Cambridge A Level Economics: Effectiveness of fiscal and monetary policy including the Laffer curve (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 part of outcome 10.3.1 (fiscal policy including Laffer curve analysis, and monetary policy) and outcomes 10.3.2 and 10.3.3 of the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topics 1 to 6 are AS Level content and topics 7 to 11 are A Level content, so this unit is A Level only. All countries and figures are invented, and money is in zu.

Read the study guide and the revision notes first. Track progress on the hub, the checklist and a free diagnostic.

Questions

1. Explain what the Laffer curve shows. [3]

2. In Country P the marginal propensity to save is 0.1, the marginal rate of tax is 0.2 and the marginal propensity to import is 0.3. The government raises its spending by 18 zu bn.

(a) Calculate the multiplier. [2] (b) Calculate the change in national output. [1] (c) Calculate the change in the budget deficit. [2]

3. In Country R the tax base (zu bn) is 600 − 5t, where t is the income tax rate in per cent, and revenue is t multiplied by the base, divided by 100.

(a) Calculate the change in revenue when the rate is cut from 80% to 70%, and when it is cut from 50% to 40%. [2] (b) Explain why the two cuts have opposite effects on revenue. [2]

4. Country S has national debt of 1,200 zu bn and nominal GDP of 1,500 zu bn. It runs a deficit of 75 zu bn. Nominal GDP then grows by 2%.

(a) Calculate the debt ratio before the deficit and after it, as a percentage of GDP. [3] (b) Explain one way in which faster economic growth could reduce the debt ratio. [2]

5. A household has a variable-rate loan of 240,000 zu. The interest rate rises from 3.5% to 5%. Inflation is 4%.

(a) Calculate the extra interest paid in a year. [2] (b) Calculate the approximate real interest rate after the rise. [1] (c) Explain how a higher policy rate could reduce demand-pull inflation. [3]

6. A bond pays 6 zu a year.

(a) Calculate its yield when its price is 120 zu and when its price is 150 zu. [2] (b) Explain how quantitative easing aims to raise aggregate demand. [2]

7. In Country Q imports are 400 zu bn and exports are 380 zu bn. The income elasticity of demand for imports is 1.6. Income grows by 2.5% and exports grow by 1.5%.

(a) Find the value of imports after the rise in income. [2] (b) Find the trade balance after the changes. [2] (c) Explain the policy conflict this shows. [2]

8. Evaluate whether fiscal policy is more effective than monetary policy at reducing cyclical unemployment in a deep recession when the policy interest rate is already close to zero. [8]

9. Government failure can arise in macroeconomic policy.

(a) Explain one example of government failure in fiscal policy. [2] (b) Explain one example of government failure in monetary policy. [2] (c) Assess which of your two examples would cause more harm. [2]

10. Country R has inflation of 1%, unemployment of 9%, a budget deficit of 6% of GDP and a policy interest rate of 0.5%. Output is below potential. Discuss whether the government should cut income tax rates or rely on monetary policy to raise growth. [10]

11. Country S raises interest rates sharply while expanding government spending.

(a) A good costs 200 zu. The exchange rate rises from 1 zu = 0.50 yu to 1 zu = 0.60 yu. Calculate the price in yu before and after, and the percentage change. [2] (b) An import costs 60 yu. Calculate its price in zu before and after, and the percentage change. [2] (c) Explain how this policy mix could reduce the effect of the fiscal expansion. [3]

Answers

1. It shows tax revenue plotted against the tax rate [1]. Revenue rises as the rate rises up to a maximum, then falls [1]. At high rates the behavioural effect (less work, avoidance, evasion) shrinks the tax base by more than the extra revenue per unit of income [1]. [3] Examiner insight: A good answer gives the shape and the reason for the fall. A statement that cutting taxes always raises revenue claims more than the curve shows.

2. (a) Withdrawal rate = 0.1 + 0.2 + 0.3 = 0.6 [1]. Multiplier = 1 / 0.6 = 1.67 [1]. [2] (b) Change in output = 1.67 × 18 = 30 zu bn [1]. [1] (c) Extra tax revenue = 0.2 × 30 = 6 [1]. Change in deficit = 18 − 6 = 12 zu bn [1]. [2] Examiner insight: Show the withdrawal rate before taking the reciprocal. Saying the deficit rises by the full spending increase ignores tax revenue from higher output.

3. (a) At 80%: base 200, revenue 160. At 70%: base 250, revenue 175. Change = +15 [1]. At 50%: base 350, revenue 175. At 40%: base 400, revenue 160. Change = −15 [1]. [2] (b) The peak is at 60%, where the base is 300 and revenue is 180. The first cut is beyond the peak, so the rise in the base outweighs the lower rate [1]. The second cut is below the peak, so the rise in the base is too small to offset the lower rate [1]. [2] Examiner insight: Locate the position on the curve for each cut. Both cuts are 10 points, so the peak explains the opposite results.

4. (a) Before: 1,200 / 1,500 = 80% [1]. After: debt = 1,200 + 75 = 1,275 and GDP = 1,500 × 1.02 = 1,530 [1]. Ratio = 1,275 / 1,530 = 83.3% [1]. [3] (b) The denominator, GDP, rises faster [1]. Tax revenue rises and welfare spending falls, so the deficit and new borrowing are smaller [1]. [2] Examiner insight: Give both the debt and the GDP figure after the change. A ratio can rise even when GDP grows.

