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GCSE Economics · Topic 2

How the economy works

This topic looks at the economy as a whole, rather than individual markets.

We will cover the government's main economic objectives, international trade and money, and the circular flow of income.

Then we look at economic growth and the economic cycle, unemployment, and how income and wealth are distributed.

In this topic

  1. 2.1The national economy and government objectivesFree below · 19 questions
  2. 2.2International trade, money and marketsOpen in Full Marks · 60 questions
  3. 2.3The circular flow of income and aggregate demand and supplyOpen in Full Marks · 52 questions
  4. 2.4Economic growth, GDP and the economic cycleOpen in Full Marks · 36 questions
  5. 2.5Unemployment: types, causes and measurementOpen in Full Marks · 79 questions
  6. 2.6Distribution of income and wealth, inequality and povertyOpen in Full Marks · 43 questions
  7. 2.7The labour market: wages, trade unions and the minimum wageOpen in Full Marks · 69 questions

2.1 · Free notes

The national economy and government objectives

Diagram: The national economy and government objectives

Key points

In more detail

Practice

The national economy and government objectives: 10 questions

Pick an answer to check it, or open the answer for the explanation.

1. Which index measures UK inflation for the government's target?

  1. RPI
  2. CPI
  3. GDP
  4. FTSE
Show answer

B: CPI. The target is 2% CPI inflation.

2. Who sets UK interest rates?

  1. The Treasury
  2. The Bank of England's Monetary Policy Committee
  3. Parliament
  4. Commercial banks
Show answer

B: The Bank of England's Monetary Policy Committee. The MPC sets Bank Rate to meet the inflation target.

3. What is structural unemployment?

  1. Temporary unemployment between jobs
  2. Unemployment caused by a mismatch of skills as industries decline
  3. Unemployment in winter
  4. Unemployment during a recession
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B: Unemployment caused by a mismatch of skills as industries decline. Retraining and mobility policies are typical responses.

4. What is fiscal policy?

  1. Changing interest rates
  2. Using government spending and taxation to influence the economy
  3. Controlling the money supply only
  4. Regulating monopolies
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B: Using government spending and taxation to influence the economy. Expansionary fiscal policy raises spending or cuts taxes.

5. What does real GDP adjust for?

  1. Population
  2. Inflation
  3. Exchange rates
  4. Unemployment
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B: Inflation. Real GDP shows output changes rather than price changes.

6. What is a likely effect of a fall in the value of the pound on UK inflation?

  1. No effect
  2. Import prices rise, which can increase inflation
  3. Import prices fall
  4. Deflation is guaranteed
Show answer

B: Import prices rise, which can increase inflation. More expensive imports can feed through into the general price level.

7. UK imports of goods and services far exceed exports for several years. Which objective is most directly threatened?

  1. Environmental sustainability
  2. Balance of payments equilibrium
  3. Low unemployment
  4. Fairer income distribution
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B: Balance of payments equilibrium. Persistent spending abroad above export earnings creates a trade deficit, which is part of the balance of payments. It threatens the aim of an equilibrium.

8. The MPC raises the Bank Rate to reduce inflation. Which type of policy is this?

  1. Monetary policy
  2. Fiscal policy
  3. Supply-side policy
  4. Protectionist policy
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A: Monetary policy. Changing interest rates is monetary policy, carried out by the Bank of England's MPC. Fiscal policy uses tax and government spending.

9. The CPI rises from 120 to 126 in one year. What is the rate of inflation?

  1. 5%
  2. 6%
  3. 126%
  4. 4.8%
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A: 5%. Inflation = (126 − 120) ÷ 120 × 100 = 5%. The 6 is a change in index points, not a percentage.

10. Why might cutting interest rates to boost growth conflict with the objective of price stability?

  1. It increases the value of the pound
  2. It raises unemployment
  3. Higher AD may push up the price level
  4. It reduces AD, lowering prices
Show answer

C: Higher AD may push up the price level. Lower rates encourage borrowing and spending, so AD rises. If the economy is near capacity, the extra demand raises prices, so growth and low inflation can conflict.

Keep going in Full Marks

Full Marks has 19 questions on The national economy and government objectives (9 more than here), set out in practice levels. You also get notes and 3D models for all 7 subtopics of How the economy works, plus games, timed exams and past papers.

Practise 2.1 in Full MarksOpen How the economy works

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