2022 OCR AS Level Economics - H060 Practice Paper with Answers

A maximum price set below the equilibrium price creates a situation where quantity demanded exceeds quantity supplied, leading to a shortage. In the long run, landlords have less incentive to maintain, build, or rent out properties, worsening the shortage. Because the price mechanism cannot allocate the housing to those willing and able to pay, non-price rationing systems (such as waiting lists, black markets, or landlord favoritism) will emerge to distribute the scarce housing.

1 mark for the correct option (C). Let's explain why other options are incorrect: A is incorrect because a lower price ceiling reduces the incentive to supply housing, leading to lower quality and quantity. B is incorrect because a maximum price below equilibrium leads to a shortage (excess demand), not a surplus. D is incorrect because quantity demanded increases along the demand curve due to the lower price, though effective transactions are limited by supply.

To find the percentage change in the quantity demanded of good Y, we use the formula for the cross elasticity of demand (XED): \(XED_{XY} = \frac{\% \Delta Q_Y}{\% \Delta P_X}\). Substituting the given values: \(-0.8 = \frac{\% \Delta Q_Y}{10\%}\). Rearranging the formula gives: \(\% \Delta Q_Y = -0.8 \times 10\% = -8\%\). This means that the quantity demanded of good Y will decrease by \(8\%\). The PED of good X is a distractor and is not needed for this calculation.

1 mark for the correct option (B). Option A is incorrect because it uses the PED of X instead of the XED. Options C and D are incorrect because the negative sign of the XED indicates a negative relationship (complements), meaning an increase in the price of X must lead to a decrease in the quantity demanded of Y.

Immunisation is a merit good with positive consumption externalities, meaning the marginal social benefit (MSB) exceeds the marginal private benefit (MPB). In a free market, individuals only consider their private benefits, leading to an equilibrium where \(MPB = MPC\). This results in underprovision (the market quantity is below the socially optimal level where \(MSB = MSC\)) and underpricing (the market price is lower than the price that reflects the true social value of the good).

1 mark for the correct option (B). Option A is incorrect because the market price is underpriced (lower than the social optimum), not overpriced. Options C and D are incorrect because positive consumption externalities lead to underprovision (underconsumption) in a free market, not overprovision.

In a command economy, the state makes all major decisions regarding what to produce, how to produce, and for whom to produce. In a market economy, these decisions are guided by consumer sovereignty and the price mechanism. Therefore, during a transition from a command to a market economy, the state's direct role in resource allocation will significantly decrease.

1 mark for the correct option (C). Option A is incorrect because the price mechanism allocates more resources in a market economy, so this would increase. Option B is incorrect because income inequality tends to increase in a market transition due to the removal of state wage controls. Option D is incorrect because competition generally increases as barriers to entry are lowered.

An outward shift of the PPF represents an increase in the economy's productive potential (long-run economic growth). This is caused by an increase in the quantity or quality of the factors of production. A net inflow of skilled immigrant workers increases both the quantity and quality of the labour force, shifting the PPF outwards. In contrast, reducing unemployment (A) or increasing capacity utilization (B) simply represents employing previously idle resources, which is shown by a movement from a point inside the PPF towards the boundary. Reallocating resources (D) represents a movement along the frontier.

1 mark for the correct option (C). Options A and B are incorrect because they represent short-run recovery/increased efficiency, moving the economy from inside the PPF closer to the frontier. Option D is incorrect because this is a movement along the existing PPF curve, indicating a change in opportunity cost decisions.

According to the Marshall-Lerner condition, a depreciation of a country's currency will improve its trade balance if the sum of the price elasticities of demand for exports and imports is greater than 1 in absolute terms (\(PED_X + PED_M > 1\)). Let's sum the elasticities for each option: Option A: \(0.3 + 0.4 = 0.7\) (less than 1); Option B: \(0.4 + 0.5 = 0.9\) (less than 1); Option C: \(0.6 + 0.7 = 1.3\) (greater than 1); Option D: \(0.2 + 0.5 = 0.7\) (less than 1). Only Option C satisfies the Marshall-Lerner condition, meaning the trade balance will improve.

1 mark for the correct option (C). Options A, B, and D are incorrect because under these elasticity values, the sum is less than 1, meaning depreciation would worsen the trade balance (inelastic demand for both imports and exports).

