2023 Edexcel IAS-Level Economics (XEC11) Practice Paper with Answers

The free-market equilibrium level of output occurs where marginal private benefit equals marginal private cost (MPB = MPC). From the table, at level 3, both MPB and MPC are equal to $30. Therefore, the free-market level is 3.

The socially optimal level of output occurs where marginal social benefit equals marginal social cost (MSB = MSC). Since there are no external costs, MSC = MPC. Looking at level 5, MSB = $40 and MSC (MPC) = $40. Therefore, the socially optimal level is 5.

Award 1 mark for the correct answer (A).

- Reject B: This reverses the free-market and socially optimal levels.
- Reject C and D: These represent incorrect levels of output where marginal private and social conditions are not met.

The unemployment rate is calculated as:

\(\text{Unemployment Rate} = \frac{\text{Number of Unemployed}}{\text{Labour Force}} \times 100\)

Where: \(\text{Labour Force} = \text{Employed} + \text{Unemployed}\)

Underemployed workers are already counted as employed. Inactive individuals (whether they want a job or not) are excluded from the labour force calculation.

\(\text{Labour Force} = 24.0\text{ million} + 1.5\text{ million} = 25.5\text{ million}\)

\(\text{Unemployment Rate} = \frac{1.5}{25.5} \times 100 \approx 5.88%\)

Rounded to one decimal place, this is 5.9%.

Award 1 mark for the correct answer (B).

- Reject A: Calculated by dividing unemployed by the entire adult population (including inactive: \(1.5 / 41.0 \approx 3.7\%\)).
- Reject C: Calculated by including inactive wanting a job as unemployed \((1.5 + 1.0) / 25.5 \approx 9.8\%\).
- Reject D: Calculated by treating underemployed as unemployed \((1.5 + 2.5) / 25.5 \approx 15.7\%\).

Consumer surplus (CS) is the area below the demand curve and above the price level. The demand curve \(Q = 20 - 2P\) can be written as \(P = 10 - 0.5Q\), where the maximum price (choke price) is $10.

At \(P_1 = 4\):
\(Q_1 = 20 - 2(4) = 12\)

\(CS_1 = \frac{1}{2} \times (10 - 4) \times 12 = 36\)

At \(P_2 = 5\):
\(Q_2 = 20 - 2(5) = 10\)

\(CS_2 = \frac{1}{2} \times (10 - 5) \times 10 = 25\)

Change in consumer surplus = \(CS_2 - CS_1 = 25 - 36 = -11\) (a decrease of $11).

Award 1 mark for the correct answer (B).

- Reject A: Occurs if the consumer only loses the surplus from the units still consumed without accounting for the deadweight loss of the lost units.
- Reject C: Incorrect calculation of initial/new surplus areas.
- Reject D: Represents the change in quantity demanded rather than consumer surplus.

First, find the initial equilibrium price before the tax is imposed by setting \(Q_d = Q_s\):
\(120 - 2P = 3P - 30 \implies 5P = 150 \implies P = 30\).

Next, adjust the supply function for the $5 specific tax. The supply curve shifts vertically upwards by $5, so the new supply function is:
\(Q_s' = 3(P - 5) - 30 = 3P - 45\).

Find the new equilibrium price by setting \(Q_d = Q_s'\):
\(120 - 2P = 3P - 45 \implies 5P = 165 \implies P' = 33\).

Consumers pay $33. The tax incidence on consumers is the increase in price they pay: \(33 - 30 = \$3\).

Award 1 mark for the correct answer (A).

- Reject B: Assumes consumers pay the entire tax of $5, which would only happen if demand was perfectly inelastic.
- Reject C: Incorrect price calculation resulting in wrong consumer tax incidence.
- Reject D: Incorrectly calculates the change from the initial price.

When a proportional income tax rate (\(t\)) is introduced, the multiplier formula is given by:
\(k = \frac{1}{1 - MPC(1 - t)}\)

Given \(MPC = 0.75\) and \(t = 0.20\):
\(k = \frac{1}{1 - 0.75(1 - 0.20)} = \frac{1}{1 - 0.75(0.80)} = \frac{1}{1 - 0.60} = \frac{1}{0.40} = 2.5\).

