Practice Data Response Practice
Figure 1: Consumer Price Inflation and Unemployment (labour force survey) for the UK
Figure 2: Selected changes to the CPI basket of goods and services, 2014
In




Film/TV series on demand subscription services
Flavoured milk
Fresh fruit snacking pot
Men's clothing hire




Takeaway coffee
After school club charges
DVD recorder
Tufted carpet
Out
Figure 3: Long Term Unemployment in the UK Economy
Figure 4: A Selection of Key UK Macroeconomic Indicators
2009
2010
2011
2012
2013
2014
Real GDP (% change)
-4.3
1.9
1.6
0.7
1.7
3.0
Consumer spending (% change)
-3.1
0.4
0.1
1.1
1.6
2.1
Capital Investment (% change)
-21.7
14.9
11.6
-2.9
12.0
8.8
Government Fiscal Balance (% of GDP)
-10.7
-9.5
-7.5
-5.9
-5.6
-5.5
Questions:
1. Explain how the rate of inflation is measured in the UK. Refer to the concept of weights in your answer (5
marks)
2. With reference to Figure 2, explain why it is necessary to regularly update the CPI basket of goods and
services. (5 marks)
3. With reference to the data in Figure 3 and your own knowledge, examine two factors that might explain the
change in the long term unemployment rate since 2009 (10 marks)
4. With reference to the data in Figures 1 and 4 and your own knowledge, discuss the effects of falling UK
unemployment on other macroeconomic objectives (30 marks)
1. Explain how the rate of inflation is measured in the UK. Refer to the concept of weights in your answer (5
marks)
 Define: The rate of inflation is measured by the annual percentage change in the consumer price index (CPI)
 CPI is a weighted price index used to calculate changes in the cost of living for a representative household
 Explain: The weights used in the CPI are based on shares of total consumer (household) spending on a large
basket of more than 700 goods and services. Heavily weighted items include housing costs, food and
transport, so changes in prices within these categories will have a significant influence on the inflation rate
which is published monthly
2. With reference to Figure 2, explain why it is necessary to regularly update the CPI basket of goods and
services. (5 marks)
 Data: Figure 2 selects items that from 2014 are no longer included in the CPI calculation e.g. DVD recorders
and items that have been included for the first time e.g. TV series on demand subscriptions
 Explain: It is necessary to update the CPI basket each year to take into account changes in the relative share
of household spending on different goods and services, this helps to make the CPI figure more
representative
 Explain: Rapid technological change and the fast-growing uptake of tablets and smartphones may have
meant that more households are taking out subscriptions to services such as iTunes and Netflix. On the
other hand, declining real incomes may have caused more people to cut back on takeaway coffees and
instead take their own drinks on the way to work or school
3. With reference to the data in Figure 3 and your own knowledge, examine two factors that might explain the
change in the long term unemployment rate since 2009 (10 marks)
 Define: Figure 3 shows the % of those unemployed in the UK who have been out of work for more than one
year – this is the most commonly-used measure of long-term unemployment
 Data: In 2009, just over 22% of the unemployed had been jobless for at least a year and this rose to 32% by
the end of 2011 and 35% at the end of 2012. Since then the figure has remained above 1/3rd of total
unemployment although there are signs of a decline in recent months
 Examine 1: The sharp rise in long term unemployment from 2009-2011 was a direct consequence of the
deep recession experienced by the UK from 2008-2010 when real GDP fell by more than 6% and there was a
large contraction in employment. Banking, other financial services, construction and many retail jobs were
badly hit and these sectors have struggled to recover in the years since. However, a delayed and weak
economic upturn has meant that many workers with skills specific to these industries have found it tough to
get new work. This means that a rise in cyclical unemployment has turned into higher structural
unemployment with many long term unemployed suffering from occupational and geographical immobility.
 Examine 2: Another factor keeping long term unemployment high at over a third of the total jobless rate has
been a period of stagnant or falling real wages which has damaged work incentives especially with the costs
of child care and commuting rising faster than inflation. The long term unemployed often need re-training to
find new work and, although government schemes can help, for thousands of people, retraining expenses
are unaffordable
 Evaluation: On balance, the main reason for the persistently high rate of long-term unemployment is the
slow pace of economic recovery made worse by shortages of affordable housing and big regional variations
in employment opportunities.
4. With reference to the data in Figures 1 and 4 and your own knowledge, discuss the effects of falling UK
unemployment on other macroeconomic objectives (30 marks)










