PODAR INTERNATIONAL SCHOOL

Grade 9
Economics

Unit 4.1 - Chapter 24- The role of government

Q. Describe the role of government, locally, nationally and internationally
The public sector in every economy plays a major role, as a producer and employer.
Governments work locally, nationally and internationally. Here are the roles they play in the
economy:

 As a producer, it provides, at all levels of government:

 merit goods (educational institutions, health services etc.)
 public goods (streetlights, defense, etc.)
 welfare services/transfer payments (unemployment benefits, pensions,
child benefits etc.)
 public services (police stations, fire stations, waste management etc.)
 infrastructure (roads, telecommunications, electricity etc.).

 As an employer, it provides at all levels of government, employment to a large

population, who work to provide the above mentioned goods and services. It also
creates employment by contracting projects, such as building roads, to private firms.

 Support agriculture and other prime industries that need public support.

 Help vulnerable groups of people in society through redistributing income and

welfare schemes.

 Manage the macroeconomy in terms of prices, employment, growth, income

redistribution etc.

 Governments also manage its trade in goods and services with other countries by
negotiating international trade deals.
 Unit 4.2 - Chapter 25- The macroeconomic aims of government
Q. Describe the macroeconomic aims of government
Full employment: those who are able to work and looking for work are in employment.
Usually, some frictional unemployment exists
Balance of Payments Stability: keep imports and exports balanced as well as flows of
finance
Economic Growth: increasing the output of the economy (Real GDP). In the long run they
aim to push the PPB (Production Possibility Boundary) outwards.
Redistribution of Income: may aim to take money from the rich (higher tax rates) and give
it to the poorer population (unemployment and social housing benefits).
Price Stability: governments aim to keep inflation at a steady rate (around 2%). This allows
firms and individuals to plan for the future more accurately.

Unit 4.3 - Chapter 26- Fiscal policy

Q.1 Differentiate between a direct and indirect tax:

Direct tax- Direct tax is the tax imposed on the income and wealth of individuals and firms. It is
usually progressive in nature. The impact (initial burden) and the incidence (final burden) is on the
same person. Tax burden cannot be transferred to anyone else. Examples of direct ta include: Income
tax, Wealth tax, Corporate tax, Inheritance tax, etc.
Indirect tax- Indirect tax is the tax imposed on expenditure on goods and services. It is usually
regressive in nature. The impact (initial burden) and the incidence (final burden) is on different
people. Tax burden can be transferred to anyone else. Example of indirect tax include: GST, VAT,
Service tax, Sales tax, etc.

Q.2 Aims of taxation/ Reasons for government imposing tax?

• Public Goods-To fund and provide public goods such as streetlight as no other private sector
firm would do it.
• Merit Goods-To encourage the production and consumption of merit goods such as healthcare
and education by using the tax revenue to give subsidies to the producers.
• Demerit Goods-To discourage the production and consumption of demerit goods such as
alcohol by imposing higher tax rates which makes it more expensive.
• Imported Goods-To discourage the consumption of imported goods, by charging higher taxes,
they become more expensive for the consumers to buy. And this tax revenue can be used to
give subsidies to exporter and domestic firms to make their products internationally
competitive.
 • Transfer payment-The tax revenue can be used as a means to provide transfer payments like
unemployment benefits, pensions, etc.
• Redistribution of income and wealth-Redistribution of income and wealth by using
progressive taxation and giving the poor benefits in the form of subsidies.
• Interest payment to the World Bank-Government can use the tax revenue in order to pay
interest on any loan that is taken from other lenders such as the IMF and the World Bank.
• Tax the firm generating Negative externalities-Government imposes tax on the firms that
generate negative externalities and external costs such as pollution, damage of the
environment, etc.

Q3. Differentiate between progressive, regressive and proportional tax

Progressive Taxation:
o As the income increases the tax rate also increases.
o More tax will be charged on the higher income group and then the tax revenue
collected will be redistributed to the poor in the form of subsidies. It bridges the gap
between the rich and the poor.

Proportional Taxation:
o Tax rate remains same at all income levels.

Regressive Taxation:
o As the income increases tax rate decreases.
Q4.(a) Define Expansionary fiscal policy: The government reduces the tax rates which help increase
investments and consumer expenditure as their disposable income rises, and they increase the
government expenditure on education, healthcare, infrastructure, etc. This leads to a rise in aggregate
demand.
Q4.(b) Define Contractionary fiscal policy: The government increases the tax rates which will
decrease investments and consumer expenditure as their disposable income falls, and they decrease
the government expenditure on education, healthcare, infrastructure, etc. This leads to a fall in
aggregate demand.

Q5. Discuss the advantages and disadvantages of direct tax

 Advantages of direct tax:

o Helps in redistribution of income
o It is based on the ability to pay the tax
o Higher revenue yield for the government
o The certainty is high as people are meant to pay it

 Disadvantages of direct tax::

o If too high, it can reduce worker incentives
o If too high, it will reduce enterprise incentives
o It can cause tax evasion where people would not pay tax on time or pay lesser tax
o Can discourage investments and savings in the economy

Q6. Discuss the advantages and disadvantages of indirect tax

Advantages of indirect tax:

• They are cost effective

• Expand the tax base for the economy, which means that more people are paying the tax
• Can be used to discourage the production and consumption of demerit goods
• They cannot be evaded

Disadvantages of indirect tax:

 • They are inflationary in nature
• They are regressive, hence can affect the poor
• Revenues are less certain and less predictable
• Can encourage tax evasion through smuggling
• Harmful to ancillary industries if the tax on raw materials is too high

Q7. Explain what is meant by a regressive indirect tax.

