N06 - N06 P1 2. a) Explain how interest rates can be used...

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N06 P1 2. a) Explain how interest rates can be used to bring about an increase in economic activity. [10] • explanation of interest rates as a tool of monetary policy • consumption will increase for a number of reasons • investment will increase for a number of reasons • explanation that a cut in interest rates reduces the cost of borrowing • possible effect on net exports • possibility of a supply-side effect • diagram showing increased spending shifting out AD curve and an increase in national income b) Discuss the strengths and weaknesses of demand-side policies. [15] • explanation of demand-side policies: fiscal policy and monetary policy • discussion of a possible trade-off between inflation and unemployment • discussion of the problems associated with deflationary fiscal policy e.g. UE, time lags • explanation of how demand-side policies can be used to reduce inflation or unemployment • discussion of the problems associated with contractionary policy: an increase in interest rates slows economic growth and negatively affects exports due to increase in exchange rate • discussion of the problems associated with expansionary fiscal and monetary policy e.g. inflation, time lags, export competitiveness, crowding out • use of an appropriate diagram 3. a) What are the causes of inflation? [10] • define inflation • explanation of demand pull inflation • explanation of cost push inflation • reference to monetary growth b) Evaluate the possible effects of a persistently high inflation rate on a country’s current account balance and its exchange rate. [15] • exports become less competitive while imports become more competitive • the likely impact of the current account balance change on the exchange rate • impact on current account balance depends on relative elasticities of demand for exports and imports. Reference to the Marshall-Lerner condition to be rewarded • reference to the purchasing power parity theory should be rewarded • define exchange rate • define current account balance N06 P2 3. Explain how an increase in government spending can lead to crowding out. [10] • increase in government spending may involve • higher interest rates raise the cost of borrowing to
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an increase in the demand for loanable funds/money firms and therefore investment is likely to fall • governments use of loanable funds means that there is less available for private investment (notion of crowding out) • a diagram showing the demand and supply for loanable funds (money) may be used together win an investment diagram • a diagram showing AD/AS, with AD shifting to the right (due to an increase in government spending) and then to the left (due to a fall in investment) may be an alternative
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N06 - N06 P1 2. a) Explain how interest rates can be used...

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