Cambridge International AS and A Level Economics: Supply-side, exchange rate and trade policies (9708)

This guide covers part of section 10.3 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028: the supply-side, exchange rate and international trade policy bullets of 10.3.1, plus 10.3.2 (problems and conflicts) and 10.3.3 (government failure in macroeconomic policy). Topic 10 is A Level content, so it is not examined at AS. The syllabus says AS content is assumed knowledge for the A Level papers, so you still need the AS basics.

Fiscal policy, the Laffer curve and monetary policy sit in a separate unit and are not repeated here. All countries, currencies and figures below are invented for illustration, not real statistics. Start from the Cambridge A Level Economics hub or the printable checklist. Then use the revision notes, the practice set and the free diagnostics. The AS ideas behind this unit are in the supply-side guide, the protectionism guide and the floating exchange rates guide.

What this guide covers

Outcome	What you must be able to do
10.3.1	Judge how well supply-side policy (market-based and interventionist), exchange rate policy and international trade policy meet each macroeconomic objective
10.3.2	Explain the problems and conflicts that follow from these policies
10.3.3	Explain how government failure can occur in macroeconomic policy

The syllabus asks you to evaluate effectiveness “in relation to different macroeconomic objectives”. Always name the objective (growth, unemployment, inflation, balance of payments, redistribution, sustainability) and say how far the policy moves it.

10.3.1 Supply-side policy

Supply-side policy aims to raise productive capacity and productivity, shifting long-run aggregate supply (LRAS) to the right. It has two families.

• Market-based policies free markets and strengthen incentives: lower marginal income tax and corporation tax rates, deregulation, privatisation, weaker restrictions on hiring and firing, lower out-of-work benefits, trade liberalisation and stronger competition policy.
• Interventionist policies use the state to improve the factors of production: spending on education, training, health, infrastructure, subsidies for research and development, and regional or industrial policy.

Worked example 1: unit labour costs

Country R’s wages per worker rise 3% while output per worker rises 6%.

• Unit labour cost = wage per worker ÷ output per worker.
• New unit labour cost relative to old = 1.03 ÷ 1.06 = 0.9717.
• Unit labour cost falls by 2.8%.

Lower unit costs shift short-run supply right, lower prices for a given output and make exports more competitive.

Worked example 2: a market-based incentive

Country R cuts the marginal income tax rate from 40% to 30%. A worker offered 20 cu for an extra hour keeps 12 cu before and 14 cu after. The net wage rises 16.7%. If hours supplied respond with an elasticity of 0.3, hours rise 0.3 × 16.7% = 5.0%. On 1,000 million hours that is 50 million extra hours. At output of 30 cu per hour the gain is 1,500 million cu, or 3.75% of an economy of 40,000 million cu. This assumes jobs exist for the extra hours.

Worked example 3: an interventionist programme

Country R trains 1.2 million workers, each producing 55,000 cu a year, so their output is 66,000 million cu. The programme costs 1,500 million cu and raises their output by 3%.

• Full gain = 66,000 million × 3% = 1,980 million cu a year.
• Best-case payback = 1,500 ÷ 1,980 = 0.76 years.
• Realistic case: nothing for two years, then only half the trainees use the skills. Gain = 990 million a year, so payback = 2 + 1,500 ÷ 990 = 3.5 years.

Effectiveness against each objective

Objective	Market-based	Interventionist
Growth	Raises potential output if incentives work	Raises productivity and capacity, slowly
Unemployment	Helps structural and frictional unemployment; little help in a demand-deficient recession	Retrains and relocates workers; needs jobs to exist
Inflation	Lower costs ease cost-push; no quick fix for demand-pull	Same, over a long time
Balance of payments	Better competitiveness, more exports	Better quality and productivity
Redistribution	May widen inequality	May narrow it by lifting skills
Sustainability and development	Can raise pollution; growth may fund development	Green infrastructure and skills support both; costly

Evaluation: the effect depends on time, the size of the response (the 0.3 above), the cost to the government and whether demand is high enough to use the new capacity.

10.3.1 Exchange rate policy

Governments influence the exchange rate by choosing a system (fixed, managed or floating), by buying or selling currency from reserves, and by changing interest rates. A lower rate is expansionary in the external sector.

Worked example 4: depreciation and the trade balance

Country T’s currency, the vessa, falls from 2.00 to 1.80 morn, a depreciation of 10%. Exports are 400 and imports 440 (both in vessas, a deficit of 40). Export prices in vessas do not change, but foreign buyers pay 10% less. Foreign prices of imports do not change, so import prices in vessas rise by 2.00 ÷ 1.80 − 1 = 11.1%.

	Elastic case	Inelastic case
Elasticity of demand for exports	1.1	0.3
Elasticity of demand for imports	0.8	0.4
Exports	400 × 1.11 = 444	400 × 1.03 = 412
Imports	440 × 1.111 × (1 − 0.8 × 0.111) = 445.4	440 × 1.111 × (1 − 0.4 × 0.111) = 467.2
Balance	−1.4	−55.2

The deficit narrows from 40 to 1.4 in the elastic case and widens to 55.2 in the inelastic case. This is the idea behind the Marshall-Lerner condition, which section 11.2.5 covers in full. Short-run elasticities are usually lower than long-run ones, so the balance may worsen before it improves.

