Cambridge A Level Economics: Supply-side, exchange rate and trade policies (9708) – Revision Notes

Full explanations are in the study guide. These notes cover part of section 10.3 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028: supply-side, exchange rate and international trade policy (10.3.1), problems and conflicts (10.3.2) and government failure (10.3.3). Topic 10 is A Level content only. Fiscal policy, the Laffer curve and monetary policy are in a separate unit.

Links: Cambridge A Level Economics hub, printable checklist, practice set and free diagnostics. All figures below are invented for illustration.

Definitions

Term	Meaning
Supply-side policy	Policy to raise productive capacity and productivity, shifting LRAS right
Market-based supply-side policy	Stronger incentives and freer markets: lower tax rates, deregulation, privatisation, labour market flexibility, competition policy
Interventionist supply-side policy	State action on factors of production: education, training, health, infrastructure, research subsidies, regional policy
Exchange rate policy	Choice of system, use of reserves and interest rates to influence the external value of the currency
Trade policy	Protection (tariffs, quotas, subsidies, other barriers) or liberalisation (lower barriers, agreements)
Policy conflict	Improving one objective makes another worse
Government failure (macro)	Intervention leaves the economy worse off or creates larger new problems

Policy against objective

	Growth	Unemployment	Inflation	Balance of payments
Market-based supply-side	Up in the long run	Falls (structural)	Lower costs	Better competitiveness
Interventionist supply-side	Up, slow	Falls with skills	Lower costs, slow	Better quality
Lower exchange rate	Up (net exports)	Falls	Rises (imports)	Better if elasticities are high enough
Higher exchange rate	Down	Rises	Falls	Worse if elasticities are high enough
Protection	Mixed	Protects jobs	Rises	Better, unless retaliation
Liberalisation	Up (competition)	Falls in some sectors, rises in others	Falls	Mixed

Methods in steps

Percentage change in unit labour cost

1. Write (1 + wage change) ÷ (1 + productivity change).
2. Subtract 1 and express as a percentage.

Effect of a currency fall on the trade balance

1. Find the percentage fall in the rate, then the rise in home-currency import prices (old rate ÷ new rate − 1).
2. Export volume change = export elasticity × percentage fall in the foreign price.
3. Import volume change = −import elasticity × percentage rise in the home price.
4. Recalculate exports and imports and compare the balances.

Effect of a tariff on payments abroad

1. Volume change = −elasticity × tariff rate.
2. Payments to foreign sellers = old value × (1 + volume change).
3. Tariff revenue goes to the government, not abroad.

Small worked reminders

Unit labour cost. Wages +4%, productivity +2%: 1.04 ÷ 1.02 = 1.0196, so unit labour costs rise 2.0%.

Tax incentive. Marginal rate cut from 35% to 25% on 40 cu earned: net pay 26 cu rises to 30 cu, up 15.4%. Hours respond only by elasticity × 15.4%.

Research subsidy. A 40% subsidy on 250 cu of research costs the government 100 cu and leaves the firm 150 cu.

Appreciation. The rate rises from 1.50 to 1.65 (10%). A home export priced at 300 cu costs 450 foreign units before and 495 after (up 10%). An import priced at 120 foreign units costs 80 cu before and 72.7 cu after (down 9.1%).

Policy lag. An inside lag of 2 quarters plus an outside lag of 4 quarters means the effect arrives about 6 quarters after the problem appeared.

Must-know distinctions

• Market-based against interventionist: incentives and freer markets against state spending and provision.
• Supply-side against demand-side: supply-side shifts LRAS; demand-side policies shift AD.
• Depreciation against devaluation: depreciation is a market fall; devaluation is a deliberate cut in a fixed rate (section 11.2.3).
• Expenditure-switching against expenditure-reducing: switching changes what is bought (exchange rate, protection); reducing lowers total spending (section 11.1.3).
• Policy conflict against government failure: a conflict arises even when the policy works as planned; failure means the policy did not work or made things worse.
• Inside lag against outside lag: the time to recognise and decide, against the time for the policy to act.

