Cambridge A Level Economics 9708 — 2018 Oct/Nov Paper 2 · Variant 3

1 The air transport market in India Over the past 20 years or so, global air transport markets have become more competitive. This is especially the case in the United States (US), the European Union (EU) and, most recently, in Asia. Governments have sought to provide opportunities for new firms, invariably ‘low-cost carriers’ (budget airlines), to open new routes and compete with established airline operators, often in domestic markets. The situation in India is typical but only to a certain extent. The country has two established airline operators with extensive international as well as domestic service networks. They now face increasing competition from a number of low-cost carriers who operate services within India. Consumers have benefitted from these changes. As well as opening new routes, the increased competition has seen all airline operators offering cheaper prices. At the same time, the established airline operators have had to reduce costs to remain competitive. Also, demand has increased for leisure travel as well as business travel. The Indian air transport market still has some restrictions imposed by the Indian government. An important restriction is the ‘5/20 rule’. This stipulates that Indian-owned airline operators must have a minimum number of aircraft (20) and have been in business for a minimum of 5 years, before they can operate international services. Opponents to the 5/20 rule argue that it seriously discriminates against Indian airline operators by not allowing them to compete in a free market. They further claim that applying the rule is having a negative impact on the Indian economy. Foreign-owned airline operators, which have a 70% share of international passenger traffic to and from India, do not have to meet the 5/20 rule. Source: Times of India, 27 February 2016 and The Mint, 25 February 2016 100 80 Number of 60 passengers carried (millions) 40 20 0 1971 1980 1989 1998 2007 2015 Fig. 1.1: Air transport – total number of domestic and international passengers carried by Indian-owned airline operators, 1971–2014 Source: Trading Economics.com, accessed 5 March 2016 (a) (i) Using Fig. 1.1, describe the trend in the number of air passengers carried since 1971. [2] (ii) Explain one possible change in a demand factor and one possible change in a supply factor which could have caused the overall trend in the Indian air travel market. [4] (b) Name and give an example of each of two factors of production that are required by airline operators. [2] (c) In February 2016, the Indian government increased the tax on aviation fuel from 8% to 14%. Use a diagram to analyse the effects of this increase on the market for aviation fuel. Explain what would determine the incidence of this tax between the aviation fuel producers and the airline operators who buy the fuel. [6] (d) Discuss whether ending the 5/20 rule would be likely to be of overall benefit to the Indian economy. [6]

Mark scheme: 1(a)(i) Overall it has increased (1 mark) Description of trend/change (1 mark) 2 candidates to refer to the change in the growth rate after about 2005. E.G. The growth rate accelerated after 2005. 1(a)(ii) For identification of a demand factor (1 mark) and for explanation (1 mark) For identification of a supply factor (1 mark) and for explanation (1 mark) 4 Demand side: e.g. increase in incomes, lower prices of complements, increased willingness to fly, poor quality rail services (tastes), advertising, etc. Supply side: more terminals, entry of new firms, fewer regulations, ease of entry for airlines to set up in India, lower operating costs, etc. 1(b) For identification of one factor together with a valid example drawn from the context of airline operators. (1 mark) Two factors = 2 marks 2 Capital: aircraft, booking systems Labour: pilots, mechanics, flight attendants Enterprise: entrepreneurs willing to take risks and organise the other factors Land: the physical area taken up by airports The candidate must use the correct term to identify the factor and provide an appropriate example from the airline industry. 1(c) For a correctly labelled diagram showing a shift to the left of the supply curve (1 mark) and the rise in price (1 mark). (Up to 2 marks) For an explanation of the incidence of the tax when the demand is elastic. (Up to 2 marks) For an explanation of the incidence of the tax when the demand is inelastic. (Up to 2 marks) 6 In this case, the airline industry is effectively the consumer of fuel. The greater the elasticity of demand the more that the incidence will fall upon the producer. The greater the inelasticity the more that the incidence will fall upon the consumer. Question Answer Marks Guidance 1(d) For an explanation of the benefits/ advantages of ending the rule (Up to 3 marks) For an explanation of the costs/ disadvantages of ending the rule (Up to 3 marks) Reserve 1 mark for a reasoned conclusion 6 The 5/20 restriction limits the supply of Indian airlines operating services outside the country. It protects the business interests of established carriers like Air India and Jet and the viability of the hub airports from which they operate. Fares are kept higher than if there were more competitors. The potential advantages of removing the 5/20 restriction are that it would open up the market, see new services and lower fares. It would not discriminate against Indian airlines relative to those that are foreign owned. The potential costs are that safety might be compromised as non-established firms enter the market, the greater competition might result in some established firms decreasing in size and losing the benefits of scale as a result, new entrants might bring poorer quality of services and so on, employee terms and conditions of services might decline. The wider effects on the Indian economy are less certain. There could be an improvement in the trade in services as Indian airlines generate foreign currency from fares; there could be a wider benefit as there are more opportunities for business travellers and tourists to visit India.

