Real wages are down in Europe: Which countries have seen the biggest

changes in salaries?

a. Define the following terms:

i. inflation (line 1) [2]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 A vague response that inflation measures a rise in prices 1
2 An accurate definition as a general increase of the prices of goods and 2
services in an economy.

ii. nominal wage (line 1) [2]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 A vague response that inflation measures a rise in prices 1
2 An accurate definition that nominal wage, or money wage, is the literal 2
amount of money you get paid per hour or by salary, i.e. does not
consider changes in average prices.

b. Calcuate the average rate of inflation across the 10 European nations in table 2 and the
average level of real wages in table 3. [3]

The average rate of inflation is calculated as: (25.4+17+16.4+11.4+9+8.9+8.2+7.1+6+3.2) /

10 = 11.26%

c. Explain using an appropriate diagram the impact of the 'supply chain bottlenecks and
higher energy prices from Russia’s war of aggression against Ukraine' on the level of
inflation throughout the European continent (paragraph 2) [4]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 For drawing a AD/AS diagram (inward shift) showing an increase in 1-2
production costs OR for explaining that as a result of the 'supply chain
bottlenecks and higher energy prices from Russia’s war of aggression
against Ukraine' production costs have risen - almost all products require
energy to make
2 For drawing a AD/AS diagram (inward shift) showing an increase in 3-4
production costs AND for explaining that as a result of the 'supply chain
bottlenecks and higher energy prices from Russia’s war of aggression
against Ukraine' production costs have risen - almost all products require
energy to make

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d. Explain why the 'the rapid rebound from the pandemic and related supply chain
bottlenecks' created inflationary pressures in 2021. [2]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 A vague response that inflation is caused by a rise in AD > AS when the 1
economy reopened and the economy rebounded.
2 An accurate definition that inflation results from when demand for goods 2
and services rises at a faster rate than the ability of the economy to
produce them. During the pandemic many economies went into
hybernation which resulted in a contraction in supply for many products.
This did not cause inflation initially as aggregate demand remained low
during this period. When economies rebounded, however, following the
removal of restrictions many economies saw a sharp rise in aggregate
demand, beyond the ability of the economy to produce those goods and
services.

e. Identify two possible reasons why real wages might be falling between Q1 2022 and Q1
2023 (table 3) [4]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 One possible reason is identified and explained. 1-2
2 Two reasons are identified and explained 3-4

The most likely reason why real wages have fallen during this period is because of high
levels of inflation - 11.26% and economic theory suggests that during periods of inflation
nominal wages are unlikely to keep up, particularly those on fixed incomes. A second reason
is because the nature of the inflation on the continent is cost-push, resulting from rises in

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energy and other production costs and not rises in income levels - this would have caused
demand-pull inflation. The only beneficieries of high energy prices are the oil producers and
not consumers.

f. Explain using an appropriate diagram the impact of lower real wages on European
economies. [4]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 For drawing a AD/AS diagram (inward shift) showing a fall in aggregate 1-2
demand OR for explaining that lower real wages will reduce economic
activity in the economy, creating a deflationary gap and disinflation (PL1
to PL2). It is also reasonable to assume that cyclical unemployment may
result from falling real wages, as aggregate demand falls below the
productive capacity of the economy to produce it.
2 For drawing a AD/AS diagram (inward shift) showing a fall in aggregate 3-4
demand AND for explaining that lower real wages will reduce economic
activity in the economy, creating a deflationary gap and disinflation (PL1
to PL2). It is also reasonable to assume that cyclical unemployment may
result from falling real wages, as aggregate demand falls below the
productive capacity of the economy to produce it.

g. Provide two reasons why 'workers in low-paying industries have often fared relatively
better than in high-pay industries in 13 countries out of 23'. Paragraph 7 [4]

Level Descriptor Mark

0 The work does not reach any of the standard described below 0
1 One possible reason is identified and explained. 1-2
2 Two reasons are identified and explained 3-4

One reason why 'workers in low-paying industries have often fared relatively better than in
high-pay industries in 13 countries out of 23' could be because of high demand for labour in
low wage industries such as retail, catering and hospitality. Advancements in AI, for

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InThinking www.thinkib.net/Economics 3
example, have reduced the need for a range of mid to high level human skills but have been
less successful in replacing low skilled employment. A second reason might be the supply of
low wage workers willing and able to work in low wage positions. It is perhaps significant
that the trend of low paying positions outperforming higher paid ones is most noticeable in
Greece, a nation with a large number of workers employed in tourism. Following the
pandemic many people went on holiday, creating a boom in the number of workers required
to work in tourism within Greece, forcing up wages in that sector.

h. Using the passage and your knowledge of economics, discuss the effectiveness of supply
side policies in raising real wage levels. [15 marks]

Definition of real wages as the level of nominal wages received by workers minus the level of
price rises in the economy. Supply side policies can be described as policies aimed at
increasing aggregate supply (AS), a shift from left to right. They enhance the productive
capacities of an economy while improving the quality and quantity of the four factors of
production. [Key terms identified].

