A Level Paper 5: Trade, Money and the Macroeconomy
Covers Labour Markets and Wage Determination, Measuring Economic Performance, Aggregate Demand and Aggregate Supply, Fiscal and Monetary Policy, Supply-Side Policy and Economic Growth, International Trade and the Balance of Payments and Money, Banking and the Financial Sector.
Questions
Question 1 [2 marks]
International Trade and the Balance of Payments
Distinguish between absolute advantage and comparative advantage in the production of a good.
Question 2 [3 marks]
Labour Markets and Wage Determination
Define "occupational immobility of labour", give one example of a barrier that causes it, and explain one consequence for unemployment.
Question 3 [3 marks]
Money, Banking and the Financial Sector
A student has an interest-free overdraft limit of 1500 pounds at their bank. Once they exceed this limit, the bank charges 18% annual interest on the amount over the limit. The student is overdrawn by 1800 pounds for a full year.
Calculate the amount of the student's overdraft that is charged interest, and the total annual interest charged.
Question 4 [3 marks]
Measuring Economic Performance
Define "underemployment", and explain why a country's official unemployment rate might understate the true amount of spare capacity in its labour market.
Question 5 [3 marks]
Fiscal and Monetary Policy
A household has an outstanding mortgage of 180000 pounds on a variable interest rate. The Bank of England raises its base rate, causing the mortgage's interest rate to rise from 4% to 4.75% per year.
Calculate the resulting increase in the household's annual interest payment on this mortgage.
Question 6 [3 marks]
Supply-Side Policy and Economic Growth
A country's productive potential (potential output) grows from 2400 billion pounds to 2472 billion pounds over one year.
Calculate the percentage growth in productive potential over the year.
Question 7 [4 marks]
Labour Markets and Wage Determination
Explain two factors, other than the wage rate, that might increase the supply of labour to the nursing profession in the UK.
Question 8 [4 marks]
International Trade and the Balance of Payments
Explain the difference between a free trade area and a customs union, using an example of what a customs union requires that a free trade area does not.
Question 9 [5 marks]
Aggregate Demand and Aggregate Supply
Explain two ways in which a fall in consumer confidence could affect aggregate demand, even before any change in household income.
Question 10 [5 marks]
Measuring Economic Performance
Country A has a higher GDP per capita than Country B when both are measured using the market exchange rate. However, the cost of living, particularly for non-traded goods and services such as haircuts and restaurant meals, is much lower in Country B.
Explain why comparing GDP per capita using purchasing power parity (PPP) exchange rates, rather than market exchange rates, might give a more accurate picture of relative living standards between the two countries.
Question 11 [5 marks]
International Trade and the Balance of Payments
A country joins a customs union. It previously imported a good from an efficient producer outside the union, paying a world price plus a tariff, but after joining switches to importing the same good tariff-free from a less efficient producer inside the union, at a higher pre-tariff price than the original supplier charged.
Using the concepts of trade creation and trade diversion, explain whether this switch in the source of imports is likely to raise or lower the country's economic welfare.
Question 12 [5 marks]
Measuring Economic Performance
Explain two limitations of using real GDP growth alone as a measure of a country's economic wellbeing.
Question 13 [5 marks]
Supply-Side Policy and Economic Growth
Analyse two potential drawbacks of relying on interventionist supply-side policies, such as large-scale government spending on infrastructure and education, to raise long-run growth.
Question 14 [6 marks]
Measuring Economic Performance
In Country X, the Gini coefficient for income inequality was 0.32 ten years ago and is 0.38 today. The Gini coefficient ranges from 0 (perfect equality) to 1 (perfect inequality).
Analyse how income inequality in Country X has changed over the ten years, describe in words what this means for the shape of the country's Lorenz curve, and calculate the percentage increase in the Gini coefficient over the period.
Question 15 [6 marks]
Fiscal and Monetary Policy
The UK economy is experiencing high inflation caused mainly by a sharp rise in global energy prices, alongside weak economic growth.
Analyse the difficulties this presents for the Bank of England in using monetary policy to meet its inflation target, and evaluate whether monetary or fiscal policy is better suited to addressing this situation.
Question 16 [6 marks]
Aggregate Demand and Aggregate Supply
A country experiences a sharp fall in aggregate demand due to a global recession, while the economy was previously operating close to full employment.
Evaluate the likely short-run and long-run effects on the economy's price level and level of real output, using the concept of the Keynesian LRAS curve.
Question 17 [6 marks]
Fiscal and Monetary Policy
A government facing a large budget deficit is deciding between raising income tax rates and cutting public spending on welfare benefits to reduce the deficit.
Evaluate which of these two approaches to reducing the deficit is likely to have less negative impact on economic growth in the short run.
