary Policy

Monetary Policy

Policy tools used by the central bank to influence and stabilise the rate of inflation and the financial system.

To evaluate this topic you need to focus on the restrictions that central banks face when they try and manipulate interest rates to control inflation.

Transmission Mechanism – Expected Results of Rate Cut

Inte

rest

Rat

e

Spend more as saving less attractive

Increase borrowing as debt cheaper

Co

nsu

mp

tio

n

Ou

tpu

t

Inve

stm

en

t

Why might conventional monetary policy not be effective?

When interest rates are at or close to the zero lower bound i.e. 0%

Once interest rates approach zero, the central bank can no longer use

the bank rate to control the economy

Conventional monetary policy is only effective if interest rates are

not already near zero

Banks will always hold onto their money in this scenario, thus limiting the desired pass-through effects of

the transmission mechanism

Negative Interest Rate

If banks lend their money

Costs (They must pay borrower)

If banks hold onto their money

No Cost

Remember this limitation only holds for interest rate cut and not an interest rate

rise

The other channels of the transmission mechanism

remain open e.g. currency influence

Why is this the case?

Central banks have now established alternative

measures e.g. QE

Advanced Evaluation Points – Conventional Monetary Policy

Time Lags Inflation Forecasts Confidence

Policy Failure Differential Impacts Sustainability

Bank rate changes take 1.5 - 2 years to

impact inflation

Economic shocks can dramatically alter

forecasts

Consumers and firms may not react in the

expected way

May get the timing wrong and coincide

with global economic patterns

Borrowers and savers will feel different

effects

To have impact on LRAS – mix of

monetary and fiscal policies required

Independence

Central bank independence from

government may result in imperfect synchronisation of policies e.g. fiscal

policy

Reduces effectiveness of policy mix

Fiscal Policy

Fiscal Policy

Spending and taxation changes made by the government to influence aggregate demand and productivity.

To evaluate this topic you need to focus on the two different forms of fiscal policy that can be implemented.


General Evaluation Points

Stimulate Consumption - Boost AD Stimulate Production - Boost AD + LRAS

PriceLevel

Real Output

P1

Y1 Y2

SRAS1

AD1

P2

AD2

A

B

PriceLevel

Real Output

P1

YFE

SRAS1

AD1

AD2

A

LRAS1

YFE2

LRAS2

D

SRAS2

Investment in low productivity policies will boost consumption not production =

unsustainable growth

Investment in capital that improves productivity e.g. transport, communications and new schools

= sustainable growth

Size DurationSpeed

How big is the initial shift?How long are these effects

likely to last for?How quickly do these effects

pass through the system?

How much is spent? One shift or multiple shifts?Is the effect instant or staggered over time?

How much have taxes changed by?

Has the fiscal policy change unlocked further economic

effects?

Are there any factors which hold back the speed of the

economic change?



Crowding Out Effects – The economy has a finite number of resources…

Fixed supply of factors of production

Government (Public Sector)

Industry (Private Sector)

Before Stimulus

Government (Public Sector)

Industry(Private Sector)

After Stimulus

What are the productivity

and efficiency implications?

BEFORE STIMULUS AFTER STIMULUS

Impact on LRAS?

Focus fiscal stimulus on productivity → investment not re-distribution

Invest in quick delivery projects → Avoid complex projects

Just as much about politics as it is about economics!

The Bigger Picture

General Evaluation Points Extent of contraction depends on

the productivity the expansion achieves

Fiscal Expansion Today

Fiscal Contraction tomorrow to repay debts

Funded by Borrowed Funds

Supply Side Policy

Supply Side Policy

Policies which aim to influence the productivity and long-run trend rate of growth of the economy.

The Role of SSP


Instigates strong LRAS

shift

Reinforce with supply side policies

Will productive

capacity expand?

Creates an initial AD

curve shift

Use of fiscal and/or

monetary policy

Relatively inexpensive –regulatory/legislative changes

If implemented effectively will not create inflationary pressures

Supports a mix of different policies that are already in action

Fiscal Policy + Supply Side Policy

PriceLevel

Real Output

P1

YFE1

SRAS1

AD1

AD2

A

LRAS1

YFE2

LRAS2

C

SRAS2

BP2

Y2

Best to implement policies that come with a minimal cost


Relax planning regulations

Salaries and pensions of civil servants

More generous transfer payments?

