Economics Section 4

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CIE IGCSE Economics Your notes
4.1 The Role of Government

Contents
4.1.1 Local, National & International
Page 1 of 2
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4.1.1 Local, National & International

Your notes
Government Roles in a Mixed Economy
Nearly every economy in the world is a mixed economy & has varying degrees of government
intervention
Governments intervention is necessary for several reasons & occurs on three distinct levels
Local intervention
National (macroeconomic) intervention
International intervention
The Role of Government In A Mixed Economy
Area of Intervention Examples of Intervention Explanation
Local Local health services Local governments are responsible for delivering
Refuse collection government services on a town/regional basis
Parking fines They usually receive funding from the central
Local prosecutions government & are held accountable for the
Parks & recreation quality of goods/services provided by the voters
Public services in their area
Local government branches are often referred to
as 'councils', 'federal' or 'state'
National Central Government Determining the best combination of policies

Fiscal Policy that will help them to meet all of their
Monetary Policy macroeconomic aims
Supply-side Policy
International Exchange rate International trade is vital to economic growth in

interventions many economies
Protectionism Governments have a role to both protect
domestic industry & to help it compete
internationally
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4.2 The Macroeconomic Aims of Government

Contents
4.2.1 The Five Macroeconomic Aims
4.2.2 Conflicts Between Macroeconomic Aims
Page 1 of 10
4.2.1 The Five Macroeconomic Aims

Your notes
Economic Growth
Economic growth is a central macroeconomic aim of most governments
Many developed nations have an annual target growth rate of 2-3%

This is considered to be sustainable growth
Growth at this rate is less likely to cause excessive demand pull inflation
Politicians often use it as a metric of the effectiveness of their policies & leadership
Economic growth has positive impacts on confidence, consumption, investment, employment,

incomes, living standards & government budgets
A diagram showing the economic growth rate of the UK since 1998

Source: Macrotrends
A Table Highlighting Some of the Economic Growth Trends in the UK Since 1998
Page 2 of 10
1998-2007 2008-2015 2016-2019 2020 -
Your notes
Steady growth Global financial crisis Gradual disinflation Supply chain issues due
fluctuating between 2- followed by rapid bounce possibly due to future to Brexit. Decreased
4% back due to government expectations regarding consumption due to the
intervention - and then the impact of the Brexit impact of Covid 19. These
steady growth vote created a deep
recession (short-lived
due to government
intervention)
Page 3 of 10
Low Unemployment
Someone is considered to be unemployed if they do not have a job & are actively seeking for one Your notes
The target unemployment rate often depends on the size of the economy e.g. India finds a rate of
6.5% good whereas Singapore aims for it to be under 2%
The closer an economy is to the full employment level of labour, the better (more efficiently) it is using
its human resources
Within the broader unemployment rate, there is an increased emphasis on the unemployment rate
within different sections of the population
E.g. youth unemployment, ethnic/racial unemployment by group
In 2021, black unemployment in the USA was 8.7% & white unemployment was 4.7%
A diagram showing the unemployment rate in the UK from 1998 - 2020

Source: Macrotrends
Unemployment tends to be inversely proportional to real GDP growth
When real GDP increases, unemployment falls
When real GDP decreases, unemployment rises
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Unemployment in the UK remained relatively high for the six years following the global financial crisis
of 2007
Your notes
Page 5 of 10
Low & Stable Rate of Inflation

Most economies have a target inflation rate of 2% using the Consumer Price Index (CPI) Your notes
A low rate of inflation is desirable as it is a symptom of economic growth
The different causes of inflation (cost push or demand pull) require different policy responses from the
Government
Demand-side policies ease demand pull inflation
Supply-side policies ease cost push inflation
A diagram illustrating the inflation rate in the UK from 2012 to 2021 using the CPI
In the UK, a continual deviation from the target of 2% would not be considered as stable
An inflation rate in April 2022 of 4-5% was considered to be unstable, eroding household
purchasing power
A low & stable rate of inflation is important as it
Allows firms to confidently plan for future investment
Offers price stability to consumers
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Balance of Payments Stability On The Current Account

The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur Your notes
between it and the rest of the world
The current account focuses mainly on the financial transactions related to exports and imports of
goods/services
Governments aim for Balance of Payments equilibrium on the Current Account

If exports > imports it will create a current account surplus
If imports > exports, it will create a current account deficit
Each one of these conditions has advantages/disadvantages associated with it
However, a current account deficit is more problematic in the long-run
The UK has traditionally run a small deficit

As a % of GDP the UK current account deficit is insignificant so has not been problematic
A diagram showing the UK Trade Deficit from 1998 to 2020. The bottom graph illustrates the trade
deficit as a % of GDP and the top one illustrates the absolute value expressed in US$
Source: Macrotrends
Page 7 of 10
In the diagram above the trade deficit has been falling steadily since 2016
During this time period the value of exports was increasing slightly faster than the value of imports
Your notes
The Redistribution of Income
The redistribution of income aims to reduce income inequality in an economy
High levels of income inequality create social unrest and can ultimately lead to revolutions
Perfect income equality is not desirable as it removes the incentive to work & study
Governments aim to redistribute income by taxing the wealthy & providing welfare payments to the
poor
Unchecked capitalism has a natural outcome of high income inequality

The wealthy are able to keep buying factors of production
The concentration of ownership becomes more & more narrow with fewer individuals owning the
bulk of the world's wealth
There is a need for governments to intervene to maintain acceptable levels of income inequality
Absolute poverty is usually worse in developing countries. However, in a developed economy such as
Germany, a 1% increase in income inequality can push a lot more households into relative poverty
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4.2.2 Conflicts Between Macroeconomic Aims

Your notes
Trade-offs Between Macroeconomic Objectives
Policy decisions by governments often create a trade-off in the macroeconomic objectives
Achieving one objective may come at the cost of worsening progress in another objective
An Explanation of the Common Trade-offs That Exist Between the Macroeconomic Objectives
Trade-off Explanation
Economic Growth & Inflation Increasing economic growth causes the economy to move
closer to full employment
Prices for remaining resources are bid up leading to inflation
which may outpace the target inflation rate of 2%
Economic Growth & Environmental Economic growth often increases pollution, negative
Sustainability externalities & the depletion of non-renewable resources
The higher the growth, the faster the depletion
Economic Growth & Inequality During periods of high economic growth, the profits the owners
of the factors of production receive are disproportionate to any
increase in workers' wages leading to greater inequality
Economic Growth & Balancing the Economic growth usually leads to higher incomes which leads to
Current Account an increase in imports by households thereby worsening the
current account balance
Low Unemployment & Low The closer an economy moves to full employment the less
Inflation workers will be available for hire & wage inflation will help
increase overall inflation
Low Unemployment & Balancing When unemployment is low, incomes are higher & imports
the Current Account increase which worsens the current account balance
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Additionally, with low unemployment wages tend to increase

which increases costs of production for firms & if they increase
their prices, then the level of exports is likely to fall Your notes
Exam Tip
You are examined on trade-offs & conflicts both MCQ & in longer essay questions. In your longer
responses, make sure you explain all of the steps in the process E.g. if economic growth increases too
quickly, there is likely to be demand-pull inflation, which raises the cost of living for the citizens,
resulting in them feeling poorer, as the purchasing power of their wage has decreased
Page 10 of 10
4.3 Fiscal Policy

Contents
4.3.1 The Government Budget
4.3.2 Taxation
4.3.3 Fiscal Policy Measures
Page 1 of 12
4.3.1 The Government Budget

Your notes
Definition of the Government Budget
The Government Budget (Fiscal policy) is presented each year as a balanced budget, a budget deficit,
or a budget surplus
A balanced budget means that government revenue = government expenditure
A budget deficit means that government revenue < government expenditure
A budget surplus means that government revenue > government expenditure
A budget deficit has to be financed through public sector borrowing

