Cambridge A Level Economics 9708 — 2019 May/June Paper 4 · Variant 1

1 Loyalty and consumer behaviour Consumer loyalty can be thought of either in relation to card schemes which offer discounts based on the amount spent with a specific retailer, emotional loyalty where customers are loyal to a particular brand, or as a monopoly loyalty where there is no alternative to the retailer or brand. Retailers recognise that price has an importance in consumers’ choice. Many supermarkets use loyalty cards to attract customers with promotions and price reductions available only to those who have a card. By using cards, supermarkets seek a marketing advantage and attempt to build barriers between retailers. Research indicates, however, that although 70% of United Kingdom (UK) consumers hold some kind of loyalty card, only about 10% are loyal to one particular card. Concerns have been raised that, when consumers are collecting points towards a particular goal, the loyalty card schemes may act as a constraint on free competition and prevent switching between brands. It is also thought that the costs of the scheme might be funded through higher prices. Further, the incentives and marketing discounts used by the scheme are often thought to be confusing and make it more difficult for the consumer to compare prices. There are risks for retailers too. It requires substantial investment to run such a scheme – one supermarket put the cost at US$60m a year. But how do loyalty card schemes fit into the context of the way in which consumers make choices? The relative importance of factors that influence consumers when choosing from which shop to buy groceries are one-stop shopping (43%), good service (22%), price (18%), the availability of a coffee shop (12%) and help with packing (6%). Loyalty cards come below these. Companies who have invested in card schemes use them as a means to gather data on customers. When the loyalty card is used the retailer can see what the customer prefers to buy and can direct future offers to their wants in specific promotions both on-line and in the mail. Loyalty schemes are thus sometimes less about loyalty and more about understanding customers’ wants. The economic model of consumer behaviour using indifference curves assumes that consumers conduct research and buy products and services in a rational way. However, many purchases are based on habit and consumer research is imprecise. When the consumer has a low involvement in research or a low emotional attachment to the product, there will be little loyalty. Source: RSA Journal 1, 2001, page 83 (a) What evidence is there in the article to suggest that loyalty cards make markets imperfectly competitive? [4] (b) Analyse why a profit maximising retailer might be interested in the link between utility, consumers’ loyalty and price elasticity of demand. [4] (c) Consider whether there is conflicting evidence in the article about the effectiveness of loyalty cards which offer price discounts. [5] (d) Discuss how the idea of rationality is used in the indifference curve theory of consumer behaviour. [7]

Mark scheme: Question Answer Marks 1(a) What evidence is there in the article to suggest that loyalty cards make 4 markets imperfectly competitive? • Create barriers to competition by reducing switches in demand, • Costs of scheme funded by higher prices • not affordable by smaller firms – high initial costs, $60m for one supermarket, • Causes confusion of information leading to imperfect knowledge. 1(b) Analyse why a profit maximising retailer might be interested in the link 4 between utility, consumers’ loyalty and price elasticity of demand. • Loyalty will mean consumers do not change suppliers, this might create a lower price elasticity of demand, (1) • Explain price elasticity (1) • With lower price elasticity can subsequently raise prices with resulting higher profits – depending on cost changes (2) 1(c) Consider whether there is conflicting evidence in the article about the 5 effectiveness of loyalty cards which offer price discounts. Evidence for the effectiveness of cards: • Cards enable retailers to find out about consumer wants and target promotions; • Article also says retailers recognise the importance of price and can offer discounts through cards. (2) In contrast to that it also says • Price is not most significant factor in determining choice; • Also there is no loyalty if buying is based on habit, or has low emotional involvement. (2) Conclusion: seems to be some conflict. (1) 1(d) Discuss how the idea of rationality is used in the indifference curve 7 theory of consumer behaviour. Explanation of indifference curves. General description without link to rationality max 4 Consumer knows combinations between which there is indifference, this is a rational calculation which remains constant over the curve, Consumer knows satisfaction levels and which combination is preferred to another, Consumer rationally compares satisfaction to price, and buys to achieve maximum satisfaction Consumer can compare two goods using rational deductions.

