Economics Edexcel-Theme4 Workbook Answers

WORKBOOK ANSWERS
Edexcel A-level
Economics A
Theme 4 A global perspective
This Answers document provides suggestions for some of the possible answers that might be
given for the questions asked in the workbook. They are not exhaustive and other answers
may be acceptable, but they are intended as a guide to give teachers and students feedback.
The abbreviation KAA stands for Knowledge, Analysis and Application. Generic levels-based
mark descriptors for longer answers are provided here.
Levels-based mark descriptors for longer answers

25-mark questions
KAA Level 4 descriptor (13–16 marks):
• Demonstrates precise knowledge and understanding of the concepts, principles and

models.
• Ability to link knowledge and understanding in context using appropriate examples.
• Analysis is relevant and focused with evidence fully and reliably integrated.
• Economic ideas are carefully selected and applied appropriately to economic issues
and problems.
• The answer demonstrates logical and coherent chains of reasoning.
Evaluation Level 3 descriptor (7–9 marks):
• Evaluative comments supported by relevant reasoning and appropriate reference to

context.
• Evaluation recognises different viewpoints and is critical of the evidence provided

and/or the assumptions underlying the analysis enabling informed judgements to be
made.
15-mark questions
• Demonstrates accurate knowledge and understanding of the concepts, principles and

models.
• Ability to link knowledge and understanding in context using relevant and focused
examples which are fully integrated.
Edexcel Economics A Theme 4 A global perspective 1
© Sam Schmitt 2019 Hodder Education

and problems.
• Evaluative comments supported by relevant chain of reasoning and appropriate

reference to context.
• Evaluation recognises different viewpoints and/or is critical of the evidence.
12-mark questions
• Demonstrates accurate knowledge and understanding of the concepts, principles and

models.
• Ability to link knowledge and understanding in context using relevant and focused
and problems.
• Evaluative comments supported by relevant chain of reasoning and appropriate

• Evaluation recognises different viewpoints and/or is critical of the evidence.
10-mark questions
 Demonstrates accurate knowledge and understanding of the concepts, principles and

models.
 Ability to link knowledge and understanding in context using relevant and focused
 Economic ideas are carefully selected and applied appropriately to economic issues
and problems.
 Evaluative comments supported by relevant chain of reasoning and appropriate

 Evaluation recognises different viewpoints and/or is critical of the evidence

TOPIC 1 Globalisation and trade
Topic 1
Globalisation and trade
Causes and effects of globalisation
1 2 marks for any two valid points (1 + 1):
 Reduced integration between countries as there is less trade in goods and services or
more protectionism
 Reduced flows in international capital or foreign direct investment (FDI)
 Reduced flows of labour between countries or emigration/immigration
2 Knowledge (1 mark) and linked analysis to globalisation (2 marks); application to some

examples of countries or projects from your own knowledge (2 marks).
International Monetary Fund (IMF) (up to 3 marks): the IMF is a specialised agency of
the UN that aims to help the world economy by promoting global financial stability (1
mark), encouraging countries to adopt sound exchange rate policies (1 mark) and
discouraging competitive depreciation (1 mark), giving loans to countries with balance of
payments difficulties (1 mark), and supporting and advising on policies to help countries
correct the underlying causes of their balance of payments problems (1 mark). In this way
it promotes trade (1 mark).
Application (up to 2 marks): promotion of market liberalisation, privatisation and free trade
after the collapse of the Soviet Union in 1990. More recently, the IMF’s first two bailouts of
Greece.
World Bank (up to 3 marks): the World Bank consists of the International Bank for
Reconstruction and Development (IBRD) and the International Development Association
(IDA) (1 mark for any). It is not a bank in the common sense but a specialised agency
affiliated with the UN that aims to promote economic development (1 mark) and is a non-
profit institution (1 mark). It aims to promote development by providing loans (1 mark),
policy advice and technical assistance for development projects (1 mark). In this way it
promotes trade (1 mark) and capital transfers (1 mark).
Application (up to 2 marks): in Bangladesh, the World Bank provided a $59.8m credit to
provide medical services and nutritional supplements to children and their mothers. In
Bosnia, the World Bank helps offer ‘microcredit’ loans, typically less than $1,000, to
individuals who wish to start small businesses and otherwise would not have access to
bank credit.

World Trade Organization (WTO) (up to 3 marks): the WTO is an international

organisation established to promote free trade (1 mark). It enforces rules (1 mark), helps
countries negotiate to reduce trade barriers (1 mark) and is an arbitrator in trade disputes
(1 mark). In this way it promotes trade (1 mark).
Application (up to 2 marks): China formally joined the body in December 2001. Russia
joined in August 2012. Liberia and Afghanistan joined in 2016.
3 Knowledge and analysis and application (1 + 1 + 1 marks per factor) for 2 factors and
total KAA 6:
Factors might be:
 Declining costs of transport, e.g. containerisation in shipping lowers costs due to

technical economies of scale, greater productivity with more advanced ports etc.
 Declining costs of communication, e.g. the rise of the internet has allowed services to
become increasingly tradeable (e.g. back office accounting, call centres etc.)
 Liberalisation of trade — could refer to the General Agreement on Tariffs and Trade
(GATT) and the WTO or the growth in the size and number of trade blocs.
 Liberalisation of capital markets — deregulation of global financial markets and hence

greater levels of FDI and the rise of multinational corporations (MNCs).
 Asia’s rise and the entry of billions of people into the world market economy — gains
from off-shoring or rising incomes in emerging markets increase demand for
tradeable goods.
Application (2 marks): reference to specific countries, industries or examples:
e.g. Taiwan-based Foxconn manufactures products for Apple in China (Shenzhen), which
are exported to the USA
e.g. China’s $900bn One Belt, One Road scheme announced in 2013 to improve transport
infrastructure between Central Asia, Middle East and Europe
Evaluation (2 marks for any relevant point):
 Significance — rise of Asia very significant because the global supply of labour
almost doubled in absolute numbers between the 1980s and early 2000s, with half of
that growth coming from Asia.
 Role of trade blocs might inhibit globalisation through trade diversion.
4 KAA (9 marks):
Possible benefits include:
 Faster global economic growth — gains from comparative advantage
 Off-shoring creates jobs in emerging economies and so reduces absolute poverty
 Inequality between countries falls — due to catch up and convergence

 Greater FDI improves diffusion of new technology
 Firms have access to larger markets and so gain economies of scale and increased
profits
 Disinflation as off-shoring lowers labour costs or greater competition increases

productive efficiency
 Increased mobility of labour allows access to foreign know-how, skilled workers,

remittances etc.
 Greater consumer surplus from lower prices, greater choice, higher quality
Possible costs include:
 Off-shoring and production in developing countries can exploit labour, e.g. long
working hours, poor conditions
 Inequality within countries rises — gains for some sectors at the expense of others,
e.g. technology and finance in developed countries
 Foreign capital is footloose, e.g. capital flight in 1997–98 Asian financial crisis —
increased interdependence increases risks of shocks
 Inflation due to rising commodity prices and so cost-push inflation
 Immigration can mean pressure on public services or constrain growth in others due
to the brain drain
 External costs — pressures on finite resources; external costs stemming from

transport
Evaluation (6 marks):
 Different countries have benefited to different extents, e.g. China much more than
land-locked fragile states.
 Recent trend of deglobalisation and regionalisation suggests there is a limit to

benefits.
 Recent apparent disregard for multilateral institutions such as the WTO, e.g. Trump’s
trade dispute with China.
Comparative advantage and the terms of

trade
5 a Comparative advantage: The ability of one country to produce a good or service at a
lower opportunity cost than another country (1 mark). If each country specialises in those
goods and services where it has an advantage, then total output and economic welfare
can be increased (1 mark).

b Absolute advantage: A country can produce a good for lower costs than another (1
mark) and so uses fewer resources to produce the same amount of goods or services
(1 mark).
6 a 1 mark for each correct row.
Country Cars Textiles
UK 500 1,000
India 200 800
Total pre-trade 700 1,800
b UK
c 1 mark per correct calculation per country.
Country Opportunity cost of Opportunity cost of

producing 1 car producing 1 textile
UK 2 ½
India 4 ¼
d 1 mark per correct row.
UK 800 400
India 0 1,600
Total post-trade 800 2,000
e The ratio between export and import prices (2 marks)
Index of terms of trade = (index of export prices/index of import prices) x 100 (2 marks)
f Terms of trade to lie between the two opportunity cost ratios, e.g. 1 car:3 textiles
Note: output before specialisation and trade is in brackets in the table below; look at answer
to (d) and choose values of exports and imports at a terms of trade of 1 car:1 textile

UK (500) 550 (export 250 cars) (1,000) 1,150 (import 750 textiles)
India (200) 150 (import 250 cars) (800) 850 (export 750 textiles)
Total post- (700) 800 (1,800) 2,000

trade
7 Knowledge (2 marks) and linked analysis to improved terms of trade (1 marks).
Application to Figure 1 (2 marks for two data references), e.g. India’s terms of trade
improved from an index of 58 in 2015 (1 mark) to 72 in 2016 (1 mark).
Analysis (1 mark) might consider:
 An improvement in the terms of trade means there has been a rise in Indian export
prices (1 mark) and/or a fall in import prices (1 mark).
 India to get relatively more imports for each unit of export (1 mark).
Knowledge for a possible factor (2 marks) might consider:
 An appreciation in India’s exchange rate (1 mark) would reduce import prices in

Indian rupees (1 mark) and/or leave export prices unchanged in rupees (1 mark).
 Increased demand for India’s exports/higher export prices (1 mark) might be because
of faster world economic growth (1 mark) or improvements in Indian competitiveness
(1 mark) or global growth leading to greater demand for more income-elastic services
and manufactured goods from India (1 mark).
 Lower import prices (1 mark) might be because of lower commodity prices (1 mark) or
import demand is income inelastic (1 mark) leading to lower increases in
demand/prices (1 mark).
8 Knowledge of economic effect (1 mark) and linked analysis (1 mark) for two effects up to
a total of 3 marks.
Application to Figure 1 (2 marks for two data references), e.g. India’s terms of trade has
improved from an index of 58 in 2015 (1 mark) to 73 in 2018 (1 mark).
Definition/knowledge: an improvement in the terms of trade means that the home economy
gets more imports for each unit of exports (1 mark).
Positives economic effects might be (1 mark):
 Higher living standards/levels of development (1 mark) because India can consume

more imports, such as cheaper medicines, which improve life expectancy and so the
Human Development Index (HDI) (1 mark).

 Improved credit rating/falling national debt (1 mark) as external debt servicing (i.e.
paying off loans and interest) will be cheaper (1 mark).
 Firms will also be able to import cheaper raw materials and capital (1 mark), which
can enhance competitiveness (1 mark) or lower cost-push inflation (1 mark).
 Improved terms of trade can also improve the current account of the balance of
payments (1 mark) if exports are relatively price inelastic, and an improvement in the
terms of trade can increase export revenue and improve the current account, since
the relative increase in price is greater than the relative fall in the quantity of export
goods sold. The same is true if imports are price inelastic; import spending would
decrease.
Negatives economic effects might be (1 mark):
 If exports are price elastic then an improvement in the terms of trade causes export
revenue to fall (1 mark) — just as import spending would rise if the demand for
imports is relatively price elastic (1 mark). Both would have a negative effect on the
current account balance of payments (1 mark).
 A decrease in export revenue (1 mark) and/or an increase in import spending could

lower economic growth (1 mark) and so reduce employment (1 mark).
9 Knowledge (1 mark) and linked analysis (up to 2 marks or 1 + 1 of two factors).
Application (2 marks) e.g. context of one country’s competitive industries, e.g. UK’s
financial services.
 Factors of production are perfectly mobile — resources used in one industry can be
switched into another without any loss of efficiency. This is unlikely and structural
unemployment might result.
 No transport costs are considered — changes to oil prices and concerns over the
external costs of transport might make transport more significant (if oil prices rise).
 Constant returns to scale — doubling the inputs in each country leads to a doubling of
total output. But there may be increasing returns to scale (perhaps because of
economies of scale) as firms specialise, so the potential gains from trade are much
greater.
 No externalities from production or consumption of the goods, e.g. China may

produce significant carbon emissions. There are no barriers to trade. Only two goods
are produced in the model. Trade finance is possible.
Free trade versus protectionism

10 Knowledge (2 marks) and linked analysis (1 marks); application to some examples of
countries from your own knowledge (2 marks).
Application (2 marks): use of examples of inward-oriented strategies, such as India

1947–90, Brazil in 1960s, China etc. or outward-oriented countries, such as Tigers —
South Korea, Hong Kong, Taiwan, Singapore.

An inward development strategy — focuses on substituting imported goods and services

with domestically produced goods (1 mark), behind protective trade barriers (1 mark).
These policies are based on the expectation that industry will benefit from economies of
scale, the current account will improve, and scarce foreign exchange will only be used for
importing essential capital goods (1 mark for each reason).
An outward development strategy — focuses on increasing exports (1 mark). It is often

associated with a laissez-faire approach to imports and is based on the expectation that
industries will exploit their comparative advantage (1 mark) and improve efficiency due to
greater competition (1 mark).
11
Domestic market Consumers Domestic firms
Quantity demanded or
Q3 Q1
supplied
Area of consumer or producer CS = area

PS = area XZPworld
surplus WVPworld
12 Other advantages include (1 mark knowledge and 1 mark analysis for each advantage):
 Increased net exports and so a shift in AD and faster growth
 Increased competition and so productive efficiency improvements and gains in

competitiveness/improved productive efficiencies
 Greater levels of FDI
 Firms gain access to larger markets, and so benefit from economies of scale and
hence earn larger profits, raising demand for labour/generating tax revenues
 Technological progress and innovation spillovers improve productivity
13 Up to 2 AO1 marks each.
a Industries in which a country has a comparative advantage in (1 mark) but which are
just starting up and so consist of low-volume producers that are short of experience (1
mark). They lack the economies of scale (1 mark) and the benefits of ‘learning by
doing’ held by foreign competitors (1 mark), who clearly have a cost advantage over
domestic firms (1 mark). Hence tariff protection is required for a limited period (1 mark)
until the domestic industry ‘learns the ropes’ and grows large enough to benefit from
economies of scale (1 mark) and so survive the full weight of international competition.
b As labour is a derived demand (1 mark), any fall in imports and rise in domestic
production (which could be illustrated on a tariff diagram, 2 marks) results in greater
domestic demand for labour (1 mark). It assists government in achieving the
macroeconomic policy objective of full employment (1 mark). Political pressures adds
to the pressure on governments to act against the outsourcing of jobs (1 mark).

c The WTO defines dumping as ‘charging a lower price for a good in a foreign market
than one charges for the same good in a domestic market, such that the foreign market
is injured’ (2 marks). Dumping can occur as foreign firms try to gain monopoly power (1
mark) in a foreign market and so amounts to predatory pricing on an international scale
(1 mark).
d These policies aim to switch consumer demand from imported goods on to

domestically produced ones (1 mark). This could be achieved by a devaluation of the
exchange rate (1 mark and further explanation 1 mark). Protectionism (1 mark and
further explanation 1 mark).
Types of import barrier

14
Term Definition Example
Tariff Tax levied on imports to increase EU Common External Tariff

their price domestically (CET) weighted average 6.7%
President Trump put tariffs on

$250bn, or 47%, of US imports
from China
Quota A trade barrier that places a limit China import quota on cotton
on the quantity of a good that can (894,000 tonnes)
be imported
Turkey put quotas on steel
imports in 2018 with 25% levy
on any imports above this
Non-tariff Any valid example is credited In South African Development

measures such as: could be technical Community (SADC), Shoprite
barriers to trade (TBT) regarding spends $5.8m on filing
standards for manufactured certificates and import permits
goods. Sanitary and phytosanitary per year to secure $13.6m duty
(SPS) measures concerning food savings
safety and animal/plant health,
environment protection and WTO Technical Barriers to
domestic regulation in services Trade (TBT) ensure that
regulations, standards, testing
and certification procedures are
fair and equitable, so domestic
goods don’t gain an unfair
advantage
Subsidies to Government grants given to Common Agricultural Policy in

domestic domestic firms to lower their costs EU
producers of production in order to make
them more price competitive than Rmb3.6bn to China’s state-
imports owned Shanghai Auto in 2018

15 12-mark question; KAA 8 marks, Evaluation 4 marks (level-based marking)
Note: economic impact can consider both negative and positive effects on the
macroeconomy (micro-based analysis capped at KAA L2 or 5/8).
Correctly labelled tariff diagram:
Analysis of economic impact (must link micro effects to macro impact):
 Imports increase in price from P1 to Ptariff and the number of imports falls from Q4 – Q1
to Q3 – Q2 and so the current account improves.
 Domestic firms increase production from Q1 to Q2 and so gain producer surplus by the
area P1ABPtariff. Greater output means a greater derived demand for labour and so
lower unemployment.
 Government gains tariff revenue CDEB and the revenue raised can be spent on
better public services or used to improve public finances.
 Consumers reduce their quantity demanded from Q4 to Q3 and so lose consumer

surplus equal to area P1FEPtariff. This implies a deterioration in living standards.
Evaluation points:
 The net effect is a loss of consumer surplus (loss of consumer surplus is greater than
the gains in tax revenue and producer surplus) and so a deadweight loss equal to the
triangles ABC and DEF.
 Price elasticity of demand determines how consumers’ demand changes in response

to the rise in price caused by the tariff. If demand is inelastic then the tariff is less
successful in reducing the number of imports.
 Price elasticity of supply determines the extent to which domestic firms can increase
production and take on new workers in response to the rise in price caused by the

tariff. If price elasticity of supply is inelastic then firms cannot increase output as much
and so imports are still needed.
 Retaliation is likely so export demand may also fall — this may offset improvements in
the current account or reductions in unemployment.
 The extent to which price increases and domestic firms benefit and imports fall
depends on the size of the tariff imposed.
16 KAA (16 marks):
Application — must have application to reach KAA L4
Analysis points might include:
 Reference to more than one country or global economy (marks are capped at Level 3
where no reference is made). Application to examples of countries and protectionist
measures.
 Loss of gains from comparative advantage — and so a decrease in world output and
fall in welfare; inflationary consequences — as import prices rise, e.g. higher input
costs and cost-push inflation; implications for global trade imbalances as surplus
countries may see fewer exports and so smaller trade surpluses, or fewer imports and
so larger surpluses.
 Use a tariff diagram to show effect of a tariff and so:
o impact on consumers of higher prices globally and a loss of consumer

surplus and so net deadweight loss
o domestic producers gain from a higher domestic output and so more

producer surplus — some gains in employment possible for countries using
protectionism (assuming not all countries become protectionist)
o tax revenue to the government, which can be used to fund public services or
to improve public finances
 Gains from protectionism — such as infant industries are allowed to grow or reduced
unemployment in sunset or strategic industries.
Evaluation (9 marks) points might include:
 Different impacts on different countries; trade surplus versus trade deficit countries;
developed and developing countries; impact likely to be on inter-trade bloc trade
rather than intra-trade within blocs.
 Impact depends on the openness to trade as a proportion of gross domestic product

(GDP), e.g. there will be a larger impact on export growth in China, Japan, Singapore
etc.
 Judgement on whether costs outweigh the benefits for the global economy.

