OxfordAQA International AS and A-level Economics: Monetary policy (9640) – 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 monetary policy (specification section 3.2.4.1) in OxfordAQA International AS and A-level Economics (9640), International AS content for exams from May/June 2021 and the International A-level from May/June 2022. All data are invented. Start with the study guide and revision notes. See the course hub and checklist.

Questions

1. Define monetary policy and state its usual prime objective. [3]

2. Country C has a target of 2% inflation with a tolerance of one percentage point either side. Its consumer price index is 112.0 in Year 1, 117.0 in Year 2 and 119.5 in Year 3.

(a) Calculate the inflation rate in Year 2 and in Year 3, giving each to 1 decimal place. [2] (b) State whether each year is inside the target range. [2]

3. In Year 2 the nominal interest rate in Country C is 3.5% and inflation is 4.5%. Calculate the approximate real interest rate and explain one effect on spending. [3]

4. Give two reasons why higher interest rates tend to lower aggregate demand, and explain each. [4]

5. A firm in Country C has a variable-rate loan of 250,000 and annual operating profit of 50,000. The rate rises from 4.5% to 6.0%.

(a) Find the extra annual interest and express it as a percentage of the firm’s profit. [3] (b) Across the economy, variable-rate household debt is 36bn. Households spend 50% of lost income and investment falls by 0.18bn. The multiplier is 1.8 and GDP is 270bn. Find the fall in real GDP, in bn and relative to GDP. [3]

6. The exchange rate moves from 1 C-unit = 3.00 D-units to 1 C-unit = 2.55 D-units. Find the percentage fall in the C-unit’s value. A machine is imported for 1,530 D-units. Work out its cost in C-units before and after the move, and the percentage rise. [4]

7. Explain how a depreciation of the currency may increase inflation. [4]

8. A government bond pays a fixed 3.6 a year on a face value of 150.

(a) Calculate the yield when the price rises from 150 to 180. [2] (b) Explain how quantitative easing can increase aggregate demand. [5]

9. Analyse two reasons why a cut in interest rates might do little to raise aggregate demand. [6]

10. Inflation in Country C is 4.5%, mostly from higher import prices after a depreciation. The output gap is -1.5%. Evaluate whether raising the interest rate is the best response. [12]

11. Evaluate the likely effects of a depreciation on the macroeconomic objectives of Country C. [9]

Answers

1. Central bank action to influence interest rates, money and credit, or the exchange rate [1], to meet its objectives, with the bank rather than the government doing the acting [1]. Prime objective: control of inflation [1]. [3] Examiner insight: A good definition names the central bank and at least one tool, not just “managing the economy”.

2. (a) Year 2: (117.0 - 112.0) / 112.0 x 100 = 4.5% [1]. Year 3: (119.5 - 117.0) / 117.0 x 100 = 2.1% [1]. (b) The range is 1% to 3%. Year 2 is above the range [1]. Year 3 is inside it [1]. [4] Examiner insight: Each year’s rate is measured against the year before it; dividing every change by Year 1 gives wrong figures.

3. Real rate = 3.5 - 4.5 = -1.0% [1]. Savers earn less than inflation, so saving is discouraged [1]. Borrowing is cheap in real terms, so spending is encouraged [1]. [3] Examiner insight: A negative result needs its sign, and the point is stronger when linked to what households do with their money.

4. Any two. Loan costs rise, so borrowers on variable rates are left with less to spend [1] and consumption falls [1]. Borrowing is dearer for firms [1] so investment falls [1]. Alternatives: asset prices fall, reducing wealth; the currency may appreciate, reducing net exports. [4] Examiner insight: Naming a channel and then its effect on a component of AD usually earns more than naming channels alone.

5. (a) 250,000 x 0.015 = 3,750 a year [1] [1]. 3,750 / 50,000 x 100 = 7.5% of profit [1]. (b) Lost income = 36 x 0.015 = 0.54bn, so consumption falls 0.5 x 0.54 = 0.27bn and the first-round fall in AD is 0.27 + 0.18 = 0.45bn [1]. GDP falls 0.45 x 1.8 = 0.81bn [1]. 0.81 / 270 x 100 = 0.3% [1]. [6] Examiner insight: Setting out each stage of a multi-step calculation makes your method clear and helps you spot slips.

6. (2.55 - 3.00) / 3.00 x 100 = -15% [1]. Before: 1,530 / 3.00 = 510 C-units [1]. After: 1,530 / 2.55 = 600 C-units [1]. Rise: (600 - 510) / 510 x 100 = 17.6% [1]. [4] Examiner insight: Divide D-units by the exchange rate to get C-units; a sense-check that the import has become dearer catches a flipped calculation.

7. Imported inputs cost more in home currency [1], so firms’ costs rise, SRAS shifts left and the price level rises [1]. Cheaper exports abroad lift net exports and AD [1], which pulls prices up when firms have few idle resources [1]. [4] Examiner insight: Answers do well when they name both routes, cost-push and demand-pull, and say when each matters.

8. (a) Yield = 3.6 / 180 x 100 [1] = 2.0% [1]. (b) The central bank pays for large purchases of government bonds with new electronic money [1]. Sellers’ bank balances rise, so the money supply increases [1]. Bond prices rise and yields fall [1], so borrowing is cheaper and investors buy other assets, raising their prices [1]. Consumption and investment rise, so the AD curve moves right [1]. [7] Examiner insight: Mentioning both the lower interest rate and the larger money supply shows the full chain; either alone is a partial answer.

9. First reason: confidence is low [1], so households and firms do not borrow even when credit is cheap [1], and AD barely moves [1]. Second reason: many households have fixed-rate loans, or savings that earn less after a cut [1], so disposable income does not rise much [1], and the effect on consumption is small [1]. [6] Examiner insight: For each reason, say why it happens and what follows for AD; a bare assertion leaves the point undeveloped.

10. A higher rate cuts consumption and investment, moving AD left [1] and easing demand-pull pressure [1]. The currency may rise, lowering import prices [1]. However, inflation here is mostly cost-push from import prices [1], so lower AD does not remove the cause [1]. An output gap of -1.5% means spare capacity [1], so reducing demand adds to unemployment [1] and slows growth [1]. The delay before the effect arrives may mean import prices have settled by then [1]. The effect depends on variable-rate debt [1]. A flexible target tolerates a temporary overshoot [1]. Judgement: the rate rise is probably not the best response, unless inflation expectations are rising [1]. [12] Examiner insight: Strong answers separate the cause of the inflation from the tool and end with a supported judgement.

11. Net exports rise as exports become cheaper and imports dearer [1], so AD shifts right [1] and growth rises [1]. Unemployment falls as output rises [1]. Inflation rises through dearer imports [1] and demand-pull [1]. The current account improves only if elasticities are high enough [1] and takes time [1]. Judgement: the gains are likely if spare capacity exists, but living standards fall for import buyers [1]. [9] Examiner insight: Ending on a judgement that depends on elasticity, spare capacity and timing is stronger than a plain list of effects.

Where marks are usually lost

• Using Year 1 as the base for every year’s inflation rate.
• Mixing up percentages and percentage points.
• Multiplying instead of dividing when converting currency.
• Stating that the government sets interest rates.
• Ending the chain at “spending falls” without reaching prices or output.
• Treating a depreciation as always good for the current account.
• Recommending a rate rise for cost-push inflation while ignoring the lost output.
• Evaluating with no judgement or no mention of the output gap.

Next steps

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

Official syllabus

OxfordAQA International AS and A-level Economics (9640), version 1.2, published by OxfordAQA: section 3.2.4.1 Monetary policy and section 3.5 Quantitative skills.