2023 Cambridge IGCSE Economics (0455) Practice Paper with Answers

To find the approximate change in real GDP per head, we use the formula:

\(% \text{ change in real GDP per head} \approx % \text{ change in nominal GDP} - \text{inflation rate} - % \text{ change in population}\)

Substituting the given values:

\(% \text{ change} \approx 5\% - 4\% - 2\% = -1\%\)

Therefore, real GDP per head fell by approximately 1%.

Award 1 mark for selecting option A, which correctly calculates the approximate change as a 1% fall using the relationship between nominal growth, inflation, and population growth.

In economics, external costs are negative third-party effects resulting from production decisions (the harm to the fishermen). Social costs are the sum of private costs (incurred by the factory) and external costs (inflicted on the fishermen). Therefore, Option A is correct.

Award 1 mark for option A. It correctly identifies the damage to the fishermen as an external cost and the sum of private and external costs as the social cost.

Non-wage factors are non-monetary benefits or conditions of a job. A generous non-contributory pension scheme and free medical insurance are positive non-wage benefits (perks) that increase the total reward package, making the job attractive despite a lower starting wage. Options A, C, and D are negative factors that would deter a worker.

Award 1 mark for option B. This option correctly identifies positive fringe benefits that attract workers to a lower-paid position.

An ageing population means that there is a higher proportion of elderly, retired people relative to the working-age population. This directly increases the dependency ratio, which is the ratio of non-working dependants to the active labour force.

Award 1 mark for option A, as it correctly identifies that an ageing population leads to a higher dependency ratio.

To reduce income inequality, the government should target support to low-income earners (e.g., reducing their income tax and providing public services like state education, which increases social mobility). To be expansionary, the fiscal policy must increase overall demand, which is achieved by cutting taxes (reducing low-income tax) and increasing government spending (spending on state education). Thus, option B satisfies both criteria.

Award 1 mark for option B. It correctly identifies the combination that is both expansionary and redistributive.

The Human Development Index (HDI) uses three dimensions: health (life expectancy at birth), standard of living (GNI per capita), and education/knowledge. The knowledge dimension is measured using mean years of schooling for adults aged 25 and over, and expected years of schooling for children entering school. Therefore, option C is correct.

Award 1 mark for option C, which correctly identifies one of the official components used to measure the knowledge dimension of the HDI.

Public goods are non-rival (one person's consumption does not reduce availability to others) and non-excludable (non-payers cannot be excluded from using them). Non-excludability leads to the free-rider problem, where individuals consume the good without paying for it. Because of this, private firms cannot charge a price to make a profit, so the free market fails to provide it.

Award 1 mark for option A, which correctly identifies the defining characteristics of a public good that cause market failure.

When a minimum wage is set above the equilibrium wage, it acts as a binding price floor. At this higher wage rate, more individuals are willing to work (an increase in the quantity of labour supplied), but employers are willing and able to hire fewer workers (a decrease in the quantity of labour demanded). This creates a surplus of labour, which directly results in unemployment.

Award 1 mark for option B, as setting a minimum wage above the equilibrium increases the quantity of labour supplied while decreasing quantity demanded, leading to an increase in unemployment.

To find the percentage change in real GDP per head, we compare the growth rate of real GDP with the growth rate of the population.
- Country W: Population grew faster than Real GDP, so real GDP per head fell (\(\frac{1.01}{1.02} - 1 \approx -0.98\%\)).
- Country X: Real GDP grew by \(+5\%\) while population grew by only \(+1\%\). Real GDP per head rose significantly (\(\frac{1.05}{1.01} - 1 \approx +3.96\%\)).
- Country Y: Real GDP and population grew at the same rate, leaving real GDP per head unchanged (\(0\%\)).
- Country Z: Real GDP and population fell at the same rate, leaving real GDP per head unchanged (\(0\%\)).

Therefore, Country X experienced the largest percentage increase in real GDP per head.

1 mark for identifying the correct country (X) based on calculating or comparing the relative changes in real GDP and population.