Patterns of trade, trade blocs and the role

of the WTO
17 Knowledge (1 mark) and linked analysis (2 marks); application to some examples of
countries from your own knowledge (2 marks).
Application (2 marks): e.g. 157 members (1 mark); 97% world trade (1 mark); Russia last
major economy to join in 2012 (1 mark); latest round of trade talks is Doha round, which
was started in 2001 (1 mark); last agreement was in Bali 2013.
Knowledge and analysis (3 marks): the WTO oversees and regulates the international
trading environment (1 mark). Its primary objective is to reduce trade barriers (1 mark), but
it also sets trade rules (1 mark) and has a dispute settlement role (1 mark).
18 1 mark for each correct row (data below to 1 d.p.)
1962 (% of world exports) 2014 (% of world exports)
USA 12 9–10
China 1 14
Japan 11 4
Germany 11 9
19 Application (2 marks) to data in table — country (1 mark) and data (1 mark).
Knowledge and understanding (2 marks) (1 + 1) for TWO reasons.
Analysis 2 marks for linked explanation to change in trade pattern (1 + 1):
 Decrease in protectionism, e.g. lower tariffs; WTO membership; trade bloc

membership (could count as two points)
 Opening up of Asia and collapse of communism (Washington Consensus)
 Changes to competitiveness, e.g. lower unit labour costs in emerging markets with
lower wages or changes to exchange rates or relative inflation rates/real exchange
rates
 Trend of global supply chains and off-shoring
 Increased FDI, particularly to Asia, leading to improved trade links/competitiveness
 Changes to comparative advantage

Evaluation (2 marks) (1 + 1) or (2 for identification and development):
 Changes to factors, e.g. trend of re-shoring; rising protectionism
20
Trade bloc Definition Example
Free trade A group of countries that agree to have free trade NAFTA
area between themselves
Customs An agreement between a group of countries to set SACU

union a common external trade policy, e.g. common
external tariff, and to allow free trade within the
membership countries
Common Members agree to free trade, common external COMESA

market trade policy, and free movement of goods and
services, capital and labour across their borders
Monetary Members agree to form a common market and Eurozone

union also form a single currency or fix their exchange
rates for their respective currencies
21 Knowledge and analysis (6 marks for definitions and development); application (4

marks for correctly labelled diagrams).
Trade creation Trade diversion
Definition Definition
The increased amount of trade due to the The diversion of trade away from
reduction in trade barriers between countries (1 countries where trade barriers are faced
mark) as consumption shifts from high-cost to countries where trade barriers are
producers to lower-cost producers inside the lower (1 mark) so consumption shifts from
trade bloc (1 mark). For example, before the a lower-cost world source to a higher-cost
trade bloc (Sworld + tariff) the country had to pay P1 producer inside the trade bloc (1 mark).
so domestic production was at Q2 and domestic For example, before joining the trade bloc
demand was at Q3. After joining the trade bloc (SEU) domestic consumers paid P1 and
(SEU) prices fall to P2 and so imports increase to imported Q3 – Q2. After joining the trade
Q4 – Q1 and so trade has been created (1 mark). bloc, products were cheaper at P2 (as
tariffs were no longer imposed on higher-
cost producers inside the bloc) and so
consumption switched away from
producers to those inside the bloc. But if
tariffs had been removed on cheaper and
more efficient world producers, prices
would have been even lower at P3 (1
mark).
Diagram

Foreign direct investment

22 a A firm that produces and sells goods and services in more than one country.
b Outsourcing, or off-shoring when across international borders. Occurs when firms try to
reduce costs by locating production facilities in other countries and hiring foreign
workers.
23 Correctly labelled AD/AS diagram with axes labelled (1 mark)
 Initial equilibrium (1 mark)
 Shift to the right in AD and/or shift to the right in AS (1 mark)
 New equilibrium labelled (1 mark)
24 KAA (16 marks):

Analysis of the benefits might include:
 Economic growth — could analyse through AD or AS or both and link to increases in

real output.
 Development — fills savings gap and so allows faster growth, which in turn reduces
absolute poverty or raises real gross national income (GNI) per capita and therefore
HDI.
 Employment — direct job creation and indirect job creation in ancillary firms and
through multiplier effects.
 Balance of payments effects — current account improves as production for export

grows/reduced need for import; investment inflow on financial account.
 Greater tax revenue and improved public finances — through corporation tax, income
tax and indirect tax.
 Technological diffusion improves productivity; greater competition and so more

productive efficiency.
Evaluation (9 marks) points might include:
 How large the multiplier, and therefore growth, is — due to profit repatriation and
remittances.
 Current account of the balance of payments worsens through profit repatriation,

import of foreign capital and foreign worker remittances.
 Jobs may not be created — use of foreign workers; takeovers are unlikely to create
new jobs etc.
 Large FDI inflows could cause Dutch disease and loss of export competitiveness for
other sectors.
 Limited tax revenue as tax breaks can be granted in order to attract MNCs and
transfer pricing reduces profits and so corporation tax revenues.
Balance of payments
25
Current account: records primarily the movements of all goods and services into and out
of the UK, but also primary and secondary income
Sub-accounts Example of transaction UK balance

(source: ONS,
Pink Book,

2018)
1 Trade in goods Mobile phones, computers, cars, −6.7% of GDP

oil
2 Trade in services Travel, insurance +5.5% of GDP
3 Primary income (income flows) Investment incomes such as −1.6% of GDP

profits, interest, dividends
4 Secondary income (current Aid, EU budget, worker −1.0% of GDP

transfers) remittances
Capital account: records capital transfers and the net acquisition or disposal of non-
produced, non-financial assets
— Example of transaction UK balance

(source: ONS,
Pink Book,
2018)
— Debt forgiveness −£1,814m
Financial account: this comprises transactions associated with changes of ownership of

the UK’s foreign financial assets and liabilities
Sub-accounts Example of transaction UK balance

(source: ONS,
Pink Book,
2018)
1 Direct investment Equity > 10%, e.g. Kraft buys £94,427m

Cadbury’s
2 Portfolio investment Equities and bonds £181,669m
3 Other investment Loans and deposits, i.e. hot money £224,830m
4 Reserve assets Gold, foreign exchange £6,799m

Causes of current account imbalances

26 Application (2 marks) to data in table above (UK trade balance 2 marks; or another
country of your choice).
Analysis (2 marks) (1 + 1) for linked explanation to a worsening in the trade deficit:
 Economic growth — rising incomes mean increased consumption of income-elastic

imports (high marginal propensity to import in the UK).
 An appreciation in the exchange rate — increases the foreign exchange price of

exports and reduces the price of imports in domestic currency.
 Higher relative inflation — increases the real exchange rate and makes the economy
less competitive.
 Lack of competitiveness (could be several points) — means relatively high unit labour
costs caused by poor labour productivity; lack of investment; limited research and
development etc.
 Poor non-price competitiveness — such as quality and design of products.
 Rising prices of essential commodity imports, which are price inelastic e.g. oil.
 Impact of a stronger exchange rate depends on the price elasticity of demand — refer
to the Marshall–Lerner condition.
 Commodity prices are volatile and so only a temporary cause.
 Possible automatic correction of the trade deficit through a gradual weakening of the
exchange rate and/or a slowdown in growth as net exports fall and growth/price level
falls.
 Appreciation in the exchange rate reduces import prices and so cost-push inflation,
possibly leading to more competitive exports as the real exchange rate weakens.
27 Application (2 marks) to US financial account data (US$240bn in 2014) or examples of

financial account inflows, e.g. China buys US treasuries, Chinese FDI into USA such as
Beijing Automotive Industry Holding Co.’s (BAIC) acquisition of General Motors’ Saab
division.
Analysis 2 marks for linked explanation to the US economy (1 + 1):
 Cheaper credit for US firms allows greater investment — AD/AS analysis of effect,
e.g. productivity rises and greater potential growth.
 Impact on the US dollar — capital inflows cause an appreciation.

Consequences (before financial crisis):
 Bid up US asset prices, such as in housing and equities — positive wealth effect and
so encourages mortgage equity withdrawal (rising consumer debt) and consumption-
led economic growth.
 Buoyant US housing market led to huge and unfruitful residential investment into
construction — excess supply and risk of house price bubble bursting.
 Easy and cheap finance of US government debt leading to larger budget deficits, e.g.
borrowing in USA used to fund tax cuts and to finance war in Afghanistan and Iraq.
 Financial institutions take excessive risks with leverage and search for higher yields
— risks of financial sector instability.
Consequences (after financial crisis):
 Poor investments, and US debtors now struggling to make repayments to China or

have suffered bankruptcy, e.g. Chinese investment into Bear Stearns and other US
banks.
 Consideration of how large Chinese capital inflows are, e.g. $1.2 trillion of US
treasuries in 2012.
 Reliance on China for investment in the US financial account to finance current

account deficits risks a sudden stop.
 Consideration of whether the benefits outweigh the costs.
28 KAA (9 marks):
Application — reference to examples of countries with trade deficits (UK, USA) and trade
surpluses (Germany, China). Reference to the significance of imbalances as a share of
GDP or trend could be used for evaluation:
e.g. the UK deficit on the current account balance was a record 5.2% GDP in 2016. It
narrowed to 3.9% GDP by 2017 (ONS Pink Book, 2018)
e.g. in 2017, Germany’s trade surplus was nearly $290bn, or about 7.8% of the country’s
GDP (Bertelsmann Foundation)
Analysis points might consider the disadvantages from current account trade deficits or
trade surpluses. (Also reward answers that focus on financial account imbalances and so
trade deficit countries are reliant on net inflows of foreign capital or trade surplus countries
are reliant on net investments overseas.)
Trade deficits are a concern because: they suggest a lack of competitiveness, which takes
time and is expensive to remedy; likely to depreciate the exchange rate and so lead to
rising import prices and cost-push inflation; net leakage from the economy and so
aggregate demand and therefore real output fall; may require loans to fund imports and so
there are opportunity costs to debt service.

Trade surpluses are a concern because: they reflect a high savings rate and reduced
domestic consumption of goods and services and imports, which could raise living
standards; ownership of foreign assets may decline in value as their currency appreciates;
export demand is vulnerable to slowdown in global growth; risks of protectionism being
imposed.
Evaluation might consider the possible benefits of trade deficits or surpluses but should try
to weigh up benefits against the costs and consider whether trade imbalances are a
concern or not.
Further evaluation might include:
 Magnitude of the effects — how large and sustained is it?
 Use of Marshall–Lerner or J-curve for exchange rate points
 Consideration of inter-temporal trade
Policies to correct imbalances

29 Knowledge (1 mark) — correctly labelled exchange rate supply and demand diagram.
UK foreign exchange market: £ against US$
Application (1 mark) — reference to a trade deficit country and currency, such as the UK
and sterling or the USA and US dollar.
Analysis (3 marks) — shift to the left in demand for sterling (1 mark) as UK export
demand falls (1 mark) and/or a shift to the right in the supply of sterling (1 mark) as UK
import spending rises (1 mark); new equilibrium labelled showing an exchange rate
depreciation (1 mark).
30 Application (1 mark): e.g. US trade in goods deficit was £736bn in 2012.

Knowledge (1 mark) and linked analysis of effect on the trade in goods deficit (3 marks)
— expenditure-reducing policies focus on cutting aggregate demand, and so consumption
(1 mark), and therefore demand for income-elastic imports (1 mark), e.g. through tighter
fiscal policy — higher direct taxes (1 mark) will lower disposable income (1 mark) and so
spending on imports, and therefore reduce the trade deficit (1 mark).
Tighter monetary policy means higher interest rates (1 mark) and so lower consumption as
borrowing cost rises (1 mark).
Other fiscal and monetary policy transmission mechanisms are also credited, e.g. lower
government spending, or less investment to reduce capital imports.
31 KAA (6 marks):
Application — reference to examples of countries with trade deficits (UK, USA) and
possible policies used, e.g. UK’s loose monetary policy (interest rates 0.5% and £375bn
quantitative easing (QE)) has caused hot money outflows and weakened sterling.
Analysis might include:
 Expenditure-switching policies focus on: devaluation or depreciation to lower export

prices and raise import prices — this means intervention in the foreign currency
markets is required to lower the value of the currency, e.g. selling domestic currency
or buying foreign exchange.
 Protectionism, e.g. use of import tariffs and other measures.
 A tariff diagram could be used to show the fall in imports.
 Tighter fiscal or monetary policies lower demand-pull inflation — and so cause

consumers to switch demand away from more expensive imports and make exports
more price competitive.
 Impact of exchange rate depreciation depends on price elasticity of demand — refer

to Marshall–Lerner condition or J-curve effect.
 Depreciation leads to a rise in costs of imported raw materials, energy, capital goods
etc., which shift SRAS up to the left and lead to cost-push inflation.
 Protectionism is likely to lead to retaliation and so a fall in export earnings.
Competitiveness
32 a The average cost of labour (1 mark) needed to produce one more unit of output (1
mark) — total cost of labour (1 mark) divided by output (1 mark). OR Unit labour costs are
determined by labour productivity (1 mark) and the cost of labour (1 mark).
b The nominal exchange rate (1 mark) adjusted for the different rates of inflation between
the two currencies (1 mark).
33 KAA (8 marks):

Note: students must refer to firms and government measures or cap at Level 2 (max. 5
marks KAA).
Application — reference to examples of specific firms, sectors and countries, and supply-
side measures.
Measures used by firms might include:
 Capital deepening — increase investment to raise the level of capital per worker, and
so labour productivity, leading to lower unit labour costs.
 Relocate the production of components or ancillary services overseas, e.g. off-

shoring call centres to India or part of manufacturing process to China.
 Increase spending on research and development to improve product quality/design

and non-price competitiveness or achieve cheaper production techniques, thereby
lowering unit labour costs.
 Use non-price and price strategies, e.g. after-sales service or predatory pricing.
Measures used by government (supply-side policies) might include:
 Invest in education and training; reduce corporation tax or grant tax credits for profits
reinvested; deregulation to increase competition and improve productive efficiency;
spend on improvements to infrastructure.
 Impact of investment on fixed costs for firms — which would raise average costs and
squeeze profit margins or lead to price increases and so reduce competitiveness.
 The fact that supply-side policies have time lags — and may be expensive,
particularly during austerity, and so are unlikely to be used or used only to a limited
extent.
34 KAA (16 marks):
Reference to India and its rise in competitiveness. For example, the World Economic
Forum (WEF) 2018 report comments: in India, the time and cost required to start a
business remains high, at nearly 29.8 days and 15% of GNI per capita. In New Zealand,
which leads the indicator on the time required to start a business, it takes just half a day.
Analysis of the impact might include:
 Exports are likely to become more competitive — therefore there will be a rise in
export revenue and a fall in import spending, leading to an improvement in India’s
trade deficit.
 Higher net exports cause AD to shift to the right. Draw a diagram to show impact on
real output and so faster economic growth.

 If prices are falling then the Bank of England may lower interest rates, encouraging
investment and borrowing to stimulate AD. In the long run impact may improve AS
and therefore encourage a shift in LRAS.
 Unemployment may decrease as exports decline — higher derived demand for labour
— and positive multiplier effects in ancillary industries.
 Impact on the value of the Indian rupee — could link to inflation or the current account
— as exports rise, the demand for the rupee also shifts out, causing the rupee to
appreciate. This lowers import costs and so leads to cost-push disinflation. It also
makes exports less competitive in the long run, but imports become cheaper, leading
to a worsening of the current account (might be used as evaluation, e.g. automatic
adjustment of floating exchange rates).
 Improvements in overall competitiveness might mask deficiencies elsewhere, such as

the health and education of India’s young workforce (half of its 1.3bn population are
below the age of 25).
 Appreciation reduces competitiveness in the long run.
 Consider the short- and long-run effects.
Fixed and floating exchange rates

35 a An index number of the value of a country’s currency relative to a weighted
(according to proportion of trade) basket of other currencies.
b This states that a devaluation only improves the current account if the combined
elasticities of demand for exports and imports are greater than 1. If they are less than 1, a
devaluation worsens the current account balance.
c The effect of currency depreciation on the trade deficit depends on price elasticity of
demand for exports and imports. The J-curve effect says that in the short run export
volumes will remain constant and import spending will rise, hence worsening the current
account — in other words, the Marshall–Lerner condition is not satisfied. Only in the long
run will the current account start to improve.
36 Knowledge (1 mark) — correctly labelled exchange rate supply and demand diagram.

Application (1 mark), e.g. UK interest rates at a historic low of 0.5% or QE £375bn.
Analysis (3 marks) — low interest rates mean hot money flows out of the economy (1
mark) as investors look to save money in currencies that earn higher interest rates or they
speculate will appreciate. (1 mark) Hot money outflows mean more pounds sterling are
supplied on the foreign exchange market (1 mark) so supply shifts out to S2 and the pound
depreciates (1 mark). There are also less likely to be hot money inflows so demand for
sterling falls (1 mark) and so demand shifts to the left to D2 and the pound depreciates (1
mark); new equilibrium labelled showing an exchange rate depreciation (1 mark).
37 Application (2 marks), e.g. UK pound fell from £1:$2 in 2007 to around £1:$1.55 in 2013.
Possible explanations are: relatively weak UK growth compared with the USA makes the
UK a less attractive place for FDI; relatively high UK inflation — this decreases the
competitiveness of UK goods and causes fewer exports and more imports; the UK is less
competitive and therefore unit labour costs are higher, so the UK imports more US goods
and exports less; speculation that the UK pound will continue to depreciate given
pessimistic forecasts and austerity measures or concerns over the UK leaving the EU;
continued use of QE and low interest rates in the UK have driven down interest rates on a
variety of possible investments, e.g. bond yields have fallen; US interest rates are
relatively higher so hot money leaves the UK and flows to the USA; the USA has
increased domestic oil production using fracking and horizontal drilling and at the same
time reduced its consumption of petrol and other oil products, leading to lower US oil
imports.
Evaluation (2 marks) (1 + 1):
 Significance and/or duration of factors
 Role of price elasticity of demand, e.g. in short-run contracts and J-curve effects

38 KAA (9 marks):
Note: students must refer to firms and government measures or cap at Level 2 (max. 5
marks KAA).
Application — reference to examples of specific firms, sectors and the context of the UK
Analysis of impact might include:
 AD/AS diagram showing a shift in AD or AS or both.
 Depreciation reduces export prices in foreign currency and raises import prices in
pounds, therefore leading to an improvement in the UK’s balance of trade.
 Increased net trade shifts aggregate demand to the right and so increases real output
and therefore UK economic growth.
 Higher real output and multiplier effects resulting from greater exports mean an
increase in derived demand for labour and so lower unemployment in the UK.
 Inflation: a shift outwards in AD leads to demand-pull inflation. An increase in import

prices raises the costs of importing raw materials, energy, capital goods etc., and so
leads to cost-push inflation.
 Possible impacts on FDI to the UK — depreciation will lower the cost of UK capital
and so increase FDI; depreciation will reduce the value of earnings from investment in
the UK and so deter FDI.
 Depends on price elasticities — Marshall–Lerner condition and the J-curve effect.
 Depends on how UK and foreign firms adjust supply chains in response to Brexit and
changes in sterling.
 Depends on exchange rate versus other UK trading partners, e.g. UK has 43% trade
with the Eurozone.
 Ceteris paribus — other factors will also affect UK growth and jobs, such as low
consumer confidence and the impact of austerity measures.
 Uncertainty over the size of the multiplier effects, e.g. high MPM in the UK will reduce
the multiplier’s size.
Single currencies
39
No more than 1.5% above the average rate of the three EU member
Inflation
states with the lowest inflation over the previous year

Budget deficit: at or below 3% GDP

Government
finances National debt: not exceeding 60% of GDP unless debt level is falling
steadily
National currency is required to enter the European Exchange Rate

Exchange rate
Mechanism (ERM) 2 years prior to entry
Long-term interest rates should be no more than 2% above the rate in

Interest rate
the three EU countries with the lowest inflation over the previous year
40 KAA (9 marks):
Application, e.g. to Greece (allow other Eurozone member countries if plausible).
Analysis points might consider:
 A new Greek currency would have a lower value than the euro and so lead to an
improvement in the Greek balance of trade; a weaker currency could lead to cost-
push inflation; exit is likely to be triggered by default on debt as Greece refuses to
accept terms proposed by the IMF and other Eurozone members. This would be likely
to lead to the collapse of the Greek banking system because depositors will withdraw
their money, resulting in the collapse of any commercial activity.
 Existing euro debt would become much more expensive to pay interest on in new
currency terms and so lead to bankruptcies. Government euro debt would also
become difficult to service and so further austerity measures might be needed.
Sovereign default might limit debt service and allow a return to balanced budgets.
 Greece would be unlikely to attract external funding and capital controls would
probably be needed. A lack of credit would reduce investment and job creation and
mean that Greek banks and firms would be entirely reliant on improved domestic
performance.
 There is no formal mechanism that allows countries to leave the euro.
 If Greece left other countries might follow, as market speculators would sell bonds of
the countries seen to be at risk of leaving, causing yield on new debt issued to sour
and bond prices to fall. This could lead to further bank failures and the risk of
contagion effects.
 Greece lacks competitiveness and an industrial base — so a depreciation might not

be enough to regain a competitive advantage.

