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4 The 0.

8% contraction in the UK economy during the three months to June came as a big - and very much
unwelcome - shock to the City…. Industrial production output was down by 0.7%, construction output was down
by 2.2% and the dominant service sector shrank by 0.6%... Businesses are struggling to find banks willing to
provide them with working capital and have mothballed investment plans.
Source: The Guardian, July 2009

In light of the above statement, evaluate the impacts on the UK economy and its implications on
government policy decisions. [25]

Suggested Answers

Introduction

State that the impacts can be classified as the 4 macro objectives.


State that generally UK is suffering from a recession.
Define recession.
State that UK can use the few macro policies to solve the problem.

Body

Generally, when the various sectors’ output is down it will indicate that there is fall in the GDP level.
The impacts on some macro aims/indicators are quite straight forward, while for some, the resultant
impact will depend on the causes of the fall in economic activity.

In an AD/AS framework, the fall in GDP can be due to demand side or supply side. In another words,
the reasons for the various sectors to reduce their output could be due to demand or supply factors.

For example, increase in cost of production, reduction in productivity, reduction in amount of


resources or level of technology are supply factors that will reduce the output level (Illustrate with
diagram). A reduction in demand from firms, consumers, government or foreigners are demand
factors that will reduce the output level (Illustrate with diagram).

Economic Growth

EC will obviously be affected negatively. GDP level will fall as AD or AS shift to the left as illustrated
by previous diagrams. Most importantly, not only will actual growth will fall, the potential growth will
also fall as the sectors indicated in extract are sectors producing capital goods. With less capital
goods produced in the SR, there will be a fall in real GDP and in the LR, as there are no capital to
replace the old ones, there might be a fall in the ability of the economy to produce.

Unemployment

With a fall in production level from the various sectors, there will be a fall in employment level or
increase in the unemployment rate. This may lead to cyclical or structural unemployment, depending
on the cause of the slow down.

Inflation

The inflation is one impact that may go either way depending on the causes of the slow down. If the
cause is a demand factor (i.e. fall in AD), there will be a fall in the GPL, while if it is a supply side
factor, then there will be an increase in the GPL. (Elaborate with reference to diagram).

BOP
The effects of BOP will generally be worsened as the economy produce less goods and services to
export. In addition, if the slow down is caused by supply factor, i.e. fall in AS, it will worsened the
situation as GPL will increase thus reducing the price competitiveness of the economy.

Overall

However, the impacts on the economy will also depend on the structure of the UK economy. The
extract only mentioned a few sectors slowing down but we need to also look at other sectors. If other
sectors other a greater contributor to the economy, and are growing then the impacts will be
minimized.

However, since the extract suggest that businesses are generally pessimistic it may indicate that it is
a wide spread phenomenon thus the impact will be great. However, there is only a 0.8% contraction
thus the impact may still be considered mild in the SR but may escalate in the LR as the “accelerator
principle” effect kicks in.

UK government can use various policy measures to solve the situation – FP, MP and SSP.

Fiscal Policy

The government can reduce the taxation or increase the government expenditure. Will work
especially well if the slow down is caused by a demand factor. Will help to increase the AD thus real
GDP. Explain how it works.

Evaluate the use of FP (the general evaluation). It may not work as well if it is used as a generally
measure to increase GDP if the slow down is caused by a fall in AS. It will worsened the inflation
problem. If it is targeted to reduce the cost of businesses and help to increase productivity of firms,
then it is more useful.

Monetary Policy

The government can decrease i/r or exchange rate to stimulate AD. Explain how it works. Again, a
general use of this will not work as well if it is caused by fall in AS. Also, if the banks are not lending
money due to lack of confidence, a reduction in i/r will have not entice banks to lend more money.
And firms may still choose not to borrow and invest.

Evaluate exchange rate policy.

Supply Side Policy

Explain and evaluate how supply side policy works.

Is the best policy to use if the down turn is cause by supply factors, but must still target it to the
appropriate causes. For example, if the cause is a fall in productivity, then measures to increase
productivity like training will be better. However, time lag.

Conclusion

The impacts on the economy as well as which policy to use depends very much on what are the
causes of the slow down. If not identify correctly, may make the situation worse.
Level Descriptors Marks
L1 Very descriptive in answer. Little conceptual knowledge. No in-depth analysis of 1–7
the situation.
L2 Good development of answer with some conceptual knowledge. May lack depth 8 – 14
in analysis. Development of points is generally complete.
L3 Very good analysis with strong content knowledge. Very in-depth in discussion. 15 – 21
Complete explanations and development of points.

E1 Evaluation without justifications. 1–2


E2 Evaluation with justifications. 3–4