Cambridge A Level Economics 9708 — 2022 Oct/Nov Paper 2 · Variant 3

1 Pakistan’s agriculture survives on subsidies As in most developing countries, the agricultural sector in Pakistan is heavily dependent on subsidies. Agriculture is an important activity, employing 45% of the population. Domestic production is vital in providing food for its growing population. Farming in Pakistan is not very profitable and without subsidies, many farmers would be forced to leave their farms. Despite subsidies, as shown in Table 1.1, the cost of production in Pakistan is much greater for a range of staple products than it is in India where farmers are more heavily subsidised. Table 1.1: Cost of production after subsidies of selected products in Pakistan and India, 2018 (Pakistan Rupees per unit) Pakistan India Wheat 76 51 Cotton 127 88 Rice 124 68 Sugar cane 222 142 Maize 119 53 The higher cost of production in Pakistan has serious implications for Pakistan’s participation in global trade in agricultural products. This problem is particularly critical as Pakistan seeks to increase exports to reduce a deficit on the current account of the balance of payments. A complaint of farmers is that GST, a sales tax, is charged when they purchase fertilisers. In May, the government gave in to pressure and cut GST on fertilisers from 17% to 2%. Farmers’ leaders want the tax to be completely removed from fertiliser sales. Their priority, however, is for a large increase in the subsidy paid to farmers to a level comparable to that paid to farmers in India. In Pakistan’s current economic position this prospect appears to be remote. Pakistan’s farmers also complain about the subsidies that are paid to farmers in richer neighbouring countries. They strongly argue that these subsidies are unfair on farmers from developing countries and are holding back their economic development. Source: Agriculture survives on subsidies, Amjad Mahmood, Dawn, 27 May 2019 (a) Explain what might be the opportunity cost if the Pakistan government agreed to pay subsidies to Pakistan’s farmers comparable to those paid to India’s farmers. [2] (b) (i) With reference to Table 1.1, state in which product group Pakistan’s farmers are most disadvantaged. [1] (ii) Explain how the lower level of subsidy currently paid to Pakistan’s farmers is likely to affect Pakistan’s trade in agricultural goods when competing with India in international markets. [3] (c) Analyse, with the help of a diagram, how the sales tax on fertilisers affects the market for fertilisers in Pakistan. [4] (d) Explain two other ways, apart from subsidies and reductions in sales tax, in which the government might support Pakistan’s farmers. [4] (e) Discuss whether agricultural subsidies should not be paid to farmers in countries which have lower opportunity costs in other areas of production. [6]

Mark scheme: Question Answer Marks Guidance 1(a) Explain what might be the opportunity cost if the Pakistan 2 Other areas of government funding may include government agreed to pay subsidies to Pakistan’s farmers healthcare, education, infrastructure etc. comparable to those paid to India’s farmers. Accept any valid example • Opportunity cost is the cost in terms of the best alternative that is forgone (1 mark) Accept answers that merge the explanation of • The decision to increase subsidies means that other areas of opportunity cost with an appropriate example for 2 government funding with a specific example will have less marks. spending allocated to them (1 mark) 1(b)(i) With reference to Table 1.1, state in which product group 1 Maize has the greatest relative cost difference Pakistan’s farmers are most disadvantaged. (2.24 although this measure is not required.) Maize (1 mark) Do not accept any other product group. 1(b)(ii) Explain how the lower level of subsidy currently paid to 3 Responses may consider the following points Pakistan’s farmers is likely to affect Pakistan’s trade in within the explanation: agricultural goods when competing with India in international • Pakistan is already at a cost disadvantage markets. when trading with India • Pakistan’s agricultural exports are likely to be It is likely to make exports of Pakistan’s agricultural products less price less competitive than similar exports from competitive / imports of India’s agricultural products more price India competitive (1) and the resulting reduction in exports (1) and • Lower subsidies exaggerate the cost increasing imports (1) is likely to lead to a (increased) deficit in differences Pakistan’s trade in agricultural goods (1) • Could mean that imports of staple foods from India increase Up to a maximum of 3 marks • Other countries will buy more goods from India due to cost difference 1(c) Analyse, with the help of a diagram, how the sales tax on 4 A sales tax increases the price of fertilisers to fertilisers affects the market for fertilisers in Pakistan. farmers in Pakistan. This can be shown by a shift to the left of the supply curve. For an accurate diagram that uses an accurately labelled D and S diagram to show a shift in the supply curve (1 mark) and the increase The effect on the market is likely to depend upon in price and reduction in quantity (1 mark) the PED for fertilisers and the size of the sales tax. For an explanation that the fall in demand will depend upon the PED for fertilisers and /or the size of the sales tax. (Up to 2 marks) 1(d) Explain two other ways, apart from subsidies and reductions in 4 Various possibilities include: sales tax, in which the government might support Pakistan’s • A minimum price for a given crop farmers. • Income support through transfer payments • Advice on how to cut costs and improve crop Identification of an additional way (1 mark) plus an explanation of how yields this will support farmers (1 mark) • Cheap finance to buy better quality seed • Policy of protectionism (N.B. do not accept 2 Up to 2 marks per identified way  2 policies of protection as 2 separate ways) • Education and training 1(e) Discuss whether agricultural subsidies should not be paid to 6 The answer should consider the benefits of farmers in countries which have lower opportunity costs in other subsidies to farmers in terms of increasing their areas of production. incomes and benefits to the economy in terms of reducing import dependence and keeping the For an explanation of the benefits of paying agricultural subsidies to prices of staple goods affordable. farmers (up to 3 marks) The evaluation should consider these benefits in countries that have lower opportunity costs in For an evaluation of whether agricultural subsidies should be paid to other areas of production e.g., may be an farmers if the country already has lower opportunity costs in other unnecessary burden on government expenditure, industries. (Up to 3 marks with 1 mark reserved for a conclusion) may invite retaliation, may restrict trade etc.