This borrowing gets added to the public debt
Reasons for Government Spending

Public expenditure (government spending) represents a significant portion of the total (aggregate)
demand in many economies. The expenditure can be broken down into three categories
1. Current Expenditures: These include the daily payments required to run the government & public
sector. E.g. The wages & salaries of public employees such as teachers, police, members of
parliament, military personnel, judges, dentists etc. It also includes payments for goods/services such
as medicines for government hospitals
2. Capital Expenditures: These are investments in infrastructure & capital equipment. E.g. High speed
rail projects; new hospitals & schools; new aircraft carriers
3. Transfer payments: Payments made by the government for which no goods/services are exchanged.
E.g. Unemployment benefits, disability payments, subsidies to producers & consumers etc. This type
of government spending does not contribute to GDP as income is only transferred from one group of
people to another
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Reasons for Taxation

Nearly every economy in the world is a mixed economy & has varying degrees of government Your notes
intervention
One of the main forms of government intervention is taxation & there are many reasons why it is
necessary
A diagram showing several reasons for government taxation in mixed economic systems
Correct market failure: in many markets there is a less than optimal allocation of resources from
society's point of view
The government aims to subsidise merit goods & tax demerit goods to address this market failure
Earn government revenue: governments need money to provide essential services, public & merit
goods
Revenue to fund this is raised through taxation
Promote equity: the wealthy are taxed to provide funds that can be utilised in reducing the
opportunity gap between the rich & poor
Support firms: in a global economy, governments choose to support key industries so as to help them
remain competitive & taxation provides the funds to do this
Support poorer households: poverty has multiple impacts on both the individual & the economy
Intervention seeks to redistribute income (tax the rich and give to the poor) so as to reduce the
impact of poverty
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4.3.2 Taxation
Your notes
The Classification of Taxes
The main source of government revenue is taxation
Direct taxes are taxes imposed on income and profits

They are paid directly to the government by the individual or firm
E.g. Income tax, corporation tax, capital gains tax, national insurance contributions,
inheritance tax
Indirect taxes are imposed on spending

The less a consumer spends the less indirect tax they pay
Examples of indirect tax include Value Added Tax (19% VAT rate in the European Union in 2022),
taxes on demerit goods, excise duties on fuel etc.
Progressive, Regressive & Proportional Tax Systems
Tax systems can be classified as progressive, regressive or proportional

Most countries have a mix of progressive (direct taxation) & regressive (indirect taxation) taxes in
place
An Explanation Of Tax Systems
System Explanation Diagram
Progressive As income rises, a larger percentage

of income is paid in tax
In the diagram, when personal income
rises from Y1 to Y2, the tax rate rises
from TR1 to TR2
Regressive
Page 4 of 12
As income rises, a smaller percentage

In the diagram, when personal income Your notes
rises from Y1 to Y2, the tax rate falls
from TR1 to TR2
All indirect taxes are regressive
In the USA, Federal income tax is
progressive but almost all State taxes
are regressive (the bottom 20% of
income earners pay as much as 6x the
% of their income than the top 20%)
Proportional As income rises, the same percentage

In the diagram, when personal income
rises from Y1 to Y2, the tax rate remains
constant at 20%
In 2022, Bolivia was using this system
with a proportional tax rate of 13%
Progressive tax systems are built around the idea of marginal tax rates
The calculation of an individual's personal income tax requires several calculations
Using this system, a salary of £60,000 would attract a tax bill of £11,499.80, calculated as follows:
Calculation Using UK Progressive Tax Rates - June 2022
Tax Paid on
Tax Band Taxable Income Tax Rate
£60,000
Personal Allowance Up to £12,500 0% 0
£12,501 to £50,000 20% £37, 499 at 20% =

Basic Rate
£7499.80
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Higher Rate £50,001 to £150,000 40% £10,001 at 40% =

£4,000
Your notes
Additional Rate Over £150,000 45% 0
£7499.80 + £4,000
Total Tax Paid on £60,000
= £11,499.80
Exam Tip
MCQ frequently test your knowledge of the different tax systems by presenting you with a table &
asking you to identify the type of tax system illustrated
Identify the type of tax system illustrated below:
Weekly Income ($) 100 150 200 250

Weekly Tax ($) 20 30 40 50
It is a proportional tax system with a constant tax rate of 20%
Principles of Taxation
In order for the population to accept a tax system & pay into it, the taxes imposed need to be
considered to be 'good'
There are several principles which should be applied when developing a 'good' tax system
1. Simple: taxpayers should know what, when, where & how to pay the tax
2. Fair (equity): taxes should reflect a taxpayer’s ability to pay - progressive taxation aims to achieve this
as the wealthy can afford to pay more than the poor do
3. Convenient: systems to collect payment should be easy & provide choice for taxpayers e.g. monthly
payments spread over 12 months or tax collected by the employer each month before the salary is paid
4. Efficient: the management of the tax system by the government should not be overly expensive or
wasteful
5. Fit for purpose: there should not be any unintended side effects of the system e.g. disincentivising
workers from working
6. Flexible: it should be easy to adjust/change as required by changes in the economy
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The Impact of Taxation

Changes in direct & indirect tax rates influence a range of economic variables Your notes
The greater the size of the change, the greater the ripple effects felt by households, firms & the
economy
Effects Of Tax Rate Changes
Impact Explanation
Incentive to work The higher the tax rate, the lower the incentive for the unemployed to
seek work - or for existing workers to work overtime
Government tax revenues There is a relationship between increasing tax rates & the level of
government revenues received
The broad idea is that as tax rates increase, a point will be reached
where disincentivized workers work less, resulting in lower incomes &
less government tax revenue
More people will actively seek to avoid paying tax (tax avoidance) or try
to move their income elsewhere
Income distribution A progressive tax system redistributes from those with higher income
to those with lower income & reduces income inequality
Sometimes the benefits of a good progressive tax system are lost by
the penalties imposed through multiple regressive (indirect) taxes
Economic growth Tax rate increases will likely cause a reduction of total (aggregate)
demand as firms & households have less disposable income
Tax rate decreases will have the opposite effect
As total demand slows down, fewer workers may be required for
production & unemployment may increase
Inflation Increasing Indirect tax rates increase costs of production for firms
possibly leading to cost-push inflation
An increase in indirect taxes reduces disposable income & so workers
may petition their employer for a salary increase
If they receive the increase the economy may face a wage-price spiral
The trade balance (X-M) An increase in taxes can reduce disposable income which is likely to
reduce the level of imports
This may improve the trade balance (exports - imports)
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Business location If the rate of corporation tax increases relative to other countries, it
may result in less inward foreign direct investment by multi-national
corporations Your notes
Page 8 of 12
4.3.3 Fiscal Policy Measures

Your notes
Fiscal Policy Defined
Fiscal Policy involves the use of government spending & taxation (revenue) to influence total
(aggregate) demand in the economy
Fiscal policy can be expansionary in order to generate further economic growth

Expansionary policies include reducing taxes or increasing government spending
Fiscal policy can be contractionary in order to slow down economic growth or reduce inflation
Contractionary policies include increasing taxes or decreasing government spending
Fiscal Policy is usually presented annually by the Government through the Government Budget
A balanced budget means that government revenue = government expenditure
A budget deficit means that government revenue < government expenditure
A budget surplus means that government revenue > government expenditure
A budget deficit has to be financed through public sector borrowing

This borrowing gets added to the public debt
Page 9 of 12
The Effects of Fiscal Policy on Government Macroeconomic Aims

To understand the effects of fiscal policy on an economy, it is useful to know how total demand (gross Your notes
domestic product) is calculated
Total (aggregate) demand = household consumption (C) + firms investment (I) + government spending
(G) + exports (X) - imports (M)
Total demand = C + I + G + (X - M)
From this, it is logical that changes to fiscal policy can influence any of these components - & often
several of them at once
Examples of The Impact of Contractionary Fiscal Policy
Example 1 The Government increases income tax levels
Effect on the economy Consumers pay more tax → discretionary income reduces → consumption
reduces → total demand reduces
Impact on macroeconomic Economic growth slows down

aims Inflation eases
Unemployment may increase as output is falling & fewer workers are
required
Current Account Improves (with less income, imports may fall)
Example 2 The Government freezes/reduces public sector workers pay
Effect on the economy Wages stagnate or reduce → Consumer confidence falls → consumption
decreases → total demand decreases