An external cost is a negative consequence of an economic activity experienced by an unrelated third party (in this case, the local municipal council and taxpayers who must pay for the water purification). Options A (wages) and C (profits) are private costs and benefits. Option D represents a private benefit to the consumers of the pesticide (the farmers).

1 mark for selecting the option that correctly identifies a negative third-party effect (external cost).

The nurse's decision shows that non-wage factors (such as pension schemes, holidays, and flexible hours) can be more important than the nominal wage rate when choosing an occupation.

1 mark for identifying that the decision is driven by a preference for non-wage factors of employment.

An ageing population occurs due to a falling birth rate and rising life expectancy.
1. The dependency ratio rises because there are fewer working-age individuals relative to the growing number of elderly retirees.
2. Government spending on pensions rises because people are living longer in retirement.
3. The size of the active labour force falls because fewer young people are entering the workforce to replace those who retire.

1 mark for selecting the row with the correct combination: dependency ratio rises, pension spending rises, and active labour force falls.

To combat demand-pull inflation, the government should implement contractionary fiscal policy. This involves:
1. Increasing income tax rates to reduce disposable income and consumer expenditure.
2. Decreasing government spending to directly reduce aggregate demand.
3. This combination will increase revenue and decrease expenditure, moving the budget balance towards a surplus (or reducing a deficit).

1 mark for selecting the row that correctly identifies contractionary fiscal policies and their impact on the budget balance.

The HDI is a composite index consisting of GNI/GDP per head, life expectancy, and educational measures (mean and expected years of schooling). A country could have a high GDP per head (e.g., from mineral resources) but if income is highly unequally distributed and public spending on education is very low, its average school enrollment and life expectancy might remain low, leading to a low HDI score.

1 mark for identifying that high income inequality and low education levels explain a divergence between high GDP per head and a low HDI rank.

Wages are determined by the demand and supply of labour. An increase in the global demand for custom mobile applications increases the derived demand for software engineers. This shifts the demand curve for their labour to the right, causing the equilibrium wage rate to rise. Option A increases supply (reducing wages); Option B (substitute capital) decreases demand; Option D decreases productivity (reducing demand).

1 mark for selecting the option that represents an increase in the demand for software engineers, leading to a higher equilibrium wage.

Public goods are characterised by non-excludability and non-rivalry. Because they are non-excludable, it is impossible to prevent non-payers from consuming them once they are provided (the free-rider problem). Consequently, private firms cannot charge consumers directly to make a profit, and the market fails to produce them. Governments must step in to provide them using tax revenue.

1 mark for identifying the correct explanation of market failure regarding public goods (non-excludability leading to the free-rider problem).

The Human Development Index (HDI) is a composite index measuring average achievement in three basic dimensions of human development: a long and healthy life (measured by life expectancy at birth), knowledge (measured by mean and expected years of schooling), and a decent standard of living (measured by GNI per capita). Therefore, life expectancy at birth (option B) is a direct component. The Gini coefficient, unemployment rate, and balance of payments surplus are not part of the HDI calculation.

1 mark for the correct answer: B. 0 marks for any other option.

The loss of earnings experienced by the fishermen is a cost imposed on a third party who is not involved in the production of chemicals. This is a classic example of an external cost (or negative externality). Social cost includes both private and external costs, while private costs are borne directly by the factory.

1 mark for the correct answer: B. 0 marks for any other option.

Wages are determined by the interaction of demand and supply in the labour market. Highly skilled neurosurgeons require extensive training and rare qualifications, making their supply highly inelastic. At the same time, the demand for their essential and specialized medical services is high. In contrast, sales assistants require fewer specialized skills, resulting in a highly elastic and abundant supply, which keeps wages lower.

1 mark for the correct answer: C. 0 marks for any other option.

The dependency ratio is calculated as the ratio of the non-working population (children under 15 and retirees over 65) to the working-age population. A fall in the birth rate means there are fewer children (dependents) relative to the constant working-age population. Therefore, the dependency ratio will decrease.

