CT7 CMP upgrade 2014final - Actuarial Education … Upgrade/CT7-PU-14.pdfBegg, D. K. H.; Fischer, S.; Dornbusch, R. 9th ed. McGraw-Hill, 2008. ISBN: 978-0077117870 (Borrow from libraries)

CT7: CMP Upgrade 2013/14 Page 1

The Actuarial Education Company © IFE: 2014 Examinations

Subject CT7

CMP Upgrade 2013/14

CMP Upgrade This CMP Upgrade lists the main changes to the textbook, the Q&A Bank and the X assignments since last year. New edition of the textbook The Core Reading for the 2014 exams is selected chapters from the new edition of the textbook, ie Economics for Business (sixth edition) by John Sloman, Kevin Hinde and Dean Garratt, published in 2013 (ISBN: 978-0-273-792598). The new edition of the textbook updates a number of sections - in particular, macroeconomic policy in the aftermath of the credit crunch. The 2014 exams will be based on this edition, so we recommend that you use this edition to prepare for the 2014 exams. Course Notes The changes in the textbook have necessitated many changes to the ActEd Course Notes. Therefore it has not been possible to provide replacement pages for all of the changes in the Course Notes. There are two options open to you: 1. You can buy a full replacement set of up-to-date Course Notes at a significantly

reduced price if you have previously bought the full price Course Notes in this subject. Please see our 2014 Student Brochure for more details.

2. You can use this upgrade, along with the sixth edition of the textbook, to update

your 2013 Course Notes. The table in Section 2 gives details of the main changes from the fifth to the sixth editions, along with page references for each module.

Page 2 CT7: CMP Upgrade 2013/14

© IFE: 2014 Examinations The Actuarial Education Company

Q&A Bank and X assignments The tables on the following pages give details of important changes to the Q&A Bank and the X assignments. Some questions have been amended in the light of the new material. In addition, some new questions have been included to test your understanding of the new material. Replacement pages and additional pages are provided where appropriate.



1 Changes to the Syllabus objectives and Core Reading There have been no changes to the syllabus objectives. The Core Reading consists of references to material from: Economics for Business. Sloman, J., Hinde, K. and Garratt, D. Sixth edition Prentice Hall 2013. ISBN:978-0-273-792598. The list of further reading has been updated. It now reads as follows: Business economics. Perman, R.; Scouller, J. Oxford University Press, 1999. 336 pages. ISBN: 978-0198775249 (Borrow from libraries) Economics. Begg, D. K. H.; Fischer, S.; Dornbusch, R. 9th ed. McGraw-Hill, 2008. ISBN: 978-0077117870 (Borrow from libraries) Economics. Lipsey, R. G.; Chrystal, K. A. 12th ed. Oxford University Press, 2011. xix, 677 pages. ISBN: 978-0199563388 (Borrow from libraries) [Earlier editions held: 11th ed. 2007; 10th ed., 2004] Economics: international edition. Krugman, P.; Wells, R. 3rd ed. Worth; Macmillan, 2013. xliii, 1014, 19, 42, 15, 16 pages. ISBN: 978-1464128738 (Borrow from libraries) Economics: special edition with global economic watch. Mankiw, N. G.; Taylor, M. P. Cengage Learning EMEA, 2010. xxiv, 916 pages. ISBN: 978-1408021286 (Borrow from libraries) [Earlier edition held: 2006] Economics. Sloman, J. 8th ed. FT Prentice Hall, 2012. xxxxiv, 835, 18, 3, 21, 23 pages. ISBN: 978-0273763123 (Borrow from libraries) [Earlier edition held: 6th ed., 2006 - available online as MyiLibrary book to members registered with Athens login) Economics for business. Begg, D. K. H.; Ward, D. 3rd ed. McGraw-Hill, 2009. 560 pages. ISBN: 978-0077124731 (Borrow from libraries) Economics for business. Sloman, J.; Hinde, K; Garratt, D.. 5th ed. FT Prentice Hall, 2010. xxxiii, 742 pages. ISBN: 978-0273722335 (Borrow from libraries) (Available online as MyiLibrary book to members registered with Athens login) [New 6th edition publication expected 30 April 2013] Essentials of economics. Sloman, J.; Garratt, D. 5th ed. FT Prentice Hall, 2010. 502 pages. ISBN: 978-0273722519 (Borrow from libraries) Foundations of economics. Bade, R.; Parkin, M. 6th ed. Pearson Education, 2012. xxxxviii, 898, 15, 22, 2 pages. ISBN: 978-0132984874 (Borrow from libraries)



