Cambridge A Level Economics 9708 — 2018 May/June Paper 4 · Variant 3

1 Inequalities of wealth In 2015, the vast and growing gap between rich and poor was revealed in a report from the charity Oxfam. Oxfam said that between 2010 and 2015, the total wealth of the world’s poorest 50% had fallen. In the same period, the wealth of the world’s richest people had increased. In 2010, the 388 richest people in the world owned the same wealth as the poorest 50%. This fell to 80 people in 2014 and to only 62 people by 2015. The report recommended that governments should do three things: make greater attempts to prevent tax avoidance; invest more in public services; and ensure there are higher wages for the low paid. On taxes, the report emphasised the need to end the use of tax havens to hide large amounts of money. It estimated that the use of tax havens by multinational companies denies developing countries at least US$100 billion a year in tax revenue. In tax havens, which include the Cayman Islands, Dubai, Hong Kong, Liberia, Luxembourg, Singapore and Switzerland, taxes are either non-existent or levied at a low rate. The Cayman Islands, in the Caribbean, refers to itself as an ‘international financial centre’. Almost 20 000 international companies are registered there. An official explained its function is to assist global capitalism to work. For example, if an American company and a Japanese company agree a business deal in their own countries they would pay tax. They would be more likely to agree the deal if it were done through a company in the Cayman Islands where no tax is paid. It is not only the developed world which makes use of tax havens. Oxfam reported that as much as 30% of all African financial wealth was thought to be held in tax havens. The estimated loss of US$14 billion in tax revenues would be enough to pay for healthcare that could save the lives of 4 million children a year and employ enough teachers to get every African child into school. To help the lowest income earners in society, government social welfare spending has become more important than ever. As well as preventing tax avoidance, a traditional cure for the problems from rising inequality has been to redistribute income through taxation from the richest to the poorest. However, this can lead to resentment and can impede economic growth. A better cure would be to encourage innovation that would benefit everybody. A combination of the internet and computer revolutions is transforming the world economy which has led to economic growth. Inevitably the leaders of these kinds of enterprises have become some of the world’s richest entrepreneurs. Sources: The Times, 18 January 2016, The Guardian, 18 January 2016, The Guardian, 19 January 2016, The Independent, 20 January 2016, and taxhaven.org, accessed 20 January 2016. (a) Distinguish between income and wealth. [2] (b) Explain the difference between equity and equality and consider whether the report’s three recommendations are based on equity or equality. [6] (c) Use the evidence in the article to consider the effect on business activity of using tax havens. [6] (d) Discuss the economic consequences for governments whose citizens and businesses avoid paying tax on a high proportion of their incomes or profits. [6]

Mark scheme: Question Answer Marks 1(a) • income is a flow of money received at intervals 2 • wealth is a stock of assets 1(b) • equality is when people are treated the same (1) 6 • equity is when people are treated fairly, but differently, having taken into account their different circumstances (1) • preventing tax evasion is treating everyone the same – equality, the amount of tax paid may be different depending on circumstances – equity (1) • more public services – depends on how the services are allocated – could be equality or equity; (1-2) • higher wages for lower paid –could be equality if dealing with the same job but different pay rates; may be equity if there is thought to be unfairness in current system of pay. (1) 1(c) Tax havens assist global capitalism to work: Businesses need to be 6 encouraged to take risks and innovation and thereby increase the size of national income through the investment multiplier. This creates employment through an increase in AD. More likely to undertake deals if tax is low. Effect of this is weakened if MNCs pay low wages and send profits to tax havens. Positive link: Tax havens are used by entrepreneurs/MNC’s to shelter incomes from taxation. These incomes could be used as investments by the MNC’s to create further wealth in countries where they operate. Negative link: Income inequalities are becoming greater between rich and poor in both developed and developing countries. Taxes create resentment and may prevent investment and impede economic growth. 1(d) Governments face a shortfall in revenue. Therefore to cover government 6 expenditure they need to borrow more because tax revenues are below potential. Education suffers, health care suffers. If the ‘rich’ do not pay sufficient tax there is an opportunity cost. Provision of welfare programmes, education, health provided by governments will be affected. Quote examples from text e.g. African countries. Governments incur administrative costs trying to recover tax which could be better spent on services. Government’s macro-aims are affected e.g. capital outflows create balance of payments deficits. Governments may have to make welfare payments to unemployed workers if MNCs fail to invest profits back into the businesses where they were generated. But paying lower taxes could be profitable for companies who might then re- invest, research more and employ more people.

