# Teaching guide: podcast - how the macroeconomy works

These podcast teaching guides cover topics from our AS and A-level Economics specifications. You can download them below.

Podcast 1: How the macroeconomy works

This podcast teaching guide looks at how the macroeconomy works. It aims to highlight how students can apply economic concepts and tools to critically analyse real life examples and comment on the potential impact to macroeconomic variables.

## Transcript

In this and the following 4 podcasts we focus on a selection of topics from our new AS and A-level specifications, chosen by members of our Teacher Network Group.

We will start with ‘How the macroeconomy works’: the circular flow of income, aggregate demand, aggregate supply analysis and other related concepts.

How the macroeconomy works is a key area of the specification and is inevitably a focus of assessment every year. Whilst the specification content is highly theoretical, it is important that students are able to apply the theory they learn to actual issues facing the UK and other economies. Students should feel confident in their use of constructs, like a diagram showing aggregate demand and aggregate supply, and confident in their analysis and observations on the likely effects of changes in macroeconomic variables.

When demonstrating knowledge of the specification the most adept responses successfully synthesise economic theory and real world events.

We could argue that the best way to achieve this is to start teaching about how the macroeconomy works by developing a sound theoretical understanding of the model of the circular flow of income and the key economic agents involved in the model. This model is the starting point of all macroeconomic analysis and so should be well developed in the classroom.

This can be done with words, equations and graphics. All three approaches have a place, although a complex algebraic approach will not be expected of students. Ultimately, the ability to draw appropriate diagrams, and then explain what a diagram shows, is the key to good exam technique.

It is important to remind students that any diagrams they draw must be supported by related commentary as unexplained diagrams will be given little or no credit.

Once we have established the importance of the basic circular flow model, in depicting the relationship between firms and households, we can further develop student understanding to include the impact of savings and investment and the relationship between these two variables. The next stage is to further develop the model to include government intervention and international trade. This expanded model, including the four new variables of government expenditure, taxation, imports and exports, forms the basis of all macroeconomic analysis. Remember, a complex algebraic approach is not required.

We can use this developed model of the circular flow to consider the impact of injections to, and withdrawals (or leakages) from the model. Linking the concept of equilibrium national income to the determinants of economic growth is also important. Students will need to have a basic understanding of how the government measures national income, and in turn economic growth.

The circular flow model can be used as a vehicle to show how we approach, the three different ways of measuring economic activity; namely the income, output and expenditure methods. In theory, the model shows us that the three approaches should all produce the same result.

Having achieved a sound understanding of the theoretical model, students should be encouraged to consider the effects, on real GDP, of changing macroeconomic variables (such as government expenditure), taxes, consumer spending and saving, investment spending and import and export volumes.

Following on from the circular flow model, the next logical step in developing this area of the specification would be to introduce the aggregate demand / aggregate supply approach to analysing macroeconomic change. We should first establish what is meant by the term aggregate and consider the implications for how the axes should be labelled on a diagram showing aggregate demand and aggregate supply. One common error encountered by examiners is the labelling of an aggregate diagram as if it were a single market - with price on the vertical axis and quantity on the horizontal axis.

So it’s worth taking a little time to define why these axes should be labelled as price level and real GDP (or real national output).

Students tend to quickly grasp the concept of aggregate demand, the equation: AD = C + I + G + X - M will assist understanding. The concept of aggregate supply, on the other hand, can provide more of a challenge to students, as they’ll need to understand the implications for the Aggregate Supply curve of extending the time period from the short run aggregate supply (commonly abbreviated to SRAS) to the long run aggregate supply (or LRAS).

Examiners regularly see candidates using SRAS and LRAS interchangeably and displaying a weak understanding of what influences Aggregate supply in both the short run and the long run.

In making clear the distinction between SRAS and LRAS it is worth relating LRAS to the production possibility frontier, for it is the same factors that influence the production possibility frontier that affect the LRAS.

A further complication to aggregate supply is the fact that the specification requires students to also understand the Keynesian aggregate supply curve which differs to the classical relationship. The Keynesian Aggregate Supply curve considers the differential impact of increases in Aggregate Demand, as an economy approaches its full potential.

It is important that students understand Keynes’ thinking on this issue and why it is that , the elasticity of aggregate supply is high, when there is a large negative output gap, resulting in a flatter curve which eventually steepens as the economy approaches full employment output. This is one of the more subtle aspects of economic theory in the specification and gives more able students the opportunity to demonstrate their evaluative skills.

Once teachers have carefully derived the aggregate demand curve and, both, short and long run aggregate supply curves, they should take time to use the diagram to analyse the impact of any changes in macroeconomic variables. Students need to be able to predict the likely effects of such changes on key indicators such as the price level, unemployment, economic growth and trade.

The two remaining theoretical constructs that students must understand are the multiplier and the accelerator. We’ve found that these are concepts that can often confuse some students. Put most simply, the multiplier, is the degree to which changes in the components of aggregate demand impact upon final changes in national output.

Students should be prepared to calculate a simple value for the multiplier from knowledge of the marginal propensity to consume. It is worth noting that more complex calculations are not expected of students but it is important to have a clear understanding of the processes at work with the multiplier. It is also essential that in questions that require detailed analysis and evaluation of macroeconomic issues, students demonstrate the ability to describe the process.

The concept of the accelerator need only be taught at the most basic level. Students just need to understand that there is a relationship to how investment spending responds to a growing economy. In other words changes in investment spending may be closely linked to past changes in national income. There are various, often quite complicated, versions of the accelerator in economic literature but it is not expected that students reproduce these.

As previously mentioned, students will benefit most from an ability to weave an understanding of the role of this concept into a longer answer. As with all key concepts, students should be taught clear definitions of concepts such as the multiplier and the accelerator, as they often feature in multiple choice questions.

What we have gone through so far, relates to economic theory. Every summer students will face questions that require them to apply these theoretical constructs to real world issues. We advise you to give students plenty of opportunities to analyse various scenarios, both real and potential. This is integral to the teaching of the specification and should give students a confident understanding of the theory so that they can apply that theory effectively; as if it were a toolkit for analysing actual events and providing likely outcomes.

One of the realities of economics is that sometimes there isn’t just one right answer to essay and context based questions. A talented student can analyse a macroeconomic issue and put forward the possible consequences of any changes, and, as long as their chain of reasoning is logical, they are likely to be given credit for what they say - even if the examiner doesn’t entirely agree.

We recommend you take time to consider a number of topical macroeconomic issues and encourage students to analyse the likely impact of change. Some topical issues from recent years could be:-

- The impact of the UK Government’s austerity programmes
- How monetary policy is conducted in an era of very low bank rates
- The impact of a rising or falling exchange rate
- The impact of a slowing world economy
- The economic implications of the UK leaving the EU

To summarise what we have covered in this podcast; a student needs to master the ability to analyse real world economic scenarios using their knowledge of macroeconomics, when such scenarios have no one correct answer students should apply a logical chain of reasoning to economic issues and should demonstrate the ability to draw and explain appropriate diagrams to support their answers. Having achieved all of this, students will be able to confidently and effectively deal with all the challenges that the AQA A level Economics context questions present.

Thank you for listening, we hope you have found this podcast useful. For more helpful AQA resources, visit the AS and A-level Economics pages of our website, aqa.org.uk/economics