2026 Edexcel IAL Economics (YEC11) Practice Paper with Answers

The new Consumer Price Index (CPI) is calculated as a weighted average of the new price indices:

\(\text{New CPI} = (0.30 \times 110) + (0.50 \times 104) + (0.20 \times 95)\)

\(\text{New CPI} = 33 + 52 + 19 = 104.0\)

Therefore, the new CPI is 104.0, making B the correct option.

1 mark for the correct calculation of the weighted index and selecting option B.

An increase in house prices increases household wealth (the wealth effect) and boosts consumer confidence. This leads to higher autonomous consumer expenditure at any given price level, causing the aggregate demand (AD) curve to shift to the right.

1 mark for identifying that higher house prices increase consumption and shift AD to the right, selecting option B.

A temporary spike in the global price of imported crude oil increases the production and transport costs for domestic firms, shifting the SRAS curve to the left. Because the spike is temporary, it does not permanently affect the productive potential (capacity) of the economy, so the LRAS curve remains unchanged.

1 mark for identifying that a temporary import cost increase shifts only the SRAS curve to the left, and selecting option C.

First, calculate the marginal propensity to withdraw (\(MPW\)) from the circular flow of income:
\(MPW = MPS + MPM = 0.15 + 0.25 = 0.40\)

Next, calculate the multiplier (\(k\)):
\(k = \frac{1}{MPW} = \frac{1}{0.40} = 2.5\)

Finally, calculate the total change in national income (\(\Delta Y\)):
\(\Delta Y = k \times \Delta I = 2.5 \times £6\text{ billion} = £15.0\text{ billion}\)

1 mark for the correct calculation of the multiplier and the final change in national income, selecting option B.

An increase in the policy interest rate raises the cost of borrowing for households and firms, and increases the return on savings. This encourages saving and reduces borrowing-financed consumption and investment, shifting aggregate demand to the left, which reduces inflationary pressure.

1 mark for identifying the correct monetary policy transmission sequence and selecting option C.

An increase in the rate of income tax is a contractionary fiscal policy (an expenditure-reducing policy). By reducing household disposable income, it lowers domestic consumption, including spending on imported goods. This reduction in imports improves the trade balance and helps reduce the current account deficit in the short run.

1 mark for identifying that raising income tax is an expenditure-reducing policy that reduces import spending, selecting option D.

To calculate the CPI in Year 2, find the weighted average of the price indices: CPI = \((105 \times 0.40) + (110 \times 0.30) + (120 \times 0.30)\) = \(42 + 33 + 36 = 111\). The inflation rate is the percentage change from the base year (Year 1 CPI = 100): \(((111 - 100) / 100) \times 100\% = 11\%\).

1 mark for correct formula or method of calculating the weighted index. 1 mark for the correct CPI in Year 2 (111). 1 mark for the correct inflation rate calculation method. 1 mark for the correct final inflation rate of 11%.

First, calculate the marginal propensity to withdraw (MPW): \(MPW = MPS + MPT + MPM = 0.15 + 0.10 + 0.15 = 0.40\). Next, calculate the multiplier (k): \(k = 1 / MPW = 1 / 0.40 = 2.5\). Finally, calculate the change in national income: \(\Delta Y = k \times \Delta I = 2.5 \times \$15\text{ billion} = \$37.5\text{ billion}\).

1 mark for identifying the formula for the multiplier or calculating the marginal propensity to withdraw (MPW = 0.40). 1 mark for calculating the multiplier value of 2.5. 1 mark for applying the multiplier to the initial injection ($15 billion * 2.5). 1 mark for the correct final answer of $37.5 billion.

Injections are exogenous additions to the circular flow of income that increase the level of aggregate demand and economic activity. Examples include investment, government spending, and exports. Leakages (or withdrawals) are flows of money out of the circular flow of income that reduce aggregate demand. Examples include savings, taxation, and imports.

1 mark for defining injections as additions to the circular flow of income. 1 mark for providing a valid example of an injection (Investment, Government Spending, or Exports). 1 mark for defining leakages/withdrawals as money leaving the circular flow. 1 mark for providing a valid example of a leakage (Savings, Taxation, or Imports).