2 Updating your 2013 Course Notes The following table gives details of the main changes from the fifth to the sixth editions, along with page references for each module. The table assumes that you have:

the sixth edition of the textbook

the 2013 version of the ActEd Course Notes. The table sets out for each module:

the chapter and page references in the sixth edition of the textbook

the details of any significant changes

the page references in the sixth edition for the significant changes

the page references in the 2013 Course Notes where the significant changes occur/fit in.

For example, using your ActEd Course Notes for Module 1:

on page 1, you can alter the page references for Chapter 2 from pages 18 - 28 to pages 15 - 23

you can read the official definition of “recession” on page 18 of the textbook and make a note of this on page 5 of your Course Notes.



Module Chapter and page references for whole module in Sixth

Edition of the textbook

Significant change to the module Page reference for significant change in the Sixth Edition

of the textbook

Page number(s) in appropriate

module of Course Notes 2013

1

Chapter 2, pages 15- 23

Recession. The official definition has been added.

Page 18 Page 5

2 Chapter 4, pages 46- 61 Equilibrium. Definition extended. Page 47 Page 12

3 Chapter 5, pages 62 - 79 none

4 Chapter 6, Sections 1 - 2, pages 82 - 92 (plus additional unchanged Core Reading)

none

5 Chapter 9, pages 128- 147 none

6 Chapter 10, pages 148- 157 Price-maker. Definition added. Page 150 Page 4

7 Chapter 11, pages 160- 175 none

8 Chapter 12, pages 176- 194

Excess capacity. Definition changed.

Interdependence. Definition changed.

Tacit collusion. Definition changed.

Page 180

Page 180

Page 182

Page 6

Page 8

Page 11

9 Chapter 8, pages 110- 124 Advertising media and examples updated. Pages 117, 121 Pages 5



Module Reference for module Significant change Reference for change Page in CN 2013

10 Chapter 15, pages 223 - 241 Price to book ratio.

Innovation. Additional motive for vertical integration.

Page 225

Page 228

Page 4

Page 7

11 Chapter 17, pages 254 - 267 Transfer pricing and tax. Page 265 Page 12

12 Chapter 20, Sections 1 - 4, pages 310 - 322

Asymmetric information. Extra point under “ignorance and uncertainty”.

Page 316 Page 9


EU restrictive practices policy. Streamlined in 2008.

Recent merger activity.

Competition and Markets Authority (CMA). Proposed new regulator.

Page 331

Page 335

Page 335 - 6

Page 5

Page 7

Page 7


Regional imbalances added under “Types of supply-side policy”.

Page 534 Page 4




15 Chapter 23, Section 1, pages 370 - 72

Chapter 24, pages 389 - 404

none

Updated trading figures.

Airbus case study updated.

WTO information updated.

Final push for DOHA.

Page 389 - 392

Page 397

Page 400 - 401

Page 403

Page 5

Page 13

Page 18

Page 19

16 Chapter 27, pages 445 - 459 Capital account. Extra information. Page 447 Page 6

17 Chapter 26, including appendix, pages 418 - 444 Chapter 29, Section 1, pages 486 - 488

Business surveys. To assess output gaps.

AS as a determinant of actual growth.

Long-term unemployment.

GDP deflator.

AD curve. Shape determined by substitution and income effects.

Deflation and the “China price” effect.

