AS Paper 6: Full AS Review
Covers Demand, Supply and Price Determination, Elasticity of Demand and Supply, 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 [3 marks]
Demand, Supply and Price Determination
Define an "extension of supply" and explain how it differs from a rightward shift of the supply curve, using an example of each.
Question 2 [3 marks]
Aggregate Demand and Aggregate Supply
In an economy, the marginal propensity to save is 0.1, the marginal propensity to tax is 0.2 and the marginal propensity to import is 0.2.
Calculate the value of the multiplier for this economy.
Question 3 [3 marks]
Elasticity of Demand and Supply
Explain why the cross price elasticity of demand between two rival brands of margarine is likely to be much larger in magnitude than the cross price elasticity of demand between margarine and bread, even though both pairs are, in some sense, related goods.
Question 4 [3 marks]
Government Intervention in Markets
The government places a specific tax of 3 pounds per unit on a good. Before the tax, the equilibrium price was 10 pounds. After the tax, the price paid by consumers rises to 12 pounds.
Calculate the amount of the tax paid by producers per unit, and the amount paid by consumers per unit.
Question 5 [3 marks]
Elasticity of Demand and Supply
When the price of a rail season ticket rises from 20 pounds to 22 pounds, the quantity demanded falls from 500 to 460 tickets per week.
Calculate the price elasticity of demand.
Question 6 [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 7 [3 marks]
Market Failure and Externalities
Define "demerit good", give one example, and explain why a free market is likely to over-consume it relative to the socially efficient level.
Question 8 [4 marks]
Supply-Side Policy and Economic Growth
Explain how privatising a state-owned steel manufacturer could act as a market-based supply-side policy to raise the economy's long-run aggregate supply.
Question 9 [4 marks]
Elasticity of Demand and Supply
A firm sells a good with a PED of -2.5 at a price of 15 pounds. The firm is considering a 4 percent price cut.
Calculate the expected percentage change in quantity demanded, and state what will happen to the firm's total revenue as a result.
Question 10 [5 marks]
Supply-Side Policy and Economic Growth
Explain how a reduction in corporation tax could act as a market-based supply-side policy to raise an economy's long-run aggregate supply.
Question 11 [5 marks]
Measuring Economic Performance
A country has a working-age population of 40 million, of whom 26 million are in the labour force. Of those in the labour force, 24.5 million are in employment.
Calculate the labour force as a percentage of the working-age population, and the unemployment rate.
Question 12 [5 marks]
Market Failure and Externalities
In a used car market, good-quality cars are worth 8000 pounds and poor-quality "lemons" are worth 3000 pounds, but buyers cannot tell the two apart before purchase. Buyers are only willing to pay the average value of a car in the market, assuming half of all cars for sale are good quality and half are lemons.
Calculate the price buyers would be willing to pay, and explain why this outcome is likely to lead sellers of good-quality cars to withdraw from the market.
Question 13 [5 marks]
Fiscal and Monetary Policy
The Bank of England raises the UK base interest rate significantly above interest rates in other major economies.
Explain, using the exchange rate transmission mechanism, how this interest rate rise could help to reduce UK inflation.
Question 14 [5 marks]
Supply-Side Policy and Economic Growth
A government is comparing a demand-side policy, a cut in interest rates, with a supply-side policy, a large increase in spending on vocational education and training, as ways to raise the economy's long-run growth rate.
Explain why the supply-side policy is likely to take much longer than the demand-side policy to have its full effect on the economy.
Question 15 [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 16 [5 marks]
Demand, Supply and Price Determination
A widely reported study links avocado consumption to health benefits at the same time as a series of poor harvests in producing countries.
Explain, using economic analysis, the likely effect of these combined events on the equilibrium price and quantity of avocados.
Question 17 [6 marks]
Government Intervention in Markets
A government introduces a generous subsidy for farmers who grow crops used to make biofuel, aiming to reduce reliance on imported fossil fuels. Over the following years, a significant amount of farmland switches from growing food crops to growing biofuel crops, and food prices in the country rise noticeably.
Evaluate the extent to which this outcome represents an example of government failure.
Question 18 [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 19 [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.
