Discuss the extent to which an increase in aggregate demand may affect output, unemployment and inflation.
(18 marks) June 2009
L1 (1 – 4 marks)
For knowledge and understanding of aggregate demand. These answers will show some awareness of the terms.
Examples of L1 answers:
– M).
of AD
L2 (5 – 8 marks)
For an application of knowledge and understanding of how an increase in AD may affect output, unemployment and
inflation. Answers should recognise how an increase in AD may be expected to affect output, unemployment and
inflation.
Examples of possible L2 answers:
Marking Guidance: 8 marks for recognising the effect on the three variables, plus limited application to one, e.g.
higher output can create jobs. 7 marks for recognising the effect on the three variables. 6 marks for recognising the
effect on two variables. 5 marks for recognising the effect on one variable.
L3 (9 – 12 marks)
For an analysis of how an increase in AD may affect output, unemployment and inflation. (9 – 12)
Examples of possible L3 answers:
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The inclusion of an AD/AS diagram showing how a shift to the right may affect output and the price level
with some supporting statements.
An increase in AD will represent more expenditure in an economy. Higher spending may encourage firms to
increase their output to meet the increase in expenditure. The increase in real GDP from Y to Y2 will
represent an increase in actual growth.
Higher output (real GDP) may encourage firms to take on more workers as they will require FOP to produce
the output. As labour is a derived demand for output, the increase in output of y to y2 will reduce cyclical
unemployment.
Higher AD may result in demand-pull inflation with excess demand, pulling up prices. As AD (expenditure)
outstrips AS (output) the disequilibrium associated to shortages will provide the opportunity to raise the
price level for goods and services from p to p2.
Marking Guidance: 12 marks for a reasonably accurate macro diagram plus at least two changes analysed. 11 marks
for a reasonably accurate macro diagram plus one change analysed. 10 marks for a reasonably accurate macro
diagram plus identification of at least two changes. 9 marks for a reasonably accurate macro diagram. NB. If diagram
provided is entirely micro, do not give credit.
L4 (13-18 marks)
For a discussion of how an increase in AD may affect output, unemployment and inflation Answers should evaluate
the possible impacts of an increase in AD on output, unemployment and inflation.
Examples of possible L4 answers:
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The effect that an increase in AD has on output (real GDP), unemployment and inflation will depend on the
size of the change. A larger increase is likely to have more of an impact than a small increase.
The final effect of an increase in AD may be greater than the initial increase due to the multiplier effect.
The impact will depend on the degree of spare capacity in the economy. If an economy is initially operating
with considerable unemployment, an increase in AD may raise output and reduce unemployment but have
no effect on the price level. In contrast, if the economy is operating close to full employment, the impact
may just be on the price level.
An increase in AD may also increase AS if it results from, e.g. an increase in investment or an increase in
government spending on education and training. In this case, an economy can experience both actual and
potential economic growth
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Guidance: For 18 marks, a candidate must have two good evaluative arguments, or three reasonable evaluative
arguments. For 17 marks, a candidate must have one good evaluative argument, and two reasonable evaluative
arguments. For 16 marks, a candidate must have one good evaluative argument, plus one reasonable evaluative
argument. For 15 marks the candidate must have, on good evaluative comments, or two reasonable evaluative
comments. For 14 marks, the candidate must have one reasonable evaluative comment and one brief evaluative
comment. For 13 marks 2 brief evaluative comments.
Example of brief:
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The overall effect will depend upon the size of the multiplier.
Example of reasonable:
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The final effect of an increase in AD may be greater than the initial increase due to the multiplier effect. The
larger the multiplier effect then the greater the final effect will be on output, employment and inflation, as
AD will increase beyond the intimal injection to have greater effect on overall output which influences these
3 macro objectives.
Example of good:
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The final effect of an increase in AD may be greater than the initial increase due to the multiplier effect. The
larger the multiplier effect then the greater the final effect will be on output, employment and inflation, as
AD will increase beyond the intimal injection to have greater effect on overall output which influences these
3 macro objectives. For example if the multiplier is significant then AD will move from AD 2 to AD3.
Price level
AD3
Price level
LRAS
This has resulted in the final output being greater (y3-y2)
than the initial injection of (y2-y). The greater level of
output leads to further reductions in cyclical
unemployment as we get closer to our productive
potential which represents full employment (yf).
However as AD continues to move along AS and reach
LRAS the level of spare capacity is reduced and the risk of
demand pull inflation rises (p to p2) as output (LRAS)
cannot continue to increase as expenditure (AD) rises at
the same rate.
Price level
AD2
AD
Price level
Price level
Real GDP