Explain how increased investment by the government in education and training can affect both aggregate demand and aggregate supply.

Evaluate the view that inflationary pressures in an economy are best reduced using supply-side policies.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definition of investment, aggregate demand, aggregate supply
• diagrams to show aggregate demand (AD) shifting right and LRAS shifting right
• explanation of how increased investment by the government in education and training can increase AD in the short term by increasing the G component of C+I+G+X-M and increase LRAS in the long term as labour productivity increases
• examples of countries in which the government has increased investment in education and training.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definition of inflation, inflationary pressures, supply-side policies
• diagram to show the impact of supply-side policies on inflation via the shift of long-run aggregate supply (LRAS) to the right
• explanation of how market based (eg deregulation, anti-monopoly policy, etc) and/or interventionist supply-side policies (eg price controls, subsidies, etc) may reduce inflationary pressures in an economy
• examples of situations where supply-side policies have helped to reduce inflationary pressures
• synthesis and evaluation.

Evaluation may include: the disadvantages of using particular supply-side policies, such as: the impact of market-based polices on equity, not as effective with demand-pull inflation, the impact of interventionist policies on the government budget and the time lags associated with supply-side policies. The advantages of supply-side policies, such as: increased real GDP, increased employment, more effective with cost-push inflation and possible improvement in economic efficiency. Consideration of deflationary monetary and fiscal policies as alternative policies to reduce inflation.

This question was generally well answered by students. The highest achieving responses focused on how increasing the government expenditure on education and training directly increases the G component of aggregate demand. They then went on to explain how higher expenditure on education and training increases aggregate supply as workers become more productive. Some candidates explained how more productive employees may earn higher incomes, which could lead to a rise in aggregate demand. This point has some logic but the focus on the direct impact of a rise in G on aggregate demand is the stronger argument. Explanations supported by a real-world example included countries that fund workplace training schemes.

Candidates found this question quite challenging because questions on policies to reduce inflation normally consider monetary and fiscal approaches rather than supply-side policies. High achieving responses to this question explained how interventionist supply-side policies such as price controls and subsidies in key markets might reduce inflationary pressure. These points were then evaluated by considering the opportunity costs of policies such as wide scale subsidies and shortages that might be created by price controls. The highest achieving responses also considered how market-based supply-side policies such as strong competition policy and reducing the power of trade unions might reduce inflationary pressures and these policies were evaluated by considering the long-term nature of this approach and how, for example, reducing trade union power might negatively affect employee welfare. The highest achieving responses used real-world examples to illustrate such countries that use fuel subsidies to reduce energy prices.