Question 20 [6 marks]
Measuring Economic Performance
Average nominal wages in a country rose from 32,000 pounds to 33,600 pounds over a year in which CPI inflation was 6%.
Calculate the approximate percentage growth in real wages over the year, and analyse the likely effect on households' living standards.
Question 21 [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 22 [6 marks]
Elasticity of Demand and Supply
A company sells razor handles, which have a PED of -2.2, alongside replacement blades that are in joint use with the handles and have a PED of -0.3. The company is considering pricing the razor handles very cheaply as a "loss leader" while charging a higher margin on the blades.
Using the concept of price elasticity of demand, evaluate whether this pricing strategy is likely to be effective in maximising the company's overall profit.
Model solutions
| Question 1[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of an extension of supply as a rise in quantity supplied caused by a rise in the price of the good itself, e.g. more wheat supplied as its price rises, shown as a movement along the supply curve | 1 |
| explaining that a rightward shift of the supply curve is a rise in supply at every price, caused by a factor other than the good's own price | 1 |
| a valid example of a shift, e.g. a fall in fertiliser costs allowing farmers to supply more wheat at every price | 1 |
| Final answer: An extension of supply is a movement along the curve caused by a price rise (e.g. more wheat supplied as its price rises); a rightward shift is a rise in supply at every price from another cause, e.g. cheaper fertiliser. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the marginal propensity to withdraw (MPW) as the sum of the marginal propensities to save, tax and import, 0.1 + 0.2 + 0.2 | M1 |
| identifying MPW = 0.5 | M1 |
| a multiplier of 1 / 0.5 = 2 | A1 |
| Final answer: Multiplier = 2. | |
| Question 3[3 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that two rival brands of margarine are very close substitutes for each other | 1 |
| explaining that a small change in the price of one brand causes a large change in quantity demanded of the rival brand, giving a large positive XED | 1 |
| explaining that margarine and bread are only weakly related goods, so a price change in one causes only a small change in demand for the other, giving an XED close to zero | 1 |
| Final answer: Rival margarine brands are very close substitutes, so a price change in one strongly affects demand for the other, giving a large positive XED; margarine and bread are only weakly related, so their XED is close to zero. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the consumer's share of the tax, 12 - 10 = 2 pounds per unit | M1 |
| calculating the producer's share as the remainder of the tax, 3 - 2 = 1 pound per unit | M1 |
| correctly stating consumers pay 2 pounds and producers pay 1 pound per unit | A1 |
| Final answer: Consumers pay 2 pounds per unit; producers pay 1 pound per unit. | |
| Question 5[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the percentage change in quantity demanded, -40 / 500 x 100 = -8% | M1 |
| calculating the percentage change in price, 2 / 20 x 100 = 10% | M1 |
| PED = -0.8 | A1 |
| Question 6[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 7[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of a demerit good as a good that is over-consumed if left to the free market, often because consumers underestimate the harm it does to themselves or to third parties | 1 |
| a valid example, e.g. tobacco or alcohol | 1 |
| explaining that consumers focus on the private benefit they receive, such as enjoyment, while ignoring or underestimating the wider costs, such as harm to their own future health or costs imposed on others, leading to over-consumption | 1 |
| Final answer: A demerit good, such as tobacco, is over-consumed in a free market because consumers focus on their private enjoyment while underestimating harm to themselves or costs imposed on others. | |
| Question 8[4 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that private owners typically face a profit motive that state-owned firms may lack | 1 |
| explaining that this profit motive gives the new private firm a stronger incentive to cut costs and operate more efficiently, e.g. reducing X-inefficiency | 1 |
| explaining that if the industry is also opened up to competition at the same time, this creates further pressure on the firm to innovate and improve productivity | 1 |
| concluding that these efficiency gains can lower costs and raise output at every price level in the industry, contributing to a rightward shift in the economy's long-run aggregate supply | 1 |
| Final answer: Privatisation gives the firm's new private owners a profit motive to cut costs and reduce inefficiency, especially if the industry is also opened to competition, and the resulting efficiency gains can raise output and shift long-run aggregate supply to the right. | |
| Question 9[4 marks] | |
|---|---|
| Answer or working | Marks |
| using %change in Qd = PED x %change in P | M1 |