Unemployment may increase as output is falling
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Your notes
Example 3 The Government cuts Government spending in their Budget
Effect on the economy Less demand for goods/services → less income for firms → output & profits
decrease → total demand decreases

Unemployment may increase as output is falling
Less corporation tax available for redistribution
Examples of The Impact of Expansionary Fiscal Policy
Example 1 The Government decreases corporation tax
Effect on the economy Firms net profits increase → investment by firms increases → total demand
increases
Impact on macroeconomic Economic growth increases

aims Inflation rises
Unemployment may decrease as output is rising which requires more
workers
Current Account - unsure - exports may rise due to new investments in
the economy, but imports may rise due to higher income generated by
the investment
Example 2 The Government increases unemployment benefits
Page 11 of 12
Effect on the economy Household income increases → consumption increases → total demand
increases
Your notes

Unemployment may decrease as output is rising which requires more
workers (although increased unemployment benefits may discourage
some people from entering the labour market)
Current Account unlikely to change as this policy helps the poorest &
imports are unlikely to increase
Redistribution of income has increased & there is more equity in
society
Strengths of Fiscal Policy

Spending can be targeted on specific industries
Short time lag as compared with monetary policy (effects of fiscal policy are seen sooner)
Redistributes income through taxation
Reduces negative externalities through taxation
Increased consumption of merit/public goods
Short term government spending can lead to an increase in the total supply of an economy
E.g. Building a new airport immediately increases government spending and total demand, but
when it is built, the potential output will have increased (Production Possibility Curve has shifted
outward)
Weaknesses of Fiscal Policy

Policies can fluctuate significantly when new governments are elected
Long term infrastructure projects may lack follow-through
Increased government spending can create budget deficits
Repaying this debt may lead to austerity on future generations
Conflicts between objectives
E.g. Cutting taxes to increase economic growth may cause inflation
Page 12 of 12
4.4 Monetary Policy

Contents
4.4.1 Monetary Policy Measures
Page 1 of 4
4.4.1 Monetary Policy Measures

Your notes
Monetary Policy Defined
Monetary policy involves adjusting the money supply so as to influence total (aggregate) demand
The money supply is the amount of money in an economy at any given moment in time
It consists of coins, banknotes, bank deposits & central bank reserves
The Central Bank in each economy is responsible for setting monetary policy
The Bank's Monetary Policy Committee usually meets 4-8 times a year to set policy
The Three Main Instruments of Monetary Policy

1. Interest Rates: Incremental adjustments to the interest rate (usually not more than 0.25%)
2. Quantitative easing (QE): Increases the supply of money in the economy. The Central Bank creates
new money & uses it to buy open-market assets such as bonds. When they buy the bond back early,
there is an injection of new money into the economy (investors get their money back & can now spend
it)
3. Exchange Rates: Adjustments to the exchange rate. The Central Bank is able to influence the
exchange rate through buying or selling its own currency. This in turn influences the level of
exports/imports
Monetary policy can be expansionary in order to generate further economic growth (also referred to
as loose monetary policy)
Expansionary policies include reducing interest rates, increasing QE, or depreciating the
exchange rate
Monetary policy can be contractionary in order to slow down economic growth or reduce inflation
(also referred to as tight monetary policy)
Contractionary policies include increasing interest rates, decreasing/stopping QE, or
appreciating the exchange rate
Page 2 of 4
The Effects of Monetary Policy on Government Macroeconomic Aims

When a policy decision is made, it creates a ripple effect through the economy impacting the Your notes
macroeconomic objectives of the government
To understand the effects of monetary policy on an economy, it is useful to know how total demand
(gross domestic product) is calculated
Total (aggregate) demand = household consumption (C) + firms investment (I) + government spending
(G) + exports (X) - imports (M)
Total demand = C + I + G + (X - M)
From this, it is logical that changes to monetary policy can influence any of these components - &
often several of them at once
Examples of The Impact of Contractionary Monetary Policy
Example 1 The Central Bank increases interest rates
Effect on the economy Existing loan repayments for households become more expensive →
discretionary income reduces → consumption decreases → total
demand falls
Firms are less likely to borrow → less investment in capital takes place →
total demand falls
Hot money flows increase → the exchange rate appreciates → exports
more expensive & imports cheaper → net exports reduce → total
demand decreases

Unemployment may increase as output is falling & fewer workers are
required
Current Account is likely to worsen as both exports & imports reduce
(exports more expensive & imports cheaper - but households have less
income for imports)
Examples of The Impact of Expansionary Monetary Policy
Example 1 The USA Federal Reserve Bank commits to $60bn a month of QE
Page 3 of 4
Effect on the economy Commercial banks receive cash for their bonds → liquidity in the market
increases → commercial banks lower lending rates → consumers & firms Your notes
borrow more → consumption & investment increase → total demand
increases

Unemployment may fall as output is increasing & more workers are
required
Current Account worsens (with more income, imports may rise)
Strengths of Monetary Policy

The Bank of England operates independently from the Government (political process)
Is able to consider the long-term outlook
Targets inflation & maintains stable prices
Depreciating the currency can increase exports
Weaknesses of Monetary Policy

Conflicting goals e.g economic growth caused by lower rates puts upward pressure on inflation
Time lags between policy & the desired impact (up to 2 years)
Firms & consumers may not respond to lower interest rates when confidence is low
Cheaper loans may inflate asset prices (e.g. property) in the long term
The interest rate has limitations on downward adjustment - the closer the rate gets to zero, the less
effective
Exam Tip
Remember that while a rise in the rate of interest is likely to increase saving by households, it is likely to
reduce investment by firms
When evaluating monetary policy, it is worth noting that monetary policy (4-8 x per year) can be
adjusted more quickly than fiscal policy (usually once per year). However, the impact of fiscal policy is
more predictable than the impact of monetary policy. For example, households may not borrow more
money if their confidence in the economy is low - irrespective of how low interest rates go.
Page 4 of 4
4.5 Supply-side Policy

Contents
4.5.1 Supply-side Policy Measures
Page 1 of 5
4.5.1 Supply-side Policy Measures

Your notes
Supply-side Policy Defined
Supply-side policies aim to increase the total supply (productive potential) of the economy
This is achieved by increasing the quality or quantity of the factors of production
It can be represented by an outward shift of the productive possibility curve
More consumer goods & more capital goods can now be produced using all of the available
resources
Outward shifts of a PPC show an increase in the total supply of an economy
The strategies used to increase total supply include education and training, labour market reforms,
lower direct taxes, deregulation, improving incentives to work & invest, and privatisation
Page 2 of 5
Supply-side Policy Measures

