Examiners can be very helpful, and tell you specifically what effect you have to write about, or they can be unhelpful and leave it up to you to interpret.
You need to know the likely effects of a change in an economic variable on:
- The price level (P)
- National income (output) (Y)
Both of these are shown directly on the AD/AS diagram.
- The level of employment
- The level of unemployment
- Public finances, (the balance between government spending and taxation)
- The Current Account balance (the balance between exports and imports)
The answer you get will depend upon:
- The ‘current state’ of the economy - is the economy near to full employment, or is there ‘slack’ in the economy.
- How big the initial change is.
- The time period being considered.
- How ‘elastic’ are the responses to the change being considered.
Step three - find the transmission mechanism
You need to fully explain both the:
- Transmission mechanism – how the initial change in a variable works its way towards the ‘final’ effect, and
- The ‘final’ effect itself.
You need explain the steps involved, from the initial change to the final effect, and to distinguish between shifts (caused by demand or supply-side shocks) and movements.
