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Cambridge IAL Economics study materials
Cambridge IAL Economics study resources

Cambridge IAL Economics: Macroeconomic Theory and Policy

Cambridge IAL Economics · Work through your exam, one topic at a time.

All guide sections

Macroeconomic Theory and Policy

This domain tests the AD/AS model, the multiplier, fiscal and monetary policy, supply-side policy, and policy conflicts. Candidates must distinguish short-run from long-run effects and nominal from real variables.

Core rules and concepts

  • AD = C + I + G + (X − M). It slopes downward because of wealth, interest-rate and net-export effects.
  • SRAS slopes upward because costs are sticky. LRAS is vertical at potential output in the neoclassical model; a Keynesian LRAS may be horizontal at low output.
  • The multiplier k = 1 ÷ (1 − MPC) = 1 ÷ (MPS + MPT + MPM). An initial injection raises equilibrium output by the injection times the multiplier, provided there is spare capacity.
  • Fiscal policy uses government spending and taxation. Automatic stabilisers work without discretionary action. A budget deficit is a flow; government debt is a stock.
  • Monetary policy uses interest rates, money supply and quantitative easing. Higher interest rates reduce consumption, investment and net exports.
  • Supply-side policy improves productive capacity through education, infrastructure, deregulation and labour-market flexibility.
  • Policy conflicts include inflation versus unemployment in the short run, growth versus the current account, and equity versus efficiency.

Worked example

MPS = 0.1, MPT = 0.2 and MPM = 0.1. The multiplier is 1 ÷ (0.1 + 0.2 + 0.1) = 2.5. A £10bn rise in government spending raises equilibrium output by £25bn if there is spare capacity. If the economy is already at potential output, the LRAS curve is vertical, so the main effect is a higher price level rather than higher real GDP. The same injection therefore has different effects depending on the output gap.

Traps that cost marks

  • Applying the multiplier when the economy is at full capacity.
  • Confusing the budget deficit with the national debt.
  • Saying contractionary monetary policy means lower interest rates.
  • Forgetting that vertical LRAS means no long-run output effect from demand policy.
  • Treating automatic stabilisers as discretionary policy.

Economic Growth and Development

This domain tests the distinction between growth and development, the measurement of both, and the policies that promote them. You should be able to evaluate GDP, GDP per capita and HDI, and explain why growth may not improve welfare.

Core rules and concepts

  • Economic growth is an increase in real GDP or potential output. Growth rate = (real GDP in year 2 − real GDP in year 1) ÷ real GDP in year 1 × 100.
  • GDP per capita growth ≈ real GDP growth − population growth. The rule of 70 estimates doubling time as 70 ÷ annual growth rate.
  • Development is multidimensional: income, health, education, inequality, environment and freedom. HDI combines GNI per capita (PPP), life expectancy, mean years of schooling and expected years of schooling.
  • PPP adjusts for differences in price levels. The Gini coefficient measures inequality from 0 to 1; the Lorenz curve shows cumulative income shares.
  • Sources of growth include savings and investment, human capital, technology, institutions, natural resources and demographics. Harrod-Domar emphasises savings; Solow emphasises technical progress; endogenous growth emphasises knowledge and human capital.
  • Strategies include import substitution, export-led growth, FDI, aid, debt relief, microfinance, property rights and investment in health and education.
  • Constraints include corruption, conflict, weak institutions, commodity price volatility, Dutch disease, debt overhang and brain drain.

Worked example

Real GDP grows by 4% and population by 2.5%. GDP per capita growth is approximately 4 − 2.5 = 1.5%. Using the rule of 70, living standards double in about 70 ÷ 1.5 ≈ 47 years. If instead population grows by 4%, GDP per capita is unchanged despite positive GDP growth. This shows why growth in total output can coexist with stagnant living standards.

Traps that cost marks

  • Treating GDP growth as equivalent to development.
  • Using nominal GDP when comparing countries over time.
  • Ignoring PPP when comparing incomes across countries.
  • Confusing the Gini coefficient with the Lorenz curve.
  • Assuming aid or FDI always raises growth; absorptive capacity and institutions matter.