Advanced Higher Economics Prelim Practice

2024 S1 Q1b Describe the following term: Productivity (2)

• productivity is the ratio of output to inputs used in production

(1)

• it is usually measured as output per worker/per hours worked (1)

• productivity is concerned with the efficiency of production (1)

Describe the following term: Low Wage Growth (2)

2024 S3 Q9c Explain possible advantages and disadvantages of low rates of unemployment for the UK economy. (7)

Advantages:

• improves the public finances as the government pays lower

benefits/receives higher tax revenue (1)

• greater consumer spending as individuals in employment earn higher incomes (1)

• higher rates of economic growth/GDP due to higher output (1)

• higher living standards due to higher incomes (1)

• may result in lower rates of poverty and therefore lower socio-economic deprivation in society (1)

Disadvantages:

• labour shortages will put upward pressure on wages (1). During periods of low unemployment firms can struggle to fill vacancies in unpopular jobs (1)

• higher inflation may be caused by rising wages (1)

• may lead to firms facing higher training costs because they need to employ workers who have been unemployed long-term or don't have skill sets required (1)

• the labour market could reach a point where each additional job added does not create enough productivity to cover its wage cost, making every successive job after that point inefficient (1)

2022 S2 Q7c Explain, using a diagram, why the negative externalities caused by the excessive consumption of alcohol are an example of market failure. (7)

Diagram

• fully labelled diagram (price, quantity, MSB, MPB, MPC=MSC, P,

Q, P1, Q1) (1)

• MPB curve above MSB curve (1)

• showing quantity and price for both initial market equilibrium

and socially optimal equilibrium (1)

• deadweight loss/welfare loss indicated (1)

Explanation

• excessive consumption of alcohol leads to negative impacts on

3rd parties as well as the individual (1) which leads to a

divergence between the marginal private benefits of

consumption and the marginal social benefits of consumption (1). In the case of negative externalities in consumption, the marginal private benefit is greater than the marginal social benefit because of the harm done to 3rd parties (1). The harms to 3rd parties include costs to the NHS, the cost of policing and other costs (1). If the market fails to internalise the harms to 3rd parties, the good is overconsumed (1). The optimal

consumption/production of a good occurs when MSB=MSC (1)

• the deadweight loss occurs because at the initial equilibrium

marginal social cost is greater than marginal social benefit and

society is better off if less is produced (1).

SPEC S2 Q6d Evaluate possible policies which could be used to reduce the market failure of excessive sugar consumption. (6)

An indirect tax on sugary food/drinks

• An indirect tax raises the price which should deter consumption

depending on the PED (1). If the PED is less than 1 (inelastic)

then will have little impact on quantity demanded (1). Some

believe that sugar is more addictive than heroin, and therefore

the PED is likely to be less than 1 (1).

• The tax revenue raised from a 'sugar tax' could be used to pay for costs of obesity/tooth decay (1) which would make it a

hypothecated tax (1). There are very few hypothecated taxes in

the UK (1) because governments prefer the flexibility to use tax

revenue on their spending priorities (1).

• This is a market-based solution which creates disincentives

through the price mechanism but gives consumers the choice to consume the product or not (1). However, it is a regressive tax as those on low incomes are more impacted than those on higher incomes, because they spend a higher proportion of their income on sugary foods (1). Also, healthier food alternatives may be more expensive which gives those on low incomes fewer substitutes (1) therefore some argue that sugar taxes are unfair because they disproportionately impact those on low incomes (1).

• Are relatively easy to impose and have already been

implemented in the UK and California/Mexico for highly sugared fizzy drinks (1). But there are questions over their effectiveness in reducing sugar consumption because there are lots of 'sugary' foods which are not included in taxes on fizzy drinks, such as fruit juices/smoothies/yoghurt drinks/chocolate etc (1).

Other policies which can be evaluated can include

• legal regulation/restrictions

• industry agreements on sugar/portion size

• education of consumers

• better food labelling — particularly of 'hidden' sugar in

processed food, eg bread, takeaway, baby food etc

• behavioural economics theories

2024 S1 Q5 Discuss possible advantages and disadvantages of raising the highest rate of income tax. (4)

Advantages:

• makes the tax system more progressive (1)

• raises tax revenue (1)

• reduces income inequality (1)

Disadvantages:

• encourages tax avoidance (relocation, loopholes) so less tax

revenue (1)

• reduces enterprise (1)

• brain drain - relocation means loss of skills (1)

• lowers tax revenue through having less disposable spending (1)

• can disincentivise the supply of labour to high paying

jobs/promotion (1)

Costs and Benefits to Renationalisation.

