JC Econs Essay Stagflation & Demand Management Policy Model Answers
One of the harder macroeconomic problem to tackle is that of stagflation. along with hyperinflation and galloping inflation, it is rather adverse as it can get easily out of control, such that it erodes confidence off households and firms, low-income one get affected much worse.
So will demand management policies be able to combat stagflation, or would we need alternative macro policy options?
Question
The citizens in USA are weathering the economic storms of stagflation, fueled by rising oil and fond prices, and intensifying housing and credit problems Adapted from ‘worries grow from worse stagflation’
(a) Explain the economic problems faced by USA.
(b) Discuss the extent to which demand management policies are effective in tackling stagflation?
JC Economics – Stagflation Macroeconomic Problem
Introduction: stagflation
Define stagflation – refers to a combination of recession (falling GDP) and high inflation (cost push inflation)
Body:
– Using the AD/AS framework explain how a fall in AD & AS caused stagflation in USA
FALL in AS: rising oll / food costs rise in costs of production push up the price of the final product (RAS shitting upward
– rising cost fall in profit margin/poor business outlook → increase in unemployment
FALL IN AD – due to the slump in property market fall in consumers’ confidence- fall in spending by the consumers; due to poor business outlook fall in investment; – due to loss of export competitiveness
A fall in both AS & AD will cause the NY to fall drastically through the multiplier. (Diagram)
Mark Scheme:
L1 (1-4marks): Sketchy answer on how fall in AD & AS affect NY with some conceptual errors.
L2 (5-6m): Able to explain how a fall in AD & AS cause stagflation but answer lacked elaboration, Or able to give either the AD or AS factors in detail and with diagram.
L3: A well-balanced and elaborated answer with appropriate examples and diagram (combined AD & AS in a diagram).
Conclusion:
Stagflation occurs when both the level of AD and AS fall.
(Read more: Stagflation Threatens to Upend the Global Economy)
JC Economics – Demand Management Policies
Suggested Answer for part (b)
Define demand management policies- policies that will shift the AD (Fiscal Policy, Monetary Policy & Exchange Rate Policy) Explain any 2 expansionary policies to raise AD to revive the economy
Expansionary MP: Fall in interest rate increase in C&I increase in AD → increase in NY through the multiplier. (elaborate)
Expansionary FP: Increase in G / Fall in T→ increase in AD- increase in NY through the multiplier (elaborate).
Currency Depreciation (US$): boost export competitiveness, c.p. increase AD increase NY through the multiplier (elaborate)
Limitations of demand management policies:
Effective only if
i) size of multiplier is large
ii) consumers & investors are confident and optimistic of the economy encourage spending and investment (MEI is interest elastic)
However, increase in AD may increase the inflationary pressure in the economy. Hence, demand management policies alone are inadequate to tackle stagflation due to rising cost of production. Need to use both SR & LR supply side policies.
Explain any one SR supply side policies to check cost push inflation (stronger exchange rate, incomes policies)
1. Stronger exchange rate → lower cost of imports (raw materials & foodstuff)→ lower cost of production → check cost push inflation.
2. Maximum price / subsidies
Explain a LR supply side policies to check inflation
Investment on infrastructure / technology / education to increase productivity and productive capacity of the economy.
Limitations of LR supply side policies: take a long time for policy to take effect, budget
Evaluation: rank the policies, etc
(More evaluation options in our Economics tuition class)
Conclusion: Demand management policy only tackle the issue of recession but not cost push inflation. There are limitations to the policy too. The effectiveness of policies depend on the root cause of the problems, seriousness of the problem and the state of the economy. Need a combination of policies (both demand and supply policies) to tackle the twin problems of recession and cost push inflation
Marking Rubric:
Level 1: Sketchy answer on the policies to tackle stagflation.
Level 2: Lop-sided answer, merely explain in detail the demand management policies with evaluation but did not consider the supply side policies. Or looking at both sides of the arguments but lacked elaboration.
Level 3: Well balanced answer on how the problems of stagflation can be tackled. Include limitations of the demand and supply-side policies
E1: Mainly unexplained judgments on the effectiveness of the policies
E2: Reasoned judgments on the effectiveness of the policies.
Econs Tuition teacher’s Remarks: Most students should expect at least 19 out of 25m for this relatively simple essay question. More on this key point in our Econs revision lessons.)