Cambridge A Level Economics 9708 — 2022 May/June Paper 4 · Variant 2

1 Recent changes in the world oil market The world price of oil is primarily determined by OPEC (Organization of the Petroleum Exporting Countries), which is a cartel consisting of 15 major oil producing countries. These countries have over 75% of the world’s reserves of oil. Saudi Arabia is effectively the leader of the cartel. It exercises leadership by adjusting the output of the cartel to maintain the price agreed by the cartel’s members. Russia and the US are not members of OPEC, but they engage in collusion with the cartel by accepting the oil price agreed by OPEC. Between 2010 and 2019 United States (US) oil production increased from 6m barrels per day (mbd) to 12 mbd, equal to the output of Russia and exceeding that of Saudi Arabia. The increase in US production was mainly through a process known as fracking, with low fixed costs and high variable costs. This contrasts with Russia and Saudi Arabia where oil production involves high fixed costs and low variable costs. In spring 2020, faced with a falling world oil price, Saudi Arabia proposed to cut its oil production. Russia did not agree with the proposal and increased its output by 4%. Saudi Arabia responded by increasing its output by 20%. The result of this disagreement was that the world price of oil fell significantly from US$70 per barrel to under US$30 per barrel. The situation was not helped by a sharp drop in the global demand for oil as many countries shut down large sections of their economies in response to the coronavirus (Covid-19) pandemic. The joint action of Russia and Saudi Arabia was thought to be an attempt to undermine the US oil industry. This was because oil exports were a major source of income for both countries. Oil was responsible for more than 60% of Russia’s exports and provided more than 30% of the country’s gross domestic product (GDP). For Saudi Arabia, the importance was even greater. The oil sector accounted for about 70% of export earnings, and 50% of GDP. The high price of oil in past years had enabled Russia to accumulate a significant budget surplus. The recent fall in the price of oil was thought to double the budget deficit of Saudi Arabia to US$100 billion at a time when the government was seeking to develop the country’s industry and reduce unemployment. (a) Define what is meant by a cartel. [2] (b) ‘Russia and the US are not members of OPEC, but they engage in collusion with the cartel.’ Explain what the term collusion means in the context of an oligopoly. [3] (c) The oil production processes used by Saudi Arabia and the US have different proportions of fixed costs and variable costs. Analyse why the fall in the price of oil may have a more significant effect on the output of oil in the US. [7] (d) Discuss, with the use of AD/AS diagrams, how Russia and Saudi Arabia are likely to be able to respond to the fall in oil prices. [8]

Mark scheme: Question Answer Marks 1(a) Define what is meant by a cartel. 2 A formal agreement (1) by firms to operate collectively (1) to raise price or limit output (1) to reduce competition/control the market (1 mark) 1(b) Russia and the US are not members of OPEC, but they engage in collusion 3 with the cartel.’ Explain what the term collusion means in the context of an oligopoly. Collusion is an informal arrangement (1 mark). An example of collusion (1) It arises when firms agree to a form of competitive behaviour which benefits the firms. Accept price leadership as tacit collusion. (1 mark) Examples one firm raises it price and all other firms in the industry agree to do the same, a refusal to reduce prices despite raw material costs falling. (1 mark) 1(c) The oil production processes used by Saudi Arabia and the US use 7 different proportions of fixed costs and variable costs. Analyse why the fall in the price of oil may have a more significant effect on the output of oil in the US. Definition of variable costs (1 mark) and fixed costs. (1mark) Recognition of higher variable costs (VC) in USA and/or lower VC in Saudi Arabia/Russia. (1 mark) Explanation of the relationship between price and average variable costs:-  If the price remains above AVC but below ATC a US well can still make a contribution to fixed costs, reducing losses. (1 mark)  If price is less than AVC a US well cannot continue in production as losses would be greater than fixed costs. (1 mark) Conclusion: Some US oil wells may close (1 mark) but without more detailed information on the AVC of US wells no definite estimate of the number can be made. (1 mark) 1(d) Discuss, with the use of AD/AS diagrams, how Russia and Saudi Arabia 8 are likely to be able to respond to the fall in oil prices. Effect of changes: Reason(s) for fall in AD (1 mark) Diagram to show AD falls in both R and SA Diagram 2 marks Price level AD1 AD AS P P1 N1 N Real GDP/output 1 mark for correct labels/axes, 1 mark for shift AD to AD1 and its outcome. Response to problem Recognition of the need for different policies between Russia and S Arabia because of budget surplus/deficit (1 mark) Russia choses expansionary FP (1 mark) because of budget surpluses (1 mark), this restores AD. (1 mark) Up to 3 marks SA because it leads OPEC, can reduces supply of oil (1 mark) which raises the oil price because of inelastic demand (1 mark) and AD will rise. (1 mark) Up to 3 marks (5 marks max) Diagram may be used in response element of the answer. (max 2 marks for diagram(s)