Page 422

Page 423

Page 428

Page 430

Page 432

Page 434

Page 15

Page 15

Page 19

Page 22

Page 24

Page 23




18 Chapter 28, pages 460 - 484

Chapter 29, Section 2, pages 488 - 490

Functional separation.

Building societies.

Monetary financial institutions.

Financial instruments.

Capital and other funds.

Discount market.

Taxing the balance sheet.

New Box 28.2 on rise of wholesale funding.

Capital adequacy ratio.

Macro-prudential regulation.

Securitisation. Box 28.3 updated.

Responses to credit crunch. Box 28.4 updated.

Money multiplier in UK.

Page 462

Page 462

Page 462

Page 462

Page 464

Page 464 and 474

Page 465

Page 466

Page 467-8

Page 468 and 474

Page 470 - 1

Pages 472 - 3

Page 478

Page 4

Page 4

Page 4

Page 4

Page 5

Page 10

Page 6

Page 5

Page 7

Pages 7, 9

Page 8

Page 11

Page 14





Horizontal Phillips curve. Updated.

Return of hysteresis.

Relationship between actual and expected inflation.

Consumption cycles.

Page 493

Page 498

Page 498 - 9

Page 500

Page 10

Page 10

Page 10

Page 11

20 Chapter 30, pages 510 - 530 Chapter 31, Section 1, pages 531 - 534

Fiscal policy as an influence on AS.

Public sector net borrowing.

Fiscal policy updated. Box 30.1.

Funding: “authorities” = Debt Management Office in UK.

Difficulties in controlling MS.

QE transmission mechanism.

Growing problems and fiscal consolidation. New section.

Page 511

Page 512

Page 514 - 6

Page 521

Page 521

Page 524

Page 528 - 9

Page 3

Page 4

Page 7

Page 11

Page 11

Page 11

Page 17



3 Changes to the Q&A Bank

Question Details of any changes

Question 3B.18 In item II of the question, please change “1950” to “1970”. In the solution, please change “exports more goods than” to “exports about the same value of goods as”.

Question 3B.46 In the solution, please change “150” to “160” and “97%” to “98%”.

Question 3B.48

Please change (iii) to (iv) and insert “(iii) the capital account [1]”. In the solutions, please add: “(iii) The capital account records the transfer of capital to and from the rest of the world. These flows comprise capital transfers and the acquisition or disposal of non-produced, non-financial assets. [1]”.

Question 4A.7 Please change “CPI (consumer price index)” to “GDP deflator”. In the solution, please replace “CPI” with “GDP deflator”.

Question 4A.14 Please add “(l) capital” to the box on the left. In the solution, please add “capital” to the “liabilities”.

Question 4B.17

Please insert “to reduce loans and advances to customers and” after “decision”. Please amend the solution to read: “A reduction in loans and advances to customers and an increase in the reserve balances at the Bank of England will increase the bank’s holdings of liquid assets and will increase the liquidity ratio (liquid assets/total assets).”




Question 4B.19

Please change the options to read:

“A interest rate on shares and bonds. B interest rate on bank deposits. C inflation rate. D interest rate foregone by not holding shares and bonds.” Please amend the solution to read: “Answer: D. The main alternative to holding low-risk and low-return money is holding higher-risk and higher-return shares and bonds, so the opportunity cost of holding money is the interest rate foregone by not holding shares and bonds. For example, if the rate of interest on a bank account is ½% and that on the best alternative is 6%, the opportunity cost is 5½%.”

Question 4B.38 In the solution to Part (i), please change “factor” to “factors” in the title, and add “and the level of aggregate supply” to the answer.

Question 4B.54

At the end of the questions, please add this new question:

“Describe the actions that the UK government has taken to try to reduce the likelihood and the impact of a future financial crisis. [6]” The solution is provided on an additional page (page 51) at the end of this pack.

Question 5.16 The solution is incorrect. Please replace “B” with “A”.