• an indirect tax is a tax on spending
• paid indirectly by consumers to the government via producers/the burden can be shifted
• example/an indirect tax may have the same rate for most goods and services
• all people pay the same rate irrespective of their income/ability to pay
• the poorer people, therefore, will pay a higher percentage of income in tax than the richer people

Q8. Explain how the direct tax can help in redistribution of income and wealth?
How it can affect the distribution of income:
• a direct tax is a tax on the income of people and firms (1)
• income tax is usually a progressive tax (1) this takes not just more of the income of the rich (1) but
also an increasing proportion of their income (1) reduces the gap between the income of the rich and
the poor (1)

• tax revenue raised may be used to help the poor (1) e.g. spending on housing, education and health
care (1) this may increase the earning potential of the poor (1)
Why the effect may be limited:
• will depend on how progressive the tax is (1) some countries operate flat taxes (1)
• will be influenced by the extent of tax avoidance (1) some of the rich may find ways of not paying
the tax (1)
• a high rate may discourage effort and enterprise (1) leading to lower output (1) higher
unemployment (1) greater poverty/more uneven distribution of income (1)
• it may be offset by the regressive nature of other taxes (1)
• other factors may change such as a lowering of the minimum wage (1) how this could affect the
distribution of income (1)
Q:9. Explain Qualities/Characteristics of a Good Tax OR Canons of taxation?
1. Certainty:- Easy to calculate, People should be able to calculate the amount of tax required to be
paid by them.
2. Convenience:- A tax should be easy to pay.
3. Equity:- It should be based on the ability to pay
4. Economical:- Cost of collecting a tax should be considerably less than the revenue it generates.
5. Flexibility:- Able to change the taxation as per boom/recession. It should not be rigid.

Q10. Using a demand and supply diagram, explain the impact of increase in indirect tax
on equilibrium price and equilibrium quantity based on price elasticity of demand?
10 (a). Who will bear more tax burden (consumer or producer) for inelastic goods such as petrol,
cigarettes?
 For Relatively Inelastic Price (PED < 1), more tax burden falls on the consumer.

10 (b). Who will bear more tax burden (consumer or producer) for unitary elastic goods?
 For Unitary Elastic Price (PED = 1), tax burden falls on both the consumer and the producer.
10 (c). Who will bear more tax burden (consumer or producer) for elastic goods such as luxury
goods, products having many substitutes?
 For Relatively Elastic Price (PED > 1), more tax burden falls on the producer.
 Unit 4.4 Chapter 27 Monetary Policy

Define monetary policy- It is a demand side macroeconomic policy. It

is adopted by the Central Bank. It uses interest rates, money supply
and exchange rate to influence aggregate demand in the economy.

Define expansionary monetary policy :- Aim is to increase AD.

Central bank will decrease interest rates and increase money supply
in the economy

Define contractionary monetary policy :- Aim is to decrease AD.

Central bank will increase interest rates and decrease money supply
in the economy.
Q. Explain how expansionary monetary policy can be used to
increase aggregate demand [4]
The central bank reduces the interest rate, increases money supply and
depreciates the domestic currency.

If interest rates fall, consumers will not be motivated to save and they would
rather spend more, also firm’s cost of borrowing decreases which causes the
firms to increase their investments.

As there is more money supply in the market, the borrowing could increase,
and consumer expenditure can also rise.

Central bank can also devalue the currency which will cause the exports to
become cheaper in the international market and causes the demand for exports
to increase resulting in increase in exports revenue, also imports become
expensive so the demand for imports falls causing the imports expenditure to
decrease resulting in rise in net exports (X-M) only if PED is elastic. The
aggregate demand rises in all these cases.

Q. Analyse how a rise in the interest rate could cause a recession.

A higher interest rate would increase the cost of borrowing (1) reduce borrowing (1)
reduce the spending power of people who have borrowed in the past (1) increase
saving (1) consumer expenditure / spending may fall (1) investment may fall / may
discourage MNCs (1) unemployment may increase / employment may fall (1) total
demand may fall (1) the output of goods and services / GDP may fall (1) if output
falls over a period of two quarters / six months there will be a recession (1).
A higher interest rate may encourage more people to buy the currency (1) to put
money into the country’s financial institutions (1) raising the value of the foreign
exchange rate (1) raising the price of exports (1) lowering demand for exports (1)
reducing the price of imports (1) increasing demand for imports (1).

Q. Analyse how an increase in the rate of interest could increase unemployment.

Rise in the rate of interest may discourage borrowing / increase cost of borrowing (1)
increase saving (1) decrease spending (1) decrease total demand (1) lower demand may
decrease output (1) encourage firms to make workers redundant (1).
Rise in the rate of interest may increase firms’ costs of production (1) this may encourage
firms to reduce their output (1).
Rise in the rate of interest may increase the exchange rate (1) higher exchange rate may
decrease exports and increase imports (1) decrease domestic production (1).

Q. Explain one similarity and one difference between monetary policy and fiscal policy.
(4)
Both monetary policy and fiscal policy are designed to achieve the government’s
macroeconomic aims by influencing total demand. This is why they are both sometimes
referred to as demand management policies.
The difference between the two is that they use different measures to influence total
demand. Monetary policy uses changes in the rate of interest, money supply and the
exchange rate, whereas fiscal policy uses changes in government spending and taxation.

Q. Discuss whether or not an increase in the rate of interest will reduce consumer
expenditure. (8)
An increase in the rate of interest would be expected to reduce consumer expenditure. This is
because households would have to pay more if they borrow. As a result, spending financed
by borrowing would be reduced. The higher interest rate would also increase the reward for
saving, so households may decide to save a higher proportion of their disposable income
and spend a smaller proportion of their disposable income.
Households that have borrowed at a variable interest rate in the past will have less money to
spend, as more of their income will be going in servicing their debt.
There are, however, a number of reasons why it is possible that an increase in the rate of
interest may not reduce consumer expenditure. If households are very confident about the
future, they may continue to borrow and spend at the same rate. If they expect that they will
earn more in the future, they may think they will have no problems paying a higher interest
rate.
A small rise in the rate of interest, especially from a low rate may have little or no effect. For
example, a rise from 1% to 1.25% is unlikely to discourage many people from borrowing or
encourage many people to save more. A rise that is not expected to last may also not affect
households’ borrowing and saving plans. Indeed, some saving and borrowing is at a fixed
rate of interest and so is not affected by short run changes in the rate of interest.
In addition, a higher rate of interest may mean that some households who are saving for a
particular target sum may have to save less to achieve their objective. This would give them
income to spend.
 Unit 4.5 Chapter 28 Supply-side policies

