Economics Today · March 2012

The following extract outlines the recent performance and prospects for the UK

economy. Knowledge and understanding of the performance of the UK economy can

greatly enhance performance by candidates in examinations. The questions are aimed

at enabling AS Level students to secure a firm understanding of key terms and provide

an opportunity to apply aggregate demand and aggregate supply analysis to the

information provided.

Key wordsAggregate demand and supply

Consumption expenditure

Investment expenditure · Net trade

AQA � 2(3.2.2 � 4(3.4.2)& 3.2.3)

Edexcel � 2(2.3.3 � 4(4.3.7)& 2.3.4)

OCR � F582 � F585

WEJC � EC2(B) � EC4(C)

CCEA � AS(2)

Int. Bacc.Standard 3.3

New 2011: 2 (2.2)

CambridgePre-U

The National Economy (h)

Exam Board AS Unit A2 Unit

Quintin Brewer, a Chief Examiner, comments on a

question involving the use of aggregate demand

and aggregate supply analysis

An introduction toaggregate demand andaggregate supply analysis

The UK economy

Investment expenditure in 2011 fell by a little over 1%, reflecting the low level of business

confidence, which has been severely knocked by the ongoing crisis in the euro zone. In turn,

this has had a negative impact on domestic and foreign demand and so is unlikely to increase

by as much as previously predicted by most economists in 2012. Further, weak domestic

demand (discussed below) was a disincentive for firms to increase investment.

Household consumption expenditure also fell during 2011 not least because average earnings

rose by about 2.4% while the inflation rate was 4.3%. In 2012 it is likely that the rate of

inflation will fall rapidly so enabling real personal disposable income to increase slowly.

However, consumer confidence might continue to fall because concerns over job security are

increasing, associated with the continued rise in unemployment.

Government austerity measures are likely to result in a fall in net borrowing by the public

sector from around £130 billion in 2011/12 to £110 billion in 2012/13. These measures

include tax increases and significant reductions in public expenditure. These cuts apply to

both current expenditure and capital expenditure as well as on transfer payments. The

reduction in government investment might have significant implications for the productive

potential of the economy.

Export growth with imports remaining almost stable resulted in an improvement in the UK’s

trade balance towards the end of 2011. This was aided by the very significant fall in the value

of sterling in 2008. The prospects for 2012 are that export growth should be continued but

probably at a slower rate while imports will be constrained because domestic demand will

continue to be weak.

(a) Distinguish between aggregate demand and aggregate supply.

(b) Explain the factors influencing short run and long run aggregate supply.

(c) Explain what is meant by the term ‘investment’.

(d) Examine two factors which have caused investment to fall in 2011.

(e) Assess the economic effects of a reduction in investment. Illustrate your

answer with aggregate demand/aggregate supply diagram(s).

(f) In the light of the information provided, evaluate the factors which might

influence consumption expenditure in the UK.

(g) Analyse the likely effect of net trade on aggregate demand in the UK

in 2011 and 2012.

15