Cambridge A Level Economics 9708 — 2018 Feb/March Paper 2 · Variant 2

1 Venezuela’s worsening economic crisis Table 1.1: Venezuela – Economic Indicators 2014–2017 2014 2015 2016 2017 (estimated) (estimated) Inflation: average % change 62.2 121.7 481.6 1642.8 in consumer prices Growth: % change in real –3.9 –5.7 –8.0 –4.5 output Unemployment: % of labour 7.2 7.4 17.4 20.7 force unemployed Source: International Monetary Fund Venezuela is suffering the worst economic crisis in its history. Ordinary people in this oil-rich country are regularly going without food. Angry, hungry mobs are queuing outside almost empty supermarkets. The government has declared a state of emergency, food is being transported under armed guard, and basic necessities are being rationed. People have to queue for hours and sometimes overnight to receive basic commodities, such as rice and cooking oil. Venezuela has the largest known oil reserves in the world — even greater than Saudi Arabia. In the past the government used money from oil exports to fund its own expenditure and to support domestic consumption. In addition, more than 1200 private companies in a wide range of sectors, such as sugar plantations and dairy farms, were nationalised. But in 2015 the oil price fell by 50% and this resulted in a shortage of money to fund government spending. The government maintained their spending by printing money, fuelling inflation. As Venezuela’s currency, the bolivar, was losing value, those holding bolivars increasingly exchanged them for US dollars. As a result, a restriction was placed upon those who could legally buy US dollars and the exchange rate was fixed. Unable to buy US dollars legally, businesses turned to the black market, where the value of the US dollar soared. While the official exchange rate is 10 bolivars per US dollar, the bolivar now trades on the black market at more than 1000 bolivars per US dollar. The collapse of the currency is made worse by oil’s continuing low price — Venezuela can no longer rely on its oil exports bringing back enough US dollars, which means it can’t import enough goods, leading to shortages. The government tried to ration basic foodstuffs and fix their prices, but as a result it became unprofitable for Venezuelan companies to make such things, and as a consequence they have simply disappeared from the shops into other illegal markets. Source: The Guardian, 22 June 2016 (a) Use a production possibility curve diagram to show what is expected to happen to the Venezuelan economy between 2014 and 2017. [2] (b) Explain what the change in the price of oil in 2015 and the resulting fall in Venezuela’s earnings from oil exports suggest about the price elasticity of demand for Venezuelan oil. [2] (c) Explain why price controls have resulted in shortages of basic foodstuffs in the shops in Venezuela. Use a demand and supply diagram to support your answer. [4] (d) With reference to the data, analyse how both demand-pull and cost-push pressures could explain the change in the rate of inflation shown in Table 1.1. [6] (e) Discuss whether the estimated rate of inflation in Venezuela will allow the bolivar to continue to perform all of its functions as money. [6]

Mark scheme: 1(a) For an accurate diagram that is correctly labelled with appropriate axes and the PPC touching both axes. (1 mark) Shows an appropriate change: a shift to the left as the productive potential of the economy falls or a movement to a point further within the curve as more unemployment occurs. (1 mark) 2 The diagram can show either a shift inwards in the PPC as the economic growth is negative and the productive potential changes or a movement to a point further inside the curve as unemployment increases. 1(b) For identification that the fall in export earnings as a result of the fall in the price of oil implies that the price elasticity of demand of oil is inelastic. (1 mark) For a clear explanation that this will result because the fall in the price of oil will have resulted in a smaller % change in quantity relative to the % change in price. (1 mark) 2 If a fall in the price of oil leads to a fall in export earnings this means that the price elasticity of demand is inelastic because a fall in price has resulted in a lower percentage rise in sales. 1(c) For an accurately labelled diagram (1 mark) Diagram shows a maximum price placed below equilibrium (1 mark) For an identification of the excess demand (1 mark) For a brief accompanying explanation of how the shortage has arisen (1 mark) 4 Maximum prices placed below equilibrium will mean that an excess demand for basic foodstuffs. This will result in shortages in the shops. 1(d) For an explanation of the creation of demand-pull inflation with due reference to the increase in the money supply related in the data. (Up to 3 marks) For an explanation of the creation of cost-push inflation with due reference to the collapse of the bolivar related in the data. (Up to 3 marks) 6 The data makes it clear that there has been an increase in the money supply as the Venezuelan government printed money to maintain it’s spending. This will create demand-pull inflation. The data also makes it clear that the collapse of the bolivar has increased the costs of imported products. As a result this will create cost-push inflation. (It may also increase demand- pull inflation as exports become cheaper and X-M increases) Question Answer Marks Guidance 1(e) For an explanation of how any function of money will be affected by the high rate of inflation (Up to 2 marks per function explained) 5 marks maximum for explanations (reserve 1) A reasoned conclusion on whether all the functions of money will be affected. (1 mark) 6 A list of functions with no discussion of how these might be affected by inflation scores maximum 1 mark The high and increasing rate of inflation will undermine the bolivar’s ability to perform its functions as money. Candidates need to identify the functions of money and then explain how these will be affected by the high rate of inflation. Whether they will all be affected depends upon the rate at which inflation rises. Candidates need to recognise this and there should be a concluding comment on whether all the functions of money will be affected.

