AS Paper 5: Intervention, Performance and Growth
Covers Demand, Supply and Price Determination, Market Failure and Externalities, Government Intervention in Markets, Measuring Economic Performance, Aggregate Demand and Aggregate Supply, Fiscal and Monetary Policy and Supply-Side Policy and Economic Growth.
Questions
Question 1 [2 marks]
Fiscal and Monetary Policy
Define "fiscal drag", and explain how a government could raise more income tax revenue without officially raising any income tax rate.
Question 2 [3 marks]
Aggregate Demand and Aggregate Supply
Define "short-run aggregate supply" (SRAS), state one factor that could cause it to shift left, and explain why.
Question 3 [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 4 [3 marks]
Fiscal and Monetary Policy
Define "contractionary monetary policy", give one example of a specific tool a central bank could use to implement it, and explain its intended effect.
Question 5 [3 marks]
Government Intervention in Markets
The government places an ad valorem (percentage) tax of 20% on a good with a pre-tax price of 40 pounds. After the tax, quantity sold falls to 1800 units per week.
Calculate the amount of tax revenue the government raises per week.
Question 6 [3 marks]
Demand, Supply and Price Determination
In the market for takeaway pizzas in a town, the demand function is Qd = 600 - 40P and the supply function is Qs = 100 + 60P, where P is the price in pounds and Q is the number of pizzas sold per week.
Calculate the equilibrium price and quantity, and calculate total consumer expenditure on pizzas per week at this equilibrium.
Question 7 [4 marks]
Government Intervention in Markets
A city council imposes a maximum rent of 800 pounds per month on privately rented one-bedroom flats, below the free-market equilibrium rent of 1100 pounds per month.
Using a diagram in words, explain the effect of this maximum rent on the quantity of flats supplied and demanded, and identify the resulting problem in the market.
Question 8 [4 marks]
Demand, Supply and Price Determination
The price of games consoles falls sharply. Games consoles and video games are complements.
Explain, using economic analysis, the likely effect of this fall in price on the equilibrium price and quantity in the market for video games.
Question 9 [5 marks]
Market Failure and Externalities
Vaccinations against a contagious illness generate a positive externality of consumption.
Analyse, with reference to free riders, why a purely free market is likely to under-provide vaccinations relative to the social optimum.
Question 10 [5 marks]
Measuring Economic Performance
The claimant count and the Labour Force Survey (LFS) are the two main measures of UK unemployment.
Explain two reasons why these two measures might give different unemployment figures at the same point in time.
Question 11 [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 12 [5 marks]
Government Intervention in Markets
Explain, using the concept of price elasticity of supply, why the burden of an indirect tax on a good with highly elastic supply falls mostly on consumers rather than producers.
Question 13 [5 marks]
Aggregate Demand and Aggregate Supply
A country experiences a rapid rise in labour productivity due to widespread adoption of new automation technology across many industries.
Explain, using the concept of the long-run aggregate supply (LRAS) curve, the likely effect of this productivity rise on the economy's potential output and price level in the long run.
Question 14 [6 marks]
Government Intervention in Markets
The UK government is considering replacing a system of tradable pollution permits with a fixed per-unit carbon tax for heavy industry.
Analyse the relative merits of a system of tradable permits compared with a carbon tax as methods of reducing carbon emissions.
Question 15 [6 marks]
Aggregate Demand and Aggregate Supply
A country's currency depreciates by 10%, making its exports more price competitive abroad and imports more expensive at home. As a result, exports rise from 280 billion pounds to 310 billion pounds, and imports fall from 260 billion pounds to 245 billion pounds, with other AD components unchanged. The economy's multiplier is 1.5.
Calculate the change in net exports caused by the depreciation, and calculate the resulting total change in aggregate demand once the multiplier effect is included.
Question 16 [6 marks]
Demand, Supply and Price Determination
The rise of video streaming services, a substitute for physical DVDs, has been accompanied by sharply falling streaming subscription prices due to increased competition between providers.
