IGCSE Economics Paper-2: Specimen Questions with Answers 35 - 36 of 100

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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 35 (4 of 5 Based on Passage)

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Short Answer▾

How important is investment?

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.

Question 36 (5 of 5 Based on Passage)

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Short Answer▾

Discuss the factors that cause Recession

Explanation

  • Recession is majorly caused by the fall in the value of real GDP or fall in the aggregate demand.

A demand-side recession occurs due to various factors, like:

  • A financial crisis. Banks reduce lending and investment during the time of shortage in liquidity.
  • An increase in rate of interest – It will increase the cost of borrowing and will reduce the demand.
  • Decline in asset prices – negative income effect will lead to less spending in the economy.
  • Decline in real wages – e. g. inflation outstripping nominal wage increases.
  • Decline in consumers confidence. Also affected by the negative multiplier effect.
  • Increase in rate of exchange – exports will become less competitive.
  • Trade war – Global economic downturn.
  • Supply-side shock, it will lead rise in oil prices and others and will cause inflation and lower spending power.

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