Cambridge A Level Economics 9708 — 2021 May/June Paper 2 · Variant 3

1 Luxembourg’s answer to resource misallocation in the transport market Congestion is unfortunately a very familiar feature of most road transport networks. It occurs when there is too much traffic relative to road capacity or more simply, when demand exceeds supply. Congestion means longer journey times and wasted fuel, which adversely affects car drivers and bus passengers. Roads are scarce resources, but usually there is no price for using them. This represents a misallocation of resources. Fig. 1.1 shows the changes in passenger journeys by public transport in Great Britain (GB) since 1997/98. The government has tried various policies to encourage more use of bus transport in the capital city, London, as well as in the rest of GB. These policies include privatisation along with increased bus subsidies and higher taxes on car users. All have failed to improve the allocation of resources and the cost of all travel continues to rise at a faster rate than the cost of living (See Fig. 1.2). The price of using cars has risen by less than other forms of transport since 2010 and some experts have suggested that a minimum price for fuel should be introduced. Billion 5 4 250 Buses Bus (outside London) 3 200 Car Buses (London) 2 150 Train Trains All items CPI 1 100 0 50 1997/98 2001/02 2005/06 2009/10 2013/14 2017/18 199719981999200020012002200320042005200620072008200920102011201220132014201520162017 Fig. 1.1: Passenger journeys by type Fig. 1.2: Transport components in of public transport in Great Britain, the Consumer Prices Index, 1997/98–2017/18 (billions) 1997/98–2017/18 (base year 1997 = 100) It is therefore interesting to see what Luxembourg, a relatively small European country, plans to do about its transport problems. From March 2020, the Luxembourg government has decided that all prices for public transport use (including buses and trains) will be removed, making travel by public transport free to consumers. The cost to its government is forecast to be almost US$1 billion per year. Luxembourg’s radical policy is one that should be given serious consideration in Great Britain and in other countries that face similar resource misallocation in their transport markets. Source: Transport Statistics for Great Britain, 2018 (a) (i) Use the information in Fig. 1.1 to describe the changes in the number of journeys by bus in Great Britain from 1997/98 to 2017/18. [2] (ii) Using the information in Fig. 1.2, explain one of the changes you have identified. [2] (b) Explain how opportunity cost can be applied to the Great British government’s decision to subsidise public transport. [2] (c) Explain whether public transport in Luxembourg has become a free good as a result of all prices being removed. [2] (d) Discuss whether a minimum price for fuel would be effective in reducing the congestion caused by the demand for roads exceeding supply. [6] (e) Discuss whether making public transport free to consumers is the best way to allocate resources in public transport markets. [6]