Renationalisation is the process of bringing industries or services previously privatized back under government ownership. Public control and accountability allow the government to be directly accountable to the public, ensuring that services are aligned with public welfare rather than profit motives. Equitable access to services ensures that essential services, such as healthcare, transportation, and utilities, remain affordable for everyone, regardless of income, with government regulation preventing price hikes. Long-term planning and investment enable governments to focus on sustainable infrastructure development and research, prioritizing the future over short-term profits. Efficiency in providing public goods is achieved when natural monopolies like water and electricity are managed by a single public entity, which can reduce wasteful duplication of resources and lower operational costs. High initial costs may strain public finances, as governments often need to buy back privatized assets or compensate shareholders, which could lead to higher taxes or borrowing. Bureaucracy and inefficiency are risks, as state-owned enterprises may suffer from slow decision-making, lack of competition, and higher costs, affecting service quality. Political interference can also be a problem, with political priorities sometimes overriding the efficiency or needs of the service, leading to poor management. The risk of overextension arises if the government takes on too many industries, resulting in underperformance due to lack of expertise. Additionally, lack of innovation and competition in state-run industries could lead to stagnation, as there would be no external market pressure to innovate. Possible political backlash may occur if taxpayers and investors oppose the costs involved, especially in times of economic strain.

SPEC S3 Q9c Apart from altering income tax, discuss other policy measures that could be introduced to reduce income inequality in the UK. (7)

Increase the National Minimum/Living Wage

• Increases incomes of those on low incomes, raising living

standards, reducing poverty (1).

• It reduces the amount that the government pays out in working tax credits (1).

• It adds to the costs of firms and may impact employment as

firms cut back on labour costs (1). It will also impact UK firms'

overall competitiveness (1). It can be inflationary if higher

labour costs are passed on to consumers (1).

• It only affects a very small proportion of the workforce, as most workers earn above the NMW/NLW (1).

Increase in State benefits

• They can be targeted at most vulnerable groups eg pensioners (1). Those on low incomes have a high marginal propensity to consume which leads to a higher multiplier effect (1).

• They can be means-tested (1) which reduces poverty and

associated socio-economic costs such as lower incidents of

mental health issues/criminality (1).

• Increasing state benefits may have to be paid for by increases in taxation or government borrowing (1) which has a negative

impact on public finances (1).

• Disincentive effects may result in small number of recipients of state benefits becoming dependent on benefits rather than

seeking employment (1). This may lead to an increase in

long-term unemployment.

Other policies might include

∙Investment in education and training — focusing on raising

attainment/widening access

∙Improving healthcare — reducing health inequality would lead to greater employability

∙Investment in affordable housing/tackling social deprivation — better educational outcomes, better health outcomes, improving employability and improving social mobility etc

∙Providing job opportunities — reducing labour immobility through reduced transport cost; providing funding for apprenticeships and government training schemes

2024 S3 Q9a Describe inflationary and deflationary pressures currently impacting the UK economy. (8)

Inflationary

• UK has experienced real wage growth (1). Wages in real terms

rose 2.1% over the year to March 2024 (1 stat). Higher wages may

increase consumer expenditure which could lead to demand-pull

inflation / wage-price spiral (1). Wages may remain high due to

tight labour market (1)

• increase in oil price due to conflict in Middle East (1)

• supply delays due to Red Sea shipping attacks (1)

• rising rent prices (1)

• increase in state pension due to triple lock (1). This year, the

link to earnings under the triple lock meant an increase of 8.5%

(1)

• more disposable income due to cut in National Insurance (1)

• services inflation, which measures price rises for things such as

haircuts or train tickets, remained elevated (1) at 5.9% (1 stat)

• some foods, such as olive oil, cocoa and crisps are rising in price

because of poor harvests (1)

Deflationary

• interest rates have risen in the UK (1). The current bank rate is

5.25% (1 stat). Higher interest rates will lead to higher mortgage

payments which will reduce discretionary income (1). This could

lead to lower consumption and aggregate demand (1)

• lower household energy prices due to lower price cap (1)

• there has been a rise in income tax (1). Credit either current UK

income tax fiscal drag or increase in income tax rates for higher

earners in Scotland (1)

• some foods, such as milk, butter, poultry and fish are coming

down in price due to falling fertiliser prices / tougher

negotiations from supermarkets on own-brand items (1)

• used car prices have fallen. 4.2% in October 2023 (1 stat)

2022 S3 Q8b Analyse the possible economic consequences of raising interest rates on the UK economy. (9)

• Can result in deflationary pressure and falling aggregate demand (1)

• Increases the cost of credit, reducing borrowing (1)

• Higher mortgage payments for 3.5m variable rate mortgages, reducing discretionary income (1)

• Negative impact on the housing market and potential wealth effect (1)

• Consumers may increase savings, causing leakage (1)

• Exchange rate may appreciate due to hot money inflows, making imports cheaper and exports more expensive, reducing AD (1)

• Tight monetary policy may take up to 18 months to impact the economy (1)

• High consumer confidence may make tightening ineffective, as consumers continue borrowing (1)

• Businesses may reduce borrowing, limiting capital investment (1)

• Tight monetary policy may raise unemployment and reduce economic growth (1)

• Ineffective if inflation is cost-push from rising import prices, as seen in 2021/22 (1)

• Interest rates are low, so further tightening may have marginal impact (1)

• A significant rise in rates after years of low rates may cause panic among consumers and investors (1)

• Interest rate rises affect different groups: by age, income, ownership, and savings (1)

SPEC S3 Q8b Describe the potential impacts of falling house prices on the UK economy. (8)

• It could result in a negative wealth effect (1), leading to lower consumer spending (1).

