AQA AS-Level · Thinka-original Practice Paper

2024 AQA AS-Level Economics 7135 Practice Paper with Answers

Thinka Jun 2024 AQA AS Level-Style Mock — Economics 7135

140 marks180 mins2024
AnalysisSample paper
An original Thinka practice paper modelled on the structure and difficulty of the Jun 2024 AQA AS Level Economics 7135 paper. Not affiliated with or reproduced from AQA.

Section A

Answer all twenty multiple-choice questions.
13 Question · 13 marks
Question 1 · multiple-choice
1 marks
In a competitive market, the weekly demand curve for a good is given by \(Q_d = 200 - 4P\) and the weekly supply curve is given by \(Q_s = -40 + 8P\), where \(P\) is price in pounds (£) and \(Q\) is quantity. If the government introduces a maximum price of £15, what will be the resulting market situation?
  1. A.An excess supply of 60 units
  2. B.An excess demand of 60 units
  3. C.An excess demand of 140 units
  4. D.An equilibrium price of £20 with no excess demand or supply
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Worked solution

To find the equilibrium price, set quantity demanded equal to quantity supplied: \(200 - 4P = -40 + 8P\), which simplifies to \(240 = 12P\), giving an equilibrium price of \(P = £20\). Since the government-mandated maximum price of £15 is below the market equilibrium price, it is a binding price ceiling. At this maximum price of £15: Quantity demanded \(Q_d = 200 - 4(15) = 140\) units. Quantity supplied \(Q_s = -40 + 8(15) = 80\) units. This results in excess demand of \(Q_d - Q_s = 140 - 80 = 60\) units.

Marking scheme

1 mark for the correct option (B). Award 1 mark for the correct answer. Reject all other options as they are mathematically or theoretically incorrect.
Question 2 · multiple-choice
1 marks
An economy's production possibility frontier (PPF) shows the maximum combinations of consumer goods and capital goods that can be produced with available resources. The following combinations are achievable: Option A (100 consumer, 0 capital), Option B (90 consumer, 10 capital), Option C (70 consumer, 20 capital), Option D (40 consumer, 30 capital), Option E (0 consumer, 40 capital). What is the opportunity cost of increasing the production of capital goods from 10 units to 30 units?
  1. A.20 capital goods
  2. B.40 consumer goods
  3. C.50 consumer goods
  4. D.90 consumer goods
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Worked solution

Opportunity cost is the value of the next best alternative foregone. At 10 units of capital goods (Option B), the economy produces 90 units of consumer goods. To increase capital goods to 30 units (Option D), consumer goods production must fall to 40 units. The opportunity cost is therefore the reduction in consumer goods: \(90 - 40 = 50\) consumer goods.

Marking scheme

1 mark for the correct option (C). Award 1 mark for the correct identification and calculation of the sacrificed consumer goods. Reject other options as they represent other values from the table.
Question 3 · multiple-choice
1 marks
In 2021, a country's Nominal GDP index was 110 (with 2020 as the base year of 100). During the same year, the country's GDP deflator was 105. Which of the following is the correct value of the country's Real GDP index in 2021 (rounded to one decimal place)?
  1. A.104.8
  2. B.105.0
  3. C.115.5
  4. D.95.5
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Worked solution

The relationship between Real GDP, Nominal GDP, and the GDP deflator is: \(\text{Real GDP Index} = (\text{Nominal GDP Index} / \text{GDP Deflator}) \times 100\). Substituting the values: \(\text{Real GDP Index} = (110 / 105) \times 100 \approx 104.76\). Rounded to one decimal place, this is 104.8.

Marking scheme

1 mark for the correct option (A). Award 1 mark for the correct calculation. Reject other options as they result from incorrect formula applications.
Question 4 · multiple-choice
1 marks
In a free market, a good that generates positive consumption externalities is often subject to market failure. At the free-market equilibrium point, which of the following statements is correct?
  1. A.Marginal Private Benefit is equal to Marginal Social Benefit
  2. B.Marginal Social Benefit is greater than Marginal Social Cost, leading to underconsumption
  3. C.Marginal Private Cost is greater than Marginal Private Benefit, leading to overproduction
  4. D.Marginal Social Cost is greater than Marginal Social Benefit, leading to allocative efficiency
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Worked solution

At the free-market equilibrium, consumers equate Marginal Private Benefit (MPB) with Marginal Private Cost (MPC). Since there are positive consumption externalities, Marginal Social Benefit (MSB) exceeds MPB. Assuming no production externalities (MPC = MSC), it follows that at the market equilibrium, \(MSB > MSC\). Because MSB is greater than MSC, there is an underconsumption of the good relative to the socially optimum level, representing a market failure.