1. Improvement in technology: Advancements in technology allow workers to produce more output with the same inputs, increasing the economy's potential capacity. 2. Increase in the size or quality of the labor force: Better education and training (human capital development) or net inward migration increases the quantity and quality of available labor, expanding productive capacity.

1 mark for identifying the first factor (e.g., technological progress or investment in infrastructure). 1 mark for explaining how this factor increases the quality/quantity of resources or potential output. 1 mark for identifying the second factor (e.g., education/training or net migration). 1 mark for explaining how this second factor increases productive capacity.

An increase in the base rate raises commercial interest rates. This increases the cost of borrowing and the incentive to save, leading to lower consumption (C) and business investment (I). As C and I fall, Aggregate Demand (AD) shifts to the left, which reduces demand-pull inflationary pressure and dampens price increases.

1 mark for explaining that higher interest rates increase the cost of borrowing or reward saving. 1 mark for linking this to a reduction in household consumption or business investment. 1 mark for explaining that this leads to a decrease or leftward shift in Aggregate Demand (AD). 1 mark for concluding that the fall in AD reduces demand-pull inflationary pressure.

Underemployment refers to a situation where individuals are counted as employed, but they are either:
1. Working fewer hours than they desire and are willing to work (involuntary part-time workers).
2. Working in positions that do not fully utilise their skills, education, or experience.

- 1 mark for identifying that workers are employed but underutilised (e.g., working fewer hours than desired or in jobs below their skill level).
- 1 mark for further development, such as distinguishing between time-related underemployment and skill-related underemployment, or providing a relevant example.

Award 1 mark for a partial or basic definition, e.g., people who have jobs but want to work more hours.

Award 2 marks for a full definition that captures either both dimensions (hours and skills) or provides a clear development, e.g., when a worker is employed but working part-time when they prefer full-time, or their skills and qualifications are underutilised in their current role.

Underemployment refers to a situation where individuals are counted as employed, but they are either:
1. Working fewer hours than they desire and are willing to work (involuntary part-time workers).
2. Working in positions that do not fully utilise their skills, education, or experience.

- 1 mark for identifying that workers are employed but underutilised (e.g., working fewer hours than desired or in jobs below their skill level).
- 1 mark for further development, such as distinguishing between time-related underemployment and skill-related underemployment, or providing a relevant example.

Award 1 mark for a partial or basic definition, e.g., people who have jobs but want to work more hours.

Award 2 marks for a full definition that captures either both dimensions (hours and skills) or provides a clear development, e.g., when a worker is employed but working part-time when they prefer full-time, or their skills and qualifications are underutilised in their current role.

The two main measures of unemployment differ in their methodology:

1. **Claimant Count**: This measures unemployment by counting the number of people who are actively registering and claiming government unemployment-related benefits (1 mark).
2. **Labour Force Survey (LFS)**: This is a sample survey of households that uses the International Labour Organization (ILO) definition of unemployment, counting anyone who is without a job, wants a job, has actively sought work in the last 4 weeks, and is available to start in the next 2 weeks (1 mark).
3. **Application**: In Zephyrus, the Claimant Count is 120,000, which is significantly lower than the LFS measure of 185,000 (1 mark).
4. **Analysis**: The difference arises because many people classified as unemployed under the ILO definition do not qualify for or choose not to claim state benefits—such as those with high household incomes or those who do not meet the contribution requirements (1 mark).

Award up to 4 marks:
- **Knowledge**: 2 marks (1 mark for defining/distinguishing the Claimant Count and 1 mark for defining/distinguishing the Labour Force Survey/ILO method).
- **Application**: 1 mark for referencing the specific data from Extract A (e.g., 120,000 claimants vs 185,000 LFS unemployed).
- **Analysis**: 1 mark for explaining a reason for the difference between the two measures (e.g., strict eligibility criteria for benefits, social stigma, or part-time workers wanting full-time hours but not qualifying for benefits).