Question 18 [6 marks]
Supply-Side Policy and Economic Growth
The table below shows a UK labour productivity index (output per worker per hour), where 2021 = 100.
2021: 100
2022: 101.2
2023: 101.8
2024: 102.1
2025: 102.5
Calculate the overall percentage growth in labour productivity from 2021 to 2025, and analyse the likely consequences for the UK economy of such a low rate of productivity growth over this period.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a country has an absolute advantage in a good if it can produce more of that good than another country using the same quantity of resources | 1 |
| explaining that a country has a comparative advantage in a good if it can produce it at a lower opportunity cost, in terms of another good given up, than another country, even without an absolute advantage | 1 |
| Final answer: A country has an absolute advantage if it can produce more of a good with the same resources than another country; it has a comparative advantage if it can produce a good at a lower opportunity cost, even without an absolute advantage. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of occupational immobility as the inability of workers to move between different types of job or occupation | 1 |
| a valid example, e.g. a lack of the qualifications or skills needed for a new occupation | 1 |
| explaining a consequence, e.g. this can cause structural unemployment to persist even where vacancies exist in other occupations | 1 |
| Final answer: Occupational immobility is the inability of workers to move between different jobs, e.g. because they lack the qualifications needed for a new occupation; this can leave structural unemployment even when vacancies exist elsewhere. | |
| Question 3[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the amount over the interest-free limit, 1800 - 1500 = 300 pounds | M1 |
| calculating the interest as 300 x 0.18 | M1 |
| annual interest of 54 pounds | A1 |
| Final answer: 54 pounds of annual interest is charged on the 300 pounds over the interest-free limit. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of underemployment as a situation where a worker is employed but would like to work more hours, or is working in a job that does not fully use their skills or qualifications | 1 |
| explaining that the official unemployment rate only counts people with no job at all who are actively seeking and available for work, so it does not include underemployed workers | 1 |
| explaining that if underemployment is widespread, for example many part-time workers wanting full-time hours, the true amount of spare labour market capacity is greater than the unemployment rate alone suggests | 1 |
| Final answer: Underemployment is when a worker has a job but wants more hours, or is overqualified for their role. Since the unemployment rate only counts people with no job at all, widespread underemployment means the true spare capacity in the labour market is greater than the unemployment rate alone suggests. | |
| Question 5[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the original annual interest payment, 180000 x 0.04 = 7200 pounds | M1 |
| calculating the new annual interest payment, 180000 x 0.0475 = 8550 pounds | M1 |
| an increase of 8550 - 7200 = 1350 pounds per year | A1 |
| Final answer: The household's annual mortgage interest payment rises by 1350 pounds per year. | |
| Question 6[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the change in productive potential, 2472 - 2400 = 72 billion pounds | M1 |
| dividing by the original value and multiplying by 100 | M1 |
| a growth rate of 3% | A1 |
| Final answer: Productive potential grew by 3%. | |
| Question 7[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying a valid factor, e.g. an increase in the number of nursing training places or degree apprenticeships | 1 |
| explaining how this factor increases labour supply, e.g. more qualified entrants become available to join the profession | 1 |
| identifying a second valid factor, e.g. improved non-monetary benefits such as flexible shift patterns, pension terms, or the social status of nursing | 1 |
| explaining how this factor increases labour supply, e.g. non-wage benefits make the profession more attractive relative to alternative careers, drawing in more workers | 1 |
| Final answer: Supply could rise due to more nursing training places and improved non-wage benefits or working conditions making the profession more attractive. | |
| Question 8[4 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a free trade area is a group of countries that remove tariffs and other trade barriers between themselves | 1 |
| explaining that each member of a free trade area can still set its own independent tariffs on imports from countries outside the area | 1 |
| explaining that a customs union goes further than a free trade area by also requiring all members to apply a common external tariff on imports from non-member countries | 1 |
| a valid example or consequence, e.g. this means a customs union member cannot independently negotiate its own separate trade deal with a country outside the union, unlike a free trade area member | 1 |
| Final answer: A free trade area removes barriers between members but lets each set its own tariffs on non-members; a customs union goes further by requiring a common external tariff, meaning members cannot independently negotiate their own trade deals with non-members. | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that lower consumer confidence can directly reduce planned consumption, as households become more cautious and save more out of current income | 1 |
| explaining this shifts the consumption component of AD down even without a change in income, a shift in the consumption function rather than a movement along it | 1 |
| identifying that lower confidence can reduce demand for durable, credit-financed goods such as cars or furniture, which are more sensitive to expectations about the future | 1 |
| explaining that households delay or cancel major purchases when uncertain about future income or job security, reducing AD further | 1 |
