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(a) (i) With reference to Extract 1, outline the components of aggregate demand. (6) (ii) Identify and explain two factors that influence the level of business investment (Extract 1, line 10). (8) (iii) With the aid of an aggregate demand and aggregate supply diagram, assess the likely effects on the UK economy of 'a reduction in business investment' (Extract 1, line 15). (12) (b) (1) With reference to Figure 1, explain how the forecast change in the savings ratio from 2010 might affect the value of the multiplier. (8) *(ii) With reference to Figure 2, discuss two likely consequences of the output gap from 2009. (12) (c) (1) With reference to Figure 3, identify the change in the UK budget deficit between 2002-03 and 2010-11. (4) *(ii) Evaluate the macroeconomic effects of the UK government trying to reduce its budget deficit, assuming economic growth remains weak. (30)Figure 2 The UK output gap N Forecast % -1 - -2 . -5- 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Figure 3 Total UK Government public spending and tax receipts 49- Forecast 45- 43 - Percentage of 41 - Gross Domestic 39- Product 37. 35 - 33 - of 1990-91 1994-95 1998-99 2002-03 2006-07 2010-11 2014-15 - Government tax receipts ...> Government spending (Source for Figures 1-3: 0 Crown Copyright Office of Budget Responsibility Economic and Fiscal Outlook, November 2011)Question 4 Consumption, Investment and the UK Government's Fiscal Target Extract 1 Components of Aggregate Demand (Report from the Office of Budgetary Responsibility) The real disposable income of UK households is forecast to have fallen by 2.3% in 2011, a post-war record. Earnings growth is not expected to overtake inflation again until 2013 and not by a significant margin until 2014. As a result, we expect consumer spending to remain broadly constant in real terms in 2012 before picking up as real household disposable income starts growing again. un We expect private sector employment to rise by around 1.7 million between the start of 2011 and the start of 2017, but this will be partly offset by a fall of around 710,000 in general government employment. The government still aims to reduce the budget deficit rapidly in order to achieve its fiscal target. Business investment has shown virtually no growth in 2011. The CBI's latest Quarterly 10 Industrial Trends Survey suggests that the investment that has taken place has largely replaced worn out assets, rather than added to the capital stock. Businesses have used some of their profits to pay back bank loans and they may also have started to build up cash reserves against further shocks as uncertainty over the outlook has risen. This might lead to a reduction in business investment in 2012. We 15 also continue to predict a small current account deficit in the medium term. (Source: @ Crown Copyright Office of Budgetary Responsibility Autumn Report, November 2011)(a) (i) Referring to the data in Figure 1, calculate an index number for the oil price in March 2012, using January 2005 as the base period. Show your working. (6) (in) With reference to Figure 1, explain two possible ways in which changes in the world economy could cause the movements in the oil price shown. (8) (ili) Using an aggregate demand and aggregate supply diagram, assess the effect on the UK economy of the rise in oil prices since 2009. (12) (b) (i) With reference to Extract 1, define a "deficit in the trade of goods and services on the current account of the balance of payments" (lines 2-3). (4) (ii) Explain two likely costs to the UK economy of a sustained deficit in the trade of goods and services on the current account of the balance of payments. (8) *(ii) With reference to Extract 1, assess the likely effect of a fall in the sterling exchange rate on the UK's deficit in the trade of goods and services. (12) "(c) Using the information provided and your own knowledge, assess the use of supply side policies, including a reduction in corporation tax, as a means of increasing UK economic growth. (30)Extract 2 Business Investment and Corporation tax Business investment as a share of GDP fell from nearly 13% in 2000 to below 8% in 2011 and surveys of business confidence are pessimistic. The previous government reduced corporation tax - a tax on company profits - from 30% to 28% in 2008. The current Chancellor is gradually reducing it further to 21% by 2014, which he hopes will increase investment by between 5% and 10% per annum during 2013-16. un (Source: adapted from @ Crown copyright) Figure 2 Main corporation tax rate (%) planned for 2014 (selected G20 and G7 countries) Russia UK China Germany India Brazil France US 0 5 10 15 20 25 30 35 40 % corporation tax (Source: @ Financial Times, 21 March 2012)Extract 1 The deficit on the current account of the balance of payments continues into the first quarter of 2012 When sterling's exchange rate fell 25% between mid-2007 and early 2009, economists thought that this would reduce the deficit in the trade of goods and services on the current account of the balance payments and boost the UK's economic growth. They were only half right. Exports of British goods have indeed recovered from the depths of recession - volumes are up 21% since 2009 - and a recent survey of manufacturers suggested activity expanding at a healthy pace. However the volume of goods imported has also increased, by 16% since 2009, and inflation has continued well above target. David Blanchflower, a former member of the Bank of England Monetary Policy Committee, said: "We underestimated the uplift to inflation from the depreciation ... 10 but we probably overestimated the positive effect of UK manufacturers replacing imports." In a recent paper, two Bank of England economists tried to explain these inaccurate estimates. Perhaps, they suggested, after the long contraction of UK manufacturing, some goods are no longer made in the UK, so it is impossible to replace certain imports. British manufacturers have almost entirely abandoned 15 some markets, particularly those for products that are labour intensive. In 1997, for example, UK producers made 16% and 22% respectively of all the leather goods and clothing sold in the country. In 2009, these market shares had fallen to 6% and 8%. Manufacturing goods in the UK also often necessitates importing raw materials, components and capital goods. This dependency on overseas suppliers is partly 20 explained by the fact that many manufacturers agreed long-term supply contracts with cheaper overseas suppliers before the depreciation of sterling. The Bank of England economists also noted there is still a large price differential with countries such as China and India, even after sterling's depreciation. Furthermore, many UK manufacturers learnt long ago to compete on brand and quality rather than 25 price, which can mean that big changes in the exchange rate have little effect on sales. However, there are hints that things might start to change as the lower exchange rate and other factors have an impact on strategic decisions. Many manufacturers are discussing bringing parts of their production home because of high wage inflation in 30 emerging markets, the desire for more responsive supply chains and lower shipping costs. (Source: adapted from @ Financial Times, April 3rd 2012)Question 1 March 2012 $ per barrel of oil 110 120 140 115 125 130 105 135 145 January-2005 July-2005 Balance of payments, Inflation and Investment January-2006 July-2006 January-2007 July-2007 Figure 1 Oil price (Brent Crude Oil), US dollars per barrel from January 2005 to January-2008 July-2008 January-2009 July-2009 January-2010 (Source: adapted from @ Financial Times, May 3rd 2012) July-2010 January-2011 July-2011 January-2012 March-2012