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2 (a) Explain why the concept of the margin is significant in the economic theory of consumer behaviour. [12] (b) Discuss whether the calculation of a marginal cost or an average cost is more significant in reaching conclusions about economic efficiency. [13]

Mark scheme: 2(a) Margin is significant in relating the utility/satisfaction to the price in 12 determining equilibrium quantity bought. Candidates can use either marginal utility theory or marginal changes on indifference curves related to budget lines. L4 (9–12): for a clear explanation and a sound comment on the relation between the price and the satisfaction obtained, referring to more than one good L3 (7–8): for a less developed answer but which still refers to the equilibrium but probably concentrates on only one good L2 (5–6): for a brief attempt which does not clearly bring out the significance of the marginal analysis L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory 2(b) Social efficiency/allocative efficiency requires that marginal social costs and 13 marginal social benefits are equal at the point of output. For productive efficiency to occur the firm is producing at its lowest average cost for the output concerned. (Not necessarily the lowest overall average cost). L4 (9–13): for an understanding of the link of marginal to allocative efficiency and average to productive efficiency with a conclusion L3 (7–8): for a less accurate understanding – probably evidenced by a weak conclusion of the role of marginal and average in the different efficiencies L2 (5–6): for an unclear answer or one which concentrates on one of the efficiencies L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory

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3 In recent years the prices of many electronic products have fallen as sales have increased. Research to improve the products is expensive but there are large economies of scale in production. Discuss what is likely to happen to the costs, prices of products and market structure in industries where there are large economies of scale. [25]

Mark scheme: 3 Costs will increase initially as research is expensive but in the long run 25 average costs would decrease. Candidates should explain how economies of scale affect costs. Market structure is likely to become more imperfect and this may lead to potentially higher profits and higher, not reduced, product prices. Small firms are unlikely to be able to afford the research. L4 (18–25): for clear explanation of economies of scale; consideration of likely effect on prices and profits as industries become larger and the market more imperfect. Conclusion should be given to a reasoned answer L3 (14–17): for an answer that concentrates more on one side – either economies or the market structure: or a briefer explanation of both parts; a conclusion should still be given L2 (10–13): for a more limited answer probably concentrating on economies. Maximum 11 if no conclusion L1 (1–9): for an answer that has some basic correct facts but includes irrelevancies and errors of theory

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4 Economic theory is often very precise in its explanation but not very useful in its application to reality. (a) Explain why, in perfectly competitive labour markets, the economic theory of wage determination is very precise. [12] (b) Discuss whether in reality such precision is found in the imperfect market structures of actual labour markets. [13]

Mark scheme: 4(a) Theory predicts certain outcome based upon the demand (MRP) and 12 cost/supply of labour. Explanation of determination of equilibrium output is required. L4 (9–12): for a clear explanation of the theory and derivation of equilibrium position, a comment about possible changes in MRP or supply with a comment about the precision of the theory. 7–8 marks if demand/supply approach used L3 (7–8): for a briefer explanation of the theory without any comment on possible changes or without a comment on the precision of the theory. 5–6 marks if demand/supply approach used L2 (5–6): for a much less developed answer with no comment on the precision of the theory and vague mention about equilibrium. 3–4 marks if demand/supply approach used L1 (1–4): for an answer that shows some knowledge but does not indicate that the question has been fully grasped or where the answer is mostly irrelevant. 1–2 marks if demand/supply approach used 4(b) Candidates could discuss whether it is possible to determine precisely the 13 MRP curve (or the demand curve), could discuss problems of measuring productivity. They could also discuss the problems of determining the marginal cost. These difficulties are accentuated, and the theory becomes even less realistic, when either trade unions or governments influence the determination of wages. There could be a range of outcomes depending on the bargaining strengths of each side. L4 (9–13): for a reasoned and clear explanation with accurate development of theoretical difficulties. 7–8 marks if demand/supply approach used L3 (7–8): for a clear but undeveloped explanation which is limited to either the demand side or the supply side. 5–6 marks if demand/supply approach used L2 (5–6): for a limited attempt to consider the theory and with a greater concentration on the descriptive elements. 3–4 marks if demand/supply approach used L1 (1–4): for an answer that shows some knowledge but does not indicate that the question has been fully grasped or where the answer is mostly irrelevant. 1–2 marks if demand/supply approach used

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5 (a) Explain what economists mean by a ‘deflationary gap’ and discuss why this could be considered problematic for an economy. Use a diagram to illustrate your answer. [12] (b) How far would you agree that the use of budget deficits is the most effective way to solve the problem of a deflationary gap? [13]

