SUGGESTED ANSWERS

EDEXCEL
Economics
Advanced Level
Suggested Answers and
Examiner Commentary for:

PAPER 2
2019
IMPORTANT NOTICE
These suggested answers have been prepared solely to help students
develop their exam technique for future exam sittings. These answers
are not endorsed by Edexcel. These answers were not written under
exam conditions and were prepared with knowledge of the relevant mark
schemes. The examiner commentary provided is written by experienced
examiners but is not endorsed by Edexcel. The answers provide just one
way to approach each question – other equally valid approaches and
responses are possible.
Edexcel Economics (A)

Paper 2 June 2019

Suggested answers Examiner

comments
Section A
This question is a
Question 1 good reminder
to candidates to
Part (a) – 1 mark MCQ be aware of the
Answer: A ‘real world’

Part (b) – 2 marks

Jan 2016 has £13 000bn = Base year Index numbers
Jan 2016 index number would be 100 are a core
quantitative skill
Mar 2017 has £15 000bn. – expect them at
(15 000 – 13 000) / 13 000 = 15.38% least once on an
exam paper!
Therefore the index number is 115.38

Part (c) – 2 marks

As the rate of credit card lending increases, the rate of consumption should increase too. This is Brief and
because many people use credit cards to finance their spending. As C increases, AD increases and this succinct, but
could lead to demand-pull inflation i.e. an increase in the rate of inflation. correctly
identifies the link
between the two
variables in the
question
Question 2

Part (a) – 4 marks Marks would be

awarded for
correct macro
labelling of the
axes. Rising
government
spending causes
a right shift in
AD, and an
increase in
infrastructure
causes a right
shift in LRAS. The
new and old
equilibrium
points are
labelled. Note
that it would be
acceptable to
draw a Keynesian
AS curve.
Part (b) – 1 mark MCQ
Answer: A

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Question 3

Part (a) – 2 marks

The Estonian Government may have increased the minimum wage (in Estonia) significantly since 2010.
In most countries, the minimum wage will increase with inflation every year but the Estonian One possible
Government, in this case, may have opted for a series of above-inflation rate increases which means reason is stated
that the real minimum wage increased – and a lot more than other European countries. and then
developed.
Part (b) – 2 marks
Labour costs are a large part of the costs of production – especially in service industries, in which
Estonia thrives. Therefore, if unit labour costs increase then the costs of production increase and this
could be passed onto the consumers in the form of higher prices. This is an example of cost-push
inflation and could lead to Estonian exports being less price competitive.
Again, this
Part (c) – 1 mark MCQ question
Answer: C highlights the
importance of
being confident
with index
numbers

Question 4

Part (a) – 1 mark MCQ

Answer: D

Part (b) – 2 marks The workings are

£500 000 x 0.17 = £85 000 correct, and the
correct units
used i.e. £
Part (c) – 2 marks
A cut in corporation tax rates should incentivise other firms from overseas to set-up and invest in the
UK. If the number of firms operating in the UK increases, then it follows that the tax revenue collected The reason is
by the Government should increase even if each firm pays slightly less (17% rather than 19%) clearly stated
corporation tax then they did before. Essentially, the increase in the total number of firms paying tax and then
outweighs the decrease in the tax rate. explained,
allowing both
marks to be
awarded

Question 5

Part (a) – 2 marks

Wealth is a stock concept. It includes the value of assets such as a house, shares, savings, cars etc …
By contrast, income is a flow concept. It includes the money paid for the use of factors of production
such as salaries for workers and rental income for property. Knowing
accurate
Part (b) – 2 marks definitions is vital
Demand for assets such as shares and bonds by large global financial institutions has increased
(because of, for example, ageing populations leading to more demand for pensions etc); this causes
the price/value of assets to rise and so those holding such assets will see their wealth rise more quickly This is a tricky
that those who do not. question
because of its
Part (c) – 1 mark focus on wealth
Answer: B rather than
income

