Government Macroeconomic Policy Objectives: five questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
A government increases direct taxation to reduce its budget deficit.
How is this likely to affect the government’s ability to achieve its macroeconomic objectives?
Answer: C.
The correct answer is C: low unemployment less likely, low inflation more likely, economic growth less likely.
Higher direct taxation reduces households' disposable income and firms' post-tax profits, so consumption and investment fall and aggregate demand shifts inward. Work through the three objectives. Weaker demand means firms produce less and need fewer workers, so low unemployment becomes less likely. Less output means slower growth, so economic growth becomes less likely. But reduced demand relieves demand-pull pressure on prices, so low inflation becomes more likely. Contractionary fiscal policy buys price stability at the cost of jobs and output.
Why the other options are wrong:
Higher direct taxation reduces households' disposable income and firms' post-tax profits, so consumption and investment fall and aggregate demand shifts inward. Work through the three objectives. Weaker demand means firms produce less and need fewer workers, so low unemployment becomes less likely. Less output means slower growth, so economic growth becomes less likely. But reduced demand relieves demand-pull pressure on prices, so low inflation becomes more likely. Contractionary fiscal policy buys price stability at the cost of jobs and output.
Why the other options are wrong:
- A claims low inflation becomes less likely, which reverses the effect of weaker demand on prices.
- B claims low unemployment becomes more likely and growth more likely, both of which contradict falling aggregate demand.
- D gets unemployment and inflation right but claims growth becomes more likely. That is inconsistent: if firms are hiring fewer workers because demand is weak, output cannot be expanding faster. Growth and employment move together here.
Question 2
The economy of a country is simultaneously experiencing a balance of payments deficit, a budget deficit, demand-pull inflation and unemployment. The government decides to cut personal income taxes. What is most likely to be its main macroeconomic objective?
Answer: C.
Cutting income tax is expansionary, so identify which problem expansion treats. More disposable income means more spending, more output and more jobs, so unemployment is the target. It works AGAINST the other three: extra demand adds to inflation, pulls in imports and worsens the balance of payments, and reduces tax revenue so the budget deficit grows. When a policy has several effects, the aim is the one it helps.
Question 3
Which macroeconomic objective is most likely to be achieved by increasing income tax?
Answer: D.
The correct answer is D: price stability.
Raising income tax reduces households' disposable income, so consumption falls and aggregate demand shifts inward. Weaker demand relieves demand-pull inflationary pressure, which helps bring the inflation rate down towards the target. Contractionary fiscal policy is a standard tool against inflation.
Why the other options are wrong:
Raising income tax reduces households' disposable income, so consumption falls and aggregate demand shifts inward. Weaker demand relieves demand-pull inflationary pressure, which helps bring the inflation rate down towards the target. Contractionary fiscal policy is a standard tool against inflation.
Why the other options are wrong:
- A, depreciation of the exchange rate, is not the likely result. Lower domestic demand reduces imports, which if anything supports the currency; and higher taxes do not lower interest rates, which is the usual channel to a weaker currency.
- B, economic growth, is undermined. Lower consumption means lower AD and slower output growth in the short run.
- C, low unemployment, is also undermined. Falling demand means firms need fewer workers, so cyclical unemployment rises.
Question 4
What is an example of a macroeconomic policy?
Answer: C.
The correct answer is C: maintain general price stability.
Macroeconomic policy targets the economy as a whole, using aggregate variables, the general price level, total output, the overall unemployment rate, the external balance. Price stability is defined across all prices in the economy and is pursued with economy-wide instruments such as interest rates, so it is macroeconomic.
Why the other options are wrong:
Macroeconomic policy targets the economy as a whole, using aggregate variables, the general price level, total output, the overall unemployment rate, the external balance. Price stability is defined across all prices in the economy and is pursued with economy-wide instruments such as interest rates, so it is macroeconomic.
Why the other options are wrong:
- A, encouraging consumption of merit goods, targets a particular category of good and works through subsidies or provision aimed at specific markets. That is microeconomic intervention.
- B, reducing pollution in the steel industry, names a single industry. Correcting an externality in one market is microeconomic.
- D, reducing unemployment in the service sector, is the sharpest trap. Unemployment is a macroeconomic variable in general, but this option restricts it to one sector, which makes it a sectoral, microeconomic objective.
Question 5
A government reduces its expenditure on workplace training, increases the level of indirect taxes, and reduces the rate of interest it pays on government debt.
How would these government macroeconomic policies be categorised?
supply-side fiscal monetary (con = contractionary, exp = expansionary)
Answer: A.
Three measures, three families, judged separately. Cutting workplace training reduces the economy's capacity, contractionary supply-side. Raising indirect taxes takes spending power out, contractionary fiscal. Paying a lower interest rate on government debt eases monetary conditions, expansionary monetary. Do not assume a government's measures all point the same way; here two tighten and one loosens.
What this practice covers
These questions are drawn from past CIE 9708 papers. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on government macroeconomic policy objectives, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Every government objective is part of AS 5.1. Incorrect. The AS topic specifies only price stability, low unemployment and economic growth. Balance-of-payments stability appears elsewhere in the AS syllabus. Development, sustainability and redistribution are included in A Level Topic 10.1, not AS Topic 5.1.
- Full employment means zero unemployment. Incorrect. Some unemployment can exist because workers are searching, industries are changing or work is seasonal.
- Economic growth means nominal GDP increased. Incorrect. Growth must be measured using real output.
- All unemployment is solved by increasing AD. Incorrect. Expansionary demand policy is most directly relevant to cyclical unemployment. Structural and technological unemployment may require supply-side measures.
- Supply-side policy only affects growth. Incorrect. By increasing productivity or capacity; it may also reduce cost pressure and improve labour-market matching.
- The policy instrument is the objective. Incorrect. “Higher interest rates” is not an objective; it may be a monetary-policy action used to pursue price stability. ---
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Government Macroeconomic Policy Objectives revision notes.