When successful, supply-side policies have the following effects on the government's Your notes
macroeconomic objectives
1. Economic growth: potential national output increases leading to higher real gross domestic product
(rGDP)
2. Inflation: a greater supply in the economy results in reductions in the prices of goods/services leading
to disinflation
3. Unemployment: this should fall as more workers are required to produce the higher levels of output
4. Current Account Balance: due to the increased supply, the prices of goods/services often decrease
which makes them relatively more attractive to foreigners - so exports increase & the current account
balance improves
5. Redistribution of income: this often worsens with the use of supply-side policies as wages fall &
government tax revenue has fallen too
Specific Types of Supply-side Policies
Supply-side Policy Explanation
Education & training Increasing government spending on education & retraining raises the
quality of the workforce
Increasing government spending on healthcare so that worker
productivity improves
Labour market reforms Decreasing trade union power so wages can be decreased encourages
firms to hire more workers as they are cheaper
Decreasing minimum wages to lower costs of production encourages
firms to hire more workers as they are cheaper
Increased government spending on improving occupational mobility
Lower direct taxes Reducing income/corporation tax rates incentivises workers to work
harder (they keep more money for themselves) & provides firms with extra
funds which they can use to invest in new machinery/technology
Deregulation This is the process of removing government controls/laws from markets

in order to increase competition
Any regulation increases costs of production for firms & deregulation
decreases costs which may result in greater supply
Page 3 of 5
Improving incentives to Restructuring the unemployment benefits system to incentivise the

work & invest unemployed to seek work Your notes
Increased government spending on innovation increases the supply of
potential jobs in the economy
Direct support to firms (subsidies) increases output & promotes
international competitiveness
Privatisation Government firms are usually so big that private enterprise refrains from
trying to compete with them. Privatisation encourages new firms to enter
the market & compete, thus increasing the total supply in the economy
Strengths of Supply-side Policies

They increase the rate of growth of an economy
They reduce inflation
They often reduce unemployment
They often increase the value of net exports as an increase in total supply usually results in lower prices
leading to greater exports
Weaknesses of Supply-side Policy

The distribution of income worsens as labour market reforms & wage policies lower worker's wages
They are expensive to implement
There are significant time lags between government expenditure & seeing the benefits e.g. education
& training often take a long time
Due to the long-term nature, changes in government often result in changes to budgets & scope of
projects
Vested interests can result in less effective outcomes e.g. There are many examples of privatisation
occurring in such a way that the government's preferred bidders obtained an asset at a knock down
price
Page 4 of 5
Exam Tip
Your notes
There are some policy measures which may be a fiscal policy or a supply-side measure e.g. building
new schools requires immediate government spending (fiscal policy), but results in greater supply of
educational institutions in the economy (supply-side). In deciding which it is in any particular question,
decide whether the government is using it with the intention of increasing total demand or total supply
When evaluating supply-side polices in essay responses, demonstrate critical thinking by

acknowledging that privatisation has been used for so long that many economies have little left to
privatise.
Remember, the private sector will also be increasing supply in an economy (it is not only up to the
government) as they are incentivised to increase their profits.
Page 5 of 5
4.6 Economic Growth

Contents
4.6.1 Measures of Economic Growth
4.6.2 Causes & Consequences of Growth
4.6.3 Causes & Consequences of Recessions
4.6.4 Policies to Generate Economic Growth
Page 1 of 15
4.6.1 Measures of Economic Growth

Your notes
Economic Growth
Economic growth is the annual increase in the level of national output as measured by the gross
domestic product (GDP)
GDP is the total value for all goods/services produced in an economy in a year
The Components of GDP

GDP can be calculated using the value of the expenditure in an economy
GDP = Consumption (C) + Investment (I) + Government spending (G) + Exports (X) - Imports (M)
GDP = C + I + G + (X-M)
If any of the components of GDP increase, then economic growth is likely to occur
Consumption is the total spending on goods/services by consumers (households) in an economy
Investment is the total spending on capital goods by firms
Government spending is the total spending by the government in the economy:

Includes public sector salaries, payments for provision of merit & public goods etc.
It does not include transfer payments
Net exports are the difference between the revenue gained from selling goods/services abroad & the
expenditure on goods/services from abroad
The Relative Importance of the Components of GDP

Depending on the country, the value of each component & its contribution to GDP can vary
significantly:
Government spending in Sweden is 53% of GDP & in the UK it is 25% of GDP
The % that each component contributes to GDP in the UK is approximately

Consumption: 60%
Investment: 14%
Government spending: 25%
Net Exports: 1%
A 1 % increase in consumption or government spending will have a much larger impact on economic
growth than a 1% increase on net exports
Page 2 of 15
Real Gross Domestic Product (GDP)

In economics, the use of the word nominal refers to the fact that the metric has not been adjusted for Your notes
inflation
Nominal GDP is the actual value of all goods/services produced in an economy in a one-year period
There has been no adjustment to the amount based on the increase in price levels (inflation)
Real GDP is the value of all goods/services produced in an economy in a one-year period - and
adjusted for inflation
For example, if nominal GDP is £100bn & inflation is 10% then real GDP is £90bn
GDP/Capita
GDP per capita = GDP / the population
It shows the mean wealth of each citizen in a country
This makes it easier to compare standards of living between countries
For example, Switzerland has a much higher GDP/capita than Burundi
Page 3 of 15
4.6.2 Causes & Consequences of Growth

Your notes
Causes of Economic Growth
1. Growth Caused by a Change in Total Demand
Actual economic growth occurs when there is an increase in the quantity of goods/services
produced in an economy in a given period of time
This is often measured by the percentage change in real gross domestic product (GDP)
If any component of real GDP increases (consumption, investment, government spending, net
exports), there will be an increase in total demand
Any movement from Point E towards the PPC boundary represents actual economic growth & is caused
by an increase in output (rGDP)
Page 4 of 15
Diagram Explanation
Previously unused factors of production are now being employed Your notes
This is demonstrated by a shift from inside the production possibilities curve (PPC) such as Point E,
towards the boundary of the PPC
At any given point in time, the actual economic growth may be less than the potential growth available
to the economy
2. Growth Caused by a Change in the Quantity/Quality of Factors of Production
Potential growth is the increase in the productive potential of an economy

This occurs when there is an increase in the quantity or quality of the factors of production available in
an economy
One example of how the quality of a factor of production can be improved is through the impact
of training and education on labour. An educated workforce is a more productive workforce and
the production possibilities increase
One example of how the quantity of a factor of production can be increased is through a change
in migration policies. If an economy allows more foreign workers to work productively in the
economy, then the production possibilities increase
Investing in new capital machinery increases the quality of capital
Investing in new technology results in an improvement to productivity
Page 5 of 15
Your notes
Outward shifts of a PPC show economic growth caused by changes to the quantity/quality of the FOP
Diagram Explanation
Economic growth occurs when there is an increase in the productive potential of an economy
This is demonstrated by an outward shift of the entire curve represented by A
More consumer goods & more capital goods can now be produced using all of the available
resources
Page 6 of 15
The Consequences of Economic Growth

Economic growth is considered to be the main contributor to an improvement in the standards of Your notes
living
Due to the negative aspects of economic growth, there is much controversy about maintaining it as a
central macroeconomic aim
Instead, arguments for a focus on societal well-being are gaining traction
A Table Summarising the Benefits & Costs of Economic Growth
Benefits of Economic Growth Costs of Economic Growth
Increased incomes lead to better standards of Rising total demand causes demand pull
living inflation & the purchasing power of people on
fixed incomes may fall
Decreased levels of absolute poverty Lack of equity in the distribution of income - the
rich may get richer & the poor poorer
Improvement in the quality/quantity of Environmental damage caused by negative

environmentally friendly technologies externalities of production & consumption
increases
Higher sales revenue for firms & greater profits Increased inflation can harm export sales
Increased investment by firms increases the The level of imports usually increases negatively
potential output of the economy impacting the current account
Reduced expenditure by governments on Increased income usually leads to greater

benefits consumption of demerit goods
Higher government tax revenue due to rising Greater output often requires more time from
incomes and surging corporate profits workers and can decrease leisure time & well-
being
Increased employment resolves some of the Resources are depleted more rapidly
negative social impacts of unemployment
Page 7 of 15
Exam Tip
Your notes
Remember this distinction as MCQ often checks for this understanding:
Growth caused by a change in total demand is represented by a movement from within the existing
PPC towards its boundary.
Growth caused by a change in the quantity/quality of the factors of production (supply-side growth)
moves the entire PPC curve outwards.
Page 8 of 15
4.6.3 Causes & Consequences of Recessions