 Those countries left in the Eurozone would be likely to suffer losses on lending to
Greece, further bailouts and an appreciation of the euro. This would limit Eurozone
demand for Greek exports.
Exam-style questions (data response)

1 Award 5 marks for correct answer = 219
Application (2 marks): 230,000 in 2000 to 481,000 in 2015.
Knowledge (2 marks):
 Base year is 2000 = 100
 Correct formula for percentage change = (251,000/230,000) × 100 = 109
Analysis (1 mark): convert answer to index form = 219
2 Application (2 marks), e.g. the number of foreign-funded enterprises in China more than
doubled from 230,000 in 2000 to 481,000 in 2015; private consumption grew by more than
$1 trillion from 2010 to 2015.
Analysis (2 marks) for linked explanation to China (1 + 1):
 Access to larger internal consumer market/rapid growth
 Access to cheap labour/educated labour force
 Access to infrastructure, e.g. electricity, transport etc.
 Favourable incentives, e.g. lower corporation tax, government subsidies, lower tariffs
etc. in special economic zones
 Low regulatory costs, such as health and safety, planning restrictions, environmental
controls etc.
Evaluation (2 marks) or (1 + 1):
 Chinese growth has increased wages and reduced Chinese competitiveness in

comparison to other low-wage Asian nations.
 Protectionism against China may limit its attractiveness as an export base.
 Significance of factors depends on the type of industry invested in, e.g. transport may
be more important for manufacturing industries than services.
3 KAA (8 marks):
Application — reference to globalisation, e.g. off-shored manufactured jobs and own

examples, e.g. Foxconn production of Apple products in China.

Note: inequality could be considered in terms of income inequality within countries, but
reward answers that consider inequality between countries, or other types of inequality,
such as wealth.
Analysis of globalisation and widening income inequality might include:
 Off-shoring increases demand for labour in low-wage countries such as China,

shifting demand for labour outwards in industries, such as manufacturing, and
therefore raising wages. Bonuses and wage rises likely to be concentrated in firms’
management, owners and shareholders. Wages in other sectors, such as agriculture,
are unlikely to rise as much, leading to wider income inequality within China.
 Similar analysis to point above but from advanced economy perspective, e.g. off-
shoring lowers labour demand, leading to lower wages.
 Immigration to advanced economies shifts supply of labour outwards, lowering

wages. Wage competition with low-wage economies limits wage rises for those jobs
that are not off-shored.
 Success of advanced economy industries, such as technology and financial services,

raises demand for labour. High skills of educated labour force raise marginal physical
product of labour. Both together raise marginal revenue product of labour and hence
wages in these industries, leading to wider inequality within countries such as the
USA and UK.
 Inequality between countries has fallen due to globalisation — e.g. rapid growth of
China — links to idea that follower countries can adopt existing technology and see
much faster economic growth.
 Further globalisation might be limited by recent protectionist moves and immigration

restrictions have limited further inequality.
 Inequality is also caused by other factors, such as automation.
 Significance of inequality varies by country depending on government policies to

redistribute incomes.
4 KAA (6 marks) of TWO macroeconomic effects within any country (otherwise cap L2 or
4/6).
Application e.g. ‘ICT allowed G7 firms to spread some stages of production to nearby
developing nations’.
Analysis of G7 countries might include:
 Improved competitiveness and improved current account of the balance of payments

— off-shoring lowers firms’ average costs and hence prices. This point could also be
linked to lower cost-push inflation.
 Unemployment rises — lower demand for labour; higher imports reduce net exports
and so shift AD to the left. Negative multiplier effects lead to further inward shifts.
Real output falls and hence lower derived demand for labour.

 Investment overseas reduces the capital stock — and so shifts aggregate supply to
the left and lowers potential growth.
 Exchange rate depreciation as capital outflows rise and imports of intermediate goods
increase, shifting the supply of a country’s currency outwards to the right in foreign
exchange markets. Deprecation either causes inflation, as it raises import costs and
so leads to cost-push inflation, or helps to improve the current account, as a weaker
exchange rate improves competitiveness.
 Government finances are likely to worsen as jobs are off-shored and hence cause
lower income tax revenues and increased spending on unemployment benefits — this
may have implications for national debt, credit ratings, opportunity costs of debt
service etc.
 Counter macroeconomic effect analysed, e.g. unemployment might fall as improved

competitiveness from off-shoring boosts export demand and creates jobs.
 Depends on the nature of the industry, e.g. ICT has made some financial services
tradeable but other services, such as retail, are less affected.
 Political concerns over globalisation might limit off-shoring and encourage more
consumption and production of domestically produced goods and services.
5 KAA (9 marks): must consider both protectionism and immigration or cap L2 (6/9).
Analysis points of arguments in favour might consider:
 Protectionism: infant industry argument; strategic industry argument; protect

unemployment in sunset industries; reduce current account deficits (expenditure-
switching policy); prevent dumping
 Immigration restriction: displaces domestic workers from employment (increases

labour supply and reduces wages and incentives for domestic workers); drain on
public services, such as social housing and places at primary and secondary school;
consume more in government benefits than contribute in tax revenue
Evaluation — arguments against (6 marks):
 Free trade arguments, such as the gains from comparative advantage; competition
and efficiency; higher profits as firms gain more revenue from access to larger
markets and costs fall due to economies of scale
 Pro-immigration arguments, such as job creation from higher consumption and AD;
higher immigration fertility expands future labour force size; net contributors to
government finances, from higher income and indirect tax revenues
 Depends on the nature of culture and ethnicity of immigrants, e.g. many Europeans
well integrated in the UK
 Protectionism — depends on the scale and type of measures, e.g. tariffs often have
less of an impact than technical regulations and product standards

 Trade bloc membership and WTO rules can limit protectionist measures
Exam-style questions (essay)

6 KAA (16 marks): students may choose either side to argue and use the opposite for
evaluation or consider a range of advantages and disadvantages and evaluate each.
 Bulgaria agrees to join Exchange Rate Mechanism (ERM II) in August 2018 with
the aim of formally joining in summer 2019
 ERM II: 1 euro: 1.96 Bulgarian lev (July 2018)
 Bulgaria introduced currency board (long-term commitment to fixed exchange rate

to German deutsche mark and full convertibility) in 1997
Advantages of a semi-fixed exchange rate (ERM II):
 Understanding of a fixed/semi-fixed exchange rate: the government and central

bank commit to intervene in foreign exchange markets to meet a specific
exchange rate target with some permitted fluctuation
 Stability/greater certainty over the exchange rate promotes more trade, e.g. as
there are lower transaction costs because there are lower search/information
costs and bargaining/contract costs when exchanging currencies.
 Stability/greater certainty over the exchange rate promotes more foreign

investment, e.g. as business confidence improves with greater certainty over the
future costs and revenues, and so profits, of any investment.
 Lower inflation, e.g. domestic firms are under pressure to keep costs and prices
low to maintain competitiveness (firms cannot rely on the automatic depreciation
of an exchange rate if exporters are not competitive).
 Lower inflation/greater monetary discipline — central bank must follow the

monetary policy moves of the country they fix their exchange rate to. This may
improve credibility of inflation control and so, e.g., improve expectations of low
inflation feeding into lower wage demands.
 Prevents competitive depreciation and accusations of unfair trading

practices/beggar-thy-neighbour policies.
 Prevents excessive speculation and bubbles that can lead to misallocation of

capital and confidence collapse when bubbles burst.
Disadvantages of a semi-fixed exchange rate (ERM II):
 Trilemma/trinity (Mundell): must choose either to control capital flows or lose

independent monetary policy (monetary policy must follow the interest rate policies
of the country they are pegged to so hot money flows do not alter the target
exchange rate). A loss of capital flows might restrict foreign credit and hence
investment. A loss of monetary policy means domestic objectives of low inflation

or growth cannot be primary to the target exchange rate and so expansionary

monetary policy cannot be used in response to a shock.
 Loss of automatic adjustment of a floating exchange rate — uncompetitive

economies with sticky prices and wages can become competitive again when their
currency depreciates.
 Central bank can act as a lender of last resort — the central bank cannot create
money and liquidity to bail out banks.
 Risks that excessive speculation can build up and encourage speculative attacks
e.g. UK in ERM in 1992; many emerging economies in 1997 Asian financial crisis.
 Depends on the degree of similarity of business cycles and economic shocks to

the country and the other country it fixes its exchange rate with.
 Depends on the size and openness of the country (optimal currency areas): if
trade is a large proportion of GDP, exchange rate stability is likely to be more
advantageous.
 Difficulty of selecting the appropriate target exchange rate — it may differ from the
equilibrium exchange rate and so risk undervaluation and accusations of beggar-
thy-neighbour policies or be overvalued, e.g. the USA has accused China of
deliberately undervaluing the renminbi against the US dollar to promote Chinese
exports.
 Forwards markets and other financial innovations can reduce the risk of exchange
rate fluctuations.
 Depends on whether there are other additional agreements, e.g. in the EU, free
movement of capital and financial market integration.
7 KAA (16 marks): students must consider how One Belt, One Road will drive globalisation
and how other factors may be more important. Alternative factors can be in analysis or in
evaluation.
 In 1990, $5 trillion worth of goods, services and finance, or 24% of global GDP,
moved across global borders. In 2007, this had increased to $30 trillion, or 53% of
GDP. By 2015, it had declined to 34% of GDP (McKinsey, 2017).
 One Belt, One Road aims to improve links between China, Central Asia, Europe and
Africa by facilitating $2 trillion in investment into ports, roads, railways and energy.
Analysis of how One Belt, One Road may drive further globalisation:
 Globalisation can be defined as the increased integration of countries through trade,

investment and migration
 Trade growth, particularly in manufactured goods, and integration of more countries

into global supply chains and markets

 Trade growth, particularly for commodity exporters, as derived demand for

commodities increases as a result of new infrastructure construction
 China’s growing influence in shaping multilateral institutions can support globalisation:
o Trade growth can be influenced by trade, through China/ASEAN and the G20
o Capital growth through new institutions such as the Asia Infrastructure Bank
and the New Development Bank, e.g. in 2013, nearly half of $30bn in foreign
investment into African infrastructure was from Chinese firms (McKinsey,
2017)
 Migration of labour as China globalises its education systems and/or becomes a

source of high-skilled workers, e.g. in constructing infrastructure
Analysis of how other factors drive globalisation:
 Refer to the typical factors reviewed in topic 1, question 3: declining costs of

transport, declining costs of communication; liberalisation of trade; liberalisation of
capital markets; Asia’s rise and the entry of billions of people into the world market
economy
Analysis of how other factors threaten globalisation or will cause deglobalisation:
 Rising inequality within countries and the view that globalisation is its principal cause
— rising wages for higher-skilled workers in advanced economies
 Protectionism, e.g. as multinationals take advantage of lower labour costs in

developing countries — NBER 2016 working paper found US trade with China erased
thousands of manufactured jobs — and hence populist moves against free trade
 Immigration controls — immigrants might be blamed for stagnant wage growth and
unemployment
 Climate change — industrialisation, urbanisation and rising consumption might be

blamed for deforestation, pollution and greater emissions from goods trade by sea
and air freight
 Depends on policymakers in advanced economies and whether the gains from

globalisation can be made more inclusive
 China’s One Belt, One Road is only one of the factors needed to drive further
globalisation, e.g. threats to personal data, intellectual property theft and large
differences in labour and environmental standards within countries may also need to
be addressed
 Next stage of globalisation likely to be digital, e.g. e-commerce (Alibaba, eBay,

Amazon) and information flows, rather than cross-border goods flows, and so
transport infrastructure may be less important than enhancing internet infrastructure
 One Belt, One Road infrastructure likely to support the UN’s Sustainable
Development Goals of universal access to clean water, sanitation and affordable,

reliable and sustainable energy, and hence may generate global support for the
project
8 KAA (16 marks): students may choose either side to argue and use the opposite for
evaluation or consider a range of costs and benefits and evaluate each.
Reference to examples of countries, sectors and firms in the EU (19 current Eurozone
members of 28 EU countries).
Benefits might include:
Lower transaction costs and so more trade; increased investment as stability/certainty

increases confidence; competition and lower prices and price transparency:
 Source cheaper inputs — lower price off-shoring, e.g. Lithuania, Latvia
 Wage competition, e.g. Romania
 Less geographical price discrimination
Lower inflation and long-term interest rates — the European Central Bank’s (ECB’s)
independent use of monetary policy to meet a 2% inflation target. Lower inflationary
expectations (due to the credibility of the ECB) have helped keep interest rates generally
low, so borrowing costs would also be lower and therefore investment would generate
higher returns.
Costs might be:
Loss of control over monetary policy:
 Policy used to achieve an average inflation rate target — does one size fit all?
 Structural differences affecting sensitivity of transmission mechanisms to changes in

interest rates, e.g. number of homeowners on variable rate mortgages.
National central banks are no longer a lender of last resort and Eurozone members could
not rely on the ECB as a central bank and lender of last resort because it is forbidden from
financing members’ budget deficits — the Eurozone lacks institutions to absorb shocks.
Fiscal policy implications:
 EU Stability and Growth Pact
 Possibility of larger fiscal transfers to Eurozone bailouts
Loss of exchange rate and automatic adjustments to current account problems, e.g.
burden of adjustment to large current account deficits (Greece: –15% of GDP in 2007) is
on deficit countries.
Not an optimal currency area:
 No fiscal union to help in event of shocks

 Structural differences prevent labour mobility, e.g. differences in labour market

regulations, such as minimum wages, pensions and trade union power
Transition costs.
 The difficulty in setting the correct exchange rate to join at
 Current problems inside the Eurozone
 Some of the gains in trade and investment have already occurred now the Eurozone
has been formed

TOPIC 2 Poverty and inequality
Topic 2
Poverty and inequality
Measuring poverty and inequality
1 Definition (1 mark) and application/measure (1 mark) in each case.
Poverty type Definition and measure
Absolute poverty A standard of living that fails to provide basic needs, such as
food, safe drinking water, shelter and clothing (1 mark).
Often measured by the number falling below a threshold level

of income such as $1.90 PPP a day (1 mark).
(previous measure was $1.25 PPP per day (2005–11))
Relative poverty The term refers to those who fall below a certain threshold
income or poverty line (1 mark) OR a standard of living that
falls significantly below the majority (1 mark).
In the UK and EU, this is defined as those earning less than

60% of median income (1 mark).
Multidimensional Measures the percentage of households that experience

poverty index overlapping deprivations in three dimensions: education, health
(MPI) and living conditions (1 mark).
A person who is ‘poor’ is deprived in at least 30% of the

weighted indicators (1 mark).
HPI-1 (for Used to measure absolute poverty in less developed countries

developing (1 mark). Its variables are: the percentage of a population likely
countries) to die before the age of 40 years (1 mark); the percentage of
people over the age of 15 years who are illiterate (1 mark); the
percentage of children under the age of 5 years who are
underweight (1 mark); the percentage of people without access
to public and private services such as healthcare and clean
water (1 mark).
2 Knowledge (1 mark) — correctly labelled Lorenz curve axes.
Application (1 mark) — correctly labelled line of perfect equality.
Analysis (3 marks) — 1 mark for each correct data point.


3 a 1 mark for each correct data point.
b Gini coefficient is Area A (between 45° line and Lorenz curve) ÷ (Area A + B) (whole
area under 45° line) (2 marks).
Causes of poverty and inequality

4 Wealth is a stock of money (1 mark) OR wealth is the value of assets owned by a
household, including houses, shares and bonds (1 mark for any listed).
Income is a flow of money (1 mark) OR income includes wages, rent, interest and profits
(1 mark for any listed).
5 The derived demand for labour is the demand for labour that results from the demand for
the product (1 mark) that labour is used to make (1 mark).
6 Knowledge and analysis: 3 marks for identification of correct factor (1 mark) and
development (2 marks) in each case.
Application: 2 marks for correctly labelled labour market diagram showing relevant shift in
the supply or demand of labour (1 mark) and original and new equilibrium wage (1 mark) in
each case.
 Differences in access to and quality of education — this determines the marginal

revenue product of labour (demand for labour) and wage levels.
 Type of employment — higher rewards to skilled labour with bonuses, share options
and performance-related pay (greater marginal product of labour and so higher
demand for labour).
 Wages for unskilled labour have risen less quickly (lower marginal product of labour
and so lower demand for labour).
 Globalisation of labour supply — supply of labour shifts right and so wages fall as
open up to China, India etc.
 Globalisation could link to off-shoring (lower demand within a country) and/or greater
labour supply within a country due to immigration.
Policies to reduce income and wealth

inequalities
7 Knowledge (2 marks) and application (2 marks) for a correctly labelled labour market
diagram.

