Edexcel IAL Economics: Global macro policies, TNC control and policy problems (YEC11) – 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 follow statement 4 (a to e) of 4.3.5 in the Pearson Edexcel International Advanced Subsidiary/Advanced Level Economics specification (YEC11), Issue 2, June 2018. The specification labels Unit 4 as an IAL compulsory unit, so this is International A2 content. All countries, firms and figures are invented. Read the study guide and revision notes first, and see the course hub and printable checklist.

Questions

1. Distinguish between tax avoidance and tax evasion. [2]

2. Country G has GDP of 400 billion currency units (cu) and a fiscal deficit of 28 billion cu. The government cuts spending by 10 billion cu. The multiplier is 2 and tax revenue is 25% of any change in GDP. Calculate the new deficit as a percentage of the new GDP, to 1 decimal place. [4]

3. Country H’s currency falls from 0.80 to 0.64 units of foreign currency. An imported good costs 16 foreign units. Imports are 30% of the consumer price basket and all the price change is passed on.

(a) Calculate the percentage change in the home-currency price of the good, and the effect on the price level. [3] (b) State one policy implication for a government that wants to control inflation. [1]

4. Country M exports a primary product. Its export price index falls to 72 and its import price index rises to 96 (both from 100).

(a) Calculate the terms of trade index. [2] (b) Explain one macroeconomic effect of this external shock. [3]

5. Firm Y has a subsidiary in Country S (corporate tax 25%) that makes 50,000 units at a cost of 40 each. It sells them to a subsidiary in Country T (tax 12.5%), which sells them to customers at 90 each. The market price between unrelated firms is 70.

(a) Calculate the total tax paid if the transfer price is 70. [2] (b) Calculate the total tax paid if the transfer price is 45. [2] (c) Calculate the tax saved by the firm. [1] (d) State one measure that governments use to regulate transfer pricing. [1]

6. In Country K, GDP is 600 billion cu. The marginal propensities to save, tax and import are 0.05, 0.15 and 0.30. Investment falls by 30 billion cu after a financial shock.

(a) Calculate the multiplier and the fall in GDP. [3] (b) Calculate the government spending that would restore GDP. [1] (c) Explain one reason why the restoration might not work as calculated. [1]

7. Country P taxes income at 0% up to 8,000 cu, 25% from 8,000 to 40,000 cu and 45% above 40,000 cu. Calculate the ratio of the incomes of a household earning 100,000 cu to one earning 10,000 cu before and after tax, and comment on the change. [6]

8. Officials in Country J find that actual GDP is 470 billion cu and estimate potential GDP at 500 billion cu. The multiplier is 2.

(a) Calculate the output gap as a percentage of potential GDP. [2] (b) Calculate the spending increase needed to close the gap. [2] (c) Revised data show that potential GDP was 480 billion cu. Explain what happens and why this matters for policy. [4]

9. Assess the effects of a rise in the central bank’s interest rate in Country L on its local, national and global economies. [9]

10. Assess whether governments can control tax avoidance by TNCs. [10]

11. Evaluate the use of demand-side policies in response to the global financial crisis of 2008. [12]

Answers

1. Avoidance is the legal reduction of tax paid, for example by using allowances or moving profit to a low-tax country [1]. Evasion is the illegal failure to pay tax that is owed [1]. [2] Examiner insight: a clear legal versus illegal contrast is what separates the two terms; saying only that both reduce tax paid does not.

2. GDP falls by 10 x 2 = 20, to 380 [1]. Revenue falls by 0.25 x 20 = 5 [1]. The net saving is 10 - 5 = 5, so the deficit is 28 - 5 = 23 [1]. 23/380 x 100 = 6.1% [1]. [4] Examiner insight: answers that ignore the revenue lost through lower GDP overstate the saving; showing each stage makes your method visible.

3. (a) Home price before = 16/0.80 = 20, after = 16/0.64 = 25 [1]. Change = (25 - 20)/20 = 25% [1]. Price level effect = 0.30 x 25 = 7.5% [1]. [3] (b) A fall in the currency raises import prices, so it works against an inflation target; the government would need another tool such as higher interest rates [1]. [1] Examiner insight: take care over the direction: a fall in the exchange rate makes imports dearer, and answers that reverse this make every later figure wrong.

4. (a) Terms of trade = 72/96 x 100 [1] = 75.0 [1]. [2] (b) Export prices fall relative to import prices, so the same exports buy fewer imports [1]. Export revenue and net exports fall, so AD and output fall [1]. The government cannot control world prices, so it can only respond, for example with fiscal stimulus or by diversifying exports [1]. [3] Examiner insight: link the index to a macroeconomic variable such as AD, growth or the current account; defining terms of trade again earns little extra.