Your notes
Causes of Recessions
A recession is a period of at least six months (2 quarters) of economic decline which causes a decrease
in the real gross domestic product (rGDP)
It can be caused by a fall in any of the factors that influence total demand (consumption, investment,
government spending, net exports) e.g. consumption fell during Covid 19 lockdowns causing many
economies to experience a recession
It can also be caused by supply-side shocks that create challenges for firms & consumers e.g. The
Russian war on the Ukraine has reduced the supply of natural gas, oil & petrol resulting in major
disruptions & increased energy costs
Factors That Reduce Total Demand & Total Supply
Demand-side Factors Supply-side Factors
A fall in consumer confidence reduces Unexpected supply shocks such as the war on
consumption Ukraine or the Japanese Tsunami of 2011
A fall in business confidence reduces A gradual decline in the productive capacity of
investment the economy when capital (machinery) grows
Increasing levels of unemployment reduce old & is not replaced
consumption A gradual decline in the level of
Decreasing levels of government spending education/training available in an economy
Increased interest rates require borrowers to On-going industrial action such as worker
repay higher amounts on their loans - this strikes which disrupt the supply of labour to an
reduces discretionary income which reduces economy
consumption Weather events which destroy agricultural
Shocks to other economies can reduce demand products or interrupt supply chains
for a country's exports thus reducing total
demand
The economic decline (recession) caused by supply-side interruptions can be illustrated using a
production possibility curve (PPC)
Page 9 of 15
Your notes
Outward shifts of a PPF show economic growth & inward shifts show economic decline (recession)
Diagram Explanation
Economic decline occurs when there is any impact on an economy that reduces the quantity or
quality of the available factors of production as depicted by the movement A
One example of how this may happen is to consider how the Japanese tsunami of 2011 devastated
the production possibilities of Japan for many years. It shifted their PPC inwards causing
economic decline
Page 10 of 15
Consequences of Recessions
The consequences of a recession depend on the severity & length of the recession e.g. The Great Your notes
Depression lasted from 1929 to 1939 whereas some economies are in & out of recession within a year
1. National output (rGDP) falls
2. More firms go bankrupt
3. Both unemployment & underemployment increase
4. Both exports & imports fall
5. Domestic & foreign investment by firms decreases/stops
6. Deflation may become an issue leading to even lower wage levels
7. Government spending on unemployment benefits increase
8. Opportunities for entrants to the workforce decrease (youth unemployment increases)
9. Governments may have to spend significant amounts of money to support the economy which carries
several major opportunity costs
Page 11 of 15
4.6.4 Policies to Generate Economic Growth

Your notes
Demand-side Policies
Demand-side policies aim to influence the total demand in an economy
The two demand-side policies are fiscal policy & monetary policy
Any policy that increases consumption, investment, government spending or net exports is likely to
cause an increase in real GDP
Examples Of Specific Types of Fiscal Policy Used to Boost Growth
Example Explanation
Many taxes on imports (import tariffs) Costs of production for firms are reduced & they can produce
are eliminated more goods/services at lower prices - which will increase total
demand
Subsidies are provided to Car manufacturers are able to produce their cars more cheaply
manufacturers of electric cars & sell them at lower prices - which will increase total demand
A government increases the level of Unemployed workers have more income available & increase
unemployment benefits their consumption - which will increase total demand
A government creates a free port zone Both multi-national & domestic companies are incentivised by
the low/no tax promise & seek to invest in free port zones -
which will increase total demand
A government announces that it will Building companies have to be employed & building materials
build 14 new schools in the next financial consumed which is all paid for by the government - & will
year increase total demand
Examples of Specific Types of Monetary Policy used to Boost Growth
Example Explanation
Page 12 of 15
The housing market is subdued & so the With cheaper loans now available, house buyers demand more Your notes
Central Bank lowers interest rates by 1% loans to purchase properties & to renovate/furnish the
properties - consumption increases & total demand increases
The Central Bank intervenes in the The nation's currency is now cheaper for foreigners to
exchange rate to depreciate it purchase and this boosts exports, which will increase total
demand
The Central Bank commits to a new Commercial banks, firms & private investors receive this money
Quantitative Easing program of $75bn a as the government purchases their bonds - they use some of it
month to invest & consume resulting in greater total demand
An evaluation of the pros & cons of fiscal/monetary policy is developed in Topic 4.3 & Topic 4.4
Exam Tip
When evaluating any demand-side policy, avoid generalisations & focus on the effects of the specific
policy mentioned. To strengthen any response, fully develop how each policy will increase total
demand as this is part of your 'chain of analysis'. Always conclude by explaining the different elements
of GDP (C + I + G + X - M) , inflation & output (real GDP)
Page 13 of 15
Supply-side Policies
Supply-side policies aim to influence the total supply in an economy Your notes
Examples Of Specific Types of Supply-side Policy Used to Boost Growth
Example Explanation
The Government reduces the level of People who rely on benefits for survival are more likely to make
welfare benefits themselves available for work. With more workers in the
economy there can be a higher level of output & economic
growth
The Government launches a new This provides a pool of skilled labour in AI & helps to grow a new
'Education & Training' fund to help fund industry resulting in greater national output & economic growth
University students studying artificial
intelligence (AI)
The Government decides to remove The removal of this protection lowers prices & encourages
quotas on all imports more competition leading to higher output & economic growth
The Government decides to build an An additional runway means that more planes can land which
additional runway at the national airport generates more economic activity (e.g. transport of
goods/services) leading to higher output & economic growth
An evaluation of the pros & cons of supply-side policy is developed in Topic 4.5
Page 14 of 15
Exam Tip
Your notes
Supply-side policies can be difficult to identify. This is because many supply-side policies are a fiscal
policy in the short term but a supply-side policy in the long term. In the example above, building a new
runway requires government spending in the short term (fiscal policy) as the government hires firms,
workers & buys the necessary materials. However, when it is finished, it increases the supply of
runways to the economy which in turns increases the economic activity - the potential output of the
economy has expanded & it is a long term supply-side policy.
In your exams, when deciding if a specific policy is fiscal or supply-side, determine whether the
government is using it with the intention of increasing total demand or total supply.
Page 15 of 15
4.7 Employment & Unemployment

Contents
4.7.1 Understanding Employment
4.7.2 Measurement of Unemployment
4.7.3 Types of Unemployment
4.7.4 Consequences of Unemployment
4.7.5 Policies to Reduce Unemployment
Page 1 of 13
4.7.1 Understanding Employment

Your notes
Employment Terminology
Key terms to understand are employment, labour force, unemployment, & full employment
1. Employment: refers to the economic use of labour as a factor of production
2. Unemployment: Someone is considered to be unemployed if they are not working but actively
seeking work
3. Labour force: A country's population is divided into the labour force - & non labour force
The labour force consists of all workers actively working PLUS the unemployed (who are seeking
work)
The non labour force includes all those not seeking work e.g. stay at home parents, pensioners,
school children (these people are economically inactive)
4. Full employment: describes the ideal situation when everyone in the economy who is willing & able to
work has a job
Page 2 of 13
Changing Employment Patterns

Many economies are experiencing changing patterns of employment within their workforce & there are Your notes
numerous reasons for this
Causes of Changing Employment Patterns
Structure of the Economy Proportion of Women Employed Formal & Informal Work
As Economies develop over Changing social attitudes Workers doing informal work
time, they tend to progress have increased the number of are not included in
through the different sectors women entering the employment statistics
(primary, secondary & tertiary) workforce Informal employment is much
resulting in changes to the The proportion of women in higher in less developed
employment pattern the workforce still varies economies & tends to
E.g. More manufacturing jobs significantly between decrease as an economy
in the secondary sector different economies e.g. develops
attract workers who had Sweden has a much higher
previously worked in the proportion of women in the
primary sector workforce than India or Saudi
Arabia
Proportion of Workers in the
Part-time & full-time Work from home
Public & Private Sector
Between the Second World Working part-time provides Covid 19 caused many people
War & the late 1980's, the more flexibility to workers & in to think about their pattern of
number of public sector recent years, there has been work. Many workers are
employees was large in many an increase in the number of reluctant to return to a
economies part-time workers commuting lifestyle &
With an increase in In some economies workers wherever possible, are
privatisation & a move may not be able to find full- continuing to work from
towards more market based time work & may be working 2 home
economies, the percentage of or 3 part-time jobs to pay the
employees in public sector bills
work has decreased in many
countries
Page 3 of 13
4.7.2 Measurement of Unemployment

