Cambridge A Level Economics 9708 — 2022 Oct/Nov Paper 2 · Variant 1

1 Governments and markets Prices, according to economists, are determined by supply and demand. In many times and places, however, prices have been set by governments. For example, in January 2020, the government of Argentina updated its list of maximum prices, setting guidelines for over 300 products. Consumers, via a smartphone app, can report any prices of these products that are above the maximum. The World Bank has collected data on the extent to which the governments of developing economies have intervened in markets to set prices. Table 1.1 shows the results of this research. Table 1.1: Government intervention in product markets to influence prices in developing economies Product market Percentage of Examples governments intervening in the market to influence price Energy 89 Petrol in Iran Bread in Benin Food 76 Rice in Haiti Building materials 13 Cement in Burkina Faso Source: Adapted from ‘In a fix’, The Economist, 11 January 2020 Governments generally impose price controls for one of three reasons: • to redistribute income in an economy: maximum prices help the poor afford the necessities of life, whereas minimum prices support the livelihoods of farmers • to stabilise a market: governments use stocks to smooth fluctuations in the price of a commodity like cocoa, buying when there is excess supply in the market and selling when there is excess demand • to control inflation: maximum prices have been used in many countries Many economists have been critical of the use of price controls by governments. In a market without government intervention, a product’s price acts as a signal of its scarcity and an incentive to overcome scarcity. However, minimum prices can lead to food rotting in warehouses while maximum prices can lead to hoarding and black markets. Another reason not to impose price controls in an economy is that they can be very unpopular. For example, in Santiago, the capital city of Chile, an increase in the minimum price on the public transport system led to widespread unrest in 2019. In the same year, the government of Iran decided to raise the minimum price of fuel sharply and suddenly, leading to a great deal of protest. A representative of the World Bank has stated that one reason not to impose price controls in an economy is that they can be hard to remove, expressing the view that ‘it is better not to have them in the first place.’ Source: Adapted from ‘In a fix’, The Economist, 11 January 2020 (a) Explain how ‘a product’s price acts as a signal of its scarcity’. [2] (b) Explain one possible reason why the Government of Iran may have decided to raise the minimum price of fuel in 2019. [2] (c) Explain, with the help of a diagram, how an effective minimum price would affect the market for a basic food, such as rice in Haiti. [4] (d) ‘Governments use stocks to smooth fluctuations in the price of a commodity like cocoa.’ Consider whether government action to smooth fluctuations helps the workings of the price mechanism. [6] (e) Discuss whether maximum price controls will always be effective in controlling inflation. [6]

Mark scheme: Question Answer Marks Guidance 1(a) Explain how ‘a product’s price acts as a signal of its scarcity’. 2 For a reference to a situation where there are limited resources to satisfy unlimited wants and needs and so price rations the available resources among competing buyers (1 mark) For a development in terms of a rising demand for a product, relative to its supply, will push up prices and act as an incentive to increase the quantity; the existence of scarcity giving rise to the need to make choices between the different uses that can be made of the scarce resources (1 mark) 2 marks maximum 1(b) Explain one possible reason why the Government of Iran may 2 Possible reasons could include: have decided to raise the minimum price of fuel in 2019. • the need to reduce the demand for fuel; an For an identification of one possible reason (1 mark) increase in the price could be effective if the PED for fuel is elastic For a more developed explanation of one possible reason (1 mark) • this could benefit the country’s current account on the balance of payments if a 2 marks maximum substantial amount of fuel is imported, although Iran does have a large amount of crude oil reserves • this will encourage producers to increase the supply of fuel which will help them to increase their profits • an increase in producer profits could lead to a substantial increase in government revenue from the taxes on profits • if subsidies have been reduced, the money saved could be reallocated 1(c) Explain, with the help of a diagram, how an effective minimum 4 Effective minimum price: price would affect the market for a basic food, such as rice in • a minimum price in a market is where a Haiti. price floor is established • to be effective, this needs to be above For an explanation of the effect of a minimum price in a market the equilibrium price (Up to 2 marks) • the equilibrium price in a market would For a correctly drawn and labelled diagram to show the operation of a be higher than would be the case if minimum price in a market for a basic food, such as rice in Haiti there was no government intervention (Up to 2 marks) • farmers are therefore guaranteed 4 marks maximum these prices • this is likely to have a positive effect on their incomes • it could lead to excess supply/surplus • this could lead to the possibility of food rotting in warehouses Diagram: • One mark for correctly labelled P, Q, D and S • One mark for showing a minimum price line above the equilibrium, for showing a price higher than the equilibrium price and for showing the change in quantity 1(d) ‘Governments use stocks to smooth fluctuations in the price of a 6 Government action might help the workings commodity like cocoa’. of the price mechanism: • it can help to stabilise a market Consider whether government action to smooth fluctuations • stocks can be used to smooth helps the workings of the price mechanism. fluctuations in the price of commodity, such as cocoa, avoiding/reducing large For an explanation of how government action to smooth price price variations fluctuations may help the workings of the price mechanism • a government could buy stocks when (Up to 3 marks) there was an excess supply of a For an explanation of how government action to smooth price product in the market fluctuations may not help the workings of the price mechanism • a government could sell stocks when (Up to 3 marks) there was an excess demand for a 5 marks maximum product in the market Reserve 1 mark for a conclusion Government action might not help the workings of the price mechanism: 6 marks maximum • it could distort the market by not allowing prices to reflect changes in the conditions of demand for, and supply of, a product • the consideration of how such action by a government might not help the workings of the price mechanism can be discussed in relation to the different functions of the price mechanism, i.e. rationing, signalling and the transmission of preferences 1(e) Discuss whether maximum price controls will always be 6 The advantages of establishing a maximum effective in controlling inflation. price in a market in the form of a price ceiling: For a discussion of the advantages of using maximum price controls • the price will be lower than what would to control inflation (Up to 3 marks) otherwise be the case if there was no government intervention For a discussion of the disadvantages of using maximum price • this would lead to a lower rate of controls to control inflation (Up to 3 marks) inflation in an economy • this helps the poor afford the 5 marks maximum necessities of life • these could include essential Reserve 1 mark for a conclusion foodstuffs, housing rents and transport • specific examples given include the 6 marks maximum price of foodstuffs, including bread in Benin and rice in Haiti The disadvantages of establishing a maximum price in a market in the form of a price ceiling: • lower prices could stimulate demand- pull inflation • the creation of a shortage as a result of the excess demand created in the market • hoarding • black/illegal markets which can charge relatively high prices • queuing or rationing • if the controls are not effective, it will not control inflation

