A Level Economics Paper 2
Covers Demand, Supply and Price Determination, Elasticity of Demand and Supply, Market Failure and Externalities and 9 more.
Questions
Question 1 [2 marks]
Government Intervention in Markets
Define "government failure" and give one example of how a government intervention intended to correct a market failure could make the allocation of resources less efficient.
Question 2 [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 3 [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 4 [3 marks]
Market Structures and Competition
In a market for independent coffee roasters, five firms have market shares of 15%, 12%, 10%, 9% and 8%, with the rest of the market shared among many small firms.
Calculate the three-firm concentration ratio for this market, and state whether this indicates the market is more consistent with monopolistic competition or with oligopoly.
Question 5 [4 marks]
Aggregate Demand and Aggregate Supply
The Bank of England raises interest rates in response to rising inflation.
Explain two ways in which this is likely to affect a component of aggregate demand.
Question 6 [4 marks]
Money, Banking and the Financial Sector
The required reserve ratio in a banking system is 5%.
Calculate the value of the simple money (credit) multiplier, and the maximum total increase in bank deposits that could result from an initial new deposit of 20 million pounds into the banking system.
Question 7 [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 8 [4 marks]
Measuring Economic Performance
The Consumer Prices Index (CPI) for a country was 108.0 in January 2025 and 112.3 in January 2026, using a base year in which the index equals 100.
Calculate the rate of CPI inflation over this period, to one decimal place, and state what this figure represents.
Question 9 [5 marks]
Market Failure and Externalities
A local authority estimates that each new tree planted in a park generates a private benefit to the land owner of 40 pounds and an external benefit to the wider community of 65 pounds from improved air quality and wellbeing.
Calculate the social marginal benefit of planting one tree, and the size of the government subsidy per tree that would be needed to fully correct this positive externality.
Question 10 [5 marks]
Elasticity of Demand and Supply
The average price of large flat-screen televisions falls by 15%, causing the quantity demanded of TV wall-mounting brackets to rise by 6%.
Calculate the cross price elasticity of demand between wall-mounting brackets and televisions, and state whether the two goods are substitutes or complements, and how strong this relationship appears to be.
Question 11 [5 marks]
International Trade and the Balance of Payments
A country's currency depreciates sharply. Even though the Marshall-Lerner condition is expected to hold in the long run, meaning the depreciation should eventually improve the current account balance, many economists predict the current account balance will actually worsen for several months immediately after the depreciation.
Explain, using the concept of the J-curve effect, why the current account balance might worsen in the short run before improving.
Question 12 [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 13 [6 marks]
Measuring Economic Performance
The table below shows data for an economy in two consecutive years.
Year 1: real GDP growth 3.2%, CPI inflation 1.8%, unemployment rate 6.5%
Year 2: real GDP growth 1.0%, CPI inflation 4.9%, unemployment rate 4.1%
Calculate the change in the unemployment rate between the two years, and evaluate the extent to which this data is consistent with a short-run trade-off between inflation and unemployment, as described by the Phillips curve.
Question 14 [6 marks]
Supply-Side Policy and Economic Growth
A government pursues an aggressive supply-side strategy of deregulating planning laws to allow rapid construction of new factories, warehouses and roads, significantly raising the economy's measured rate of growth in potential output over several years.
Evaluate the extent to which a rapid rise in measured potential output, achieved in this way, necessarily represents an improvement in the population's overall wellbeing.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of government failure as a situation where government intervention leads to a net welfare loss, or a less efficient allocation of resources than before the intervention | 1 |
| a valid example, e.g. a subsidy intended to support struggling farmers instead being used to expand production of a crop already in surplus, wasting government resources | 1 |
| Final answer: Government failure occurs when an intervention makes resource allocation less efficient than before, e.g. a farm subsidy intended to help struggling farmers instead expanding output of an already oversupplied crop. | |
| Question 2[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 3[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 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| summing the three largest market shares, 15 + 12 + 10 | M1 |
| a three-firm concentration ratio of 37% | A1 |
| correctly identifying this as more consistent with monopolistic competition, since no small group of firms dominates the market | 1 |
| Final answer: Three-firm concentration ratio = 37%, more consistent with monopolistic competition than with oligopoly. | |
| Question 5[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying an effect on consumption, e.g. higher interest rates raise the cost of borrowing and mortgage repayments | 1 |
| explaining this reduces disposable income and discourages borrowing for spending, reducing consumption | 1 |
| identifying an effect on investment, e.g. higher interest rates raise the cost of borrowing for firms | 1 |
| explaining that this reduces the expected return on marginal investment projects, so firms invest less, reducing investment | 1 |
| Final answer: Higher interest rates raise borrowing costs, reducing both consumption (via mortgage and loan repayments) and investment (via the cost of business borrowing). | |
| Question 6[4 marks] | |
|---|---|
| Answer or working | Marks |
| using the money multiplier formula, 1 / reserve ratio | M1 |
| calculating the multiplier, 1 / 0.05 = 20 | M1 |
| the maximum total increase in deposits, 20 x 20 = 400 million pounds | A1 |
| correctly noting this is a theoretical maximum, assuming all banks are fully loaned up and no cash is withdrawn from the system | 1 |
| Final answer: Money multiplier = 20; maximum total increase in deposits = 400 million pounds (a theoretical maximum). | |
| Question 7[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 8[4 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the change in the index, 112.3 - 108.0 = 4.3 | M1 |