Free medication for pensioners

Export subsidies/support

Build more care homes

R&D tax reliefReduce basic rate of

income tax

Relax employment laws

Relax financial regulation

Reduce VAT

Defence spending


Best approach to ensure fiscal policies can react to economic shocks effectively, use alongside SSPs rather than as an alternative

Need to identify the outcome and effectiveness of fiscal policies, need to identify where the expenditure gets diverted to


The key area here is to broaden out from isolated policies to how a mixture of economic policies can be blended together to reach a sustainable outcome.

SSPs take time to have the desired effect

Some regulatory changes can be

complex to administer

Stakeholder dissatisfaction –

workers and firms

External influences –EU rules can restrict

Exchange Rates

Exchange Rates

The value or price of a currency expressed in terms of another currency.

Must be comfortable with the connotations of ER changes…


S

D

P

I

C

E

trong

earer

ound

mports

heaper

xports

W

C

P

I

D

E

eak

heaper

ound

mports

earer

xports

ER Rise ER Fall

X Prices

M Prices

AD

SRAS

Inflation

RISE

FALL

FALL

RISE

RISE

FALL

RISE

RISE

FALL

FALL

Possible Evaluation Points

Currency changes are caused by economic events/policies and can provide further evaluation points regarding the overall effects.


Marginal Propensities

Marginal propensity to import?

Marginal propensity to export?

Elasticity

Relative import and export elasticities?

Marshall-Lerner condition (only if PED of X and M > 1)?

Ceteris Paribus Assumptions

Counter-balancing forces - Exchange rate change could be offset by some other factors, exchange rate might just rebalance

Policy Impacts – what monetary and fiscal policy changes are on the horizon?

Time Lags

Impact on consumption may not be immediate? Some consumers may still consume from the same source

Automatic impact on firms’ costs? Can firms match these changes in demand?

State of the Economy?

Position of the economy e.g. level of spare capacity?

Business Response

Businesses need to adjust to exchange rate changes to maintain competitiveness e.g. absorb cost changes or pass them on? Invest in greater

production scale? Outsource business departments?

Trade

Trade

Trade concerns the international exchange of goods and services between different countries in the global economy.

The key area here is that we are focusing on specific trading elements and not the full current account.

Why is this relevant?


X

M

Real output

Price level

ADSRASLRAS

Jobs

GrowthInflation

Fiscal finances

Current Account

Capital Account

Income distribution

This allows you to extend your analysis of basic

AD-AS shifts to talk about some of the trading

implications

This concerns EVALUATION because it can lead you

down the path of talking about factors which affect the competitiveness of the

economy

Application to the AD-AS framework


AD Expansion

PriceLevel

Real Output

P1

YFE

SRAS

AD1

AD2

A

LRAS

BP2

Y2

What could instigate this?

Direct tax cut Increase in G

Indirect tax cut Currency weakness

More confident External inflation

External growth Rate cut

Basic Effects

Real output rises

Price level rises

AD Increase

Greater levels of inflation –makes domestic goods

relatively more expensive (Hurts Exports)

Higher levels of AD –increases consumption at all levels including consumption

(Increases Imports)

Results in net exports (X-M) falling and this will bring the AD curve back towards full

employment

Relative Price Level!

We should focus on the relative changes in the price level before we assess trade implications

Changes in the price level contributes to the cyclical nature of economic systems

UK receives a competitive boost against EU!

UK Price Level EU Price Level

Trade Protection

Trade Protection

Policies which aim to increase the production of domestically produced goods at the expense of foreign imports.

The key area to evaluate when it comes to protectionist measures are country specific factors ahead of just looking at the general reasons for and against.

Welfare Implications of Trade

Welfare Implications

Price

Quantity

P

QDOM

SDOM

D

Price

Quantity

P

QDOM

SDOM

D

SWORLD

QSDOM Q2

PWORLD

Domestic Market – No Trade Domestic Market – Free Trade

The trick with trade evaluation is to keep things simple…

This in itself is a powerful argument for free trade but does it apply to the real world?

Try to avoid getting caught up in drawing tariff and quota diagrams as they are difficult to replicate accurately and quickly in an exam.