 Correctly labelled labour market diagram (1 mark)
 Initial NMW impact on the quantity of labour demanded and supplied (1 mark)
 New NMW shown above the old NMW and equilibrium wage (1 mark)
 New NMW impact on the quantity of labour demanded and supplied (1 mark)
Analysis (2 marks) for linked explanation to income distribution (1 + 1):
 Increases in the income of the lowest paid (1 mark) make pay distribution more equal
(1 mark). It reduces exploitation of minority groups (1 mark) and reduces male–
female pay differentials and therefore income inequality (1 mark). The resulting
incentive to work (1 mark) lowers voluntary unemployment and so reduces income
inequality (1 mark).
 Raising the marginal cost of employing an extra worker (1 mark) leads to a

contraction of labour demand (1 mark) but encourages an extension in labour supply
(1 mark) and so results in excess supply or unemployment (1 mark) and so may
worsen income distribution (1 mark).
Evaluation (2 marks) for developed point or (1 + 1):
 Evaluation may argue that higher unemployment could worsen income inequality as
real-wage unemployment is caused or firms’ costs are increased and so firms fire
workers to maintain profit levels.
 Significance of NMW — impact depends on the new level of the NMW and how much
the NMW has increased in contrast to average earnings/equilibrium wage rate.
8 Knowledge and analysis (3 marks for definitions and development); application (2

marks).
A progressive tax is a tax where the proportion of income paid in tax increases as income
rises (1 mark). With a progressive tax, the marginal rate of tax exceeds the average rate of
tax (1 mark). Progressive taxes will raise government revenue (1 mark), which can be

used to provide means-tested benefits (1 mark) such as unemployment benefit (1 mark) or

other examples (1 mark).
Other examples: (up to 2 marks) such as UK’s 45% top rate of income tax on incomes
over £150,000 or higher personal allowances of £12,000 from 2018.
A regressive tax is where the proportion of income paid in tax decreases as income rises
(1 mark) or the marginal rate of tax exceeds the average rate of tax (1 mark). An indirect
tax is a tax on expenditure on goods and services (1 mark) and this will make up a greater
proportion of a lower economic group’s income as households have a higher APC or MPC
(1 mark) and so will be paying proportionally more of their income consuming goods and
services with indirect taxes levied on them (1 mark), such as VAT at 20% (1 mark) or
excise duties on alcohol, fuel and tobacco (1 mark).

1 Knowledge (2 marks) and linked development/analysis (1 mark).
Application to Extract 1 (2 marks): any TWO data references such as:
 Gini coefficient — top 1% share of total income rose from 5.7% in 1990 (1 mark) to
7.8% in 2016–17) (1 mark); Gini 0.34 in 1990 (1 mark) and 0.36 in 2007 (1 mark)
 Relative poverty — rising from 21% in 2011‒12 (1 mark) to 22% in 2016‒17 (1 mark)
Knowledge (1 mark) + linked development (1) such as (maximum 3 marks in total):
 Gini coefficient — headline measure of inequality (1) across the entire distribution into
a single statistic between 0 and 1 (1 mark). For example, a figure of 0 would mean
everyone received exactly the same income (1 mark) and a figure of 1 would mean all
income went to only one person (1 mark).
 Relative poverty — those who fall below a certain threshold income or poverty line (1
mark) OR a standard of living that falls significantly below the majority (1 mark). In the
UK and EU, this is defined as those earning less than 60% of median income (1
mark).
2 Application (2 marks) to Figure 1, e.g. median income increased 8% in 5 years after the
Great Recession (1) compared with 22% after the 1980s recession (1).
Analysis (2 marks) for linked explanation to growth in UK real median income (1 + 1)

might include:
UK real median income was slower to increase after the Great Recession because:
 Productivity growth was weak (1 mark), which meant lower marginal revenue product
and hence wage rates (1 mark)
 Rise in the number of workers in part-time and zero-hours contracts (1 mark) limited
wage growth
 Fall in demand for labour (1 mark) as public sector employment cut as part of
austerity (1 mark)

 Sectoral change from manufacturing to services (1 mark) and relatively lower wage
growth in service sector, such as food and accommodation services (1 mark)
UK real median income was faster to increase after the Great Recession because:
 Unemployment rose by less (1 mark) and reduced more quickly than in the 1990s,
e.g. due to more flexible labour markets (1 mark) in terms of decentralised wage
bargaining (1 mark)
 Macroeconomic policy was more expansionary (1 mark), e.g. Bank of England cut
interest rates (1 mark) from 5.75% in 2007 to 0.5% by March 2009. Fiscal boost (1
mark) amounted to 2.2% of gross domestic product (GDP), including a VAT cut,
spending on infrastructure for schools, hospitals and green energy, and training help
for the unemployed
 Depreciation of sterling (1 mark) helped boost exports and hence income growth (1
mark)
 Fall in UK labour supply (1 mark), e.g. as younger workers returned or remained in

full time education
Evaluation (2 marks); (1 + 1):
• Trends relate to average incomes across the whole population but there is great
variation in incomes across different groups in the population.
 Unclear causality — does lower productivity growth mean lower wages or did lower
wages cause greater employment and hence lower productivity?
 Public sector jobs protected in health and education — departments ring-fenced from
austerity.
3 KAA (6 marks):
Application might include:
 The Great Recession saw a fall in living standards.
 Since the beginning of the recovery (2011–12), real median household income has
grown at an average of 1.6% per year.
 Relative income poverty has increased slightly over recent years, rising from 21% in
2011‒12 to 22% in 2016‒17.
Analysis of measures might include:
 Real median household income — income adjusted for inflation for the middle
household — if all households in the UK were sorted in a list from poorest to richest,
the median provides a good indication of the standard of living of the ‘typical’
household in terms of income.
 Real gross national income (GNI) or GDP per capita — GNI or GDP adjusted for
inflation shows the total income of the country. Per capita divides this by the
population.

 Relative poverty.
 The human development index (HDI) — a composite measure of the average quality
of life in a country that includes life expectancy, mean and expected years of
schooling and real GNI per head (PPP).
 Other measures, such as net income, disposable income etc.
Evaluation (4 marks) might include:
 Relative benefits of different measures, e.g. mean incomes can be skewed by a few
households with very high incomes.
 Adjustments for inflation, such as the UK’s consumer price index, may exclude
housing costs.
 Living standards are a normative concept.
4 KAA (8 marks):
Application might include:
 Use of Extract 1, e.g. Gini coefficient in the UK 0.34 in 1990 rising to 0.36 in 2007; top
1% share of total income increased from 5.7% in 1990 to 7.8% in 2016–17.
 Use of Extract 2, e.g. US income inequality has been increasing since the late 1970s;
US Gini index rising from 34.6 in 1979 to 41.1 in 2007.
Analysis might include (must refer to both globalisation and technological change or cap
KAA 5/8):
 Globalisation and labour supply — supply of labour shifts right and so wages fall as
open up to China, India etc.; immigration increases supply of labour within countries
such as the USA.
 Globalisation and labour demand — competition and off-shoring lowers demand for
labour within a country.
 Technological change increases demand for higher skilled labour and replaces low-
skill labour.
 Causes of inequality vary between countries depending on policy responses and the
nature of institutions.
 Impact of globalisation may be small as the trade volumes and immigration flows are
still small relative to the size of many economies.
 Technological change — broad categorisation that could include mechanisation but

also reorganisation of production and changes in consumer tastes, and it is unclear
which is most important.
5 KAA (9 marks):

Application — reference to data from extracts on Gini coefficients and relative poverty or
use of your own examples
Analysis points might consider the following — evaluation may consider opposite
argument for each effect:
Inequality can increase growth because:
 It provides incentives for innovation and entrepreneurship.
 Households with higher incomes have higher savings rates, and savings can fund
productive investment (Harrod–Domar or link to circular flow: investment = saving).
Inequality can lower economic growth because:
 It lowers ability of low-income groups to spend on education and healthcare and so

lowers labour productivity growth.
 It lowers ability of low-income groups, and their lower levels of savings, to fund
entrepreneurship.
 Higher-income groups have a lower marginal propensity to consume and so there are
lower levels of consumption, aggregate demand and therefore growth.
 Lower consumption can also slow growth, as there is lower investment (lower
effective demand — accelerator theory of investment).
 Policy responses can deter growth, e.g. backlash against economic liberalisation and
free trade or limited provision of public goods.
 Inequality of outcomes does not generate the ‘right’ incentives if it rests on rents —
individuals have an incentive to divert their efforts toward securing favoured treatment
and protection, resulting in resource misallocation, corruption and nepotism. Extreme
inequality may lead to conflict and so deter investment.
 Higher income inequality associated with the global financial crisis as stagnant growth
of low-income groups leads to relaxed credit access, leverage and lower mortgage
underwriting standards.
 Policies that reduce income inequality may be growth enhancing, e.g. a rise in
secondary education attainment.
 There are large disparities in income inequality, with Asia and eastern Europe
experiencing marked increases in inequality, and countries in Latin America exhibiting
notable declines (although the region remains the most unequal in the world).
Exam-style question (essay)

6 KAA (16 marks):
The best answers might consider several causes of income inequality, and then analyse
the extent to which fiscal policy addresses them. Some answers might consider the
aspects of fiscal policy that are also a supply-side policy, which should be rewarded. Allow

answers that consider policies other than fiscal policy (e.g. minimum wage increase) as a
better solution, provided the evaluation is sound.
Analysis of fiscal policy as a solution to income inequality should aim to link the policy to
the causes of inequality. Analysis and evaluation might include:
 Discussion of progressive direct tax, such as higher income tax for high-income
earners, or higher personal income tax allowances. But a higher top rate of tax might
have disincentive effects, e.g. people and businesses relocating abroad and so lower
job creation in the economy. And such a fiscal policy is not focused on the underlying
causes of income inequality, such as rapid technological change in the unskilled
sectors, but only the symptom.
 Reduced use of regressive indirect taxes. But this may lower indirect tax revenues
and so reduce the government’s ability to spend on benefits etc. to help those on low
incomes.
 Greater spending on means-tested benefits, such as unemployment benefit or

working tax credit. But risks causing poverty trap, and so raises the effective marginal
tax rate = proportion of extra income which is lost through tax or removal of benefits.
 Greater spending on education and training to improve occupational mobility of labour

or raise the marginal physical product of labour. But this is difficult under austerity, or
likely to have time lags, or difficult to choose correct policy.
 Greater spending on healthcare to boost human capital/MPP/extend working life. But

healthcare spending already an increasingly large part of UK government
spending/opportunity costs or private healthcare systems may be needed.
 Greater spending on policies to improve geographical mobility of labour, such as

housing subsidies. But again this is expensive and difficult to gauge correct level of
subsidy or target them appropriately.
It may not target the underlying cause, such as globalisation or social norms, but instead
the symptoms.
Alternative solutions may be more effective:
 National minimum wage
 Increase opportunities for women or ethnic minorities
 Policies to reduce wealth inequality
 Disaggregation — some countries may have used fiscal policy more effectively than
others; or be less able to use it, e.g. less economically developed countries (LEDCs)

TOPIC 3 Emerging and developing economies
Topic 3
Emerging and developing economies
Economic growth and development
1 In each case: knowledge and analysis (3 marks for identification of correct factor and
development); application (2 marks for correctly labelled AD/AS diagram showing
relevant shift in AD or AS and original and new equilibrium real output). Allow analysis
based on higher or lower rates of UK economic growth as long as it is justified.
Actual growth is the increase in real gross domestic product (GDP) (1 mark). Actual
growth has fallen as aggregate demand has shifted to the left (1 mark). Any valid reason
for a fall in AD will be awarded up to 2 marks, e.g. weak growth in the EU has reduced
demand for UK exports and so caused net exports and therefore AD to fall, reducing real
output.
Potential growth is the underlying growth rate of the productive potential of the economy
(1 mark) based on the average rate of growth over a long period (1 mark). Potential growth
has fallen as aggregate supply has shifted to the left (1 mark). Any valid reason for a fall in
AS will be awarded up to 2 marks, e.g. the problems in financial markets have
permanently damaged productivity (1 mark) as investment and long-run capital per worker
have fallen (1 mark) and so aggregate supply has shifted to the left (1 mark).
2 Application (2 marks), e.g. reference to a country; UK in 2018 — HDI 0.922 and gross
national income (GNI) per capita $39,116 (2011 PPP).
Knowledge for correct definitions and linked analysis to development (3 marks).

Definition of economic growth — increase in real GDP (1 mark).
Definition of development, e.g. greater Human Development Index (HDI) (1 mark).
Benefits of economic growth trickle down through rising real incomes and so rising
consumption of goods and services such as education or healthcare (1 mark), leading to a
multiplier effect (1 mark) and job creation, and so higher GNI per capita and so HDI (1
mark).
3 KAA (6 marks):
Application — 13th 5-Year Plan (2016–20) medium-high GDP target of 6.5%; double
GDP and per capita income by 2020 from 2010 base.
Analysis might include that slower growth may be targeted in order to reduce growing
income and wealth disparities; to develop China’s western regions; to increase school
enrolment; to provide more affordable housing; to reduce negative externalities from
industrialisation; to lower inflationary pressures; to find new drivers of growth and shift
growth from investment-driven to consumption-driven; to continue the move to
marketisation and full convertibility of China’s currency, the yuan, on the capital account by
2020.
 Faster growth brings benefits such as: greater tax revenues, which can be
redistributed; job creation; profits and so greater investment and potential growth;
rising living standards as real incomes rise.
 Growth rate only reduced from the previous plan’s 7.0% target (and before 7.5%), so
unlikely to have significant differences.
The Harrod–Domar and Lewis models

4 Application (2 marks), e.g. reference to a country and its savings rate; in 2018, Benin
17% of GDP or DRC 22.1% of GDP (World Bank).
Knowledge for correct definition and linked analysis (3 marks).
Difference between private saving and private investment (1 mark). Domestic savings are
inadequate (1 mark) to support the level of investment (1 mark) required for take-off (1
mark) of 10% GDP (1 mark) in Rostow’s model (1 mark) and so foreign direct investment
(FDI) or foreign aid (1 mark) can be used to fill the gap (1 mark).
5 Application (2 marks), e.g. reference to a country and its savings rate; in 2017, 11.2% of
GDP in Madagascar (World Bank).
Knowledge for correct definition and linked analysis (3 marks):
 Low incomes and a lower marginal propensity to save
 Low rates of economic growth (slow real per capita growth)

 Lack of financial infrastructure, e.g. limited access to banks in rural areas; high
minimum deposits
 Limited or a lack of mandatory pension contributions
 Demographic trends/young-age dependency ratios — young save less
 Higher income inequality
7 Application (2 marks), e.g. reference to a country and its savings rate; developing
countries in East Asia, such as China, Singapore, Korea, Malaysia, Thailand and Taiwan
had high rates of economic growth and high savings rates.
Higher rates of saving may not be invested (1 mark). Investment is determined by the
marginal efficiency of capital (1 mark) and so the cost of borrowing and therefore of
interest rates are increasing (1 mark), investment falls with the result that AD or AS may
not shift as much to the right (1 mark) and lead to higher real output (1 mark).
Other similar analyses may refer to: business confidence determining investment;
accelerator; credit availability etc. Further analysis may refer to things not being equal,
such as other components of AD; investment in showcase projects which do little to boost
growth.
8 Application (2 marks), e.g. reference to a country and migration such as China.
Definition of law of diminishing returns (2 marks) — if increasing quantities of a variable

factor are applied to a given quantity of a fixed factor, the marginal product of the variable
factor will eventually decrease.
The traditional rural agricultural sector has a fixed amount of arable land (1 mark) and is
overpopulated and so has surplus labour that can be withdrawn without any loss of
agricultural output (1 mark) and so the marginal product of labour is zero (1 mark).

9 KAA (6 marks):
Application — China, e.g. Hukou household registration system. As a result of internal

migration China’s urban population rose from roughly 170 million in 1978 to 540 million in
2004. In 2009, there were 145 million rural–urban migrants in China, accounting for about
11% of the total population.
If wages are 30% higher than rural wages, workers will move to the modern urban
industrial sector where the marginal product of labour is much higher. The industrial sector
will then employ these extra workers without pushing up wages. This allows firms to make
large profits, which are then reinvested. Growth means more jobs for surplus rural labour
(and the additional workers increase output, and therefore also incomes and profits,
further). Extra incomes will also increase demand for domestic products while increased
profits fund increased investment. Hence rural–urban migration offers self-generating
growth. Faster growth means rising real incomes, leading to rising real GNI per capita and
HDI and lower absolute poverty.
 Lewis turning point reached — rural wages begin to converge with the industrial
sector. At that point, labour shortages appear and urban employers must offer higher
wages to lure workers from the countryside. Corporate profits, export competitiveness
and asset prices fall.
 Other factors also promote development, e.g. export-led growth or high levels of
investment into infrastructure.
Aid
10 Knowledge 1 mark for each definition; application 1 mark for each example.
Bilateral aid Assistance by a single UK’s Department for International

country to another Development (DFID) gives
humanitarian aid to Syria
Multilateral Joint assistance by a Any example, such as the World Bank’s

aid number of countries to International Development Association
another (IDA) gives aid to Nepal
Tied aid Aid spending is limited Any example, such as UK funding of a

to the goods and hydroelectric dam in Malaysia
services provided by the
donor country or has
certain conditions
attached
Concessional Concessional loan Any example, such as IDA $125m for

loan means interest rates are

lower and repayment infrastructure in Yemen

periods longer than
commercial loans
11 1 mark for each correct row
Largest ODA donors (DAC) ($bn) Largest ODA recipients ($bn)
2016–17 average 2016–17 average
1 USA 34.6 India 3.516
2 Germany 23.8 Afghanistan 3.024
3 UK 18.4 Syria 2.524
4 Japan 11.9 Vietnam 2.308
12 Any three from the following points/linked developments:
Point Linked development
1 Micro credit gives small- To allow new businesses to start up and so boosts
scale loans real incomes, creates jobs etc.
2 It promotes gender As many borrowers are women — improves gender

equality inequality index, which measures gender inequalities
in three important aspects of human development:
reproductive health; empowerment; and economic
status
3 Small loans can be used This can increase labour productivity and so increase
to fund essentials such as the opportunity to earn higher future incomes and
food, school fees etc. reduce absolute poverty
4 It helps insure against Leading to fluctuations in incomes and so the

income volatility, e.g. reliant standard of living — ability to consume goods and
on agriculture/employment services such as housing or healthcare
linked to volatile commodity
markets
13 KAA (9 marks):
Application — reference to country, donors, specific projects.
Analysis of the benefits might consider:

 Aid represents an injection of resources, which fills the savings gap and therefore
allows investment and potential growth.
 Aid can help to cover the foreign exchange gap when countries struggle to finance
their current account deficits, therefore promoting trade/allowing import of essential
capital, medicines etc.
 Aid can supplement government finances and so be spent on supplying essential

public and merit goods, such as new schools or training for doctors to fight disease.
 Aid enables infrastructure changes to be made, such as roads or greater access to

power, or clean water, directly improving levels of development and helping attract
FDI.
 Aid enables payment of interest on foreign debt. Aid allows transmission of new
technology, ideas etc.
Analysis of costs might include (this could be used for evaluation):
 Aid is spent on current spending (rather than capital) such as public sector wages, or
can lead to corruption, undermining institutions’ legitimacy and fuelling conflict.
 Aid repayments have an opportunity cost — debt servicing will become a problem if
GDP does not rise fast enough to allow comfortable repayment.
 Aid can encourage dependency and allow poorly governed countries to continue to
waste money on showcase projects, the military or consumption.
 Aid can suffer from diminishing marginal returns.
 Aid can cause Dutch disease, making exports uncompetitive.
 It can also distort the market, with excessive bureaucracy and cheap supplies
undermining local business.
 Aid is unsustainable. What happens when aid stops?
 Are the ‘right’ social, political, cultural and institutional conditions in place to maximise
the chances of successful use?
 Aid promised and aid given are often different — average absolute difference
between aid promised and aid given was equal to 3.4% of each sub-Saharan African
nation’s GDP between 1990 and 2005.
 What type of aid is given — are they loans or grants? What are the conditions
attached?
 Most aid has become bilateral — making aid hard to monitor and largely
unaccountable. Even when aid is disbursed, these programmes are scattered among
many small efforts rather than in a unified national plan.