Automatic stabilisers are built-in features of government spending and taxation that automatically smooth fluctuations in the economic cycle without any explicit, discretionary government intervention. During an economic recession, households and firms earn less income, which automatically reduces direct tax revenues (like income tax and corporation tax). Simultaneously, unemployment rises, which automatically increases government spending on welfare benefits. This injects purchasing power back into the economy, mitigating the depth of the recession.

1 mark for the correct option (B). Options A and D are incorrect because these are examples of discretionary fiscal policy, which requires active government legislation or decisions. Option C is incorrect because this is monetary policy, not fiscal policy.

Market-based supply-side policies aim to improve the efficiency and capacity of the economy by reducing government intervention, encouraging free markets, and increasing flexibility. Reducing the power of trade unions and deregulating the labor market reduces hiring/firing costs and wage rigidity, which allows the labor market to clear more efficiently. In contrast, funding scientific research (A), retraining schemes (B), and broadband expansion (D) are interventionist supply-side policies because they rely on direct government funding and active state involvement.

1 mark for the correct option (C). Options A, B, and D are incorrect because these are interventionist supply-side policies involving government spending and direct intervention to correct perceived market failures in infrastructure, training, and innovation.

A maximum price (or price ceiling) set below the equilibrium price prevents the price from rising to clear the market. At this lower price, the quantity demanded (\(Q_d\)) exceeds the quantity supplied (\(Q_s\)), resulting in a shortage (or excess demand).

1 mark for the correct option (B). No partial marks.

The cross elasticity of demand is defined as: \(\text{XED} = \frac{\% \Delta Q_d \text{ of Y}}{\% \Delta P \text{ of X}}\). Rearranging this formula to find the percentage change in quantity demanded of Y: \(\% \Delta Q_d \text{ of Y} = \text{XED} \times \% \Delta P \text{ of X}\). Given \(\text{XED} = +1.2\) and \(\% \Delta P \text{ of X} = +10\%\), we have: \(\% \Delta Q_d \text{ of Y} = +1.2 \times 10\% = +12\%\). The positive sign confirms they are substitute goods, so an increase in the price of X leads to an increase in demand for Y.

1 mark for the correct calculation and option (D).

Allocative efficiency from a societal perspective occurs where the full cost to society equals the full benefit to society. Therefore, the socially optimal level of production is where Marginal Social Cost (MSC) equals Marginal Social Benefit (MSB).

1 mark for the correct option (B).

In a pure free market, there is no government intervention. Resources are allocated purely through the price mechanism (the invisible hand), where the forces of demand and supply determine relative prices and signal to producers and consumers how to allocate resources.

1 mark for the correct option (C).

An increase in productive capacity represents long-run economic growth, which is shown by an outward shift of the entire PPF, indicating that the economy can now produce more of both goods.

1 mark for the correct option (B).

A decrease in UK interest rates reduces the reward for saving in UK financial institutions, leading to hot money outflows as investors sell Pounds to buy other currencies (increasing the supply of Pounds). An increase in UK demand for imports means UK residents sell more Pounds to purchase foreign currency (further increasing the supply of Pounds). Both actions shift the supply of Pounds to the right, causing a depreciation.

1 mark for the correct option (B).

To reduce inflationary pressure caused by excess aggregate demand, a contractionary fiscal policy is required. This involves reducing government expenditure (directly reducing aggregate demand) and/or increasing income tax rates (reducing consumer disposable income and consumption, which indirectly reduces aggregate demand).

1 mark for the correct option (C).

To calculate the percentage change in the value of the Pound sterling:

$$\text{Percentage Change} = \frac{\text{New Value} - \text{Original Value}}{\text{Original Value}} \times 100$$

$$\text{Percentage Change} = \frac{1.38 - 1.20}{1.20} \times 100$$

$$\text{Percentage Change} = \frac{0.18}{1.20} \times 100 = 15\%$$

The external value of the Pound sterling has appreciated by 15%.

Award 1 mark for the correct calculation of 15% (or an appreciation of 15%). Do not accept -15% or any other numerical value.

To calculate the percentage change in the value of the Pound sterling:

$$\text{Percentage Change} = \frac{\text{New Value} - \text{Original Value}}{\text{Original Value}} \times 100$$

$$\text{Percentage Change} = \frac{1.38 - 1.20}{1.20} \times 100$$

$$\text{Percentage Change} = \frac{0.18}{1.20} \times 100 = 15\%$$

The external value of the Pound sterling has appreciated by 15%.

Award 1 mark for the correct calculation of 15% (or an appreciation of 15%). Do not accept -15% or any other numerical value.

