DATA RESPONSE

Course: A2 - Year: 2020 - Serie: May/June - Version: 1/3

(a)

Nudge theory is based on the idea that economic agents can be “nudged” towards
behaviour that is beneficial for society when choices are presented in a better way. It
uses reinforcement and makes indirect suggestions to achieve non-forced compliance (i.e.
individuals retain their freedom to choose).

(b)

First, the information indicates that nudges can be used to “get people back to work”.
For example, public employment agencies may start offering breakfast to jobseekers. The
resulting decrease in unemployment leads an improvement in resource utilization so the
economy’s Gross Domestic Product (GDP) is likely to increase.

Second, the information indicates that nudges can be used to “encourage [people] to
pay their taxes on time”. For example, the government could send emails or text messages to
taxpayers some time before the filing deadline and inform them about the percentage of the
population that has already filed their taxes. The resulting rise in tax revenue will enable the
government to increase its spending and will therefore stimulate the economy’s GDP.

Third, the information indicates that nudges can be used to encourage people to “study
for improved qualifications”. For example, the government can support the development of
alumni associations that provide variety of benefits and services to graduates. A more
educated labour force has a higher productivity so the economy’s GDP can be expected to
rise.

(c)
On the one hand, a demand-side policy is a macroeconomic policy aimed at influencing
the economy through changes in Aggregate Demand (AD). A demand-side policy that
increases (resp. decreases) AD is known as expansionary) resp. contractionary). There are 2
main types of demand-side policies: fiscal policy (i.e. changes in taxes and spending by the
government) and monetary policy (i.e. changes in the money supply by the central bank). The
information indicates that “one method of dealing with [the government budget deficit] was to
increase taxation” or alternatively to “reduce government expenditure on public services”.
These are examples of contractionary fiscal policies. Higher tax rates on households will
reduce their disposable income and reduce their consumption. Besides, higher tax rates on
businesses may undermine investment. Overall, higher taxes or lower government
expenditure will result in a decrease in AD, which can be expected to lead to lower real GDP,
higher unemployment and lower inflation.

On the other hand, a supply-side policy is a macroeconomic policy aimed at influencing

the economy through an increase in Aggregate Supply (AS). Supply-side policies include a
range of measures aimed at increasing the economy’s productive potential. As we mentioned
earlier, nudges aimed at encouraging people to “study for improved qualifications” can be
regarded as a supply-side policy because they will improve labour productivity. Likewise,
nudges aimed at “encouraging [people] to pay their taxes on time” can also be regarded as a
supply-side policy if they are intended to provide the government with the revenue necessary
to finance the development of new and improved infrastructures, to support Research &
Development (R&D) or to fund education and training. The same goes if the government
chooses to “increase […] borrowing”. Overall, these policy instruments will lead to an increase
in AS and it can be expected to lead to higher real GDP, lower unemployment and lower
inflation.

(d)

Overall, the article does not support the idea that GDP is a good measure for well-
being.
It mentions that the Human Development Index (HDI) is often used to measure the
quality of life. The HDI is indeed a reliable indicator of the quality of life because it is multi-
dimensional and includes not only the purchasing power of a country’s average resident but
also the quality of healthcare and the level of education which are clearly positively related to
the quality of life.
However, Table 1.1 shows that there is no clear relationship between a country’s GDP
and its HDI. For example, Norway is ranked 1st in terms of HDI but only 29th in terms of its
GDP which seems to suggest that a high HDI ranking is not necessarily associated with a high
GDP ranking. Besides, Pakistan is ranked 117th in terms of its HDI but 43rd in terms of its GDP
which seems to suggest that a relatively low HDI ranking is not necessarily associated a
comparably low GDP ranking.
This is because GDP merely measures national income, which is clearly one key
determinant of the quality of life, but it is not the only one. Besides, Table 1.1 suggests that
GDP is calculated at current prices. If an economy experiences a high rate of inflation, then
its nominal GDP will rise even during periods of economic stagnation. Also, GDP is not a good
indicator of the quality of life because is not adjusted for the population size and its changes
over time. For instance, the UK and India have comparable GDPs but their populations clearly
do not enjoy the same standards of living. In order to take out the distortionary effect of the
population size and its changes over time, we should instead focus on GDP per capita. Finally,
Table 1.1. suggests that nominal exchange rates have been used to convert GDP data from
various countries into US dollars. This method undermines the reliability of GDP as a
measurement of the quality of life because it does not acknowledge that the purchasing power
of 1 US dollar can vary drastically from one country to another. In particular, 1 USD usually
has a stronger purchasing power in developing countries, so using nominal exchange rates
understates the standard of living in low-income economies. The use of Purchasing Power
Parity (PPP) exchange rates is therefore more suitable if GDP data is to enable reliable cross-
country comparisons of well-being.

Nb: In my opinion, this is a bad question because the answer is one-sided. Indeed, as
mentioned in the mark scheme “there is no real evidence that GDP is a comparable accurate
measure of well-being”.