1 mark for the correct answer: A. 0 marks for any other option.

A progressive income tax takes a higher percentage of income from high-income earners, which helps reduce income inequality. A flat-rate indirect tax is regressive because lower-income households spend a larger proportion of their income on consumer goods compared to higher-income households. Replacing a progressive tax with a regressive tax will make the income distribution less equal.

1 mark for the correct answer: B. 0 marks for any other option.

Opportunity cost is defined as the next best alternative forgone when making a choice. Since the consumer's first preference is the book, her next best alternative is the customized meal (her second preference). The cinema ticket is not the immediate next best alternative.

1 mark for the correct answer: B. 0 marks for any other option.

Price elasticity of demand (PED) is calculated as: \( \text{PED} = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}} = \frac{-5\%}{+10\%} = -0.5 \). Since the absolute value of PED is less than 1, demand is inelastic. When demand is inelastic, a price increase leads to an increase in total revenue because the percentage increase in price is greater than the percentage decrease in quantity demanded.

1 mark for the correct answer: A. 0 marks for any other option.

Real GDP measures the value of all final goods and services produced within a country over a period, adjusted for inflation (meaning it measures physical output). An increase in physical output while the general price level remains constant (option B) means real GDP has risen. Option A represents inflation with constant output (nominal GDP rises, but real GDP remains constant). Option D implies real GDP actually decreased because nominal GDP grew slower than inflation.

1 mark for the correct answer: B. 0 marks for any other option.

Real GDP per head is an average measure (total real GDP divided by population). If income is highly unequally distributed, a small percentage of the population receives most of the income, meaning the average GDP per head is much higher than the income of a typical citizen. Therefore, it overestimates the standard of living for the majority. Unpaid work and the informal economy lead to an underestimate, while lower pollution means living standards are higher than GDP suggests, also leading to an underestimate.

1 mark for identifying the correct option. A highly unequal distribution of income means the average GDP per head does not represent the typical citizen's standard of living.

A sea wall is a public good, which is characterized by non-excludability and non-rivalry. Non-excludability means that once the sea wall is built, it is impossible to prevent residents who have not paid from enjoying its benefits (the free-rider problem). As a result, private firms cannot profitably charge for it, leading to a missing market.

1 mark for identifying the correct option. Non-excludability leads to the free-rider problem, preventing private firms from charging a price.

The supply of highly skilled professionals like neurosurgeons is very inelastic because it takes many years of training and education to qualify. This limits the number of people who can perform the role at any given time, keeping supply low relative to demand and pushing up wages. Conversely, unskilled porter roles require minimal training, making their supply highly elastic.

1 mark for identifying the correct option. A highly inelastic supply of skilled labor restricts quantity and raises wages.

An ageing population means a higher proportion of retired citizens relative to the working-age population. This leads to increased government spending on state pensions and healthcare. Since government resources are scarce, spending more on older citizens creates an opportunity cost, as less funding may be available for other areas like education.

1 mark for identifying the correct option. Higher pension spending creates an opportunity cost for other public services.

To combat demand-pull inflation, the government needs to reduce aggregate demand using contractionary fiscal policy. Decreasing government spending directly reduces demand, and increasing income tax reduces consumers' disposable income, which lowers private consumption. Decreasing interest rates is monetary policy, not fiscal policy.

1 mark for identifying the correct option. Contractionary fiscal policy involves reducing government spending and increasing taxation to lower aggregate demand.

Absolute poverty is defined by a lack of access to basic human needs (such as clean water, food, shelter, and basic healthcare). Relative poverty is a comparative measure, occurring when households receive 50% or 60% less than average household incomes in their specific country, meaning they cannot participate fully in society.

1 mark for identifying the correct option. Absolute poverty relates to basic survival needs, whereas relative poverty relates to income inequality within a society.

