A Level H1 Economics 2019 Question 2 Answer Key

(a) From Table 1, real GDP growth rate is at 2.6%, suggesting US’s real GDP has increased in 2015. The increase in real GDP means higher production of goods and services, which means more goods and services are available for consumption in the country. Furthermore, the population growth rate is at 0.8%, slower than real GDP growth rate, this means real GDP per capita has increased. With higher real income per person, purchasing power increases. Each person can purchase more goods and services. Hence, material living standards in US increased.

Table 1 also indicates unemployment rate to be at 5.3%, lower than OECD average of 6.8%. This suggests a greater percentage of US citizens being employed and are earning income, thus having the purchasing power to purchase goods and services, increasing the material living standards in US.

US’s Gini coefficient is higher than the OECD average, suggesting US is having a more severe income disparity. This means the higher real income per person could be concentrated among the rich and the poor may not see much increase in income, limiting the improvement in their material living standards.

However, the indicators do have limitations. Since positive real GDP growth rates imply higher levels of production, it could mean that air quality could have worsened due to the increase in emissions arising from production of goods and services. Thus, while the citizens could enjoy higher purchasing power and greater quantity of goods and services available, the worsening of air quality could lead to poorer health and higher healthcare costs. Hence, the indicators are limited in measuring the non-material aspect of living standards.

(b) Income inequality in US is rising, as supported by the rising Gini coefficient in Figure 3.

Rising income inequality has continued for a long time in US.

Income inequality in US is more severe than other developed countries.

Wealth inequality in US is more severe than income inequality in US.

(c) (i) Increase consumption (C) and investment (I) due to tax cuts or increase in government expenditure (G) due to spending on infrastructure will lead to rise in aggregate demand (AD). Assuming the economy is operating near to full employment level of output, the rise in AD from AD1 to AD2 increases real GDP from Y1 to Y2 via the multiplier effect, leading to the rise in production of goods and services. Firms increase the employment of workers for the rise in production levels, thus leading to lower rates of unemployment.

However, the rise in AD also leads to increase in GPL, as there is competition for increasingly scarce resources, leading to rise in GPL from P1 to P2. Thus lower rates of unemployment might be expected to be associated with higher rates of inflation.

(c) (ii) Unemployment rates in US has fallen throughout from 2009 to 2016, but annual inflation rate has increased only from 2010 to 2011 and 2015 to 2016. Thus data in Table 2 does not always support the expectation in (ci).

One possible reason for this could be that the corporate tax cuts which increases investment, leads to greater efficiency of capital. This in turn reduce the average cost of production and raises the productive capacity in the economy. The lower cost of production allows firms to lower prices, and this will lead to a downward shift of the aggregate supply (AS) curve. The increased productive capacity increases the full employment output of the economy, hence there is also a rightward shift of AS.  AS curve shifts from AS1 to AS2, the real output increases (Y1 to Y2), lowering unemployment rates and at the same time offsetting the increase in equilibrium general price level where GPL falls from P2 to P3, leading to lower rates of inflation.

(d) US Federal Reserve expects aggregate demand (AD) will continue to rise in 2017, which can lead to demand-pull inflation. Thus the US central bank proposed for interest rates to rise to curb demand-pull inflation. When interest rate is increased, cost of borrowing increases, consumers will cut back borrowing from banks to purchase big-ticket items, leading to fall in consumption (C). Increase in interest rates also lead to higher opportunity cost to consume, consumers will be more inclined to save than spend, leading to fall in C. With the same expected returns to investment, the rise in interest rates leads to less investment being profitable, lowering investment levels (I). Lowering of C and I leads to fall in AD, AD shifts left from AD1 to AD2. GPL falls from P1 to P2, lowering demand-pull inflation.

(e) Introduction

Accelerating changes in technology can refer to greater use of automation and the shift from labour-intensive methods to capital-intensive methods of production.

Accelerating changes in technology can result in structural unemployment

With greater use of machines and technologies by firms, lower-skilled labour will be replaced and this is supported by Extract 7 which mentioned that changes in technology reduce employment opportunities for the lower-skilled workers. These lower-skilled labour might also not have the ability to find new jobs easily as their skills do not match the skills set required by the new industries in the new growth sectors, where it is likely specialized skills and IT knowledge are required. This thus causes a mismatch of skills leading to the rise in structural unemployment.  

Accelerating changes in technology can result in re-distributional consequences

As technologies replace lower-skilled labour, especially in the low end manufacturing industries, supply of low skilled workers would increase thus reducing the market wage rates for these workers. At the same time, there will be an increase in demand for high skilled workers to maintain/operate the technologies. Thus this increases the wages for high skilled workers. As such, technological advancement could worsen income distribution, leading to the widening of the income gap between low skilled and high skilled workers, contributing to the re-distributional consequences.

Accelerating changes in technology may not result in worsening unemployment and re-distributional consequences

If the lower-skilled labour are supported with skills upgrading programmes, even if they are displaced by technologies, they can go on retraining and equip themselves with skills that will satisfy the requirements in the labour market. This reduces the mismatch of the skills workers possess with the skills required by the economy, preventing structural unemployment. At the same time, this also means demand for lower-skilled labour can also increase if they are retrained, allowing them to earn a higher wage, reducing the wage gap between low-skilled and high-skilled workers.

Conclusion

Structural unemployment and re-distributional consequences are likely to result in the short run as it takes time for workers to learn new skills. However, in the long run, such a consequence can be mitigated if there is policy of retraining implemented.

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