Edexcel IAL Economics: Global macro policies, TNC control and policy problems (YEC11) – Revision Notes

These notes condense statement 4 (a to e) of 4.3.5 in the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (Issue 2, June 2018). Unit 4, Developments in the global economy, is an IAL compulsory unit: it supplies International A2 (IA2) content, not International AS. For full explanations and worked examples, read the study guide. Then try the practice questions. Other links: course hub, printable checklist and the free diagnostics. All figures are invented.

Key definitions (4a, 4c)

Term	Meaning
Fiscal policy	Changes to government spending and taxation
Monetary policy	Changes to interest rates, money supply or central bank asset purchases
Exchange-rate policy	Managing the currency’s value, for example by intervening or changing interest rates
Supply-side policy	Measures to raise productive capacity (LRAS)
Direct controls	Rules and limits, such as price caps, quotas or capital controls
Quantitative easing (QE)	Central bank creates money to buy bonds, lowering long-term yields
TNC	A firm operating in more than one country
Tax avoidance	Legal reduction of tax paid
Tax evasion	Illegal non-payment of tax owed
Transfer pricing	Price charged between parts of one firm
Arm’s length principle	Intra-firm prices should equal prices between unrelated firms
External shock	An event outside the government’s control that hits the economy

Formulas and results

Item	Formula
Deficit ratio	Deficit/GDP x 100
Multiplier	k = 1/mpw, where mpw = mps + mpt + mpm
Change in GDP	Initial change in spending x k
Net deficit saving from a spending cut	Cut - (tax rate x change in GDP)
Pass-through effect on prices	Import weight x % change in import price x share passed on
Terms of trade	(Export prices index divided by import prices index) x 100
Inflation	(CPI new/CPI old - 1) x 100
Output gap	(Actual - potential)/potential x 100
Tax saved by shifting profit	Profit shifted x (high rate - low rate)

Tools by objective (4a)

• Cut deficit and debt: raise taxes or cut spending (lowers AD, may slow growth and reduce revenue); supply-side policy raises growth and revenue slowly.
• Control inflation: higher interest rates (less borrowing, lower AD); stronger currency (cheaper imports, weaker exports); lower spending or higher tax; supply-side measures to cut costs; price controls as a direct measure.
• Respond to external shocks: match the tool to the type. Demand shocks suit AD policy. Cost shocks (SRAS shift) create a dilemma between output and prices.
• Cut poverty and inequality: progressive taxes, transfers, minimum wage, education and training, regional policy.

Method for a policy-tool answer: (1) name the tool and the change; (2) give the chain (rate up, borrowing down, AD left, output and prices down); (3) apply to the context given; (4) evaluate with a limit such as a time lag, a side effect or the state of the economy; (5) reach a judgement.

Exchange-rate and shock arithmetic

Appreciation = fewer units of home currency needed per unit of foreign, so import prices fall. Quick check: foreign price/exchange rate gives the home price.

Terms of trade worked reminder: export index 120, import index 96 gives 120/96 x 100 = 125.0, an improvement (each export buys more imports).

2008 crisis response (4b)

Tool	What was done	Side effect or limit
Interest rates	Cut sharply to very low levels	Little room left; banks cautious
QE	Central banks bought bonds	Asset prices rise, helping asset owners most
Bank rescues	Governments supported banks	Public debt rises; moral hazard
Fiscal stimulus	Higher spending, tax cuts	Larger deficits; leakages abroad
Automatic stabilisers	Revenue falls, benefits rise	Deficits rise

Key point: the crisis began in finance, so weak bank lending and low confidence limited how well lower interest rates worked. Later tightening of policy in some countries raised the question of timing.

TNC controls (4c)

Measures: arm’s length rule; documentation; country-by-country reporting; anti-avoidance rules and closing loopholes; international agreements on minimum effective rates; tax authority cooperation.

Limits: tax competition and the threat of FDI leaving; information gaps and low enforcement capacity; differing national rules; need for many countries to agree; risk of losing jobs and technology transfer.

Transfer pricing reminder: profit moves to the low-tax country when the transfer price into it is set low. Profit shifted of 2.0m between rates of 35% and 15% saves 2.0m x 0.20 = 0.40m.