To calculate the percentage change in the exchange rate:

1. Calculate the absolute change in the value of the Florin:
\(0.74\text{ €} - 0.80\text{ €} = -0.06\text{ €}\)

2. Calculate the percentage change relative to the initial value in January:
\(\left(\frac{-0.06}{0.80}\right) \times 100 = -7.5\%\)

3. Since the value of the Florin relative to the Euro fell from 0.80 to 0.74, the Florin has **depreciated**.

Award marks as follows:
- **1 mark** for the correct calculation of the percentage change of \(-7.5\%\) (or a decrease of \(7.5\%\)). Allow 1 mark if the calculation is correct but the minus sign is omitted, provided depreciation is stated.
- **1 mark** for identifying that the Florin has **depreciated**.

To calculate the Price Elasticity of Demand (PED):

1. Calculate the percentage change in quantity demanded (\(\% \Delta Q_d\)):
\(\% \Delta Q_d = \frac{9,600 - 12,000}{12,000} \times 100 = \frac{-2,400}{12,000} \times 100 = -20\%\)

2. Calculate the percentage change in price (\(\% \Delta P\)):
\(\% \Delta P = \frac{1.38 - 1.20}{1.20} \times 100 = \frac{0.18}{1.20} \times 100 = +15\%\)

3. Calculate PED:
\(\text{PED} = \frac{\% \Delta Q_d}{\% \Delta P} = \frac{-20\%}{15\%} \approx -1.33\) (or \(-1.3\))

Award marks as follows:
- **1 mark** for correct working showing the calculation of both percentage changes (\(\% \Delta Q_d = -20\%\) and \(\% \Delta P = 15\%\)), or for correctly setting up the formula with these numbers.
- **1 mark** for the correct final answer of \(-1.33\) (accept \(-1.3\) or the positive equivalent \(1.33\) / \(1.3\) as economists often ignore the negative sign).

An indirect tax increases the private cost of consumption. This shifts the market supply curve upwards, increasing the market price and reducing the quantity demanded. Economically, this aims to internalise the negative externalities (external costs, such as the strain on national healthcare services) so that consumers face the full social cost of their consumption, reducing market failure and shifting resource allocation closer to the socially optimal level.

Award 1 mark for a correct explanation that the tax internalises negative externalities of consumption, reduces overconsumption, or shifts the market equilibrium closer to the socially optimum level of output.

1. Initial Equilibrium: The market is initially in equilibrium where demand equals supply at price \(P_e\) and quantity \(Q_e\). 2. Imposition of Price Ceiling: The government imposes a maximum price, \(P_{max}\), below the equilibrium price \(P_e\). Because it is legally binding, the price cannot rise to clear the market. 3. Disequilibrium (Shortage): At \(P_{max}\), there is a contraction in supply to \(Q_s\) and an extension in demand to \(Q_d\). This creates a shortage (excess demand) equivalent to \(Q_d - Q_s\). 4. Quantity Traded: Despite the high demand, the actual quantity traded in the market falls to \(Q_s\), as sellers cannot be forced to sell more than they are willing to supply at that price.

Diagram representation (2 marks): - 1 mark for correctly showing the initial equilibrium (\(P_e\), \(Q_e\)) and the maximum price line (\(P_{max}\)) set below \(P_e\). - 1 mark for showing the resulting quantity supplied (\(Q_s\)) and quantity demanded (\(Q_d\)), showing the shortage. Explanation (2 marks): - 1 mark for explaining that a shortage (excess demand) of \(Q_d - Q_s\) arises because price is legally prevented from rising to the equilibrium level. - 1 mark for explaining that the actual quantity traded falls from \(Q_e\) to \(Q_s\) because suppliers reduce their output at the lower price.

1. **Define/Identify the Externality**: The consumption of energy drinks results in negative consumption externalities because the private consumption by individuals imposes external costs on third parties (taxpayers who must fund the costly emergency medical treatment for heart palpitations and anxiety).

2. **Divergence of Benefits**: Consumers only consider their personal Marginal Private Benefit (MPB), such as increased energy or taste, and ignore these external costs. This means the Marginal Social Benefit (MSB) is lower than the Marginal Private Benefit (MSB < MPB).

3. **Market Outcome**: Under a free market, resource allocation is determined where MPB = MPC (Marginal Private Cost). Because external costs are ignored, the market equilibrium quantity ($Q_m$) is greater than the socially optimum quantity ($Q_s$), where MSB = MSC.

