Cambridge A Level Economics: Controlling inflation, demand for money and interest rate determination (9708) – Practice Questions

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 – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover outcomes 9.4.6 to 9.4.8 of the Cambridge International AS and A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. They are A Level content (topic 9). All countries and figures are invented, and money is in currency units (cu). Read the study guide and the revision notes first. The course hub and checklist show the rest of the syllabus, and the free 10-minute diagnostics help you choose what to revise next.

Questions

1. State the three motives for holding money in Keynes’s liquidity preference theory. [3]

2. A bond pays a fixed 12 cu a year for ever.

(a) Calculate its price when the market interest rate is 6%, and when it is 8%. [2] (b) Calculate the percentage change in the price when the rate rises from 6% to 8%. [2]

3. In Country A the demand for money is 160 − 10r, where r is the interest rate in percent. The money supply is 100.

(a) Find the equilibrium interest rate. [2] (b) The central bank raises the money supply to 120. Find the new rate. [2] (c) Explain why a rise in the money supply might fail to lower the rate in a liquidity trap. [2]

4. In Country B the demand for loanable funds is 140 − 8r and the supply is 20 + 4r, in billions of cu.

(a) Find the equilibrium rate and quantity. [2] (b) Government borrowing adds 24 to demand at every rate. Find the new rate and quantity. [2] (c) Explain what happens to private borrowing. [2]

5. The marginal propensity to withdraw in Country C is 0.25. The government cuts its spending by 5 cu.

(a) Calculate the multiplier. [1] (b) Calculate the change in AD. [1] (c) Explain why the fall in the price level may be smaller than the fall in AD. [2]

6. Inflation in Country D is 7%. The policy interest rate is 5%.

(a) Calculate the approximate real interest rate. [1] (b) The rate is raised to 9%. Calculate the new approximate real rate. [1] (c) Explain why a rise to 7% would not tighten policy. [2]

7. A firm in Country E imports a component priced at 60 foreign units (fu). The exchange rate is 0.75 fu per cu, then rises to 0.80 fu per cu.

(a) Calculate the cu price of the component at each rate. [2] (b) Calculate the percentage change in the price. [1] (c) Explain one drawback of relying on a stronger currency to reduce inflation. [2]

8. In Country A wages rise by 6% and output per worker by 3%.

(a) Calculate the percentage change in unit labour costs. [2] (b) Explain whether demand-side or supply-side policy is better suited to this cost pressure. [3]

9. Explain why the demand for money slopes down against the interest rate. [4]

10. Inflation in Country G is 8%. Analysts say about half comes from dearer imported fuel and half from strong consumer demand. The central bank is considering a rise in its policy rate. Evaluate this policy. [8]

11. In Country H households raise their saving and the central bank raises the money supply.

(a) Using loanable funds theory, explain the effect of higher saving on the interest rate. [2] (b) Using Keynesian theory, explain the effect of the larger money supply. [2] (c) Assess whether the interest rate must fall. [4]

Answers

1. Transactions [1], precautionary [1], speculative [1]. [3] Examiner insight: Name the motives and avoid a vague label such as “spending”. Credit goes to precise terms.

2. (a) Price = coupon ÷ rate. At 6%: 12 ÷ 0.06 = 200 cu [1]. At 8%: 12 ÷ 0.08 = 150 cu [1]. [2] (b) Change = 150 − 200 = −50 [1]. As a percentage of 200: −25% [1]. [2] Examiner insight: A percentage change needs the starting price as the base. Using 150 as the base is a common slip.

3. (a) 160 − 10r = 100 [1], so r = 6% [1]. [2] (b) 160 − 10r = 120 [1], so r = 4% [1]. [2] (c) At a very low rate, bond prices are high and people expect them to fall [1], so extra money is held in the demand for money and the rate does not fall further [1]. [2] Examiner insight: Show the equation set equal before the answer. Part (c) needs the reason people hold the extra money, not only the term “liquidity trap”.

4. (a) 140 − 8r = 20 + 4r [1], so 120 = 12r: r = 10%, quantity 60 [1]. [2] (b) 164 − 8r = 20 + 4r [1], so 144 = 12r: r = 12%, quantity 68 [1]. [2] (c) The higher rate reduces private demand for funds [1]: at 12% private demand is 140 − 96 = 44, down from 60, so private borrowing falls by 16 (crowding out) [1]. [2] Examiner insight: Separate private and government borrowing in part (c). Total borrowing rises while private borrowing falls.