5. (a) Interest before = 240,000 × 0.035 = 8,400. Interest after = 240,000 × 0.05 = 12,000 [1]. Extra = 3,600 zu [1]. [2] (b) Real rate = 5 − 4 = 1% [1]. [1] (c) Borrowing becomes dearer and saving more rewarding, so consumption and investment fall [1]. Aggregate demand falls [1]. Excess demand shrinks, which reduces upward pressure on prices [1]. [3] Examiner insight: Build the chain in order and keep it about demand-pull inflation. A claim that the rise also fixes cost-push inflation would need support.

6. (a) At 120: 6 / 120 = 5% [1]. At 150: 6 / 150 = 4% [1]. [2] (b) The central bank creates money to buy bonds, which raises their prices and lowers yields [1]. Lower borrowing costs and higher asset values encourage investment and consumption [1]. [2] Examiner insight: Say that yields fall because prices rise. That link is the point of the mechanism.

7. (a) Rise in imports = 1.6 × 2.5 = 4% [1]. New imports = 400 × 1.04 = 416 [1]. [2] (b) New exports = 380 × 1.015 = 385.7 [1]. Balance = 385.7 − 416 = −30.3 zu bn, from −20 [1]. [2] (c) Growth raises income, and imports rise by more than exports [1]. A policy that pursues growth therefore worsens the balance of payments, so the two objectives conflict [1]. [2] Examiner insight: Use the figures from your own working. A conflict is explained when you say which objective gains and which loses.

8. Fiscal policy raises AD directly through government spending [1]. The multiplier means output rises by more than the initial spending [1]. Higher output creates jobs, which cuts cyclical unemployment [1]. Monetary policy has little room when the interest rate is near zero [1]. Quantitative easing may lower yields, but firms may not borrow when confidence is low [1]. Crowding out is small in a slump, because private investment is already weak [1]. Fiscal policy has lags and a larger deficit adds to debt [1]. Judgement: fiscal policy is likely to be more effective in a deep recession with near-zero rates, but the choice depends on spare capacity, the type of unemployment, and whether the deficit is sustainable [1]. [8] Examiner insight: The question names a condition (near-zero rates). Answers gain by using it, and lose by comparing the two policies in general.

9. (a) A stimulus is decided during a slump but takes months to spend [1]. It may arrive in a recovery and add to demand pressure, making the cycle less stable [1]. [2] (b) The central bank forecasts inflation wrongly and keeps rates too low [1]. Asset prices or inflation then rise too fast [1]. [2] (c) A reasoned judgement, for example that a persistent error on rates may do more harm than fiscal lags, because automatic stabilisers offset part of those lags [1]. It must say what it depends on, such as the size of the forecasting error [1]. [2] Examiner insight: Name the policy in each part. A “which is worse” part needs a reason and a condition, not only a choice.

10. A tax cut raises disposable income and consumption [1]. The multiplier amplifies the rise in output [1]. Lower tax rates may improve work incentives, and if the rate is beyond the Laffer peak revenue could rise [1]. The deficit is already 6% of GDP, so a tax cut adds to debt and may raise borrowing costs [1]. The effect depends on the propensity to save, and households may save much of the extra income [1]. A rate of 0.5% leaves little room for monetary policy [1]. Quantitative easing could lower yields, though its effect on spending is uncertain [1]. With inflation at 1% and output below potential, expansion is unlikely to cause much inflation, so risk is low [1]. Both policies have lags [1]. Judgement: a targeted tax cut, perhaps paired with monetary support, is likely to be best if spare capacity is large and the deficit can be financed, but the answer depends on how households use extra income [1]. [10] Examiner insight: Use all the figures given, because inflation, the deficit and the near-zero rate each change the answer.

11. (a) Before: 200 × 0.50 = 100 yu. After: 200 × 0.60 = 120 yu [1]. Rise = 20% [1]. [2] (b) Before: 60 / 0.50 = 120 zu. After: 60 / 0.60 = 100 zu [1]. Fall = 16.7% [1]. [2] (c) High interest rates attract foreign funds and raise the exchange rate [1]. Foreign buyers pay more for exports while imports cost less at home, so net exports fall [1]. This reduces AD and offsets part of the fiscal stimulus, so the two policies work against each other [1]. [3] Examiner insight: The percentages differ because one price is the reciprocal of the other. State which price you are comparing.

Where marks are usually lost

• Treating the Laffer peak as known, or saying a tax cut always raises revenue.
• Using a multiplier that leaves out taxes and imports.
• Forgetting that extra output brings extra tax revenue.
• Mixing up nominal and real interest rates.
• Writing that monetary policy solves cost-push inflation.
• Ending an evaluation without a judgement that says what it depends on.

Next steps

• Re-read the revision notes.
• Tick off outcomes on the checklist and see the course hub.
• Take one of the free 10-minute diagnostics.
• Book a free trial class at /trial/.

Official syllabus

Cambridge International AS & A Level Economics 9708 syllabus, for examination in 2026, 2027 and 2028, version 2, published by Cambridge University Press & Assessment. These questions cover part of outcome 10.3.1 and outcomes 10.3.2 and 10.3.3.