 Aid can get delayed by red tape — 29% of delayed or lost aid due to administrative
problems in donor countries (Economist, June 2008).
Debt relief and the role of the World Bank

and the IMF
14 An agreement by the lender(s) to write off all or part of an outstanding debt.
15 a Debt relief encourages irresponsible spending by countries that will expect regular
bailouts in the future (2 marks). Funds are squandered on corruption, consumption or poor
projects and countries may choose to borrow more money with little financial accountability
(up to 2 marks).
b Rent-seeking behaviour by public decision makers that leads to a misallocation of

resources (1 mark), e.g. a decision taken on the basis of a bribe rather than the most
efficient use of the scarce resources available (1 mark). This might then deter investment,
FDI and aid (1 mark).
16
1 Opportunity costs The funds not spent on debt relief can now be spent on areas
of debt service — that promote growth and/or development such as:
this may be up to
TWO points Investment into infrastructure or foreign capital can be used to
purchase essential capital imports
Spending on improving human capital by increasing

healthcare provision or education
Spending on poverty eradication
Spending on reducing environmental degradation
2 Break cycle of Many debts are often serviced or repaid through further
debt borrowing, therefore perpetuating low levels of development
3 Conditions Debt cancellation can be tied to conditions such as low levels

attached can of corruption, economic reform and liberalisation of markets
promote growth
and development
17 Application (2 marks) — specific IDA or International Bank for Reconstruction and

Development (IBRD) intervention, e.g. IDA’s economic development and poverty reduction
strategy (EDPRS) in Rwanda focusing on improving agricultural productivity.
Explanation of World Bank role (3 marks): the World Bank consists of the IBRD (1 mark)
and the IDA (1 mark). It is not a bank in the common sense but a specialised agency
affiliated with the UN (1 mark) that aims to promote economic development and achieve

the Millennium Development Goals (1 mark). It does this by providing loans, policy advice
and technical assistance for development projects (1 mark for each).
18 Application (2 marks) — specific IMF intervention, e.g. IMF in Argentina in 1990s when
austerity was advised in order to balance budgets and regain investor confidence.
Explanation of IMF role (3 marks): the IMF is an international lender of last resort (1 mark),
assisting countries that have acute balance of payments difficulties (1 mark). Its loans
come with conditions (1 mark) in order to achieve macroeconomic stability (1 mark) and
structural adjustment (1 mark). It also advises on policies to help countries correct the
underlying causes of their balance of payments problems (1 mark).
19 KAA (9 marks):
Application — reference to examples and specific countries, e.g. market reforms tried in
Chile in 1975 under Pinochet (shock therapy), or IMF intervention after the 1997 Asian
financial crisis.
Note: market-based strategies might be used for KAA and government planning for
evaluation; or vice versa; or both types of strategy might be considered for KAA.
Note: cap L2 (6/9) if strategies are not linked to development.
Analysis of market-based strategies might include:
 Trade liberalisation (may count as two points — two different advantages, e.g. gains
from comparative advantage), which may increase real output, incomes and hence
GNP per capita.
 Liberalisation of the economy: this can be carried out via a reduction or elimination of
controls, and privatisation of public sector assets. Greater competition and investment
will shift LRAS and boost real incomes, leading to greater consumption of healthcare
and education.
 Capital market liberalisation to encourage FDI and spread technology.
 Incomes policy: wage restraint and removal of subsidies and the reduction of transfer
payments.
 Fiscal contraction: a reduction in the size of the public sector through cuts in public
expenditure (less crowding out if running budget deficit and lower inflation), or cuts in
taxation to boost private sector spending.
Evaluation (6 marks): government planned approach might consider:
 Government intervention is necessary to correct market failures such as reducing

income inequality, externalities, etc. This in turn may reduce relative poverty.
 Growth might require direct public and/or coordinated public–private investment into
development projects and industrial growth. Developing manufacturing strategies can
boost labour productivity and hence MRP and real incomes.
 Governments must provide merit goods such as healthcare and education.

 Counter examples, e.g. China has been very successful with a more gradual
approach to market reforms and government ownership or regulation of firms.
Primary product dependency, buffer

stock schemes and fair trade
20 a Soft commodities are raw materials used in the production of other goods (1 mark);
agricultural goods like tea, coffee, sugar beet, etc. (1 mark each). Ethiopia produces coffee
(1 mark) and sesame seeds (1 mark).
b Hard commodities are minerals and metals like iron ore, tin, oil, etc. (1 mark for any).
The Democratic Republic of Congo produces cobalt and copper (1 mark for country and
example).
21 a Application: use of specific example of commodity price changes (2 marks), e.g.

from 1998 to 2008, real energy prices rose by a factor of 5, metal prices by 140% and food
prices by 40% (World Bank, 2018); all primary commodities rose by 13% and energy by
24% from 2016 to 2017 (IMF).
Identification of why prices fluctuate (3 marks): agricultural crops are highly sensitive to
weather, climate and disease; supply is price inelastic in the short run, due to the time
taken to grow or extract crops and, often, their unsuitability for storage; supply lags behind
demand because future supply requires the investment of time etc. Demand is price
inelastic because commodities are necessities etc.
Correctly labelled supply and demand diagram showing price inelastic supply (1 mark) and
a shift in supply or demand leading to a proportionally larger change in price (1 mark).
b Application: specific example of commodity and a country (2 marks), e.g. Angola

and oil.
Identification of impacts (1 mark for each point) might include: destabilises household
income/job security and so living standards; deters firms’ long-run investment due to a lack
of confidence in future costs, revenues and so profits. For governments in the poorest less
economically developed countries (LEDCs), this can have significant effects on their
export revenues and tax revenues, and therefore on their ability to maintain macro stability
and provide public services.
22 a Knowledge and understanding for definition of terms of trade — ratio of the

average price of a country’s exports to the average price of its imports (1 mark).
Application (2 marks): sub-Saharan Africa’s initial terms-of-trade deterioration is

estimated at 18.3% for 2015 with declines of about 40% for oil-exporting countries.
Primary products (exports) have an inelastic income elasticity of demand (1 mark), and so
as world incomes grow, export demand grows more slowly (1 mark). Manufactures
(imports) have an elastic income elasticity of demand (1 mark), and so as incomes grow,
import demand for luxuries and manufactures is likely to grow faster (1 mark). If the
demand for exports grows only slowly relative to imports, the price of exports is likely to fall
relative to imports (1 mark) and so the terms of trade will deteriorate (1 mark).

b Knowledge and understanding for definition of terms of trade — ratio of the

average price of a country’s exports to the average price of its imports (1 mark).
Application (2 marks): sub-Saharan Africa’s initial terms-of-trade deterioration is

estimated at 18.3% for 2015 with declines of about 40% for oil-exporting countries.
Analysis (2 marks):
Higher prices of foreign goods will not only lower consumption possibilities for households
but also increase foreign debt burdens and make imported factors more expensive, e.g.
essential capital goods, energy or food. A deterioration of the terms of trade will have a
negative effect on the current account if the demand for export goods is price inelastic, as
total export revenues will fall. Inelastic demand for imports will also be negative for the
current account, as total import spending will rise.
23 Application (2 marks), e.g. Colombia coffee prices boomed in the late 1970s.
Knowledge and understanding (2 marks) — correctly labelled exchange rate diagram (1

mark) and shift in demand outwards to right (1 mark).
Coffee prices rise leading to a rise in export revenue (1 mark) and so increase in demand
for the peso (1 mark) and an appreciation of the peso (1 mark). Appreciation reduces the
competitiveness of its other non-coffee exports (1 mark) such as textiles and chemicals (1
mark). At the same time, resources shift to meet the increased demand for untraded
domestic production (1 mark), such as construction and retail (1 mark), and to support the
booming coffee export sector, therefore weakening the ailing other export industries further
(1 mark).
 Significance of coffee exports as a share of Colombia exports
 Impact of Colombian inflation relative to the rest of the world and so Colombia’s real
exchange rate
 Other factors also affect competitiveness, e.g. unit labour costs or non-price factors
 Coffee price volatility
24 KAA (6 marks):
Application: through reference to specific countries or examples, e.g. Starbucks fair trade
coffee; Ben and Jerry’s fair trade ice cream; Caribbean fair trade bananas.
Analysis might include: guaranteed and stable prices encourage long-term planning and
investment; higher wages and so higher living standards; social premiums lead to better
infrastructure, e.g. clinics and schools; enforcement of better labour conditions;
compliance with environmental standards reduces external costs; counters the monopsony
power of large multinational corporation (MNC) food producers.
 Only price, not quantity, is guaranteed.


 Higher prices encourage over-production, which can reduce the price for non-fair-
trade producers as supply increases.
 Certification charges are high at £1,570 for producer’s first year — not focused on
poorest countries that cannot afford these rates.
 Disincentivises diversification and moves up value chain.
 Does not target underlying distortions in trade, e.g. Common Agricultural Policy
(CAP).
Population growth, corruption, property

rights and other constraints
25 Possible points include:
 Money intended for public sector investment may be siphoned off to individual bank
accounts — this is a leakage from the circular flow and may never be reinjected if the
money is diverted abroad.
 Money may be spent on maintaining a particular political structure, e.g. by acquiring

arms, rather than on more productive capital expenditure.
 Contracts may be awarded on the basis of non-market criteria, e.g. in exchange for
side payments or to family members. This is likely to create allocative inefficiency and
to reduce incentives for firms outside the corruption to compete.
 Lower real GNP per capita — if population growth exceeds economic growth then
real GNP per capita falls.
 Increasing dependency ratio (where there are a large number of children and non-
income earners who need support), so it is harder to achieve high incomes per capita.
 Pressure on scarce resources (food, healthcare, education), e.g. educational

expenditure has to favour quantity over quality, therefore reducing the stock of human
capital.
 Downward pressure on wages with a larger pool of surplus labour.
 Environmental impact — forest encroachment, deforestation, fuel wood depletion, soil

erosion, declining fish and animal stocks, inadequate and unsafe water, air pollution,
etc.
 Inequality rises — the poor are the ones who are made landless, suffer first from cuts
in government health and education programmes, bear the brunt of environmental
damage, and are the main victims of job cuts.

 Deters investment and so increases in productive potential — earnings from

investment are insecure as they may be expropriated, e.g. less able to rent land.
 Raises protection costs, which is an unproductive use of resources — secure

property rights mean that individuals can devote fewer resources to protecting their
property, which frees these resources and so raises productivity.
 Reduces ability to borrow and so access to credit for firms or households — reduces
investment into business or some household spending channels.
 Reduces household spending on agricultural land — limits spending on fertilisers,

tree planting etc. and so reduces improvements in agricultural productivity.
 Discourages household spending on housing improvements (land cannot be used as

collateral for loans) — reducing their living standards.
 Weaker property rights for women lead to gender inequality — less ability to empower
women through individual private tenure of land etc.

1 Knowledge and understanding for definition of HDI — 1 mark for any correct dimension:
Geometric mean of three equally weighted dimensions (1 mark): life expectancy at birth;
mean and expected years of schooling; GNI per capita.
Application (1 mark): country and use of HDI data, e.g. Democratic Republic of Congo
lowest HDI 0.286 or Niger 0.295.
Analysis (3 marks):
Advantages (up to 2 marks for ONE):
Broader measure of development than just standard of living represented by GNI per
capita; inclusion of education and health measures reflects access to and quality of public
services; UN collects data and free from bias; data collected regularly and so easy and
cheap to compile.
Disadvantages (up to 2 marks for ONE):
Only captures part of human development and so excludes other factors such as
inequalities, e.g. between income groups, genders or regions, poverty levels, human
security, political freedom, etc.; development is a normative concept and so maybe other
factors should be measured or different weightings given to each dimension, e.g. GNI per
capita may be significant for low-income countries; changes to the quality of education and
healthcare can take time to be reflected in changes in life expectancy or living standards.
2 Application (2 marks), e.g. use of problems in Indonesia or other relevant problems or

countries.
Knowledge and understanding (2 marks) (1 + 1) for TWO benefits.
Analysis (2 marks) for explanation linked to Extract 2 (1 + 1):
Possible explanations might be:

 Transport costs fall (lower fuel costs) — so reducing production costs and increasing
price competitiveness.
 Impact on delivery speed and non-price competitiveness of exports.
 Encourages FDI — perhaps firms are more likely to invest in more competitive and
high-tech ports in China, Korean and Japan.
 Raw material and intermediate good imports are faster to arrive — saving businesses
time and money in supply chain management/storage costs and reducing cost-push
inflationary pressures.
 Promotes potential growth — with the resulting outward shifts in aggregate supply.
 Multiplier effects of infrastructure construction and greater derived demand for labour
leading to lower unemployment and higher living standards.
 Promotes tourism and so benefits from sectoral change/exports with higher income
elasticity of demand.
 Improves geographical mobility of labour — lower structural unemployment.
 Aggregate demand and multiplier effects.
 Electricity, water supply and sanitation directly impact living standards.
 Impact of irregular electrical supply, e.g. on local businesses and farms or living
standards of households and/or costs of generating electricity by generator, e.g.
opportunity costs of higher costs on hospitals using generators, such as fewer
operations or less spending on drugs.
 Extent of the growth promotion — which depends on other complementary factors

that might promote growth, e.g. the quality of human capital and level of capital per
worker.
 Time lags — policies may be implemented to improve infrastructure but time is

needed to plan and construct new ports etc.
 Financing new infrastructure is expensive with resulting impacts on government

finances.
 Maintaining infrastructure is also expensive and necessary to avoid capital

depreciation.
3 KAA (8 marks):
Application: use of Extract 1, e.g. 13 economies have grown at an average rate of 7% or

more for at least 25 years. Botswana, Brazil, China, Hong Kong, Indonesia, Japan, South
Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand; investment at least 25%
of GDP, with 5–7% investment into infrastructure and 7–8% of GDP spent on education,
training and health.

Analysis might include: promoting manufacturing/industrialisation — Lewis model;

increase in savings — Harrod–Domar model; aid; debt relief; promotion of FDI; supply-side
policies; microfinance; outward-looking strategies.
 External costs of industrialisation
 Savings gap could be filled by external finance
 Problems associated with aid such as moral hazard
 Impact of debt relief on future credit, aid flows, etc.
 Prioritisation of strategies or delays before strategies affect growth
4 KAA (6 marks):
Application, e.g. oil 95% of exports, 70% of total government revenue and 46% of GDP.
 Buffer stock diagram with:
o labels showing quantity bought at low prices and/or released at high prices
o area of government spending or revenue gained from sales
 Analysis of how buffer stock minimises price fluctuations — refer to intervention when
supply is limited and prices above ceiling price and when supply is too great and
prices fall below the floor price.
 Difficulties in setting the correct ceiling and floor prices — asymmetric information or
problems with trying to satisfy both oil-producing firms and consumers.
 Development of point above, e.g. lobbying by oil producers may mean floor prices are
too high and the government has always to buy excess supply, possibly leading to
government failure.
 Costs of financing the scheme, e.g. opportunity costs of government spending or

impact on public finances.
 Need to include other oil producers to affect global oil prices or risk of possibly
cheaper oil imports undercutting floor prices.
5 KAA (9 marks):
Application: reference to commodity exporters, e.g. Zambia and copper; Ivory Coast and
cocoa.
Analysis points might consider: volatile revenues deter investment and limit productivity
growth; Prebisch–Singer — decline in terms of trade; price volatility, due to price-inelastic

supply and demand, leads to big changes in living standards; lack of access to developed
countries’ export markets; links to corruption and conflict; Dutch disease.
 Gains from comparative advantage.
 The significance of effects varies from agriculture to metals to energy.
 Recent commodity price boom.
 Other factors might exacerbate the problem or be more significant.

6 KAA (16 marks):
Lower labour productivity — so lower potential growth; lower wages — so increased

poverty levels; risks of poverty trap — so savings gap, which constrains growth and
development; discourages FDI — so less likely to have benefits of job creation, for
example; less occupationally mobile labour force — so higher structural unemployment is
likely if the economies suffer shocks; less internationally competitive as unit labour costs
are higher — risks current account deficits.
 Complementary investment into physical capital and infrastructure could offset the
problems or be a more significant constraint.
 Low wages may mean unit labour costs are still low and the economy internationally
competitive.
 Role of World Bank and donors in helping to provide aid to overcome this problem.
 Growth through comparative advantage and trade may still be possible, e.g. primary
products (Nigeria’s oil export earnings in 2012 were $93bn), which provide tax
revenue to improve provision in the future.
7 KAA (16 marks):
Analysis points might include: tourism is a significant way to increase growth.
Award application to specific countries or examples, e.g. the Maldives, where tourism
accounts for about one-third of GDP and about two-thirds of foreign exchange earnings.
 Creates export-led growth — income-elastic service exports with particular increase

in demand from emerging economies.
 Direct job creation — in hotels, tourist sites, construction, etc. Indirect job creation
through local multiplier.

 Attracts MNC hotel chains — prospect of profits raises MEC and encourages
domestic investment.
 Better infrastructure, such as airports, ports and roads — spillover benefits for local
industry, e.g. improved roads reducing business costs, increasing geographical
mobility of labour.
 Vital source of tax revenue — to fund improved public services, e.g. indirect taxes on
tourists and additional taxes on high-end hotels and restaurants.
 Source of foreign exchange — which allows essential imports to be maintained.
 Sector rebalance — as allows diversification away from primary products and into
higher-productivity areas.
Analysis points might include: other factors are more significant sources of growth:
 Aid, debt relief, greater levels of FDI, trade liberalisation, etc.
 But high income elasticity of demand means risks of over-reliance on tourism due to
external shocks.
 But the size of the multiplier (= 1⁄MPW) may fall as tourists demand imported goods,
large MNC hotels repatriate profits and foreign managers remit wages.
 But investment into an area/purchase of holiday homes can lead to pressure on local
housing costs and lead to collapse of local community life, as economic opportunities
are limited.
 But can lead to large external costs — damage to local and cultural environment and
displacement communities.
8 KAA (16 marks):
Use of examples and application to a country should be included.
Analysis points might include: must show implicit understanding of factors linked to
development, e.g. impact on HDI. Problems of primary product dependency; corruption;
poor governance; debt; disease; demographic changes; human capital inadequacies.
 Differing impact from different primary products, e.g. energy versus agriculture.
 Problems differ between countries or regions.
 Significance of constraints or interconnected nature of many constraints exacerbates

the problems.
 Successful intervention of policies or aid etc. to mitigate the problems.