Marking scheme

1 mark for the correct option (B). Award 1 mark for identifying the correct relationship between MSB and MSC and the resulting underconsumption. Reject other options as they describe incorrect relationships or incorrect outcomes.
Question 5 · multiple-choice
1 marks
A firm operating in a competitive industry finds that its average total cost (ATC) is currently falling as its output expands. From this, it can be concluded with certainty that:
  1. A.marginal cost must be falling
  2. B.marginal cost must be below average total cost
  3. C.average fixed cost must be rising
  4. D.marginal cost must be above average total cost
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Worked solution

The relationship between marginal and average values dictates that if the average total cost (ATC) is falling, the marginal cost (MC) must be below it. MC can be rising or falling, but as long as it is lower than ATC, it will pull the average down. Average fixed cost (AFC) always falls as output increases, and MC being above ATC would cause ATC to rise.

Marking scheme

1 mark for the correct option (B). Award 1 mark for correct identification of the marginal-average relationship. Reject other options as they represent logical errors in cost theory.
Question 6 · multiple-choice
1 marks
In a simplified closed economy with no government sector, the marginal propensity to save (MPS) is 0.25. If there is an autonomous increase in investment of £40 billion, what is the resulting final change in equilibrium national income?
  1. A.An increase of £10 billion
  2. B.An increase of £40 billion
  3. C.An increase of £160 billion
  4. D.An increase of £200 billion
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Worked solution

The multiplier \(k\) is calculated as \(1 / \text{MPS}\). Given \(\text{MPS} = 0.25\), the multiplier is \(1 / 0.25 = 4\). The change in national income \(\Delta Y\) is given by \(\Delta Y = k \times \Delta I\). Substituting the values: \(\Delta Y = 4 \times £40\text{ billion} = £160\text{ billion}\).

Marking scheme

1 mark for the correct option (C). Award 1 mark for calculating the multiplier of 4 and multiplying it by £40 billion to obtain £160 billion. Reject options that use incorrect multiplier formulas or values.
Question 7 · multiple-choice
1 marks
In the long-run equilibrium, which of the following characteristics is shared by a firm operating in a perfectly competitive market and a firm operating under monopolistic competition?
  1. A.They both face a perfectly elastic demand curve
  2. B.They both achieve allocative efficiency
  3. C.They both earn only normal profits
  4. D.They both produce at the minimum point of their average total cost curve
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Worked solution

In the long run, both perfectly competitive and monopolistically competitive markets have low barriers to entry and exit. Any short-run supernormal profits attract new entrants, which shifts the demand curves until all firms earn only normal profits (where price equals average total cost). Monopolistically competitive firms face downward-sloping demand curves, do not achieve allocative efficiency (since price is greater than marginal cost), and do not produce at minimum ATC.

Marking scheme

1 mark for the correct option (C). Award 1 mark for identifying that both market structures lead to normal profits in the long run. Reject other options because they only apply to perfect competition.
Question 8 · multiple-choice
1 marks
During a prolonged downturn in economic activity, a decline in aggregate demand leads to widespread job losses across the manufacturing and services sectors. This type of unemployment is best classified as:
  1. A.structural unemployment
  2. B.frictional unemployment
  3. C.seasonal unemployment
  4. D.cyclical unemployment
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Worked solution

Unemployment that is caused by a deficiency in aggregate demand, typically associated with recessions or downturns in the economic cycle, is known as cyclical (or demand-deficient) unemployment. Structural unemployment is due to mismatches in skills or location; frictional is due to short-term transitions between jobs; and seasonal is due to seasonal demand fluctuations.