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2 (a) Explain how governments face increasing opportunity cost in their decision-making. Use a production possibility curve diagram to support your answer. [8] (b) Discuss whether decision-making is more effective when undertaken by governments in a planned economy rather than by individuals in a free market economy. [12]

Mark scheme: 2(a) AO1: knowledge and understanding illustrated with a correctly labelled diagram with a concave PPC (Up to 2 marks) For an explanation of the choice and opportunity cost facing governments in deciding which goods and services to produce in their economy (Up to 2 marks) AO1: maximum 4 marks AO2: application recognising that the opportunity cost increases as resources shift from the production of one type of good to another (1 mark) Explanation of why costs increase as the combination of goods produced changes with due reference to the suitability of resources. (Up to 3 marks) AO2: maximum 4 marks 8 Opportunity cost is the cost in terms of the next best alternative foregone. Governments face opportunity cost when they have to decide what to produce. This can be expressed using ppc diagrams. For example, the opportunity cost of government spending on health is the spending on defence that has to be foregone. As resources are shifted from the production of one good to another the cost increases. The sacrifice becomes greater as less appropriate resources are used to produce alternative goods and services. Question Answer Marks Guidance 2(b) AO3: analysis of the advantages and disadvantages that arise when resources are allocated through central planning. (Up to 4 marks) Analysis of advantages and disadvantages that arise when resources are allocated through the free market. (Up to 4 marks) AO3: maximum 8 marks For evaluation of the strengths and weaknesses of the two systems (Up to 3 marks) Conclusion on which system is most effective. (1 mark) AO4: maximum 4 marks 12 In a planned economy national, regional and local planning committees undertake decision-making. Decision- making in this system lacks signals transmitted through the price mechanism to express consumer wants. In a free market economy the factor enterprise allocates resources in response to signals from consumers through the price mechanism.

More questions on Resource allocation in different economic systems

3 (a) Explain the way in which economists measure how much the supply of a good changes as its price changes. Explain two factors that influence the result. [8] (b) Discuss how supply-side policies might increase the stock of capital goods and the quantity of labour supplied to an economy. Consider whether these policies will be effective for each of these factors of production. [12]

Mark scheme: 3(a) AO1: knowledge and understanding showing an accurate formula to measure price elasticity of supply (1 mark) For a clear and accurate understanding of either elastic supply or inelastic supply (1 mark) AO1 and AO2: knowledge and understanding and application providing explanation of two factors that influence the price elasticity of supply. (Up to 3 marks per factor explained) Maximum 8 marks 8 Candidates need to understand the concept of price elasticity of supply and the factors that influence it such as the availability of factors of production, the nature of the product and the time period under consideration. 3(b) AO3: analysis explaining how supply–side policies could improve the stock of capital goods. (Up to 4 marks) Analysis explaining how supply–side policies could improve the supply of labour. (Up to 4 marks) AO3: maximum 8 marks For evaluative comment considering whether these policies would be effective in both cases (Up to 3 marks) Conclusion (1 mark) AO4: maximum 4 marks 12 Supply side policy attempts to increase aggregate supply in an economy. This can be achieved in a number of ways. For e.g. improving incentives through tax cut, subsidising capital formation and increasing the provision of education in an economy. Candidates need a firm grasp of the appropriate policy for increased capital formation and increases in the supply and quality of labour.

More questions on Supply-side policy

4 (a) Describe what is meant by a rise in an economy’s terms of trade. Outline how a change in an economy’s exchange rate and its domestic price level might each cause this to come about. [8] (b) Discuss whether a rise in an economy’s terms of trade is likely to be of overall benefit to that economy. [12]

Mark scheme: 4(a) AO1: knowledge and understanding showing an accurate formula that measures the terms of trade (1 mark) For a clear understanding of any change in export prices and/or import prices that would represent a rise in the terms of trade (1 mark) AO1 and AO2 knowledge and understanding and application showing why a change in an economy’s exchange rate might lead to a rise in an economy’s terms of trade. • the exchange rate rises (1 mark) • export prices rise, import prices fall and this is expected to lead to a rise in that economy’s terms of trade (1 mark) • whether the terms of trade does rise depends upon whether there are other factors to offset the effect of the rise in this exchange rate (one example required e.g. a higher rate of inflation in other countries) (1 mark) For knowledge and understanding and application showing why a change in an economy’s domestic price level might lead to a rise in an economy’s terms of trade. • the price level rises (1 mark) • the price of exports rises and this is expected to lead to a rise in that economy’s terms of trade (1 mark) • whether the terms of trade does rise depends upon whether other factors offset the effect of the rise in that economy’s domestic price level (one example required e.g. a fall in the country’s exchange rate) (1 mark) Maximum 8 marks 8 Candidates need a good knowledge of the terms of trade and be able to explain why a rise in an economy’s terms of trade might result from a change in an economy’s exchange rate and it’s inflation rate. A key word in the question is ‘might’ so one mark is reserved for identifying a reason why the changes might not lead to a rise in the terms of trade. Question Answer Marks Guidance 4(b) AO3: analysis of the positive effects of the rise in the terms of trade. (Up to 4 marks) Analysis of the negative effects of the rise in the terms of trade. (Up to 4 marks) AO3: maximum 8 marks For evaluative comment on the overall benefit aspect of the rise. (Up to 3 marks) Conclusion (1 mark) AO4: maximum 4 marks 12 A rise in the terms of trade might have several benefits but there will also be negative effects. The rise will mean that more imports can be purchased per unit of exports. The negative effects include the decline in the international competitiveness of goods produced by the country and the possibility of a current account deficit.

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