Supply-side policies comes in two types, the

first are free-market supply-side policies,
which involve policies to increase
competitiveness and free-market efficiency.
For example, privatisation, deregulation, lower
income tax rates, and reduced power of trade
unions. The second includes interventionist
supply-side policies involve government
intervention to overcome market failure. For
example, higher government spending on
transport, education and
communication. [Application].

The diagram to the right illustrates supply side

policies, which have resulted in a rise in GDP
from Y1 to Y2, representing economic growth
and crucially, falling inflation levels. For
example, tables one and two show that the
European continent is struggling with high
levels of inflation, caused by higher production
costs that realistically can only be resolved,
long term, by supply-side
improvements. [Analysis].

Successful implementation of supply-side

policies might bring about improvements in the
quantity and or quality of a nation's factors of
production, illustrated by a shift outwards in
the nation's productive capacity
(diagram2). One policy that might be
successful in achieving this is

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through investments in training and education, as a workforce equipped to produce better
quality products is likely to be more productive and capable of contributing to rises in living
standards over time. That said, this is one area that a nation finds difficult to improve in the
short term, as the improvements take around than 10 or 15 years to observe. [Example of
supply side improvement].

The productivity of capital might also be improved by governments providing incentives for
businesses to improve their capital base, investing in new machinery as well as high value
added industries such as bio-tech or IT services. [Example of supply side improvement].

Entrepreneurship can also be encouraged, through a series of subsidies and government

incentives for new businesses. [Example of supply side improvement]. It is surely
significant that nations such as Luxembourg and Ireland have adopted a policy of low
corporation tax rates which has increased the number of companies locating into their
countries, while much of the rest of Europe appears to be on a very different path - high
levels of taxation that some believe discourages investment and drives down productivity in
the long-term. [Real world example].

On the other hand, it could also be argued that supply-side policies may not be the only
answer to improving living standards in the long-run. Despite their proven record they also
do have weaknesses/limitations that reduce their effectiveness. [Counter arguments
introduced].

The first of these is that it may be difficult for governments to implement a comprehensive
range of policies. For example, supply-side measures imply tax cuts for the better off (to
encourage enterprise and for people to work
harder) and this may be unpopular because
reducing tax rates for high-earning individuals
has no direct benefit to mid and low-threshold
earners. Those receiving cuts to benefits will
also be disadvantaged. [Counter argument
identified].

One further supply side that governments may

have some success with is the promotion
of greater competition in labour
markets, through the removal of restrictive
practices, and labour market rigidities, such as
the protection of employment. This might
be unpopular, particularly with some
employees and will be particularly resisted by the unions themselves. [Counter argument
identified]. Such policies might be effective in raising productivity levels but equally it
might have the opposite impact and result in further unrest and more industrial action?
[Evaluation].

For these reasons governments, whilst waiting for supply-side measures to work,
governments will almost certainly employ demand side policies in the form of contractionary
fiscal and monetary policies, to bring inflation under control. For example, rises in interest

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rates and higher taxes will reduce aggregate demand in the economy, reducing inflationary
pressures in the economy. This is illustrated on diagram 3 by a fall in aggregate demand,
reducing the level of average prices (from P1 to P2) and a fall in real output from Y1 to Y2.
This will make living standards worse in short-term and will certainly do little to
improve sluggish productivity but at the current moment both the government and central
bank probably consider that they little other choice? [Evaluation and third diagram
explained].

In conclusion, therefore, European governments and central banks will rely on

contractionary demand side policies, in the immediate term, to reduce inflation and then rely
on supply-side measures to secure economic growth and improved living standards in the
long-term. [Conclusion].

Responses should be graded according to the following criteria:

There is no clear answer to the question but some limited: 1-3

• Use of economic terms
• Application of economic theory
• Evaluation
• Use of information from the case example to support the answer
There is a vague answer to the question with limited: 4-6
• Use of economic terms
• Application of economic theory
• Evaluation
• Use of information from the case example to support the answer
There is an answer to the question with satisfactory: 7-9
• Use of economic terms
• Application of economic theory
• Evaluation
• Use of information from the case example to support the answer
There is a clear answer to the question with good: 10=12
• Use of economic terms
• Application of economic theory
• Evaluation
• Use of information from the case example to support the answer
There is a clear answer to the question with excellent: 13-15
• Use of economic terms
• Application of economic theory
• Evaluation
• Use of information from the case example to support the answer

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