Award 1 mark for the correct answer (B).

- Reject A: This is the original multiplier before taxes are introduced (\(1 / (1 - 0.75) = 4\)).
- Reject C: Incorrect application of the formula by subtracting taxes directly from MPC.
- Reject D: Incorrect calculation of the multiplier.

The current account balance is:

\(\text{Current Account Balance} = \text{Trade in Goods Balance} + \text{Trade in Services Balance} + \text{Net Primary Income} + \text{Net Secondary Income}\)

Where:
\(\text{Trade in Goods Balance} = 180 - M_g\) (where \(M_g\) is import of goods)
\(\text{Trade in Services Balance} = 70 - 55 = +15\)

Substituting into the formula:
\(-20 = (180 - M_g) + 15 + (-15) + (-5)\)

\(-20 = 175 - M_g \implies M_g = 195\).

Thus, imports of goods are $195 billion.

Award 1 mark for the correct answer (C).

- Reject A: Calculated by subtracting rather than adding the deficit, which yields a surplus of $20 billion.
- Reject B: This would be the import value if the current account was in perfect balance (0).
- Reject D: Calculated by making a sign error in the balance of trade calculation.

Step 1: Calculate the percentage change in the price of Good A (cinema tickets):
$$\%\Delta P_A = \frac{10.00 - 8.00}{8.00} \times 100 = +25\%$$

Step 2: Calculate the percentage change in the quantity demanded of Good B (streaming subscriptions):
$$\%\Delta Q_B = \frac{1,800 - 1,200}{1,200} \times 100 = +50\%$$

Step 3: Calculate XED using the formula:
$$XED = \frac{\%\Delta Q_B}{\%\Delta P_A} = \frac{+50\%}{+25\%} = +2.0$$

Step 4: Determine the relationship between the goods:
Since the XED value is positive (+2.0), the two goods are substitutes.

1 mark for correct calculation of the percentage change in price of Good A (+25%).
1 mark for correct calculation of the percentage change in quantity demanded of Good B (+50%).
1 mark for correct calculation of XED (+2.0 or 2) with correct working (allow 1 mark for correct formula if arithmetic error is made).
1 mark for identifying that the goods are substitutes based on the positive sign.

To calculate Real GDP, use the formula:
$$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$$

For 2022:
$$\text{Real GDP}_{2022} = \frac{\$450 \text{ billion}}{120} \times 100 = \$375 \text{ billion}$$

For 2023:
$$\text{Real GDP}_{2023} = \frac{\$495 \text{ billion}}{125} \times 100 = \$396 \text{ billion}$$

1 mark for showing or using the correct formula:
$$\text{Real GDP} = \frac{\text{Nominal GDP}}{\text{GDP Deflator}} \times 100$$
1 mark for correct calculation of 2022 Real GDP ($375 billion).
1 mark for correct calculation of 2023 Real GDP ($396 billion).
1 mark for stating both final answers with correct units (billion dollars / $bn).

(a) Total government expenditure on the subsidy is calculated as:
$$\text{Total Subsidy Spending} = \text{New Quantity} \times \text{Subsidy per unit}$$
$$\text{Total Subsidy Spending} = 12,000 \times \pounds 100 = \pounds 1,200,000 \text{ (or } \pounds 1.2 \text{ million)}$$

(b) The consumer benefit per unit is the reduction in price paid by the consumer:
$$\text{Consumer Benefit per unit} = \text{Original Price} - \text{New Price} = \pounds 400 - \pounds 330 = \pounds 70 \text{ per unit}$$
$$\text{Total Consumer Benefit} = \text{New Quantity} \times \text{Consumer Benefit per unit}$$
$$\text{Total Consumer Benefit} = 12,000 \times \pounds 70 = \pounds 840,000$$

1 mark for identifying the new quantity of 12,000 units as the basis for subsidy calculations.
1 mark for correct calculation of total weekly government expenditure on the subsidy (£1,200,000 or £1.2m).
1 mark for calculating the consumer benefit per unit (£70).
1 mark for correct calculation of total consumer benefit (£840,000).