Mark scheme: 1(a)(i) Use the information in Fig.1.1 to describe the changes in the number of journeys by bus in Great Britain from 1997/98 to 2017/18. Various possibilities including: • Bus passenger journeys outside London have fallen over the period/from c 3.2 bn to c 2.7bn • Bus passenger journeys in London increased up to 2013/14 but have then fallen slightly/overall have increased/from c 1.3 bn to c2.3 bn • Overall bus passenger journeys have increased (1 mark for any of these) 2 The data clearly shows that overall during the period bus passenger journeys outside of London have fallen BUT within London, over the same period bus passenger journeys have increased. Within London, passenger journeys increased up to 2013/14 but declined thereafter. 1(a)(ii) Using the information in Fig.1.2, explain one of the changes you have identified. Various possibilities including: • Public transport fares have increased above the rate of inflation • Bus passenger fares have increased faster than rail fares for most of the period • Bus fares have increased at their largest rate of growth since 2016 • Substituting bus journeys for rail journeys Identify the factor (1 mark) and explain with reference to the selected change in 1(a)(i) (1 mark) OFR applied if candidate wrongly identifies changes for part a but then provides a valid explanation 1 +1 2 Explanations are likely to focus on price elasticity of demand/consumer preferences and/or cross elasticity of demand/degree of substitutability between bus journeys and other forms of transport. Question Answer Marks Guidance 1(b) Explain how opportunity cost can be applied to the Great British government’s decision to subsidise public transport. A simple understanding of what opportunity cost is (1 mark) Which is applied to a valid example in context (1 mark) 2 Valid examples could include money committed to subsidising public transport may have been used for new roads, education, health services etc. 1(c) Explain whether public transport in Luxembourg has become a free good as a result of all prices being removed. Explain what is meant by a free good (1 mark) Explain why this is not a free good (1 mark) 2 Explanation must refer to factors of production being needed to provide transport services i.e. there is a cost involved which is not the case with free goods Do not reward answers that clearly confuse free goods with public goods 1(d) Discuss whether a minimum price for fuel would be effective in reducing the congestion caused by the demand for roads exceeding supply. For an analysis of the effect of introducing a minimum price in a market. (up to 3 marks) For analysis which explains why a minimum price may not be effective. (up to 3 marks) MAXIMUM of 5 marks for analysis 1 mark for a justified conclusion as to whether a minimum price would be effective in reducing congestion 6 A minimum price for fuel above the equilibrium price would increase the price for car users and in theory, lead to reduced demand and reduced congestion. However, this would only be effective if the demand for fuel was price elastic. In addition, it will lead to excess supply and the possible formation of informal markets. It also depends on the ability of the government to maintain and enforce the minimum price. Question Answer Marks Guidance 1(e) Discuss whether making public transport free to consumers is the best way to allocate resources in public transport markets. Analysis of the benefits of free public transport (up to 3 marks) Analysis of the benefits of any other valid policy (up to 3 marks) MAXIMUM of 5 marks for analysis Award up to 1 mark for an evaluation of which policy is likely to be the most effective 6 Various alternative policies could be – Maximum prices for bus and rail fares – Transfer payments for bus and rail transport users – Subsidies

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2 Market research has estimated that the cross-elasticity of demand for hotels in Barbados with respect to the price of flights to Barbados is –2.5, and that the cross-elasticity of demand for flights to Antigua with respect to the price of flights to Barbados is +0.5. (a) Explain what is meant by cross-elasticity of demand and what these values mean in terms of the effect of changes in the price of flights to Barbados on (i) the demand for hotels in Barbados, and (ii) the demand for flights to Antigua. [8] (b) Growing pressures on the budget and on the environment from increasing tourist numbers to Barbados led the government to announce a new indirect tax on incoming tourists in June 2018. Discuss the likely effectiveness of the new indirect tax in raising tax revenue and reducing tourist numbers. [12]

Mark scheme: 2(a) Market research has estimated that the cross-elasticity of demand for hotels in Barbados with respect to the price of flights to Barbados is –2.5, and that the cross- elasticity of demand for flights to Antigua with respect to the price of flights to Barbados is +0.5. Explain what is meant by cross-elasticity of demand and what these values mean in terms of the effect of changes in the price of flights to Barbados on (i) the demand for hotels in Barbados, and (ii) the demand for flights to Antigua. For knowledge and understanding of the concept of cross elasticity of demand. What it measures (1 mark) and the formula (1 mark) (i) Identify that this would suggest hotels are a complement to flights due to the negative sign (1 mark) explain why the value is negative (1 mark) with reference to the size of the coefficient (1 mark) (up to 3 marks) (ii) Identify that this would suggest that flights to Antigua are a substitute for flights to Barbados due to the positive sign (1 mark) explain why the value is positive (1 mark) with reference to the size of the coefficient (1 mark) (up to 3 marks) to a larger percentage fall in demand for hotel accommodation (complements) and a smaller percentage increase in demand for flights to Antigua (substitutes). In the explanations, reference must be made to the significance of the size of the coefficient for the third mark Question Answer Marks Guidance 2(b) Growing pressures on the budget and on the environment from increasing tourist numbers to Barbados led the government to announce a new indirect tax on incoming tourists in June 2018. Discuss the likely effectiveness of the new indirect tax in raising tax revenue and reducing tourist numbers. For an analysis of how the new tax will raise tax revenue and reduce tourist numbers (up to 4 marks) For an analysis of other factors which may reduce the effectiveness of the new indirect tax (up to 4 marks) Up to 4 marks for an evaluation of the likely impact on the market of the new indirect tax, that may also consider other ways in which the government could raise additional revenue and reduce tourist numbers. Reserve 1 mark for a reasoned conclusion as to whether the new indirect tax would be truly effective 12 The effectiveness of the tax will depend on the PED for holidays in Barbados; incidence will vary with rate of tax. A diagram would help here although it is not essential. There are no KU marks awarded in part b for merely explaining/defining terms or phrases within the question

