This comprehensive revision presentation by tutor2u Co-founder Geoff Riley is designed to provide support for AS Economics students (and their teachers) in the final stages of their revision for the Unit 2 paper on macroeconomics.

1. Preparing for the May 2012
Unit 2 Macro Paper
Geoff Riley (tutor2u) April 2012

2. About the Author
Geoff Riley
Geoff is co-founder of tutor2u and Leader for Teaching and
Learning Technologies at Eton College. Previously Geoff was Head
of Economics at Eton College from 2000-2010 and Head of
Economics & Politics at the Royal Grammar School, Newcastle.
Geoff is also an experienced examiner and presenter at tutor2u
student and teacher workshops. He continues to teach Economics
and is also a leading proponent of using digital tools as a way of
enhancing teaching and learning in Economics.
For more revision Geoff is a newly elected Fellow of the Royal Society of Arts. He
established a thriving Entrepreneurship Society whilst at Eton
advice for A Level College and for nine years ran the Keynes (Economics) Society. He
Economics is also responsible for organising the teacher judging panel for the
courses, follow annual essay competition run by the Royal Economic Society.
Geoff on Twitter
Geoff has developed a specialist interest in the use of the Open
web for educational purposes and is an expert user of Moodle, the
popular open-source VLE platform. Geoff is a regular presenter at
in-house inset training events for teachers.

3. Exam success is
not a lottery!
Know your
terms
Get the
diagrams right
Show current
awareness

4. What really matters on this paper?
• Determinants of macro performance
– Understanding AD-AS analysis / changes in AD and AS
– Using this analysis to explore recent and current
developments and policies e.g. Recession and
recovery
• Analysing and critically evaluating a range of
macroeconomic policies (e.g. MP, FP and SS-P)
– How do policies work? The transmission mechanism
– What are the limitations / constraints of each policy?

5. What really matters on this paper?
• Understanding the external environment and
how it impacts on the British economy (e.g.
Events in Europe, the effects of globalisation)
• Being aware of how the different macro
topics link together
– e.g. Inflation and unemployment, growth and
trade, productivity and investment
• Key is to show the examiner that you know
what is actually happening in the UK economy

6. Macroeconomic performance and stability (1)
• Domestic objectives:
– GDP: Real economic growth (short and long
term)
– CPI: Price stability (low stable positive
inflation)
– Jobs: Achieving higher employment / less
unemployment
– Higher living standards (i.e. GDP per capita
and other measures of well-being and social
welfare, addressing inequality issues)

7. Macroeconomic performance and stability (2)
• External objectives
– Sustainable position on the current account of the
BoP
– Improving competitiveness in global markets
• Restoring economic stability
– Absorbing domestic and external economic shocks
– Putting in place effective policies for stronger
growth
– Re-balancing the economy away from debt-fuelled
consumption

8. Key Issue: Can the UK be re-balanced?
Exports
Invest
ment
Balanced
recovery in
Demand
and Output
The government wants
higher exports and Achieving this looks harder
investment to kick-start a than the coalition expected
“balanced recovery”

9. A selection of re-balancing policies
Currency depreciation
• A boost to UK export competitiveness
• Improved net trade balance (over time)
• Higher exports creates positive multiplier & accelerator effects
Supply-side support for industry
• Reversing de-industrialisation
• Establish more technology innovation centres
• Increase graduates and apprentices in technical subjects
Improving the supply of credit
• Project Merlin
• Plan for a credit easing scheme
• Green Investment Bank for renewable investment schemes

10. Aggregate Demand (AD)
• Total demand for domestically-produced
goods and services
• AD =
Consumer spending (C)
+ Investment spending (I)
+ Government spending (G)
+ Exports of goods and services (X)
- Imports of goods and services (M)

11. Trying to achieve macro stability
Macro stability replaced
by macro volatility in
recent years

12. Another look at the cycle
Consensus of economists is that the UK economy will
expand by 2.0% a year for the rest of this decade, about
two thirds the rate seen in the ten years prior to the
recession

13. A permanent loss of output
???
Without effective policies / reforms and
a stronger recovery in our trade
partners – UK economic growth likely to
be slower in the years ahead

14. Long term effects from recession
• Fall in capital spending
• Rising unemployment
– Structural unemployment SLOW
– Long term unemployment Growth
• Continued credit squeeze
– Less finance for exporters and
Ahead
business-start-ups
– Rising inequality in income

15. Trend growth is falling – why?
Recession may have
inflicted damage on
trend growth

16. The output gap is negative
Inflation has averaged
over 3% since 2008
No change in policy base
rates for over 3 years
Plenty of spare capacity

17. Household demand is main short term
driver of AD. Weak consumption in 2009
and again now – lots of causal factors –
living standards are falling for most workers.
While inflation has risen to 3.5%, average
pay rises have fallen to 1.1%

18. What is causing falling consumption?
Credit still in short supply – and expensive
People need to save and pay back debt
UK housing slump – falling asset prices
Rising unemployment – now above 2.7 million
Low consumer confidence
Falling real disposable income for millions
Lots of things in
macroeconomics are
multi-causal!