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2 (a) Explain why demerit goods are over-consumed and merit goods are under-consumed. [8] (b) Discuss the extent to which the introduction of a maximum price in a market will benefit consumers. [12]

Mark scheme: 2(a) Explain why demerit goods are over-consumed and merit goods 8 Demerit goods are over-consumed because of are under-consumed. imperfect information on the part of those who consume them. They are not aware of the risks to For knowledge and understanding of the difference between demerit health of over consumption. The positive side goods and merit goods e.g., demerit goods are those that are thought effects of consuming merit goods are not to be undesirable for consumers / worse for them than they realise (1) appreciated by all consumers due to imperfect and merit goods are those that are thought to be desirable for information. consumers / better for them than they realise (1) We cannot expect any discussion regarding costs For application that explains that demerit goods are often and benefits including externalities, private costs overconsumed because of imperfect information (1) giving an example and benefits, social costs and benefits as these (1) with further development e.g., also because of low income, poor are not on the AS syllabus but these may be education, low prices of demerit goods, addiction (1) rewarded if included. For application that merit goods are often underconsumed because of imperfect information (1) giving an example (1) with further development e.g., also because of low income / high prices of merit goods (1) 2(b) Discuss the extent to which the introduction of a maximum price 12 The purpose of maximum price legislation is to in a market will benefit consumers. ensure that consumers get access to supplies of essential products such as various types of food For analysis of how the introduction of a maximum price in a market and in some cases, water and power supplies. It may benefit consumers. (Up to 4 marks) may also free up income to purchase other essential items. To be effective the maximum For analysis of how the introduction of a maximum price in a market price must be below the equilibrium price in a free may not be of benefit to consumers. (Up to 4 marks) market, and this may be referred to in the first part of the analysis. An accurate diagram should not For evaluation that clearly considers the extent to which consumers be expected but would enhance the quality of the may benefit from the introduction of a maximum price in a market (up analysis. to 3 marks) that leads to a reasoned conclusion (1 mark) However, the problem with a maximum price is that demand invariably exceeds supply at this price. Shortages can occur and this can lead to an informal market and profiteering along with rationing and queuing. Consumers may end up paying even more than the equilibrium price to get the supplies they need.

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3 (a) Explain the difference between a progressive direct tax and a regressive indirect tax, with an example of each. [8] (b) Discuss whether an increase in direct taxes or an increase in interest rates is the more effective way of reducing inflation. [12]

