Cambridge A Level Economics 9708 — 2011 May/June Paper 2 · Variant 1

This document consists of 3 printed pages and 1 blank page. DC CB (SE/MCW) 34432/2 © UCLES 2011 [Turn over UNIVERSITY OF CAMBRIDGE INTERNATIONAL EXAMINATIONS General Certificate of Education Advanced Subsidiary Level and Advanced Level ECONOMICS 9708/21 Paper 2 Data Response and Essay (Core) May/June 2011 1 hour 30 minutes Additional Materials: Answer Booklet/Paper READ THESE INSTRUCTIONS FIRST If you have been given an Answer Booklet, follow the instructions on the front cover of the Booklet. Write your Centre number, candidate number and name on all the work you hand in. Write in dark blue or black pen. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters, glue or correction fluid. Section A Answer this question. Brief answers only are required. Section B Answer any one question. You may answer with reference to your own economy or other economies that you have studied where relevant to the question. At the end of the examination, fasten all your work securely together. The number of marks is given in brackets [ ] at the end of each question or part question. * 7 4 9 4 7 1 5 2 6 6 *

2 9708/21/M/J/11 © UCLES 2011 Section A Answer this question. 1 Problems for Dairy Farmers in the United States Milk is used to make a range of products, including butter, cheese and ice cream, as well as serving as a drink. This was of no help to US dairy farmers in 2009 when they faced a falling price for their milk. Fig. 1 shows the extent of the price change in recent years. While consumers purchase milk by volume (litres), farmers are paid by weight (kilograms). Fig. 1: Average milk price paid to farmers in the US, Jan 2007 to August 2009 40 35 Price in euros (€) per 100 kg 30 25 20 15 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Dec 2007 2007 2008 2008 2009 2009 2007 2008 2009 Nov A price fall was also experienced by New Zealand as shown in Table 1. Table 1: Average annual milk price (€ per 100 kg) in the US and New Zealand, 2007–2009 2007 2008 2009 US 30.69 27.49 19.30 New Zealand 22.48 25.17 16.21 US farmers blamed their problems on the global recession, the strength of the US$ and high cattle feed prices. At the same time, New Zealand and Australia increased their exports and the European Union (EU) reintroduced its export subsidies on milk products. The world milk industry has often had support from governments that have paid subsidies to farmers and supplied free milk to young children. US farmers were hoping for extra government intervention.

3 9708/21/M/J/11 © UCLES 2011 (a) (i) Compare the average milk price paid to farmers in the US in August 2008 with that in August 2009. [2] (ii) How far does Fig. 1 suggest that the price of milk is subject to regular seasonal influences? [2] (b) (i) Compare the changes in milk prices in the US and in New Zealand between 2007 and 2009. [2] (ii) Explain two possible reasons for the different level of milk prices in the US and New Zealand. [4] (c) Explain how one group, other than dairy farmers, would lose from lower milk prices and how another group would gain from lower milk prices. [4] (d) Discuss the case for the use of government subsidies for the production of milk. [6] Section B Answer one question. 2 (a) Explain the functions of an economic system. [8] (b) Discuss possible reasons why mixed economic systems have replaced most of the former planned economic systems. [12] 3 (a) Explain how the effects of a devaluation on the level of economic activity differ from those of a deflation. [8] (b) Discuss whether inflation can be both the cause and the result of fluctuations in an economy’s exchange rate. [12] 4 (a) Explain how the different international transactions of a country are recorded in its balance of payments account. [8] (b) Discuss the use of tariffs and quotas as policies to reduce a current account deficit. [12]

4 9708/21/M/J/11 © UCLES 2011 BLANK PAGE Copyright Acknowledgements: Question 1 © Farmgate prices of milk USA; www.clal.it; 2 September 2009. Permission to reproduce items where third-party owned material protected by copyright is included has been sought and cleared where possible. Every reasonable effort has been made by the publisher (UCLES) to trace copyright holders, but if any items requiring clearance have unwittingly been included, the publisher will be pleased to make amends at the earliest possible opportunity. University of Cambridge International Examinations is part of the Cambridge Assessment Group. Cambridge Assessment is the brand name of University of Cambridge Local Examinations Syndicate (UCLES), which is itself a department of the University of Cambridge.

UNIVERSITY OF CAMBRIDGE INTERNATIONAL EXAMINATIONS GCE Advanced Subsidiary Level and GCE Advanced Level MARK SCHEME for the May/June 2011 question paper for the guidance of teachers 9708 ECONOMICS 9708/21 Paper 2 (Data Response and Essay – Core), maximum raw mark 40 This mark scheme is published as an aid to teachers and candidates, to indicate the requirements of the examination. It shows the basis on which Examiners were instructed to award marks. It does not indicate the details of the discussions that took place at an Examiners’ meeting before marking began, which would have considered the acceptability of alternative answers. Mark schemes must be read in conjunction with the question papers and the report on the examination. • Cambridge will not enter into discussions or correspondence in connection with these mark schemes. Cambridge is publishing the mark schemes for the May/June 2011 question papers for most IGCSE, GCE Advanced Level and Advanced Subsidiary Level syllabuses and some Ordinary Level syllabuses.