Step 1: Calculate the Marginal Propensity to Withdraw (MPW):
$$MPW = MPS + MPT + MPM$$
$$MPW = 0.15 + 0.20 + 0.15 = 0.50$$

Step 2: Calculate the multiplier (k):
$$k = \frac{1}{MPW} = \frac{1}{0.50} = 2$$

Step 3: Calculate the total change in national income (\(\Delta Y\)):
$$\Delta Y = k \times \Delta J$$
$$\Delta Y = 2 \times \$30 \text{ billion} = \$60 \text{ billion}$$

1 mark for calculating the marginal propensity to withdraw (MPW = 0.50) or stating the correct formula:
$$k = \frac{1}{MPS + MPT + MPM}$$
1 mark for calculating the correct value of the multiplier (2).
1 mark for stating the multiplier equation/relationship with aggregate demand injections:
$$\Delta Y = k \times \Delta J$$
1 mark for calculating the correct final total change in national income ($60 billion).

(a) Calculate Marginal Social Cost (MSC):
$$MSC = MPC + MEC$$
$$MSC = \pounds 15 + \pounds 8 = \pounds 23$$

(b) At this level of output, Marginal Social Cost (MSC) is £23, while Marginal Social Benefit (MSB) is only £12. Because \(MSC > MSB\), the cost of producing the last unit to society is greater than the benefit society derives from consuming it. Therefore, output should be decreased to achieve allocative efficiency (where \(MSB = MSC\)).

1 mark for using the correct formula:
$$MSC = MPC + MEC$$
1 mark for calculating MSC as £23.
1 mark for comparing MSC (£23) and MSB (£12) to show MSC > MSB.
1 mark for concluding that output must be decreased to restore allocative efficiency/remove welfare loss.

Real Gross Domestic Product (GDP) measures the total output of goods and services produced within an economy over a given period (usually a year), taking into account inflation. By adjusting for changes in the price level (using constant prices from a base year), it reflects actual changes in the volume of production rather than changes in prices.

Knowledge / Understanding (2 marks):
- 1 mark for identifying/defining GDP (e.g., the total value of all goods and services produced within an economy/country in a given time period).
- 1 mark for explaining the 'real' aspect (e.g., adjusted for inflation / measured at constant prices / adjusted for changes in the price level).

**Knowledge and Analysis (2 marks):**
* Identifying that the subsidy aims to correct market failure or reduce negative externalities associated with petrol/diesel vehicles (1 mark).
* Explaining how the subsidy works: it lowers the cost of production for firms or lowers the price for consumers, shifting the market supply/demand curve to increase the consumption of a merit good (EVs), which helps transition consumers away from more polluting options (1 mark).

**Application (2 marks):**
* Reference to the cost of negative externalities from the extract: "cost the economy $3 billion annually in healthcare and environmental cleanup" (1 mark).
* Reference to the change in EV sales or policy size: sales increased from "12,000 to 28,000 units" or the introduction of a "15% subsidy" (1 mark).

**Marking Scheme (4 marks total):**

* **Knowledge and Analysis (Up to 2 marks):**
* 1 mark for identifying a valid economic reason (e.g., to internalise positive externalities of EVs, reduce negative externalities of petrol/diesel cars, or correct market failure).
* 1 mark for explaining the transmission mechanism (e.g., subsidy lowers relative prices, encouraging consumers to switch to cleaner energy alternatives).

* **Application (Up to 2 marks):**
* 1 mark for extracting relevant data regarding the social cost (e.g., "$3 billion annually").
* 1 mark for extracting relevant data regarding the policy action or outcome (e.g., "15% subsidy" or quantity rising from "12,000 to 28,000 units").

**Knowledge and Analysis (2 marks):**
* Identifying that the subsidy aims to correct market failure or reduce negative externalities associated with petrol/diesel vehicles (1 mark).
* Explaining how the subsidy works: it lowers the cost of production for firms or lowers the price for consumers, shifting the market supply/demand curve to increase the consumption of a merit good (EVs), which helps transition consumers away from more polluting options (1 mark).

**Application (2 marks):**
* Reference to the cost of negative externalities from the extract: "cost the economy $3 billion annually in healthcare and environmental cleanup" (1 mark).
* Reference to the change in EV sales or policy size: sales increased from "12,000 to 28,000 units" or the introduction of a "15% subsidy" (1 mark).