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2 A rational consumer will always purchase less of an item as the price increases. Discuss, with the use of indifference curve analysis, whether this statement is correct. [25]

Mark scheme: 2 A rational consumer will always purchase less of an item as the price 25 increases. Discuss, with the use of indifference curve analysis, whether this statement is correct. Meaning of a rational consumer, definition/description of an indifference curve (IC), meaning of the budget line (BL). Interaction of IC and BL to determine quantity demanded. Change in price of a good and its effect on quantity demanded. Split of change in quantity demanded into substitution effect (SE) and income effect (YE). The nature of SE is always negative and YE can be either positive or negative. Combined effect on quantity demanded. Relevant diagrams. The effect of a large negative income effect more than offsetting the substitution effect (Giffen good) may be explained/analysed. L4 (18–25 marks): For answer which develops the analysis and discusses the effect of the change in price on the quantity demanded due to the size and sign of the SE and YE. Reference to a Giffen good (or a Veblen good) is made. Evaluation comment(s) is/are made. L3 (14–17 marks): For an answer which analyses the effect of a change in price on the quantity demanded. There is reference to the SE and YE. L2 (10–13 marks): For a limited explanation which describes IC and BL and the derivation of the quantity demanded at a given price. A basic diagram of a single equilibrium point is drawn. L1 (1–9 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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3 (a) Explain the relationship between marginal revenue and average revenue and their role in determining the output and profit of a profit maximising firm in a perfectly competitive market. [12] (b) Discuss the significance of economies of scale for the survival of firms. [13]

Mark scheme: 3(a) Explain the relationship between marginal revenue and average revenue 12 and their role in determining the output and profit of a profit maximising firm in a perfectly competitive market. Definition of average revenue (AR) and marginal revenue (MR). Understanding of their nature in a perfectly competitive market. Marginal costs (MC) equality to MR for profit maximising output. The difference between AC and AR to determine the level of profits. Short run and long run changes. L4 (9–12 marks): For an answer which refers to average and marginal revenue and analyses the relationship between MR/MC and AR/AC in both the short run and long run and links the two, to determine profits in perfect competition. L3 (7–8 marks): For an answer which refers to average and marginal revenue and analyses the relationship between MR/MC and AR/AC in the short run or long run to determine profits in perfect competition. L2 (5–6 marks): For an answer which explains average and marginal revenue in the context of a perfectly competitive firm. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial. 3(b) Discuss the significance of economies of scale for the survival of firms. 13 Definition and explanation of internal/external economies of scale (EoS), reference to impact of EoS on barriers to entry (BtE). Ability to access EoS and long run average costs (LRAC) impact on competitive position compared with other firms in an industry and survival. EoS and the development of oligopoly and/or monopoly industries and long run survival of the firm within those market structures. L4 (9–13 marks): For an answer which develops an analysis of the relationship between EoS and BtE with reference to LRAC, and market structure(s) and the survival of a firm. A comparative analysis is drawn with the survival of small firms. A conclusion is reached for 12/13 marks. L3 (7–8 marks): For an answer which develops an analysis of the relationship between EoS and BtE, with reference to LRAC, and the survival of a firm. Alternatively, the analysis compares the ability to gain EoS, with the competitive strength of a firm and its survival. There is limited reference to market structure(s). A limited comparison is drawn with the survival of small firms. L2 (5–6 marks): For an answer which defines and explains economies of scale with reference to LRAC. Answer is largely descriptive. No link to survival. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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4 (a) Explain how the problems of climate change, such as global warming, may be regarded as a consequence of resource misallocation. [12] (b) Evaluate two policies a government may implement to reduce the impact of climate change. [13]

Mark scheme: 4(a) Explain how the problems of climate change, such as global warming, may 12 be regarded as a consequence of resource misallocation. The allocative efficiency implications of the effects of overuse of carbon emission producing fuels, on externalities in consumption and production. Externalities marginal private/benefits social efficient output. L4 (9–12 marks): For an answer which explains and analyses climate change in terms of externalities and private and social costs/benefits and link to resource misallocation. L3 (7–8 marks): For an answer which explains and analyses climate change in terms of externalities or private or social costs/benefits with link to resource misallocation. L2 (5–6 marks): For an answer which explains externalities and private and social costs/benefits and comments on the outcome. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial. 4(b) Evaluate two policies a government may implement to reduce the impact 13 of climate change. Analysis of two from a range of policies is possible: taxation of carbon producing activities, subsidies of alternative fuels, prohibition of activities, improved information, pollution permits. Evaluation may refer to direct cost of implementation, environmental effectiveness, allocative efficiency, effect on production costs, local effects on employment, the international aspects of climate change or regressive/progressive income effects. L4 (9–13 marks): For an answer which analyses two policies which may reduce the impact of climate change. Evaluation is made. L3 (7–8 marks): For an answer which analyses two policies. L2 (5–6 marks): For an answer which defines and explains one or two policies. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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5 The best outcome for labour markets is that the forces of supply and demand are left to determine wages without government interference. Discuss with the use of diagrams, whether this statement is always true. [25]