19. Stagnant house prices
Falling prices - known as
asset price deflation
Average UK house prices are 25% below
their peak in 2007
The average deposit required for a
mortgage is £38,000 – tough to find

20. Consumer confidence remains weak
Recession caused
steep drop in Sentiment now being held back by
consumer fiscal austerity + persistent high
confidence inflation and rising unemployment

21. Steep fall in capital spending during
the recession – how can this be
stimulated? Key to long term growth
Mis-leading for many businesses
who pay way above the base rate

22. Analysis: What factors affect the level of
capital investment spending?
Expected
Actual &
profits and
expected
business
demand
taxes
eExpectations
matter in
Interest
rates + Business
macroeconomics! availability confidence
of finance

23. Jobs and prices
Worsening trade off
between 2 key macro
objectives

24. Does the UK have an inflation problem?
CPI inflation has been above the 2%
target for most of the last four years
Analysis: Lower inflation in 2012 should increase
the real value of consumers' incomes

25. Showing demand-pull inflation
Price Level Demand pull inflation occurs when
AD rises and SRAS is inelastic i.e.
The output gap is positive
SRAS
P2
P1
AD2
AD1
Y1 Y2
National Output

26. Showing cost-push inflation
Price Level A fall in SRAS might be caused by
higher costs of production –
leading to lower supply at each
price level
SRAS2
SRAS1
AD1
Y2 Y1
National Output

27. Oil prices affect AD and SRAS
Global oil prices have risen
strongly after the recession –
comfortably above $100 a
barrel – with big effects on
businesses and consumers
The external environment matters a lot for the UK economy

28. Is 4% inflation a problem for the UK?
Objectives: Don’t kill off the recovery
• Need stronger growth now rather than higher inflation
• 4% inflation is not high looked at long run context
4% inflation may not last!
• Much of rise in inflation is temporary
• Due to external factors e.g. Oil and food prices
A little extra inflation can be good!
• Helps to reduce the real value of debt
• Rising revenues and profits for some businesses

29. 8% of labour force out of work & rising
Economy needs to
grow at least 2% for
Deep recession (> 6% fall in
unemployment to
output) and weak recovery
start falling
(GDP grew only 0.7% in 2011)

30. Unemployment rose sharply during
the recession and is growing once
more – a worrying sign

31. Unemployment is much higher in some
of Europe’s economies.
Youth unemployment in Greece and
Spain is over 50% of the labour force

32. Long term youth unemployment
More than a million young people are
now unemployed across the UK. 225,000
have been out of work for at least a year
Long term youth unemployment has
more than doubled since the start of the
2008 recession

33. Analysis: Explaining high youth
unemployment – 16-24yrs
Human Reluctant
Capital Employers
(skills) – less new
Deficit jobs
Reduced Weakness
retirement of existing
rates limit training
chances schemes

34. Targeted stimulus policies to boost labour demand
Expansion of apprenticeship schemes
Housing reforms to improve geographical mob
Measures to stimulate business start-ups
Active regional growth & development policies

35. 3 Years of 0.5% Base Interest Rates
Lower interest
rates is an
easing or
relaxation of
monetary policy
The UK’s Bank of England has
now kept the cost of borrowing
at 0.5% for three years

36. How changes in interest rates are
supposed to affect demand and prices
Change in market
interest rates
Impact on aggregate
demand (C+I+G+X-M)
Effects on output and
jobs & investment
Time Lags – might take 1-2
years for full effect to happen Feeds through to Real
GDP and Prices

37. Factors limiting effects of low interest rates
Businesses Weakness in Deleveraging
Fragile
cash economies in the UK
Consumer
hoarding of our major financial
and Business
despite trading system –
Confidence
rising profits partners cutting loans

38. Defending the
Bank of England
Prompt action in 2008-09 avoided
sustained deflation
Cuts in policy rates & QE has
avoided deep depression
Some re-balancing of UK economy
now happening
Crisis was unprecedented – a once
in lifetime shock
Difficult for low policy rates to
work in a liquidity trap

39. Quantitative Easing (QE)
QE is a deliberate expansion of the central bank's balance sheet and the
monetary base – electronically creating money to improve liquidity in banking

40. By February 2012, the
Has QE Worked?
total size of the QE
programme was £325bn Lower yields on
bonds saves
government money
Useful policy when
fiscal policy is being
squeezed
Bank lending is still
weak – risk averse
banks

41. 25% depreciation in sterling v US$
Low stable pound for last three years
Has the fall in sterling
been of benefit to the
UK economy?