Scales of impact (4d)

Scale	Question to ask
Local	Which region, industry or group depends on this? Who gains or loses jobs and prices?
National	Effect on AD, AS, the objectives and the budget
Global	Effect on trade, exchange rates, capital flows, other countries’ policies

Policymaker problems (4e)

• Inaccurate information: estimates and revisions (potential output, GDP, inflation); wrong gap, wrong policy.
• Risks and uncertainties: unknown multiplier, pass-through and confidence effects; time lags; reactions by firms and other governments.
• External shocks: world prices, foreign demand and other countries’ policies are outside control.

Worked reminders

Cutting a deficit. Spending is cut by 8 billion cu, the multiplier is 2.5 and revenue is 20% of any change in GDP. GDP falls 8 x 2.5 = 20; revenue falls 0.20 x 20 = 4; the deficit falls by 8 - 4 = 4 billion cu, half of the cut. The higher the multiplier, the smaller the saving.

Progressive tax. Income tax is 0% up to 5,000 cu and 20% above. At 25,000 cu, tax = 0.20 x 20,000 = 4,000, an average rate of 16%. At 45,000 cu, tax = 0.20 x 40,000 = 8,000, an average rate of 17.8%. Because the share of income paid grows as income grows, the tax is progressive.

Evaluation prompts

Use these to turn description into judgement.

• Time: how long before the policy works, and does the short run differ from the long run?
• Size: is the change big enough, and what is the multiplier or pass-through?
• State of the economy: spare capacity, inflation, the exchange rate and banks’ health.
• Side effects: what other objective suffers (growth, jobs, prices, the trade balance, inequality)?
• Who gains and loses: consumers, exporters, savers, borrowers, regions, other countries.
• Information: how accurate are the estimates the policy relies on?

Must-know distinctions

• Avoidance (legal) versus evasion (illegal).
• Demand shock (AD shifts) versus supply shock (SRAS shifts).
• Fiscal tools (spending, tax) versus monetary tools (rates, QE).
• Policy aim (the objective) versus tool (the instrument).
• Local versus national versus global impact.

Quick self-test

1. A country has a deficit of 30 billion currency units (cu) and GDP of 600 billion cu. Calculate deficit/GDP.
2. The marginal propensity to withdraw is 0.25. Calculate the multiplier.
3. A government cuts spending by 12 billion cu. The multiplier is 2 and tax revenue is 25% of any change in GDP. Calculate the net fall in the deficit.
4. The consumer price index rises from 105.0 to 109.2. Calculate inflation.
5. Export prices are at 120 and import prices at 96. Calculate the terms of trade index.
6. A TNC shifts 2.0m profit from a country taxing at 35% to one taxing at 15%. Calculate the tax saved.
7. A currency rises from 0.60 to 0.75 foreign units. A good costs 30 foreign units. Calculate the home price before and after.
8. Using question 7, imports are 20% of the price basket and half of the price change is passed on. Calculate the effect on the price level.
9. Actual GDP is 1,150 and potential 1,200. Calculate the output gap.
10. State two limits to a government’s ability to control TNC tax avoidance.
11. Explain why lower interest rates may fail to raise lending after a financial crisis.

Answers

1. 30/600 x 100 = 5.0%.
2. 1/0.25 = 4.
3. GDP falls 12 x 2 = 24; revenue falls 0.25 x 24 = 6; net fall = 12 - 6 = 6 billion cu.
4. (109.2/105.0 - 1) x 100 = 4.0%.
5. 120/96 x 100 = 125.0.
6. 2.0m x (0.35 - 0.15) = 0.40m.
7. Before 30/0.60 = 50; after 30/0.75 = 40, a fall of 20%.
8. 0.20 x (-20%) x 0.5 = -2.0%.
9. (1,150 - 1,200)/1,200 x 100 = -4.2%.
10. Any two: tax competition or threat of FDI leaving; information gaps; need for international agreement; weak enforcement capacity.
11. Banks may want to repair their finances and fear defaults, firms expect weak demand and may not borrow, so lending stays low despite cheaper credit.

Where marks are usually lost

• Stating that a spending cut reduces the deficit by the full amount, with no multiplier effect on revenue.
• Naming a tool without a chain of reasoning to the objective.
• Confusing avoidance with evasion, or calling transfer pricing illegal by definition.
• Using real countries’ data from memory instead of the context in the question.
• Listing the 2008 measures without any evaluation of effectiveness or side effects.
• Answering only at the national level when the question asks about local or global effects.
• Forgetting that an external shock cannot be controlled, only responded to.
• Ending without a judgement that weighs short run against long run.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, first assessment June 2020, Pearson Education Limited: Unit 4, 4.3.5 statement 4 (a to e).