Cambridge A Level Economics 9708 — 2017 May/June Paper 2 · Variant 3

1 Zambia bears the brunt of China’s economic slowdown Fig. 1: Zambian kwacha and copper price 5 7500 6 7000 Zambian kwacha 7 6500 copper price against the (US$ per tonne) US dollar 8 6000 (kwacha per US$), inverted scale 9 5500 10 5000 Jan Jan Sep 2014 2015 Key copper price kwacha per US$ Source: Thomson Reuters Datastream Zambia was one of Africa’s main beneficiaries when China’s economy was expanding. With copper its key export, China’s huge demand for minerals helped the southern African nation enjoy a decade of economic boom. But as China’s economy slows down, Zambia finds itself with real problems. A large mining group has announced it is to suspend production for 18 months. In addition, a Chinese-owned company has said it will suspend operations and cut jobs in Zambia because of the copper price. The situation highlights the vulnerability of Africa’s resource-dependent nations to the fortunes of China. Zambia is Africa’s second biggest copper producer and depends on the metal for about 70% of its foreign exchange earnings and 25–30% of government revenue. Copper prices have fallen 18% this year, sliding to a six year low of below US$5 000 per tonne last month. As a result, Zambia has been ranked top of an index of African nations most exposed to China’s slowdown. In 2012, Zambian exports to China amounted to 4.3% of Zambia’s national income. During the boom years, mining led to billions of dollars of investment. Much of this was foreign direct investment from China. The sector was a key driver of Zambia’s economy, which grew by an annual average of 6.4% over the last decade – one of the world’s fastest growth rates. The Zambian government is now struggling to balance its budget. It is expected that the 2015 fiscal deficit will be much greater than previously estimated, and the government has pledged to reduce its spending. A further problem is that the weakness of Zambia’s currency, the kwacha, risks feeding through into inflation. The government has spoken of the need for economic diversification to reduce the country’s dependence on copper. This is a tough task which China’s slowdown has highlighted for many resource‑rich African nations. Source: Financial Times, 9 September 2015 (a) (i) What is the overall trend in the value of the Zambian kwacha from January 2014 to September 2015 shown in Fig. 1? [1] (ii) Explain why the economic slowdown in China has resulted in this change in the value of the kwacha. [3] (iii) Explain how the change in the value of the kwacha might feed into inflation in Zambia. [4] (b) Explain how the fall in China’s demand for copper would be likely to affect each of the components of aggregate demand in Zambia. [6] (c) Consider whether economic theory would support the view that diversification of the Zambian economy is the most effective way of tackling the problems it faces as a result of the slowdown of China’s economy. [6]

Mark scheme: 1(a)(i) The trend in the value of the Kwacha is declining or downward (1 mark) 1 1(a)(ii) For an explanation of the fall in the demand and the price of copper as a result of China’s slowdown (1 mark) For an explanation of how the fall in the price of copper has resulted in a fall in the demand for the Kwacha and a fall in the Kwacha’s value as the demand for the currency is less than the sUpply. (Up to 2 marks) 3 The slowdown of China’s economy has reduced the demand for minerals including copper. The result is a fall in the price of copper shown in Fig.1. Zambia’s export earnings have fallen leading to a fall in the demand for the Kwacha and a fall in its value. 1(a)(iii) Up to 4 marks for an explanation of cost-push inflation in the context of Zambia’s economy • For recognition that a fall in the value of the Kwacha will make Zambia’s imports more expensive. (1 mark) • For an explanation that this will lead to rising costs for Zambia’s producers and consumers (Up to 2 marks) • For clear recognition that this represents cost-push inflation (1 mark) Allow credit for explanations of demand-pull inflation if consistent with the context of the extract. 4 The change in the value of the Kwacha is likely to cause cost-push inflation through the rise in import prices. There will be a rise in the price of imported raw materials and components used by Zambian businesses and pressure Upon the components of Zambian household expenditure. Theoretically, the decline in the Kwacha could generate demand-pull inflation, but given the context of the extract, this is unlikely. Question Answer Marks Guidance 1(b) For identification of all the components of aggregate demand: • For C+I+G+X-M (1 mark) • Or Consumption + Investment + government spending + net exports (2 marks) (2 marks maximum) For explaining: • how consumption might be affected (1 mark) • how investment might be affected (1 mark) • how government spending might be affected (1 mark) • how net exports might be affected (1 mark) (4 marks maximum) 6 The notation for aggregate demand is worth only one mark. If the components are named then two marks are available. China’s declining demand for copper is likely to: • reduce consumption because household incomes fall • reduce investment because business activity declines • increase government spending because welfare payments to the unemployed rise or through counter- cyclical government spending Or it may reduce government spending because as tax receipts will fall and the government will tighten its belt. Either is accepted as long as an explanation is included • Net exports will fall in the short-run, but may rise in the long-run as the Kwacha declines. • An explanation of the likely changes is necessary to score a mark here. 1(c) • For identifying and explaining the relevant economic theory (1 mark) • For a discussion of the costs and benefits of diversification (Up to 3 marks) • For a discussion of the costs and benefits of specialisation (Up to 3 marks) (5 marks maximum) For a reasoned conclusion on whether specialisation or diversification is more effective. (1 mark) 6 Diversification of the Zambian economy implies that specialisation on copper production should be abandoned and other sectors developed. This runs counter to the principle of comparative advantage which suggests that economies should specialise in producing goods and services that have the lowest opportunity costs. Some candidates might develop arguments that justify diversification, but these should be assessed in terms of underlying economic theory.