42. Has a weaker pound helped the UK economy?
Export boost –
injection of AD
A stimulus for
British industry
Foreign investment
into UK has grown

43. Limits to the impact of a cheaper currency
Higher import prices and increased
cost-push inflation
Businesses are finding it hard to get
export finance from the bank
Recession in main UK export markets
including the Euro Zone
Competitiveness is not just about cost
and price – innovation / design counts

45. Growing trade surplus in services
Trade deficit in goods close to £100b

46. Key services:
Business services
Financial services
Transport and tourism
Education and Health
Creative industries
Research and development
Key goods:
Manufactured goods
Oil / gas / minerals
Food and drink
Components

47. Why does the UK economy still run such a
large trade deficit?
High income elasticity of demand for
imported goods and services
Some weaknesses on supply-side of the
economy (i.e. Research / investment)
Many UK businesses are finding it hard to
finance a rise in exports (credit squeeze)
The majority of our exports go to slow-
growing countries in Europe and USA

48. Fiscal Policy
The big issue in fiscal policy is the
decision by the Coalition
government to introduce a period
of fiscal austerity – i.e. Cutting the G>T =
budget deficit through spending budget
cuts and tax rises deficit

49. Govt Spending has macro & micro effects
and demand and supply-side effects!

50. Taxes also have microeconomic effects!
And demand and supply-side effects

51. How much borrowing can the UK take?
Government debt is rising but long
term bond yields remain low
Fiscal austerity as Coalition aims to cut
the size of the budget deficit over the
next five years – will the pain work?

52. The UK government can borrow
money for 10 years at cheap interest
rates (around 2%) – whereas the cost
of borrowing for other countries is
significantly higher – this gives the UK
an advantage – has it been used well?

53. The case for budget deficit reduction
• High debt threatens stability and recovery
• Government wants credibility in financial markets
• Higher future taxes will squeeze the private sector
• Inequitable to leave future generations with debt
• Doubts about effectiveness of stimulus policies

54. Counter-arguments to fiscal austerity
• UK should take advantage of low
interest rates to fund much
needed infrastructure
• Economy is depressed and
unemployment is high. Spending
is needed to create jobs
• Sensible fiscal stimulus policies
are self-financing – they create
extra tax revenue over time
• Poor households and families
with children will bear the brunt
of austerity – it will make
inequality worse

55. The UK economy is exposed to many
external demand shocks
1. A big rise or fall in the sterling exchange rate
2. Recession in major trading partners which affects
the demand for exports e.g. Euro Zone crisis
3. A prolonged slump in the housing market
4. Continued credit crunch
1. Squeezing supply of loans – impact on businesses and
consumers
2. Making it harder for export businesses to take advantage
of the competitive exchange rate

56. BRICs growth
Economic growth in the BRIC
countries is slowing down but is
still higher than for advanced
Western nations. How would a
sharp slowdown in China affect the
British economy? Can you find
some connections?

58. A fall in aggregate demand
Price Level An initial change in AD can have a
much greater final impact on
equilibrium national income. This
is known as the multiplier effect
AD2 LRAS
AD1
SRAS
Y1 Y2
Real National Output

59. Multiplier effect is strongest when SRAS is
elastic and when AD rises
Price Level An initial change in AD can have a
much greater final impact on
equilibrium national income. This
is known as the multiplier effect
AD2
AD1
SRAS
Y1 Y2
National Output

60. Supply-side shocks
• Supply-side can be affected by shock effects
• Not all shocks are negative for growth, prices and jobs
• SRAS:
– Changes in global food prices
– Volatility in the prices of imported raw materials / energy
– Changes in import tariffs and other import controls
– Changes in indirect taxes on businesses and subsidies
• LRAS
– Impact of new technologies on costs and productivity
– Long term impact of innovation and invention
– Unexpected changes in the size of net labour migration

61. Analysing “economic shocks”
• Make good use of AD-AS analysis (use your AS economics!)
• Consider short-run and possible longer-run effects
– 1/ First round effects (immediate or short term)
– 2/ Second round fallout (medium term effects – can be positive
or negative)
• The impact of shocks will vary from country to country
• How big is the shock?
• Is the shock temporary or more persistent?
• Consider how economic policy might respond to the shocks
• How much freedom to change policies do countries have?
• Use your economic knowledge – keep up to date!