Analyse the likely effect on the equilibrium price and quantity in the market for physical DVDs, and evaluate whether firms selling DVDs are likely to remain profitable in the long run.
Question 17 [6 marks]
Aggregate Demand and Aggregate Supply
An economy has a marginal propensity to consume of 0.6 and no other withdrawals. The government increases government spending by 25 billion pounds.
Calculate the value of the multiplier and the resulting total change in aggregate demand, and analyse one factor that could make the actual increase in AD smaller than this calculated figure.
Question 18 [6 marks]
Market Failure and Externalities
Long-term health research into the effects of vaping is still limited, and many consumers may not fully understand the potential risks when they decide to vape.
Evaluate the extent to which this imperfect information is likely to cause the free market to allocate resources inefficiently in the market for vaping products.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of fiscal drag as a rise in the effective tax burden that occurs when tax thresholds are not raised in line with rising wages or prices | 1 |
| explaining that as nominal wages rise over time while tax thresholds are frozen or rise more slowly, more income is pulled into higher tax bands, or more people begin paying tax at all, raising tax revenue without any explicit rate rise | 1 |
| Final answer: Fiscal drag is a rise in the effective tax burden caused by freezing tax thresholds while wages rise; as more income moves into higher tax bands, the government collects more revenue without raising any tax rate. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of SRAS as the total output producers are willing and able to supply at a given price level in the short run, when at least one factor of production is fixed | 1 |
| a valid factor causing a leftward shift, e.g. a rise in the cost of raw materials, energy or wages | 1 |
| explaining that higher production costs reduce firms' profitability at each price level, so they supply less at every price, shifting SRAS left | 1 |
| Final answer: SRAS is the total output firms are willing to supply at each price level in the short run; a rise in costs such as energy or wages raises production costs and shifts SRAS to the left. | |
| Question 3[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 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of contractionary monetary policy as policy aimed at reducing aggregate demand, typically by raising interest rates or reducing the money supply | 1 |
| a valid example, e.g. raising the base or policy interest rate, or selling government bonds | 1 |
| explaining that this raises the cost of borrowing, discouraging consumption and investment and reducing aggregate demand | 1 |
| Final answer: Contractionary monetary policy reduces AD, typically via a central bank raising the base interest rate, which raises borrowing costs and discourages consumption and investment. | |
| Question 5[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the tax per unit as 20% of the original price, 0.20 x 40 = 8 pounds | M1 |
| identifying that tax revenue equals tax per unit multiplied by the new quantity sold | M1 |
| tax revenue = 8 x 1800 = 14400 pounds | A1 |
| Final answer: Tax revenue = 14400 pounds per week. | |
| Question 6[3 marks] | |
|---|---|
| Answer or working | Marks |
| setting Qd equal to Qs, 600 - 40P = 100 + 60P | M1 |
| solving to find P = 5 and Q = 400 | A1 |
| calculating total expenditure as price x quantity = 5 x 400 = 2000 pounds per week | A1 |
| Final answer: Equilibrium price = 5 pounds, equilibrium quantity = 400 pizzas per week, total consumer expenditure = 2000 pounds per week. | |
| Question 7[4 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that at a rent of 800 pounds, below the equilibrium of 1100 pounds, quantity demanded for flats rises above the free-market equilibrium quantity | 1 |
| explaining that quantity supplied of flats falls below the free-market equilibrium quantity, since landlords receive a lower rent than before | 1 |
| identifying that quantity demanded now exceeds quantity supplied at the maximum rent, creating a shortage of rental flats | 1 |
| a developed point, e.g. this shortage might lead to non-price rationing methods, such as long waiting lists or landlords being more selective about tenants | 1 |
| Final answer: At 800 pounds, below the 1100 pound equilibrium, quantity demanded rises and quantity supplied falls, creating a shortage of flats; landlords may then ration flats by other means, such as waiting lists or tenant selection, rather than by price. | |
| Question 8[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that games consoles and video games are complements | 1 |
| explaining that a fall in the price of consoles increases demand for consoles and therefore increases demand for video games | 1 |
| explaining that the demand curve for video games shifts rightward | 1 |
| concluding that both the equilibrium price and equilibrium quantity of video games rise | 1 |