Your notes
The Claimant Count & Labour Force Survey
Unemployment is often measured using two different approaches
The International Labour Organisation (ILO) Survey
The Claimant Count
The Differences Between the ILO Labour Force Survey & The Claimant Count
The ILO Labour Force Survey The Claimant Count
An extensive survey is sent to a random sample Counts the number of people claiming
of ≈ 60,000 households every quarter unemployment benefits
Respondents self-determine if they are More stringent requirement to be considered
unemployed based on the ILO criteria unemployed than with the ILO survey
Ready to work within the next two weeks Requires claimants to meet certain criteria &
Have actively looked for work in the past excludes many e.g.
one month Those with savings
The same survey is used globally so it's useful for People who claim pensions
making international comparisons Married women who are looking for a job
Page 4 of 13
Calculating the Unemployment Rate

Three Metrics Are Commonly Used When Analysing the Labour Market in an Economy Your notes
Unemployment rate Employment rate Labor force participation rate
no. actively seeking no. inemployment labourforce

= x 100 = populationof workingage x 100 = x 100
totallabourforce totalpopulation
The employment rate could be increasing even as the unemployment rate is increasing:
May be caused by increased immigration which causes working age population to increase
May be caused as people move from being economically inactive to employed
Unemployment rates do not capture the hidden unemployment that occurs in the long term
Workers look for a job but may eventually give up and become economically inactive
This actually improves the unemployment rate as fewer people are actively seeking work
Worked example
The table provides information about a country's labour market
Population size 4000000

Labour force size 2400000
Number employed 1800000
Number of full-time
200000
students
What is the unemployment rate of this country?

a) 15%
b) 25%
c) 50%
d) 75%
Step 1: Decide which information in the table is useful
Page 5 of 13
The number of full time students would not be included in the labour force size, so it is not useful (it
is a distraction)
The key infromation is the labour force size & the number employed Your notes
Step 2: Calculate the number of unemployed in the labour force

Labour force - employed = unemployed
2,400,000 - 1,800,000 = 600,000 unemployed
Step 3: Calculate the unemployment rate
no. actively seeking

= x 100
totallabourforce
600,000
= x 100
2,400,000
= 25%
Page 6 of 13
4.7.3 Types of Unemployment

Your notes
Types of Unemployment
It is possible to classify the causes of unemployment into three categories
1. Structural unemployment occurs when there is a mismatch between jobs and skills in the economy
It usually happens as the structure of an economy changes e.g. the secondary sector is declining
and the tertiary sector is growing
There is no longer a need for a specific type of worker e.g. ship builders in Glasgow
Many Western industries have relocated production to China causing structural unemployment in
their economies
Unless workers receive help to retrain, they are often left unemployed or underemployed
2. Cyclical unemployment is caused by a fall of total (aggregate) demand in an economy

This typically happens during a slow down or recession
At least one of the components of real gross domestic product (rGDP) is falling (consumption,
investment, government spending or net exports)
The demand for labour is a demand derived from the demand for goods/services
As output falls in the economy, firms lay off workers
3. Frictional unemployment occurs when workers are between jobs

This is usually short-term unemployment
Workers have voluntarily left their previous job to search for another
Page 7 of 13
4.7.4 Consequences of Unemployment

Your notes
Consequences of Unemployment
The effects of unemployment, especially long-term unemployment, are extremely damaging
There are impacts on the individual, the economy, the government, and firms
Page 8 of 13
Long term unemployment affects individuals, the economy, government, and firms
Your notes
Government's receive less tax revenue & have higher expenditure in the form of welfare payments
Individuals suffer significant emotional, relational & financial consequences
Firms may find it harder to find workers to employ (as they have moved on) once the economy starts to
recover
The economy contracts as there is a higher level of inefficient use of available resources
Page 9 of 13
4.7.5 Policies to Reduce Unemployment

Your notes
Demand-side Policies
Expansionary fiscal policy & expansionary monetary policy aim to increase total (aggregate) demand
in an economy
The demand for labour is derived from the demand for goods/services
If total demand for goods/service increases there will be a higher demand for labour leading to
lower unemployment
Total demand can be increased through any policy which increases one of the components of real
gross domestic product (rGDP)
Examples of Demand-side Policies Which Are Likely To Reduce Unemployment
Broad Policy Type Specific Policy Explanation
Expansionary Fiscal Government decreases Firms pay less tax → firms have more profit → firms hire
Policy corporation tax more workers → firms increase output →
unemployment falls
Expansionary Fiscal Government increases Defence firms receive more orders from the
Policy expenditure on national government → they hire more workers to produce the
defence output → unemployment falls
Expansionary Fiscal Government decreases Households have more discretionary income →

Policy personal income tax consumption increases → in order to produce the
extra goods/services, firms hire more workers →
unemployment falls
Expansionary Monetary The Central Bank lowers Household repayments on existing loans fall →
Policy interest rates Households have more discretionary income →
consumption increases → in order to produce the
Page 10 of 13
extra goods/services, firms hire more workers →

unemployment falls
Your notes
Expansionary Monetary The Central Bank Many firms receive money as the Central Bank buys
Policy increases the money back their bonds → they decide to use the extra
supply through money to invest in new equipment & technology →
quantitative easing investment increases allowing the production of the
more goods/services → firms hire more workers →
unemployment falls
Demand-side policies are very effective at dealing with unemployment caused by a fall in total
(aggregate) demand
They are not effective at dealing with frictional & structural unemployment
One conflict caused by expansionary policy is that demand pull inflation is likely to occur
Expansionary monetary policy tends to increase inequality in the distribution of income as the poor are
usually unable to benefit from it (banks do not necessarily lend to the poorest households)
Page 11 of 13
Supply-side Policies
Supply-side policies aim to improve the quantity/quality of the factors of production thereby raising Your notes
potential output
If output increases then firms will require more workers to produce that output & unemployment
may fall
Examples of Supply-side Policies Which Are Likely To Reduce Unemployment
Specific Supply-side Policy Explanation
The Government reduces trade Trade union power weakens → firms lower wages → costs of production
union power decrease → firms can produce more output with the same input → firms
hire more workers as they are cheaper → unemployment falls
The Government reduces Regulations removed → costs of production decrease as firms no

regulation on the oil & banking longer need to spend money meeting requirements → firms can
industries produce more output with the same input → firms hire more workers as
they are cheaper → unemployment falls
The Government introduces new Cheaper to study green technology → more students develop their skills
long term training subsidies for → supply of skilled workers in the industry grows → new firms launch →
students of green technology output increases & more workers are required → unemployment falls
Supply-side policy tends to be long term e.g. breaking trade union power is a long term process, as is
training
It is most effective in dealing with unemployment caused by frictional & structural unemployment
It does not help deal with unemployment caused by demand side issues e.g. a recession
Page 12 of 13
Protectionist Policies
Protectionism involves the use of government policies that restrict international trade in order to Your notes
protect domestic industries, including employment in domestic industries
Some firms are unable to compete with international firms & without protection, go out of business
Their workers become unemployed
To avoid this, governments help domestic firms to survive by subsidising them, or placing import
tariffs on a range of products which raises the price of the goods/services provided by foreign
competitors
Protectionist policies may well protect employment of some workers in the industry targeted, but
create even higher unemployment in related industries
E.g. in 2016, The Trump Administration placed tariffs on all steel imports which protected around
1,600 jobs in the steel industry. However, the raised price of imported steel, which is used as a
factor of production in many industries, reduced output & increased unemployment in many
related industries
A deeper evaluation of protectionism is available in Sub-topic 6.3.2
Page 13 of 13
4.8 Inflation & Deflation

