A Level Paper 3: Policy and the Labour Market
Covers Labour Markets and Wage Determination, Money, Banking and the Financial Sector, Supply-Side Policy and Economic Growth, Fiscal and Monetary Policy, Government Intervention in Markets and Market Failure and Externalities.
Questions
Question 1 [2 marks]
Market Failure and Externalities
Define "merit good" and give one example connected to education or health.
Question 2 [3 marks]
Government Intervention in Markets
Define "subsidy", give one example of a good the UK government subsidises, and explain its purpose in one sentence.
Question 3 [3 marks]
Supply-Side Policy and Economic Growth
Define "interventionist supply-side policy", give one example, and explain how it differs from a market-based supply-side policy.
Question 4 [3 marks]
Money, Banking and the Financial Sector
Define "quantitative easing" (QE), and explain its intended effect on the money supply and on long-term interest rates.
Question 5 [5 marks]
Labour Markets and Wage Determination
Explain two reasons why the wages of premier league footballers are far higher than the wages of nurses, despite nursing arguably having greater social value.
Question 6 [5 marks]
Fiscal and Monetary Policy
A government increases its capital spending on a new national rail network, rather than increasing current spending such as public sector wages.
Explain why this type of government spending might affect the economy's long-run aggregate supply (LRAS), as well as its aggregate demand (AD), unlike a rise in current spending.
Question 7 [5 marks]
Labour Markets and Wage Determination
A single hospital trust is the only significant employer of specialist nurses in a rural area, giving it monopsony power in this local labour market. As a monopsonist, the trust must raise the wage paid to all its nurses, not just new hires, to attract an extra nurse.
Explain why this monopsonist is likely to employ fewer nurses and pay a lower wage than would occur under a competitive labour market.
Question 8 [5 marks]
Supply-Side Policy and Economic Growth
A government spends 4.5 billion pounds building a new rail line, which is expected to raise the country's potential output by 0.15% once complete, in an economy with a current potential output of 2600 billion pounds.
Calculate the expected increase in potential output resulting from this project, and comment on whether this appears to represent good value for the government's spending.
Question 9 [5 marks]
Market Failure and Externalities
Explain, using the concept of information failure, why cigarettes are classified as a demerit good, and why this might justify government intervention beyond simply taxing the negative externality of secondhand smoke.
Question 10 [6 marks]
Labour Markets and Wage Determination
A single large distribution company is the only significant employer of warehouse labour in a rural town, giving it monopsony power in the local labour market.
Analyse how the introduction of a national minimum wage, set appropriately, could increase both the wage and the level of employment in this labour market compared with the unregulated monopsony outcome.
Question 11 [6 marks]
Fiscal and Monetary Policy
During a period of very low interest rates, a central bank creates new money electronically to buy large quantities of government bonds from financial institutions, as part of a programme of quantitative easing (QE).
Evaluate the effect of this policy on the government's cost of borrowing, and consider one significant risk associated with using QE on a large scale.
Question 12 [6 marks]
Labour Markets and Wage Determination
The UK government requires large companies to publish their gender pay gap each year, but does not require them to take any specific corrective action.
Evaluate whether mandatory gender pay gap reporting alone is likely to be an effective policy for narrowing the gender pay gap.
Question 13 [6 marks]
Fiscal and Monetary Policy
A country's national debt is 1800 billion pounds and its GDP is 2400 billion pounds.
Calculate the debt-to-GDP ratio, and analyse why a government running a budget deficit does not necessarily cause this ratio to rise.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of a merit good as a good that would be under-consumed in a free market because consumers underestimate the benefits to themselves or to others | 1 |
| a valid example, e.g. vaccinations or education | 1 |
| Final answer: A merit good, such as education or vaccinations, would be under-consumed in a free market because consumers underestimate the benefits it brings to themselves or to society. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of a subsidy as a payment by government to producers (or consumers) to lower the cost of production or price and encourage output or consumption | 1 |
| a valid example, e.g. renewable energy generation or public transport fares | 1 |
| explaining the purpose, e.g. to encourage a higher level of output or consumption than the free market would otherwise provide | 1 |
| Final answer: A subsidy is a payment from government to producers (or consumers) to lower costs and encourage output, e.g. subsidies for renewable energy generation, aimed at encouraging more output than the free market would provide. | |
| Question 3[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of interventionist supply-side policy as direct government action or spending aimed at raising productive capacity | 1 |
| a valid example, e.g. government spending on infrastructure, education or healthcare | 1 |
| correctly distinguishing it from a market-based policy, e.g. it relies on direct government provision or funding rather than incentivising private decisions such as through a tax cut | 1 |
| Final answer: Interventionist supply-side policy is direct government action to raise productive capacity, e.g. spending on infrastructure or education, rather than relying on market incentives such as a tax cut. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of QE as a central bank creating new money electronically to buy financial assets, typically government bonds, from financial institutions | 1 |