You need to go further than just list the arguments for and against and focus on country-specific characteristics


For Trade Protection Against Trade Protection

Protects the economy Raises prices of imports

Protects infant industries Lack of competition

Protects sunset industries Range of goods narrows

Prevents dumping Less specialisation

Protects product standards Possible government failure

Restrictions from the EU and WTOMay be part of a supply side reform package

Timeframe

SR – Light relief to protect an industry

LR – Unlikely to save a failing industry

Retaliatory Action

Countries may retaliate –trade war!

Can actually hurt the industry that it was meant to protect

Secondary Markets

Tariffs and quotas have indirect effects on firms that use that good i.e. carmakers use steel

Inefficiencies

Protectionist measures result in production and

consumption inefficiencies –

protectionist is second best approach

Comparative Advantage

Better to focus on developing efficient

industries

Costly to prop up loss-making industries

Strategic Implications

keeps strategically important industries

alive

Gives countries bargaining power in

future trade talks

Alternatives

Regulations are just as effective as tariffs and can

level an uneven playing field by supporting

producers

Could the government use tariff revenue to finance

the admin costs of applying these measures?

EU has effectively used regulations to enforce

standards and encourage intra-union trade between

member states

Current Account Deficits

UK Current Account

Records flows of money between the UK and other countries including exchange of goods and services, investment income and transfer payments.

You need to be able to evaluate whether it is desirable for a country to run a current account surplus or deficit.

How do current account imbalances emerge?

BORROW to buy more

Spend on domestic goods

and services

Proceeds of sales paid to

owners of F of P (includes workers)

Sold to domestic market

Domestically produced goods and

services

Spend on Imports (M)

Sold as Exports (X)

If Import > Export need to BORROW to fund it = Deficit

Spend onImports (M)

What are the effects of a current account deficit?

(X-M) turns negative and this results in an ISOLATED drop in aggregate demand

Deficit offset by financial account surplus– how is the deficit financed? Borrowed on international markets or via FDI & capital inflows (effectively from trade surplus elsewhere)

Greater demand for imports applies downward pressure on the domestic currency

Does this give the economy’s exports a competitive boost?

Are these effects offset by higher import prices passing through the economy?

Overall impact on current account deficit long-term from currency devaluation may depend on Marshall-Lerner condition (J-Curve Effect)!

Country becomes more vulnerable to capital flight from investors and bilateral political tensions due to foreign ownership of domestic assets – risk of exchange rate crash

How does this influence trade discussions between countries?

Leaves the country’s currency, financial sector and economy vulnerable to a currency run

Could these higher prices pass through the economic system and override the initial competitive boost to the country’s exports?

Current account imbalances are not generally perceived to be a big problem as they are a natural representation of the global trading system

The global economy B of P also balances – total country deficits are balanced by total country surplus!

The importance of the issue is whether the current account deficit/surplus is a reflection of a country’s competitiveness or just a general economic imbalance

Deficit from lack of competitiveness = PROBLEM Deficit from greater demand = NO PROBLEM

Long-term productivity-enhancing and price competitiveness policies to rectify

Short-term expenditure-reduction policies to rectify or accommodate with greater domestic

production

Globalisation

Globalisation

The process of economic and financial integration that has progressively removed national boundaries from the financing, production, sale and

distribution of goods and services.

Main point to evaluate here is the link between globalisation and living standards.

Globalisation Benefits

Globalisation Results on UK Economy

Results in greater access to better

quality goods and services for

consumers and firms

Contributed to trading consistency and

economic familiarity with countries in the

global economy

Resulted in countries focusing and

specialising in the goods and services

they are most efficient at producing

Increased levels of inward investment have contributed to

job creation and knowledge-sharing

benefits

Evaluate means that we cannot just list the benefits of globalisation – we need to consider the importance and distribution of these benefits.

Distribution of Benefits


Increases trade, product choice and welfare amongst countries

Developed countries stand to benefit the most from this as this is where most of the wealth

holders are situated

If asset prices and MNC values increase → widens the gap between the rich and poor (higher levels of wealth and income inequality) → unlikely to

feed through to sustained development benefits

Sustainability of Growth


Globalisation may have lifted growth rates in developing countries, but has that contributed to

higher rates of development and economic welfare?