More questions on Exchange rates

2 (a) Use the concept of income elasticity of demand to explain how a rise in incomes would affect the demand for an inferior good and for a necessary good. [8] (b) Discuss the range of policies that are available to businesses to increase sales when incomes are falling. Consider which is most likely to be successful. [12]

Mark scheme: 2(a) For knowledge and understanding of the concept of income elasticity of demand • For statement of what the concept measures (1 mark) • For an accurate formula (Up to 2 marks) • For elaboration e.g. in terms of elastic/inelastic (1 mark) (4 marks maximum) For application: • showing how inferior goods react when incomes rise. (2 marks) • showing how necessary goods react when incomes rise (2 marks) (4 marks maximum) concept of income elasticity of demand and how it is used by economists to distinguish between inferior and necessary goods as incomes rise. 2(b) For analysis • of any policy available to business to increase sales when incomes are falling with due reference to the strengths and weaknesses of the policy. (Up to 6 marks for each policy) (8 marks maximum) For evaluation that assesses and compares • the relative strengths and weaknesses of each policy (Up to 3 marks) • to reach a conclusion concerning which policy is most likely to be successful. (1 mark) (4 marks maximum) 12 Policies that are available include reducing the price of the good, advertising to increase demand and switching production to inferior goods. Reward attempted evaluation. For example, it might be difficult to maintain sales through price cuts if demand is inelastic. Advertising might be expensive. Switching production to inferior goods might be difficult if the business has invested in capital. Allow a mark for the conclusion offered if it is based Upon the evaluative comment.

More questions on Differing objectives and policies of firms

3 (a) Explain the role of profit in an economy where the price mechanism operates to allocate resources. [8] (b) Discuss whether resources are more effectively allocated in a planned economy or in a market economy. [12]

Mark scheme: 3(a) For knowledge and understanding of: • profit as the reward to the factor enterprise for organising the factors of production and taking the risk of production (4 marks maximum) For application: • That shows how, motivated by profit, entrepreneurs allocate resources in response to price signals in a market economy. (4 marks maximum) understanding of the role of profit as reward to enterprise for the undertaking of the risk and organisation of production and the way in which enterprise responds to price changes in order to receive the reward of profit. Diagrams may be used, but are not essential for full marks. 3(b) For analysis containing: • an explanation of the way in which resources are allocated in a planned economy with due reference to the strengths and weaknesses of allocation in this type of economy (Up to 6 marks) • an explanation of the way in which resources are allocated in a market economy with due reference to the strengths and weaknesses of allocation in this type of economy (Up to 6 marks) (8 marks maximum) For evaluation that assesses and compares • the relative strengths and weaknesses of the allocation of resources in each economy (Up to 3 marks) • and reaches a conclusion on which type of economy allocates resources most effectively (1 mark). (4 marks maximum) 12 Candidates need to be aware of the way in which resources are allocated in each type of economy and the strengths and weaknesses of each. These include the lack of production of public goods in a market economy. Also, the underproduction of merit goods and the overproduction of de-merit goods. The weakness of a planned economy includes the lack of price signals with the result that there are often shortages and surpluses in the market.

More questions on Resource allocation in different economic systems

4 (a) Explain how the functions of money are affected when there is a high rate of inflation in an economy. [8] (b) Discuss how effective monetary policy is likely to be in correcting both inflation and deflation when they each occur in an economy. [12]

Mark scheme: 4(a) For knowledge and understanding of the four functions of money: • Medium of exchange (1 mark) • Store of value (1 mark) • Unit of account (1 mark) • Standard of deferred payment (1 mark) (4 marks maximum ) For application • showing how each function will be affected by a high rate of inflation (4 marks maximum) 1 maximum for the knowledge and understanding element. Only a brief explanation of how each function of money is affected is required. 4(b) For analysis containing: • an explanation of the way in which monetary policy can be used to solve the problem of inflation with due reference to the effectiveness of such a policy (Up to 4 marks) • an explanation of the way in which monetary policy can be used to solve the problem of deflation with due reference to the effectiveness of such a policy (Up to 4 marks) (8 marks maximum) For evaluation that assesses and compares • the likely effectiveness of monetary policy in solving inflation with its likely effectiveness in solving deflation (3 marks) • and reaches a conclusion on whether it is likely to be effective in solving only one or both problems (1 mark) (4 marks maximum) 12 Monetary policy is any action taken by the monetary authorities to change the quantity of money, the rate of interest or credit terms. It is usually operated by the central bank of an economy. When faced with inflation it is likely that the central bank will limit the money supply, raise the rate of interest and tighten credit controls. When faced with deflation these measures would be reversed. Whether the policy is likely to be effective depends Upon the extent to which spending is sensitive to changes in the money supply, the rate of interest and credit terms. If only inflation or deflation considered then 4 maximum.

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