More questions on Indifference curves and budget lines

2 (a) Explain the meaning of and whether there is a link (i) between externalities and public goods (ii) between transfer payments and the poverty trap. [12] (b) Consider whether the existence of externalities in production means that it is impossible to achieve an optimal allocation of resources. [13]

Mark scheme: 2(a) Explain the meaning of and whether there is a link 12 (i) between externalities and public goods (ii) between transfer payments and the poverty trap. Meaning of externality and public goods (4), link? Existence of externalities can be found with public goods which are not provided by the market. (2); meaning of transfer payments and poverty trap (4) link? Poverty can be relieved by transfer payments. Finding work but only on a low income may result in withdrawal of transfer payment and cause return to poverty (2) L4 (9–12 marks) For a sound explanation of all four concepts and conclusion about the two links. L3 (7–8 marks) For weaker explanation of four concepts or sound explanation of three concepts and conclusion about at least one of the links. L2 (5–6 marks) For a sound explanation of two of the concepts but little comment about the link. L1 (1–4 marks) For an answer that has some basic correct facts but includes irrelevancies and errors of theory. 2(b) Consider whether the existence of externalities in production means that 13 it is impossible to achieve an optimal allocation of resources. Explanation of meaning of efficiency allocation and explanation of the analysis which ensures an efficient optimum may be reached. Allocative efficiency is intended. Allocative efficiency ensures that no one can be made better off without someone being worse off. Individual actions are not always best for society as a whole and externalities (market failure result). Discussion of necessity/desirability of government intervention to achieve efficiency. This could be by taxes, subsidies, regulation, information provision, ownership, persuasion (nudge theory) rather than by enforcement. L4 (9–13 marks) For an accurate discussion of externalities and market failure, with examples and a conclusion about the need for and methods of government intervention. Expect at least three methods. L3 (7–8 marks) For a more limited discussion of the externalities and market failure and more limited range of methods governments can use to overcome market failure. Expect at least two methods. L2 (5–6 marks) For a brief analysis of externalities and very scant coverage of methods to correct them. Expect at least one method. L1 (1–4 marks) For an answer that has some basic correct facts but includes irrelevancies and errors of theory.

More questions on Private costs and benefits, externalities and social costs and benefits

3 (a) Explain what is meant by ‘the principal–agent problem’ and analyse why it is likely to be found in some market structures and not others. [12] (b) Explain what is meant by a contestable market and discuss whether a firm in a contestable market necessarily aims to maximise its profit. [13]

Mark scheme: 3(a) Explain what is meant by ‘the principal–agent problem’ and analyse why 12 it is likely to be found in some market structures and not others. The owner of the business (principal) is not necessarily taking the decisions about its operation. This is done by managers (the agent). There may be difference between the aims and objectives of the two. Unlikely to occur in perfect competition, firms are too small; or monopolistic competition. Occurs in larger firms, usually with shareholders in oligopoly and monopoly. L4 (9–12 marks) For clear explanation of the ‘problem’ and a comment on why it occurs in some market structures and not others. L3 (7–8 marks) For a less developed explanation but with a judgement on where the ‘problem’ may exist. L2 (5–6 marks) For a briefer explanation, or an inaccurate description of market structures, unclear judgement. L1 (1–4 marks) For an answer that has some basic correct facts but includes irrelevancies and errors of theory. 3(b) Explain what is meant by a contestable market and discuss whether a 13 firm in a contestable market necessarily aims to maximise its profit. Contestable market is one with zero entry and exit costs. No barriers to entry and no barriers to exit, such as contractual agreements. For a market to be perfectly contestable, industry technology would be readily available to potential entrants. This makes the market potentially competitive and aims other than profit maximising might exist. Discussion of alternative aims; behavioural, managerial, satisficing, limit pricing. L4 (9–13 marks) For a clear explanation of contestable market, and aim of perfectly competitive firm with two alternative aims. Good structure to the answer. L3 (7–8 marks) For a weaker comment either the explanation of contestable, or the perfectly competitive aim or only one alternative aim. L2 (5–6 marks) For a brief undeveloped answer with lack of clarity about contestable and the alternative aim. L1 (1–4 marks) For an answer that has some basic correct facts but includes irrelevancies and errors of theory.