| substituting -2.5 x -4% | M1 |
| a 10% rise in quantity demanded | A1 |
| correctly stating total revenue will rise, because demand is price elastic | 1 |
| Final answer: Quantity demanded rises by 10%; total revenue increases because demand is elastic. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that lower corporation tax raises firms' after-tax profits | 1 |
| explaining that this increases the funds firms retain that can finance investment in new capital or technology | 1 |
| identifying that lower corporation tax could also make the country more attractive for foreign direct investment | 1 |
| explaining that more investment, domestic or foreign, raises the economy's capital stock and productive capacity over time | 1 |
| a concluding point that this shifts long-run aggregate supply to the right, raising potential output | 1 |
| Final answer: Lower corporation tax raises firms' after-tax profits and makes the country more attractive for investment, both of which can raise investment in capital and technology, increasing the capital stock and shifting LRAS to the right. | |
| Question 11[5 marks] | |
|---|---|
| Answer or working | Marks |
| labour force participation rate = 26 / 40 x 100 | M1 |
| participation rate = 65% | A1 |
| unemployed = 26 - 24.5 = 1.5 million, and unemployment rate = 1.5 / 26 x 100 | M1 |
| unemployment rate = approximately 5.8% | A1 |
| correctly noting the unemployment rate is calculated as a percentage of the labour force, not the whole working-age population | 1 |
| Final answer: Labour force participation rate = 65%; unemployment rate = approximately 5.8% (1.5 million unemployed out of a labour force of 26 million). | |
| Question 12[5 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the average value as (8000 + 3000) / 2 | M1 |
| a price of 5500 pounds | A1 |
| explaining that owners of good-quality cars, worth more than 5500 pounds, are unwilling to sell at this price and will withdraw from the market | 1 |
| explaining that as good-quality cars leave the market, the average quality, and buyers' willingness to pay, falls further | 1 |
| identifying this as an example of adverse selection caused by asymmetric information, which can cause the market to fail by driving out good-quality goods entirely | 1 |
| Final answer: Buyers would be willing to pay 5500 pounds, the average value; since good-quality cars are worth more than this, their owners withdraw from the market, an example of adverse selection that, in the extreme, can drive good-quality cars out of the market entirely. | |
| Question 13[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a higher UK interest rate, relative to other countries, makes holding funds in pounds more attractive to foreign and domestic investors seeking a higher return | 1 |
| explaining that this increases demand for pounds in the foreign exchange market | 1 |
| explaining that this causes the pound to appreciate against other currencies | 1 |
| explaining that an appreciation makes imported goods and raw materials cheaper in pound terms, directly reducing cost-push inflationary pressure | 1 |
| a developed point, e.g. an appreciation also makes UK exports more expensive abroad, reducing net exports and aggregate demand, which further helps to reduce demand-pull inflationary pressure | 1 |
| Final answer: A higher UK interest rate attracts foreign capital seeking a better return, raising demand for pounds and causing the currency to appreciate; this makes imports cheaper, directly easing cost-push inflation, while also making exports more expensive and reducing net exports and aggregate demand, further easing demand-pull inflation. | |
| Question 14[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a cut in interest rates can affect consumption and investment decisions relatively quickly, often within months, as borrowing becomes cheaper | 1 |
| explaining that vocational education and training takes years to complete before newly trained workers enter the workforce with improved skills | 1 |
| explaining that even once trained, it then takes further time for these workers to be matched with, and become fully productive in, suitable jobs | 1 |
| identifying that supply-side policies more broadly often involve long-term structural changes, such as building new infrastructure or changing institutions, which naturally take years rather than months to complete and have effect | 1 |
| a developed point, e.g. this means demand-side policy is often used to manage the economy in the short run, while supply-side policy is aimed at raising the economy's performance gradually over a much longer time horizon | 1 |
| Final answer: An interest rate cut can affect spending decisions within months, but training workers takes years to complete before they enter the workforce with new skills and become fully productive, and supply-side policies often involve long-term structural change; this is why demand-side policy tends to manage the economy in the short run while supply-side policy aims at improvement over a much longer time horizon. | |