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2 (a) Using examples, explain why some goods cannot be provided as private goods. [8] (b) Discuss whether all forms of transport should be subsidised by the government. [12]

Mark scheme: 2(a) For a knowledge and understanding of private goods in terms of excludability and what that means (1 mark) and rivalry in consumption and what that means (1 mark) (KU: up to 2 marks) For application of why some goods are non-excludable and therefore cannot be provided as private goods (Up to 3 marks) For application of why some goods are non-rival are therefore cannot be provided as private goods (Up to 3 marks) If no example is provided then 2 marks maximum for each type of good. 8 excludability and rivalry. This is normally achieved through the price mechanism and once a good is purchased, it cannot be consumed by others. Rivalry could also raise the price of a good. If a consumer does not have the resources, they cannot consume certain private goods. Public goods are provided to overcome this problem; they are non- excludable and non-rival. Their provision does through raise the issue of free riders. Reward relevant examples of private and public goods. Credit those candidates who include a consideration of rejectability if this adds to the quality of the answer. 2(b) For an analysis of the costs/benefits of a subsidy on those forms of transport that might be considered as merit goods (Up to 4 marks) For an analysis of the costs/benefits of a subsidy on those forms of transport that are not considered as merit goods (Up to 4 marks) (AN: up to 8 marks) For evaluative comment on whether all forms of transport should be subsidised with 1 mark reserved for a conclusion (EV: up to 4 marks) 12 There are various arguments for subsidising transport. The arguments depend upon the extent to which different forms of transport could be considered as merit goods.

More questions on Government policies to achieve efficient resource allocation and correct market failure

3 In August 2015, the Chinese Government devalued its currency, the yuan, by around 5%. (a) Explain how a government intervenes to manage the value of its currency in the foreign exchange market. [8] (b) Discuss the likely effects of the devaluation of the yuan on both the Chinese economy and countries that trade with China. [12]

Mark scheme: 3(a) For knowledge and understanding that an exchange rate is the price of one currency in terms of another or a basket of currencies (1 mark) that is determined by the interaction of demand and supply in the foreign exchange market (1 mark) (KU: up to 2 marks) For application of how a government could influence the demand for its currency to manage its value (Up to 3 marks) For application of how a government could influence the supply of its currency to manage its value (Up to 3 marks) 8 by affecting the supply and/or demand for its currency through buying and selling foreign exchange reserves, changing interest rates, exchange control regulations and so on. 3(b) For an analysis of the likely effects of a devaluation on the Chinese economy (Up to 4 marks) For an analysis of the likely effects of a devaluation on countries that trade with China. (Up to 4 marks) (AN: up to 8 marks) For evaluative judgement of the likely relative impact on the Chinese economy compared to other trading partners. Reserve 1 mark for a reasoned conclusion on the overall impact on each economy. (EV: up to 4 marks) 12 The action by the Chinese government was a deliberate decision, namely a devaluation. The likely effect is to make Chinese exports to other countries even more price competitive whilst imports from elsewhere become less competitive. Reference to Marshall-Lerner and the J- curve effect are relevant.

More questions on Current account of the balance of payments

4 (a) Using a diagram, explain the significance for an economy of the interaction of aggregate demand and aggregate supply. [8] (b) Analyse the causes of an increase in aggregate supply. Discuss the extent to which this might be beneficial for an economy. [12]

Mark scheme: 4(a) For knowledge and understanding that uses a correctly labelled diagram (1 mark) to show that equilibrium exists in the economy at the intersection of AD and AS (1 mark) (KU: up to 2 marks) Using a diagram:- For application showing how either an increase or decrease in aggregate demand in terms of its impact upon prices, employment and real output is determined by its interaction with aggregate supply curve. (Up to 3 marks) For application showing how either an increase or decrease in aggregate supply in terms of its impact upon prices, employment and real output is determined by its interaction with aggregate demand curve. (Up to 3 marks) 8 Question Answer Marks Guidance 4(b) For analysis that explains any causes of an increase in AS (Up to 4 marks) For analysis that explains any the costs and benefits of the increase in AS (Up to 4 marks) (AN: up to 8 marks) For evaluative judgement on whether the increase in aggregate supply will have be of overall benefit with 1 mark reserved for a reasoned conclusion. (EV: up to 4 marks) 12 Aggregate supply can increase for many reasons such as advances in technology, improved education and training, net immigration, net investment, discovery of new resources and so on. Reference to short and long run is relevant. Benefits include a rise in the standard of living, more leisure time, new products, etc. The possible costs include a rise in unemployment, depletion of resources. An evaluative comment might be that it depends upon the existence or otherwise of a deflationary gap.

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