4. **Market Failure**: This overconsumption leads to a misallocation of resources and a deadweight welfare loss to society, which constitutes market failure.

Max 4 marks:
- Up to 2 marks for explaining the negative consumption externality and its context:
- 1 mark for identifying/defining a negative consumption externality (or explaining that marginal social benefit is less than marginal private benefit, $MSB < MPB$).
- 1 mark for applying this to the case study context (e.g., consumers ignore the external cost of taxpayer-funded emergency medical treatments).

- Up to 2 marks for explaining the market failure outcome:
- 1 mark for explaining that this divergence leads to overconsumption/overproduction in the free market relative to the social optimum ($Q_m > Q_s$).
- 1 mark for explaining that this overconsumption results in a misallocation of resources or a deadweight welfare loss to society.

1. **Effect on Export Prices**: An appreciation of the Zephyrian Dollar means foreign buyers must exchange more of their own currency to buy the same amount of Zephyrian goods. Consequently, the price of Zephyrian exports rises in foreign currencies, making exports less competitive.

2. **Effect on Import Prices**: Conversely, Zephyrian consumers find that domestic currency can buy more foreign currency, making the price of imported goods cheaper in domestic terms.

3. **Volume Changes**: Due to these price changes, the quantity demanded for Zephyrus's exports will fall, while the quantity demanded for foreign imports will rise.

4. **Balance of Trade Impact**: Assuming the Marshall-Lerner condition holds (or that demand is price elastic), the total value of export revenue will decrease and total expenditure on imports will increase, resulting in a worsening (deterioration) of Zephyrus's balance of trade.

Max 4 marks:
- 1 mark for explaining that currency appreciation makes Zephyrian exports more expensive for foreign consumers.
- 1 mark for explaining that currency appreciation makes foreign imports cheaper for domestic consumers.
- 1 mark for explaining the impact on quantities/volumes (i.e., volume of exports falls and volume of imports rises).
- 1 mark for concluding that the overall balance of trade is likely to worsen/deteriorate (or trade deficit increases / surplus decreases), ideally mentioning the assumption of price elasticity of demand.

### Analysis of Positive Impacts:
* **Productivity and LRAS Shift:** Public investment of £5 billion into high-speed digital infrastructure (5G and fiber-optic broadband) directly improves the capital stock of the economy. This enhances the productive capacity of rural areas, reduces transaction costs, and enables businesses to operate more efficiently. Consequently, it can reverse Aldovia's low labour productivity growth (currently at 0.2%).
* **Diagrammatic Analysis:** This policy can be illustrated using an AD/AS diagram. The initial £5bn spending increases Aggregate Demand (AD) in the short run. In the long run, as the broadband network becomes active, it shifts the Long-Run Aggregate Supply (LRAS) curve to the right, raising potential GDP from \(Y_1\) to \(Y_2\) and lowering inflationary pressures.
* **Regional Rebalancing:** Upgrading infrastructure in rural regions integrates isolated markets, allowing for more balanced regional development and reducing structural unemployment.

### Evaluation and Drawbacks:
* **Fiscal Drag and High Debt:** Given Aldovia's high national debt, a £5 billion public spending programme risks widening the fiscal deficit. This could lead to higher future taxation or increased borrowing costs, which might crowd out private investment and offset the growth benefits.
* **Time Lags:** Infrastructure projects are notorious for long time lags (planning, execution, and adoption). The productivity benefits may not be realized for several years, making it an ineffective tool for short-term economic stimulus.
* **Opportunity Cost:** The funds could instead be used to fund the corporate tax cuts or directly subsidise education and R&D, which might yield faster or more efficient productivity gains.
* **Government Failure:** Publicly funded projects run the risk of inefficiency, cost overruns, or misallocation of resources compared to market-led digital expansion.

### Conclusion:
While public digital infrastructure investment is crucial for modernising Aldovia's economy and sustaining long-run growth, its overall effectiveness depends on how the government finances the debt and how efficiently the project is managed. If the fiscal burden is too heavy, the tax cut alternative might prove more sustainable in the medium term.

**Marking Scheme (10 Marks Total):**

* **Level 3 (7-10 marks):**
- Strong, focused analysis of the link between infrastructure investment, productivity, and the rightward shift of the LRAS curve.
- Good integration of the case details (the £5 billion digital spend, rural regions, 0.2% productivity growth).
- Well-developed evaluation addressing key limitations (time lags, opportunity costs, high national debt context).
- Formulates a clear, reasoned concluding judgment.