Mark scheme: 5(a) Candidates will provide a clear definition of the term ‘deflationary gap’ 12 supported by an accurate, clearly labelled supporting diagram which identifies the deflationary gap. Some attempt should be made to establish why this might cause economic problems such as high levels of unemployment, low levels of economic growth and low consumer/investor confidence. L4 (9–12): for an answer that extends the range of reasons why a deflationary gap might produce negative outcomes, such as potential long run negative effects on expectations or the existence of a liquidity trap. Responses which attempt to locate possible positive effects, for example lower cost of living, improvement in the balance of payments, should also be rewarded. There should be a conclusion. L3 (7–8): for an answer that makes some attempt to analyse why a deflationary gap is likely to be associated with negative outcomes such as unemployment and/or low growth rates. L2 (5–6): for answer that describes what is meant by a deflationary gap and is supported by a reasonably accurate diagram. L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory. 5(b) Responses should indicate a clear understanding of what is meant by a 13 budget deficit and the economic circumstances where governments would choose to use them. Reference should then be briefly made to the problems created by a deflationary gap and the links between these and the use of budget deficits. Some attempt should be made to discuss the effectiveness of using budget deficits and also some consideration of alternatives such as the reliance on the operation of market forces and/or the use of supply side policies. L4 (9–13): for responses that recognise there are problems associated with deficit financing such as crowding out, long term effects on the price level. Higher level four responses will then consider alternative approaches such as supply side policies and/or market liberalisation. A conclusion should be provided. L3 (7–8): for responses that analyse the links between the use of budget deficits and deflationary gaps. Clear diagrams illustrating how deficits can be used to close the gap will be provided. Some attempt should be made to develop answers which recognise that budget deficits alone are unlikely to solve problems associated with negative expectations. L2 (5–6): for an understanding of the term budget deficit and how this might provide a solution to the problem of a deflationary gap. Answers will be descriptive and not go beyond linking the policy to key issues of unemployment and low growth rates. L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory.

More questions on Effectiveness of policy options to meet all macroeconomic objectives

6 (a) Explain the quantity theory of money. Consider its relevance to economic policies that might be used to control inflation. [12] (b) The Phillips curve suggests that inflation can only be controlled at the expense of higher levels of unemployment. To what extent do you agree with this view? [13]

Mark scheme: 6(a) Candidates should explain that the quantity theory of money uses an identity 12 where total expenditure equals total income, and this can presented in the form MV = PT. Each variable should be explained and the key assumptions relating to V and T established. Then the direct link between changes in the money supply and the price level should be identified and discussed in relation to other economic policies which might be used to reduce inflation. L4 (9–12): for an answer that attempts to evaluate the relevance of the theory to policies used to control inflation. Difficulties relating to how we measure the variables might be discussed and/or the effectiveness of polices based on this theory in relation to alternative policies L3 (7–8): for an answer that uses the formula to analyse the potential impact on the price level when the money supply increases and which recognises the importance of reducing the growth of the money in order to control inflation L2 (5–6): for an answer that states the formula and explains each variable and the assumptions which are made regarding V and T L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory 6(b) Answers should explain the nature of the Phillips curve and how it was 13 derived. Discussion relating to the suggested ‘trade off’ between inflation and unemployment should be provided. Alternative explanations of the relationship between inflation and unemployment should also be considered, as well as an attempt to evaluate whether inflation can be controlled without raising the level of unemployment. A conclusion is required. L4 (9–13): for an answer that discusses the contention and identifies alternative explanations of the relationship between inflation and unemployment. Some reference to problems with empirical evidence or the neglect of inflationary expectations might be discussed. A conclusion should be provided L3 (7–8): for an answer that analyses the relationship between inflation and unemployment and which provides an accurately labelled supporting diagram. Comments upon the particular shape of the curve and/or it was derived might also be made L2 (5–6): for answer that demonstrates knowledge of the relationship between inflation and unemployment as indicated by the Phillips curve L1 (1–4): for an answer that has some basic correct facts but includes irrelevancies and errors of theory

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7 Economic development can only be achieved by economic growth and this depends solely on higher levels of government investment. To what extent would you agree with this statement? [25]

Mark scheme: 7 Answers should clearly distinguish between economic growth and 25 development and examine the extent to which economic growth relies solely on higher levels of investment. Alternative ways of achieving economic development should be discussed and the role of private sector investment as an alternative to government investment should also be considered. A conclusion should be drawn based on the preceding discussion. L4 (18–25): for an answer that examines the extent to which economic development can only be achieved by economic growth and which discusses whether economic growth is the sole determinant of investment. A conclusion would be required L3 (14–17): for an answer that attempt to analyse the relationship between change in the level of investment and changes in growth and how this might impact on the level of development L2 (10–13): for an answer that provides a descriptive account of the difference between economic growth and economic development and the difference between government and private investment L1 (1–9): For an answer that shows some knowledge but does not indicate that the question has been fully grasped or where the answer is mostly irrelevant

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