Marking scheme

1 mark for the correct option (D). Award 1 mark for identifying that demand-deficient unemployment during a recession is cyclical. Reject other options as they refer to non-demand-deficient types of unemployment.
Question 9 · Multiple Choice
1 marks
A country produces capital goods and consumer goods. If it operates at a point inside its Production Possibility Frontier (PPF), this implies that...
  1. A.the economy is achieving productive efficiency but not allocative efficiency.
  2. B.it can produce more consumer goods only by sacrificing capital goods.
  3. C.there are unemployed resources in the economy.
  4. D.the opportunity cost of increasing production of either good is constant.
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Worked solution

Inside the PPF, an economy has underutilized or unemployed resources. Therefore, it is possible to increase the production of both consumer and capital goods without sacrificing any of either, meaning there is no opportunity cost. Productive efficiency is only achieved on the frontier itself.

Marking scheme

1 mark for the correct option C. 0 marks for any other option.
Question 10 · Multiple Choice
1 marks
An increase in the price of Good X from £10 to £12 causes the quantity demanded of Good Y to increase from 100 units to 150 units. In addition, an increase in consumer incomes of 10% causes the quantity demanded of Good Y to fall by 5%. Which of the following is correct for Good Y?
  1. A.Good Y is an inferior good and a complement to Good X
  2. B.Good Y is a normal good and a substitute for Good X
  3. C.Good Y is an inferior good and a substitute for Good X
  4. D.Good Y is a normal good and a complement to Good X
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Worked solution

First, calculate the cross elasticity of demand (XED) to determine the relationship between Good X and Good Y. The percentage change in the price of Good X is \(\frac{12 - 10}{10} \times 100 = +20\%\). The percentage change in the quantity demanded of Good Y is \(\frac{150 - 100}{100} \times 100 = +50\%\). The XED is \(\frac{+50\%}{+20\%} = +2.5\). Since the XED is positive, Good Y is a substitute for Good X. Second, calculate the income elasticity of demand (YED) for Good Y. A 10% increase in income leads to a 5% fall in quantity demanded, so YED is \(\frac{-5\%}{+10\%} = -0.5\). Since the YED is negative, Good Y is an inferior good. Therefore, Good Y is an inferior good and a substitute for Good X.

Marking scheme

1 mark for the correct answer (C). No partial marks are available for multiple choice questions.
Question 11 · Multiple Choice
1 marks
If the price elasticity of demand for a product is perfectly inelastic, and the government introduces an indirect tax of £5 per unit on producers, which of the following is the most likely outcome?
  1. A.The market price will remain unchanged and the producer will pay the full tax
  2. B.The market price will rise by exactly £5 and the consumer will pay the full tax
  3. C.The market price will rise by less than £5 and the tax burden will be shared
  4. D.The market price will rise by more than £5 and the consumer will pay the full tax
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Worked solution

When demand is perfectly inelastic, the quantity demanded is completely insensitive to changes in price. Graphically, the demand curve is vertical. When an indirect tax of £5 is levied on producers, the supply curve shifts vertically upwards by £5. Because consumers will purchase the exact same quantity regardless of price, the equilibrium price increases by the full amount of the tax (£5). Therefore, the incidence of the tax falls entirely on the consumer.

Marking scheme

1 mark for the correct answer (B). No partial marks are available for multiple choice questions.
Question 12 · Multiple Choice
1 marks
In Year 1, a country has a nominal GDP of £400 billion. In Year 2, nominal GDP rises to £440 billion. If the price index (GDP deflator) rises from 100 to 110 over the same period, how has real GDP changed between Year 1 and Year 2?
  1. A.Real GDP has increased by 10%
  2. B.Real GDP has remained unchanged
  3. C.Real GDP has decreased by 10%
  4. D.Real GDP has increased by 40%
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Worked solution

To find real GDP, we adjust nominal GDP for changes in the price level using the formula: \(\text{Real GDP} = \text{Nominal GDP} \times \frac{100}{\text{Price Index}}\). In Year 1, Real GDP is \(£400\text{ billion} \times \frac{100}{100} = £400\text{ billion}\). In Year 2, Real GDP is \(£440\text{ billion} \times \frac{100}{110} = £400\text{ billion}\). Thus, real GDP has remained completely unchanged.