Growth externalities chip away at the benefits that globalisation produces

Increased trade results in increased carbon

emissions

Increased production puts a greater strain on

the global stock of resources

MNC Activity and Influence


MNCs are at the heart of increased levels of integration between countries

All of these points have to be raised against the economic benefits that clustered MNC activity has

on both the local and national economy

Spread of MNCs has diluted the local culture within economies

Some argue MNCs have driven down wages and exploited workers

MNCs are offered tax advantages in order to invest → this provides an unfair advantage

Specialisation Risks


Globalisation encourages the specialisation of products, creating efficiency and price benefits

This is why it is strategically important to keep some industries alive

If countries specialise in producing only a select number of goods and services then they are

vulnerable → industry downturn could prompt a recession

There is also a danger that some countries can become too dominant on the world trading stage

such as China



Demand + Supply Impact Development Benefits Living Standards

Globalisation has brought down transportation and

communication costs

Globalisation has facilitated growth of incomes in developed

and developing countries

Environmental consequences of huge increases in air travel

This has accelerated advances in education and healthcare

Offshoring production and greater trading and financial access increases range and

quality of products

Creates more jobs but this focuses production in cities and

hurts the local environment

Economic Integration

Economic Integration

Where a group of countries take steps to increase the trade levels between themselves.

The key area to evaluate is to assess whether in fact greater levels of economic integration will create or divert trade.

Mechanisms of the EU Customs Union

Implications of EU Customs Union

A B

C

FTAD E

The EU Customs Union enables member countries to trade freely amongst each other,

whilst applying a common external tariff against non-members i.e. the US.

If the UK were to withdraw from this agreement, how would it affect the UK goods

markets that the US holds a comparative advantage in?

In an exam you would need to EVALUATE the consequences for UK trade patterns with non-

EU countries upon leaving the EU – trade creation or diversion?

Trade gets diverted away from US producers to EU producers!THE BIG PICTURE

There are always winners and losers from trade agreements but the

ultimate objective is to increase trade

Difficulty is the terms of trade vary from good to good

Helps explain why the negotiating time for FTAs are exhaustive

How has the UK’s trade relationship with the EU affected UK-US trade?

Trade between the UK and US is created, but diversion away from EU countries!

Price

Quantity

P

Q

PUS

QDQS

Quantity of Imports

PUS+T

QS+T QD+T

D

SUK

Producer Surplus

Government Tax Revenue

DWL due to Inefficient Production

DWL due to Reduced Consumption

Consumer Surplus

Net Welfare Loss +

Trade gets diverted away from US producers to EU producers!

++---

Member of EU – EU Tariffs Apply to US Firms

UK has no trade agreement with the US

SUS

SUS + EU TARIFF

UK Leaves the EU – EU Tariffs Removed

UK can facilitate this with a US trade deal

Price

Quantity

P

Q

PUS

QDQS

Quantity of Imports

PUS+T

QS+T QD+T

D

SUK

SUS

SUS + EU TARIFF

Net welfare gain, increase in trade but loss in tax rev

Does the trade agreement cover all goods?

Is the impact of the trade agreement reciprocal?

Are tariffs abolished immediately?

Does the agreement cover other trade frictions?

UK application - Does the agreement cover services?

UK regulatory divergence from other countries?

If poor deal with EU then this causes diversion that dilutes the benefits of the US trade agreement. Depends on the size of relative gains/losses.


The Euro – Single Currency

Single Currency (Currency Union)

A currency that circulates and is used by two or more countries without further levels of economic integration.

You need to be able to evaluate the implications of a country participating in a single currency such as the Euro.

Basic Evaluation Points – how do individual countries cope with domestic economic shocks?

Advantages > Disadvantages e.g. France, Germany

Disadvantages > Advantages e.g. PIGS Countries

PriceLevel

Real Output

P1

YFE1

SRAS1

AD1

AD2

A

LRAS1

SRAS2

LRAS2

B

YFE2

PriceLevel

Real Output

P1

YFE1

SRAS1

AD1AD2

A

LRAS1LRAS2

B

YFE2

P2

Conversion costs

Fiscal policy limitations?

Reliance on ECB?

Collective monetary policy?