| Final answer: The demand for video games shifts right because consoles and games are complements, so both equilibrium price and quantity of video games rise. | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that vaccination benefits both the individual and others by reducing disease transmission (a positive externality) | 1 |
| explaining that individuals base their decision on private marginal benefit only, ignoring the external benefit to others | 1 |
| explaining that this means social marginal benefit exceeds private marginal benefit | 1 |
| identifying the free-rider problem, that some individuals may rely on others being vaccinated (herd immunity) without paying the cost themselves | 1 |
| concluding that market output of vaccinations is below the socially optimal level | 1 |
| Final answer: Because private marginal benefit is below social marginal benefit and free riders exist, the free market under-provides vaccination relative to the social optimum. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the claimant count only measures those actually claiming unemployment-related benefits | 1 |
| explaining this excludes people who are unemployed but not eligible for or not claiming benefits, e.g. some school leavers or those with a working partner, causing the claimant count to understate unemployment | 1 |
| identifying that the LFS is based on a survey using the internationally agreed ILO definition, counting anyone actively seeking and available for work in the reference period | 1 |
| explaining that the LFS can include people not claiming any benefit, so it can differ from the claimant count depending on benefit eligibility rules | 1 |
| a further valid distinction, such as timing or publication differences, since the claimant count is administrative monthly data while the LFS is based on a rolling three-month survey | 1 |
| Final answer: The claimant count only captures benefit claimants while the LFS uses a survey-based ILO definition including non-claimants, so the two rarely give identical figures. | |
| Question 11[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 12[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that elastic supply means producers can easily reduce the quantity they supply in response to a fall in the price they receive | 1 |
| explaining that if producers reduce quantity supplied in response to the tax, this creates a shortage at the original price, pushing the market price up | 1 |
| explaining that producers therefore pass most of the tax on to consumers via a higher price, being unwilling to absorb it themselves | 1 |
| explaining that if supply were inelastic instead, producers would find it harder to reduce quantity, so a larger share of the burden would fall on them | 1 |
| a concluding point that the more elastic supply is relative to demand, the greater the share of the tax passed on to consumers | 1 |
| Final answer: Elastic supply lets producers easily redirect resources away from a taxed good, so the price rises and most of the tax is passed on to consumers; the more elastic supply is relative to demand, the larger the consumer's share of the burden. | |
| Question 13[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a rise in labour productivity raises the amount of output the economy can produce using its existing quantity of labour and capital | 1 |
| explaining that this represents an increase in the economy's productive potential, shown as a rightward shift of the LRAS curve | 1 |
| explaining that, other things being equal, this allows the economy to produce more real output without generating extra inflationary pressure | 1 |
| identifying that if aggregate demand also grows over time, the economy can sustain a higher level of real output at a similar price level than if productivity had not improved | 1 |
| a developed point, e.g. this is the underlying mechanism behind long-run economic growth, distinguishing it from a short-run, temporary rise in output caused only by a rise in aggregate demand | 1 |
| Final answer: Rising productivity increases the economy's productive potential, shifting the LRAS curve to the right; this lets the economy sustain higher real output without generating extra inflationary pressure, and is the underlying mechanism behind genuine long-run economic growth, rather than a temporary AD-driven rise in output. | |
| Question 14[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that tradable permits set a fixed quantity of allowed pollution (a cap) and let the market determine the price | 1 |
| explaining that a carbon tax fixes the price of polluting and lets the market determine the resulting quantity of emissions | 1 |
| analysing that permits therefore give certainty over the total quantity of emissions, which a tax does not guarantee | 1 |
| analysing that a tax gives firms cost certainty, which may be preferable for business investment planning, compared with a potentially volatile permit price | 1 |