An increase in business investment (I) directly increases Aggregate Demand (AD) because investment is a key component of the aggregate demand formula: \(AD = C + I + G + (X - M)\).

**Diagrammatic Analysis:**
- The diagram should have 'Price Level' (PL) on the vertical axis and 'Real Output' or 'Real GDP' (Y) on the horizontal axis.
- The initial equilibrium is shown at the intersection of \(AD_1\) and \(SRAS\), giving an initial price level of \(P_1\) and real output of \(Y_1\).
- A rightward shift of the aggregate demand curve from \(AD_1\) to \(AD_2\) illustrates the increase in business investment.
- This leads to a new equilibrium at a higher price level \(P_2\) and a higher real output \(Y_2\).

**Written Analysis:**
- Investment increases when businesses buy new machinery, software, or build new premises, often triggered by a fall in interest rates or improved business confidence.
- Because investment is a component of AD, this spending increases total demand in the economy, represented by the rightward shift from \(AD_1\) to \(AD_2\).
- To meet this higher demand, firms increase production, leading to economic growth and a rise in real GDP (from \(Y_1\) to \(Y_2\)).
- As the economy approaches full capacity, competition for scarce resources drives up production costs, leading to demand-pull inflation and an increase in the price level (from \(P_1\) to \(P_2\)).

**Diagram (2 marks):**
- 1 mark for drawing a correctly labelled AD/AS diagram showing the initial equilibrium (labelled \(P_1\) and \(Y_1\)) at the intersection of \(AD_1\) and \(SRAS\).
- 1 mark for showing a rightward shift of the AD curve to \(AD_2\), leading to a higher price level (labelled \(P_2\)) and higher real output (labelled \(Y_2\)).

**Written Analysis (4 marks):**
- 1 mark for identifying investment (I) as a component of aggregate demand (\(AD = C + I + G + (X - M)\)).
- 1 mark for explaining a factor that causes investment to rise (e.g. lower interest rates, business tax cuts, or improved business confidence).
- 2 marks for explaining the transmission mechanism: how the shift in aggregate demand incentivises firms to increase production, which raises real national output (\(Y_1\) to \(Y_2\)), and how increased resource competition drives up the price level (\(P_1\) to \(P_2\)).

Knowledge, Application, and Analysis (6 marks): 1. Loss of purchasing power: The rise in inflation to 7.8% alongside a 3.5% fall in real wages indicates that nominal wage growth is failing to match price rises. Consumers can buy fewer goods and services, reducing material living standards. 2. Regressive impact on low-income households: Since essentials like heating (impacted by a 40% energy price rise) and food make up a larger share of lower-income budgets, these households face a more severe reduction in discretionary income. 3. Increased borrowing costs: The monetary policy response (interest rates rising from 1.5% to 5.0%) increases the cost of mortgages, credit cards, and personal loans, further reducing disposable income for consumer spending. Evaluation (2 marks): 1. Redistribution effects: Debtors benefit because inflation reduces the real value of their outstanding debt, while savers suffer because their savings lose real purchasing power. 2. Nature of inflation: If the inflation is caused by temporary supply-chain bottlenecks and imported energy shocks, the negative effects on consumers may be short-lived once global supply stabilizes.

Knowledge, Application, and Analysis (Up to 6 marks): Level 3 (5-6 marks): Candidate displays a clear understanding of the effects of inflation on consumers, with strong and direct application to the extract (e.g., referencing the 3.5% fall in real wages, 40% energy cost hike, or interest rate rise to 5.0%) and logical chains of economic reasoning. Level 2 (3-4 marks): Candidate provides some economic analysis of the impacts, with partial application to the context. Level 1 (1-2 marks): Candidate identifies basic impacts of inflation but with little or no analysis or contextual application. Evaluation (Up to 2 marks): Level 2 (2 marks): Evaluative comments are well-developed and balanced, considering factors such as the difference between savers and borrowers, or the temporary versus permanent nature of the inflationary shock. Level 1 (1 mark): Candidate provides a simple evaluative statement without further development or logical support.

