Cambridge O Level Economics: Monetary policy (2281) – 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 sections 4.4.1 to 4.4.3 (Monetary policy) of the Cambridge O Level Economics 2281 syllabus for examination in 2026, within topic 4. The syllabus is not tiered. The countries, firms and figures are made up, and calculators may be used. Start with the study guide and the revision notes. The course hub and printable checklist show what else to cover, and the wider topic has its own practice set.

Questions

1. Define money supply. [2]

2. Define monetary policy. [2]

3. Explain how a rise in the interest rate may reduce the rate of inflation. [4]

4. A small bakery in Country B has a loan of 40,000. The interest rate rises from 7% to 10%.

(a) Calculate the extra interest the bakery pays in a year. [2] (b) Calculate the percentage increase in its yearly interest cost. Round to one decimal place. [2] (c) Explain one reason why the bakery may now cut its investment. [2]

5. In Country C the interest rate on savings is 4% and inflation is 6.5%.

(a) Estimate the real interest rate. [2] (b) A saver deposits 1,000 for a year. Calculate the buying power of the money at the end of the year, in start-of-year prices, to two decimal places. [3] (c) Explain who gains when the real interest rate is negative. [2]

6. The money supply of Country D grows from 250 billion to 272.5 billion in a year. Real output grows by 4%.

(a) Calculate the growth in the money supply. [2] (b) Explain why this may threaten stable prices. [3]

7. In Country F banks must keep 8% of deposits as reserves and lend the rest. A new deposit of 2,000 enters the banking system.

(a) Calculate the maximum total deposits that can result. [2] (b) Calculate the new lending created. [1] (c) The central bank raises the requirement to 12.5%. Calculate the change in maximum total deposits. [3] (d) State one assumption behind your answers. [1]

8. Country E has an exchange rate of 1 E-unit = 4 F-units. It exports a machine priced at 2,400 E-units and imports a good priced at 6,000 F-units. The E-unit then falls to 1 E-unit = 3 F-units.

(a) Find the machine’s price in F-units at each exchange rate. [2] (b) Work out the percentage change in that price. [2] (c) Find the imported good’s price in E-units at each rate, and the percentage change. [3] (d) Demand for the machine has a price elasticity of 1.2. Estimate the percentage change in the quantity sold. [2]

9. Explain two ways in which a cut in interest rates could reduce unemployment, and one reason why it might not. [6]

10. A government wants both low inflation and full employment. Discuss whether a rise in the interest rate can achieve both. [8]

11. Country G (invented) has growth of 0.5%, unemployment of 11% and low inflation. The central bank cuts its rate from 5% to 3%, and the G-unit falls from 1 G-unit = 2.0 H-units to 1.6 H-units. A firm there has a loan of 120,000 and exports a good priced at 5,000 G-units.

(a) Calculate the yearly interest saved by the firm. [2] (b) Find the export price in H-units at each rate, and the percentage change. [3] (c) Evaluate whether these measures will help Country G achieve its macroeconomic aims. [7]

Answers

1. The stock of money [1] held in a country at a given moment, such as notes, coins and bank deposits [1]. [2] Examiner insight: State what is counted and where it is held; the phrase “money in the economy” alone is thin.

2. Action on borrowing costs, the quantity of money and the currency’s value [1] by the government or central bank to steer the economy towards its macroeconomic aims [1]. [2] Examiner insight: Naming the measures plus the purpose makes a complete definition; tax and spending changes belong to fiscal policy and gain nothing here.

3. Loans become dearer, so households and firms borrow less [1]. Saving pays more, so households spend less [1]. Total spending falls or grows more slowly [1]. Firms find it harder to raise prices, so inflation slows [1]. [4] Examiner insight: Answers gain credit when each step leads to the next; a bare statement that “inflation falls” skips the explanation the command word asks for.

4. (a) Interest at 7% is 40,000 × 0.07 = 2,800 and at 10% is 4,000 [1]. Extra = 4,000 − 2,800 = 1,200 [1]. [2] (b) (1,200 ÷ 2,800) × 100 [1] = 42.9% [1]. [2] (c) Borrowing costs more, so fewer projects are expected to earn enough profit [1]. Less money is left after paying interest to fund new equipment [1]. [2] Examiner insight: Use the old figure as the base for a percentage change; dividing by the new one gives a different answer. Show the working before the rounded result.

5. (a) Real rate ≈ 4 − 6.5 [1] = −2.5% [1]. [2] (b) 1,000 × 1.04 = 1,040 [1]. Divide by the price rise: 1,040 ÷ 1.065 [1] = 976.53 [1]. [3] (c) Borrowers gain [1] because the real value of what they owe falls as prices rise faster than interest accumulates [1]. [2] Examiner insight: Say clearly that the saver is worse off in buying power even though the balance grew; stating only the nominal gain misses the point of real rates.

