AQA GCSE Economics: Interest Rates and Government Income and Expenditure (8136)

This guide covers 3.2.1.1 Interest Rates, Saving, Borrowing, Spending and Investment and 3.2.1.2 Government Income and Expenditure, from AQA GCSE Economics (8136), for first teaching from September 2017. Both open 3.2.1 Introduction to the National Economy, assessed on Paper 2.

Syllabus coverage

AQA GCSE ECONOMICS (8136) — 3.2.1.1 INTEREST RATES, SAVING, BORROWING, SPENDING AND INVESTMENT

Students should understand what is meant by an interest rate; the factors that influence different rates of interest; how changes in interest rates affect consumers’ decisions to save, borrow or spend; how changes in interest rates affect producers’ decisions to save, borrow or invest; and how to calculate interest on savings.

3.2.1.2 GOVERNMENT INCOME AND EXPENDITURE

Students should understand the main sources of UK government revenue; the main areas of UK government spending; the difference between direct and indirect taxation; and that some taxes can be progressive and others regressive.

How to approach it

For interest rates, keep the consumer and producer perspectives explicitly separate, since exam questions often ask about one or the other specifically. A rise in interest rates typically discourages consumer borrowing and spending (loans become more expensive) while encouraging saving (returns on savings improve); the same rise discourages producer/business borrowing and investment for the same reason, while making holding cash in savings relatively more attractive than expanding operations. Practise stating the direction of each effect and a brief reason, not just the direction alone.

For government income and expenditure, the direct/indirect and progressive/regressive distinctions are commonly tested together and easy to conflate, so learn them as two separate axes. Direct versus indirect describes how a tax is collected: a direct tax (such as income tax) is paid directly by the individual or organisation on whom it is levied; an indirect tax (such as VAT) is collected by an intermediary (a retailer) and passed on, ultimately falling on the consumer through the price of goods. Progressive versus regressive describes how the tax burden changes with income: a progressive tax takes a larger percentage of income from higher earners; a regressive tax takes a larger percentage of income from lower earners (a common example being a flat-rate tax on a good that lower earners spend a higher proportion of their income on).

The factors influencing different interest rates are worth naming specifically too: the level of risk associated with the borrower (a riskier borrower typically faces a higher rate to compensate the lender), the length of the loan or savings term, and the wider level of interest rates set by the central bank all play a role in why different loans or savings products offer different rates even within the same economy at the same time.

Worked example: calculating interest on savings

A student deposits £1,800 in a savings account offering a 5% annual interest rate. Calculate the interest earned after one year, and explain how a rise in this interest rate might change the student’s saving behaviour.

Step 1: calculate interest earned
        interest = principal x rate = 1800 x 0.05 = 90
        (that is, GBP90 earned in interest after one year)

Step 2: explain the behavioural effect of a rate rise
        a higher interest rate increases the return on savings,
        making saving more attractive relative to spending now, so
        the student is more likely to save a larger proportion of
        their income than before

Pairing a numeric interest calculation with a behavioural explanation in the same answer reflects how this content is typically assessed together.

Key terms to define precisely

Interest rate — the cost of borrowing money, or the reward for saving it, usually expressed as a percentage of the amount borrowed or saved per year. Direct tax — a tax paid directly by the individual or organisation on whom it is levied, such as income tax or corporation tax. Indirect tax — a tax collected by an intermediary (typically a business) and passed on to the government, ultimately borne by the consumer through the price of goods and services, such as VAT. Progressive tax — a tax where the percentage of income paid rises as income rises, so higher earners pay a larger proportion of their income. Regressive tax — a tax where the percentage of income paid falls as income rises, so lower earners pay a larger proportion of their income relative to higher earners. Government revenue and spending decisions in this sub-topic connect directly to the broader policy objectives (economic growth, price stability, employment, balance of payments) covered in 3.2.2, since taxation and spending are among the main tools a government has to influence those objectives.

Common mistakes

Describing the effect of an interest rate change without specifying whether it is a rise or a fall, leaving the direction of the effect ambiguous. Confusing direct and indirect taxation with progressive and regressive taxation, when these are two separate classification systems that can combine in different ways (for example, income tax is both direct and typically progressive). Applying interest rate effects to consumers and producers identically, without noting that businesses respond through investment decisions specifically, not just general spending. Miscalculating simple interest by forgetting to convert a percentage rate to a decimal before multiplying.

Quick revision checklist

• Practise explaining how a rise and a fall in interest rates each affect consumer saving, borrowing and spending.
• Do the same for producer saving, borrowing and investment decisions.
• Keep direct/indirect and progressive/regressive as two separate classification axes for taxation.
• Practise simple interest calculations, converting percentages to decimals correctly.

Related resources

• Interest Rates and Government Income and Expenditure revision notes
• Interest Rates and Government Income and Expenditure practice questions

Official syllabus

AQA GCSE Economics (8136) specification, first teaching from September 2017 — aqa.org.uk/8136.