### Indicative Content

**Knowledge, Application, and Analysis (8 marks - KAA):**
* **Definition/Understanding of Fiscal Policy**: Government spending (\(G\)) is a key injection into the circular flow of income and a component of Aggregate Demand: \(AD = C + I + G + (X - M)\).
* **Short-run Impact on AD**: An injection of $50 billion shifts AD to the right (from \(AD_1\) to \(AD_2\)). This increases real output and creates employment opportunities, addressing the 7.5% unemployment rate.
* **The Multiplier Effect**: The initial injection leads to a larger final increase in national income as spending becomes income for workers and suppliers, who then spend a portion of it.
* **Long-run Supply-side Impact**: Infrastructure investment (transport, energy) improves the economy's productive capacity. This shifts the LRAS curve to the right, which boosts productivity and potential economic growth.

**Evaluation (6 marks):**
* **Inflationary Risks**: Since the economy is operating close to full capacity and inflation is already 4.2% (above the 2% target), the fiscal expansion is highly likely to cause demand-pull inflation as AD rises faster than aggregate supply can adjust in the short term.
* **Balance of Payments Impact**: The high marginal propensity to import (MPM) means that much of the multiplier effect will leak out of the domestic economy, dampening the domestic growth impact and worsening the current account deficit.
* **Time Lags**: Infrastructure projects (transport, energy grids) have long planning and construction periods. The supply-side benefits (shift in LRAS) may take several years to materialise, whereas the demand-pull inflation will occur much sooner.
* **Opportunity Cost and National Debt**: The $50 billion cost will increase the national debt, potentially leading to higher future taxation or crowding out of private investment.

### Marking Grid (14 Marks Total)

| Level | Marks | Descriptor (KAA - 8 Marks) |
|---|---|---|
| **Level 3** | 7–8 | Detailed explanation of both demand-side and supply-side macroeconomic effects, supported by precise economic theory and clear reference to Extract A (e.g., multiplier, capacity constraints, unemployment). |
| **Level 2** | 4–6 | Reasonable explanation of the effects of government spending, but may focus heavily on demand-side or supply-side only. Some application to the extract. |
| **Level 1** | 1–3 | Identification of basic effects (e.g., 'GDP rises', 'jobs are created') with little economic depth or application. |

| Level | Marks | Descriptor (Evaluation - 6 Marks) |
|---|---|---|
| **Level 2** | 4–6 | Two or more well-developed evaluation points (e.g., discussing the inflation conflict due to current capacity limits, the import leakages, and time lags). |
| **Level 1** | 1–3 | Generic evaluative comment(s) without deep explanation or direct connection to the context of Country X. |

### Introduction
- **Define key terms:**
- **Supply-side policies:** Government actions designed to increase the productive capacity (potential output) of the economy, shifting the Long-Run Aggregate Supply (LRAS) curve to the right. These can be market-based (e.g., deregulation, tax cuts) or interventionist (e.g., spending on education, training, and infrastructure).
- **Monetary policy:** The use of interest rates, money supply, and exchange rates by the central bank to influence aggregate demand (AD) and achieve macroeconomic stability.
- **Sustained economic growth:** A continuous increase in the real GDP of an economy over time.
- **Price stability:** Low and stable inflation (typically a target like 2% in many inflation-targeting economies).
- **Thesis:** While supply-side policies are uniquely suited to achieving both objectives in the long run by expanding capacity, they are constrained by long time lags and high costs. Monetary policy is more effective for short-term demand-side stabilization but cannot solve structural growth constraints.

### Section 1: Analysis of Supply-Side Policies
- **Mechanism:** Supply-side policies increase the quantity or quality of the factors of production, or improve productive efficiency.
- **Analytical framework (AD/AS):**
- A successful supply-side policy shifts the LRAS curve to the right from \(LRAS_1\) to \(LRAS_2\).
- If aggregate demand is growing, this expansion in capacity allows the economy to grow from \(Y_1\) to \(Y_2\) without experiencing inflationary bottlenecks.
- Indeed, ceteris paribus, a rightward shift in LRAS reduces the price level (or slows down the rate of inflation), directly achieving both growth and price stability.
- **Examples:**
- **Interventionist:** Investment in infrastructure (reducing transport costs/bottlenecks) and education/training (boosting labor productivity and reducing structural unemployment).
- **Market-based:** Deregulation and labor market reforms (reducing trade union power, reducing unemployment benefits) to increase competition and labor flexibility.

