AQA A-Level Economics: Economic Policy

Read the following extract and answer the question that follows.

The following extract was written for this exercise.

Verdania is a medium-sized economy whose government has set itself the central objective of raising the long-run growth rate, which has been stuck at around 1.4 per cent a year. The Chancellor faces a choice between three routes. A group of advisers urges a sharp cut in the top rate of income tax, arguing that Verdania sits on the wrong side of the Laffer curve: lower rates would sharpen incentives to work and invest, broaden the tax base, and so cost the Treasury little or nothing in lost revenue. A second group prefers a large rise in capital spending on roads, broadband and skills, funded by extra borrowing. A third group wants neither, pressing instead for supply-side reform - deregulation, training subsidies and competition policy - on the grounds that only measures that raise productive capacity can lift growth without stoking inflation or worsening the public finances. The economy is close to full capacity, the budget deficit is already widening and the national debt is rising.

Verdania: fiscal and macroeconomic data	Year 1	Year 2
Top rate of income tax (%)	45	45
Budget balance (% of GDP)	-3.5	-4.2
National debt (% of GDP)	62	65
Real GDP growth (% per year)	1.6	1.4
Unemployment rate (%)	4.8	4.5

Question: Evaluate the view that a cut in the top rate of income tax is the best way for Verdania to raise its long-run growth rate. [25 marks]

An economy is in a deep recession, with high unemployment and a great deal of idle plant and equipment. The government decides to use expansionary fiscal policy, raising its spending in order to increase aggregate demand.

Explain how this expansionary policy affects real output and the price level when the economy has plenty of spare capacity, with the help of a diagram. [15 marks]

A government introduces a package of supply-side policies - investment in education and training, and reforms to improve the flexibility of labour and product markets - which successfully raises the economy's productive capacity.

Analyse, using the classical view of aggregate supply, how successful supply-side policies affect the economy's long-run output and price level, with the help of a diagram. [9 marks]

The table below shows government spending, tax revenue and nominal GDP for the economy of Larenco in a single financial year.

Item	Value (£bn)
Government spending (G)	420
Tax revenue (T)	378
Nominal GDP	1,050

Calculate (a) the budget balance (T - G), stating whether Larenco has a budget deficit or a budget surplus, and (b) the budget deficit or surplus as a percentage of GDP. (6 marks)

With growth weakening and inflation below its target, the central bank of Pellandia cuts its main interest rate.

Explain how this cut in the interest rate (expansionary monetary policy) is likely to affect aggregate demand in Pellandia. (5 marks)

In the economy of Tamarra, the national debt - the accumulated stock of past government borrowing - stands at £1,656bn, while nominal GDP for the year is £1,380bn.

Calculate Tamarra's national debt as a percentage of GDP. (4 marks)