Cambridge A Level Economics 9708 — 2018 May/June Paper 2 · Variant 1

1 Russia’s economic problems are getting worse Russia’s currency, the rouble (RUB), has been falling rapidly in value. Content removed due to copyright restrictions An index of the real exchange rate fell from a value of 100 in 2010 to 75.8 in 2015 and this should have the effect of eventually helping to encourage exports. Source: Adapted from The Economist Table 1.1: Selected economic indicators for Russia 2013–2015 Economic Indicator 2013 2014 2015 Annual inflation rate 6.8% 7.8% 15.4% Economic growth rate 1.3% 0.6% –3.9% Nominal exchange rate 38.4 56.3 61.3 (RUB per US$) Source: Adapted from The World Fact Book (a) (i) Using Table 1.1, calculate the percentage fall in the nominal value of the rouble against the US dollar between 2013 and 2015. [2] (ii) Explain the difference between a nominal exchange rate and a real exchange rate. [2] (b) Explain, using a demand and supply diagram, how the fall in the price of a barrel of oil contributed to a decline in the value of the rouble. [4] (c) Analyse the likely impact the depreciation of the rouble could have on the Russian economy. [6] (d) Discuss whether the privatisation of some state assets would be of overall benefit to the Russian economy. [6]

Mark scheme: 1(a)(i) 2013: 38.4 RUB against the US dollar 2015: 61.3 RUB against the US dollar A fall of 22.9 compared with initial value of 38.4 = a fall of 59.63541% Accept a fall of 59.6% or 59.64% 2 wrong answer 2 marks for correct answer, even if no calculation method shown 1(a)(ii) • A nominal exchange rate is one that is expressed in money terms without taking into account the effects of inflation (1) • A real exchange rate is one where a nominal exchange rate has been adjusted, taking into account the effects of inflation on the value of a currency in terms of its purchasing power / reflects the purchasing power of money at constant prices (1) 2 1(b) Diagram: • P, Q, D and S all correctly shown and labelled (1) • Shift of the demand curve for roubles to the left (1) Explanation: • Russia’s exports are heavily dependent on oil; the oil price has tumbled from its mid-2014 peak of over US$100 a barrel to only about US$40 a barrel (1) • This has meant that other countries needed fewer roubles to buy oil from Russia, causing a shift of the demand curve to the left with a resulting fall in the price and in the quantity traded (1) 4 Question Answer Marks Guidance 1(c) Analysis of positive effects Up to 4 marks Analysis of negative effects Up to 4 marks Maximum of 6 marks 6 A depreciation of the Russian rouble would make exports cheaper, making them more price competitive on the international market, and this could lead to an increase in the demand for them. It would also make imports dearer, making them less price competitive on the international market, and this could lead to a decrease in the demand for them. The overall effect could therefore be an improvement in the current account balance, which would be advantageous to the Russian economy. The actual effect of the depreciation will depend on the extent to which the demand for both exports and imports is price elastic. Candidates could refer to the Marshall-Lerner condition which states that the depreciation will only lead to an improvement in the current account balance if the sum of the price elasticity of demand for exports and the price elasticity of demand for imports is greater than 1. Candidates could also refer to the J-curve effect which states that the current account balance will get worse before it gets better. Candidates could also refer to the fact that the imported goods could include imported raw materials and components, leading to an increase in the cost of production which would not be advantageous to the Russian economy. In addition to the balance of payments effects, candidates may also consider possible inflation, employment and growth effects. Question Answer Marks Guidance 1(d) For identification and explanation of the possible benefits of privatisation (Up to 3 marks) For identification and explanation of the possible costs of privatisation (Up to 3 marks) (5 marks maximum for explanation) For evaluative conclusion on the factors identified in relation to whether the privatisation of some state assets would be of overall benefit for the Russian economy. (1 mark for evaluation) 6 Definition of privatisation: the transfer of the ownership of a firm or an industry from the state or public sector to the private sector. The sale of some state assets would bring revenue in. The sale of some state assets would reduce public expenditure on such assets. The overall effect of increasing public revenue and reducing public expenditure would be to contribute positively to a reduction in the size of the budget deficit in Russia, although it is uncertain whether this would be sufficient to bring down the size of the budget deficit from 7% of GDP to 3% of GDP. The privatisation of some state assets could also lead to an improvement in efficiency. However, privatisation will lead to firms aiming for profit maximisation and this could lead to detrimental effects on the Russian economy, such as an increase in unemployment.