**Marking Scheme (4 marks total):**

* **Knowledge and Analysis (Up to 2 marks):**
* 1 mark for identifying a valid economic reason (e.g., to internalise positive externalities of EVs, reduce negative externalities of petrol/diesel cars, or correct market failure).
* 1 mark for explaining the transmission mechanism (e.g., subsidy lowers relative prices, encouraging consumers to switch to cleaner energy alternatives).

* **Application (Up to 2 marks):**
* 1 mark for extracting relevant data regarding the social cost (e.g., "$3 billion annually").
* 1 mark for extracting relevant data regarding the policy action or outcome (e.g., "15% subsidy" or quantity rising from "12,000 to 28,000 units").

An indirect tax is a tax imposed on spending, which effectively increases the cost of production for firms. In a demand and supply diagram, the initial market equilibrium is determined by the intersection of the demand curve (D) and the supply curve (S1), giving an initial price of P1 and quantity of Q1. The imposition of an indirect tax shifts the supply curve vertically upwards from S1 to S2 (or S + tax) by the exact amount of the tax per unit. As a result of this shift, the market price rises from P1 to P2, causing a contraction along the demand curve to a new, lower equilibrium quantity of Q2. The vertical distance between S1 and S2 represents the tax per unit. This intervention achieves the policy objective of reducing the consumption of sugary soft drinks, while also generating tax revenue for the government (represented by the area P2 P3 A B, where P3 is the net price received by the producer).

Diagram (3 marks): - 1 mark for showing original demand, supply, and equilibrium price (P1) and quantity (Q1). - 1 mark for showing the supply curve shifting vertically upwards/leftwards from S1 to S2 (or S + tax). - 1 mark for showing the new, higher equilibrium price (P2) and lower quantity (Q2), and optionally identifying the tax per unit or government tax revenue. Written Analysis (3 marks): - 1 mark for explaining that the indirect tax increases the cost of production for firms, which reduces supply. - 1 mark for explaining that this higher cost is partially passed on to consumers, raising the retail price from P1 to P2 and causing a contraction in quantity demanded. - 1 mark for explaining a further economic consequence, such as the generation of government tax revenue or the reduction in consumption of a demerit good to correct market failure.

### Economic Analysis (KAA - up to 5 marks):

* **Definition of Maximum Price**: A government-imposed price control set below the free-market equilibrium price, designed to protect consumers by keeping essential goods affordable.
* **Excess Demand (Shortage)**: At the lower maximum price \(P_{max}\), the quantity demanded by consumers increases from \(Q_e\) to \(Q_d\). However, because the price is lower, the profitability for farmers decreases (especially with rising fertilizer and fuel costs), causing the quantity supplied to contract from \(Q_e\) to \(Q_s\). This creates a shortage equal to \(Q_d - Q_s\).
* **Impact on Consumers**: Low-income households who are able to purchase the rice at \(P_{max}\) experience an increase in consumer surplus and improved living standards. However, many consumers will face shortages, empty shelves, and non-price rationing (such as queuing or rationing schemes).
* **Impact on Producers**: Rice farmers suffer from lower revenues and profit margins. Some may exit the market, reduce production, or smuggle/divert rice to neighboring countries where prices are higher, further worsening the domestic shortage.
* **Creation of Black Markets**: Desperate consumers unable to buy rice through official channels may turn to illegal parallel markets, where rice is sold at prices higher than both \(P_{max}\) and the original equilibrium price.

### Evaluation (EV - up to 3 marks):

* **Magnitude of the Price Gap**: The severity of the shortage depends on how far below the market equilibrium the maximum price is set. A price set only slightly below equilibrium will have negligible negative effects, whereas a price set significantly below will cause a severe shortage.
* **Price Elasticity of Demand (PED) and Supply (PES)**: In the short run, both demand and supply for staple foods tend to be price inelastic, meaning the shortage might initially be small. In the long run, however, PES becomes more elastic as farmers shift to alternative crops, leading to a much larger shortage over time.
* **Enforcement and Administrative Costs**: The success of the policy depends heavily on the government's ability to police stores and prevent black market activity. High enforcement costs could lead to government failure.
* **Alternative Policies**: Rather than imposing a price ceiling, the government could subsidize agricultural inputs (fertilizer and fuel) to shift the supply curve outward, reducing prices naturally without causing shortages.