To find the unemployment rate, use the following steps:

1. Calculate the number of unemployed people:
\[\text{Unemployed} = \text{Labour force} - \text{Employed}\]
\[\text{Unemployed} = 12\text{ million} - 10.8\text{ million} = 1.2\text{ million}\]

2. Calculate the unemployment rate as a percentage of the labour force:
\[\text{Unemployment rate} = \left( \frac{\text{Number of unemployed}}{\text{Labour force}} \right) \times 100\]
\[\text{Unemployment rate} = \left( \frac{1.2\text{ million}}{12\text{ million}} \right) \times 100 = 10\%\]

1 mark for the correct calculation and answer: 10% (or 10).

Acceptable working showing the correct process: \(\frac{1.2}{12} \times 100\).

Based on the extract, the government of Zandaland used or considered the following fiscal policy measures to address its budget deficit or raise revenue: (1) An increase in the standard rate of Value Added Tax (VAT), (2) A reduction in public spending on infrastructure, (3) Introducing a new carbon tax on heavy industries, and (4) Raising corporate tax rates for large multinational companies. Any two of these correctly identified earn 1 mark each.

Award 1 mark for each valid fiscal policy measure identified from the extract, up to a maximum of 2 marks. Acceptable answers include: - Increase in the standard rate of Value Added Tax (VAT) - Reduction in public spending on infrastructure - Introducing a new carbon tax - Raising corporate tax rates.

Government spending on education increases the quality of the labour force by providing workers with better skills and training (1 mark). This increases their productivity and employability (1 mark), allowing them to transition more easily into new industries and fill job vacancies, which reduces structural unemployment (1 mark).

1 mark for identifying that education improves skills, qualifications, or human capital of workers. 1 mark for explaining that this increases productivity or employability. 1 mark for explaining that this helps workers adapt to structural changes in the economy or matches them with vacant jobs to reduce structural unemployment.

A subsidy reduces the production costs of bus operators, allowing them to lower fares (1 mark). Lower fares encourage consumers to substitute private cars for public transport (1 mark). This leads to fewer cars on the road, reducing negative externalities such as air pollution and traffic congestion, thereby reducing market failure (1 mark).

1 mark for explaining that a subsidy reduces costs of production or lowers fares for public transport. 1 mark for explaining that this causes a shift from private car use to public transport (substitutes). 1 mark for explaining that this reduces negative externalities (e.g. pollution, congestion) to correct or reduce market failure.

A complete and correct diagram must illustrate the following economic principles:
- **Axes:** The vertical axis must be labelled 'Price' (or 'P') and the horizontal axis 'Quantity' (or 'Q').
- **Curves:** A downward-sloping demand curve, labelled 'D', and an upward-sloping supply curve, labelled 'S0' (or 'S1').
- **Shift:** A rightward (or downward) shift of the supply curve to 'S1' (or 'S2') to reflect the lower cost of production due to the government subsidy.
- **Equilibriums:** The original equilibrium must show price 'P0' and quantity 'Q0'. The new equilibrium, where the original demand curve intersects the new supply curve, must clearly show a lower price 'P1' and a larger quantity 'Q1'. Arrows indicating the direction of the changes are helpful but not strictly required as long as the labels are clear.

Award 1 mark for each of the following up to a maximum of 4 marks:
- **1 mark:** Correctly labelled axes (Price/P and Quantity/Q) and original demand and supply curves (D and S).
- **1 mark:** Correctly labelled original equilibrium price (P0) and quantity (Q0).
- **1 mark:** Supply curve shifted to the right (S0 to S1) as a result of the subsidy.
- **1 mark:** Correctly labelled new equilibrium price (P1) and quantity (Q1) showing a decrease in price and an increase in quantity.

A reduction in corporate tax rates increases the post-tax profits of firms. With higher retained profits, firms have a greater incentive and financial capability to invest in capital goods, machinery, and new technology. This increase in investment acts as a component of aggregate demand, stimulating short-term economic activity. In the longer term, the addition of more and better capital equipment enhances labor productivity and expands the country's productive capacity (shifting the production possibility curve outwards). Additionally, lower corporate taxes attract foreign multinational companies to set up domestic operations (Foreign Direct Investment), creating jobs, expanding production, and resulting in higher national output (real GDP) and economic growth.

