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Analyse the impact of the following scenarios.

1) Government announces a large increase in spending on health and education.

An increase in spending on health and education (increase in government spending ) is likely to impact on aggregate demand. As we know that government spending is a component of aggregate demand, so increase in spending is likely to lead to an increase in aggregate demand (assuming that other thing are not changing – CETERIS PERABUS ). Therefore the aggregate demand curve will shift to the right. This will lead to a rise in inflation (demand pull inflation), if aggregate supply would not increase. As AD shifts to the right, the Real GDP rises and we will expect higher economic growth (assuming that AS will be changing too, in case to avoid a high inflation). This, in turn, would suggest that unemployment is likely to fall.

2) Bank of England signals rise in interest rates of 0.5 %

An increase in interest rates is likely to have an influence on both aggregate supply and aggregate demand. One of the main components of AD is consumption and it is affected by interest rates. Consumers borrow money and spend them (consumer expenditure = consumption). If they know that interest rate has increased they will borrow less and therefore spend less (in case they will wait for declining in interest rates to buy a new car, for instance). Changes in interest rate also affect investment ( in case with AD, investment means money spent on capital goods by firms). Obviously, firm will spend less on capital goods if interest rate rises (less investment). Interest rates might also affect government spending. One of the sources of money for the government is borrowing. As interest rate rises, it is more expensive for the government to borrow, so it would probably cut its spending. Interest rate could affect a balance of payments, because changes in interest rate lead to changes in exchange rate. If interest rate rises, the currency falls, therefore import is becoming more expensive and export is becoming cheaper. In some cases it could lead to increase in trade surplus (more exports than imports, because imports are more expensive and exports are becoming more competitive in some cases). A rise in interest rate also would probably lead to fall in production, because it would more expensive for firms to borrow in case to expand or cover their debts. Considering all this consequences of a rise in interest rate we can say that the AD curve and the AS curve shift to the left, causing a fall in a capacity of the economy, which tends to fall in economic growth, rise in unemployment level.

3) Government “stealth taxes” increase a tax burden to highest level for 50 years.

This type of tax is actually not recognized by firms or households, so it doesn’t affect consumption or investment or production process. What it might affect is government spending, because the government can raise money from increasing “stealth taxes” , but the task doesn’t say anything about increasing government spending.

4) UK productivity levels at their highest level for 10 years.

Providing this information tends to raise firms’ confidence ( how they are optimistic about future economic prospects), that would lead to increase in capital investment and probably increase in production. Consumer confidence also will increase, that means that consumption will rise. As the result AS and AD will increase and the both curves will shift to the right. This will tend to rise in economic growth and fall in unemployment rate. Inflation rate would depend on how AD and AS will increase.