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3 (a) Explain what is meant by aggregate supply and explain one reason why the aggregate supply curve of an economy would shift outwards in (i) the short run, and (ii) the long run. [8] (b) Discuss whether an increase in aggregate demand would be of overall benefit for an economy. [12]

Mark scheme: 3(a) Explain what is meant by aggregate supply and explain one reason why the aggregate supply curve of an economy would shift outwards in (i) the short run, and (ii) the long run. For explanation of aggregate supply e.g. total output in an economy (1 mark) that distinguishes between short run and long run (1 mark) (up to 2 marks) Identify a reason (1 mark) plus up to 2 marks for an explanation of why this causes the SRAS to move outwards. (up to 3 marks) Identify a reason (1 mark) plus up to 2 marks for an explanation of why this causes the LRAS to move (up to 3 marks) – an increase in the supply of labour – net investment – other factor inputs – devaluation of the exchange rate – government regulations – discovery of new resources – better education and training – advances in technology 3(b) Discuss whether an increase in aggregate demand would be of overall benefit for an economy. For an analysis of the benefits of an increase in aggregate demand to the economy (up to 4 marks) For an analysis of the possible problems for an economy if aggregate demand increases (up to 4 marks) Up to 4 marks for an evaluation which clearly compares the benefits and the problems for an economy resulting from an increase in AD with one mark reserved for a reasoned conclusion 12 A good answer should consider firms, government and consumers/workers The benefits for an increase in AD may include economic growth, higher employment etc The problems may include inflation, current account deficit etc There are no KU marks awarded in part b for merely explaining/defining terms or phrases within the question

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4 (a) Explain how a free trade area differs from a customs union and explain two reasons why countries move towards tariff-free trade. [8] (b) Discuss the view that the gains from tariff-free trade are greater for countries who are net importers than for countries who are net exporters. [12]

Mark scheme: 4(a) Explain how a free trade area differs from a customs union and explain two reasons why countries move towards tariff-free trade. Up to 2 marks for an explanation of the difference between a free trade area and a customs union. Knowledge and understanding of what is meant by a free trade area (1 mark) and knowledge and understanding of how this differs from a customs union (1 mark) Identify a reason why countries may move to tariff free trade (1 mark) and up to 2 marks that clearly explains the benefits to countries × 2 (3 marks maximum per reason) advantage is not required. The main difference is in terms of a common external tariff in a customs union. Reference to common policies as in the case of the EU is also OK. Various benefits of free trade include – specialisation – higher living standards – cheaper and better quality products and more choice – increased employment – to benefit from the principle of comparative advantage Question Answer Marks Guidance 4(b) Discuss the view that the gains from tariff-free trade are greater for countries who are net importers than for countries who are net exporters. Up to 4 marks for an analysis of the benefits/gains /advantages and disadvantages from tariff-free trade for countries who are net importers. Maximum of 3 marks for answers that only considers either advantages or disadvantages Up to 4 marks for an analysis of the benefits/gains /advantages and disadvantages from tariff free trade for countries who are net exporters. Maximum of 3 marks for answers that only considers either advantages or disadvantages Up to 4 marks for an evaluation that clearly compares the impact of tariff free trade on both countries who are net importers and those who are net exporters with 1 mark reserved for a valid conclusion as to whether the statement may be justified. 12 This is an unusual statement, given that economic theory tends to concentrate on the benefits of increased exports not imports. The benefits from tariff-free imports can include cheaper supplies, better quality and range of goods, puts pressure on domestic producers to be more efficient etc. But the disadvantages may include a threat to domestic businesses. The benefits for net exporters include higher growth, increased employment etc. but the disadvantages may include higher inflation. There are no KU marks awarded in part b for merely explaining/defining terms or phrases within the question

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