| a further comparative point, e.g. permits can create their own market failure if over-allocated or if a black market emerges, or the two differ in administrative and monitoring costs | 1 |
| a reasoned overall judgement, e.g. permits are preferable where an absolute emissions target must be met, while a tax may suit administrative simplicity and revenue certainty | 1 |
| Final answer: Permits guarantee the quantity of emissions reduced but with an uncertain price; a tax gives price and cost certainty but an uncertain quantity outcome, so the better choice depends on the government's priority. | |
| Question 15[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the change in exports, 310 - 280 = 30 billion pounds | M1 |
| calculating the change in imports, 245 - 260 = -15 billion pounds | M1 |
| explaining that a fall in imports itself raises net exports, since less spending leaks abroad | 1 |
| the total change in net exports of 30 - (-15) = 45 billion pounds | A1 |
| multiplying by the multiplier, 45 x 1.5 | M1 |
| a total change in aggregate demand of 67.5 billion pounds once the multiplier effect is included | A1 |
| Final answer: Net exports rise by 45 billion pounds, a 30 billion pound rise in exports plus a 15 billion pound fall in imports; once the multiplier of 1.5 is applied, the total increase in aggregate demand is 67.5 billion pounds. | |
| Question 16[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that streaming and DVDs are substitutes | 1 |
| explaining that a fall in the price of streaming raises demand for streaming and reduces demand for DVDs, shifting the DVD demand curve left | 1 |
| explaining that this lowers both the equilibrium price and equilibrium quantity of DVDs | 1 |
| identifying that if revenue falls below total costs (including normal profit), firms may exit the market in the long run | 1 |
| a valid evaluative point, e.g. firms could differentiate through collectors' editions or special packaging to sustain a smaller niche market rather than exiting entirely | 1 |
| a reasoned overall judgement, e.g. the mainstream DVD market is likely to shrink substantially in the long run, though a smaller niche market may survive | 1 |
| Final answer: As streaming becomes cheaper it draws demand away from DVDs, so DVD price and quantity both fall; in the long run many DVD sellers are unlikely to remain profitable and may exit or move to a smaller niche market such as collectors' editions. | |
| Question 17[6 marks] | |
|---|---|
| Answer or working | Marks |
| using the multiplier formula, k = 1 / (1 - MPC) | M1 |
| k = 1 / (1 - 0.6) = 2.5 | A1 |
| change in AD = 25 x 2.5 | M1 |
| change in AD = 62.5 billion pounds | A1 |
| identifying a factor, e.g. if part of the extra income leaks abroad through spending on imports, a withdrawal not accounted for in this simple multiplier, the true increase in AD would be smaller | 1 |
| a further developed point, e.g. or if higher government spending raises interest rates and crowds out private investment, the net effect on AD could be smaller than the simple multiplier suggests | 1 |
| Final answer: Multiplier = 2.5, so AD rises by 25 x 2.5 = 62.5 billion pounds in this simple model; the actual rise is likely to be smaller if some of the extra spending leaks abroad via imports, or if the higher government spending crowds out private investment through rising interest rates. | |
| Question 18[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that if consumers underestimate the true costs of vaping, their perceived marginal private benefit will exceed the true marginal social benefit | 1 |
| explaining that this causes consumers to demand and consume more vaping products than they would if they had full information, resulting in market failure through over-consumption | 1 |
| identifying that this represents a form of information failure, since decisions are being made on the basis of imperfect or incomplete knowledge | 1 |
| an evaluative point on the scale of the problem, e.g. the extent of over-consumption depends on how large the true long-term health costs eventually turn out to be, which is not yet fully known | 1 |
| a further evaluative point, e.g. some consumers may vape for reasons other than misjudging the risk, such as it being a substitute for smoking, or peer and social influence, so imperfect information may not be the only cause of current consumption levels | 1 |
| a reasoned overall judgement, e.g. imperfect information is likely to cause some degree of market failure through over-consumption, but the size of this failure is genuinely uncertain until more conclusive long-term evidence on health effects becomes available | 1 |
| Final answer: If consumers underestimate vaping's true long-term health costs, their private benefit will exceed the social benefit, causing over-consumption and market failure through information failure; however, the scale of this failure is hard to judge because long-term health evidence is still limited and other factors, such as vaping as a substitute for smoking, also affect demand. | |