EFFECTIVE CHAINS OF REASONING/ANALYSIS OF DIAGRAMS

The new economics specification places a heavy emphasis on a student’s application skills (AO2Application andAnalysis). For example, Paper 1 now explicitly requires students to use real world examples when answering the fifteen-mark question. For top marks to be awarded, the rubric (below) states that “relevant real-world examples” must be “fully developed to support the argument”. Amongst other things, this means that explanations of diagrams should be in context if you want to score well.

Below are two model answers that highlight the difference between a contextualised explanation of a diagram, and one that simply describes the diagram. Unfortunately, a lot of students provide simple textbook answers like example one below and, whilst it is technically correct, it doesn’t show any application of the student’s knowledge. Without any context or real-world application, example 1 would fail to meet the new rubric requirement.

example 1 – no context or examples (level 2 response)

The diagram above is a representation of a deflationary gap.Adeflationary gap exists when actual output in the economy is less than potential output. IfAD falls due to a reduction in consumer spendingAD will shift toAD1 and, as a result, output will fall from Y(f) to Y1. Prices will also fall from Po to P1. The gap between Y(f) and Y1 represents the deflationary gap and the economy will now be experiencing a less than full employment, short term equilibrium.

Example 2 – in context with an example (level 4 response)

The diagram above is a representation of a deflationary gap in Spain in 2007/8.Adeflationary gap exists when actual output in the economy is less than potential output. During that time of financial crisis consumption spending fell dramatically in Spain as consumers cut back in the face of high levels of unemployment (approximately 25%) and uncertainty.As consumption spending fell in Spain,AD would decrease significantly fromAD toAD1. WhenAD falls like this the level of output also falls from Y(f) to Y1. The gap between Y(f) and Y1 represents a deflationary gap where approximately seven million people were unemployed at the height of the crisis. At this point, Spain was experiencing a less than full employment, short term equilibrium.

Paper 3 - Policy Question Advice

Another new feature of the syllabus is the policy question at the end of paper 3. The policy paper presents a problem (set out in the paper’s previous questions) and requires you to provide a recommended solution.

Of course, you must fully understand the problem presented in the question before you can begin to suggest a viable solution.As a result, it is necessary to structure your essay as follows:

Step 1: Outline the Problem and signpost the solution,

Step 2: Explain your Solution (Point,Explain,Apply,Evaluate x2), Step 3: Synthesis/Conclusion.

Example problem:

Possible solution:

1. Outline the problem and how it relates to the solution China is experiencing cost-push inflationary pressures due to internal supply side issues (higher labour costs) and external factors such as rising energy costs. There are also demand side pressures due to strong export demand. As any suitable solution to inflation is always determined by the causes of the problem, it is necessary for China to adopt a complementary strategy that involves a policy mix of contractionary monetary policy and supply-side growth. This will ensure that inflation is brought under control while limiting the inevitable cut in economic growth.

2. Solution ( Point.Explain.Apply.Evaluate) balanced paragraphs X 2

In the trade off between inflation and growth, price stability takes precedence as it can impact future growth.As a result, it will be necessary for China’s central bank to increase interest rates from the current 4.5%. The increase in rates will make borrowing more expensive, which will reduce domestic demand. It will also appreciate the value of the Yuan and make exports more expensive. The combined reduction in domestic and international demand will lower prices and reduce real output. We can see this as a movement along the Phillips curve from “a” to “b” in the diagram below.

The increase in interest rates will also send a signal to the market that the issue is being taken seriously, which will manage consumer and producer“expectations” of future increases in price levels. However, as we can see from the diagram above, their will be a trade off between inflation and unemployment in China. As spending declines in response to the cost of borrowing, firms will cut back on labour costs and the level of employment. The extent of this downturn in growth will depend on the magnitude of the interest rate rise necessary to curb inflation. Given that inflation is not particularly high at 4%, and that the inflationary pressures are “temporary” due to external influences, this would suggest that any interest rate rise could be reversed fairly quickly thereby limiting the impact on employment in the longer term.

If inflation becomes persistent despite interest rate rises, then the supply side becomes more important to minimise the impact on employment and growth Specifically, it is necessary to address the long-term structural issues in the Chinese labour market that are causing costs for firms to rise. Labour market reforms that increase productivity will reduce costs and increase output. Tax reforms that remove “rigidities” in the labour market and incentivise work will be beneficial here. For example, China might lower personal and corporate taxes to incentivise investment in more efficient technology and training which would increase the output per worker and the productive potential of the Chinese economy. This can be seen in the diagram above as a shift inward of the Phillips curve and a reduction of unemployment and inflation at point “c”. The problem with such policies is, of course, that these take time to implement and feed through to the economy. This means that a shorter-term supply-side strategy to reduce costs - such as eliminating trade barriers – could be a more effective policy to relieve the upward pressure on prices in China. However, such trade liberalisation could negatively effect demand in the longer term as demand for imported goods increase and more money leaks from the Chinese economy. This will increase unemployment in the Chinese export sector as consumers go for cheaper imported goods and services. Again, the trade off between controlling inflation and maintaining employment levels and the economic welfare of its citizens depends on the correct mix of policies being adopted.

3. Conclusion (The most important consideration is …)