| correctly stating this increases the money supply and injects liquidity into the banking system | 1 |
| explaining the purpose is to lower long-term interest rates and encourage lending, investment and spending, particularly when the base rate is already very low | 1 |
| Final answer: Quantitative easing is a central bank creating new money to buy assets such as government bonds; it increases the money supply and liquidity in the banking system, aiming to lower long-term interest rates and encourage lending and spending. | |
| Question 5[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that footballers have a very inelastic supply, since extremely few people have the rare, largely innate talent required | 1 |
| explaining that this restricted supply, combined with high demand from clubs' large broadcasting and commercial revenues, pushes footballers' wages very high through MRP | 1 |
| identifying that nurses' MRP does not reflect their full social value, since much of their output (patient health and care) is not sold at a market price | 1 |
| explaining that as a largely publicly-employed profession, nurses' wages are constrained by government or NHS pay budgets rather than a market-clearing private-sector wage | 1 |
| a further point, e.g. footballers generate marginal revenue product directly tied to individual performance through ticket, broadcast and sponsorship revenue, unlike nurses whose contribution is harder to attribute individually | 1 |
| Final answer: Footballer supply is extremely limited by rare talent, and elite football generates very high revenue tied to individual performance, driving wages up via MRP; nurses' social value is not fully priced in a market and their pay is constrained by public sector budgets, keeping wages far lower despite that social value. | |
| Question 6[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that, like any rise in government spending, the rail spending directly raises a component of aggregate demand, an effect that is then increased further by the multiplier | 1 |
| explaining that current spending, such as public sector wages, mainly affects aggregate demand and does not directly add to the economy's stock of productive capital | 1 |
| explaining that capital spending on infrastructure, such as a new rail network, instead adds to the economy's stock of capital and improves the transport network firms and workers rely on | 1 |
| explaining that this can raise the economy's productive potential over time, shown as a rightward shift in the long-run aggregate supply (LRAS) curve, not just AD | 1 |
| a developed point, e.g. this dual effect means well-targeted capital spending can support growth in both the short run, through AD, and the long run, through LRAS, in a way that current spending on its own generally cannot | 1 |
| Final answer: Like any government spending, rail spending raises AD through the multiplier; but because it adds to the economy's capital stock and infrastructure, unlike current spending on wages, it can also raise the economy's productive potential over time, shifting LRAS to the right as well, supporting both short-run and long-run growth. | |
| Question 7[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that because the trust must raise the wage of all existing nurses to attract one more, the marginal cost of labour (MCL) rises faster than the wage (supply) curve | 1 |
| explaining that the trust employs where the marginal cost of labour equals the marginal revenue product (MRP) of labour, then pays the wage read off the labour supply curve at this quantity | 1 |
| identifying that because MCL lies above the supply curve, the wage paid is lower than the wage that would prevail if MCL equalled the supply curve, as under competition | 1 |
| identifying that the resulting level of employment is also lower than the competitive equilibrium level, since MCL equals MRP at a smaller quantity of labour than where supply would equal MRP | 1 |
| a developed point, e.g. this is sometimes described as monopsony exploitation, since nurses are paid a wage below the value of their marginal contribution to output | 1 |
| Final answer: Because the monopsonist's marginal cost of labour rises faster than the wage it pays, it maximises profit by employing where MCL equals MRP, which happens at both a lower wage and a lower level of employment than would occur under a competitive labour market, sometimes described as monopsony exploitation. | |
| Question 8[5 marks] | |
|---|---|
| Answer or working | Marks |
| increase in potential output = potential output x 0.15% | M1 |
| substituting 2600 x 0.0015 | M1 |
| increase in potential output = 3.9 billion pounds | A1 |
| comparing this to the 4.5 billion pound cost, noting the single-year output increase (3.9 billion) is smaller than the one-off cost | 1 |
| a developed point that this rise in potential output recurs every year once the line is built, so the project's value should be judged over its full lifetime rather than a single year | 1 |
| Final answer: Expected increase in potential output = 2600 x 0.0015 = 3.9 billion pounds; this is smaller than the 4.5 billion pound cost in a single year, but because this rise in potential output recurs every year once the line is built, the project could still represent good value when judged over its full lifetime rather than one year alone. | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying information failure as consumers not having full information about, or underestimating, the harmful effects of smoking on their own health | 1 |
| explaining that this means consumers overconsume relative to what they would choose with full information about the private costs to themselves | 1 |
| identifying that a demerit good is over-provided or over-consumed by the free market because social costs, including to the consumer, exceed the costs the consumer recognises | 1 |
| explaining that taxing only the externality to third parties would not correct the additional overconsumption caused by consumers' own misjudgement of the risks to themselves | 1 |
| identifying an additional policy addressing the information failure directly, e.g. health warnings on packaging or advertising bans, alongside the tax | 1 |