| dividing by the starting index and multiplying by 100 | M1 |
| a CPI inflation rate of approximately 4.0% | A1 |
| correctly stating this represents the percentage increase in the general price level of a representative basket of goods and services over the year | 1 |
| Final answer: CPI inflation is approximately 4.0%, the percentage rise in the general price level over the year. | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying social marginal benefit = private marginal benefit + external marginal benefit | M1 |
| social marginal benefit = 40 + 65 = 105 pounds | A1 |
| identifying the subsidy should match the size of the external benefit to align private and social incentives | M1 |
| a subsidy of 65 pounds per tree | A1 |
| explaining that this subsidy raises the private incentive to plant trees toward the socially optimal quantity | 1 |
| Final answer: Social marginal benefit = 105 pounds per tree; a subsidy of 65 pounds per tree (matching the external benefit) would align private incentives with the social optimum. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| using XED = % change in quantity demanded of brackets / % change in price of televisions | M1 |
| substituting 6 / -15 | M1 |
| XED = -0.4 (negative) | A1 |
| correctly stating a negative value means wall-mounting brackets and televisions are complements | 1 |
| correctly stating that, since the magnitude (0.4) is below 1, this is a moderately weak complementary relationship | 1 |
| Final answer: XED = -0.4 (negative), so brackets and televisions are complements, though the magnitude indicates a moderately weak complementary relationship. | |
| Question 11[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that in the short run, the volume of exports and imports is relatively unresponsive to the change in relative prices caused by the depreciation, since existing contracts and habits take time to change | 1 |
| explaining that immediately after the depreciation, the same physical volume of imports now costs more in domestic currency, since each unit of foreign currency needed to pay for them is more expensive | 1 |
| explaining that because import volumes have not yet fallen much, and export volumes have not yet risen much, the immediate effect is a rise in the domestic currency cost of imports, worsening the current account balance | 1 |
| explaining that over time, as consumers and firms respond to the new relative prices, export volumes rise and import volumes fall by more, eventually improving the current account balance, consistent with the Marshall-Lerner condition | 1 |
| identifying that plotting the current account balance over time in this situation traces out a shape resembling the letter J, giving the effect its name | 1 |
| Final answer: In the short run, trade volumes are slow to adjust, so the depreciation mainly raises the domestic currency cost of imports before their volume falls much, worsening the current account; over time, as export and import volumes adjust more fully to the new relative prices, the balance improves, consistent with the Marshall-Lerner condition, tracing a J-shaped path over time. | |
| Question 12[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 13[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the change in the unemployment rate as 4.1 - 6.5 | M1 |
| a fall of 2.4 percentage points between Year 1 and Year 2 | A1 |
| explaining that the Phillips curve suggests a short-run trade-off in which lower unemployment is associated with higher inflation, and this data shows exactly that pattern, with unemployment falling and inflation rising sharply between the two years | 1 |
| explaining a possible mechanism, e.g. lower unemployment reflects a tighter labour market that could be pushing up wage growth and costs, feeding through into higher consumer price inflation | 1 |
| an evaluative point, e.g. the sharp slowdown in real GDP growth alongside rising inflation is not fully explained by a simple demand-side Phillips curve trade-off, and could instead suggest a negative supply-side shock, such as a rise in import or energy costs, pushing inflation up while also slowing growth | 1 |
| a reasoned overall judgement, e.g. the fall in unemployment alongside rising inflation is broadly consistent with a short-run Phillips curve trade-off, but the accompanying slowdown in growth suggests supply-side cost pressures may also be playing an important role, rather than the pattern being explained by demand alone | 1 |
| Final answer: Unemployment fell by 2.4 percentage points between the two years, while inflation rose sharply, broadly consistent with a short-run Phillips curve trade-off between lower unemployment and higher inflation; however, the sharp slowdown in growth alongside rising inflation suggests a negative supply-side shock, such as higher import or energy costs, may also be contributing, rather than the pattern being purely a demand-side trade-off. | |
| Question 14[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a rise in potential output measures the economy's capacity to produce more goods and services, which is conventionally associated with higher living standards | 1 |
| identifying that rapid construction of factories, warehouses and roads is likely to increase negative externalities, such as pollution, congestion and loss of natural habitats, that are not captured in the potential output figure | 1 |
| explaining that these environmental costs reduce actual wellbeing in ways that a headline growth figure does not reflect | 1 |
| identifying a further consideration, e.g. whether the benefits of this growth, such as new jobs and incomes, are widely shared across the population or concentrated among a small group | 1 |
| an evaluative point, e.g. growth achieved with careful regard for its environmental and distributional impact is more likely to represent a genuine improvement in wellbeing than growth alone | 1 |
| a reasoned overall judgement, e.g. a rapid rise in measured potential output is not, on its own, sufficient evidence of improved wellbeing, and the value of the extra output needs to be weighed against any environmental and social costs the strategy creates | 1 |
| Final answer: A rise in potential output raises the economy's productive capacity, conventionally linked to higher living standards, but rapid construction is also likely to increase pollution, congestion and habitat loss, costs not captured in the output figure, and the benefits may not be evenly shared; so a rapid rise in measured potential output does not, on its own, prove that overall wellbeing has genuinely improved. | |