9 KAA (16 marks):
Analysis points might include — must refer to aid and debt relief:
Aid:
 Aid represents an injection of resources, which fills the savings gap and therefore
allows investment and potential growth.
 Aid can help to cover the foreign exchange gap when countries struggle to finance
their current account deficits, therefore promoting trade/allowing import of essential
capital, medicines, etc.
 Aid can supplement government finances and so be spent on supplying essential

public and merit goods, e.g. new schools or training for doctors to fight disease.
 Aid enables infrastructure changes to be made, e.g. roads or greater access to

power, or clean water, helping attract FDI.
 Aid enables payment of interest on foreign debt. Aid allows transmission of new
technology, ideas, etc.
Debt relief:
• Application to any country and specific debt forgiveness example (2 marks), e.g.
Guinea $2.1bn in debt relief from the World Bank and the IMF heavily indebted poor
countries (HIPC) initiative.
• The opportunity costs of debt service are huge. The funds not spent on debt relief can
now be spent on areas that promote growth and/or development e.g.:
o investment into infrastructure or foreign capital can be used to purchase

essential capital imports
o spending on improving human capital by increasing healthcare provision or

education
o spending on poverty eradication
o spending on reducing environmental degradation
• This breaks the cycle of debt as many debts are often serviced or repaid through
further borrowing, therefore perpetuating low levels of development.
• Debt cancellation can be tied to conditions such as low levels of corruption, economic
reform and liberalisation of markets. Therefore debt relief acts as an incentive and
encourages development.
Evaluation of aid:
Aid is spent on current spending (rather than capital) such as public sector wages or can

lead to corruption, undermining institutions’ legitimacy and fuelling conflict. Aid repayments
have an opportunity cost — debt servicing will become a problem if GDP does not rise fast
enough to allow comfortable repayment. Aid can encourage dependency and allow poorly
governed countries to continue to waste money on showcase projects, the military or
consumption. Aid can suffer from diminishing returns. Aid can cause Dutch disease,
making exports uncompetitive. It can also distort the market, with excessive bureaucracy
and cheap supplies undermining local business.
Evaluation of debt relief:
• Debt cancellation can encourage more irresponsible borrowing, as debts do not have
to be repaid — moral hazard. Countries may choose to borrow more money with little
financial accountability.
• Funds that were intended for debt service are squandered and therefore fail to
improve economic development. Risks of corruption mean the benefits are uncertain.
• Debt cancellation costs those who were owed the money and so the lack of
repayments may limit their ability to offer future loans to other developing countries or
to spend on their own public services.
• Failure to repay loans may damage developing countries’ credit rating and so their
ability to take new loans or attract more foreign investors.
• Debt may not be the most significant constraint on growth and development. Other
initiatives may be more successful in increasing development, e.g. more FDI, better
governance, etc.
• There are alternative approaches to debt relief such as rescheduling debt.
• Qualifying for debt relief takes time, during which poverty continues, and some
countries may not qualify, yet they are in great need of support, as they do not meet
HIPC requirements such as stopping civil war.
• Debt relief may become only short-term and isolated help for a country.
• Debt relief may cause foreign aid flows to be cut as loan repayments are not recycled
into aid or aid is redirected to other countries.
• Debt relief may be granted but fail to be fully delivered for a substantial period of time.

TOPIC 4 Monetary policy and the financial sector
Topic 4
Monetary policy and the financial
sector
Role of financial markets and market
failures
1 Any three from:
1 Facilitate saving Allows households to save for retirement or unexpected income

shocks and allows for increased bank deposits to fund domestic
investment
2 Lend to firms and Helps reduce borrowing costs and allows firms to finance
households investment and households to buy durable goods and houses
3 Reduce risks and Futures or contracts for future delivery can be paid for to
promote confidence in guarantee future prices for buyers and sellers of commodities
commodity markets and so avoid the problems of price volatility
4 Provide a market to Allows households to store wealth and receive dividends as an

trade equities income; allows firms to raise funds for investment through initial
public offerings (IPOs) or new equity through secondary offerings
2 Any three from:
Point Linked development and example
1 Lack of perfect Financial products are often complex and difficult for customers to
information understand, e.g. pensions — consumers buy them many years
before they retire and then may find out their fund does not
provide sufficient income
2 Asymmetric Complexity of financial products means sellers may know more

information than buyers (lemons problem), e.g. Payment Protection Insurance
(PPI) leading to mis-selling and possibly adverse selection

3 Systemic risk Interlinkages between banks and financial institutions means bank
externalities runs can spread as confidence in all banks starts to fail
4 Market rigging and Attempts to manipulate the price of a product, often through
the abuse of market collusion, to alter its price and so gain profits, e.g. LIBOR scandal
power
5 Bubbles and herding Speculators can copy each other’s behaviour and so buy assets
simply because others also are. This can lead to bubbles — when
an asset’s value does not reflect its underlying value — and
dramatic and unexpected asset price falls
3 KAA (8 marks):
Application to specific countries and examples of financial products, e.g. the International
Monetary Fund (IMF) financial development index data — mean in advanced economies
0.55, emerging markets (EM) 0.23 (2013); private credit 50% of gross domestic product
(GDP) in EM compared to 130% in advanced economies; stock market capitalisation 40%
of GDP in EM vs 70% GDP in advanced economies.
Analysis of benefits for growth might include:
 Increases saving — link to Harrod–Domar model
 Positive feedback between increasing entrepreneurship and rising growth and the
need for financial services
 Allows firms to raise funding for capital investment outside of the banking system, e.g.
equities and corporate bonds, and so greater access to foreign direct investment
(FDI), e.g. mergers and acquisitions
 Efficient system of allocating capital to the most productive uses
 Monitoring investment and exerting corporate control, e.g. standards expected for
publicly listed companies and shareholder activism
 Typically associated with higher household credit, and so more borrowing to fund
purchase of durable goods or houses, leading to wealth effects or consumption-led
growth
 Risk transformation — spreading of risks associated with one lender reduces

exposure to defaults and improves resilience of the banking system
Analysis of disadvantages for growth might include (these could be used for evaluation):
 Rising financial market development associated with increasing occurrence of

banking crises leading to bank losses, confidence falls, credit constraints, etc.
 Promotes risk taking and leverage (particularly if poor regulation)
 Buoyant financial services sector may lead to Dutch disease and a diversion of
human capital away from other productive sectors

 Marginal returns to growth from further financial development diminish at high levels
of financial development.
 Trade-offs between financial development and growth and stability (although this
depends on the nature of regulation).
 The pace of financial development is important — faster pace leads to more

instability.
 Financial market stability and consequences for growth depend on the proportion of
retail versus institutional investors.
4 KAA (9 marks):
Application, e.g. reference to Northern Rock nationalised Feb 2008; split into two
companies in Jan 2010, Northern Rock plc (bank) (later sold to Virgin Money in 2011) and
Northern Rock (asset management) plc.
Analysis points (for nationalisation):
 As part of a package of measures to provide stability for the financial system during
the financial crisis — injection of capital as capital ratios inadequate (holding more
illiquid assets but less financially resilient); a lack of capital would lead to credit
constraints and resulting impact on investment and consumption and so both
aggregate supply and demand.
 Reduce the risk of runs on the banking system — crisis of confidence could lead to a
lack of liquid assets as banks lack ability to repay every depositor in the short run.
 Systemic risk avoided as banks lend and borrow to each other to meet short-term
liquidity requirements.
 Collapse of Northern Rock and other banks would lead to the loss of savings with
resulting impact on pensioners’ living standards or household wealth and
consumption.
 Weakened banking system would also reduce access to credit for firms and so curb
investment.
 Collapse of banks would impact employment directly and also indirectly through
negative multiplier.
 Banks are a key service sector export for the current account and so a weakened
banking system could worsen the current account deficit.
Analysis points (against nationalisation) — these could be used for evaluation:
 Moral hazard — deters other banks from pursuing lending to riskier borrowers or
taking excessive risks with high leverage ratios or the purchase of risky financial
products.

 Promotes stability in the housing market if banks less likely to lend to sub-prime
borrowers.
 Allows banks to gain profits when high-risk strategies pay off but then not rely on
taxpayer support when they fail — avoiding the resulting negative impact for public
finances.
 Creative destruction (Schumpeter) — part of cleansing the banking system and

allowing reallocation of resources to more efficient banks.
 Depends on the size and importance of the bank, e.g. its market share or its wider
linkages with the financial system.
 Depends on the wider performance of the UK economy.
 Depends on the wider resilience and strength of the banking system.
 Depends on whether the bank is purely domestic or has a global operation that could
be used to support itself.
Role of central banks

5 Application (2 marks) — examples of a central bank and specific actions, e.g. in the UK,
the Bank of England’s Monetary Policy Committee (MPC) sets interest rates in order to
achieve a 2% inflation target.
Knowledge and analysis (3 marks) points might include:
 Sets interest rates and controls the money supply in order to achieve price stability
 Manages the government’s finances
 Lender of last resort — banker to the banks
 Oversees the soundness of the financial system — macro-prudential regulation (PRA

in UK)
 Operates an inter-bank payment system
6 Application (2 marks), e.g. reference to a specific country, e.g. European Central Bank
(ECB) (6 and 18 central bank governors of Eurozone members) independent from
Eurozone governments.
Analysis 2 marks for linked analysis (1 + 1):
 Delegating responsibility reduces scope for short-term political considerations (e.g.

focus on growth promotion without worrying about long-run inflationary
consequences) and adds credibility with economic expertise.

 Members of committee publicly accountable for their votes, e.g. communicate the
trade-offs inherent in making their decisions.
 Pre-announced meeting cycles encourage early action to counter inflation and so the
size of future interest rate rises.
 Public understanding encouraged by regular and open communications through

minutes, Inflation Report and speeches by MPC — in the UK, an open letter is written
to the chancellor if the inflation target is not met.
 Clear and credible inflation target.
 Engenders confidence in meeting inflation target and so reduces inflationary

behaviour, e.g. wage increases.
 Disadvantages, such as: quantitative easing (QE) has led to purchase of government
bonds and so helped it borrow at a lower cost.
 Government control of interest rates might have led to greater focus on growth and
employment and so more rapid recovery from the financial crisis.
 Increasing power of central banks without democratic accountability.
7 Application (2 marks), e.g. UK’s 2% inflation target.
Knowledge and understanding (2 marks) (1 + 1) for ONE argument for and ONE
against.
Analysis 2 marks for linked explanation (1 + 1):
Possible reasons for inflation target:
 Anchors inflationary expectations and so wage bargaining behaviour even if inflation

departs from its target value.
 Stable inflation prevents more dramatic changes in interest rates and so promotes
more stability and investment.
 Other benefits of low inflation, e.g. improved competitiveness.
 Improves transparency of central bank operations and so predictability of future path

for interest rates — this in turn improves confidence and so investment.
 May mean asset price bubbles are avoided, as high inflation is often associated with
them.
Possible arguments against inflation target:
 Goodhart’s Law — inflation target will become a poor indicator of the economy, as it
will change inflationary expectations and so feed into successfully meeting the target.

 Supply shocks will change inflation but demand-side monetary policy may be
ineffective at dealing with this and lead to undesirable trade-offs with growth and
employment.
 Use of short-run Phillips curve suggests trade-off with higher unemployment.
 Sacrifices focus on other objectives such as growth, e.g. ECB slow to cut interest
rates in response to the financial crisis.
 Successful inflation targeting depends on the quality of forecasting (due to time lags
of monetary policy affecting the real economy).
 Low inflation in the global economy due more to globalisation and the rise of Asia
than to successful monetary policy inflation control.
 Targets might be a hybrid with other aims, such as supporting other government
objectives or allowing inflation to deviate in the short term in order to prioritise other
aims.
 Difficulties in choosing the correct price level measure to target.
Monetary policy
8 Application (2 marks) e.g. CPI inflation 1.9% in Q1 2019 (Bank of England), GDP growth
0.2% Q4 2018 (ONS)
Knowledge and analysis (1 mark + linked analysis 2 marks) might consider:
 Demand-pull (dis)inflation (a shift in AD) might be caused by:
o Consumption growth rose at 0.3% in 2018, perhaps due to consumer

confidence over job security and low unemployment, or due to real income
rises, leading to higher demand-pull inflation.
o Falling investment (fell 0.9% in Q4 2018), perhaps due to Brexit uncertainty

and/or slower global growth, leading to lower demand-pull inflation.
o Falling net trade — the current account deficit widened to 4.4% GDP in 2018
Q4 — perhaps as imports from the EU rise as firms stockpile, or exports fall
to global economy as global growth slows, leading to lower demand-pull
inflation.
 Cost-push inflation (a shift in SRAS or LRAS) might be caused by:
o Growth in potential supply capacity — slower net migration will reduce labour
supply growth and/or weak productivity growth will cause cost-push inflation.
o Sterling’s Brexit-referendum-related depreciation will raise import prices and

so shift SRAS inwards to the left and so lead to cost-push inflation.

o Unit labour costs will rise, perhaps as wage growth rises as unemployment
falls, and/or productivity growth remains weak, shifting SRAS inwards and
leading to cost-push inflation.
o Rising oil prices, which affect petrol prices, and production and transport
costs, have shifted SRAS inwards and so have led to cost-push inflation.
9 Knowledge and analysis (1 mark + linked analysis 2 marks) might consider:
 Promotes confidence due to more predictable future costs and revenues and so
profits from investment. Greater investment will add to the capital stock and so shift
LRAS outwards, causing growth.
 Low and stable prices will improve UK’s relative competitiveness, therefore increasing
net exports and so AD, leading to higher real output and so growth.
 Low inflation keeps inflationary expectations low and so prevents wage–price spirals
raising firms’ costs and so deterring investment or FDI, etc.
Application (2 marks), e.g. UK inflation target 2% ± 1%.
10 Application (2 marks), e.g. UK’s QE £375bn.
Knowledge and understanding (2 marks) (1 + 1) for TWO transmission mechanisms.
Analysis (2 marks for linked explanation to growth) (1 + 1). Possible explanations might
be:
 A central bank purchases government securities from banks and financial institutions.
This increases the amount of cash in circulation or increases the money supply (as
the private sector receives cash from the bank in exchange for the bonds). This
causes an increased demand for bonds and so a rise in their price and a consequent
fall in their yield. This lowers other interest rates and so encourages private
investment.
 Financial institutions receive cash in exchange for selling their bonds. They will then
rebalance their portfolios and so invest into other assets such as equities and
corporate bonds. This will drive down borrowing costs in other markets.
 Bonds and other assets will increase in price and demand for them is increased. This
will lead to a positive wealth effect.
 QE leads to lower interest rates and so hot money outflows. This will lower export
prices and so increase export revenue and so AD.
 It may lead to demand-pull inflation and so reduce competitiveness.
 Higher asset prices risk bubbles and aggressive policy responses or sudden
contractions and confidence falls.

1 Application (up to 2 marks):

 In June 2014 (1 mark), the ECB (1 mark) charged banks 0.4% (1 mark)
 Policy interest rates near zero (1 mark)
Knowledge (2 marks):
 Definition/implicit understanding of interest rates, e.g. the interest rate is the overnight
lending rate on loans and deposits from a central bank to commercial banks (1 mark);
interest rate is the price of credit (1 mark)
 Commercial banks must pay to have the central bank keep their deposits (1 mark)
 Allows (nominal) interest rates to go below zero (1 mark)
Analysis (1 mark):
 Increases bank lending (1 mark)
 Reduces cost of borrowing for firms and consumers (1 mark)
 Reduces bank profits (raises costs of deposits or borrowing) (1 mark)
2 Application (2 marks):
 Europe, with much higher levels of social insurance and taxation, has correspondingly
stronger automatic stabilisers than does the USA or Japan.
 In the 2008–9 recession, automatic stabilisers could have ironed out 13% of the drop
of GDP in the euro area.
Knowledge and analysis (4 marks) (1 + 1) and (1 + 1) for TWO transmission

mechanisms on how they might promote economic growth.
 Fiscal policy is automatically expansionary (1 mark) and there is no time lag for the
introduction of higher discretionary spending and/or lower rates of tax (1 mark).
 During a recession, tax revenues tend to reduce (1 mark):
o as incomes fall — progressive income tax systems will lead to lower tax
revenues (1 mark) and hence smaller leakages from the economy (1 mark)
o as profits fall and hence corporation tax revenues falls (1 mark)
 During a recession, government expenditure tends to rise (1 mark) as unemployment

benefit payments rise (1 mark).
Evaluation (2 marks) or (1 + 1) — could consider why growth is not promoted:
 Larger budget deficits may lead to crowding out of private sector investment
 Depends on the size of the government
 Depends on the size of unemployment benefits
 Depends on the size of the multiplier


 Depends on the current levels of national debt and budget deficits, e.g. countries with
higher debt are more likely to introduce discretionary spending cuts as tax revenues fall
3 KAA (8 marks):
Note: level-based marking; must link to macroeconomic effect or cap L2 5/8
 Application, e.g. countries that experienced banking crises suffered a 4 percentage

point higher output loss during 2011–13; corporate failures and employment losses
undermined the ability of borrowers to service their loans, spiralled back to sap bank
balance sheets, forced banks to retrench credit further.
 Bank balance sheet stress tests: test bank resilience to shocks, e.g. severe
recessions, or falls in house prices. Helps microprudential regulators check that
individual banks can continue to provide services, e.g. credit to households. Helps
macroprudential regulators see how shocks affect many banks. A reduction in credit
will further reduce expenditure and so increase the severity of recessions and the
likelihood of bank losses on outstanding loans.
 Government guarantees of banking sector liabilities: ensure depositors receive a

minimum repayment and hence reduce bank runs. This reduces the need for banks to
sell assets or recall loans and so ensure lending is maintained and hence investment
and consumption are not reduced.
 Purchases of toxic assets from banks: if banks have a mix of good and toxic assets
then asymmetric information means investors are likely to sell equity and banks will
be less able to raise capital and continue to lend and borrow.
 Capital injections: in return for equity, banks receive cash to restore the ratio of capital
to losses on risky loans (health of balance sheet).
Note: level-based marking
 Stress testing may be focused on shocks to the UK economy and not capture
external shocks affecting bank operations in other countries.
 Greater government guarantees of banking sector liabilities can lead to moral hazard
and encourage bank risk taking.
 Purchases of toxic assets from banks are expensive for the government —
consequently likely to worsen government finances/opportunity costs in the context of
fiscal austerity.
 Capital injections are costly; additional capital may be used to expand lending or
reinvested unwisely into high-risk assets.
4 KAA (6 marks):
Note: level-based marking; must link factors to output and have TWO factors or cap L2
(4/6)

 The absence of an independent nominal exchange rate: countries using the euro,
which suffered negative demand-side shocks, were unable to boost net exports and
AD through a depreciation in their exchange rate.
 Fiscal stress: countries using the euro, which had large current account deficits, e.g.
Ireland, Portugal, Spain and Italy, relied on foreign capital to cover their savings–
investment gap. Foreign investors became wary of lending to such countries and this
increased borrowing costs for both banks and government, leading to large increases
in budget deficits and national debt. Austerity measures were introduced, which
depressed AD.
 Lack of a fiscal backstop: banks in the Eurozone, e.g. in Ireland, were large compared
to GDP and poorly capitalised. In 2007, Irish bank debt was 700% of GDP.
Governments had to bail them out but there was no central fiscal fund to support
them. Again, austerity measures were introduced, which depressed AD.
 Burden of adjustment after the crisis fell entirely on domestic prices and output:
Eurozone countries were unable to reduce trade deficits and improve competitiveness
through their own floating exchange rates. Competitiveness had to be improved by
internal devaluation through wage and price disinflation. This weakened AD and
hence output.
 ECB intervention, such as 2012 outright monetary transactions, did reduce investor
concerns and lower bond yields and borrowing costs across the Eurozone.
 European Stability Mechanism was set up to provide emergency loans and lent
money to Greece, Ireland, Portugal and Spain, helping to alleviate the earlier
problems of fiscal stress and the lack of a fiscal backstop.
5 KAA (9 marks):
Note: level-based marking; must refer to both helicopter money and raising inflation targets
or cap L2 (6/9)
Allow analysis marks for arguments in favour of the policy proposal and evaluation marks
for arguments against it OR vice versa
Application — extract 2 and own knowledge:
 Inflation target of ‘roughly 2%’
 ‘Policy interest rates near zero in most advanced economies’
 Abenomics — in 2013, the Bank of Japan announced a new 2% inflation target
Analysis of reasons for and against ‘helicopter money’ might consider:
 Central bank creates money and uses this to fund larger budget deficits, thereby
funding higher levels of expansionary fiscal policy, and hence higher levels of
aggregate demand and growth. Analysis could consider the merits of higher
government spending or tax cuts.