More questions on Different market structures

4 ‘A rise in wages and salaries will increase the costs of production, decrease profits, cause inflation and is detrimental.’ Discuss whether the economic theory of wage determination supports the view that an increase in the level of wage rates is detrimental for the firm and for the worker. [25]

Mark scheme: 4 ‘A rise in wages and salaries will increase the costs of production, 25 decrease profits, cause inflation and is detrimental.’ Discuss whether the economic theory of wage determination supports the view that an increase in the level of wage rates is detrimental for the firm and for the worker. Candidates should consider each part of the statement. The theory of wage determination should be explained. Do a rise in wages necessarily decrease profits, cause inflation and would it be detrimental to the firm and worker. Comment should be given on how the outcome may be affected by changes in productivity, changes in the demand for the product, the existence of trade union bargaining, a minimum wage affecting the supply, by large monoposonies forcing down wages from the competitive level. There should be a conclusion and a well-structured answer L4 (18–25 marks) For a critique of the statement and a thorough explanation of the analysis of wage determination with a clear comment on effect on firm and worker depending on what changes prompted the rise in wages. L3 (14–17 marks) For a weaker critique of the statement with weaker structure on how wage rises affect the firm and worker. Or a good account of the effect on either the firm or the worker. L2 (10–13 marks) For a correct but undeveloped analysis with much briefer critique of the statement. L1 (1–9 marks) 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.

More questions on Labour market forces and government intervention

5 (a) Distinguish between the internal value of money and the external value of money and consider whether there is a link between these two values. [12] (b) ‘Policies which attempt to control the internal value of money will automatically make it difficult to control the external value of money.’ Discuss the view that this statement is only partially correct. [13]

Mark scheme: 5(a) Distinguish between the internal value of money and the external value of 12 money and consider whether there is a link between these two values. Answers should explain that the internal value of money will be determined by inflation and subsequent purchasing power and the external value will be determined by the foreign exchange value of the domestic currency. Links between the two values should be discussed. For example, an increase in inflation might lead to a fall in the exchange rate, therefore a fall in the internal value might be associated with a fall in the external value. L4 (9–12 marks) For an answer which attempts to discuss how a change in the internal value of money might affect the external value and vice versa. Good responses will provide at least two examples and consider changes in both directions. Might also discuss the strength of the links. L3 (7–8 marks) For an analysis of what might affect each of the two types of value and a limited attempt to identify why a change in one value might lead to a change in the other value. L2 (5–6 marks) For an explanation of what is meant by internal and external value of money and establishing a clear distinction between the two. L1 (1–4 marks) 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. 5(b) ‘Policies which attempt to control the internal value of money will 13 automatically make it difficult to control the external value of money.’ Discuss the view that this statement is only partially correct. Policies which attempt to control the internal value of money will include all policies used to control inflation. These might include monetarist, Keynesian demand pull and Keynesian cost push. Different policies would be expected to have a different impact on the external value of money. The response should use analysis to establish the links between the policies and their impact and make some attempt to discuss whether such policies automatically make it difficult to control the external value of money. L4 (9–13 marks) For an answer which attempts to evaluate how far the statement under consideration can be described as ‘only partially’ correct. There should also be a discussion relating to whether these policies will ‘automatically’ make it difficult to control the external value of money. Examples and evidence should be provided to form a conclusion. L3 (7–8 marks) For an answer which analyses why policies identified to control the internal value will have some impact on the external value. For example, an increase in interest rates to help control demand pull inflation might lead to an increase in exchange rates due to short term capital inflows. L2 (5–6 marks) For an answer which explains alternative policies to control inflation and recognises that these policies will have an effect on the external value of money. L1 (1–4 marks) 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.