Q. Discuss whether or not supply-side policy measures always reduce unemployment.

(8)
One key supply-side policy measure, education and training, would be expected to reduce
unemployment. If workers are better educated and trained, they will be more skilful and
more productive. This will make them more attractive to employers. It should also mean that
they are more occupationally mobile. Should they lose a job, they should be able to find
another one relatively quickly.
Whether the other supply-side policy measures will always reduce unemployment is more
debatable. The intention behind cutting income tax and lowering unemployment benefit
may be to reduce unemployment by making work more attractive relative to depending on
unemployment benefit. If the gap between pay and unemployment benefit is widened, some
of the unemployed may search more actively for jobs. If, however, there is a lack of demand
for labour or if the unemployed do not have the skills to fill any job vacancies,
unemployment will not fall.
One of the aims of labour market reforms is also to reduce unemployment. If, for instance, it
is made easier for firms to hire and fire workers, firms may be encouraged to employ more
workers. There is, nevertheless, the possibility that removing employment protection may
increase short term unemployment as workers may be made redundant on a more frequent
basis.
It is debatable whether privatisation will increase or decrease unemployment. It may increase
employment if the industry responds to the greater exposure to market forces by becoming
more efficient and increases its sales. Privatisation, on the other hand, may not increase
efficiency. The industry may just change from a state-owned monopoly to a private sector
monopoly. If so, competitive pressures on the industry will not increase and it may not
become more efficient. A private sector industry may also be less concerned about keeping
employment high than a state-owned industry. Indeed, it may be prepared to reduce output
in order to push up the price. If it takes such action, unemployment will rise.
So, it cannot be concluded that supply-side policy measures will always reduce
unemployment. It would be hoped that they would, but there is a chance that some may
increase unemployment. The outcome will be influenced by the supply-side policy measures
used and how economic agents respond to them.

Q. Discuss whether supply-side policy measures will reduce inflation. [8] (March 2016
qp22 Q5d)
Supply-side policy measures include government policy measures designed to increase total
(aggregate) supply/quality of resources/quantity of resources (1). They include government
spending on education and training, privatisation, regulation, cuts in direct taxes, cuts in
unemployment benefits and trade union reforms (1).
Up to 5 marks for why they might:
Supply-side policy measures may reduce costs of production (1) e.g. cuts in corporation tax
will lower costs (1). They may increase labour productivity (1) e.g. education (1). Lower costs
and higher productivity will increase aggregate supply/productive potential (1) higher
aggregate supply/productive potential may reduce cost-push inflation (1) allow total demand
to increase without causing inflation (1).
Up to 5 marks for why they might not:
Some policy measures e.g. education spending will increase total (aggregate) demand (1)
this may rise by more than total supply (1) causing demand-pull inflation (1). The policy
measures may not work e.g. privatisation may lead to private sector monopolies developing
(1) these may push up prices (1). Spending on education may not improve labour
productivity (1). Some supply-side policy measures take time to work e.g. education
spending (1) by that time inflation may not be a problem or people may have got so used to
inflation they act in a way that causes further inflation (1).
 Chapter 23 Market structure [Pg. no. 201-206]

 Learning Objective:-
 Explain the features of perfect competition
 Explain the features of monopoly
 Differentiate between the features of perfect competition and monopoly
 Discuss the advantages and disadvantages of perfect competition and
monopoly.

Q. Define Perfect competition

An ideal market structure that has many buyers and sellers, identical or homogeneous products, no
barriers to entry

Q. Identify three reasons accounting for consumer preference for one firm’s products over that of
rival firms.

A consumer may prefer to buy one firm’s products over that of rival firms if the products are cheaper,
have better quality or enjoy a better brand image

Q. If a firm’s products become more popular than those of its rivals, what will happen to its market
share?

If a firm’s products become more popular than those of its rivals, it will attract more customers and
gain a higher market share.
Q. In each case, consider what type of barriers to entry and exit may exist in the following markets:
a airlines b film production

c steel production d window cleaning.

a Airlines – barriers to entry include take-off and landing slots at airports, safety requirements and
brand loyalty.

b Film production – possible barriers include brand loyalty and monopoly ownership of retail outlets.
c Steel production – barriers to entry include high set-up costs and scale of production.

d Window cleaning – there are few barriers to entry into this market. It is cheap to enter and leave,
start-up costs are low, large-scale production does not lower unit costs significantly and branding and
advertising are not particularly significant

Q. Analyse how a change in the number of firms in a market can affect the profits that are earned. (6)

If the number of firms in a market goes from a high number to one, the type of profits earned may
change in the long run. In a very competitive market, the long run profit earned is likely to be normal
profit. If the firms enjoy a higher profit in the short run, new firms would be attracted into the
market. The increase in supply would drive down price and return profit to the normal level. In
contrast, if a market moves to a monopoly, supernormal profit may be earned. Not having
competitors may result in the firm driving up price. Consumers may pay the higher price as they will
not have alternatives to switch to.

Q. Discuss whether or not a monopoly benefits consumers. (8)

A monopoly is often thought to be harmful to consumers. If there is only one firm in the market,
consumers do not have a choice of producers. The choice of products may also be limited with few
variations in the goods or services made.

There will be a lack of competitive pressure for a monopolist to keep price low and quality high.
Consumers will not be able to switch to rival firms if they think the monopolist is charging a high
price and producing products of a low quality.

The lack of competition may mean that the monopolist becomes inefficient. It may not make much
effort to keep costs low, to respond to changes in consumer demand and to innovate to improve
production methods and the quality of the product.

Of course, a monopoly may be defined as a firm that has 25% or 40%-plus share of the market. In
these cases, there will be some competition in the market. Three large firms, for example, may
compete quite rigorously. A firm might also have a 100%-share of the domestic market but may still
face foreign competition.

There is also the possibility that one firm controlling the market may benefit consumers. One large
firm, instead of a number of smaller firms, may be able to take advantage of economies of scale.
Having lower costs of production may mean that, even with a larger profit margin, the price charged
by the monopolist may be lower than that which would exist in a more competitive market.
 The quality of the products produced by a monopoly may be higher. This is because the higher profit
that a monopoly may earn may be used to finance spending on research and development,
improving existing products and developing new ones.

A monopolist may also charge a relatively low price and produce a good quality product in order to
discourage new firms from trying to enter the market. In addition, while consumers will not have a
choice of producers in a monopoly market, a monopoly may produce a range of variations of
products.