| Question 15[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 16[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the health study raises demand for avocados, shifting the demand curve right | 1 |
| identifying that poor harvests reduce supply of avocados, shifting the supply curve left | 1 |
| explaining that both shifts raise the equilibrium price | 1 |
| explaining that the effect on equilibrium quantity is ambiguous, since the demand shift raises quantity while the supply shift lowers it | 1 |
| a developed point that the actual change in quantity depends on the relative size of the two shifts | 1 |
| Final answer: Equilibrium price rises because both effects push price up; the effect on equilibrium quantity is ambiguous, depending on the relative size of the demand and supply shifts. | |
| Question 17[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that the subsidy was intended to achieve a policy goal, reducing reliance on imported fossil fuels, by lowering the cost of producing biofuel crops | 1 |
| identifying that the subsidy created a strong incentive for farmers to switch land from food crops to biofuel crops, an effect the government may not have fully anticipated | 1 |
| explaining that the resulting fall in food crop supply raises food prices, imposing a cost on consumers that was not intended by the original policy | 1 |
| identifying this rise in food prices as an unintended consequence, and therefore a form of government failure, since the intervention creates a new problem while solving the original one | 1 |
| an evaluative point, e.g. whether this counts as an overall failure depends on the relative size of the benefit, reduced fossil fuel reliance, against the cost of higher food prices, which requires further information to judge | 1 |
| a reasoned overall judgement, e.g. the policy shows a genuine risk of government failure through unintended consequences, and could potentially be improved by limiting the subsidy to land unsuitable for food production, rather than concluding the subsidy itself was entirely misguided | 1 |
| Final answer: The subsidy achieved its aim of encouraging biofuel production but had the unintended consequence of diverting land from food crops and raising food prices, a cost the policy did not intend to create; this is a real risk of government failure, though whether it outweighs the benefit of reduced fossil fuel reliance depends on the relative size of each effect, and could potentially be reduced by targeting the subsidy more carefully. | |
| Question 18[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 19[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. | |
| Question 20[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating nominal wage growth = (33,600 - 32,000) / 32,000 x 100 | M1 |
| nominal wage growth = 5% | A1 |
| real wage growth (approximately) = nominal wage growth - inflation rate = 5% - 6% | M1 |
| real wage growth = approximately -1% (a fall in real wages) | A1 |
| explaining that despite nominal wages rising, workers can afford fewer goods and services on average since prices rose faster than wages | 1 |
| a developed point, e.g. this represents a fall in living standards that may be particularly harmful for lower-income households who spend a higher share of income on essentials | 1 |
| Final answer: Nominal wages grew by 5%, but with 6% inflation, real wages fell by approximately 1%, meaning households can afford slightly less despite the pay rise, a fall in living standards that may hit lower-income households hardest. | |
| Question 21[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 22[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that razor handles have elastic demand (PED = -2.2), so a low price on handles should generate a large percentage increase in quantity demanded | 1 |
| identifying that blades have inelastic demand (PED = -0.3), so a higher price on blades causes only a small fall in quantity demanded of blades | 1 |
| explaining that because handles and blades are in joint use (complements), selling more handles cheaply increases the customer base who will need to buy blades repeatedly | 1 |
| explaining that charging a higher price on the inelastically demanded blades allows the company to earn a high revenue and profit margin on repeat blade purchases | 1 |
| an evaluative point, e.g. the strategy's success depends on customers being unable or unwilling to switch to cheaper generic blades from a rival firm, which would undermine the inelastic demand assumption for the company's own blades | 1 |
| a reasoned overall judgement, e.g. the strategy is likely to be profitable only if the company can prevent close substitute blades entering the market, otherwise the elastic demand for handles will not be offset by durable profit on blades | 1 |
| Final answer: Selling handles cheaply exploits their elastic demand to build a large customer base, while inelastic demand for blades lets the company profit from repeat purchases at a higher margin; the strategy works only if rival firms cannot supply cheaper substitute blades, since this would undermine the inelastic pricing power on blades. | |