| a developed point, e.g. falling confidence can also depress business investment via lower expected future sales, compounding the fall in AD through a second component | 1 |
| Final answer: Lower consumer confidence directly reduces planned consumption as households save more out of caution, and reduces spending on durable, credit-financed goods most sensitive to expectations, both of which lower AD even before any fall in income. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that market exchange rates are determined mainly by international trade and financial flows, and can diverge substantially from the relative cost of buying goods and services within each country | 1 |
| explaining that PPP exchange rates instead adjust for differences in the price of a similar basket of goods and services in each country | 1 |
| identifying that if the cost of living, especially for non-traded goods, is much lower in Country B, its GDP measured at market exchange rates will understate how much its citizens can actually buy with their income | 1 |
| explaining that converting using PPP would raise Country B's GDP per capita relative to Country A's, better reflecting the real quantity of goods and services its citizens can afford | 1 |
| a developed point, e.g. this matters most when comparing countries at very different levels of development, where the gap between market and PPP exchange rates tends to be largest | 1 |
| Final answer: Market exchange rates reflect trade and financial flows and can diverge from the true cost of living in each country; PPP exchange rates instead adjust for the actual price of a similar basket of goods, so using PPP would raise Country B's GDP per capita relative to Country A's, better reflecting what its citizens can really afford to buy. | |
| Question 11[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that trade creation occurs when joining a trading bloc causes a country to switch from a less efficient domestic producer to a more efficient producer inside the bloc, raising welfare | 1 |
| explaining that trade diversion occurs when a country instead switches from a more efficient producer outside the bloc to a less efficient producer inside it, simply because the external tariff no longer applies to trade within the bloc | 1 |
| identifying that switching from the original, efficient, external producer to a less efficient producer inside the union, as described here, is an example of trade diversion | 1 |
| explaining that resources are now being used less efficiently overall, even though the country itself avoids paying the tariff, since a genuinely more efficient supplier has been replaced by a less efficient one | 1 |
| concluding that this trade diversion is likely to reduce the country's, and the world's, overall economic welfare compared with trading freely with the original efficient supplier | 1 |
| Final answer: This is an example of trade diversion, since the country switches from a more efficient external producer to a less efficient one inside the union purely because of the tariff; this generally lowers overall economic welfare compared with trading freely with the original, more efficient, supplier, even though the country itself avoids the tariff. | |
| Question 12[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying a limitation, e.g. GDP does not directly measure income distribution, so growth could accompany rising inequality with many people no better off | 1 |
| explaining the consequence, e.g. average GDP per capita could rise while median living standards stagnate if gains are concentrated among a few | 1 |
| identifying a second limitation, e.g. GDP excludes non-market activity such as unpaid housework or caring, and does not subtract negative externalities such as pollution | 1 |
| explaining the consequence, e.g. GDP growth could overstate genuine wellbeing if it comes with worse environmental quality or a decline in valuable unmeasured activity | 1 |
| a further valid point, e.g. GDP does not capture leisure time, so growth achieved through very long working hours may not represent a genuine improvement in wellbeing | 1 |
| Final answer: Real GDP growth does not show how gains are distributed, so it can rise alongside worsening inequality, and it excludes non-market activity, environmental damage and leisure time, all of which affect true economic wellbeing. | |
| Question 13[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying a drawback relating to cost, e.g. interventionist policies are often expensive and must be financed by higher taxation or borrowing | 1 |
| explaining a consequence of this, e.g. higher borrowing may increase national debt, or higher taxation could reduce incentives elsewhere in the economy, partly offsetting the supply-side benefit | 1 |
| identifying a second drawback relating to time, e.g. many interventionist policies, such as building infrastructure or educating a workforce, take a long time to feed through into higher productive capacity | 1 |
| explaining a consequence of this, e.g. the policy will not address a current, short-term problem such as a demand-side downturn, and the long time lag makes its effects hard to evaluate | 1 |
| a further valid point, e.g. government may lack the information to identify which projects will most effectively raise productive capacity, risking inefficient spending | 1 |
| Final answer: Interventionist supply-side policies can be costly (requiring higher tax or borrowing) and slow to take effect, so they may not solve short-term problems and could involve inefficient spending. | |
| Question 14[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a rise in the Gini coefficient from 0.32 to 0.38 indicates that income inequality has increased over the ten years | 1 |
| explaining that this is because the Gini coefficient moves closer to 1, perfect inequality, as inequality rises | 1 |
| describing, in words, that the country's Lorenz curve has moved further away from the 45-degree line of perfect equality, bowing out further from it than it did ten years ago | 1 |