Mark scheme: 5 The best outcome for labour markets is that the forces of supply and 25 demand are left to determine wages without government interference. Discuss with the use of diagrams, whether this statement is always true. The demand (MRP theory) and supply of labour and the determination of wages. Reference to elasticities on the wage level. The implementation and impact of minimum wage legislation. The effect of monopsony on the labour market. L4 (18–25 marks): For an answer which analyses the effects of supply and demand on the wage level in a competitive labour market and imperfect labour market. Government intervention in the labour market is analysed and discussed. Accurate diagrams are present. An evaluation of the truth of the statement is made. L3 (14–17 marks): For an answer which analyses the effects of supply and demand on the wage level in a competitive labour market or an imperfect labour market. Accurate diagrams are present. An explanation of government intervention in the labour market is given. L2 (10–13 marks): For a limited explanation which describes the effects of supply and demand on the wage level in a competitive labour market. L1 (1–9 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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6 (a) Distinguish between the characteristics of developed (high-income) and developing (low-income) countries. [12] (b) Discuss whether gross domestic product (GDP) is the best measure of the standard of living. [13]

Mark scheme: 6(a) Distinguish between the characteristics of developed (high income) and 12 developing (low income) countries. GDP per capita, population age structure, education, health care, foreign debt levels, sectoral distribution of employment, level of employment, level of infrastructure or level of urbanization. L4 (9–12 marks): For an answer which explains and analyses the relationship between three or more characteristics. L3 (7–8 marks): For an answer which explains and analyses the relationship between two characteristics. L2 (5–6 marks): For an answer which explains two characteristics. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial. 6(b) Discuss whether gross domestic product (GDP) is the best measure of the 13 standard of living. Definition of gross domestic product (GDP) and its use in the form of real GDP per head as a measure of the standard of living. The use of HDI/MEW/ or other measures of standard of living, a discussion of their merits as measures of the standard of living. L4 (9–13 marks): For an answer which discusses the relative merits of GDP and an alternative measure of the standard of living. GDP is evaluated against an alternative measure. L3 (7–8 marks): For an answer which analyses the use of real GDP per capita as a measure of the standard of living and comments on an alternative measure of the standard of living. L2 (5–6 marks): For an answer which defines and explains the use of real GDP or GDP per capita as a measure of the standard of living. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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7 (a) Explain the relationship between the Keynesian demand for money and the rate of interest. [12] (b) Discuss whether monetary policy alone is sufficient for a government to achieve its macroeconomic aims simultaneously. [13]

Mark scheme: 7(a) Explain the relationship between the Keynesian demand for money and 12 the rate of interest. The description of the transaction, precautionary and speculative demands for money, their individual relationship with the rate of interest. The combined effect of the 3 demands and the rate of interest. L4 (9–12 marks): For an answer which provides a detailed explanation and analysis of the three demands for money and relates them to the rate of interest. L3 (7–8 marks): For an answer which explains and analyses two of the demands for money and relates them to the rate of interest. L2 (5–6 marks): For an answer which explains two of the demands for money. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial. 7(b) Discuss whether monetary policy alone is sufficient for a government to 13 achieve its macroeconomic aims simultaneously. Identification of government macroeconomic aims: employment, inflation, growth or balance of payment equilibrium. Explanation of the monetary policy process and the limitations of this policy. Explanation of alternative policy(ies) e.g. fiscal, supply side policy. Comparison and discussion of their relative ability to achieve stated economic aims – employment, inflation, growth or balance of payment equilibrium. L4 (9–13 marks): For an answer which discusses and analyses the impact of monetary policy changes on two government macroeconomic aims and the impact of an alternative policy are compared. An evaluation of the statement. L3 (7–8 marks): For an answer which analyses the impact of monetary policy changes on two government macroeconomic aims. Reference is made to an alternative policy which may help achieve those aims. L2 (5–6 marks): For an answer which defines and explains the monetary policy and/or two government macroeconomic aims. L1 (1–4 marks): For an answer which has some basic correct facts but includes irrelevancies. Errors of theory or omissions of analysis will be substantial.

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