Choosing and combining policies

• Structural unemployment and a weak trade position need supply-side policy, which is slow but lasting.
• Demand-deficient unemployment needs a rise in AD, so supply-side policy alone will not solve it.
• A weak currency can speed up the adjustment but adds import costs; pair it with supply-side policy so that competitiveness lasts.
• Protection is a short-term shield. Its gains fade if the shielded firms do not improve, and trading partners can retaliate.
• Liberalisation helps long-run efficiency, but the losers are concentrated in particular industries and regions, so adjustment help matters.
• Open economies are exposed to world demand, so a domestic policy can be swamped by shocks abroad.

Trade-off sketch. Draw LRAS as a vertical line and AD and SRAS as usual. A supply-side success moves LRAS and SRAS right: output up, price level down. A currency fall moves AD right through net exports and SRAS left through import costs: output up, price level up. Say which curve shifts, in which direction, and why.

Government failure: causes and effects

Causes: poor information and forecasts, time lags, short-term political aims, lobbying, administration cost, unintended effects, policy reversals.

Effects: policy arrives at the wrong point in the cycle, inflation or unemployment worsens, debt rises, resources are wasted, the government loses credibility.

Evaluation checklist

Time horizon, size of the response, spare capacity, type of inflation or unemployment, openness of the economy, exchange rate system, effects on other objectives, retaliation, cost and who pays.

Quick self-test

1. Wages rise 2% and productivity rises 5%. What happens to unit labour cost?
2. A worker’s marginal tax rate falls from 50% to 40% on 30 cu earned. By what percentage does the net amount rise?
3. A currency falls from 3.00 to 2.50. By what percentage has it fallen, and by what percentage do home-currency import prices rise?
4. Is the depreciation in question 3 more likely to improve the trade balance in the short run or the long run? Why?
5. Imports are 15% of the price index and import prices rise 8%. What is the direct effect on the price level?
6. Imports of 200 face a 10% tariff and demand elasticity 1.5. What happens to payments to foreign sellers?
7. Give one reason why a tariff may fail to improve the balance of payments.
8. Name two market-based and two interventionist supply-side policies.
9. A government raises interest rates to defend a fixed exchange rate during a recession. Which two objectives conflict?
10. A stimulus is decided when the output gap is negative but works when the economy is at capacity. Which cause of government failure is this?

Answers

1. Unit labour costs fall: 1.02 ÷ 1.05 = 0.9714, a fall of 2.9%.
2. Net pay rises from 15 cu to 18 cu, a rise of 20%.
3. The currency falls 16.7%. Home import prices rise 3.00 ÷ 2.50 − 1 = 20%.
4. The long run. Demand for exports and imports is more elastic once buyers and firms have time to adjust.
5. 15% × 8% = 1.2 percentage points, if costs are passed on in full.
6. Volume falls 15%. Payments fall from 200 to 170, a fall of 30. The tariff revenue (10% of 170 = 17) goes to the government.
7. Trading partners may retaliate, cutting exports. Demand for imports may be inelastic.
8. Market-based: lower marginal tax rates, deregulation, privatisation, weaker restrictions on hiring and firing. Interventionist: training, infrastructure, research subsidies, health spending.
9. Growth and unemployment against the exchange rate target (internal against external balance).
10. Time lags (the policy acts at the wrong point in the cycle), a form of macroeconomic government failure.

Where marks are usually lost

• Listing policies with no link to a named objective.
• Writing “exports rise” without saying why: a cheaper currency lowers the foreign price.
• Forgetting that import elasticities decide the result, not just the direction of the rate.
• Leaving out imported inflation after a currency fall.
• Calculating a percentage change in the exchange rate from the wrong base.
• Treating a tariff as a tax paid abroad rather than by home consumers.
• Using “government failure” as a label without a specific cause.
• Evaluating with generic words (“it depends”) rather than naming the factor that decides.
• Forgetting that supply-side effects are long-run and need demand to use the capacity.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, version 2, published by Cambridge University Press & Assessment. These notes cover 10.3.1 (supply-side, exchange rate and international trade policy), 10.3.2 and 10.3.3.