AQA GCSE Economics: Interest Rates and Government Income and Expenditure — Practice Questions

These are original questions written for Marlbridge, in the style and at the standard of the examination. They are not reproduced past-paper questions — examination boards hold copyright in their own papers. Use these alongside the official past papers available free from your board.

Related: Interest Rates and Government Income and Expenditure study guide | Interest Rates and Government Income and Expenditure revision notes

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Section A

1. State the two factors, other than the central bank’s rate, that influence the interest rate offered on a particular loan or savings product. [2]

2. State the difference between a direct tax and an indirect tax. [2]

Section B

3. A bank raises the interest rate it offers on savings accounts, and its lending (loan) rate rises by a similar amount at the same time, as is typical when the central bank’s base rate rises. Explain the likely effect on consumer saving and consumer borrowing. [4]

4. Explain how a rise in interest rates is likely to affect a manufacturing business’s investment decisions. [4]

5. A student deposits £2,400 in a savings account offering 4% annual interest. Calculate the interest earned after one year, and explain how a fall in this rate might change the student’s saving behaviour. [5]

6. Explain the difference between a progressive tax and a regressive tax. [4]

7. A government introduces a flat-rate £2 charge added to every packet of cigarettes, regardless of the buyer’s income. Classify this tax on both the direct/indirect axis and the progressive/regressive axis, explaining your reasoning. [6]

8. Identify two areas of UK government spending and two sources of UK government revenue. [4]

9. Evaluate whether raising interest rates or raising income tax is the more effective way for policymakers to reduce spending in the economy. [9]

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Answers

1. The level of risk associated with the borrower (a riskier borrower typically faces a higher rate) [1]; the length of the loan or savings term [1].

2. A direct tax is paid directly by the individual or organisation on whom it is levied (such as income tax) [1]; an indirect tax is collected by an intermediary (such as a retailer) and passed on, ultimately falling on the consumer through the price of goods (such as VAT) [1].

3. Saving: a higher interest rate improves the return on savings, making saving more attractive, so consumers are likely to save more [1] [1]. Borrowing: a higher interest rate makes loans more expensive to repay, so consumers are likely to borrow less [1] [1].

4. A rise in interest rates makes borrowing to fund investment more expensive for the business, discouraging it from taking out loans to expand [1] [1]. At the same time, holding cash or making other low-risk returns becomes relatively more attractive than committing money to investment, further discouraging the business from investing [1] [1].

5. Calculation: interest = principal × rate = 2,400 × 0.04 = £96 [1] [1]. Explanation: a fall in the interest rate reduces the return on savings, making saving less attractive relative to spending now [1] [1], so the student is more likely to save a smaller proportion of their income than before [1].

6. A progressive tax takes a larger percentage of income from higher earners as income rises [1] [1]. A regressive tax takes a larger percentage of income from lower earners, meaning the percentage paid falls as income rises [1] [1].

7. Direct/indirect: this is an indirect tax, since the retailer collects it within the price of the packet and passes it on to the government, rather than the buyer paying it directly [1] [1]. Progressive/regressive: this is regressive relative to income, because a fixed £2 charge takes a larger percentage of a low earner’s income than a high earner’s income, assuming similar smoking habits [1] [1] [1]. This illustrates why a flat-rate indirect tax is frequently, though not automatically, regressive [1].

8. Any two spending areas: health, education, welfare/pensions, defence [1 each]. Any two revenue sources: income tax, National Insurance, VAT, corporation tax [1 each].

9. Case for interest rates: a rate rise affects the whole economy in a broad, general way, discouraging both consumer and producer spending through the cost of borrowing [1] [1] — though the effect is not instantaneous: existing fixed-rate mortgages and loans only reprice as contracts come up for renewal, so the full impact spreads out over months, not days; it is set by the central bank rather than government, which can make it a faster and more politically independent tool to adjust than legislated tax changes [1]. Case for income tax: a tax rise directly reduces disposable income for those affected, giving the government more precise control over which income groups are affected — for example, a progressive rise falls more heavily on higher earners [1] [1]; unlike interest rate changes, it does not depend on how consumers and businesses choose to respond to a changed cost of borrowing, so its effect on take-home income is more certain, though it still requires legislation and a tax year or payroll cycle to take effect, rather than being immediate [1]. Judgement: interest rates act more broadly across the whole economy and can be adjusted faster by the central bank, but their effect on spending is delayed and uneven as existing contracts reprice, while income tax gives more targeted and certain control over disposable income but takes its own time to legislate and implement; which is “more effective” depends on whether the goal is a broad reduction in spending or a targeted, certain one aimed at particular income groups, and on how much weight is given to speed of decision versus speed of real-world effect [1] [1].

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Where marks are usually lost

• Describing an interest rate change’s effect without stating whether it is a rise or a fall.
• Confusing direct/indirect taxation with progressive/regressive taxation, rather than treating them as two separate classification axes that combine independently.
• Applying interest rate effects to consumers and producers identically, without stating that investment is the producer-specific decision.
• Miscalculating simple interest by forgetting to convert a percentage rate to a decimal before multiplying.
• Ending an evaluation question without a reasoned judgement on which policy tool is more effective and why.

Approaching interest rates and government finance questions

For any interest rate question, always state the direction of the change (rise or fall) before explaining the effect, and keep the consumer and producer perspectives separate, since examiners will often ask about one specifically rather than “the economy” in general. For taxation questions, run through both classification axes in turn — how the tax is collected, then how its burden changes with income — rather than trying to describe a tax with a single label, since the specification tests exactly this two-axis reasoning through examples like the cigarette-tax question above. For the final evaluative question style, a reasoned judgement that directly compares the two policy tools on a stated basis (speed, breadth, precision, or certainty of effect) scores considerably more than simply restating the arguments for each tool without weighing them against each other.