Q. Explain why firms in a perfectly competitive market always earn only

normal profit in the long run [4]
The firms can enter or exit freely. The firms will enter when the existing firms are
making super-normal profits. With the entry of new firms, the supply would increase
which would reduce the price and hence the existing firms will be left only with
normal profits. Similarly, if the existing firms are sustaining losses, some of the
marginal firms will exit. It will reduce the supply due to which price would rise and the
existing firms will be left only with normal profit.

Features of Perfect Competition

 Large number of buyers and sellers, hence a single seller is insignificant to decide
the price of a product, Prices are determined by the industry’s market forces, this
makes firms in this kind of a market, price takers.
 Free entry and exit of firms- There are no legal, financial, capital barriers. Firms
can enter whenever they want, and those who want to leave can leave whenever
they feel to do so. All firms will make only normal profit in the long run
 Free from government intervention- Since industries market forces decide the
price, the government need not interfere in the price mechanism.
 Perfect mobility of resources- all resources are occupationally and geographically
mobile, means that all capital, labour are allowed to move from one firm to another
without any restrictions.
 Perfect information about product- Both parties, the producers and consumers, have
perfect knowledge about the products being sold.
 Homogenous products- All products sold are identical in shape, size, colour, taste, etc. So
this means that no advertisement is needed to promote the products. All the goods are
perfect substitutes of each other.
 Uniform price- Since all products are same in looks and nature, all firms sell it at the same
price.
 Advantages of perfect competition:
 Prices tend to be lower than in monopoly
 Output tends to be higher than in monopoly
 Normal profits are made in the long run
 Quality of the product is usually good and better than in monopoly

Disadvantages of perfect competition:

 Due to lack of large profits, they cannot reinvest in research and development
 Due to this, no new features are added
 No opportunities of economies of scale

Q. Define monopoly [2]

It refers to a single firm which has control over the supply of a product which has no close
substitute.

Features of Monopoly [PENDISCS]

 Price maker- As there is only one firm, they are significant to decide and make the price.
 Entry barriers- there are high legal [copyrights, patents, trademarks, etc] financial, capital
barriers which does not allow other firms to enter the market.
 No close substitutes- As there is only 1 seller, the consumers have no other choice. They
have to either buy the product from the monopolist or go without it.
 Discrimination in price among buyers- The monopoly usually charges different prices to
different people and exploits them.
 Industry and firm are the same:- A monopolist is the sole seller and producer of the
product. A monopoly firm itself is an industry.
 Single seller: - There is no competition as there is only one single producer or seller of the
product. But, the number of buyers is large
 Complete control over the market supply: - As he is the sole producer or seller of the
product, he has complete hold over the market.
 Supernormal profits in the long run: - Since he is the sole seller, there are a lot of entry
barriers, he earns Supernormal profits in the long run.
 Advantages of monopoly:
 Large profits can be reinvested to improve the quality of products
 There can be opportunities of economies of scale
 This could lower cost, and possible lower price
 Avoids wasteful duplication of resources

Disadvantages of monopoly:
 They can be highly inefficient
 Prices will tend to be higher than in perfect competition
 Output will tend to be lower than in perfect competition
 Products may deliberately be made of poor quality
 Lack of competition
 Abnormal profits in the long run
 There is less consumer sovereignty: as there are no (or very little) other firms selling the
product, output is low and thus there is little consumer choice.
 Monopolies may not respond quickly to customer demands.

Exemplar Answer
Q. Analyse why price can be lower in a monopoly market than in perfect competition. [6]

Price can be lower if the monopoly enjoys economies of scale such as bulk buying /perfect
competition is unable to enjoy economies of scale, if possible to enjoy economies of scale
would lower average costs . It can be lower if the monopoly is subsidised e.g. state owned
enterprises . It can be lower if the monopoly avoids wasteful duplication/perfect
competition may result in wasteful duplication e.g. provision of water pipes . It can be lower
if a monopoly keeps price low as a barrier to entry making it difficult for new firms with high
average costs to enter the market . A monopoly is a price maker/can influence price a
perfectly competitive firm is a price taker/unable to influence price . A state monopoly may
not be trying to maximise profit may be trying to promote economic welfare keep prices low
to make the product affordable

Q. Explain why monopolies have low costs of production. [6 marks]

Answer:-

Monopolies are firms that dominate the market for a particular product. They supply
100% of the market and usually there are no substitutes to the product it supplies. There is no
competition for a monopoly. A monopoly may not have a low cost of production as it may
allocate resources inefficiently. Monopolies do have any competition as they may simply
produce low quality products and earn large profits without working hard to lower costs of
production.

A monopoly will usually require a large scale of production to operate and may soon
grow too large and face diseconomies of scale. It may have supply constraints pushing up the
cost of production. It may be subject to labour diseconomies as the workers feel alienated in
such a large enterprise leading to extra cost of labour disputes. All this could promote increased
costs of production. Furthermore, governments may implement regulations that the monopoly
must rigidly follow increasing the cost of production at each step.

Q. Why monopolies may not have low cost of production [6 marks]

However, monopolies may be able to maintain a low cost of production as it grows. It can benefit
from economies of scale. The advertising cost will be spread over a large base, lowering costs.
Banks will provide loans easily due to available collateral and suppliers will also reduce costs as
they can deliver bulk orders lowering their transport costs. These internal economies of scale
help monopolies keep low costs of production.
 Monopolies may invent new production methods, technologies and invest in R & D to
keep their costs low to compete with international firms. They may also try to be efficient if
there are high fines or high taxes in the economy

Conclusion:- If monopolies enjoy economies of scale they will get lower cost of
production, however if they incur diseconomies of scale then the cost of production will
increase.

Topic:- Chapter 31 – Inflation and deflation

Define inflation:- Inflation is the persistent rise in the average price levels of a
basket of goods and services in an economy during a specific period of time,
generally 1 financial year. The value of money falls during this period. It is calculated
using CPI.

Disinflation is when the rate of inflation falls but the price levels still continue to
rise.

Deflation is the persistent fall in the average price levels of a basket of goods
and services in an economy during a specific period of time, generally 1
financial year. The value of money rises during this period. It is calculated
using CPI.