| explaining that this bowing out reflects a larger share of total income being held by higher earners relative to the cumulative share of the population | 1 |
| calculating the percentage change in the Gini coefficient, (0.38 - 0.32) / 0.32 x 100 | M1 |
| a percentage increase of approximately 18.8% | A1 |
| Final answer: Income inequality has increased over the ten years, since the Gini coefficient has moved closer to 1; the Lorenz curve has bowed further away from the line of perfect equality, reflecting a larger income share going to higher earners. The Gini coefficient rose by about 18.8%. | |
| Question 15[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that this is a form of cost-push, supply-side inflation, driven by rising input or energy costs rather than excess demand | 1 |
| explaining that raising interest rates to control this inflation would further reduce an already weak level of growth and aggregate demand, risking recession | 1 |
| explaining that interest rates have limited power to directly reduce global energy prices, since the cause lies outside the domestic economy | 1 |
| analysing that this creates a policy conflict between the inflation target and other objectives such as growth and employment | 1 |
| a developed evaluative point on fiscal policy, e.g. targeted measures such as energy subsidies or a windfall tax could support demand and cushion households without raising interest rates economy-wide | 1 |
| a reasoned overall judgement, e.g. fiscal policy may be better suited to a targeted, cost-push shock, while monetary policy retains a role only if the inflation risks becoming embedded via wage-price spirals | 1 |
| Final answer: Because the inflation is cost-push and externally driven, raising interest rates further weakens growth without addressing the root cause; targeted fiscal measures are likely better suited to this specific shock, though monetary policy would still need to act if inflation became embedded. | |
| Question 16[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that a fall in AD when close to full employment moves the economy leftward and downward along both AD and a near-vertical Keynesian LRAS | 1 |
| explaining that in the short run this is likely to cause both the price level to fall (or inflation to slow) and real output and employment to fall, since prices and wages are not fully flexible downward | 1 |
| identifying that the Keynesian LRAS curve becomes more elastic (flatter) at output levels below full employment | 1 |
| explaining that this means output could remain persistently below its previous level, a negative output gap, rather than quickly self-correcting | 1 |
| an evaluative point, e.g. the size and persistence of the fall depends on the strength of automatic stabilisers or any discretionary policy response | 1 |
| a reasoned overall judgement, e.g. without policy intervention a Keynesian view suggests the economy could remain stuck below full employment for a sustained period, unlike a classical view expecting a faster self-correction | 1 |
| Final answer: A sharp AD fall from near full employment lowers both the price level and real output or employment in the short run; on a Keynesian view, LRAS becomes flatter below full employment, so output could remain persistently below its previous level without active demand-management policy, unlike the faster self-correction a classical view would predict. | |
| Question 17[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that raising income tax reduces households' disposable income across a broad base, directly reducing consumption | 1 |
| explaining that this has a contractionary multiplier effect, especially if higher earners with a lower marginal propensity to consume are affected less than intended | 1 |
| identifying that cutting welfare benefits particularly reduces the income of lower-income households | 1 |
| explaining that because lower-income households typically have a higher marginal propensity to consume, an equivalent-sized benefits cut could have a LARGER negative multiplier effect on AD than a similarly-sized tax rise on higher earners | 1 |
| an evaluative point, e.g. the overall growth impact depends on exactly who is affected by each policy and by how much, not simply which policy is used | 1 |
| a reasoned overall judgement, e.g. a broadly-based income tax rise on higher earners may have a smaller negative short-run growth effect than an equivalent cut to benefits concentrated on low-income, high-MPC households | 1 |
| Final answer: Because lower-income benefit recipients tend to have a higher marginal propensity to consume than income tax payers, an equivalent-sized cut to benefits is likely to reduce AD and growth by more in the short run than a similarly-sized rise in income tax, though the precise impact depends on exactly who is affected by each measure. | |
| Question 18[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the change in the productivity index, 102.5 - 100 = 2.5 | M1 |
| a percentage growth in labour productivity of 2.5% over the four years from 2021 to 2025 | A1 |
| identifying that this represents a very low average annual rate of productivity growth, well under 1% per year | 1 |
| explaining that low productivity growth limits the rate at which real wages can rise sustainably without generating inflation | 1 |
| explaining that it also limits the growth of the economy's long-run trend or potential output, constraining how fast the economy can grow without triggering inflationary pressure | 1 |
| a further consequence, e.g. weak productivity growth makes it harder to fund rising public spending demands, such as an ageing population's healthcare needs, without raising taxes or borrowing, or it can weaken UK international competitiveness | 1 |
| Final answer: Labour productivity grew by only about 2.5% over the four years; such weak growth limits sustainable real wage rises, constrains the economy's trend growth rate, and makes funding rising public spending harder without more tax or borrowing. | |