 But would require coordination of independent central banks and government,

raising political debate over whether tax cuts or spending would be more effective
— e.g. the US government shut down for 35 days in 2018/19 when the national
debt ceiling was reached.
 Central banks create money and transfer this to private household’s bank
accounts. Consumption should increase, either due to a positive wealth effect or
higher disposable income, leading to greater levels of aggregate demand.
 But governments may become used to this policy and be reluctant to give it up,
breaking central bank credibility and allowing unelected central bankers to
influence politically driven fiscal measures.
 Unlike QE, the electronic creation of money is not used to buy an asset, such as
government bond, and also carries an opportunity cost — issuing money does
generate profits in the form of either debtors’ interest payments or coupons
received from government bonds.
Analysis of reasons for and against raising inflation targets might consider:
 Low nominal interest rates and low inflation mean real interest rates even lower
and hence central banks have limited ability to lower interest rates further to
promote spending and economic growth.
 But central banks could use other monetary policies, such as negative interest
rates, further QE and clarifying their future commitment to expansionary policies
(forward guidance).
 In order to avoid risks of higher unemployment — according to the idea of secular

stagnation, negative real interest rates are needed to equate saving and
investment with full employment.
 But higher inflation rates can deter long-term investment decisions, as the range of
price changes will be larger, making future decisions over saving and the
profitability of investment more uncertain.
 Current rates of low inflation risk deflation and higher real value of debt,
exacerbating the risks of recession
 But changing inflation targets would damage the credibility central banks have
gained in anchoring inflation expectations, e.g. risking wage-price spirals.
6 Application (2 marks) — correct use of Table 2 data from 2014 Q2 and 2015 Q2 for
first time-house purchases (1 mark) and for remortgage (1 mark).
Knowledge and analysis (3 marks):
 Correct calculation of annual percentage change for first-time house purchases:

(20.66 – 22.06)/22.06 × 100 = −6.35%
 Correct calculation of annual percentage change for remortgage: (26.17 –

24.10)/24.10 × 100 = +8.59%
7 Application (2 marks), e.g. deflationary countries such as Japan.

Analysis 2 marks for explanation linked to Extract 3 (1 + 1). Possible damaging effects
might be:
 Definition/understanding of deflation, e.g. a sustained fall in the general price

level/negative inflation rate.
 Deters consumer spending as households wait for the prices of goods and services to
fall in the future.
 Increases real value of debt and debt repayments, leading to lower disposable
income and consumption, or profits and investment.
 Real wage unemployment as real wages rise but nominal wages are sticky and do
not fall to restore the labour market to equilibrium.
 Lower consumption and higher unemployment can lead to falling AD and so falling
profits for firms. Firms will cut costs to maintain profits, leading to negative multiplier
effects and further unemployment and deflation.
 Real interest rates increase — raises borrowing costs and encourages saving. This
reduces the expansionary impact of low interest rates and QE on growth and
employment.
 Net savers will benefit from higher real interest rates and more higher real wealth or
incomes.
 Improves competitiveness and so the current account of the balance of payments.
 Impact depends on the cause of deflation — falling AD more harmful than increasing
LRAS, which should also raise real incomes and lead to faster growth/employment.
8 KAA (8 marks):
Application — use of Table 2 such as the fall in residential loans for house purchase from
70.10% in Q2 2014 to 67.71% in Q2 2015 (3.4% fall) or a rise in the number of
remortgages (24.10% to 26.17%).
 Transmission mechanisms of low interest rates through consumption, investment and

net exports (each counts as a separate point)
 Use of QE
 Use of other unconventional monetary policies, e.g. UK’s funding for lending scheme
 Use of Extract 3, e.g. debt overhang means continuing weak consumer demand; the
real return on new investment may collapse. Central banks’ quantitative easing has
had mixed success. Weak aggregate demand caused by ageing populations that

want to consume less and the increasing income share of the very rich, who are
unlikely to increase their already-large consumption.
 Depends on access to credit and/or demand for credit
 Depends on real interest rates
 Risk of liquidity traps
 Time lags for monetary policy to affect spending
 Ceteris paribus — offset by contractionary fiscal policy or slow global growth
9 KAA (6 marks):
Application e.g. use of extract such as ‘weak aggregate demand caused by ageing
populations that want to consume less’; ‘increasing income share of the very rich, who are
unlikely to increase their already-large consumption’.
Analysis of secular stagnation might include:
 Definition/understanding of secular stagnation — negative real interest rates needed

to equate saving and investment with full employment.
 Problem of interest rates reaching zero lower bound.
 Low real interest rates can mean further shocks may need to be corrected with
negative interest rates; furthermore, low real interest rates can increase investors’ risk
taking and undermine the financial system.
 Concerns that productivity growth has slowed as the pace of technological progress
may have also slowed — this limits growth in LRAS and potential output.
 Firms and households paying off debt and so reducing AD; if new savings do not find
profitable investment then growth will fall and may suffer the paradox of thrift.
 Risk of hysteresis as unemployment suffered in recession is not fully reversed and

leads to skill atrophy and weaker potential growth.
Allow analysis of other factors causing slow growth: fiscal consolidation, deflation, poor
infrastructure, etc.
 Pro-growth policies could be employed, e.g. expansionary fiscal policy or supply-side

reforms
 Raising retirement ages to reduce saving
 Significance of different possible causes of slow growth
 Differences in performance between countries and regions
10 KAA (9 marks):

Application — reference to specific countries and fiscal and monetary measures, e.g.
responses to the Great Recession:
 In the UK, the MPC cut the base rate from 5.75% in 2007, eventually to 0.5% by
March 2009. Fiscal boost amounted to 2.2% of GDP, including a VAT cut, spending
on infrastructure for schools, hospitals and green energy, and training help for the
unemployed.
 In the USA, the Federal Reserve cut interest rates from 5.25% in 2007 to 0.25% by
2008. Obama signed a stimulus plan worth almost 6% of GDP, mixed between tax
cuts for businesses and spending on health, education, social security and
infrastructure.
Analysis points might consider (must link to growth):
 Analysis of monetary policy measures through consumption, investment and net

exports and so AD
 Analysis of QE
 Analysis of fiscal policy measures, e.g. indirect tax cuts increasing real incomes or
increases in government spending
 Analysis of supply-side impact of fiscal policy, e.g. potential output affected by

spending on education and health
 Impact of multiplier
 Comparisons between the effectiveness of monetary and fiscal policy, e.g. risks of
liquidity traps or pressure on governments to introduce fiscal consolidation to prevent
crowding out etc.
 Time lags before different polices are implemented and feed through to growth
 Uncertainty over the size of the multiplier effect
 Depends on the elasticity of LRAS and the size of output gaps
Exam-style question (essay)

11 KAA (16 marks):
Analysis points might include (must include both monetary policy and regulation to reach
Level 3 KAA):
 Interest rate cuts, e.g. in the UK, the Bank’s MPC cut the base rate from 5.75% in
2007, eventually to 0.5% by March 2009. Analysis of transmission mechanisms to AD
and the consequences of the Great Recession, such as rising unemployment.

 Use of QE, e.g. in the UK between January 2009 and November 2012, the Bank
injected £375bn in three rounds of QE, and money created was used to buy
government bonds; resulting analysis of lower bond yields and so interest rates or
financial institutions portfolio rebalancing.
 Use of other monetary policy measures, e.g. in the UK, the Discount Window Facility
(DWF) allows banks to borrow government bonds against a range of collateral for up
to 3 years. Banks can then lend these bonds in return for liquidity.
 Other UK measures include: Special Liquidity Scheme in April 2008; Funding for
Lending Scheme; extended collateral 3-month long-term repo operations.
 Macroprudential regulation, e.g. in the UK, the Financial Policy Committee (FPC)
whose primary role is to identify, monitor, and take action to remove or reduce risks
that threaten the resilience of the UK financial system as a whole. This can help avoid
the uncertainties and loss of confidence associated with the Great Recession due to
widespread worries over the negative effects of sub-prime assets on interconnected
markets and financial institutions.
 Demand for credit limited the positive impacts of low interest rates on spending, e.g.
low consumer and business confidence.
 Banks forced to increase capital requirements and meet leverage caps (Basel III)
made banks more risk averse and restricted credit supply and raised borrowing costs
for small and mid-sized enterprises (SMEs) and borrowers without large collateral.
 Failure of Lehman Brothers in 2008 and nationalisation of some banks meant

macroprudential regulation was introduced too late and it is difficult to test its
effectiveness.
 For macroprudential regulation to work, coordination is needed globally to ensure the

interconnections of significant financial centres do not generate systemic problems or
capital flow to those centres with the most lax regulatory framework.
 Fiscal policy may also be needed, e.g. in the UK, the October 2008 Credit Guarantee
Scheme made £250bn available for inter-bank lending and in January 2009 the Asset
Protection Scheme allowed institutions to insure themselves against future losses on
some assets, e.g. collateralized debt obligations (CDOs).

TOPIC 5 Role of the state in the macroeconomy
Topic 5
Role of the state in the macroeconomy
Fiscal policy: public expenditure, taxation,
public sector finances
Public expenditure
1 Application to a country and example (2 marks), e.g. in the UK the top rate of income tax, 45%.
Knowledge and analysis (up to 3 marks): demand management to achieve macroeconomic

objectives, e.g. to increase the rate of sustainable growth and create employment; to maintain
sound public finances in the medium term; to raise revenue to fund government spending; to
reduce market failure, through the provision of merit and public goods and taxation of demerit
goods; to redistribute income and wealth.
Current Government spending on goods and Medicines for the NHS

expenditure services such as wages for public
sector employees
Capital Government spending on assets or New schools or hospitals

expenditure capital goods
Transfer Government payments that do not Jobseeker’s Allowance (JSA) and

payments contribute directly to output pensions
3 Answers will depend on the country chosen.
4 KAA (9 marks):
Application — reference to a country, e.g. UK’s government spending fell from 49.6% of gross
domestic product (GDP) in 2009 to 43.2% in 2015 and 36.7% in 2017.
Analysis of effects (positive and/or negative, e.g. impacts on macroeconomic objectives) and may
consider either rise or fall of government spending as a share of GDP.
A fall in government spending as a share of GDP might consider:
 A fall in government spending as a share of GDP will help the government reach its target of
balancing the budget by 2025–26 or a structural deficit below 2% of GDP by 2020–21.

 A fall in government spending implies a smaller budget deficit and so reduced borrowing and
perhaps a fall in national debt as a share of GDP or various benefits such as less crowding
out, improved credit rating, lower opportunity costs of debt service, etc.
 A fall in government spending could be a symptom of faster economic growth — due to

automatic stabilisers and falls in spending on JSA as unemployment also falls.
 A fall in government spending implies spending cuts, fewer public sector workers and
negative multiplier effects, leading to higher unemployment.
 A fall in government spending might mean less capital spending, leading to worse-quality
health and education services and so weaker productivity, or depreciation of infrastructure
and so lower potential growth.
 A fall in government spending implies cuts to welfare, e.g. benefit cap or less spending on
public services and social housing. This may widen income inequality.
 A fall in government spending as a share of GDP might imply a larger share of the economy
for net exports or private investment and so more productive/efficient use of resources and a
more diversified economy.
 Changes in the pattern of government spending and the opportunity costs for different
departments, e.g. in the UK a growing and ageing population will increase demands for many
public services — NHS spending is expected to grow by 6.1% in real terms from 2015 to
2020; over three-quarters of this real increase will be needed just to keep pace with the
changing size and demographic structure of the population.
 A fall in government spending as a share of GDP is one measure, but further information may
be needed to assess its effects: e.g. government spending in nominal terms — the £500 a
week benefit cap introduced in 2015; and in real terms — school budgets protected in real
terms, maintaining per pupil protected spending.
 Spending falls will depend on the driving force behind them.
 Spending cuts will have differing impacts on different regions of the UK, e.g. approx. 70% of
Northern Ireland’s GDP and 30% of workforce in public sector.
 Unemployment benefits are a small proportion of overall government spending and a small
proportion of welfare spending, e.g. in the UK in 2014, JSA was £4bn of £210bn spent on
social security and tax credits and so unlikely to be a significant cause of lower government
spending.
Taxation
5
Direct Taxes paid by an individual taxpayer, such as a Income or corporation

taxation worker or firm, directly to the government tax
Indirect Taxes paid on expenditure on goods and services VAT or excise duties

taxation on petrol, alcohol and

tobacco
6 Answers will depend on the country chosen.
7 KAA (6 marks):
Application — reference to indirect and income tax rates in a country, e.g. UK VAT increased
from 15% to 17.5% to 20%; or income tax for incomes over £150,000 increased to 50% (then cut
to 45%).
Analysis of TWO macroeconomic effects might include:
Indirect taxes
 Impact on SRAS and cost-push inflation
 Impact on real incomes and MPC and so AD and real output
 Impact on tax revenues and public finances
 Worse income inequality (regressive effects)
Direct taxes
 Impact on disposable income and AD and real output
 Impact on incentives to work and LRAS
 Impact on public finances — Laffer curve — tax avoidance or evasion?
 Improved income distribution (progressive tax)
 Impacts depend on MPC of different income groups, e.g. high-rate taxpayers have a lower
MPC so consumption may not fall as much.
 Impact on tax revenue will depend on the tax rate/Laffer curve position.
 Impact depends on the number of higher-rate taxpayers.
 Comparison between different effects, e.g. income inequality could improve if direct taxes are
progressive but worsen if indirect taxes have a regressive effect.
Public sector finances

8 Boost the credibility of the government’s plans to manage public finances (1 mark); provide
independent analysis of the UK’s public finances (1 mark); produce the official 5-year forecast for
the economy and public finances (1 mark).

Term Definition
Budget deficit The amount by which government spending exceeds tax revenue or the
amount the government needs to borrow over the fiscal year
National debt Total government debt or the total amount of government borrowing that is
still outstanding
Trade deficit Import spending on goods and services is greater than the value of export
revenue
10 Application — use of country and example (2 marks), e.g. in the UK, a discretionary fiscal policy
change is the VAT increase to 20%.
Knowledge (1 mark) — understanding of fiscal policy as changes in government spending and tax
(to affect aggregate demand).
Analysis (1 + 1 mark) for each definition:
 Discretionary fiscal policy — policy made by judgemental methods rather than following rigid
rules, such as the golden rule.
 Automatic fiscal policy — government spending and tax revenues that change with the level
of economic activity, dampening the swings in the economic cycle.
11 KAA (8 marks):
Application: in 2017/18 UK’s cyclically adjusted net borrowing was 2.0% of GDP; public sector net
debt, 84.7% of GDP; government revenue, 36.4% of GDP; and spending, 38.5% of GDP.
Analysis of arguments in favour of a fiscal target of a structural deficit below 2% of GDP might
include:
 Definition of structural budget deficit: when public spending continues to exceed revenues
even if the economy is growing steadily at its highest sustainable employment rate, i.e.
potential/trend growth rate.
 Related argument that when the UK economy has recovered then this part of the deficit
should disappear to avoid adding to levels of national debt and to generate investor
confidence/better credit ratings on government debt.
 It leads to lower interest rates, as there is no crowding out of private investment.
 It leads to lower interest rates as government debt credit ratings improve and confidence in
the economy improves. This will increase investment and potential output.
 It provides scope to respond to another negative economic shock, such as Brexit or the US–
China trade war, without running out of what the International Monetary Fund (IMF) calls fiscal
space.

 We need to reduce the debt burden for future generations, i.e. costs of reducing debt now
outweigh future benefits. But the current generation will suffer the costs of the Great
Recession and of higher taxation.
Analysis of arguments against might include (could be used as evaluation):
 Fiscal policy needed to offset weak growth — through use of automatic stabilisers or
discretionary and expansionary fiscal policy; particularly important, as monetary policy is zero
bound.
 Public investment as a share of GDP is falling in most advanced economies and infrastructure
spending investment or measures to improve labour force skills could improve potential
growth.
 Public sector job losses due to spending cuts and resulting negative multiplier effects can
increase spending on benefits/reduce tax revenues and increase unemployment.
 The UK has an escape clause from this target should growth fall below 1%.
 Depends on current economic performance, e.g. concerns over global trade disputes or
securing a new UK trade deal with the EU after Brexit.
 Depends on how budget surplus is achieved — due to efficiency savings in government, or

improved tax collection, or a combination of spending cuts/tax rises.
Supply-side policies
12 KAA (8 marks):
Application to a specific country and policies, e.g. in the UK, Small Firms Loan Guarantee
Scheme — 75% of a commercial loan to a small business is guaranteed against default by
government.
Privatisation of state-owned enterprises; deregulation of markets to increase competition;

reductions in income tax and reducing marginal rate of tax on lower-paid workers to incentivise
work; education and training to improve human capital; tax credits for investment into research and
development.
 Time lags; short-run benefits on growth
 Impact on public finances, e.g. austerity in the UK makes tax cuts or spending rises unlikely
 Impact on real output depends on the elasticity of LRAS; or if a Keynesian or classical view of
the economy is followed (is there sufficient demand to take advantage of increased potential
output?)

 Other policies may be more effective, such as loose monetary policy or fiscal policy
13 KAA (8 marks):
Application — reference to particular countries and global institutions, e.g. market reforms in
Chile under Pinochet from 1974, such as privatisation, opening up to trade (tariffs initially cut to
10% and later joining the APEC trade bloc) and foreign direct investment (FDI).
Note: supply-side policies must link to labour productivity or cap L2 (5/8)
Analysis of market-oriented supply-side policies might include:
 Cut income tax to improve incentives to work. Higher wages increase hard work and
productivity and also attract higher productivity workers to the labour force.
 Cut corporation tax to improve investment and attract FDI. Greater capital per worker will
increase productivity.
 Privatisation.
 Deregulate, e.g. reduce labour market regulations such as minimum wages or trade union
power.
 Promote competition and market efficiency through tougher competition law.
 Export-oriented industrialisation.
Analysis of government interventionist supply-side policies might include:
 Public investment into infrastructure. Greater geographical mobility of labour will allow firms
access to a larger pool of higher-productivity workers.
 Public investment into healthcare and education. This will reduce absenteeism and improve
workers’ physical health and skills, boosting output per hour and per worker.
 Correct market failures, e.g. provide public goods or subsidies, research and development
(R&D) costs, which have positive externalities.
 Import substitution industrialisation — protect infant industries, perhaps through subsidies or

state-provided credit for investment.
 Often combination of both types of approach, e.g. South Korea or more recently China.
 Risks of government failure, e.g. unintended effects.
 Government intervention can be influenced by myopia or political considerations.
 Costs of financing some measures — trade-offs with other objectives, e.g. improving public
finances.