4 Changes to the X assignments


X1.21

In the solution, please add the following bullet point:

“a rise in the dividend yields on the shares in the emerging market fund, which makes it more attractive for investors seeking income [½]”.

X1.23 In the solution, the following note has been added: “Note that these calculations are very sensitive to rounding.”

X1.24

In the solution, the following note to markers has been added: “Markers: In part (i), note that the question requires the students to “... explain, with reference to the definition of the relevant measure of elasticity, ...”. Consequently, in each of the three parts of the question, students should only score one of the two available marks if they simply calculate the answer, without providing any explanation.”

X2.14 In the solution, please replace “finance” with “cash”.

X2.24 In the solution, for the penultimate point, the mark has been reduced from 1 to ½.

X2.27

In the solution, for the diagrams, the marks have been reduced from 1½ to 1 for each. Under “Average cost”, the second point has been extended to read: “However, in monopolistic competition, firms produce to the left of the lowest point on the AC curve (so they have excess capacity), ie assuming they have the same cost curves, under monopolistic competition each firm sells a lower output at a higher price than under perfect competition. [1]”

X3.13 Please add the following to the solution: “since it is intended to increase competition.”

X3.14 Please add the following to the solution: “as it involves government intervention in the market.”




X3.17

This question has been changed. Replacement question pages (pages 7-8) are provided at the end of this pack. The solution is now as follows: “Answer: C. Country A has an absolute advantage in both goods as it can produce more of both goods with the same resources, ie one hour of labour. The opportunity cost of producing 10 units of Good X for Country A is the 5 units of Good Y it could have produced instead. Therefore the opportunity cost of 1 unit of Good X for Country A is ½ unit of Good Y. Similarly, the opportunity cost of producing 1 unit of Good X for Country B is ⅓ unit of Good Y. This is lower so Country B has the comparative advantage in producing Good X.”

X3.20 Item II has been changed to “net current transfers”. Replacement question pages (pages 7-8) are provided at the end of this pack. The solution is unchanged.

X3.21 Please add the following to the solution: “by making exports less competitive and imports more competitive.”

X3.25 Please change item I to “increase the price of imports”. The solution is unchanged.

X3.30 Please insert “possible” before “impact”. In the 7th point in the solution, please replace “money” with “profit”.

X3.33

Please change “Net capital transfers” to “Capital balance”. In the solutions, after the solution to Part (ii), the following note has been added: “Also remember that trade credit is recorded as a negative item since it is a loan to the purchasing countries.”

X3.36

In the solution to Part (ii), the quantities in the diagram ( 1Q and

2Q ) have been relabelled FQ and SQ respectively, to indicate the

“free market equilibrium” and the “social optimum”.




X4 In the table of multiple-choice solutions, please change the solution to Question 22 from “A” to “C”.

X4.11

This question has been changed. Replacement question pages (pages 3-8) are provided at the end of this pack. The solution is now as follows: “Answer: C. The aggregate demand (AD) curve is downward sloping, ie as the price level increases, AD falls. This effect is made up of a substitution effect, as consumers and firms switch to savings and/or imports (Options A, B and D) and an income effect as consumers’ purchasing power falls – assuming incomes do not increase in line with prices. (Although firms’ profit might benefit from falling real wages, investment is unlikely to increase while consumer spending is falling.)”

X4.13 The wording of the question has been changed slightly. Replacement question pages (pages 3-8) are provided at the end of this pack. The solution is correct.

X4.15

This question has changed. Replacement question pages (pages 3-8) are provided at the end of this pack. The solution is now as follows: “Answer: B. The capital adequacy ratio (CAR) is the ratio of a bank’s capital (shares and reserves) to its risk-weighted assets, so an increase in the riskiness of a bank’s assets will result in an increase in its risk-weighted assets and a decrease in its CAR. The liquidity ratio, which is the ratio of liquid assets to total assets, will be unaffected. (In practice, banks might decide to hold a higher liquidity ratio if they felt there was increased danger of bad debt.)”