Real Income is when inflation is adjusted for income. For e.g. If the person’s
salary has increased by 10% and the inflation rate is 6% then his real income has
increased only by 4%.

Q. Explain the causes of inflation

Types of Inflation

 Demand-pull Inflation: It is when Aggregate Demand increases at a faster

rate than Aggregate Supply leading to increase in the general price level.
 Aggregate Demand can increase due to increase in Consumer spending,
investment by firms, government spending and net exports.
 AD= C+I+G+(X-M)
 C=Consumer spending
 I=Investment by firms
 G=Government spending
 X=Exports
 M=Imports
 (X-M)=Net Exports

 Aggregate Demand has increased from AD to AD1, Aggregate Supply has expanded,
General Price Level has increased from PL to PL1 and the Real GDP has increased
from Y to Y1.
 Cost-push Inflation: This is when the cost of production rises, leading
to decrease in the aggregate supply of the economy as firms decide to
lower output to reduce costs.
o Reasons for Cost-push Inflation:
 Rent of factory increases
 Increase in the cost of raw materials
 Higher transport costs
 Increase in import prices due to higher tariffs
 Increases in wages can increase wage bill
 Higher indirect tax
  In the graph above, aggregate supply decreases from AS to AS1, resulting in
an decrease in real GDP from Y to Y1. AD contracts.
 Inflation occurs subsequently, with price levels rising from PL to PL1

3. Imported inflation:
As the price of imports increases, the price of domestic goods using imports as raw materials
also increases, causing an increase in the general prices of all goods and services.
Imported inflation may be caused by foreign price increases or depreciation of country’s
exchange rate.
4. Monetary Inflation:-
It is when the money supply of the country increases, or the interest rate falls in the
economy. Money supply can be increased by increasing printing of currency notes and coins.

Consumer Price Index (CPI)

 How is CPI calculated?

Normal Year: The year in which the inflation rate is to be calculated using
the CPI should be a normal year. These should be a normal year that is free
from any war and other economic crisis.
Survey: A survey is conducted amongst 7000 households and by that the
CPI is calculated. People are asked to keep record of their expenditure on
basket of goods and services. Then a basket which contains food spending,
transport, clothing, etc. is chosen.
Weight: Weights are attached to the basket of goods and services to show
how important the good is to the consumer and what proportion of the
income is spent.
Average Price: The average price of the basket of goods and services is
collected from retail outlets and the prices are recorded.
Change: After 3 months the Change in the Average Price of the basket of
goods and services is recorded by collecting prices from various retail
outlets.
Base Year: The base year index will always be 100 because it calculates the
percentage change in the price.
Weighted Index: Weights are then multiplied into the index to get the
weighted index.

 Numerical working of CPI:

 Category Weight Price Index Weighted Price
(%) Index (%)
Food 4/10 × 10 = 4
Housing 1/10 × -5 = - 0.5
Transport 1/4 × 0 = 0
Entertainment 1/4 × 8 = 2
Inflation Rate 5.5%

Q. Discuss whether supply-side policy measures will reduce inflation. [8] (March 2016 qp22
Q5d)

Supply-side policy measures include government policy measures designed to increase total
(aggregate) supply/quality of resources/quantity of resources (1). They include government
spending on education and training, privatisation, regulation, cuts in direct taxes, cuts in
unemployment benefits and trade union reforms (1).
Up to 5 marks for why they might:
Supply-side policy measures may reduce costs of production (1) e.g. cuts in corporation tax
will lower costs (1).
They may increase labour productivity (1) e.g. education (1). Lower costs and higher
productivity will increase aggregate supply/productive potential (1) higher aggregate
supply/productive potential may reduce cost-push inflation (1) allow total demand to
increase without causing inflation (1).
Up to 5 marks for why they might not:
Some policy measures e.g. education spending will increase total (aggregate) demand (1)
this may rise by more than total supply (1) causing demand-pull inflation (1).
The policy measures may not work e.g. privatisation may lead to private sector monopolies
developing (1) these may push up prices (1).
Spending on education may not improve labour productivity (1).
Some supply-side policy measures take time to work e.g. education spending (1) by that
time inflation may not be a problem or people may have got so used to inflation they act in a
way that causes further inflation (1).

Q. Define a ‘weighted price index’. [2] s16 qp22 q5a

A measure of changes in the price level/measure of inflation (1) which takes into
account the different proportions spent on items in a basket of goods and services (1).

Q. Discuss whether an increase in taxes will cause deflation. [8] (w16qp21 Q2d)

Up to 5 marks for why it might:

An increase in income tax will reduce disposable income (1) reducing tax payers’ purchasing
power (1) this may reduce consumer expenditure (1) lower consumer expenditure may
reduce investment (1) which may reduce total demand (1) this may cause deflation/lower
the price level (1).
Higher corporation tax may result in firms reducing output (1) this may lower employment
(1) lowering total (aggregate) demand (1) this may cause deflation/lower the price level (1).
If producers decide not to pass on the extra cost to consumers (1) higher taxes may not
cause prices to change (1).

Up to 5 marks for why it might not:

Workers may reduce saving when their disposable income falls (1) leaving consumer
expenditure unchanged (1).
Workers may respond to higher tax by pressing for wage rises (1) if granted these may push
up costs of production (1) causing cost-push inflation (1).
With higher tax revenue e.g. higher income tax revenue (1) the government may spend
more (1) leaving total demand unchanged (1).
Increasing indirect taxes will cause prices to rise (1) because they add to the production
costs of firms (1) who wish to maintain their profits (1).