Macroeconomic policies in a global context

14 Arguments in favour of fiscal policy in promoting growth (must link to growth and contain examples
to reach KAA L3)
Application — reference to fiscal policies in a country/context, e.g. the UK’s use of fiscal stimulus
in response to the Great Recession — fiscal boost 2.2% of GDP, including a VAT cut from 17.5%
to 15%, spending on infrastructure for schools, hospitals and green energy, and training help for
the unemployed.
Analysis (KAA 9 marks) of how fiscal policy can increase growth might include:
 Role of automatic stabilisers — in a recession, government spending on unemployment

benefits reduces the size of falls in consumption; lower incomes may mean lower tax rates in
a progressive tax system; there may be other transfer payments such as food and housing
support.
 Role of discretionary policy — in order to boost AD and so increase output during a recession.
Several points are possible, such as:
o increased government spending and positive multiplier effects
o increased capital spending can have supply-side benefits too
o cuts to direct taxes, e.g. income tax to raise disposable income or corporation tax to
increase investment — both can also have supply-side effects
o cuts to indirect taxes, e.g. VAT to lower price levels and to increase real incomes and
consumption
Evaluation (6 marks) might consider:
 Time lags before discretionary fiscal policies are introduced, e.g. time to recognise action is
needed, time to implement changes (UK budget is annual) and time for government to plan
additional areas to spend on. Automatic fiscal policy does not suffer these lags.
 Depends on the size of the tax net and so ability to use government spending — advanced
economies have larger tax revenues as a share of GDP due to smaller informal economies
and more efficient tax collection systems.
 Adverse side effects, e.g. unemployment benefits weaken incentives to work or can delay
reallocation of productive workers following structural unemployment.
Arguments in favour of monetary policy in promoting growth (must link to growth and contain
examples to reach KAA L3 (KAA 9)
 Interest rate cuts and analysis of transmission mechanisms through lower borrowing costs
and boosts to discretionary incomes and consumption. Lower borrowing costs also raise rates
of return on investment and increase capital spending. Net exports rise as hot money outflows
weaken the exchange rate.

 In the global financial crisis, in the UK, the Monetary Policy Committee (MPC) cut the base
rate from 5.75% in 2007, eventually to 0.5% by March 2009. In the USA, the Federal Reserve
cut rates from 5.25% in 2007 to 0.25% by 2008.
 In the global financial crisis, quantitative easing (QE) was introduced (central bank buying
bonds with electronically created money). This injects cash into the economy but more
importantly drives down long-term interest rates. By 2014 the Bank of England had bought
£375bn of government bonds. In the USA by October 2014 the Federal Reserve’s QE
programme had spent US$4.5 trillion.
 Depends on the demand for credit (confidence) and supply of credit (banks’ willingness to
lend, debtor credit ratings, etc.)
 Interest rate transmission mechanisms depend on various factors, such as the number of
homeowners on variable mortgages, the size of consumer debt and the proportion of trade as
a share of GDP.
Wider evaluation ideas:
 Discussion of ongoing debates over fiscal policy and classical versus Keynesian views, e.g.
Ricardian equivalence or concerns over hysteresis or cuts to government capital spending.
 Depends on wider global fiscal and monetary policy responses and rates of global growth.
15 Analysis can be arguments for or against renewing the multilateral trading system or a mixture
(KAA 9 marks).
Arguments for renewing the multilateral trading system might consider:
 For example, the success of the World Trade Organization (WTO):
o in resolving trade disputes, e.g. in 2014 when China removed the export quotas
introduced in 2012 on rare earth elements
o promoting global trade, through rounds of trade talks, e.g. the Bali Package in 2013;
negotiating entry of major economies, e.g. China in 2001
o promotion of global free trade, e.g. Uruguay round 1994, which led to the creation of
the WTO
 Linked analysis to the benefits of global free trade, e.g. the gains from comparative advantage
 Avoiding complex set of overlapping and different bilateral trade deals, which make global
supply chains more complex and expensive as lower-cost producers’ competitive advantage
might be eroded by trade restrictions, e.g. tariffs or different product regulatory standards
Arguments against renewing the multilateral trading system might consider:
 Use of examples, such as President Trump’s US–China trade dispute, e.g. tariffs imposed on
steel

 The failings of the WTO might consider:
o failure to resolve trade disputes, e.g. between Boeing in the USA and Airbus in the
EU over subsidies given to aircraft manufacture
o failure to agree a new trade in Seattle 1999 or the annual attempts to sign the 2001
Doha deal, which finally collapsed in 2008
o failure to ensure developing countries are integrated into global trade and they have
access to advanced economies, e.g. west Africa’s cotton farmers cannot compete
with US subsidies or EU agricultural subsidies as part of the Common Agricultural
Policy (CAP)
 Linked analysis to the gains from protectionism, e.g. protection of strategic, infant or sunset
 Regional trade blocs still lead to trade creation and may be easier to negotiate and sign.
 Some new trade deals cut regional groups, e.g. Regional Comprehensive Economic
Partnership (RCEP) comprising China, ASEAN countries, India, Japan, Australia, New
Zealand and South Korea.

1 Application (2 marks) for two pieces of data from Figure 5:
 Jan 2017 US$1:0.95 euros; Jan 2018 US$1:0.83 euros
Knowledge (1 + 1 marks) of TWO factors and analysis/linked development of one (1 mark), e.g.
linked to demand or supply of US$ on foreign exchange markets:
 Higher interest rates in other countries lead to hot money outflows
 Lower investor confidence in the USA
 US balance of trade deficit
2 Application (2 marks) for (1 + 1) for TWO countries, e.g. USA 88% of GDP, Japan 230% of GDP
Knowledge (1 + 1 marks) and analysis (2 marks) of TWO reasons (4 marks):
 Different rates of economic growth and so the role of automatic stabilisers in adding to budget
deficits/surpluses
 Differences in expansionary or contractionary fiscal policy, such as stimuli after the global
financial crisis or austerity measures
 Structural differences between countries, e.g. size of the informal economy, which would
affect tax collection; demographic profile of country, e.g. ageing population in Japan
Evaluation (2 marks) or (1 + 1):

 Consideration of key factors that affect national debt, e.g. long-run effects of smaller working
populations and rising healthcare costs a key factor
 Depends on size of automatic stabilisers, e.g. size of unemployment benefits
 Recent bias towards budget deficits likely to mean rising national debt in the long term in all
countries
3 KAA (8 marks); Evaluation (4 marks)
Allow analysis of direct controls, e.g. wage, price or quantity controls, or other controls apart from
capital controls, e.g. on joint ventures.
Must be analysis of capital controls to reach KAA L3.
KAA (8 marks) for the benefits of direct controls on capital:
 Understanding of capital flow as FDI, portfolio investment, hot money, debt investment, etc.;
capital controls can be quantity or price based, e.g. Brazil 6% tax on foreign currency
converted into equities or into short-term debt.
 Capital controls may be on capital inflows and have advantages such as:
o Reduce financial account surpluses and so current account deficits
o Reduce reliance on volatile hot money flows and risks of sudden withdrawal/capital
flight and an economic shock, e.g. 1997 Asian financial crisis
o Reduce risks of excessive foreign borrowing and domestic credit boom, asset price
bubbles, excessive risk taking, e.g. the IMF accepts capital controls as a crisis
mechanism after the 2008 global financial crisis
o Reduce risks of currency appreciation and loss of competitiveness
o Allow operation of a fixed exchange rate (trilemma/trinity) and so use of monetary

policy for domestic objectives
 Capital controls may be on capital outflows and have advantages such as:
o Allow domestic monetary policy to be more autonomous as less risk of hot money
outflows if expansionary monetary policy is used or other countries tighten monetary
policy
Evaluation (4 marks) for disadvantages of capital controls:
 May limit cheap and sufficient access to foreign credit to finance domestic investment and
promote growth
 Free movement of capital allows efficient allocation of capital around the world, leading to
capital flows to countries in need of capital and benefits for investors due to diversified risk
and potential for greater returns
 Administrative costs of controls

 Risks beggar-thy-neighbour concerns/protectionism as trading partners view this as a way to

keep exchange rates undervalued
 Depends on the type of capital control, e.g. FDI most likely to bring technological spillovers or
can ensure capital flows to long-term debt
4 KAA (8 marks) for TWO factors might consider reasons for FDI, such as:
 Access to a large market or rapidly increasing demand:
o e.g. China — largest auto market; one-third of global smartphones bought there
o e.g. Kenya — only 10% have web access; 70% use mobile financial transfer system
 Avoid trade barriers by locating inside a country or trade bloc or within export processing
zones:
o e.g. Nissan in UK
 To gain from lower production costs, e.g. cheap (where there are growing and young labour
forces) or skilled labour with higher productivity:
o e.g. Nike in Vietnam
o e.g. Foxconn in China
 Access to resources, e.g. to extract energy and metals:
o e.g. Africa — 40% of world’s gold, one-third of cobalt
o e.g. Shell in Nigeria (10% of oil reserves in Africa)
o e.g. Total in Angola (US$16bn)
 Other reasons for investment, e.g. hot money flows looking for the best interest rates and
currency appreciations; investors look for safety, e.g. buy government bonds with high credit
ratings in large liquid currencies, such as US$ and euro
Evaluation (4 marks) might consider:
 Significance of each factor
 Trends in recent rates of economic growth or current trend in commodity prices
 Recent trade disputes/bilateral and regional trade might affect
 Depends on short-term speculative investment versus long-term greenfield investment into

new projects
5 Must contain reference to a developing economy(ies) and both QE and interest rates to reach KAA
L3
KAA (9 marks) of macro impact (positive and/or negative, e.g. impacts on macroeconomic
objectives)

 QE (central bank buying bonds with electronically created money drives down long-term
interest rates in advanced economies). By 2014 the Bank of England had bought £375bn of
government bonds. In the USA by October 2014 the Federal Reserve’s QE programme had
spent US$4.5 trillion. This can lead to large capital outflows to developing economies such as
Brazil, India, South Africa and Turkey, and so currency appreciation and a loss of
competitiveness.
 QE can also lead to capital outflows to developing countries that are willing to take more risk
to generate better returns, e.g. South America where government and corporate debt
issuance nearly tripled from 2009 to 2017. This might encourage rising national debt and
asset bubbles.
 Near-zero interest rates lead to faster expenditure and growth in advanced economies. This
boosts import demand, as import spending is usually income elastic. This in turn promotes
export-led growth and improved trade balances in developing countries that trade with them.
 Recent trend of increases in interest rates and reductions in QE
 Capital outflows are driven by factors other than interest rates, e.g. regulation, political
stability, financial market size and sophistication

6 KAA (16 marks):
This essay could be structured in several ways, e.g. groupings by time period, economic thinker or
policy type.
Analysis points of fiscal policy might include:
 In the Great Depression, the USA introduced a balanced budget. In 1930, Hoover ran a
budget surplus. By 1931/32 fiscal policy was weakly expansionary, but negligible given the
size of the fall in GDP. Justified by a classical view of the economy and a fear that
government borrowing would crowd out private investment and printing money was not
possible due to the constraints of the Gold Standard.
 In the Great Depression, recovery may have started under Franklin D. Roosevelt’s New Deal.
There was an increase in government spending but more important may have been recovery
in confidence and the bank deposit insurance scheme.
 In the Great Depression, the increase in spending was associated with the Second World
War.
 In the global financial crisis (GFC), Keynesian responses were seen with fiscal stimuli to
reduce demand-deficient unemployment. Most countries had fiscal stimulus packages in
place within 5 months of the collapse of Lehman Brothers in September 2008. In the USA, the
plan was worth 6% of GDP, mixed between tax cuts for businesses and spending on health,
education, social security and infrastructure. In the UK, the fiscal boost amounted to 2.2% of
GDP, including a VAT cut to 15% and spending on infrastructure for schools, hospitals and
green energy, and training help for the unemployed.

Analysis of monetary policy might include:
 In the Great Depression, the USA raised interest rates in September 1931 to preserve the
value of the dollar (linked to the value of gold). This reduced aggregate demand. Real interest
rates rose further as deflation set in. The money supply and availability of credit also fell
because of a nationwide banking crisis and the collapse of many banks. Some studies
suggest that money supply fell by 31% between 1929 and 1933.
 In the GFC, in the UK, the MPC cut the base rate from 5.75% in 2007, eventually to 0.5% by
March 2009. In the USA, the Federal Reserve cut rates from 5.25% in 2007 to 0.25% by
2008.
 In the GFC, QE was introduced (central bank buying bonds with electronically created
money). This injects cash into the economy but more importantly drives down long-term
interest rates. By 2014 the Bank of England had bought £375bn of government bonds. In the
USA by October 2014 the Federal Reserve’s QE programme had spent US$4.5 trillion.
Other issues:
 The impact of protectionism — in 1930, the Hawley–Smoot Tariff Act led to a trade war and
world trade (X – M) contracted, setting off a cycle of falling AD.
 The role of the Gold Standard and monetary policy restrictions — in 1931 the UK left the Gold
Standard. This meant that the value of the pound immediately fell by 25% and money supply
constraint was relaxed, with interest rates reduced from 6% to 2%. In the GFC, both the USA
and UK had free-floating exchange rates.
 The impact of the financial sector — in the Great Depression, around 4,000 banks went
bankrupt in 1933. This led to a collapse in confidence and lower consumption and investment.
In contrast, in October 2008 the UK government announced a bank rescue package worth
£500bn, and the US Treasury decided to spend up to $700bn. This protected depositors in
banks and prevented a decline in market confidence.
 Some lessons were not learned, e.g. regulating consumer credit in the run-up to both
recessions.
 Some lessons were learned, e.g. economies are not self-stabilising due to positive feedback
mechanisms and so some interventions are necessary, such as automatic stabilisers.
 Despite fiscal stimuli in the immediate response to the GFC, many countries introduced fiscal
consolidation plans, e.g. in the UK from 2010.
 Discussion of ongoing debates over fiscal policy and classical versus Keynesian views, e.g.
Ricardian equivalence or concerns over hysteresis or cuts to government capital spending.
7 KAA (16 marks):
Students must analyse each of the thinkers to achieve Level 4.


 Understanding of the ideas of Marx, e.g. increasing income inequality/exploitation of workers;

declining rates of profit as signal of impending crisis; fundamental instability of capitalist
systems.
 Understanding of the ideas of Smith, e.g. laissez faire and importance of markets; division of
labour/gains from specialisation; need for government intervention into infrastructure;
concerns over the formation of monopolies.
 Understanding of the ideas of Keynes, e.g. fiscal stimuli/importance of multiplier;

disequilibrium in markets and failure to self-correct; importance of animal spirits/confidence;
paradox of thrift.
 Application of ideas to today’s economy, e.g. Keynesian responses to the global financial
crisis/concerns over liquidity traps; no purely market-based economies suggests doubts over
Smith/appreciation of Marx as all have a degree of government intervention; Smith’s concerns
over monopolies and banks being too big to fail; importance of Smith and financial market
liberalisation or Thatcher’s supply-side reforms.
 Answer varies by country and economic system, e.g. China still sets 5-year plans.
 Failure of central planning/communism suggests capitalism/market-based systems preferable

— 1990 Washington Consensus.
 All thinkers advocated intervention by governments, although to differing degrees.
 Keynesian thought more prevalent at the macro level but Smith more at the micro level or little
evidence of Keynesian macro policies in recent decades as policy predominantly monetary
and supply-side.

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WORKBOOK ANSWERS

Levels-based mark descriptors for longer answers

KAA Level 4 descriptor (13–16 marks):

• Demonstrates precise knowledge and understanding of the concepts, principles and

• Ability to link knowledge and understanding in context using appropriate examples.

• The answer demonstrates logical and coherent chains of reasoning.

Evaluation Level 3 descriptor (7–9 marks):

• Evaluative comments supported by relevant reasoning and appropriate reference to

• Evaluation recognises different viewpoints and is critical of the evidence provided

KAA Level 3 descriptor (7–9 marks):

• Demonstrates accurate knowledge and understanding of the concepts, principles and

© Sam Schmitt 2019 Hodder Education

• The answer demonstrates logical and coherent chains of reasoning.

Evaluation Level 3 descriptor (5–6 marks):

• Evaluative comments supported by relevant chain of reasoning and appropriate

• Evaluation recognises different viewpoints and/or is critical of the evidence.

KAA Level 3 descriptor (6–8 marks):

• Demonstrates accurate knowledge and understanding of the concepts, principles and

• The answer demonstrates logical and coherent chains of reasoning.

Evaluation Level 3 descriptor (3–4 marks):

• Evaluative comments supported by relevant chain of reasoning and appropriate

• Evaluation recognises different viewpoints and/or is critical of the evidence.

KAA Level 3 descriptor (5–6 marks):

 Demonstrates accurate knowledge and understanding of the concepts, principles and

Evaluation Level 3 descriptor (3–4 marks):

 Evaluative comments supported by relevant chain of reasoning and appropriate

 Evaluation recognises different viewpoints and/or is critical of the evidence

Edexcel Economics A Theme 4 A global perspective 2

© Sam Schmitt 2019 Hodder Education

 Reduced flows in international capital or foreign direct investment (FDI)

 Reduced flows of labour between countries or emigration/immigration

2 Knowledge (1 mark) and linked analysis to globalisation (2 marks); application to some

Edexcel Economics A Theme 4 A global perspective 3

© Sam Schmitt 2019 Hodder Education

World Trade Organization (WTO) (up to 3 marks): the WTO is an international

Factors might be:

 Declining costs of transport, e.g. containerisation in shipping lowers costs due to

 Liberalisation of capital markets — deregulation of global financial markets and hence

Application (2 marks): reference to specific countries, industries or examples:

Evaluation (2 marks for any relevant point):

 Role of trade blocs might inhibit globalisation through trade diversion.

Possible benefits include:

 Faster global economic growth — gains from comparative advantage

 Off-shoring creates jobs in emerging economies and so reduces absolute poverty

 Inequality between countries falls — due to catch up and convergence

Edexcel Economics A Theme 4 A global perspective 4

© Sam Schmitt 2019 Hodder Education

 Greater FDI improves diffusion of new technology

 Disinflation as off-shoring lowers labour costs or greater competition increases

 Increased mobility of labour allows access to foreign know-how, skilled workers,

Possible costs include:

 Inflation due to rising commodity prices and so cost-push inflation

 External costs — pressures on finite resources; external costs stemming from

 Recent trend of deglobalisation and regionalisation suggests there is a limit to

Comparative advantage and the terms of

Edexcel Economics A Theme 4 A global perspective 5

© Sam Schmitt 2019 Hodder Education

6 a 1 mark for each correct row.

Country Cars Textiles

India 200 800