X4.22

This question has changed. Replacement question pages (pages 3-8) are provided at the end of this pack. The solution is now as follows: “Answer: C. Under a policy of constrained discretion, the government has some discretion in economic policy but it is constrained by the rules that it sets itself. For example, the need to keep inflation and the public sector deficit on target would limit the extent to which aggregate demand could be raised to reduce unemployment. Macro-prudential regulation involves regulating the financial system as a whole to ensure that it is resilient to shocks. According to Goodhart’s law, controlling a symptom (or indicator) of a problem will not cure the problem itself; instead, the indicator will cease to be a good indicator of the problem. Fiscal consolidation is a term that has been used to describe the process of reducing government borrowing, which soared as a result of the recent credit crunch and the global recession.”


X4.27 In Part (ii) of the question, please insert “annual” before “spending”. The solution has been rewritten and reorganised but the mark scheme is unchanged.

X4.28 Please replace “effects” with “problems”. In the solution, under “Balance of payments”, please replace “an unexpected decrease” with “a decrease”.

X4.33

Please replace the question with the following: “Discuss the extent to which inflation targeting has resulted in a horizontal Phillips curve. [6]”

Replacement solution pages (pages 17-18) are provided at the end of this pack.



5 Other tuition services

In addition to this CMP Upgrade you might find the following services helpful with your study.

5.1 Study material We offer the following study material in Subject CT7:

Mock Exam

Additional Mock Pack

ASET (ActEd Solutions with Exam Technique) and Mini-ASET

Sound Revision

Revision Notes

My Test – an online revision product containing over 400 questions

Flashcards. For further details on ActEd’s study materials, please refer to the 2014 Student Brochure, which is available from the ActEd website at www.ActEd.co.uk.

5.2 Tutorials We offer the following tutorials in Subject CT7:

a set of Regular Tutorials (usually lasting two or three full days)

a Block Tutorial (lasting two or three full days)

a Revision Day (lasting one full day)

an Online Classroom – a comprehensive collection of over 100 tutorial units, including both teaching units and guided questions. You can watch a sample of the Online Classroom tutorial units on the ActEd website.

For further details on ActEd’s tutorials, please refer to our latest Tuition Bulletin, which is available from the ActEd website at www.ActEd.co.uk.



5.3 Marking You can have your attempts at any of our assignments or mock exams marked by ActEd. When marking your scripts, we aim to provide specific advice to improve your chances of success in the exam and to return your scripts as quickly as possible. For further details on ActEd’s marking services, please refer to the 2014 Student Brochure, which is available from the ActEd website at www.ActEd.co.uk.



6 Feedback on the study material ActEd is always pleased to get feedback from students about any aspect of our study programmes. Please let us know if you have any specific comments (eg about certain sections of the notes or particular questions) or general suggestions about how we can improve the study material. We will incorporate as many of your suggestions as we can when we update the course material each year. If you have any comments on this course please send them by email to [email protected] or by fax to 01235 550085.

CT7: Q&A Bank Part 4 – Solutions Page 51


Solution 4B.54

A number of policies have been (or are in the process of being) introduced:

The bank levy on banks’ liabilities aims to raise sufficient revenue to cover the fiscal costs of any future support ... [1]

... and also to encourage banks to engage in less risky lending. [½]

Capital requirements, through the capital adequacy ratio (CAR), aim to ensure that each bank has sufficient capital to cover its particular risk portfolio of assets. [1]

Macro-prudential regulation involves assessing the stability of the financial system as a whole in the light of economic conditions ... [1]

... and, if necessary, a counter-cyclical buffer (an increase in the CAR) can be applied to all banks in order to build up a capital buffer in boom times to draw on in times of recession or financial difficulty. [1]

Measures to increase liquidity include the extension of repo operations to a wider range of assets and for a longer time period ... [1]

... and the use of asset swaps whereby banks borrow gilts against a wide range of collateral for a fee, and can then obtain liquidity by lending gilts in the money market. [1]

Under the Asset Protection Scheme, financial institutions, for a fee, can insure themselves against future losses incurred on assets. [1]

[Maximum 6]


All study material produced by ActEd is copyright and is sold for the exclusive use of the purchaser. The copyright is owned

by Institute and Faculty Education Limited, a subsidiary of the Institute and Faculty of Actuaries.