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2 (a) Explain two factors that will determine the price elasticity of demand for a particular brand of car and how this price elasticity of demand may change over time. [8] (b) Discuss whether knowledge of price elasticity of demand or income elasticity of demand would be of greater use to a business that produces cars. [12]

Mark scheme: 2(a) Explain two factors that will determine the price elasticity of 8 Definition of PED: the measurement of the demand for a particular brand of car and how this price elasticity extent to which a change in price leads to a of demand may change over time. change in quantity demanded For Knowledge and Understanding: Formula of PED: percentage change in the For a correct definition of price elasticity of demand quantity demanded of a product divided by the For a correct formula of price elasticity of demand. (Up to 2 marks) percentage change in the price of a product. 2 marks maximum Factors affecting PED: • the availability and price of substitutes: For Application: the market contains many firms and so Application of one factor affecting the PED for a particular brand of PED for a particular brand of car is car, taking into account how this may change over time. likely to be relatively elastic (Up to 3 marks) • the price of the product relative to income: the higher the relative Application of a second factor affecting PED for a particular brand of proportion of income accounted for by car, taking into account how this may change over time. a particular brand of car, the more (Up to 3 marks) elastic the PED is likely to be, although this could change over time as 6 marks maximum incomes rise • loyalty: if consumers have a strong loyalty to a particular brand of car, this will tend to make PED relatively inelastic • need or want: the degree to which a particular brand of car is seen as a necessity or a luxury • the time period: the PED for any particular brand of car is likely to increase over time, so it is more likely to be relatively elastic in the LR than in the SR 2(b) Discuss whether knowledge of price elasticity of demand or 12 The usefulness of knowledge of price income elasticity of demand would be of greater use to a elasticity of demand: business that produces cars. • the business will be able to predict the effect of a change in the price of a car For Analysis: on demand reasonably accurately Analysis of the usefulness of knowledge of the price elasticity of • if demand is price elastic, a fall in price demand to a business that produces cars. (Up to 4 marks) will lead to an increase in revenue • if demand is price inelastic, a fall in Analysis of the usefulness of knowledge of the income elasticity of price leads to a decrease in revenue demand to a business that produces cars. (Up to 4 marks) • if PED is unitary elastic, a change in price will not lead to a change in 8 marks maximum revenue For Evaluation: The usefulness of knowledge of the income For exercising some judgement on whether knowledge of price elasticity of demand: elasticity of demand or income elasticity of demand would be of • the business will benefit from knowing greater use to a business that produces cars.(Up to 4 marks) about the effect of changes in income in an economy, e.g. as incomes Reserve 1 mark for a conclusion increase, production can shift from a basic car 4 marks maximum • knowledge of YED will enable the business to plan for the future, e.g. having the resources to meet demand • increases in income in an economy may lead the business to produce better and more luxurious cars with more features and functions (luxuries have a YED of more than 1 and so the business will be able to know whether to produce more luxury goods)

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3 (a) Explain, with the use of a diagram(s), how the production possibility curve of an economy could be affected by a decrease in the quantity of labour available, but an increase in its quality. [8] (b) Discuss whether supply side policies will be successful in increasing the quantity and quality of the factor enterprise in a modern economy. [12]