• Negative equity for borrowers (1) could reduce their geographical mobility (1).

• Loss of jobs in construction/estate agencies as profits fall (1), due to fewer people moving and needing these services (1). One new-build house supports five jobs (1).

• Falling house prices lead to lower profits for house builders (1), worsening the supply of housing (1) and existing housing shortages (1).

• If severe, there are negative consequences for banks (1): defaults on mortgages could lead to bad debts if the house value is lower than the mortgage (1).

• Lower prices will make housing more affordable for first-time buyers (1), helping those wishing to own their first home (1)

.• It may reduce speculation in the housing market (1), eventually leading to a more stable market (1)

.• Negative expectations may lead to a fall in demand for property (1) as potential buyers delay purchases (1), causing further price drops (1). However, this may benefit the rental market, as sellers are forced to rent out properties (1), leading to higher supply and lower rents (1).

• The government may receive less revenue from stamp duty/LBTT (1).

• Regional differences may occur, with some areas experiencing rising house prices while others see falling prices (1).

2024 S3 Q12a Describe the role of the World Trade Organization (WTO). (4)

Negotiation

• The WTO is a global international organisation dealing with/overseeing the rules of trade between nations (1).

• It is also a forum for governments to negotiate trade agreements (1).

• The WTO's global system lowers trade barriers (1).

Dispute Settlement

• It aims to reduce trade tensions by helping to settle disputes (1).

Monitoring

• The WTO monitors trade practices to ensure that countries comply with its rules (1).

• It ensures the principle of non-discrimination, giving the weaker countries a stronger voice as differences in bargaining power are narrowed by agreed rules, consensus decision-making, and coalition building (1).

Technical Assistance

• The WTO can encourage good governance by reducing arbitrariness and opportunities for corruption, while promoting transparency (1).

• It provides assistance to developing countries to help them participate in global trade (1).

SPEC S3 Q10b Discuss the possible economic implications of the on-going trade war between China and America on the US economy (8)

∙ A trade war leads to lower exports, lower output and lower growth (1).

• US $200bn worth of tariffs have been imposed by the US on Chinese goods (1). Chinese have imposed US $60bn on US goods (1).

• Consumers may lose the benefit of cheap imports/less choice/inferior domestically produced goods (1).

• Higher inflation in US due to higher import costs (1).

• Free trade and specialisation lead to higher world output and more efficient use of global resources (1), and protectionism prevents this (1).

• In the short-run, inefficient domestic industries are protected (1), but in the long-run this just reinforces inefficiency (1).

• The US economy may experience fewer job losses and lower unemployment because there is less competition from Chinese goods (1). Lower unemployment leads to lower benefits paid out by government (1).

• Some industries will benefit (steel) but some will lose out (soy beans) (1).

• The Current Account of US Balance of Payments may improve as imports fall (1).

• Less industrial theft of US intellectual property could lead to higher profits for US firms (1).

• Government tax revenues may go up from tariffs (1), depending on the elasticity of imports (1). But lower exports from US firms to China lower their profits (1), leading to lower corporation tax (1).

• If other countries decide to increase protectionism the global economy could suffer a depression similar to the 1930s (1).

2022 S3 Q11b Explain why strengthening trade links with the USA is a key economic objective of the UK government. (7)

•America is the UK's single biggest export market; therefore, the UK wishes to strengthen and grow this market. (1)

•Post-Brexit, the UK government aims to build free trade agreements (FTAs) with countries around the world, as exports to the EU have declined. (1)

•Securing favourable trading conditions with the US could create opportunities for the export of UK services to the US. The UK services sector is crucial to the economy, and this could benefit the UK economy as a whole. (1)

•A UK-USA FTA could increase the flow of investments between the two countries. (1)

•The UK government aims to secure "cutting-edge" provisions that maximise opportunities for digital trade across all sectors of the economy. This could enable regulatory cooperation to protect UK users from harmful content. (1)

•Both the UK and the US are world leaders in digitally delivered services and digital innovation, which could lead to further advancements in digital innovation. (1)

•There is potential for a UK-US FTA to serve as a springboard for the UK to join the US-Mexico-Canada Agreement (USMCA), further boosting UK exports in the region. (1)

•Specific industries in the UK could particularly benefit from a trade deal, such as:

Scottish exports, including whisky, salmon, and cashmere, which are vital to the Scottish economy. (1)

One in five exports from the Midlands go to the US, and a trade deal could boost the region's ceramic industry. (1)

A deal with the US could open a vast market for Welsh sheep farmers and help revitalise the area. (1)

These regions, which have faced economic hardship, could see stimulation in regional development from such a trade deal. (1)

•Sustainability is a key government objective, and a UK-USA FTA could integrate sustainability goals into broader international trade policy. (1)