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2 (a) Explain why both merit goods and demerit goods are examples of private goods. [8] (b) Discuss whether merit goods and demerit goods are best provided by a market economy. [12]

Mark scheme: 2(a) For knowledge and understanding of merit goods and demerit goods. Knowledge and understanding of merit goods as an example of a product that is under-consumed as a result of information failure. (Up to 3 marks) Knowledge and understanding of demerit goods as an example of a product that is over-consumed as a result of information failure. (Up to 3 marks) (KU total: Up to 4 marks) For application showing how merit goods and demerit goods are examples of a private good. Application to examples of merit goods, such as education and health care. (Up to 3 marks) Application to examples of demerit goods, such as cigarettes and alcohol. (Up to 3 marks) (APP total: Up to 4 marks) 8 failure in relation to both merit goods and demerit goods. Both merit goods and demerit goods are examples of a private good because: There is rivalry in consumption, i.e. once a product has been consumed by one person, it cannot be consumed by another person. There is excludability in consumption, i.e. it is possible to exclude a person from consuming a product if another person has consumed it and they have not paid for it. Question Answer Marks Guidance 2(b) For analysis of the provision of merit goods through a market economy. (Up to 4 marks) For analysis of the provision of demerit goods through a market economy. (Up to 4 marks) (AN total: Up to 8 marks) For evaluative comment on whether the provision of merit goods and demerit goods through a market economy will always be the best form of provision. (1 mark for a conclusion) (EV total: Up to 4 marks) 12 Advantages of a market economy: Possible advantages of a market economy, such as decisions taken by individual consumers, who aim to maximise utility/satisfaction, and by individual producers, who aim to maximise profits. Important role of a price mechanism to allocate resources efficiently, with prices acting as a signalling device. There is likely to be greater efficiency arising from the existence of a profit motive and of competition, with no government intervention. Disadvantages of a market economy: A market economy, as well as having potential benefits, can also have potential drawbacks, such as the under-production of merit goods and the over-production of demerit goods.

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3 (a) Explain the factors that can affect the price elasticity of demand for a product. [8] (b) Discuss the extent to which knowledge of a product’s cross-elasticity of demand is likely to be important to a firm supplying that product. [12]

Mark scheme: 3(a) For knowledge and understanding of the concept of price elasticity of demand as the percentage change in the quantity demanded of a product divided by the percentage change in the price of the product. (KU total: Up to 2 marks) For application of factors to the determination of the PED of a product. The question does refer to factors, i.e. a minimum of two factors need to be explained. Up to 3 marks for one factor that is very well explained. A candidate needs to explain a minimum of two factors to gain all 6 marks. (APP total: Up to 6 marks) 8 that can affect the PED for a product: • the period of time • the number and availability of substitutes • the degree of necessity • the durability of a product • the proportion of income taken by a product • the width of definition of a product • the amount of money spent on a product 3(b) For analysis of the importance of XED to a firm. Analysis of a positive XED. (Up to 4 marks) Analysis of a negative XED. (Up to 4 marks) (AN total: Up to 8 marks) For evaluative comment on the extent to which XED is likely to be important to a firm supplying that product (1 mark for a conclusion) Candidates need to consider that the extent to which XED is likely to be important to a firm supplying a particular product will depend on a number of factors, such as how close a substitute or a complement is to the firm’s product and so how significant a change in a competitor’s price will be, and how large the original price change was. XED is likely to be more important when the relationship between two products is a close one. Candidates could evaluate whether XED is likely to be more or less useful than PED or YED. Candidates could also bring zero cross elasticity of demand into the discussion. (EV total: Up to 4 marks) 12 Candidates can comment on whether XED is positive, which will be the case if the two products are substitutes, giving rise to competitive demand, or whether it is negative, which will be the case if the two products are complements, giving rise to joint demand. XED is important to the decisions of a firm, enabling it to estimate the effect on the demand for one of its products of a change in the price of a substitute or a complement in the market.

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4 (a) Explain the characteristics that money needs to have in order to perform its functions effectively. [8] (b) Discuss the likely consequences for an economy of an increase in the money supply. [12]

Mark scheme: 4(a) For knowledge and understanding of the characteristics of money. (KU total: Up to 4 marks) For application showing how the characteristics of money are necessary in order for money to perform its functions effectively, e.g. money needs to be divided into smaller units so that products at various prices can be bought and sold and money needs to be portable if it is going to be convenient for the users of it. Application to at least three characteristics and three functions required for full marks. (APP total: Up to 4 marks) 8 • acceptability • portability • scarcity • recognisability • relative stability of value • divisibility • durability • uniformity • stability of supply. Four functions of money: • a medium of exchange • a measure of value/unit of account • a standard for deferred payment • a store of value or wealth. 4(b) For analysis of the likely consequences for an economy of an increase in the money supply. Candidates need to refer to the impact that an increase in the money supply can have in an economy, especially in relation to the existence of inflation. An increase in the money supply can lead to demand-pull inflation, especially if AD is in excess of AS. Accept an answer that focuses on the consequences of inflation. (AN total: Up to 8 marks) For evaluative comment on the extent to which an increase in the money supply in an economy is likely to be inflationary (1 mark for a conclusion). Candidates need to consider that the extent to which an increase in the money supply will lead to inflation will depend on whether AD is in excess of AS. If there is an increase in AS which matches the increase in AD, then the effect of the increase in the money supply will not necessarily be inflationary. The consequences will also depend on the extent of the size of the increase in the money supply and the state of an economy at the time of the increase. (EV total: Up to 4 marks) 12

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