Unless prior authority is granted by ActEd, you may not hire out, lend, give out, sell, store or transmit electronically or

photocopy any part of the study material.

You must take care of your study material to ensure that it is not used or copied by anybody else.

Legal action will be taken if these terms are infringed. In addition, we may seek to take disciplinary action through the

profession or through your employer.

These conditions remain in force after you have finished using the course.

CT7: Assignment X3 Questions Page 7


Question X3.17

If, with one hour of labour, Country A can produce 10 units of Good X or 5 units of Good Y; and Country B can produce 6 units of Good X or 2 units of Good Y, then: A Country A has an absolute advantage in Good X and a comparative advantage in

Good X.

B Country B has an absolute advantage in Good X and a comparative advantage in Good X.

C Country A has an absolute advantage in Good X and Country B has a comparative advantage in Good X.

D Country B has an absolute advantage in Good X and Country A has a comparative advantage in Good X. [1½]

Question X3.18

The table below shows the hours of labour needed to produce one unit of Goods X and Y in Countries A and B.

Good X Good Y

Country A 4 7

Country B 3 6

At which of the following rates of exchange (in terms of the number of units of Good Y that are swapped for each unit of Good X) would both countries benefit from international trade based on the principle of comparative advantage? A 0.50 B 0.54 C 0.58 D 0.62 [1½]

Page 8 CT7: Assignment X3 Questions


Question X3.19

Which of the following is NOT a problem associated with trade restrictions used to protect domestic industries? A Consumers pay more for goods and services. B Other countries may reduce tariffs in retaliation. C Domestic industries may become more inefficient. D Governments incur increased administrative costs. [1½]

Question X3.20

The balance of trade includes: I flows to and from reserves II net current transfers III the services balance A I and II B II and III C I only D III only [1½]

Question X3.21

A balance of payments deficit is LEAST likely to be corrected by: A imposing tariffs. B increasing the value of the domestic currency. C reducing the level of aggregate demand. D discouraging imports. [1½]

Question X3.22

Which of the following is recorded as a plus in the balance of payments accounts of Country A? A a fall in Country A’s foreign exchange reserves B short-term lending by Country A to the rest of the world C the purchase of foreign shares by residents of Country A D the payments of interest by residents of Country A to residents of other countries [1½]



Question X4.7

Which of the following statements is TRUE? A The output gap is potential output less actual output.

B Potential growth is the percentage annual increase in the capacity of the economy to produce.

C If potential growth exceeds actual growth there will be a decrease in unemployment.

D Potential output is the output that could be produced if all firms were working at full capacity. [1½]

Question X4.8

If the population of the country is 59 million, the number in work is 25 million and the number out of work and looking for work is 3 million, the unemployment rate is: A 5.1%. B 10.7%. C 12%. D 42.4%. [1½] Question X4.9

Which one of the following is best suited to reducing the level of structural unemployment? A lowering the rate of interest B raising the rate of unemployment benefit C higher voluntary redundancy payments for workers in declining industries D more government funds for retraining of the unemployed [1½] Question X4.10

A consumer prices index is a measure of changes in: A the pattern of consumer spending. B the average standard of living. C average earnings. D the average cost of living. [1½]



Question X4.11

Which of the following is NOT a substitution effect on aggregate demand as a result of a rise in the price level? A the decrease in investment caused by the increase in interest rates B the decrease in consumption caused by the decrease in the real value of savings C the decrease in consumption caused by the decrease in real incomes D the increase in the demand for imports caused by reduced competitiveness [1½] Question X4.12

