A Level Economics: Government Macroeconomic Intervention (A Level) — Practice Questions (Cambridge 9708)

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs — Cambridge International holds copyright in its own papers. Use these alongside the official past papers available from your board.

Each question practises a skill tested in the June 2024 Paper 42. After each answer there is an examiner insight, a mark-scheme insight or a tip, and, where one matches, the real question to try next.

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Questions

1. Distinguish between cost-push and demand-pull inflation, and state which type is caused by a sharp rise in the world price of imported fertiliser and fuel. [3]

2. A central bank raises its interest rate to reduce inflation. (a) Explain one way in which higher interest rates reduce inflation. (b) Explain why this policy may be less effective when inflation is cost-push. [4]

3. A government greatly increases its spending on roads and railways at the same time as the central bank raises interest rates. Explain why these two policies may work against each other in controlling inflation. [3]

4. Inflation in a country is 7% and the central bank raises interest rates to bring it down to 3%. Using the idea of the short-run Phillips curve, explain the policy conflict that this creates. [3]

5. Explain how one supply-side policy could reduce cost-push inflation in the long run. [2]

6. A government collects a tax of $3 on each packet of cigarettes. Because fewer people now smoke, annual sales fall from 900 million packets to 700 million packets. (a) Calculate the fall in the government’s annual tax revenue. (b) State two ways in which the government could respond to this loss of revenue. [4]

7. A country’s exports of copper fall by $4 billion. In this economy the marginal propensity to save is 0.1, the marginal propensity to tax is 0.1 and the marginal propensity to import is 0.05. Calculate the multiplier and the likely final fall in national income, and explain why the fall is larger than $4 billion. [3]

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Answers

1. Cost-push inflation is caused by rising costs of production (such as wages, raw materials or imports), which shift aggregate supply to the left [1]. Demand-pull inflation is caused by aggregate demand rising faster than the economy’s capacity to produce [1]. A rise in the price of imported fertiliser and fuel causes cost-push (imported) inflation [1].

Examiner insight (Cambridge 9708 June 2024 examiner report, Paper 42, Question 4): good responses related the theory to the question’s setting of cost-push inflation; answers that missed this setting were weaker.

Source for the examiner insights on this page: Cambridge International AS & A Level Economics 9708 June 2024 Principal Examiner Report for Teachers, Paper 9708/42 section, paraphrased.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 4.

2. (a) Higher interest rates raise the cost of borrowing (and the reward for saving), so households spend less on credit-financed goods and firms invest less [1]. Consumption and investment fall, so aggregate demand falls and there is less upward pressure on prices [1]. (A higher exchange rate making imports cheaper is also accepted.) (b) Cost-push inflation comes from higher costs reducing aggregate supply; higher interest rates act on aggregate demand, not on the cause [1]. Prices may fall only slowly while output falls and unemployment rises further [1].

Examiner insight (Cambridge 9708 June 2024 examiner report, Paper 42, Question 4): good evaluation recognised that the fiscal and monetary policies in the question (a tax cut and a rise in interest rates) may suit demand-pull rather than cost-push inflation.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 4.

3. Higher government spending is an injection that increases aggregate demand, adding to inflationary pressure [1]. Higher interest rates reduce consumption and investment, lowering aggregate demand [1]. The two effects partly cancel out, so the overall effect on inflation is uncertain and the central bank may need to raise rates further [1].

Tip: when two policies are used together, say which way each moves aggregate demand and then judge the combined effect.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 4.

4. The short-run Phillips curve shows an inverse relationship between inflation and unemployment [1]. Higher interest rates reduce aggregate demand, so inflation falls, but firms produce less and unemployment rises as the economy moves along the curve [1]. The objective of price stability conflicts with low unemployment (and with economic growth) in the short run [1].

Examiner insight (Cambridge 9708 June 2024 examiner report, Paper 42, Question 4): some candidates referred to the Phillips curve but could not apply it to the question; use it to show the specific trade-off the policy creates.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 4.

5. Any one policy explained, for example: education and training raise labour productivity [1], which lowers unit labour costs and shifts aggregate supply to the right, reducing cost pressure on prices [1]. (Other valid policies: investment in energy infrastructure to cut energy costs; deregulation to increase competition.)

Examiner insight (Cambridge 9708 June 2024 examiner report, Paper 42, Question 4): discussing supply-side policies, or whether the fiscal and monetary policies had supply-side effects, was appropriate evaluation for inflation caused by supply disruption.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 4.

6. (a) Revenue before = $3 × 900 million = $2.7 billion; revenue after = $3 × 700 million = $2.1 billion [1]. Fall = $0.6 billion ($600 million) [1]. (b) Any two of: raise other taxes, such as income tax or taxes on other goods [1]; cut government spending [1]; borrow more, accepting a larger budget deficit.

Mark-scheme insight (Cambridge 9708 June 2024 mark scheme, Paper 42, Question 1(d)): where tax revenue falls, the mark scheme credits the government cutting its spending, raising taxes on other goods or on income, or running a budget deficit.

Source for the mark-scheme insights on this page: Cambridge International AS & A Level Economics 9708 June 2024 mark scheme for Paper 42 (9708/42), paraphrased. Cambridge’s 9708 past papers page publishes the Paper 41 mark scheme from this series, not the Paper 42 one.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 1(d).

7. Marginal propensity to withdraw = 0.1 + 0.1 + 0.05 = 0.25, so the multiplier = 1 ÷ 0.25 = 4 [1]. Final fall in national income = 4 × $4 billion = $16 billion [1]. The fall is larger because the copper workers and firms who lose income spend less, which reduces other people’s incomes in further rounds of spending [1].

Mark-scheme insight (Cambridge 9708 June 2024 mark scheme, Paper 42, Question 1(d)): the mark scheme credits the chain from lower exports to a smaller (X − M) component of aggregate demand, and then to lower output.

Try the real question next: Cambridge International AS & A Level Economics 9708, June 2024, Paper 42, Question 1(d).

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Where marks are usually lost

• Treating all inflation as demand-pull and ignoring the context given.
• Explaining a policy’s effect on aggregate demand without saying whether this tackles the actual cause of inflation.
• Naming the Phillips curve without using it to explain the trade-off.
• Leaving out a withdrawal when calculating the multiplier (it is 1 ÷ (MPS + MPT + MPM)).
• Treating two countries or two policies as if they must have the same effect.