Marking scheme

1 mark for the correct answer (B). No partial marks are available for multiple choice questions.
Question 13 · Multiple Choice
1 marks
In a simplified closed economy with no government sector, the marginal propensity to consume (MPC) is 0.8. If investment spending increases by £20 billion, what will be the final change in national income?
  1. A.An increase of £20 billion
  2. B.An increase of £80 billion
  3. C.An increase of £100 billion
  4. D.An increase of £160 billion
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Worked solution

In a closed economy with no government, the only leakage is saving, which means the marginal propensity to save (MPS) is \(1 - \text{MPC} = 1 - 0.8 = 0.2\). The multiplier formula is \(k = \frac{1}{1 - \text{MPC}} = \frac{1}{0.2} = 5\). The change in national income is calculated as \(\Delta Y = k \times \Delta I = 5 \times £20\text{ billion} = £100\text{ billion}\). Therefore, national income increases by £100 billion.

Marking scheme

1 mark for the correct answer (C). No partial marks are available for multiple choice questions.

Section B

Answer either Context 1 or Context 2. Refer to the insert provided.
7 Question · 53 marks
Question 1 · Definition
3 marks
Define the term 'inflation' (Extract B, paragraph 2).
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Worked solution

To achieve all 3 marks, a candidate must define inflation as a sustained (or persistent) rise in the general (or average) price level of goods and services in an economy over a period of time.

Key components for full marks:
- Sustained/persistent rise: 1 mark
- General/average price level: 1 mark
- Over time: 1 mark

Alternatively, defining it as a persistent decline in the purchasing power of money can also achieve full marks if explained clearly.

Marking scheme

3 marks: For a clear, precise definition of inflation containing both key elements (sustained/persistent rise AND general/average price level).
2 marks: For a definition that identifies one key element clearly (e.g., 'a rise in the general price level' or 'a continuous increase in prices').
1 mark: For identifying that prices are rising or that the value of money is falling without further precision.
Question 2 · Definition
3 marks
Define the term 'inflation' (Extract B, paragraph 2).
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Worked solution

To achieve all 3 marks, a candidate must define inflation as a sustained (or persistent) rise in the general (or average) price level of goods and services in an economy over a period of time.

Key components for full marks:
- Sustained/persistent rise: 1 mark
- General/average price level: 1 mark
- Over time: 1 mark

Alternatively, defining it as a persistent decline in the purchasing power of money can also achieve full marks if explained clearly.

Marking scheme

3 marks: For a clear, precise definition of inflation containing both key elements (sustained/persistent rise AND general/average price level).
2 marks: For a definition that identifies one key element clearly (e.g., 'a rise in the general price level' or 'a continuous increase in prices').
1 mark: For identifying that prices are rising or that the value of money is falling without further precision.
Question 3 · Calculation
4 marks
Select data from Extract A is presented below:

Table 1: Selected Economic Data for Country X
YearNominal GDP (£ billion)GDP Price Deflator (Base Year 2015 = 100)20204201052023540120
Using the data in Table 1, calculate the percentage change in Country X's real GDP between 2020 and 2023. Give your answer to one decimal place.
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Worked solution

To find the percentage change in real GDP between 2020 and 2023, follow these steps:

Step 1: Calculate Real GDP for 2020
Using the formula:
\(\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Price Deflator}} \times 100\)
\(\text{Real GDP}_{2020} = \frac{\text{420}}{\text{105}} \times 100 = \text{\pounds 400 billion}\)

Step 2: Calculate Real GDP for 2023
\(\text{Real GDP}_{2023} = \frac{\text{540}}{\text{120}} \times 100 = \text{\pounds 450 billion}\)

Step 3: Calculate the percentage change between 2020 and 2023
Using the formula:
\(\text{Percentage Change} = \frac{\text{New Value} - \text{Old Value}}{\text{Old Value}} \times 100\)
\(\text{Percentage Change} = \frac{450 - 400}{400} \times 100 = \frac{50}{400} \times 100 = 12.5\%\)

The percentage change in real GDP between 2020 and 2023 is 12.5%.

Marking scheme

4 marks: Correct answer of 12.5% (or 12.5)
3 marks: Real GDP calculated correctly for both 2020 (£400bn) and 2023 (£450bn), but an arithmetic error is made in the percentage change calculation.
2 marks: Real GDP calculated correctly for one of the years (£400bn for 2020 or £450bn for 2023).
1 mark: Correct formula stated for Real GDP: \(\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Price Deflator}} \times 100\) or correct formula for Percentage Change.
Question 4 · Data Interpretation
4 marks
### Context 1