Award 1 mark for each logical link in the analysis (up to 5 marks): (1) Lower corporate taxes increase firms' retained/post-tax profits. (2) This increases the incentive or funds available for firms to invest in capital or technology. (3) Higher investment increases aggregate demand. (4) Investment improves labor productivity or expands productive capacity. (5) It can attract foreign direct investment (FDI). (6) These factors lead to an increase in real GDP or economic growth.

Why it might reduce living standards: Higher income tax rates reduce household disposable income. This decreases consumer expenditure on goods and services, leading to lower material living standards. Additionally, high tax rates can act as a disincentive to work, leading to a reduction in labour supply and economic growth. Why it might not reduce living standards: The government can use the tax revenue to invest in public services, such as free healthcare and education, which directly improves non-material living standards. Furthermore, tax revenues can be redistributed to low-income families through welfare payments, helping to reduce absolute poverty and income inequality.

Level 3 (5-6 marks): Discusses both sides in detail. Explains both how higher income taxes reduce disposable income and material living standards, and how public spending from tax revenues can improve non-material living standards or reduce inequality. Level 2 (3-4 marks): Explains only one side of the argument (either the negative impact on living standards or the positive impact of government spending). Level 1 (1-2 marks): Identifies simple points, such as tax reduces income or government uses tax to fund services, without full explanation.

Why they will reduce market failure: Subsidies lower the production costs for bus operators, allowing them to reduce fares. Lower fares make public transport more attractive relative to private car travel. This encourages commuters to switch from private cars to buses, reducing negative externalities such as traffic congestion, air pollution, and carbon emissions. This moves the market closer to the socially optimum level of output. Why they might not reduce market failure: Bus operators may not pass on the subsidy in the form of lower fares, instead using it to increase their profits. Even with lower fares, demand for bus travel may be price inelastic if people find public transport inconvenient or unreliable. There is also an opportunity cost, as the government could have spent the money on other areas like education or healthcare, and subsidies may make bus operators inefficient.

Level 3 (5-6 marks): Balanced discussion of both sides. Explains how subsidies lower fares and reduce negative externalities (congestion/pollution) and explains the limitations, such as price inelasticity, lack of pass-through, inefficiency, or opportunity cost. Level 2 (3-4 marks): Explains only one side (either how subsidies reduce market failure, or why they may not work). Level 1 (1-2 marks): Identifies basic points, such as subsidies lower costs or pollution is bad, without detailed economic explanation.

Collective bargaining refers to the negotiations between representatives of trade unions (acting on behalf of their members) and employers or employers' associations. The goal of this process is to reach a mutual agreement on terms of employment, including wage rates, working hours, safety regulations, and other benefits.

Award 1 mark for identifying that it involves negotiations between trade unions / representatives of workers and employers / management. Award 1 mark for stating the purpose of these negotiations (e.g., to agree on wages, working hours, or other terms of employment).

Collective bargaining is the mechanism through which trade unions negotiate with employers or management on behalf of employees. The objective is to reach a collective agreement on wages, working hours, safety standards, and other terms of employment.

1 mark for stating that it involves negotiations between a trade union (or representatives of workers) and employers (or management). 1 mark for identifying that the goal is to reach an agreement on wages, hours, and/or working conditions.

Demerit goods are products that are worse for consumers than they realize due to information failure (1 mark). When consumers drink sugary beverages, they only consider their private costs and benefits, ignoring the long-term damage to their health (1 mark). Furthermore, this consumption creates negative externalities or external costs on third parties, such as increased healthcare burdens on taxpayers and lost economic productivity (1 mark). Because these external costs are ignored in a free market, it leads to overconsumption and an overallocation of resources, which constitutes market failure (1 mark).