Contents
4.8.1 Definitions & Measurement
4.8.2 Causes & Consequences of Inflation
4.8.3 Causes & Consequences of Deflation
4.8.4 Policies to Control Inflation & Deflation
Page 1 of 14
4.8.1 Definitions & Measurement

Your notes
Inflation & Deflation
Inflation is the sustained increase in the general price level of goods/services in an economy
The general price level is measured by checking the prices of a 'basket' of goods/services that an
average household will purchase each month
This basket of goods is turned into an index and it is called the consumer price index (CPI)
The UK has an inflation target of 2% per annum
Low inflation is better than no inflation as it is a sign of economic growth
Deflation occurs when there is a fall in the general price level of goods/services in an economy
Deflation only occurs when the percentage change in prices falls below zero %
Exam Tip
Remember that a reduction in the inflation rate from e.g. 5% to 3% means that prices are still rising but
rising more slowly (inflation at a decreasing rate is called disinflation)
MCQ will check your understanding of decreasing inflation by asking you questions such as:
In which year are prices their highest?
Y1 Inflation = 5%
Y2 inflation = 3%
Y3 inflation = 1%
Y3 is the answer. Prices are 9% higher in Y3 than at the start of Y1 (5% + 3% + 1%)
Page 2 of 14
Using the Consumer Price Index (CPI) to Measure Inflation & Deflation
Inflation is the sustained increase in the general price level of goods/services in an economy Your notes
The inflation rate is the change in general price levels in a given time period
The inflation rate is calculated using an index with 100 as the base year
If the index is 100 in year 1 and 107 in year 2 then the inflation rate is 7%
The consumer price index (CPI) is used to measure inflation
The Consumer Price Index (CPI)

A 'household basket' of 700+ goods/services that an average family would purchase is compiled on
an annual basis
A household expenditure survey is conducted to determine what goes into the basket
Each year, some goods/services exit the basket & new ones are added
Goods/services in the basket are weighted based on the proportion of household spending
E.g. More money is spent on food than shoes, so shoes have a lower weighting in the basket
Each month, prices for these goods/services are gathered from hundreds of locations across the
country
These prices are averaged out
The price x the weighting determines the final value of the good/service in the basket
These final values are added together to determine the price of the 'basket'
Cost of basket in year X

CPI = x 100
Cost of basket in base year
The percentage difference in CPI between the two years is the inflation rate for the period
Page 3 of 14
Worked example
Your notes
Using the information in the table, calculate the inflation rate for 2021 if the price of the basket in the
base year (2019) was $400
Basket 2020 Basket 2021

Good Price 2020 Price 2021 Weighting (Price x (Price x
weighting) weighting)
Housing, water,
950 1200 34% 323.00 408.00
electricity, gas
Transport 250 325 11% 27.50 35.75
Food 500 620 9% 45.00 55.80
Recreation &
300 340 10% 30.00 34.00
culture
Clothing &
190 210 5% 9.50 10.50
footwear
$435.00 $544.05
Step 1: Calculate the CPI for 2020
Cost of basket in 2020

CPI = x 100
435
= x 100
400
= 108 . 75
Step 2: Calculate the CPI for 2021
Page 4 of 14
Cost of basket in 2021

CPI = x 100
Your notes
544 . 05
= x 100
400
= 136 . 01
Step 3: Calculate the percentage difference between the CPI for 2021 and 2020
New CPI − Old CPI

nﬂationrate = x 100
Old CPI
136 . 01 − 108 . 75
= x 100
108 . 75
= 25. 07%
Page 5 of 14
4.8.2 Causes & Consequences of Inflation

Your notes
The Causes of Inflation
An increase in the general price level in an economy can be caused by demand pull inflation or cost
push inflation
1. Demand Pull Inflation

Demand pull inflation is caused by excess demand in the economy
Total (aggregate) demand is the sum of all expenditure in the economy
rGDP = Consumption (C) + Investment (I) + Government spending (G) + Net Exports (X-M)
If any of the four components of rGDP increase, there will be an increase in the total demand in the
economy leading to an increase in the general price level
Demand pull inflation has occurred
An Example of Demand Pull Inflation

If the Central Bank lowers the base rate, there is likely to be increased borrowing by firms &
consumers
This will result in an increase in consumption & investment which will increase the rGDP
It is likely to lead to a form of demand-pull inflation
2. Cost Push Inflation

Cost push inflation is caused by increases in the costs of production in an economy
If any of the costs of production increase (labour, raw materials etc.), or if there is a fall in productivity,
the total supply will decrease
With less supply, prices rise leading to an increase in the general price level
Cost push inflation has occurred
An Example of Cost Push Inflation

Trade Unions negotiate higher wages for workers
The wage increases represent an increased cost of production for firms
With the inputs, firms now produce less & supply reduces leading to higher general price levels
Cost push inflation has occurred
Page 6 of 14
The Consequences of Inflation

Your notes
The Impact Of Inflation On Different Stakeholders
Firms Consumers Government Workers
Uncertainty: Rapid Purchasing Power: International Higher Wages:

price changes create Decrease in Competitiveness: Workers demand
uncertainty & delay purchasing power Inflation erodes higher wages to
investment worsens their quality international compensate for
Menu change of life competitiveness of reduced purchasing
costs: Price changes Savings: There is a export industries as power
force firms to change decrease in the real their products now Morale: If wage
their menu prices too value of savings (as look relatively more increases ≠ inflation,
& this can be money will be worth expensive to motivation &
expensive less in real terms) foreigners productivity may fall
Lenders: Financial Real Income: There is Trade-offs: There as workers do not
firms that lend money a fall in real income are involved in receive the same real
are worse off as the for those on fixed tackling inflation e.g benefit for the work
money lent out is now incomes/pension reducing inflation they are doing
worth less than Borrowers: anyone may increase
before who borrows money unemployment
benefits as the and/or reduce
repayments are economic growth
worth less than when Government Debt:
the money was inflation erodes the
originally borrowed value of government
debt as the
repayments are
worth less than when
the money was
originally borrowed
Page 7 of 14
Exam Tip
Your notes
Remember, governments want some inflation - usually 2-3% as this is a sign of economic growth.
However, inflation in excess of that is harmful in many of the ways described above.
When evaluating inflation a considerable positive for many governments is the fact that it erodes the
value of government debt. This may be difficult to grasp, but if a government has a lot of debt, it may
actually be happy to let inflation run at a higher level for a period of time. The trade-off is that everyone
in the economy who is not a 'borrower' is worse off & if inflation is high, it can lead to social unrest &
economic instability.
Page 8 of 14
4.8.3 Causes & Consequences of Deflation

Your notes
Demand-side Deflation
Deflation occurs when there is a fall in the average price level of goods/services in an economy as
measured by the consumer price index (CPI)
Deflation only occurs when the percentage change in prices falls below zero %
Deflation can be caused by either demand-side or supply-side factors

The two different causes of deflation have very different consequences for the economy
Demand-side Deflation (Bad Deflation)
Demand-side deflation is caused by a fall in total (aggregate) demand in the economy