**Table 1: UK Government Capital Investment in Transport Infrastructure, 2021 to 2024**

| Year | Nominal Investment (£ billions) | Transport Construction Price Index (Base year 2021 = 100) |
|---|---|---|
| 2021 | 24.0 | 100.0 |
| 2024 | 31.5 | 112.5 |

Using the data in **Table 1**, calculate the percentage change in the real value of government capital investment in transport infrastructure between 2021 and 2024. Give your answer to two decimal places.
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Worked solution

To calculate the percentage change in the real value of government capital investment between 2021 and 2024, follow these steps:

**Step 1: Calculate the Real Investment for 2021**

Since 2021 is the base year (Index = 100.0):
\[\text{Real Investment (2021)} = \frac{\text{Nominal Investment}}{\text{Price Index}} \times 100\]
\[\text{Real Investment (2021)} = \frac{\pounds24.0\text{bn}}{100.0} \times 100 = \pounds24.0\text{bn}\]

**Step 2: Calculate the Real Investment for 2024**

Using the 2024 data (Nominal = \pounds31.5bn, Index = 112.5):
\[\text{Real Investment (2024)} = \frac{\pounds31.5\text{bn}}{112.5} \times 100 = \pounds28.0\text{bn}\]

**Step 3: Calculate the percentage change in real investment from 2021 to 2024**

\[\text{Percentage Change} = \frac{\text{New Real Value} - \text{Old Real Value}}{\text{Old Real Value}} \times 100\]
\[\text{Percentage Change} = \frac{\pounds28.0\text{bn} - \pounds24.0\text{bn}}{\pounds24.0\text{bn}} \times 100\]
\[\text{Percentage Change} = \frac{\pounds4.0\text{bn}}{\pounds24.0\text{bn}} \times 100 \approx 16.6667\%\]

Rounded to two decimal places, the answer is **16.67%**.

Marking scheme

Calculation:
- **4 marks**: Correct answer of **16.67%** (accept 16.7% or 16.67, with or without the % sign).
- **3 marks**: For finding the correct real values of \pounds24.0bn and \pounds28.0bn, but making an arithmetic error when calculating the percentage change.
- **2 marks**: For correctly calculating the real value in 2024 as \pounds28.0bn but failing to progress further.
- **1 mark**: For showing understanding of the formula to convert nominal values to real values (i.e., \(\text{Real} = \frac{\text{Nominal}}{\text{Index}} \times 100\)) or the percentage change formula.
Question 5 · Diagrammatic Drawing
4 marks
Extract B states that 'the government has decided to impose an indirect tax on sugary soft drinks to curb their consumption.'

Draw a demand and supply diagram to show the effect of introducing an indirect tax on the equilibrium price and quantity of sugary soft drinks, and shade the area representing the tax revenue collected by the government.
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Worked solution

To construct the diagram correctly:
- **Axes**: Label the vertical axis as 'Price' (or \(P\)) and the horizontal axis as 'Quantity' (or \(Q\)).
- **Curves**: Draw a downward-sloping Demand curve (\(D\)) and an upward-sloping Supply curve (\(S_1\)).
- **Initial Equilibrium**: Identify the intersection of \(D\) and \(S_1\) as the initial equilibrium, labelling the corresponding price as \(P_1\) and quantity as \(Q_1\) on the respective axes.
- **Shift**: Shift the supply curve vertically upwards to \(S_2\) (where the vertical distance between \(S_1\) and \(S_2\) represents the unit tax).
- **New Equilibrium**: Identify the intersection of \(D\) and \(S_2\) as the new equilibrium, labelling the new higher price as \(P_2\) and the lower quantity as \(Q_2\) on the axes.
- **Tax Revenue**: Identify the per-unit tax as the vertical distance between the two supply curves at quantity \(Q_2\) (from \(P_2\) down to the consumer cost on \(S_1\), which can be labelled as \(P_3\)). Shade the rectangular area \((P_2 - P_3) \times Q_2\) to represent the government's tax revenue.