Page 2 Mark Scheme: Teachers’ version Syllabus Paper GCE AS/A LEVEL – May/June 2011 9708 21 © University of Cambridge International Examinations 2011 1 (a) (i) Compare the average milk price paid to farmers in the US in August 2008 with that in August 2009? [2] Fell (1), by €9 or 33% approx (1) Allow range of figures €8.7–9.5 or 32%–35% (ii) How far does Fig. 1 suggest that the price of milk is subject to regular seasonal influences? [2] No / Very little (1), supporting reference to data (1) (b) (i) Compare the changes in milk prices in the US and in New Zealand between 2007 and 2009. [2] Both fell overall (1), US price fell continuously, NZ price rose then fell (1), US price fell more in % and absolute terms. NZ prices fell more rapidly 2008–9. Any two points (ii) Explain two possible reasons for the different level of milk prices in the US and New Zealand. [4] Allow two interpretations of the question 1. Why US prices are higher than those in NZ The price difference may reflect productivity, costs of production / efficiency, government action, € exchange rate, comparative advantage, demand and supply conditions etc. Identified reason (1), explained reason (2). 2. Why are prices falling in US and NZ, as above. (c) Explain how one group, other than dairy farmers, would lose from lower milk prices and how another group would gain from lower milk prices. [4] Losers: Government (increased farm support expenditure, reduced tax income); associated activities e.g. farm suppliers (lower sales); local retailers (less demand from farmers); banks (loan defaults); farm workers (wages, employment), producers of substitutes. Gainers: Consumers (lower prices); producers of milk-based goods (lower costs) (d) Discuss the case for the use of government subsidies for the production of milk. [6] Benefits: increase exports, reduce imports, support essential industry and employment, lower prices for basic foodstuff for low incomes, promotion of merit good etc. to max. (4) Problems: financial cost (taxation), opportunity cost, misdirection of resources, inefficiency, dependence, etc. to max. (4)

Page 3 Mark Scheme: Teachers’ version Syllabus Paper GCE AS/A LEVEL – May/June 2011 9708 21 © University of Cambridge International Examinations 2011 2 (a) Explain the functions of an economic system. [8] An economic system is the means by which a country answers the basic economic problem. Limited resources and unlimited wants result in scarcity and choices have to be made. The system allows the questions of what?, how?, and for whom? to be answered. It arranges for resources to be employed to meet demands and for producers and consumers to be satisfied. This may be done by the price system, state planning or a mixture of the two. Understanding of the economic problem 2 marks Explanation of the role of the economic system 6 marks (b) Discuss possible reasons why mixed economic systems have replaced most of the former planned economic systems. [12] Planned economies are based on state control and direction while a mixed economy uses the market system supported by appropriate government intervention. Recent history illustrates the failure of the planned economy to raise living standards and perform as well as mixed economies. Mixed economies proved more efficient, more innovative, more flexible and provided greater choice and higher living standards. Planned economies were unable to coordinate economic decision making, lacked incentives, lacked quality control, were slow to change and caused considerable environmental damage. Despite the attempts of planned economies to provide citizens with security and a minimum standard of living, the advantages of the mixed economy were more highly valued. Understanding of the two types of system 2 marks Analysis of the performance of the planned system up to 6 marks Discussion of the relative merits of the two systems up to 6 marks max. 10

Page 4 Mark Scheme: Teachers’ version Syllabus Paper GCE AS/A LEVEL – May/June 2011 9708 21 © University of Cambridge International Examinations 2011 3 (a) Explain how the effects of a devaluation on the level economic activity differ from those of a deflation. [8] Devaluation is the lowering by the government of a currency’s international value under a fixed exchange rate system. Deflation refers to a persistent fall in the general price level or a lower level of economic activity possibly resulting from government policy. Devaluation should improve the current account and boost the economy with higher demand, employment and growth. Deflation harms confidence, reduces spending and increases unemployment. Understanding of devaluation and deflation 4 marks Explanation of the different effects 4 marks (b) Discuss whether inflation can be both the cause and the result of fluctuations in an economy’s exchange rate. [12] Higher inflation than trading partners may mean a fall in the exchange rate because of increased supply and reduced demand for the currency. This will result from fewer exports, more imports, reduced confidence and outflows of investment. Overall it would mean a worsening of the balance of payments. A fall in the exchange rate will increase the cost of imports (cost push inflation) and increase the demand for exports (demand pull inflation). A rise in the exchange rate would reduce inflationary pressure. Whether these effects occur will depend upon the rate of inflation, the relative rates of inflation, the government’s ability to control inflation, the nature of the exchange rate system and the direction of the change in the exchange rate. Understanding of inflation and the exchange rate 2 marks Analysis of the impact of the changes up to 6 marks Discussion of the conditions affecting the process up to 6 marks max. 10

Page 5 Mark Scheme: Teachers’ version Syllabus Paper GCE AS/A LEVEL – May/June 2011 9708 21 © University of Cambridge International Examinations 2011 4 (a) Explain how the different international transactions of a country are recorded in its balance of payments accounts. [8] The transactions involve trade in goods and services, incomes from work and investment, profits and dividends (IPD), government and private transfers (remittances), direct investment, portfolio investment and short term capital flows. The items are recorded as inflows (+) or outflows (-) and divided between the current account (goods and services, income and transfers) and the capital and financial accounts. Understanding nature of international transactions up to 3 marks Explanation of the recording of the items in the balance of payments up to 5 marks (b) Discuss the use of tariffs and quotas as policies to reduce a current account deficit. [12] Current account deficit means more outflows than inflows on trade, transfers and income. Tariffs are a tax on imports while quotas are a limit on quantity of imports. A tariff will raise revenue and be more effective the higher the price elasticity of demand and will operate through the market system. A quota will be effective when demand and supply are inelastic, will work with more certainty and benefit is more likely to accrue to the importer. Both methods involve intervention in the free market and may attract retaliation, there may be difficulty in setting the right level, they will have administrative costs and will be ineffective if the cause of the deficit is the performance in the income or transfer sections. Understanding of current deficit, tariff and quota up to 3 marks Analysis of the operation of tariffs and quotas up to 4 marks max. 12 Discussion of their merits and drawbacks up to 6 marks