62. Where will economic growth come from?
Labour Innovation
Productivity Capital
Market and
Improvements investment
Participation Enterprise

63. Assess the policies that might be most effective in achieving faster
economic growth in the UK over the next few years
• Fiscal Policy
– Employment taxes e.g. Cuts in national insurance
– Reduced taxes on lower-paid jobs
– Incentives for green investment
– Youth training guarantees
– Fast-forwarding capital projects e.g. Transport
– New house building
– Revising deficit reduction plans (less austerity)

64. Assess the policies that might be most effective in achieving faster
economic growth in the UK over the next few years
• Monetary Policy
– Credit easing programme
– Intervention in currency markets
• Supply-side Policies
– Attacking the infrastructure deficit
– Migration policy (e.g. Caps)
– Enterprise policies
– Green Investment Bank
– Relax planning for construction

65. The LRAS curve
Price Level LRAS is assumed to be independent of
the price level and is drawn vertical LRAS
LRAS curve
AD1 represents the
normal capacity
level of the
economy
SRAS1
Y1 Yfc
National Output

66. An increase in productive potential
Price Level An increase in the supply-side
capacity of the economy is shown LRAS LRAS2
by shift in LRAS
AD1
SRAS1
Y1 Yfc Yfc2
National Output

67. Supply-side policies for improved trade
• Employee incentives
Productivity • Better management
• Market Competition
• Tax incentives
Innovation • Science & Technology
• Universities
• Capital investment
Capacity • Attracting FDI
• Infrastructure

68. Some examples of applying AD-AS diagrams
• How changes in interest rates affect AD and inflation
• How changes in taxation might impact on LRAS
• How movements in the exchange rate affect AD & AS
• Impact of supply-side policies to stimulate enterprise
• Economic consequences of labour migration
• Effects of changes in import tariffs and quotas
• Multiplier effects from economic stimulus policies
• Analysing the impact of the credit crunch / recession
• Analysing the causes of higher cost-push inflation

69. Remember the Wee-Steps Approach
Wider context – consider the bigger picture in an issue
W and use it to weight your arguments
Efficiency – Does this achieve a more/less efficient
E allocation of resources?
Equality – Do some parties benefit more/less than others
E from a policy change?
Scope – How many people are affected by the point? Is it
S wide reaching or narrow?
T Time – How long will it last, SR or LR or both?
Effectiveness – does it solve the issue it was intended to
E solve? Are there better alternatives?
Prioritisation – which of your points is the strongest and
P why. Be specific about the context of the question – use
this in your final paragraph
Scale or Magnitude – where people are affected how
S strong is the impact?

70. Improving your Macro Evaluation (1)
1. Most macro problems have multiple causes
2. No single macro policy works in isolation
3. Combination of policies needed for short & longer
term
1. Demand side policies and supply side policies
2. Be clear on the main ideas behind Keynesian
macro theory
4. Remember – economics is a social science – we can
never be certain about how people will respond

71. Improving your Macro Evaluation (2)
5. Expectations and confidence are crucial – e.g.
Weak animal spirits during the early stages of a
recovery
6. Policy time lags are uncertain e.g. The time lag
between economic recovery and falling
unemployment
7. Use data to support or reject a point of view
8. Question reliability of the data – especially if out
of date

72. Macro Evaluation (3)
• Importance of macro awareness / knowledge
1. It is crucial that you show an awareness of what is actually
happening in the British economy
2. Use the extracts in your answer – make at least three explicit
data references in your final answer (from charts, table and
text)
3. Also show awareness of events / issues in other countries –
useful for comparative illustrations e.g. Events in the USA,
Europe, China
• AD-AS analysis must always be used as foundation to show impact
on output, prices, employment
• Remember to offer a clear final conclusion in the essay questions
at the end of the data response paper

73. The best evaluation answers in AS macro papers
Make good use of data provided
Start with clear and accurate analysis
Provide some real-world context
Cover a range of different policies
Consider short run + long run effects
Ask whether a change is significant
Are aware of the limits to policies
End with a reasoned conclusion