Q. Analyse how a central bank could reduce inflation.

A central bank could use contractionary monetary policy (1).
A central bank could increase the rate of interest (1) increase saving (1) reduce
borrowing (1) reduce consumer expenditure (1) reduce total (aggregate) demand (1)
reduce demand-pull inflation (1).
A central bank could reduce the money supply (1) print less money / sell government
bonds (1) restrict bank lending (1) fewer loans may reduce investment (1) reduce
consumer expenditure (1).
Raising the exchange rate (1) may reduce the price of imports (1) lowering cost-push
inflation (1).
One effect of a lower interest rate might be to lower costs of production (1) reduce
cost-push inflation (1).
Q. Analyse the advantages of a low rate of inflation.
• Low inflation means prices are still rising (1) but not a high rate (1).
• May stop purchasing power being reduced too much / wages may keep pace with
inflation (1).
• May increase international price competitiveness (1) as may be below the inflation
rate of other countries (1) increasing exports (1) reducing imports (1) improving the
current account position (1).
• May create greater certainty / stability (1) as costs may not be rising significantly (1)
encouraging firms / MNCs to invest (1) increasing output / GDP (1) increasing
employment / lowering unemployment (1).
• May encourage saving (1) as real value may be maintained (1) provide funds for
investment (1).
• It may raise profit (1) if demand-pull (1) encouraging firms to expand (1) increasing
employment / lowering unemployment (1).
• May stop a random redistribution of income (1) protecting savers (1).
• Low menu costs (1) reduce pressure on firms’ costs of production (1).
Q. Explain the advantages and disadvantages of inflation.
Advantages of inflation to the economy
Inflation below 5% is good for the economy as it revives the economy, business confidence
increases due to which investments by firm increases, real GDP increases leading to
Economic Growth, since more output is produced then the demand for labour will also
increase as labour has derived demand so the unemployment rate will decrease. Borrowers
will gain during inflation and Government’s debt decreases. Payers of fixed income earners
will gain during the inflation.
Disadvantages of inflation to the economy
However Inflation above 5% is harmful for the economy as consumers will find a fall in the
purchasing power and their living standard decreases.
Lenders will lose during the inflation. People who earns fixed income like salaried and
pensioners will tend to lose during the inflation as the price level keeps increases but their
income remains the same. Also those whose income increases at a lesser rate compared to
inflation rate will find a fall in their real income, will also lose during the inflation. Students
will find it difficult to pay the fees and overall the demand for goods and services will
decrease.
Due to a fall in aggregate demand the firm’s output decreases, so revenue and profit level
decreases. Factors of production will become redundant (unemployed). Ancillary industries
who supply raw materials to the company will also lose. Since company earns lesser profits
the shareholders may get less or no dividend. Also share prises falls so shareholders get
affected.
Government will receive lesser tax revenue on the other hand government spending on
unemployment benefit increases leading to government budget to go into deficit. Also
exports become expensive in the international market so the demand for exports decreases,
on the hand imports might become cheaper compared to the domestic goods so the
demand for imports increases, this will lead to increases in the current account deficit.
Conclusion:- Inflation below 5%(low and stable rate of inflation) is good for the economy,
however inflation above 5% is harmful to the economy.

Q. Discuss whether deflation is a greater problem than inflation. [10]

Problems of inflation:
• the real value (purchasing power) of money falls
• certain people are badly affected, e.g. those on fixed incomes
• saving is discouraged because the real value of savings can fall
• businesses suffer when the increase in costs is greater than the increase in prices
• exports are discouraged because prices become more expensive in foreign markets

Problems of deflation:
• businesses will not be encouraged to increase production
• workers will lose jobs leading to an increase in unemployment
• this period of reduced economic activity will not only lead to a fall in output and
employment but also in incomes
• this can give rise to a slump
Candidates can get no more than 8 marks for explaining the problems of inflation and
deflation (no more than 4 marks if they just deal with one).
They need to make an attempt to state why one could be more of a problem than the other
(and why) to get 9 or more marks. Inflation is certainly a more frequent problem in recent
years than deflation; many countries have suffered from inflation but few from deflation.
Inflation, however, may be accompanied by a rise in output.
Note: credit should also be given for a comparison of the relative benefits of inflation and
deflation.
Note: maximum of 10 marks. [10]
 Topic:- Chapter 29 Economic Growth

Learning Objective:-
 Define GDP, Real GDP
 Differentiate between real GDP and Nominal GDP
 Define Economic Growth and explain its causes.
 Discuss the advantages and disadvantages of Economic Growth

 Define economic growth:

Economic growth- Economic growth indicates the quantitative increase in the national
income over a period of time. It refers to the increase in the real GDP in the short run and it
refers to an increase in the productive potential output in the long run.

 Define GDP:
GDP- GDP stands for Gross Domestic Product. It refers to the money value of all finished
goods and services produced in an economy over a given period of time. Generally 1
financial year.

Differentiate between real and nominal GDP:

Real GDP- This is the inflation adjusted GDP. IT is calculated at constant or base year price.
This means that if real GDP rises by 10% then the output of the country has also risen by
10%.

Nominal GDP- This is the GDP without adjusting inflation. It is calculated at current price.
This means that if nominal GDP rises by 10% and inflation rate is 3%, then the real GDP or
the output has risen only by 7%.

Define real GDP per capita:

Real GDP per capita- This refers to the real GDP of an economy divided by the total
population to show the national average income in the economy.

What are the different ways to calculate the real GDP?

 Expenditure method- This is the sum of Consumer expenditure + Investments by
firms + Government spending + (Exports – Imports).
 Income method- This includes all the factor incomes that are received from the
factors of production. Rent, Wages, Interest and Profit.

How is economic growth indicated?

In the short run, a rise in real GDP, is shown by a point moving outwards on the productive
potential output. In another words, this can be shown by an increase in aggregate demand,
where the aggregate demand curve shifts to the right, causing the real GDP as well as the
price levels to rise.

In the long run, a rise in real GDP, is shown by the whole curve in the productive potential
output shifting outwards. Otherwise, it can be shown by an increase in the production of
capital goods on the PPO.
Q. Explain how can a country achieve Economic Growth [6 marks]

Economic growth can be achieved in the short run by increasing the real GDP of an
economy. Government will follow expansionary fiscal policy wherein the aim is to
increase aggregate demand. The Government will reduce the direct tax due to which
the disposable income will increase and the consumer spending will increase. The
Government can also reduce corporate tax due to which firms will be motivated to
invest more so the Investment by firms will also increase.
Point A to B- Economic Growth in the short run [increase in real GDP]
Point B to C- Economic Growth in the long run [increase in Productive
Potential Output]

Government can also increase its spending on merit goods, public goods,
infrastructure, etc. which will eventually result in an increase in AD. Aggregate
Demand can increase due to increase in consumer spending, investment by firms,
government spending and net exports. Increase in AD leads to increase in real GDP,
employment and Economic Growth. The Central Bank can also follow expansionary
monetary policy wherein they will decrease the interest rates and increase the
money supply which will cause consumer spending and investment by firms to
increase and eventually increase in AD.