Total (aggregate) demand is the sum of all expenditure in the economy as measured by the real gross
domestic product (rGDP)
rGDP = Consumption (C) + Investment (I) + Government spending (G) + Net Exports (X-M)
If any of the four components of rGDP decrease, there will possibly be a decrease in the total demand
in the economy leading to a decrease in the general price level
Demand-side deflation has occurred
The Consequences of Demand-side Deflation
Unemployment Consumers Lose Confidence Debt
With a decrease in output, fewer With falling output & rising Debt feels more burdensome as
workers are required & so unemployment, households lose the value of any debt is worth
unemployment increases confidence choosing to save more. Real cost of borrowing
instead of spend. Consumption increase as real interest rates rise
falls & rGDP reduces even more when the price level falls e.g. if
interest rates are 1.5% & the
inflation rate is –1.5%, then the real
interest rate is 3%
Firms Lose Confidence Bankruptcies Exports
Page 9 of 14
Falling output & falling prices Falling output & falling prices Persistently falling prices can
cause firms to lose confidence & reduce the profits of firms. Some prove attractive to foreigners &
so they delay investment, further firms will be unable to continue & the level of exports may increase Your notes
reducing rGDP will go out of business (this helps offset some of the
reduction in rGDP)
Page 10 of 14
Supply-side Deflation
Supply-side deflation is caused by increases in the productive capacity of the economy Your notes
This is brought about by any increase in the quantity/quality of the factors of production
It effectively creates a condition of excess supply in the economy
General price levels fall
National output (rGDP) increases
The Consequences of Supply-side Deflation
Unemployment Consumers Gain Confidence Debt
With a decrease in costs, the With rising output & falling price Debt still feels more burdensome
output of firms increases. More levels, households become more as the value of any debt is worth
workers are required & so confident & consumption more
unemployment falls increasing - increasing rGDP even
more
Firms Gain Confidence Exports
Rising output & falling costs of Persistently falling prices boosts

production cause firms to gain international competitiveness &
confidence & exports increase
increase investment, thereby
increasing rGDP
Exam Tip
Falling prices caused by a recession are not good for an economy. In this scenario, national output is
falling which means that fewer workers will be required to produce goods/services so unemployment
will increase.
Falling prices caused by an increase in supply are good for an economy. In this scenario, national
output is rising which means that more workers will be required to produce goods/services so
unemployment will decrease.
Page 11 of 14
4.8.4 Policies to Control Inflation & Deflation

Your notes
Policies To Tackle Inflation
Demand pull inflation is best addressed using contractionary demand side policies
Contractionary fiscal policy & contractionary monetary policy aim to reduce total (aggregate)
demand in an economy
If total demand for goods/services decrease there will be a fall in the general price level thereby
reducing the level of inflation
Total demand can be decreased through any policy which decreases one of the components of real
Examples of Demand-side Policies Which Are Likely To Reduce Demand Pull Inflation
Contractionary Fiscal Government increases Firms pay more tax → firms have less profit → firms
Policy corporation tax invest less → rGDP falls → inflation decreases
Contractionary Fiscal Government decreases Government spending decreases → defence firms

Policy expenditure on national receive fewer orders from the government → national
defence output falls → inflation decreases
Contractionary Fiscal Government increases Households have less discretionary income →

Policy personal income tax consumption decreases → national output falls →
inflation decreases
Contractionary The Central Bank Household repayments on existing loans rise →

Monetary Policy increases interest rates households have less discretionary income →
consumption decreases → national output falls →
inflation decreases
Page 12 of 14
Contractionary The Central Bank Firms receive less money from the sale of bonds →
Monetary Policy decreases the money investment decreases → national output falls →
supply by stopping inflation decreases Your notes
quantitative easing
Demand-side policies are more effective in the short term at dealing with inflation caused by a rise in
total (aggregate) demand
They are less effective at dealing with cost push inflation
One conflict caused by contractionary policy is that reducing demand pull inflation also reduces
output & employment
Examples of Supply-side Policies Which Are Likely To Reduce Cost Push Inflation
Specific Supply-side Policy Explanation
The Government reduces Regulations removed → costs of production decrease as firms no

regulation on the oil & banking longer need to spend money meeting requirements → national output
industries (total supply) rises → inflation reduces
The Government changes More workers move into the country → the price of labour (wages) falls →
migration policies to allow more costs of production reduce for firms → national output (total supply)
workers into the country rises → inflation reduces
The Government builds a new Speed & capacity of transport infrastructure is improved → costs of
rail network serving ports & production decrease as firms benefit from the improvements → national
airports output (total supply) rises → inflation reduces
Supply-side policy tends to be long term, but highly effective in reducing price levels
They do not help deal with inflation caused by demand side issues
Page 13 of 14
Policies To Tackle Deflation

Deflation caused by a fall in total demand (e.g. during a recession) is best addressed using Your notes
expansionary demand-side policies
Expansionary fiscal policy & expansionary monetary policy aim to increase total (aggregate)
demand in an economy
When total demand increases, general price levels also increase
This reduces or eliminates the deflation
Total demand can be increased through any policy which increases one of the components of real
Examples of Demand-side Policies Which Are Likely To Reduce Deflation
Expansionary Fiscal Government increases Defence firms receive more orders from the
Policy expenditure on national government → total demand increases → deflation is
defence improved/eliminated
Expansionary Fiscal Government decreases Households have more discretionary income →

Policy personal income tax consumption increases →total demand increases →
deflation is improved/eliminated
Expansionary Monetary The Central Bank lowers Household repayments on existing loans fall →
Policy interest rates Households have more discretionary income →
consumption increases → total demand increases →
deflation is improved/eliminated
Demand-side policies can very effective at dealing with deflation

Expansionary monetary policy tends to increase inequality in the distribution of income as the poor
are usually unable to benefit from it (banks do not necessarily lend to the poorest households)
Page 14 of 14

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CIE IGCSE Economics Your notes

4.1 The Role of Government

4.1.1 Local, National & International

Area of Intervention Examples of Intervention Explanation

National Central Government Determining the best combination of policies

International Exchange rate International trade is vital to economic growth in

CIE IGCSE Economics Your notes

4.2 The Macroeconomic Aims of Government

4.2.1 The Five Macroeconomic Aims

Many developed nations have an annual target growth rate of 2-3%

Economic growth has positive impacts on confidence, consumption, investment, employment,

A diagram showing the economic growth rate of the UK since 1998

1998-2007 2008-2015 2016-2019 2020 -

A diagram showing the unemployment rate in the UK from 1998 - 2020

Low & Stable Rate of Inflation

A low rate of inflation is desirable as it is a symptom of economic growth

Balance of Payments Stability On The Current Account

Governments aim for Balance of Payments equilibrium on the Current Account

The UK has traditionally run a small deficit

Unchecked capitalism has a natural outcome of high income inequality

4.2.2 Conflicts Between Macroeconomic Aims

Additionally, with low unemployment wages tend to increase

CIE IGCSE Economics Your notes

4.3 Fiscal Policy

4.3.1 The Government Budget

A budget deficit has to be financed through public sector borrowing

Reasons for Government Spending

Reasons for Taxation

Direct taxes are taxes imposed on income and profits

Indirect taxes are imposed on spending

Progressive, Regressive & Proportional Tax Systems

Tax systems can be classified as progressive, regressive or proportional

System Explanation Diagram

Progressive As income rises, a larger percentage

As income rises, a smaller percentage

Proportional As income rises, the same percentage

Calculation Using UK Progressive Tax Rates - June 2022

Personal Allowance Up to £12,500 0% 0

£12,501 to £50,000 20% £37, 499 at 20% =

Higher Rate £50,001 to £150,000 40% £10,001 at 40% =

Additional Rate Over £150,000 45% 0

Weekly Income ($) 100 150 200 250

It is a proportional tax system with a constant tax rate of 20%

The Impact of Taxation

4.3.3 Fiscal Policy Measures

Fiscal policy can be expansionary in order to generate further economic growth

A budget deficit has to be financed through public sector borrowing

The Effects of Fiscal Policy on Government Macroeconomic Aims

Examples of The Impact of Contractionary Fiscal Policy

Example 1 The Government increases income tax levels

Impact on macroeconomic Economic growth slows down

Example 2 The Government freezes/reduces public sector workers pay

Impact on macroeconomic Economic growth slows down

Example 3 The Government cuts Government spending in their Budget

Impact on macroeconomic Economic growth slows down

Examples of The Impact of Expansionary Fiscal Policy

Example 1 The Government decreases corporation tax