| Final answer: Because smokers underestimate the harm to their own health, cigarettes are overconsumed beyond even the externality to others, so a tax on the externality alone under-corrects; health warnings or advertising restrictions can address the information failure directly. | |
| Question 10[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a monopsonist faces an upward-sloping labour supply (average cost of labour) curve, with a marginal cost of labour curve above it | 1 |
| explaining that a profit-maximising monopsonist employs where marginal cost of labour equals marginal revenue product, at a lower wage and lower employment than the competitive outcome | 1 |
| explaining that imposing a minimum wage at the appropriate level effectively makes the labour supply curve horizontal up to that wage | 1 |
| explaining that this can remove the incentive for the monopsonist to restrict employment in order to keep wages low | 1 |
| concluding that, set correctly, the minimum wage can raise both the wage rate and employment towards the competitive equilibrium level | 1 |
| a valid evaluative caveat, e.g. if the minimum wage is set above the competitive equilibrium wage, employment could then fall, so the outcome depends on setting the correct level | 1 |
| Final answer: Because the firm has monopsony power, a correctly set minimum wage can raise both the wage rate and employment towards the competitive level, though setting it too high could reduce employment. | |
| Question 11[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that when the central bank buys large quantities of government bonds, this raises demand for those bonds | 1 |
| explaining that higher demand for government bonds pushes up their price, and because bond yields move inversely to price, this lowers the yield, the effective interest rate, on government debt | 1 |
| explaining that a lower bond yield directly reduces the government's cost of borrowing on both new and refinanced debt | 1 |
| identifying that this could be especially useful when a government wants to borrow heavily, for example to fund a large fiscal stimulus, without pushing up its own borrowing costs sharply | 1 |
| identifying a significant risk, e.g. the large expansion of the money supply from QE could eventually contribute to excessive inflation, or asset prices such as shares and property, which QE also tends to inflate, could become unsustainably high | 1 |
| a reasoned overall judgement, e.g. QE can be an effective way to hold down government borrowing costs during a crisis, but sustained large-scale use carries a real risk of longer-term inflationary pressure or inflated asset prices, particularly if not reversed once the economy recovers | 1 |
| Final answer: By buying large quantities of government bonds, QE raises their price and lowers their yield, directly reducing the government's cost of borrowing; but sustained large-scale QE risks contributing to future inflation or unsustainably inflated asset prices, particularly if the resulting expansion of money and credit is not reversed once the economy recovers. | |
| Question 12[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that publishing the pay gap creates reputational pressure on companies, since poor results may be publicly criticised by employees, the media or investors | 1 |
| explaining that this reputational pressure could incentivise companies to voluntarily address the gap, for example through mentoring schemes or reviewing promotion practices, even without a legal requirement to do so | 1 |
| identifying a limitation, e.g. reporting alone requires no specific action, so a company facing little public scrutiny could simply publish the figures and change nothing | 1 |
| identifying that the pay gap may partly reflect factors reporting alone cannot fix, such as more women working part-time or taking career breaks for childcare, which reporting only measures rather than addresses | 1 |
| an evaluative point, e.g. reporting is more likely to be effective when combined with other measures, such as shared parental leave policies or transparent promotion criteria, rather than as a policy on its own | 1 |
| a reasoned overall judgement, e.g. mandatory reporting is likely to raise awareness and apply some reputational pressure, but is unlikely to be sufficient alone to substantially close a persistent pay gap without complementary policies addressing its underlying causes | 1 |
| Final answer: Publishing the gap creates reputational pressure that may encourage some voluntary action, but reporting alone requires no specific changes and cannot address underlying causes such as career breaks for childcare, so it is likely to raise awareness without being sufficient on its own to substantially close the pay gap. | |
| Question 13[6 marks] | |
|---|---|
| Answer or working | Marks |
| debt-to-GDP ratio = debt / GDP x 100 | M1 |
| debt-to-GDP ratio = 1800 / 2400 x 100 = 75% | A1 |
| identifying that if nominal GDP grows faster in percentage terms than the debt added by the deficit, the debt-to-GDP ratio can fall even while running a deficit | 1 |
| explaining that a deficit adds a fixed amount to the numerator (debt) each year, but if the denominator (GDP) grows faster, due to real growth and/or inflation, the ratio can still fall | 1 |
| a developed point, e.g. this is why economists focus on the deficit as a percentage of GDP and the relationship between the interest rate on debt and the rate of nominal GDP growth, rather than the deficit's absolute size | 1 |
| a further point, e.g. a small, sustainable deficit funding productive investment that raises long-run growth could support a falling debt ratio over time, unlike an unproductive deficit | 1 |
| Final answer: Debt-to-GDP ratio = 1800 / 2400 = 75%; a deficit does not automatically raise this ratio, because if nominal GDP grows faster in percentage terms than the debt added by the deficit, the ratio can still fall, which is why the relationship between growth, interest rates and the deficit's size relative to GDP matters more than the deficit's absolute size. | |