Loss of sovereignty

No exchange rate risks/costs

Easy price comparisons

Facilitates greater trade

Economies of scale

Attracts FDI

Advanced Evaluation Points – Compare the difficulties of the € to the success of the £


Reference to the success factors of the pound (£) across the UK’s separate regions

Common Language/Culture

Common Laws/Taxes

Labour Mobility

Free Trade

No Inflation Differentials

Fiscal Transfers System

One language and integrated cultures

Devolved administrations but symmetry

Scottish workers move to London

Goods move freely across regions

No need for ER to adjust for inflation

Poor UK regions receive payments

What factors will make a currency zone work for individual member countries/regions?

High Levels of Market Integration – Movement of labour, capital, goods and services

Factors can move from one area to another to achieve economic balance

Convergent Economic Patterns – Similar economic conditions across the currency zone

Economic symmetry makes it easier to make policy decisions that support all member countries

Euro entrance and fiscal rules can be fatally restrictive for less competitive economies?

Stable Inflation (<1.5%) Budget Deficit (<3%) National Debt (<60%) Peg £ to € for 2 years

European Union (EU)

European Union (Single Market and Customs Union)

A political and economic union of 28 member states established to increase trade, investment and cooperation between countries in the bloc.

Evaluate means that we cannot just list the costs and benefits of EU membership – we need to consider which costs and benefits are important.

The UK’s membership of the European Union (EU) is a political application of cost-benefit analysis –personal viewpoints often dominate the value (or lack) of continued membership

EU Common Market (Single Market)

Promotes high levels of market integration – free movement of labour, capital, goods and services. This supports lower prices, higher levels of trade, more jobs and greater FDI flows.

EU membership has coincided with the UK running a current account deficit – impact on AD?

Could trade deals with the rest of the global economy replace these benefits post-Brexit?

Stable Economic, Political and Legal Framework (Regulatory Alignment)

The UK’s membership of the EU has been an ongoing process of increased integration since the 1970s.

How disruptive could it be for the UK economy to unpick all these laws, standards and regulations? How long would this uncertainty last for?

Upon leaving, the UK could be in a position to re-balance its trading position with the rest of the world. How far would UK regulatory standards have to diverge to become compatible with countries like the US?

Does the UK have the same trade negotiating bargaining power outside of the EU?

Regulatory divergence from the EU could hurt the productivity and efficiency of UK firms that rely on integrated European supply chains. Reduction in business investment could hurt the productive capacity of

the UK economy.

Immigration System (Free Movement of Labour)

The UK must allow free movement of people from the EU as a condition of being a part of the EU’s common market.

The flow of migrants from the EU allows UK businesses to fill labour shortages left by UK workers. Are EU migrants really more suited to UK jobs than non-EU migrants?

An increase in the supply of labour has contributed to lower wages in a concentration of low-skilled industries. Has this damaged the UK’s productivity performance?

EU migrants make a valuable contribution to the Government’s tax revenue to help fund productivity-enhancing projects. Has the squeeze on local services and the housing market offset the benefits of higher

tax receipts?

EU Annual Budgetary Payments

The UK pays a net figure of £9bn annually to the EU to help finance development projects, EU policies and help cover staffing and administration costs.

Some of the UK’s share gets re-directed back to the economy via rebates from the UK’s participation in the Common Agricultural Policy (CAP) and Common Fisheries Policy (CFP). Are these policies an appropriate

use of funds? Does the UK benefit from development projects implemented across the wider union?

If the UK left the union it could claim back this budgetary figure for domestic investment purposes. Is this figure actually a substantial amount compared to the government’s annual expenditure plans? Possibility

of government failure from domestic use of funds?

Development Economics

Development Economics

The field of economics that focuses on the strategies that can encourage economic development in less developed countries (LDCs).

The nuanced evaluation points here relate to the different implementation levels for policies that encourage growth and development in LDCs compared to HDCs.

Basic Development Concepts

Sustainable Growth

Econ. Development

Sustainable growth requires increasing productive capacity (LRAS shift)

LDCs will require a different mix of policies to become a mature DC economy

Then countries need to have the system in place to convert this growth into development

benefits

PriceLevel

Real Output

P1

YFE1

SRAS1

AD1

AD2

A

LRAS1

YFE2

LRAS2

C

SRAS2

BP2

Y2

Application of the Harrod-Domar Model

Intervention Strategies to attract capital

LOW SAVINGS

LOWINVESTMENT

LOW ECONOMIC GROWTH

LOW PRODUCTIVITY

Developing Economies

Borrow Overseas Aid

Servicing Costs?

