IGCSE Economics Paper-2: Specimen Questions with Answers 31 - 32 of 100

Passage

In developing countries, inflation is not purely a monetary phenomenon. Factors typically related to fiscal imbalances, driving higher money growth and exchange rate depreciation, dominate the inflation process in developing countries.

Question 31 (5 of 5 Based on Passage)

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What happens when unemployment and inflation are positively correlated?

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Explanation

The positive correlation between inflation and unemployment has its own set of challenges faced by the fiscal policymakers. Policies that aim at boosting economic growth and bringing down the level of unemployment tend to exacerbate rate of inflation.

  • According to economic theory, as the rate of unemployment falls, the rate of inflation rises. This concept is explained in what is known as “the Phillips Curve.”
  • This positive relationship has broken down to the concept known as stagflation. When both inflation and unemployment rise is termed as stagflation.

Example in the United States when inflation and unemployment were positively correlated was the 1970՚s. This was termed as stagflation. It is the combination of

  • High inflation
  • High unemployment
  • Sluggish economic growth

Passage

In the recession that began in late 2007 in the United States, the first main element of GDP that faltered was the part of investment called residential structures. When housing prices started falling in 2006, new home construction slowed down. In 2008, this sector had shrunk by more than 40% from where it had been just a few years earlier.

Question 32 (1 of 5 Based on Passage)

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How important is investment?

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Explanation

  • Productivity in a business is largely determined by the investment choices that had been made before you began to work.
  • The kind and quality of capital you had to work with strongly influenced your productivity. Capital is available due to the investment choices made by the business.
  • Investment adds to the nation՚s capital stock. An increase in capital shifts the aggregate production function outward, increases the demand for labor, and shifts the long-run aggregate supply curve to the right.
  • Investment therefore affects the economy՚s potential output and thus its standard of living eventually.
  • Investment is a component of aggregate demand. A change in investment will shift the aggregate demand leading to a change in real GDP and the prices in the short run.
  • An increase in investment shifts the aggregate demand curve to the right; a reduction shifts it to the left.

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