**Marking Scheme (Total: 8 marks)**

**Knowledge, Application, and Analysis (KAA) - 5 marks**
* **1-2 marks**: Identifies a maximum price or its basic effects. Shows limited understanding, possibly with an incomplete diagram or weak application to Zendia's rice market.
* **3-4 marks**: Explains at least two economic effects of the maximum price (e.g., shortages, smuggling, impact on consumer/producer surplus, black markets). Good application to the details in Extract A (e.g., mentioning low-income household budgets or rising agricultural input costs).
* **5 marks**: Clear, comprehensive analysis of multiple economic effects, supported by robust economic theory (e.g., explicit reference to demand/supply movements and the resulting shortage) and thorough contextual integration.

**Evaluation (EV) - 3 marks**
* **1 mark**: Identifies an evaluative comment or limitation of the policy (e.g., mentioning that it depends on elasticity or enforcement).
* **2 marks**: Explains an evaluative point in depth (e.g., contrasting the short-run and long-run consequences on supply elasticity).
* **3 marks**: Provides highly developed evaluation points, weighing the overall benefits against costs, discussing policy alternatives (like subsidies), or assessing the likelihood of government failure.

Analysis (8 marks): 1. Definition: A subsidy is a payment by the government to suppliers to lower their production costs and encourage consumption of a merit good. 2. Diagram: The diagram should show either (a) a positive consumption externality diagram where MSB is greater than MPB, and a subsidy shifts MPC downwards to MPC - subsidy, increasing consumption from the market output \(Q_1\) to the socially optimal output \(Q_2\), or (b) a standard demand and supply diagram showing a rightward shift of supply (\(S_1\) to \(S_2\)) due to the subsidy, leading to a fall in price (\(P_1\) to \(P_2\)) and an increase in quantity (\(Q_1\) to \(Q_2\)). 3. Explanation: Lowering the price of public transport shifts commuters away from private cars (positive cross-price elasticity of demand). This reduces the volume of cars on the road, lowering the external costs of driving, such as carbon emissions, noise pollution, and lost productivity due to traffic delays. Evaluation (6 marks): 1. Fiscal/Opportunity Cost: Subsidies require substantial government funding, which could have been allocated to other essential sectors like health or education, or to directly building better roads. 2. Elasticities of Demand: If the price elasticity of demand (PED) for public transport is inelastic (due to poor service reliability, safety concerns, or lack of routes), the lower fares will not significantly increase ridership. Similarly, if the cross-price elasticity of demand between cars and public transport is low, car drivers will not switch. 3. Government Failure: Subsidies may reduce the incentive for transport firms to remain cost-efficient, leading to X-inefficiency (waste) and higher long-term costs without improving services.

Knowledge, Application, and Analysis (8 Marks): - Level 3 (6-8 marks): Detailed analysis of how the subsidy reduces costs, lowers fares, and leads to a shift away from private car usage to resolve market failure. The candidate provides an accurate, fully-labelled diagram (either a positive consumption externality diagram or a market subsidy diagram) that is directly linked to the analysis. - Level 2 (3-5 marks): Some explanation of the effects of a subsidy with a relevant diagram, but the links to correcting market failure/congestion may be weak or incomplete. - Level 1 (1-2 marks): Basic identification of what a subsidy is, with a flawed or missing diagram. Evaluation (6 Marks): - Level 3 (5-6 marks): Robust evaluation of at least two key limitations (e.g., opportunity cost, PED/XED values, risk of government failure) with clear economic reasoning. - Level 2 (3-4 marks): Limited evaluation points or only one point explained in depth. - Level 1 (1-2 marks): Generic evaluative comments with little to no economic development.

Introduction: Expansionary monetary policy involves central bank action to lower interest rates or increase the money supply (e.g., via Quantitative Easing) to stimulate aggregate demand (AD). Market-based supply-side policies aim to increase the economy's productive capacity (LRAS) by reducing government intervention and increasing free-market efficiency (e.g., deregulation, income tax cuts, and reducing trade union power). Both policies seek to achieve economic growth and reduce unemployment, but they target different aspects of the economy.