Essential in SR

Repayment Schedules?

Unhelpful in LR

Effective Use of Funds?

Conditions to Receive Aid?

Attract FDI

Greenfield or Acquisition?

Greenfield Improvements

Benefits may be limited?

Policy Approach

Characteristics of LDCs is likely to require a blended approach

An injection into the circular flow of income with

associated multiplier effects

Exports promote self-reliance, whereas aid

promotes dependency

Trade may allow sectors within an economy to

develop economies of scale and create opportunities to

access new technology

Free trade may inhibit the development of infant

industries due to higher import costs

Export-Led Growth Foreign Aid Protectionism

Market-Led Strategies Alternative Strategies Interventionist Strategies

Earnings generate foreign currency that can be used to

finance imports necessary for development

Aid may be directed at prestige projects and be

misappropriated by corrupt officials

Effectiveness of aid depends on the type of aid given and

how it is distributed

Real World Data

The evaluation points you make can be strengthened by the use of real world data.

Does the data support or critique the economic analysis or even your own judgements?

It is good to go into the exam with a general idea of the UK’s recent macroeconomic performance…

GR

OW

TH

-2.5-2.0-1.5-1.0-0.50.00.51.01.5

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18

Q1

20

18

Q3

UK GDP quarterly growth

has recovered since the

financial crisis –driven by

services sector growth.

UN

EMP

LOY

MEN

T

3.0

4.0

5.0

6.0

7.0

8.0

9.0

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Q1

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Q3

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Q1

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Q3

20

18

Q1

20

18

Q3

UK unemployment

rate has fallen to its lowest level

since 1975 –4.0%.

INFL

ATI

ON

-1

0

1

2

3

4

5

6

Jan

20

09

Jun

20

09

No

v 2

00

9

Ap

r 2

01

0

Sep

20

10

Feb

20

11

Jul 2

01

1

Dec

20

11

May

20

12

Oct

20

12

Mar

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Au

g 2

01

3

Jan

20

14

Jun

20

14

No

v 2

01

4

Ap

r 2

01

5

Sep

20

15

Feb

20

16

Jul 2

01

6

Dec

20

16

May

20

17

Oct

20

17

Mar

20

18

Au

g 2

01

8

Jan

20

19

UK CPI inflation rate has

stabilised in around target of 2% since 2015 –helped control real incomes.

TRA

DE

PR

OD

UC

TIV

ITY

-8

-6

-4

-2

0

2

19

97

19

98

19

99

20

00

20

01

20

02

20

03

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04

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05

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06

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07

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09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

Trade balance Total current account balance

UK current account deficit (% of GDP) has

deteriorated since the 1990s

due to less reliance on

manufacturing

80

90

100

110

120

130

20

07 Q

4

20

08 Q

2

20

08 Q

4

20

09 Q

2

20

09 Q

4

20

10 Q

2

20

10 Q

4

20

11 Q

2

20

11 Q

4

20

12 Q

2

20

12 Q

4

20

13 Q

2

20

13 Q

4

20

14 Q

2

20

14 Q

4

20

15 Q

2

20

15 Q

4

20

16 Q

2

20

16 Q

4

20

17 Q

2

20

17 Q

4

20

18 Q

2

20

18 Q

4

Output per hour

Output per hour (2007 trend)

Output per worker (2007 trend)

Output per worker

Synoptic Strengths

A lot of these topics may only become relevant when evaluating an alternative economic policy. This means even if you are not asked directly about some of these topics in an exam question, you will still receive credit for bringing them in to assess

other relevant issues.

This is particularly relevant for PAPER 3 (Micro + Macro). Only one essay question but lots of issues you can raise…

MICRO EFFECTS

P

O

P

S

I

C

L

E

Price

Output

Profits

Structure of the Market

Inefficiency

Competition

Labour Markets

Externalities

MACRO EFFECTS

D

I

G

E

S

T

I

F

Development

Inflation

Growth

Employment

Structure of the Economy

Trade

Inequality

Fiscal Effects

Scale a MACRO issue down to assess micro effects

Scale a MICRO issue up to assess macro effects

Documents

AQA Edexcel OCR Evaluation Booster Pack › images › easyblog...Evaluation Booster Pack ... We have selected some of the core theories and models across the AQA, EDEXCEL and OCR