Economics II | Custom PHD Thesis

Economics II

Case Study 1 – INVESTING IN INFRASTRUCTURE

Study Extracts A, B and C, and then answer all parts of Context 1 which follow.

Extract A: UK public sector investment and borrowing, 2003 to 2011 (£ billion)

Extract B: Business leaders call for measures to boost growth

Britain’s economy has suffered a period of unimpressive growth since the depths of
the recession in 2008 and 2009. In 2011, the growth in real GDP was just 0.7% and
official estimates for the second quarter of 2012 show a contraction in GDP of 0.5%, a
third consecutive quarterly decline. The Government blames external shocks, such as
the ongoing crisis in the eurozone (The eurozone consists of those countries that have
adopted the euro as their currency), and the slowdown in growth in America and
China for the weak recovery of the UK economy. However, many believe that the UK
Government’s austerity policy of reducing the budget deficit, by reducing government
spending and increasing taxation, has meant that the recovery has been much weaker
than necessary.

Many business leaders want to see more measures to stimulate growth. They tend to
support the policy of cutting the budget deficit in order to reduce borrowing by the
public sector, but they also argue for investment in infrastructure (such as building
new roads and rail networks) to reduce costs, increase productive capacity, create jobs
and improve Britain’s long-term competitiveness.
Source: news reports, September 2012

Extract C: Is investment in infrastructure the solution to low growth?
The weak recovery of the UK economy has led to renewed demands for a boost to
investment in the infrastructure of the UK economy. The Coalition Government has
responded by relaxing planning rules and by providing construction companies with a
guaranteed return on their investment to try to encourage the private sector to finance
large scale projects. The Government says that it hopes to encourage infrastructure
investment in, for example, transport, energy supplies, housing, and faster broadband
and mobile phone networks. However, it is reluctant to finance such investment in the
infrastructure by increasing government spending. More government spending on
infrastructure projects could mean cuts elsewhere, tax increases or more borrowing.

Investing in infrastructure can be expected to result in a multiplier process and is
important for growth. It can increase real GDP by reducing unproductive journey
times, improving labour mobility, providing better access to overseas markets,
attracting foreign firms to set up in the UK and by increasing aggregate demand
during the construction phase of the projects. However, any increase in spending
might, in the short run, also lead to higher inflation and an increase in the balance of
payments deficit.

Questions:

(a) Define the term ‘multiplier process’. (3 marks)

(b) Using Extract A, identify two significant points of comparison between public
sector investment and borrowing over the period shown. (6 marks)

(c) Extract B states: ‘The Government blames external shocks, such as the ongoing
crisis in the eurozone, and the slowdown in growth in America and China for the
weak recovery of the UK economy.’

With the help of an appropriate diagram, explain why low growth in the rest of the
world is likely to affect the recovery of the UK economy.
(6 marks)
Diagram:

(d) Extract C states: ‘The weak recovery of the UK economy has led to renewed
demands for a boost to investment in the infrastructure of the UK economy.’

Using the data and your economic knowledge, assess the likely consequences of
increased spending on infrastructure for the performance of the UK economy.
(15 marks)

Extra Space

Case study 2 – CONSUMPTION – UK RETAIL SECTOR

Study Extracts A and B and then answer all parts of case study 2 which follows.

Extract A: Quarterly percentage change in consumer sales: UK retail sector by
volume
Quarterly % change*
All retailing Food retailing Non-food
retailing
2012 April 0.0 0.5 -0.3
May 0.9 0.5 1.1
June 1.9 0.9 2.6
July 1.8 1.3 2.1
August 1.5 1.5 1.4
* Quarterly changes. For example, the August figure for ‘All retailing’ sales of
1.5% indicates that the volume of consumer sales has increased by 1.5% between
May and August.

Extract B: An eventful summer in 2012
In June 2012, the Monetary Policy Committee (MPC) received fresh evidence of a
recovery in consumer spending and indicated that inflationary pressures were
building. This recovery is reflected in the consumer sales data and was no doubt
helped along by the sports competition in Germany. In the UK, for example, there
was a notable rise in sales of competition-related products such as widescreen
televisions and alcohol.

Germany, as the host country, received a significant economic boost, caused most
importantly by government spending of approximately £1.5 billion on stadiums and
transport for infrastructure. The Centre for Economics and Business Research
predicted a £1.3 billion boost to the UK economy. In both countries, the multiplier
process would bring considerable benefits to aggregate demand and to jobs.

As July progressed, the UK experienced record-breaking temperatures. Once again,
retail sales were given a boost. Supermarkets, for example, benefited significantly
from higher demand for salad products, fresh fruit, drinks and suntan lotion. On the
supply side, however, one estimate predicted that the heat-wave would cost the UK
economy £168 million per day in lost output because of lower labour productivity.
Internationally, the latest crisis in the Middle East damaged business confidence and
led to oil and petrol price rises.

In August the MPC took the City and the media by surprise when it raised the base
rate from 4.5% to 4.75%. It justified this with reference to a number of factors
including higher energy prices and a faster pace of economic activity. It is difficult
not to conclude that the events of the summer had each played their part in some way
in the MPC’s decision. Certainly, by late summer, the UK economy was facing mixed
fortunes, with inevitable consequences for economic growth.

Questions:

(a) Using Extract A, identify two main features in the consumer sales data for the
period April to August 2012. (6 marks)

(b) Explain the meaning of aggregate demand (AD) and explain what factors cause
shifts in the curves.
(8 marks)
12

(c) Using the data and your economic knowledge, evaluate the extent to which the
events outlined in Extract B might have affected UK macroeconomic performance.
(16 marks)

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