Analysis of Expansionary Monetary Policy: Lowering interest rates reduces the cost of borrowing for households and firms. This encourages consumer spending on durables (C) and business investment (I). Additionally, lower interest rates reduce the incentive to save and lead to a depreciation of the exchange rate, boosting net exports (X-M). As a result, AD shifts to the right from \(AD_1\) to \(AD_2\). In an AD/AS diagram, this increases real output (Y) and reduces demand-deficient (cyclical) unemployment, as firms hire more workers to meet the increased demand. This policy can be implemented quickly by central banks and has a powerful short-term multiplier effect.

Evaluation of Expansionary Monetary Policy: However, expansionary monetary policy has limitations. If the economy is operating close to full capacity, a rightward shift in AD will lead to demand-pull inflation rather than substantial growth in real output. There is also a time lag of up to 18-24 months for interest rate changes to fully affect real GDP. Furthermore, in a deep recession or liquidity trap, consumer and business confidence may be so low that interest rate cuts fail to stimulate borrowing and spending (as seen in many developed nations post-2008).

Analysis of Market-Based Supply-Side Policies: Market-based supply-side policies focus on shifting the Long-Run Aggregate Supply (LRAS) curve to the right. For example, reducing personal income tax rates increases the incentive to work and enter the labor force, expanding the labor supply. Lowering corporation tax increases retained profits, encouraging investment in capital and research and development (R&D). Deregulation reduces the barriers to entry, fostering competition and efficiency. On an AD/AS diagram, a rightward shift in LRAS from \(LRAS_1\) to \(LRAS_2\) increases potential GDP, lowers the price level, and reduces structural and frictional unemployment by making labor markets more flexible.

Evaluation of Supply-Side Policies: Conversely, supply-side policies have significant drawbacks. They suffer from very long time lags, as education, training, and infrastructure projects take years to yield productivity gains. There is also a major fiscal cost; cutting taxes can increase the government's budget deficit in the short run. Furthermore, market-based policies often worsen income inequality\u2014for instance, reducing unemployment benefits or weakening trade unions can harm low-income households and increase relative poverty.

Conclusion / Judgment: Ultimately, the relative effectiveness of these policies depends on the nature of the economic slowdown and the type of unemployment. If unemployment is predominantly cyclical (caused by a lack of AD during a recession), expansionary monetary policy is highly effective and necessary for rapid stabilization. However, if unemployment is structural (due to skills mismatches or rigid labor markets), demand-side policies will only cause inflation, making supply-side policies superior for long-term non-inflationary growth. Thus, the most effective strategy is a coordinated approach using monetary policy to manage short-term demand fluctuations and supply-side policies to expand long-term productive capacity.

Knowledge, Application, and Analysis (12 marks)
- Level 1 (1-3 marks): Identifies basic terms (monetary policy, supply-side policies, growth, unemployment). Simple assertions without developed economic chains of reasoning.
- Level 2 (4-6 marks): Basic explanation of how monetary policy (e.g., lower interest rates) shifts AD and how supply-side policy shifts LRAS. Provides simple diagrams or descriptions of AD/AS shifts.
- Level 3 (7-9 marks): Systematic analysis of both policies. Explains the transmission mechanisms clearly (e.g., interest rate -> borrowing cost -> investment -> AD -> real GDP and employment; deregulation/tax cuts -> incentives/costs -> LRAS -> productive capacity). Analysis is supported by accurate diagrams.
- Level 4 (10-12 marks): Precise, detailed, and logical economic analysis of both policies. Evaluative tone starts to emerge. Distinguishes clearly between cyclical and structural unemployment and short-run vs long-run growth.

Evaluation (8 marks)
- Level 1 (1-2 marks): Identifies basic limitations (e.g., policies take time, cost money).
- Level 2 (3-5 marks): Explains limitations in context (e.g., monetary policy time lags, liquidity trap, inflation risk; supply-side fiscal costs, inequality, long time frames).
- Level 3 (6-8 marks): Offers a balanced, critical evaluation. Evaluates the relative effectiveness based on the state of the economy (recession vs full capacity) or the type of unemployment (cyclical vs structural). Provides a clear, justified concluding judgment.