6. (a) (272.5 − 250) ÷ 250 × 100 [1] = 9% [1]. [2] (b) Money supply grows by 9% but output by only 4% [1]. People and firms have more to spend than the economy produces [1]. This can pull prices up, causing inflation [1]. [3] Examiner insight: Compare the two growth rates in your answer; quoting the 9% on its own does not show why it threatens prices.

7. (a) 2,000 ÷ 0.08 [1] = 25,000 [1]. [2] (b) 25,000 − 2,000 = 23,000 [1]. [1] (c) 2,000 ÷ 0.125 = 16,000 [1]. Change = 16,000 − 25,000 [1] = −9,000, a fall of 9,000 [1]. [3] (d) All loans are spent and redeposited in the banking system, and no cash is held outside banks [1]. [1] Examiner insight: State the direction of the change as well as its size; an answer of “9,000” with no sign leaves it unclear whether the money supply rose or fell.

8. (a) Before: 2,400 × 4 = 9,600 F-units [1]. After: 2,400 × 3 = 7,200 F-units [1]. [2] (b) (7,200 − 9,600) ÷ 9,600 × 100 [1] = −25% [1]. [2] (c) Before: 6,000 ÷ 4 = 1,500 E-units [1]. After: 6,000 ÷ 3 = 2,000 E-units [1]. Change = 500 ÷ 1,500 × 100 = +33.3% [1]. [3] (d) Quantity change ≈ 1.2 × 25 [1] = 30% rise [1]. [2] Examiner insight: Exports are multiplied by the rate and imports divided by it; a different base gives a different percentage in each direction, so explain the base you used.

9. First way: cheaper loans lead firms to invest and expand [1], so they need more workers and unemployment falls [1]. Second way: households borrow and spend more [1], sales rise and firms hire more workers [1]. It may not work because business confidence is low [1], so firms do not borrow even at a low rate and do not hire [1]. [6] Examiner insight: Two distinct routes (firms and households) earn more than one route repeated; a limitation needs a reason, not just the word “confidence”.

10. A higher rate reduces borrowing and spending [1]. Firms find it harder to raise prices, so inflation slows [1]. However, lower sales make firms cut output [1] and employ fewer workers, so unemployment rises [1]. The two aims therefore conflict: success on one tends to harm the other [1]. The effect on prices is weaker if inflation is cost-push, caused by dearer imports or wages, since spending is not the cause [1]. Effects also take months to appear, so a small rise may change little [1]. Judgement: a rate rise is more likely to cut inflation than to deliver full employment, so it cannot achieve both together [1]. [8] Examiner insight: With a discuss question, set out both sides and finish with a verdict that answers the question asked; a list of points without a verdict leaves the task unfinished.

11. (a) 120,000 × 0.05 = 6,000 and 120,000 × 0.03 = 3,600 [1]. Saving = 2,400 [1]. [2] (b) Before: 5,000 × 2.0 = 10,000 H-units [1]. After: 5,000 × 1.6 = 8,000 H-units [1]. Change = −20% [1]. [3] (c) Cheaper loans encourage firms to invest and households to spend, which raises output and may cut unemployment [1]. A weaker currency makes exports cheaper abroad, so export sales rise if demand is elastic [1]. Both support growth and jobs, and inflation is low, so there is room to loosen policy [1]. However, with low confidence firms may not borrow [1]. A weaker currency makes imported inputs dearer and could raise prices [1]. Higher spending may draw in imports and worsen the current account [1]. Judgement: the measures probably help because unemployment is high and inflation is not a threat, but the gain depends on confidence and on elastic foreign demand [1]. [7] Examiner insight: Use the data in the question (unemployment, low inflation) to support the judgement; answers gain credit when evaluation is applied to the case, not recited in general.

Where marks are usually lost

• Defining monetary policy by tax or government spending.
• Stating that rates “affect the economy” with no chain of steps.
• Using the new value, not the original, as the base for a percentage change.
• Multiplying when the question needs division for imports at an exchange rate.
• Forgetting the sign or direction of a change in deposits or prices.
• Confusing a nominal rate with a real rate.
• Writing a list of evaluation points with no verdict.
• Ignoring the case data when asked to evaluate.

Next steps

• Re-read the revision notes and the study guide.
• Check the course hub and printable checklist.
• Take one of the free 10-minute diagnostics.
• Try a free trial class at /trial/.

Official syllabus

Cambridge O Level Economics 2281, syllabus for examination in 2026, published by Cambridge University Press & Assessment (Cambridge Assessment International Education): section 4.4, Monetary policy.