* **Level 2 (4-6 marks):**
- Explains how infrastructure spending increases economic growth, but may lack depth on supply-side mechanics.
- Some application to Aldovia's situation.
- Evaluative points are raised (e.g., cost or time lags) but not fully developed or balanced.

* **Level 1 (1-3 marks):**
- Descriptive understanding of supply-side policy or economic growth.
- Lacks structured analysis, application to the context, or evaluation.

Introduction: Define key terms. A current account deficit occurs when a country's total spending on imports of goods, services, and net income transfers exceeds its receipts from exports. A currency depreciation refers to a decrease in the value of a domestic currency relative to other currencies in a floating exchange rate system. The view argues that depreciation is the most effective corrective policy through expenditure-switching effects. Analysis of the mechanism: A depreciation reduces the price of exports in terms of foreign currency, making them more competitive abroad. Simultaneously, it increases the price of imports in terms of domestic currency, making foreign goods less attractive to domestic consumers. Assuming domestic consumers switch to locally produced goods and foreign consumers purchase more exports, the trade volume improves. We can represent this on an AD/AS diagram: an increase in net exports (X-M) shifts the Aggregate Demand (AD) curve to the right, increasing real output and potentially restoring balance. Analysis of the Marshall-Lerner Condition: The success of depreciation relies on the Marshall-Lerner condition, which states that depreciation will only improve the current account balance if the absolute sum of the price elasticities of demand for exports and imports is greater than one (|PEDx + PEDm| > 1). If demand is price-inelastic, the total expenditure on imports will rise and export revenue will fall, worsening the deficit. Evaluation Point 1 (The J-Curve Effect): In the short run, the Marshall-Lerner condition often does not hold because trade contracts are pre-signed and consumer habits take time to change, meaning PED for both exports and imports is inelastic. As a result, the current account deficit initially worsens. Over the medium-to-long term, as consumers and firms adjust, demand becomes more elastic, and the trade balance improves. This is illustrated by the J-curve diagram, which plots the trade balance over time. Evaluation Point 2 (Imported Inflation): A weaker currency raises the price of essential imported raw materials and finished goods. This can lead to cost-push inflation, which increases domestic costs of production and shifts the Short-Run Aggregate Supply (SRAS) curve to the left. If domestic inflation rises, the initial price-competitiveness gain from depreciation is eroded, neutralizing the policy's benefits. Evaluation Point 3 (Alternative Policies): To evaluate if depreciation is the 'most effective' policy, it must be compared to alternatives. If the deficit is cyclical (caused by excess domestic demand), expenditure-reducing policies such as contractionary fiscal policy (higher taxes, lower government spending) or tight monetary policy (higher interest rates) are highly effective at dampening import demand. If the deficit is structural (due to poor productivity, lack of innovation, or weak infrastructure), then supply-side policies (education, training, deregulation) are far more effective in the long run than depreciation, as they address the root cause of non-price uncompetitiveness. Conclusion: In conclusion, while a depreciation can be highly effective in the medium term if the Marshall-Lerner condition is met, it is rarely the most effective policy on its own for a persistent deficit. If the deficit is structural, relying solely on depreciation will lead to a continuous cycle of currency decline and inflation. Therefore, a policy mix combining depreciation with supply-side reforms and appropriate domestic demand management is the most effective approach to achieve long-term external stability.

AO1 (Knowledge and Understanding) - 6 marks: Clear, accurate definitions of current account deficit, depreciation, and related economic concepts (Marshall-Lerner condition, J-curve). Excellent understanding of expenditure-switching vs. expenditure-reducing mechanisms. AO2 (Application) - 4 marks: Relevant application of the concepts to the context of correcting a balance of payments deficit, with appropriate references to export and import demand elasticities. AO3 (Analysis) - 5 marks: Coherent, structured analysis of how depreciation works to change relative prices, affect export revenue and import expenditure, and the subsequent impacts on AD/AS and trade balances. Use of diagrams (such as J-curve or AD/AS) to support the analysis is highly rewarded. AO4 (Evaluation) - 5 marks: Balanced and critical evaluation of the view. Detailed discussion of the limitations of depreciation (J-curve, imported inflation, retaliation risks) and comparison with alternative policies (monetary, fiscal, and supply-side policies). A well-justified final judgment is provided on whether depreciation is the 'most' effective policy.