Other effects: if imports make up 25% of the price index, import prices up 11.1% add about 25% × 11.1% = 2.8 percentage points to the price level. Imported inputs raise firms’ costs too. Higher net exports raise AD, so growth and employment rise if spare capacity exists.

Worked example 5: defending a rate

Country T wants to hold 2.00 morn. At that rate the supply of vessas exceeds demand by 50 million a month, so the central bank buys 50 million vessas, paying 100 million morn from reserves. Reserves of 480 million morn last 4.8 months. After that it must raise interest rates to attract buyers or let the rate fall. A fixed target is therefore only as strong as the reserves and the willingness to change interest rates.

10.3.1 International trade policy

Trade policy is protectionism (tariffs, quotas, subsidies, other barriers) or liberalisation (removing barriers, joining trade agreements).

Worked example 6: a tariff

Country V imports goods worth 300 (before tariff). A 15% tariff raises the home price 15%. Demand for imports has elasticity 1.2.

• Volume change = −1.2 × 15% = −18%. Payments to foreign sellers = 300 × 0.82 = 246, a fall of 54.
• Tariff revenue = 15% × 246 = 36.9, which goes to the government.
• If imports are 12% of the consumer price index, prices rise by about 12% × 15% = 1.8 percentage points.
• Retaliation: the partner puts a 10% tariff on Country V’s exports of 250, with demand elasticity 1.5. Volume falls 15% to 212.5, a loss of 37.5. Net gain to the balance of payments = 54 − 37.5 = 16.5.
• If the partner retaliates with 20%, exports fall 30% to 175, a loss of 75, and the net result is −21.

The tariff helps the balance only if retaliation stays below about 14.4% (54 ÷ 250 = 21.6%, ÷ 1.5).

Objective	Protection	Liberalisation
Balance of payments	Cuts imports; retaliation can cancel it	Exports may rise; imports rise more at first
Unemployment	Protects jobs in the shielded industry	Jobs lost where industries cannot compete
Inflation	Raises prices	Lowers prices and costs
Growth	Less competition and less efficiency	Competition, scale and specialisation

10.3.2 Problems and conflicts

Policy problems come from the policy and from the economy.

• Conflicts between objectives. Depreciation in example 4 gives net exports +38.6. With a multiplier of 1.6, output rises 38.6 × 1.6 = 61.8, or 3.1% of an economy of 2,000. The price level rises about 2.8 percentage points. Growth and the balance of payments improve at the cost of inflation.
• Internal against external balance. A fixed rate forces interest rates to follow the target. A country in recession with a weak currency cannot cut rates freely.
• Growth against equity and sustainability. Market-based tax cuts and deregulation may widen income gaps or raise pollution.
• Protection against inflation and growth. Tariffs help local jobs and raise prices.
• Time lags. Supply-side effects take years. Exchange rate effects can arrive in the wrong order.
• Limits on effectiveness. Small open economies depend on foreign demand. Other countries’ policies and shocks can overwhelm domestic policy.

A good answer ranks the conflicts: which objective has priority, and what does it cost?

10.3.3 Government failure in macroeconomic policy

Government failure occurs when intervention leaves the economy worse off than before, or produces new problems that outweigh the benefits. Causes: poor information and forecasts, time lags, short-term political aims, lobbying by vested interests, administrative cost, unintended effects and policy that changes direction.

Worked example 7: the timing problem

Country W has an output gap (percentage of potential output) that closes by itself. A stimulus is decided in period 1 but takes effect from period 5, adding 2 points to the gap.

Period	1	2	3	4	5	6
Gap, no stimulus	−3	−3	−2	−1	0	+1
Gap, with stimulus	−3	−3	−2	−1	+2	+3

The policy arrives when the economy is already at capacity and pushes it into overheating. If each point of positive gap adds 0.5 points to inflation (an invented rule), the stimulus adds 1.0 point to inflation by period 6.

Consequences of macroeconomic government failure: inflation, unemployment, debt, loss of policy credibility, wasted resources and cycles of stop-go policy. Trade protection shows another cause: producer lobbying gains a tariff while the many consumers who pay for it have no voice.

Evaluating policy effectiveness

1. Which objective, and how large a change is needed?
2. How big is the response (elasticities, the multiplier)?
3. How long does it take?
4. What does it cost, and who pays?
5. What does it do to other objectives?
6. How does the exchange rate system, the openness of the economy and global conditions change the answer?
7. Would a combination of policies work better than one?

Common errors

• Describing a policy without saying which objective it helps.
• Assuming a lower exchange rate always improves the balance of payments.
• Forgetting retaliation or imported inflation.
• Treating all supply-side policies as the same; separate market-based from interventionist.
• Ignoring time lags and spare capacity.
• Using government failure as a conclusion without a cause.

Paper 4 Section B and C questions are worth 20 marks, are not divided into parts and need evidence of evaluation, so link each point back to the objective and finish with a supported judgement.

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. This guide covers 10.3.1 (supply-side, exchange rate and international trade policy), 10.3.2 and 10.3.3.