5. (a) 1 ÷ 0.25 = 4 [1]. [1] (b) 5 × 4 = a fall of 20 cu [1]. [1] (c) If the economy has spare capacity, the short-run aggregate supply curve is flat [1], so most of the fall in AD reduces real output and employment and little reduces prices [1]. [2] Examiner insight: Link the price level to the shape of SRAS. A general claim that prices are sticky earns less than a stated chain.

6. (a) 5 − 7 = −2% [1]. [1] (b) 9 − 7 = +2% [1]. [1] (c) At 7% the real rate would be 0% [1], so borrowing would still cost nothing in real terms and spending would not be discouraged [1]. [2] Examiner insight: Show the subtraction, and quote the real rate as a signed number with its unit.

7. (a) 60 ÷ 0.75 = 80 cu [1]; 60 ÷ 0.80 = 75 cu [1]. [2] (b) (75 − 80) ÷ 80 = −6.25% [1]. [1] (c) Exports become dearer in foreign currency, so export demand falls [1], which reduces net exports and can cut output and employment [1]. [2] Examiner insight: Divide by the exchange rate when the rate is quoted as foreign units per cu. Check the direction against common sense.

8. (a) 1.06 ÷ 1.03 = 1.0291 [1], so unit labour costs rise by 2.91% [1]. [2] (b) The cause is a cost rise, shifting SRAS left [1]. Lower AD would reduce output and employment but not unit costs [1]. Supply-side policy raising productivity attacks the cause, though it is slow [1]. [3] Examiner insight: Tie the policy to the cause named in the data. A judgement that ignores the figures reads as generic.

9. Speculative demand falls as the interest rate rises [1]. Bond price is inversely related to the rate [1]. At high rates bond prices are low and people expect them to rise, so they hold bonds and less money [1]. At low rates prices are high and people expect a fall, so they hold more money [1]. [4] Examiner insight: Each step needs the link before the conclusion. Describing the slope without the bond price reasoning leaves the explanation incomplete.

10. Higher rates make borrowing dearer and saving more rewarding [1], so investment and consumption fall and AD shifts left, with a multiplier effect [1]. This helps against the demand-pull half [1]. It does little against imported fuel costs, which are cost-push and set abroad [1]. There are time lags before spending responds [1]. The cost is slower growth and higher unemployment [1]. A stronger currency, or supply-side measures, may help with imported costs [1]. Judgement: a rate rise is partly effective, suited to the demand half, and the case for it improves if the economy is near full capacity and expectations of inflation are falling [1]. [8] Examiner insight: Split the case into the two causes and judge the policy against each. A balanced answer reaches a conclusion that follows from that split.

11. (a) Saving shifts the supply of loanable funds right [1], so the equilibrium rate falls [1]. [2] (b) The vertical money supply shifts right [1], so at the old rate there is excess supply of money and the rate falls [1]. [2] (c) Both theories point to a lower rate [1]. In a liquidity trap the rate cannot fall further [1]. Higher expected inflation, or a government deficit raising demand for funds, would push the rate up [1]. So the rate falls unless those offsetting factors are large [1]. [4] Examiner insight: State both predictions first, then test them. Credit tends to go to answers that name a specific offsetting factor.

Where marks are usually lost

• Writing a ratio such as a multiplier without stating what it is the reciprocal of.
• Taking the percentage change in bond price from the wrong base.
• Describing policy effects without naming the curve that shifts.
• Using nominal interest rates where the real rate drives decisions.
• Giving evaluation that is not linked to the causes of inflation in the data.
• Treating the bond price and the interest rate as moving together.
• Confusing a movement along the demand for money curve with a shift.
• Mixing up loanable funds and liquidity preference in one explanation.
• Ending an evaluation with no judgement.

Next steps

• Review with the revision notes and the study guide.
• Use the course hub and checklist to plan what is next.
• Take the free 10-minute diagnostics.
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Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment (Cambridge International Education), section 9.4, outcomes 9.4.6 to 9.4.8. Topic 9 is A Level content.