Evaluation points for your upcoming Economics exam

AS Unit 1 — Microeconomics

Government intervention:

Indirect Taxes
Taxes can be ineffective if PED of the good or service is inelastic. Therefore, an increase in price from higher taxes will have minimal effect on quantity perhaps because its an addictive good or a good with few substitutes.
The revenue generated from taxes can be used to clean up the negative externalities. For instance, revenue created from taxing cigarette consumers can be used to fund the healthcare expenditure.
It’s often very difficult to internalise the cost of externalities. As a result, determining the appropriate rate of tax is quite challenging.
Indirect taxes are regressive in nature — higher proportion is taken from low income earners. So, an increase in VAT will lead to poor people paying more tax, which increases inequality in society.

Subsidies
Government subsidies have an opportunity cost — the grant provided by the government could have been utilized elsewhere. Also, the cost of subsidy will have to be met through taxation. The most efficient way to raise money for subsidising merit goods, would be to tax goods with negative externalities.
Subsidies encourage inefficiency by discouraging inefficient firms from reforming themselves. Also, such inefficient firms start to become reliant on subsidies.
Are the benefits derived from subsidies passed onto consumers? It depends upon PED of the good or service.

Regulation
Regulations are created to protect consumers but, in many cases, regulatory bodies fall prey to regulatory capture. Instead of protecting consumers, the regulatory bodies start to protect the industry it was formed to regulate i.e. they act in the best interest of firms. Hence, regulation can be quite ineffective because of regulatory capture.
However, regulation is legally binding and it can be useful if suitable penalties are in place.
Unlike taxation, regulation provides no choice to consumers and it has to be followed. Whereas with tax, consumers have the option to consume.
Regulation can have significant admin and monitoring costs for the government.

Tradeable Pollution Permits
It is difficult to know how many permits to give out. If surplus permits are issues then the scheme will be unsuccessful because businesses might solely purchase permits and not invest in green technology.
Difficult to measure pollution levels. There is potential for hiding pollution levels e.g. VW scandal.
Administration costs of implementing the scheme can be enormous.
The more developed countries feel that their industries are highly established to drastically change methods of production in order to reduce pollution. Therefore, industralised countries believe that it would be much easier for underdeveloped nations to have a tradeable pollution permit scheme.

AS Unit 2 — Macroeconomics

Below we have written some Theme 2 evaluation points which can be useful for Paper 2 and 3:

Inflation
Inflation can result in a loss of international competitiveness because your goods and services become more expensive therefore it negatively affects your current account position. However, it depends upon on the PED of goods and services produced i.e. elastic vs inelastic.

Interest Rates
Interest rate is the cost of borrowing and reward for saving. A decrease in interest rates will increase AD. Firstly, a fall in interest rate stimulates consumption because it’s cheaper to borrow and the opportunity cost of spending is low. As a result, consumption which is 60% of AD increases causing a rightward shift in AD. Secondly, a decrease in interest rates in the UK results in a fall in the exchange rate because there are less ‘hot money flows’ being injected into the UK economy thereby demand for Sterling falls.
However, it can potentially result in cost-push inflation because its expensive to import raw materials and capital equipment.
Also, are banks willing and able to lend? During the financial crisis, we witnessed a ‘liquidity trap’ — interest rates were at historic lows however banks did not have sufficient cash to lend. Hence, the government introduced Quantitative Easing to provide banks with money to lend.

Fiscal Policy
Expansionary fiscal policy will not increase AD because the higher government spending will crowd out the private sector. This is because the government may have to borrow from the private sector thereby the private sector will have lower funds for investment.
It depends on the size of the multiplier. If the multiplier effect is large, then changes in government spending will have a bigger effect on overall demand. (Remember: Multiplier = 1/(1-MPC) or 1/MPW)
It depends on the state of the economy. Fiscal policy is highly effective when monetary policy cannot stimulate AD. In a deep recession, we have seen a liquidity trap occurring therefore during such recessions fiscal policy can be quite important.
It depends on other components of AD. Suppose consumer confidence is low, will a reduction in taxes increase consumer spending? Most likely no.

Monetary Policy
I.R effects can take approximately two years to have their full effects. If interest rates were to increase today then businesses will not stop their investment half way. Most likely, businesses will continue their existing projects but deter future projects from starting.
I.R. can be difficult to implement in certain scenarios. During the 2008 financial crisis, the UK experienced a rise in CPI inflation to over 5%. However, economic growth was very low. So, on the one hand, inflation is above the target of 2% so they should consider raising interest rates to prevent the economy from overheating. However, with low economic growth, the economy needs interest rates to decrease in order to stimulate AD.
Are the effects of interest rates shared equally? Not quite. Individuals with large mortgages will be affected significantly by interest rate changes than older people with less or no mortgages. Effects of interest rates not equally shared.
Interest rates are set by the BOE thus its free from any political interference by the government.

Contact Kiran S for more information.

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