Economic Growth can also be achieved in the long run by increasing the quantity
and quality of resources which will cause an outward shift in the PPC resulting in an
increase in productive capacity. Government will follow supply side policies such as
subsidy, cut in tax, privatization, training and education, encourage
competition(reduce monopoly) to increase productivity in the economy
Advantages of economic growth:
 Increase in the productive potential output
 Increase in the real GDP per capita
 This causes an increase in living standards
 Consumers get to choose from a wider variety of goods and services
 The quality of services and facilities improves
 Infrastructure in the economy improves
 Increase in exports helps improve the balance of payments and the country’s foreign
reserves can become better.
 There is a rise in capital investments
 Due to increase in investments, more employment opportunities are created
 Government tax revenue rises
 Economic reputation and status improves

Disadvantages of economic growth:

 Rapid industrial growth causes a lot of negative externalities
 Pollution leads to harming the environment
 Exhaustion of non-renewable resources such as oil, coal, etc.
 Rise in aggregate demand causes demand-pull inflation in the economy
 Cost of living rises and might reduce the living standards
 Unequal distribution of income and wealth
 Degradation of land and extinction of many species
Define recession:
Recession- When the real GDP of the economy declines for two consecutive quarters, this
phase is called as recession.
Answer:- B 3 recessions

Data Response Question 1

Section A [30 marks]

Q1. (i) describe what happened to output between 2003 and 2004 [2]
(ii) explain in which year output was highest in Lesotho [2]
(iii) explain in which year output was lowest in Lesotho [2]
Q2. calculate GDP per capita if a country had a Gross Domestic Product (GDP) of US$20000000 with
the population of 5000 people [2]
Q3. Differentiate between real GDP and Nominal GDP. [4]
Q4. Explain how expansionary fiscal policy can help in achieving Economic Growth [6]
Q5. Analyse how supply-side policies can help in achieving Economic Growth [6]

Answers

Q1. (i) Output has increased but at a slower rate

(ii) 2010 as every year the output is increasing

(iii) 2000 being the initial year

Q2. GDP per capita= 20000000/5000 = $4000/-

Q3. Real GDP- This is the inflation adjusted GDP. IT is calculated at constant or base year
price. This means that if real GDP rises by 10% then the output of the country has also risen
by 10%.

Nominal GDP- This is the GDP without adjusting inflation. It is calculated at current price.
This means that if nominal GDP rises by 10% and inflation rate is 3%, then the real GDP or
the output has risen only by 7%.

Q4. Government will follow expansionary fiscal policy wherein the aim is to increase
aggregate demand. The Government will reduce the direct tax due to which the
disposable income will increase and the consumer spending will increase. The
Government can also reduce corporate tax due to which firms will be motivated to
invest more so the Investment by firms will also increase. Government can also
increase its spending on merit goods, public goods, infrastructure, etc. which will
eventually result in an increase in AD. Aggregate Demand can increase due to
increase in consumer spending, investment by firms, government spending and net
exports. Increase in AD leads to increase in real GDP, employment and Economic
Growth.
Q5.

Data Response Question 2

Section A [30 marks]

Answer this question.

1 Cambodia aims to be a top rice exporter Currently approximately 80% of Cambodia’s

export revenue comes from the sale of clothing. The Cambodian Government wants to
encourage clothing producers to export more but its current priority is to promote the export
of rice. In 2012 Cambodia was the world’s seventh largest exporter of rice. The government
aim is for the country to be in the top five. Raising export revenue above its 2012 level of
US$6 billion would reduce the country’s deficit on the current account of its balance of
payments.

To achieve the government’s aim, there are a number of improvements that need to be made
to increase Cambodia’s Gross Domestic Product (GDP). One is to develop the country’s
infrastructure, including building more roads and ports. Better transport infrastructure needs
to be combined with increased investment in the agriculture industry. In addition, the skills of
farm workers need to be developed. Those farm workers already skilled need to be
encouraged to stay in the country rather than emigrate.

The Cambodian Government is also seeking to increase investment in the manufacturing and
service sectors. Investment is influenced by a range of factors. One of the most important of
these is the economic growth rate. Countries with a high economic growth rate tend to spend
a high proportion of their income on capital goods.
Cambodia is attracting investment from other countries, most significantly from China. Such
investment is the result of a number of factors including a young population and
improvements in the country’s financial sector. In 2012 the country’s population was 15
million with the birth rate exceeding the death rate by 13 per thousand of the population.
Emigration exceeded immigration with a net migration rate of minus 0.3 per thousand of the
population.

In 2012 Cambodia opened its first stock exchange which is called the Cambodian Securities
Exchange (CSX). The first company to trade on the CSX was the Phnom Penn Water Supply
Authority. The Cambodian company is recognised as one of the most efficient water
companies in Asia. It is a popular company to work for, partly because it pays relatively high
wages.

(a) Using information from the extract, calculate the value of Cambodia’s clothing exports in
2012. [2]

(b) Explain two reasons why demand for Cambodia’s rice may increase in the future. [4]

(c) (i) Explain why high economic growth can increase investment. [4]

(ii) Using Table 1, comment on whether the information supports the view that high
economic growth leads to a high rate of investment. [3]

(d) Define GDP [2]

(e) Discuss whether building more roads and ports would increase Cambodia’s exports of
rice. [5]

(f) Explain what is meant by Economic Growth (Definition 2 marks + Diagram 2 marks) [4]
(g) Discuss whether Economic Growth is always beneficial to the economy [6]
(d) GDP- GDP stands for Gross Domestic Product. It refers to the money value of all finished
goods and services produced in an economy over a given period of time. Generally 1
financial year. [2]

(e) Discuss whether building more roads and ports would increase Cambodia’s exports
of rice. [5]

Up to 3 marks for why it might:

• may reduce transport costs (1) reduce costs of production (1) reduce prices (1) make rice
more price competitive (1)

• enables more rice to reach the coast/easier distribution of rice/easier access (1) and enables
more rice to be shipped abroad (1) increase quality of exports (1) make rice more quality
competitive (1) open up new markets (1)

Up to 3 marks for why it might not:

• costs other than transport costs may rise (1)