Data: Figure one shows that LFS unemployment peaked at 8.5% of the labour force in autumn 2011 and has
been on a downward trend since. It is now below 6% and was 5.7% in the 3 months to January 2015. Figure 1
tells us that unemployment in the UK is still higher than at the start of the last recession but in 2015 it could
well dip below that figure
Effect 1: The most direct effect of falling unemployment has been to stimulate faster short run economic
growth – although growth and employment can feed off each other in positive ways. Fig 4 shows that in
2014, the UK economy grew by 3%, the fastest growth since the recession and a return to actual growth
being above trend. Employment has been expanding and this creates extra factor incomes within the
circular flow driving higher consumer spending. If consumption is growing, we also expect to see (with a time
lag) a positive effect on business capital investment as companies look to increase their capacity to meet
rising demand. Fig 4 shows that capital spending rose by 12% in 2013 and nearly 9% in 2014.
Evaluation: Although falling unemployment is good for growth, there are worries that many new jobs are
low pad and insecure e.g. with the rise of zero hours contracts. Many people are having to take second jobs
to pay their bills; unemployment is falling but under-employment remains high (and hard to measure)
Effect 2: A second effect of falling unemployment is on government finances. A key macro objective is for
the government to run a sustainable budget and with more in work, tax revenues from income tax, national
insurance and VAT ought to be rising, helping to bring down the size of the fiscal deficit. Fig 4 indicates that
the annual fiscal deficit almost halved from -10.7% of GDP in 2009 (a recession year) to -5.6% in 2013.
Evaluation: This improvement in the deficit is welcome for the government, but Fig 4 shows that the deficit
remains stubbornly high – above 5% of GDP in 2014 – causing the national debt to rise further. One reason is
that, although unemployment has been declining, real wages for millions in work have been dropping too
and this has meant actual tax revenues have been lower than forecast.
Effect 3: In standard economic theory, a rapid fall in unemployment ought to bring about a rise in
inflationary pressure not least in the labour market. The original Phillips Curve idea suggested a non-linear
trade-off between jobs and prices; if unemployment fell too low, then price inflation would accelerate as
wages rose and the costs of raw materials and components also increased. There is a risk that two crucial
macro-economic objectives might conflict with each other.
Evaluation: In fact, as data in Fig 1 show since 2011 both inflation and unemployment have been on a
downward trend. CPI inflation has dropped from 5% to less than 1% and the latest figures show inflation at
0.3% with a risk of price deflation at some stage during 2015. Overall this is good news for the UK economy
since the Misery Index (the sum of inflation and unemployment rates) has declined from 13.5 in 2011 to 6.5
in 2014. Falling inflation has largely been the result of favourable external factors such as the steep fall in
world oil prices and the deflationary effects of a stronger currency. Falling unemployment, by boosting
aggregate demand, will help the Bank of England to steer the UK away from a sustained period of deflation.
Effect 4: One downside of falling unemployment is that the current account of the balance of payments for
the UK has worsened; in 2014 there was a record trade deficit in goods as imports of foreign-produced
technologies, textiles, vehicles all grew strongly. A trade deficit is a dampener on growth because it causes a
net outflow from the circular flow and a loss of demand for domestically-supplied products.
Evaluation: That said, rising imports is a sign that the economy is recovering and that consumer confidence
is picking up. A rise in imports might also be the result of businesses stepping up their investment to
purchase capital goods and technologies developed overseas.
Final Reasoned Comment: Unemployment in the UK is lower than most other EU countries and, despite the
structural supply-side problems of long term unemployment, skills gaps and persistently high jobless rates in
certain regions; the fall is good news for sustaining recovery from the deep recession of 2008-2010.
Analysis Diagrams – best put in the body of your main answer
Phillips Curve – unemployment – inflation trade off
Wage
Inflation
(%)
Trade-off is worsening as the economy comes up against
capacity constraints – leading to excess of aggregate
demand over aggregate supply
W3
A favourable trade-off because the economy has plenty
of spare capacity – SRAS is elastic when unemployment
is high
W2
Short Run Phillips Curve (SRPC)
W1
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold
U3
U2
U1
Unemployment Rate (%)
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold
Falling unemployment – rising aggregate demand and short run economic growth
Formatted: Font: 9 pt, Not Bold
Formatted: Font: 9 pt, Not Bold