Micro example

Macro example

Magnitude (Size of a change)

Note: If the data tells you the size of the change you must use this in your evaluation.

A rise in global oil prices of 1US$ per barrel is unlikely to have a major impact on the costs of production of firms.

A 25% fall in the value of the £ is likely to have a more significant effect on exports and imports than a depreciation of only 5%.

Significance

As there is an increase in wages of 10% and wages are the main component in the costs of football clubs this will have a significant effect on their costs of production and profits.

As consumer spending represents around two thirds of the total of AD in the UK a fall in consumer spending is likely to have a significant impact on AD and on growth and employment.

Short run/Long run

The short run effects of a subsidy may be to reduce production costs and reduce prices. However, if firms come to rely on subsidies in the long run they may allow costs to rise and inefficiencies to set in leading to higher prices for the consumer.

An increase in investment can have both short run and long run benefits for the economy. In the short run it will raise AD and stimulate economic growth leading to a positive multiplier effect. In the long run it will increase productive capacity as the quality of capital improves.

Elasticity

In the short run an increase in demand for wheat will lead to an increase in bread prices because supply is likely to be more inelastic as farmers need time to respond to the higher demand. In the long run as more wheat is grown supply will become more elastic and the wheat price may fall back.

In the short run a depreciation in the exchange rate may cause the Balance of Payments on current account to worsen as exports and imports are price inelastic due to existing contracts. In the long run when these contracts are renegotiated demand for exports and imports will become more elastic and so the Balance of Payments on current account may improve.

Lack of Information

The government may have insufficient information about the extent of the negative externalities created to decide what level of taxation to charge. Therefore they may charge too little in which case the social optimum is not reached and the negative externalities continue or they may charge too much in which case the costs exceed the benefits and the social optimum is not attained.

The government may lack knowledge about the impact of cuts in welfare on the unemployed. It is difficult to measure the incentive effects of cutting welfare payments and may lead to greater negative externalities arising from a lack of social cohesion.  

Prioritise

The government may lack the funds to subsidise all merit goods or provide them for free, therefore it may have to prioritise and decide which are the most important merit goods with the greatest positive externalities, eg. education.

The government has several economic objectives. At any one time it may have to prioritise these objectives. Since 2010 one of their main objectives has been to reduce the budget deficit therefore the emphasis has been on fiscal austerity. Other objectives such as greater equality of income have been regarded as less important.

Conflicts/Trade offs

In taxing a good the government is trading off or reducing some consumer surplus in order to increase welfare. The tax will increase the price of the product which will reduce consumer surplus but it will also reduce consumption and production of the good which increases economic welfare.

There may be conflict between government objectives. One objective may need to be traded off for another. For example the conflict between low inflation and low unemployment. Expansionary fiscal policy may help to achieve lower unemployment but it may also cause higher inflation. Therefore, the government may need to look at alternative policies to deal with the higher inflation, such as monetary or supply-side policies.

Ceteris Paribus

(All other things remaining equal)

A fall in the price of oil will lead to a fall in the costs of production and an outward shift in supply ceteris paribus. However, if other factors do change, eg the level of wages increases then there will be an increase in production costs for firms which may offset the impact of the fall in oil prices.

Fiscal expansion may lead to an increase in AD through higher government spending and lower taxation as long as other factors do not change. However, economies are constantly subject to both demand side and supply side shocks which can alter AD, eg. if there is a recession in the euro zone it is likely to lead to a fall in demand for UK exports and so reduce the level of AD. This will offset any positive impacts created by the fiscal expansion.