5. (a) Profit in S = (70 - 40) x 50,000 = 1.5m, tax = 0.375m [1]. Profit in T = (90 - 70) x 50,000 = 1.0m, tax = 0.125m, total 0.50m [1]. [2] (b) Profit in S = 5 x 50,000 = 0.25m, tax = 0.0625m. Profit in T = 45 x 50,000 = 2.25m, tax = 0.28125m [1]. Total = 0.34375m [1]. [2] (c) 0.50 - 0.34375 = 0.15625m [1]. [1] (d) The arm’s length principle (or documentation rules or country-by-country reporting) [1]. [1] Examiner insight: set out each subsidiary’s profit and tax in a small table; unlabelled figures are hard to follow and easy to mix up.

6. (a) mpw = 0.05 + 0.15 + 0.30 = 0.50 [1]. Multiplier = 1/0.50 = 2 [1]. Fall in GDP = 30 x 2 = 60 billion cu [1]. [3] (b) 60/2 = 30 billion cu [1]. [1] (c) A high marginal propensity to import means some spending leaks abroad, or confidence may stay low so the real multiplier is smaller [1]. [1] Examiner insight: write the three propensities down before adding them; omitting one is a common slip, and the later parts depend on it.

7. Tax on 10,000: 0.25 x 2,000 = 500, net 9,500 [1]. Tax on 100,000: 0.25 x 32,000 = 8,000 [1] plus 0.45 x 60,000 = 27,000, total 35,000, net 65,000 [1]. Before tax the ratio is 100,000/10,000 = 10.0 [1]. After tax it is 65,000/9,500 = 6.8 [1]. A progressive tax narrows the gap in disposable income, though very high rates may weaken incentives [1]. [6] Examiner insight: apply each rate only to its own slice of income; applying the top rate to the whole income is the usual error, and the comment should refer to your own numbers.

8. (a) (470 - 500)/500 [1] = -6.0% [1]. [2] (b) Gap = 30 billion cu [1]. Spending = 30/2 = 15 billion cu [1]. [2] (c) The true gap is 480 - 470 = 10 billion cu, but the stimulus adds 15 x 2 = 30 billion cu, so output overshoots by 20 billion cu [1]. AD exceeds potential output, so inflationary pressure builds [1]. Data are estimates and are revised [1], so policy sized on inaccurate information can be the wrong size [1]. [4] Examiner insight: the best answers calculate the overshoot and then name the problem (inaccurate information) rather than saying “data can be wrong” in general.

9. Local: firms and households in areas reliant on credit-sensitive sectors face higher borrowing costs [1]; jobs may be lost locally while savers gain [1]; the effect depends on the area’s industry mix, so some places barely notice [1]. National: borrowing and spending fall, shifting AD left [1]; output and inflation fall and unemployment may rise [1]; time lags and spare capacity affect the outcome, and cost-push inflation responds less [1]. Global: higher rates attract capital and appreciate the currency [1]; partner countries sell less to Country L but face lower import prices from it [1]; the effect is small if Country L is a small economy, and other central banks may respond [1]. [9] Examiner insight: answers that give three developed scales, each with a chain and a qualification, tend to do better than a national answer with the other scales added as one line.

10. Measures: the arm’s length principle forces intra-firm prices towards market prices, reducing profit shifting [2]. Country-by-country reporting shows where profits and tax arise, so authorities can challenge mismatches [2]. Limits: a TNC can threaten to move FDI to a low-tax country, so governments compete on rates [2]. Authorities lack information on private intra-firm pricing, and rules differ between countries, so cooperation is needed and enforcement capacity may be weak [2]. Judgement: control is partial; it improves with agreement among many countries, and avoidance within the law persists until loopholes close, so effectiveness depends on cooperation and the country’s strength [2]. [10] Examiner insight: a judgement that names what the outcome depends on is stronger than “it depends”; keep it tied to the points already made.

11. Monetary: policy rates were cut to very low levels and QE lowered long-term yields [2]. Fiscal: banks were rescued and governments raised spending or cut taxes, with automatic stabilisers adding to deficits [2]. Chain: these actions supported spending, and the multiplier spread the effect, preventing a deeper fall in output [2]. Evaluation: banks and firms wanted to repair balance sheets, so lower rates did not fully revive lending [1]; leakages abroad cut the multiplier [1]; debts and deficits rose, which later constrained policy [1]; QE raised asset prices, benefiting wealthier households [1]. Judgement: policy probably limited the fall, but the recovery was slow because the underlying problem was in finance; the effect is hard to prove because we cannot observe what would have happened otherwise [2]. [12] Examiner insight: each tool needs a link to its cause of weakness or side effect; a list of measures with no evaluation earns little credit for the evaluation skill.

Where marks are usually lost

• Using the spending cut as the full deficit saving, with no multiplier effect on revenue.
• Reversing the effect of a currency fall on import prices.
• Leaving out a unit or the base of a percentage (percentage of what?).
• Applying the top tax rate to all income instead of the top slice.
• Treating transfer pricing as evasion; it is usually legal avoidance.
• Describing the 2008 policies as a list with no evaluation.
• Covering only the national level when the question names local and global.
• Concluding without weighing short run against long run.

Next steps

• Revisit the revision notes and the study guide.
• Tick off the content on the printable checklist and see the course hub.
• Take the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, first assessment June 2020, Pearson Education Limited: Unit 4, 4.3.5 statement 4 (a to e).