Award up to 4 marks: 1 mark for defining demerit goods or identifying information failure (consumers do not fully realize the health harms). 1 mark for explaining that consumption generates external costs/negative externalities. 1 mark for providing a relevant example of an external cost (e.g. higher public healthcare spending, reduced productivity of workers). 1 mark for explaining that this leads to overconsumption/overallocation of resources (or social costs exceeding social benefits), resulting in market failure.

Demerit goods are products that are worse for consumers than they realize due to information failure (1 mark). When consumers drink sugary beverages, they only consider their private costs and benefits, ignoring the long-term damage to their health (1 mark). Furthermore, this consumption creates negative externalities or external costs on third parties, such as increased healthcare burdens on taxpayers and lost economic productivity (1 mark). Because these external costs are ignored in a free market, it leads to overconsumption and an overallocation of resources, which constitutes market failure (1 mark).

Award up to 4 marks: 1 mark for defining demerit goods or identifying information failure (consumers do not fully realize the health harms). 1 mark for explaining that consumption generates external costs/negative externalities. 1 mark for providing a relevant example of an external cost (e.g. higher public healthcare spending, reduced productivity of workers). 1 mark for explaining that this leads to overconsumption/overallocation of resources (or social costs exceeding social benefits), resulting in market failure.

When a government increases personal income tax, workers see a higher proportion of their wages deducted. This directly reduces their disposable income (income after tax). With less disposable income, households are likely to decrease their consumer spending (consumption). Because consumption is a major component of aggregate demand (AD), this reduction in spending causes aggregate demand to decrease. A lower level of aggregate demand reduces the pressure on the economy's productive capacity, meaning that there is less competition for goods and services. As a result, firms are less able or willing to raise prices, which reduces demand-pull inflation and stabilizes the general price level.

Award up to 6 marks for a coherent and logical analysis: - Identifies that an increase in income tax reduces disposable income (1 mark). - Explains that this leads to a decrease in consumer spending/consumption (1 mark). - Recognizes that consumption is a component of aggregate demand (1 mark). - Explains that a reduction in consumption leads to a fall in aggregate demand (1 mark). - Explains that lower aggregate demand reduces pressure on resources/productive capacity (1 mark). - Concludes that this reduction in demand-pull inflation slows down the rate of price increases (1 mark).

Arguments that an increase in income tax rates will reduce economic growth: 1. It reduces consumers' disposable income, which leads to a fall in consumer expenditure. Since consumption is a major component of aggregate demand (AD), this fall can lead to a reduction in output and slower short-run economic growth. 2. High income tax rates can act as a disincentive to work. Workers may reduce their hours or refuse promotions because a larger proportion of their extra income is taxed. This can decrease labor productivity and the total supply of labor, restricting long-term economic growth. 3. Higher taxes reduce household savings, which may lead to fewer funds being available in banks for business investment. Arguments that an increase in income tax rates will NOT reduce economic growth: 1. The government can spend the extra tax revenue on public services, capital projects, and merit goods. Government spending (G) is also a component of AD, which can offset the decline in consumer spending. 2. Public investment in infrastructure, education, and healthcare improves the productive capacity of the economy (shifting long-run aggregate supply to the right), leading to long-term sustainable growth. 3. If the economy is overheating and experiencing high inflation, an increase in income tax acts as a contractionary fiscal policy to stabilize prices, which provides a more stable macroeconomic environment for future business investment.

Level 3 (6-8 marks): A balanced discussion that analyzes both sides of the argument. The response clearly explains how higher income tax rates can reduce economic growth (e.g., through reduced disposable income, consumption, and work incentives) and why they might not (e.g., through government reinvestment in infrastructure, education, or stabilizing inflation). Economic terminology is used accurately. Level 2 (3-5 marks): Explains one side of the argument in detail (e.g., only why higher taxes reduce growth) or offers a limited, superficial two-sided response. Some economic terms are used correctly. Level 1 (1-2 marks): Identifies simple points without analytical development (e.g., stating that people will have less money or that governments will have more money to spend).