### Section 2: Analysis of Monetary Policy
- **Mechanism:** Central banks adjust policy interest rates to influence borrowing costs, consumer spending, business investment, and the exchange rate (altering AD).
- **Controlling Inflation:** If the economy is overheating, contractionary monetary policy (raising interest rates) is highly effective at reducing inflationary pressures by dampening AD (shifting AD to the left/slowing its growth).
- **Promoting Growth:** In a slowdown, expansionary monetary policy (lowering interest rates or Quantitative Easing) can stimulate AD and short-run economic growth.
- **Limitations:** Monetary policy faces a trade-off. Attempting to stimulate growth via expansionary monetary policy can lead to demand-pull inflation if the economy approaches full capacity (Yfe). It does not increase the underlying productive capacity (LRAS) of the economy on its own.

### Section 3: Evaluation
- **Time Lags:** Supply-side policies have exceptionally long time lags. For example, educational reforms can take a generation to impact labor productivity, whereas interest rate changes can be decided instantly (though they have a transmission lag of 12 to 18 months to be fully felt in the real economy).
- **Cost and Government Finances:** Interventionist supply-side policies are highly expensive and can worsen government budget deficits, potentially causing crowding out or requiring future tax rises. Monetary policy is independent of the government budget.
- **Uncertainty of Outcome:** Supply-side policies may fail (e.g., government failure in choosing infrastructure projects or ineffective training programs). Market-based policies can also increase income inequality.
- **Nature of Inflation:** If inflation is caused by global supply-side shocks (e.g., rising global commodity prices), contractionary monetary policy can reduce inflation but at the cost of causing a severe recession, whereas supply-side policies (like improving energy self-sufficiency) are more appropriate but take years.

### Conclusion
- Supply-side policies are indeed more effective—and indeed necessary—for achieving *sustained* (long-run) non-inflationary growth, as they address the structural capacity of the economy.
- However, they are not a substitute for monetary policy. Without monetary policy to manage short-run business cycles and demand-pull shocks, the macroeconomic environment would be too unstable for supply-side policies to succeed. Therefore, an optimal policy mix uses monetary policy for short-run stabilization and supply-side policies for long-run structural improvement.

### Mark Allocation:
- **Knowledge, Application, and Analysis (12 Marks):** Levels-of-response based on the depth of economic concepts, accuracy of AD/AS framework explanation, and application to both policy instruments.
- **Level 4 (10–12 marks):** Direct, coherent, and detailed analysis of both supply-side and monetary policies. Clear explanation of how they impact both growth and price stability. Highly accurate use of economic terms and implicit/explicit AD/AS diagrammatic reasoning.
- **Level 3 (7–9 marks):** Good understanding of both policies, but the analysis may be slightly unbalanced (e.g., focusing heavily on supply-side and neglecting monetary policy, or vice versa) or have minor gaps in explaining the link to both objectives.
- **Level 2 (4–6 marks):** Basic explanation of the policies. Links to growth and inflation are superficial or disjointed.
- **Level 1 (1–3 marks):** Identification of terms (growth, inflation, interest rates) with minimal or no structural analysis.

- **Evaluation (8 Marks):** Levels-of-response based on the ability to critique the policies and provide a balanced judgment.
- **Level 3 (6–8 marks):** Evaluative comments are deep, well-structured, and balanced. Addresses critical issues such as time lags, cost/opportunity cost, policy conflicts, and the state of the economy. Concludes with a strong, justified judgment on which is more effective or how they interact.
- **Level 2 (3–5 marks):** Some evaluative points are made (e.g., mentioning that supply-side policies take a long time), but lacks depth, balance, or a clear concluding judgment.
- **Level 1 (1–2 marks):** Generic evaluative statements without sufficient economic justification.