Marking scheme

**Marking Scheme (Max 4 marks):**
- **1 mark**: For correctly labelling the axes (Price and Quantity) and showing the initial equilibrium price (\(P_1\)) and quantity (\(Q_1\)) at the intersection of demand (\(D\)) and supply (\(S_1\)).
- **1 mark**: For drawing a parallel or non-parallel upward (leftward) shift of the supply curve to \(S_2\) (or \(S + \text{tax}\)).
- **1 mark**: For correctly showing and labelling the new higher equilibrium price (\(P_2\)) and lower equilibrium quantity (\(Q_2\)).
- **1 mark**: For correctly shading or outlining the rectangular area of government tax revenue (the area bounded by \(P_2\), \(P_3\), the vertical axis, and the vertical line at quantity \(Q_2\)).
Question 6 · essay
10 marks
Extract C highlights that public transport is often under-consumed in major cities, leading to high levels of congestion and air pollution. Explain how the under-consumption of a merit good, such as public transport, leads to market failure and how a government subsidy can correct this. Support your answer with an appropriate marginal social and private benefit and cost diagram.
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Worked solution

Relevant Economic Theory & Concepts: * Merit Goods: Goods that provide greater benefits to society or individuals than they realise, often due to information failure or positive externalities of consumption. * Market Failure: The misallocation of resources where the free market fails to achieve allocative efficiency, leading to a net welfare loss. * Positive Externality of Consumption: When the consumption of a good yields benefits to third parties not involved in the transaction (e.g., lower pollution and reduced road congestion for non-users of public transport). * Subsidy: A payment by the government to producers to lower their costs of production, encouraging higher output and lower prices. Diagrammatic Representation: An appropriate diagram should illustrate: 1. Axes: Price/Cost/Benefit on the vertical axis, and Quantity on the horizontal axis. 2. Demand Curves: Marginal Private Benefit (MPB) and Marginal Social Benefit (MSB) curves, where MSB lies above/to the right of MPB to reflect the positive external benefit (MSB = MPB + MEB). 3. Supply Curves: Marginal Private Cost (MPC) and Marginal Social Cost (MSC), assumed to be equal (MPC = MSC) for simplicity. 4. Market Equilibrium: Output Q1 and price P1, where MPB = MPC. 5. Socially Optimal Equilibrium: Output Q2 and price P2, where MSB = MSC. 6. Deadweight Loss (Welfare Loss): A shaded triangular area pointing towards Q2, representing the lost welfare due to under-consumption (Q1 < Q2). 7. Subsidy Effect: A downward shift of the MPC curve to MPC - Subsidy (or MPC_sub), lowering the price paid by consumers to P_consumer and expanding the quantity consumed to Q2, thereby eliminating the deadweight loss. Explanation of the Process: 1. Why Under-consumption Occurs: Consumers only consider their private benefits (MPB) and private costs (MPC) when deciding to use public transport. Because they ignore the external benefits (MEB) to others (such as cleaner air and quieter roads), public transport is under-consumed in a free market (Q1 < Q2). This results in allocative inefficiency and a deadweight loss. 2. How a Subsidy Corrects This: By granting a subsidy equal to the marginal external benefit at Q2, the government reduces the private cost of supply, shifting the MPC curve down to MPC_sub. This drives down the price to consumers, which increases the quantity demanded from Q1 to the socially optimum level Q2. As a result, the external benefits are internalised, and the deadweight loss is fully eliminated.

Marking scheme

Level Descriptor and Marks: * Level 3 (7-10 marks): Shows a clear and thorough understanding of how under-consumption of a merit good leads to market failure and how a subsidy corrects it. Includes a fully and accurately labeled diagram showing the positive externality in consumption, the deadweight loss, and the shift caused by the subsidy. Explains the link between the diagrammatic analysis and the economic reasoning clearly, using key terms accurately (e.g., MPB, MSB, MSC, deadweight loss, allocative efficiency). * Level 2 (4-6 marks): Shows some understanding of merit goods, externalities, or subsidies, but the explanation may be incomplete or contain minor errors. Includes a diagram that is mostly correct but may have labeling errors (e.g., confusing MPB and MSB) or fails to clearly illustrate how the subsidy shifts the equilibrium to the social optimum. The link between the diagram and text is weak or lacks logical progression. * Level 1 (1-3 marks): Demonstrates basic knowledge of terms (e.g., defining a subsidy or a merit good) but lacks coherent economic analysis. The diagram is missing, incorrect, or unlabelled. Mark Allocation Notes: * Diagram (up to 4 marks): 1 mark for correct axes and curves (MPB, MSB, MPC); 1 mark for showing market equilibrium vs. social optimum; 1 mark for correctly shading the deadweight loss; 1 mark for illustrating the shift in supply/MPC due to the subsidy. * Explanation (up to 6 marks): Up to 3 marks for explaining how under-consumption of merit goods leads to market failure; up to 3 marks for explaining how a government subsidy shifts incentives and achieves allocative efficiency.
Question 7 · Evaluation Essay
25 marks
Extract F highlights the growing pressure on low-income households due to rising rental prices in major cities.