More questions on Exchange rates

6 ‘The failure of the policy of quantitative easing (QE) to solve problems associated with an economic recession illustrates the weakness of monetary transmissions mechanisms in particular and monetary policy in general.’ Critically evaluate this statement. [25]

Mark scheme: 6 ‘The failure of the policy of quantitative easing (QE) to solve problems 25 associated with an economic recession illustrates the weakness of monetary transmissions mechanisms in particular and monetary policy in general.’ Critically evaluate this statement. Quantitative Easing should be explained and the problems generally associated with an economic recession should be clearly identified. The links between Quantitative Easing and the monetary transmissions mechanism should be established and these links should be further extended to allow a discussion of the effectiveness of monetary policy on real variables such as income, output and employment. Evaluative comment and a conclusion should be provided to assess the accuracy of the statement. L4 (18–25 marks) For an answer which focuses upon each of the four elements referred to in the statement and makes an attempt to assess the extent to which problems associated with a recession might be solved by the use of Quantitative Easing. Evaluative comment should produce a conclusion/judgement regarding the success/failure of Quantitative Easing L3 (14–17 marks) For an answer which attempts to link each element of the statement and provides some analysis of how/why these elements are linked. Diagrams might be used to illustrate how the monetary transmissions works and how this might address the problems associated with a recession L2 (10–13 marks) For a correct explanation of each of the key elements of the statement but no attempt to link these elements to address the specific question L1 (1–9 marks) 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.

More questions on Monetary policy

7 (a) Assess the impact of foreign direct investment (FDI) on developing economies. [12] (b) It is often stated that the problem of ‘a vicious cycle of poverty’ exists in developing countries. Explain what this means and discuss how this problem might be solved. [13]

Mark scheme: 7(a) Assess the impact of foreign direct investment (FDI) on developing 12 economies. Answers should clearly identify what is meant by foreign direct investment (FDI) and should demonstrate an awareness of its special importance regarding developing economies. Links between FDI and multinational corporations should also be referred to. The focus should be upon the impact of FDIs on developing economies. This focus would examine both positive and negative impacts on key areas of a developing economy such as: growth; employment; infrastructure; balance of payments; environment. L4 (9–12 marks) For an attempt to evaluate how far FDI proceeds to create a net positive effect on relevant key indicators of development such as economic growth, productivity, employment and foreign trade. A conclusion should look at whether the overall net effect of FDI could be considered beneficial L3 (7–8 marks) For a detailed analysis of the how foreign direct investment might impact on undeveloped economies. Analysis should focus upon a comparison between the potential positive and potential negative effects of FD L2 (5–6 marks) For a brief, undeveloped answer which describes the potential impact on a few economic issues but does not provide any supporting analysis L1 (1–4 marks) 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. 7(b) It is often stated that the problem of ‘a vicious cycle of poverty’ exists in 13 developing countries. Explain what this means and discuss how this problem might be solved. A clear explanation of the connections between low incomes, low savings, low investment and low growth rates should be provided. Responses might also refer to the cycle of poverty relating to development which refers to links between low income, low levels of education, low productivity. The effectiveness of alternative measures introduced to break these cycles should be discussed. L4 (9–13 marks) For a comparison of alternative solutions and some attempt made to evaluate the likely effectiveness of different approaches. A wide range of measures might be discussed including: supply side policies; use of overseas aid; promote export led growth; increase productivity in the primary sector; incentives to increase savings; direct government intervention. L3 (7–8 marks) For a more detailed examination of the nature of a cycle of poverty should be provided with an attempt to analyse why the cycle continues and why it is difficult to introduce policies which might break the cycle. Possible solutions based on analysis should be provided L2 (5–6 marks) For knowledge and understanding of what is meant by a ‘cycle of poverty’ in relation undeveloped countries but no attempt to analyse why the cycle occurs. L1 (1–4 marks) 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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