Which of the following are functions of money? I a medium of exchange II a means of evaluation III a means of storing wealth A I, II and III B I and II C II and III D I only [1½] Question X4.13

Which one of the following is a high-earning but relatively illiquid asset of banks? A certificates of deposit B advances to customers C Treasury bills D cash held at the Bank of England [1½] Question X4.14

The process of repackaging assets into marketable securities is known as: A secondary action. B speculation. C securitisation. D subcontracting. [1½]



Question X4.15

An increase in the average riskiness of a bank’s assets, assuming that nothing else changes, will result in: A an increase in the capital adequacy ratio. B a decrease in the capital adequacy ratio. C an increase in the liquidity ratio. D a decrease in the liquidity ratio. [1½] Question X4.16

To improve the cash position of banks, the central bank could do any of the following EXCEPT: A buy government bonds from banks with an agreement to sell them back later B issue more government bonds and fewer Treasury bills C buy Treasury bills from the banks before maturity D rediscount Treasury bills [1½] Question X4.17

Which of the following methods of financing the public sector deficit would NOT increase the money supply? A selling government bonds to the central bank B selling government bonds to the non-bank private sector C selling Treasury bills to the banks D none of the above [1½] Question X4.18

If the level of real output is assumed to be fixed, the quantity theory of money in its simplest form assumes that the: A ratio of the velocity of circulation to the price level rises when the money supply

increases.

B ratio of the velocity of circulation to the price level is fixed.

C ratio of the money supply to the velocity of circulation is fixed.

D ratio of the money supply to the price level is fixed. [1½]



Question X4.19

An increase in the money supply will have a bigger impact on real output the more: A interest-elastic is the demand for money and the more interest-elastic is the

demand for investment.

B interest-inelastic is the demand for money and the less interest-elastic is the demand for investment.

C interest-elastic is the demand for money and the less interest-elastic is the demand for investment.

D interest-inelastic is the demand for money and the more interest-elastic is the demand for investment. [1½]

Question X4.20

In the diagram, the distance ab represents the: A output gap. B recessionary gap. C deflationary gap. D inflationary gap. [1½]

E

GDP (Y)

E

45o

Y

YF Ye

a

b



Question X4.21

Assume that the actual rate of unemployment is below the natural rate of unemployment because the expected rate of inflation is below the actual rate of inflation. If the expected rate of inflation rises to equal the actual rate of inflation, then: A real output will increase and unemployment will increase. B real output will increase and unemployment will decrease. C real output will decrease and unemployment will increase. D real output will decrease and unemployment will decrease. [1½] Question X4.22

Operating economic policy within a framework of rules is known as: A macro-prudential regulation. B Goodhart’s law. C constrained discretion. D fiscal consolidation. [1½] Question X4.23

An increase in government spending has: A a greater impact than an equal decrease in taxation has on national income.

B the same impact as an equal decrease in taxation has on national income.

C a smaller impact than an equal decrease in taxation has on national income.

D a multiplier effect on national income that is smaller than the multiplier effect of an equal decrease in taxation. [1½]



Question X4.24

A government wishing to increase aggregate demand might use any of the following measures EXCEPT: A buying government securities on the open market B allowing interest rates to fall C increasing the tax on consumer goods D increasing social security benefits [1½] Question X4.25

Which of these events would increase banks’ ability to lend? I the central bank sells securities in the open market II an increase in banks’ minimum reserve ratio III the central bank undertakes a policy of quantitative easing A I and II B II and III C I only D III only [1½] Question X4.26

Which of the following is NOT a way to reduce inflation? A slowing the rate of growth of the money supply

B tight controls on prices and incomes through prices and incomes policies

C devaluing the domestic currency

D keeping the domestic currency at a fixed exchange rate with respect to the currency of a low inflation economy [1½]