• demand for road space may increase more than supply (1) increasing congestion (1)
increasing transport costs (1)

• there is no guarantee that farmers would use the new roads (1)

• there will be no increase in exports if agriculture lacks investment to increase output (1)

• the quality of the roads and ports built may be poor (1) particularly if there is a lack of
skilled workers to build them (1)

• there may be a lack of associated capital equipment e.g. vehicles to use roads and ports (1)

• demand for rice may fall (1) due to e.g. changes in tastes (1) costs and prices falling more in
other countries (1)

• supply of rice may fall (1) due to e.g. bad weather (1)

(f) Definition-Economic growth- Economic growth indicates the quantitative increase in the
national income over a period of time. It refers to the increase in the real GDP in the short run
and it refers to an increase in the productive potential output in the long run. Diagram:-

(g) Definition of Economic Growth- 1 mark

Any 3 points well explained in both advantages and disadvantages are enough to get 6 marks
 Chapter 33- Poverty
· Absolute poverty: a situation where certain people do not receive enough income to
meet even basic needs, such as food and shelter or may give a numerical value e.g.
$1.25 a day
· Relative poverty: a situation where certain people are poor in relation to others, but
this does not necessarily mean that they are poor in absolute terms
Policies to reduce poverty:
o Redistribution of income: through progressive taxation and through benefits, could
increase the incomes of poorer people. Tax revenue collected will be redistributed to
the poor in the form of subsidies and merit goods.
o Provision of employment opportunities: employment creation schemes.
o Expansionary fiscal and monetary policy: due to which aggregate demand will
increase which will cause the demand for labour to increase resulting in higher
employment which will increase income and thereby reduce poverty.
o Improvement in education provision: will increase the literacy rate, helping to
make people more employable.
o Retraining measures: will make people more employable, increasing their incomes.
o Provision of subsidies: e.g. on food, will help to reduce the cost of living.
o Subsidised or zero-cost housing: will mean that people will not have to pay very
much (or nothing at all) for housing.
o Minimum wage: will ensure that all labour is paid a minimum level of remuneration.
Disadvantages of policies to reduce poverty:
o Redistribution of income: Progressive taxation and benefits will still leave a lot of
people very poor and more fundamental policies may be needed, such as very high
levels of subsidies. It reduces business and worker incentives and may also lead to tax
avoidance/evasion
o Education & retraining initiatives: will have no effect if the level of demand in the
economy is so low that there are no jobs to be applied for.
o Subsidy- Government may not be able to give subsidy if the govt. Budget is in deficit
and if they still provide it then the country’s debt will increase.
o Minimum wage: the effect of the introduction of a minimum wage will ultimately
depend on the rate at which it is set. If the NMW is set too low then the people won’t
be able to afford basic necessities and may remain poor. If the NMW is set too high
the company may not demand that many workers which will raise the classical
unemployment/redundancy and will not reduce poverty.
o Government policies: it is less an issue of whether particular policies can have an
effect. It is linked to the extent of the policies, i.e. how far-reaching they are.
o Government failure: there may be government failure e.g. in form of corruption
which prevents funds reaching the poor.
Chapter 32- Living Standards
refer to the social and economic well-being of individuals in a country at a
particular point in time.

measures the average income per person in an economy.

Formula:
= Overall Real GDP
Population

Advantages of Real GDP per capita:

o takes into account the size of the country’s population
o it gives an indication of the value of the goods and services available to people
o income/output/expenditure is a key determinate of their living standards
o the information is available on every country

Disadvantages of Real GDP per capita:

o Distribution of income may vary a great deal, some people in the country may have
good living standards, whilst others have poor living standards ( a very few rich
people can skew the average upwards)
o Does not consider the quality of and access to education, health care, clean water and
sanitation, technology
o GDP accounting methods can be different and official GDP figures can be overstated
due to technical errors
o GDP also doesn’t differentiate between the positive and negative values economies
place on different output/expenditure. For example, if the output rises because the
sales of tobacco, alcohol or pornographic materials, it might show in the records as a
rise in GDP per head but might not actually make people better off.
o Does not show the impact on the natural environment.

Advantages of HDI:

· The Human Development Index (HDI) is a measure of the standard of living which
takes into account the: LIE
Life Expectancy Index at birth:
§ How long people are expected to live
Income Index i.e. Real GDP per capita:
§ The average amount of money earned in one year by each person living in the
country.
Education Index:
§ Mean years of schooling (years that a 25-year-old person or older has spent in
schools)
§ Expected years of schooling (years that a 5-year-old child will spend in education in
his own life)
HDI value ranges from 0 to 1, closer to 1 represents the most developed country and closer to
0 represents the least developed country.

Disadvantages of HDI:
o It combines a set of separate indicators into one, so a country with good literacy rates
and education index but poor life expectancy can have a low HDI value
o There are wide divergences in HDI within countries
o GNI per head doesn’t say anything about inequalities in income and wealth within
countries
o It doesn’t consider other factors such as quality of air, quality of water, % of GDP
spent on healthcare and education, doctors per 1000 population, hospital beds per
1000 population, gender empowerment, political freedom, crime rates etc. which are
also important indicators of living standards
o The HDI information for all countries may not be available such as war-struck
countries where civilization has been disrupted

· Describe three features of a developing country. (6 marks)

o 1 mark each for identification of three features:
§ Low incomes/low GDP per capita
§ Low Human Development Index/low standard of living
§ Low life expectancy
§ Low school enrolment/education
§ High level of absolute poverty
§ High level of malnutrition/starvation
§ High rate of population growth
§ High birth rate
§ High death rate
§ High infant mortality rate
§ May have a large primary/small tertiary sector
o 1 mark each for descriptions:
§ Low GDP per capita: Gross Domestic Product of a country is low when divided by
the number of people living in that country
 § Low standard of living: means low wages/unemployed can only afford
necessities/poor quality housing/education/health

§ Low life expectancy: the number of years, on average, that the people in a country can
expect to live, relative to the number of years a person, on average, is expected to live
in a developed country
§ High level of absolute poverty: the basic needs for food, clothing and shelter are not
being met, is much higher than in developed countries
§ High death rate: the number of people dying in a developing country per thousand of
population is higher than would be the case in a developed country.

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