Mark scheme: 3(a) Explain, with the use of a diagram(s), how the production 8 Production possibility curve: possibility curve of an economy could be affected by a decrease • a PPC is based on a two-product in the quantity of labour available, but an increase in its quality. economy • a PPC shows the range of For Knowledge and Understanding: combinations of two products that may For knowledge and understanding of the production possibility curve be produced if the existing level of of an economy. (Up to 2 marks) resources in an economy is being fully utilised 2 marks maximum A decrease in the quantity of labour: For Application: • this would lead to a reduction in the For a diagram and explanation of how a decrease in the quantity of productive potential of an economy (1) labour would shift the PPC to the left. (Up to 3 marks) Diagram: For a diagram and explanation of how an increase in the quality of • correct labelling of axes and PPC labour would shift the PPC to the right. (Up to 3 marks) drawn in such a way that it touches both axes (it can be straight or curved) 6 marks maximum (1) • the PPC shifts to the left (1) An increase in the quality of labour: • this would lead to an increase in the productive potential of an economy (1) Diagram: • correct labelling of axes and PPC drawn in such a way that it touches both axes (it can be straight or curved) (1) • the PPC shifts to the right (1) 3(b) Discuss whether supply side policies will be successful in 12 Potential advantages of supply side increasing the quantity and quality of the factor enterprise in a policies: modern economy. • lower taxes could encourage people to become entrepreneurs For Analysis: • higher expenditure on education and Analysis of the potential advantages of supply side policies in training/reskilling could improve the increasing the quantity and quality of the factor enterprise in a modern quality of the factor enterprise, making economy. (Up to 4 marks) entrepreneurs more innovative and more willing to take a risk Analysis of the potential limitations of supply side policies in • deregulation could lead to laws being increasing the quantity and quality of the factor enterprise in a modern reduced to make the setting up of an economy. (Up to 4 marks) enterprise easier • financial support from the government 8 marks maximum would enable more enterprises to survive and to stay in business For Evaluation: For exercising some judgement on whether supply side policies will Potential limitations of supply side policies: be successful in increasing the quantity and quality of the factor • the effects of supply side policies can enterprise in a modern economy.(Up to 4 marks) take a long time to show, e.g. training • some entrepreneurs might become too Reserve 1 mark for a conclusion dependent on government support and so become inefficient 4 marks maximum • the policies will not guarantee that all enterprises will be successful • a policy of privatisation might actually reduce the quantity of the factor enterprise needed • questionable whether enterprise can be taught/trained

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4 (a) Explain, with the use of a diagram(s), two factors that could bring about a depreciation in the value of a country’s exchange rate in a freely floating exchange rate system. [8] (b) Discuss whether protectionist policies would be the most effective way to correct a current account deficit on the balance of payments in an economy. [12]

Mark scheme: 4(a) Explain, with the use of a diagram(s), two factors that could 8 Definition of a floating exchange rate bring about a depreciation in the value of a country’s exchange system: rate in a freely floating exchange rate system. • one in which the exchange rate is determined by the intersection of the For Knowledge and Understanding: demand for a currency and the supply For a correct explanation of a floating exchange rate system of a currency or not fixed by the (1 mark) government For a correct diagram showing a floating exchange rate system Diagram: (1 mark) • vertical axis needs to indicate that it is the price of a currency rather than any 2 marks maximum price in order for the diagram to be given a mark, assuming that D and S For Application: are correctly labelled Explanation of one factor that could bring about a depreciation in the value of a country’s exchange rate in a freely floating exchange rate Factors that could bring about a system. (Up to 3 marks) depreciation: • a decrease in the demand for a Explanation of a second factor that could bring about a depreciation currency, e.g. if fewer exports are sold in the value of a country’s exchange rate in a freely floating exchange • an increase in the supply of a currency, rate system. (Up to 3 marks) e.g. if more imports are bought • lower interest rates 6 marks maximum • a higher rate of inflation compared with trading competitors because exports will be less competitive • a deficit in the balance of payments on current account will contribute to a depreciation 4(b) Discuss whether protectionist policies would be the most 12 Potential advantages of protectionist effective way to correct a current account deficit on the balance policies: of payments in an economy. • tariffs would make imports more For Analysis: expensive and discourage the The potential advantages of protectionist policies to correct a current consumption of them account deficit on the balance of payments in an economy. • quotas would restrict the volume of (Up to 4 marks) imported products • embargoes would place a complete The potential limitations of protectionist policies to correct a current ban on certain imported products account deficit on the balance of payments in an economy. • excessive administrative burdens (‘red (Up to 4 marks) tape’) would make it much more difficult to actually get products into a 8 marks maximum country • export subsidies would help to make For Evaluation: domestic products more price For exercising some judgement on whether protectionist policies competitive in international markets would be the most effective way to correct a current account deficit on the balance of payments in an economy. (Up to 4 marks) Potential limitations of protectionist Reserve 1 mark for a conclusion policies: • tariffs may not be very effective if the 4 marks maximum demand for the imported products is relatively price inelastic • some quotas may not be that restrictive • an embargo could lead to retaliation • there may be ways of getting round the excessive administrative burdens • the effect of export subsidies would depend on the PED for the products and could also lead to retaliation

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