Taking into account your economic knowledge, evaluate the view that the introduction of a maximum rent (a price ceiling) is the most effective policy for the government to improve the affordability of housing for low-income households.
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Worked solution

Introduction:

Housing affordability is a critical issue in many urban areas, representing a form of market failure where the price mechanism fails to allocate resources equitably, leading to poverty and social exclusion. A maximum price (or price ceiling) is a government-imposed limit above which landlords cannot legally charge rent, and it must be set below the market equilibrium to be binding.

Economic Analysis of Maximum Rent Controls:

In a free market, equilibrium rent is determined at the intersection of demand and supply. If the government imposes a maximum rent below this equilibrium, the immediate effect is to lower the price of renting. According to the law of demand, a lower price increases the quantity demanded of rental housing. Conversely, according to the law of supply, a lower price reduces the quantity supplied, as landlords find letting properties less profitable and some may choose to sell their properties or convert them to other uses. This creates a state of disequilibrium characterized by excess demand (a housing shortage).

This shortage leads to several unintended consequences:

  • Non-price rationing: Since price can no longer allocate housing, other methods arise, such as long waiting lists, landlord bias/discrimination, or the emergence of black markets (e.g., landlords demanding illegal 'key money' or side payments).
  • Deterioration in housing quality: Landlords, facing capped revenues and excess demand, have little incentive to maintain or upgrade properties, leading to slum-like conditions.
  • Long-term supply contraction: Developers are discouraged from constructing new rental accommodation, which worsens the structural undersupply of housing.

Alternative Policies:

To evaluate whether rent controls are the 'most effective' policy, they must be compared to alternatives:

  1. State Provision of Social Housing: The government can directly fund and build affordable homes. This shifts the supply curve of housing to the right, lowering market rents naturally while increasing the overall quantity of housing. However, this is highly expensive (opportunity cost of public funds) and takes a long time to implement.
  2. Subsidies / Housing Benefits: Providing financial support directly to low-income tenants increases their purchasing power. However, if the supply of rental housing is highly inelastic, this subsidy will simply bid up market rents, primarily benefiting landlords rather than tenants, while placing a substantial burden on taxpayers.
  3. Planning Deregulation: Easing planning restrictions makes it cheaper and faster for private firms to build houses, shifting supply to the right. However, this can lead to negative environmental externalities and poorly planned infrastructure.

Evaluation and Conclusion:

In conclusion, while a maximum rent control is politically popular and provides immediate financial relief to existing low-income tenants, it is highly ineffective as a long-term solution. By creating a persistent shortage and discouraging maintenance, it hurts the very people it aims to help. It is a policy that treats the symptom (high prices) rather than the cause (lack of supply).

Therefore, a maximum rent control is not the most effective policy. A far superior approach is a combination of supply-side policies, specifically direct state investment in building social housing, alongside planning reforms to increase supply, supplemented by targeted housing benefits to support vulnerable families in the short run.

Marking scheme

Marking Scheme & Level Descriptors (25 Marks):

  • Level 5 (21-25 marks): Strong, focused economic analysis, well-developed chains of reasoning. Comprehensive evaluation throughout, leading to a balanced and well-supported conclusion. Clear understanding of the trade-offs of maximum prices and alternative policies. Excellent use of relevant economic terms.
  • Level 4 (16-20 marks): Good economic analysis with logical chains of reasoning. Evaluation is present and has some depth, though it may not be fully integrated into a cohesive argument. Clear conclusion, with some appreciation of alternatives.
  • Level 3 (11-15 marks): Sound economic analysis of rent controls, but may contain some gaps in reasoning or lack a clear diagrammatic explanation. Limited or one-sided evaluation, with a basic conclusion.
  • Level 2 (6-10 marks): Basic economic knowledge is shown, but analysis is weak or purely descriptive of the housing market. Very limited or no evaluation.
  • Level 1 (1-5 marks): Identification of few relevant points about rent or housing. No meaningful analysis or evaluation.

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