CT7: Assignment X4 Solutions Page 17


If income were to continue to rise by the same amount, then new investment would be constant, but eventually, the rate of increase in national income will slow down as the economy approaches full-capacity output, and so new investment will fall. [1] The accelerator principle thus helps to explain the great swings in activity in the capital goods industry. [½] The accelerator works with the multiplier to accentuate booms and slumps in the business cycle. [½] [Maximum 5] Solution X4.33

The Phillips curve shows an inverse relationship between unemployment and inflation. In the 1990s, the curve seemed to disappear – in fact, it seemed to have become horizontal. Many believed this to be a result of inflation targeting. [1] The UK has had a policy of inflation targeting since 1992. In 1997, the Bank of England was given independence to set interest rates in order to attain an inflation target, which, since 2003, has been 2% ( ±1% ) based on the Consumer Price Index. [1] If the inflation target itself and the methods by which it is controlled are credible, inflation targeting can be a powerful weapon in controlling expectations of inflation and hence inflation. Indeed, if it is completely successful, the Phillips curve would become a horizontal line at 2%, and the Phillips curve trade-off would disappear. [1] This seemed to be the case in the UK for the period 1993-2002 when unemployment fell from 10% to 5% without increasing inflation. [½] Changes in unemployment can occur without changing the inflation rate if the changes result from small changes in the level of aggregate demand or from long-term changes in the level of equilibrium unemployment, eg reductions in structural unemployment because of improved training. [1] However, since inflation is controlled by interest rates, and since interest rates also affect unemployment, the trade-off will still exist, particularly if large changes in interest rates are made. [½] Furthermore, both unemployment and inflation are determined by aggregate demand, which can be affected by a range of factors. For example, a Phillips curve trade-off re-emerged in 2008-9 as the recession caused an increase in unemployment and a decrease in the rate of inflation. [1]

Page 18 CT7: Assignment X4 Solutions


We also have to question the government’s commitment to inflation alone. In times of high unemployment, the government might resist higher interest rates and choose to trade-off a higher level of cost-push inflation for a lower level of unemployment. For example, cost-push pressures in 2010-11 took inflation to about 5%, but the Bank of England kept interest rates at 0.5%. [1]

This flexible approach to inflation targeting was formalised in March 2013 with a change to the Bank of England’s mandate. It is now allowed to temporarily depart from its inflation target in order to provide a more stable path for output. This suggests that a horizontal Phillips curve is less likely in the future. [1] [Maximum 6] Solution X4.34

(i) Automatic stabilisers

When the economy is in a recession, employment will be below its full-employment level and private sector consumption and investment spending will be reduced. This will reduce government revenues from taxation. [½]

At the same time, the government will be paying out more in social security and unemployment benefits. Together, these two effects will reduce net taxation and reduce withdrawals from the circular flow of income. This will help to reverse the recession, by increasing the level of national income. [½]

Conversely, when the economy is in a boom, tax revenues will be high, as more people are in employment and private sector consumption and investment spending are increased. Additionally, government spending on unemployment benefits will be low. The increased taxes and reduced benefit payments will increase net taxation and increase withdrawals. This will help to take the heat out of the boom and reduce the level of national income. [1] [Total 2]

(ii) Discretionary fiscal policy

Discretionary fiscal policy can be used to fine-tune the economy, ie to smooth out the booms and slumps in the economic cycle. For example, if the economy is experiencing an upturn in the economic cycle, the government may wish to reduce aggregate demand by decreasing government spending and/or increasing taxation. This would be a net withdrawal from the circular flow in addition to that brought about by automatic stabilisers. [1]

Discretionary fiscal policy can also be used to remove any severe deflationary or inflationary gaps. For example, in 2008-09, many governments undertook expansionary fiscal policies (as well as expansionary monetary policies) to counteract the decrease in aggregate demand caused by the credit crunch. [1]

Documents

CT7 CMP upgrade 2014final - Actuarial Education … Upgrade/CT7-PU-14.pdfBegg, D. K. H.; Fischer, S.; Dornbusch, R. 9th ed. McGraw-Hill, 2008. ISBN: 978-0077117870 (Borrow from libraries)