Mark scheme: 3(a) Explain the difference between a progressive direct tax and a 8 A direct tax is one that is paid by individuals or regressive indirect tax, with an example of each. businesses direct to the government. It is based on an individual’s income or on the profits of a For knowledge and understanding of the difference between a direct business. Examples are income tax and profits tax and an indirect tax e.g., a direct tax is a tax on income and wealth tax. An indirect tax is so-called because it is not (1) and an indirect tax is a tax on the sale of/ spending on goods and directly collected by the government-retailers and services (1) local government agencies are the main collectors. The tax is based on the purchase of For application that provides a valid identification of a direct tax (1 products. Examples are GST or VAT and duties mark) and explains why it may be progressive with reference to the charged on sales of petrol, cigarettes and alcohol. burden of taxation as income rises (1 mark) with accurate reference to the marginal rate of taxation. (1 mark) OR the marginal rate of tax will A direct tax is usually progressive, the rate of be higher (1 mark) than the average rate of tax (1 mark) taxation increasing as income increases. Indirect Up to 3 marks taxes are regressive since they have to be paid irrespective of the income of the consumer. For application that provides a valid identification of an indirect tax (1 mark) and explains why it is considered regressive with reference to The marginal rate of taxation is the proportion of the relative burden of taxation between higher and lower income extra income taken in tax. This will rise with a groups (1 mark) with accurate reference to the marginal rate of progressive tax thus increasing the burden on taxation (1 mark) OR the marginal rate of tax will be lower (1 mark) higher income groups. It will fall with a regressive than the average rate of tax (1 mark) tax thus increasing the burden on lower income Up to 3 marks groups. The average rate of tax refers to the proportion of income taken so for a progressive tax the marginal rate of taxation will be higher than the average rate of taxation and lower for a regressive tax. 3(b) Discuss whether an increase in direct taxes or an increase in An increase in direct taxes is likely to lead to a fall interest rates is the more effective way of reducing inflation. in AD and therefore inflation due to a fall in consumption and investment. It is likely to be For an analysis of the advantages and disadvantages of increasing easy to implement and may be seen as fair if the direct taxes to reduce inflation. N.B if only advantages or tax is progressive as the burden will fall more on disadvantages are considered then maximum mark of 3. Up to higher income groups. However, it may reduce 4 marks incentives and lead to lower economic growth. For an analysis of the advantages and disadvantages of increasing An increase in interest rates should lead to an interest rates to reduce inflation. N.B if only advantages or increase in savings and a fall in consumption and disadvantages are considered then maximum mark of 3. Up to investment due to the increase in borrowing. The 4 marks effects are likely to be quicker than an increase in direct taxes due to the speed of implementation. For an evaluation of which may be the more effective way of reducing However, it may have similar consequences to an inflation (up to 3 marks) that leads to a reasoned conclusion (1 mark) increase in direct taxes and it may be ineffective if interest rates are already very low, or confidence levels remain high. Both evaluation and analysis may make reference to the fact that effectiveness of both methods depends on the type of inflation i,e., if it is cost- push rather than demand -pull, they may be ineffective..

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4 (a) Explain how a higher rate of inflation in an economy compared to its trading partners and a decline in the exchange rate will each affect the terms of trade in an economy. [8] (b) Since 2018, China and the United States (US) have been imposing tariffs on trade with each other. Discuss the view that some will benefit and some will lose but the overall impact of these tariffs will be negative. [12]

Mark scheme: 4(a) Explain how a higher rate of inflation in an economy compared to 8 Terms of trade is a measure of the relationship its trading partners and a decline in the exchange rate will each between export prices and import prices in an affect the terms of trade in an economy. economy. By definition, a favourable movement or improvement is when export prices increase For knowledge and understanding of what is meant by terms of relative to a change in import prices. Import prices trade i.e., it is a measure of the ratio of export to import prices (1) plus could fall while export prices remain unchanged. an accurate formula showing index of export prices / index of import prices (1). A higher rate of inflation compared to that in trading partners will result in an increase in export For application that explains the effect of a higher rate of inflation prices and an improvement in the terms of trade. compared to trading partners on the terms of trade of an economy. It will increase the relative price of exports (1) and reduce the relative A decline in the exchange rate results in a relative price of imports (1) therefore leading to an improvement of the terms of fall in export prices compared to trading partners. trade (1) Terms of trade deteriorates. (Up to 3 marks) For application that explains the effect of a decline in its exchange rate will affect the terms of trade in an economy. It will reduce the relative price of exports (1) and increase the relative price of imports (1) and lead to a deterioration in the terms of trade (1) (Up to 3 marks) 4(b) Since 2018, China and the United States (US) have been imposing 12 Protection occurs where a government protects tariffs on trade with each other. its domestic producers from external competition through measures such as tariffs. These Discuss the view that some will benefit and some will lose but the measures distort the market and do not lead to an overall impact of these tariffs will be negative. efficient allocation of resources. For analysis that explains the benefits of imposing tariffs N.B if only Benefits: protecting employment, infant industry one benefit is considered then maximum mark of 3. Up to 4 marks argument, sunset industries argument, reducing deficit on current account of the balance of For analysis that explains the costs of imposing tariffs N.B. if only one payments. cost is explained then maximum mark of 3. Up to 4 marks Costs: higher prices for consumers, less choice, For evaluation that considers the costs and benefits and assess protects inefficient firms and industries. whether the overall impact will be negative (up to 3 marks) leading to a reasoned conclusion (1 mark) Evaluation may make a comparison with the benefits of free trade.

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