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Section B

Question 6 (a) – 5 marks

The forward exchange market is a market which ensures that a buyer of a currency can buy a specified
value of currency at a specified exchange rate at some point in the future. This is known as a forward
contract and the price of a forward contract is known as the forward rate. In Extract A, Nielsen are
said to be buying lots of forward contracts because of the volatility of the Pound and other currencies This is a good
(because of the uncertainty of Brexit) and also the fact that they operate in different countries in answer that
Europe and in China. The advantage of buying a contract is that it ‘locks in an exchange rate for a explains what a
certain period of time, regardless of how the rate moves, … and this can be used as a way of fix costs”. forward market
Nielsen will now find it easier to budget and to quote prices to their buyers. is, its purpose
and its relevance
to the data
Question 6 (b) – 8 marks provided
Figure 1 shows that the value of the Pound has depreciated from July 2016 to May 2017. In July 2016,
£1 = $1.48 and by May 2017 that had fallen to £1 = $1.28. This is a depreciation of 13.51% against the
dollar.
Starting by
One impact of this depreciation is that imported goods will be relatively more expensive. This is interpreting the
particularly bad for manufacturing firms that buy their raw materials and component parts from data, using
overseas. It is likely, for example, that Nielsen imports its picture frames from China. The depreciation technical
of the Pound would mean that the frames are more expensive which would increase costs for Nielsen language i.e.
and might mean that they lose competitiveness. depreciation,
from the case
On the other hand, the Pound’s depreciation against the dollar doesn’t necessarily mean that the study is an
Pound has also depreciated against other currencies like the Chinese Renminbi. The change in the excellent place to
cost of imports is determined by the exchange rate fluctuations against that particular currency. start

A second impact might be that the price of exports is now relatively cheaper. If the value of the The structure of
Pound has fallen, goods and services priced in Pounds are now relatively cheaper to foreigners – who this 8-mark
have to spend less of their own currency. As a result, UK exporting firms should see an increase in answer is very
sales revenue and profits. good – 2 distinct
points, each of
The impact, however, is only limited to exporting firms. If a firm, like Nielsen, sells most of its goods which is briefly
domestically then it won’t see much of an increase. Similarly, it depends on the PED of the product. evaluated, and
The UK’s main exports are price inelastic (e.g. Financial services) and, therefore, a fall in price is unlikely importantly, set
to lead to an increase in the value of exports. in the context of
the data

Question 6 (c) – 10 marks

Rising inflation means that the purchasing power of income decreases; real income falls. As a result,
people can buy less and are unable to satisfy their wants and needs to the extent that they could do
previously because their purchasing power has fallen. Their living standards – in terms of quantity of
food being bought, amount of heating consumed etc - will fall. Or, if they try and maintain their
current living standard, they will have to spend more money than before. This means they have less This paragraph
surplus (if any) which may mean that they start falling behind with their debt repayments or being includes a data
unable to save. This suggests that subjective happiness of households in the UK may fall. reference, and a
very clear,
On the other hand, subjective happiness is not just measured by ‘number of items purchased’. explicit link to
Current UK measures take into account things like family relationships, personal freedoms, and subjective
community. Real income is not the only factor affecting people’s subjective happiness; it is possible happiness.
that people could still be happy even though real income is falling as long as their family relationships
are stable, they are able to express political views and they have trust in their local community.
The significance of income to happiness cannot be totally disregarded though. Even current UK The evaluation
measures of happiness show that there is a strong correlation between income and happiness. This is paragraph shows
often explained in terms of being able to access better levels of healthcare and education. Healthy a strong
people are generally happier and well-educated people have greater opportunities to find understanding

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 employment and increase their income. The data suggests that unemployment is extremely low, and off subjective
so this may also be a factor that contributes to higher subjective happiness. happiness.

On the other hand, the theorist Richard Easterlin suggested that happiness was better explained
through relative income. He acknowledged that there was a general relationship: high income earners
tend to be happier than low income earners. But he also suggested that subjective happiness is more
dependent on one’s income relative to one’s immediate community. For example, “we only feel
happier if we feel better off than the people with whom we compare ourselves”1. Therefore, even This is an
though real income is falling it is not true that everyone will be less happy. Some people may actually excellent piece of
become happier if their real income falls by less than other people in their immediate community. theory to refer to
When inflation rises, it tends to hit savers harder than borrowers, and this redistribution of income may
affect subjective happiness.

Question 6 (d) – 12 marks

Central banks can try to control inflation through a variety of means such as increasing the Base rate
of interest and reducing the money supply/access to credit. Extract C explains that the Bank of
England is trying to reduce commercial banks’ ability to lend. If successful, this should reduce people’s
ability to spend on credit cards and other forms of financing such as PCP financing on cars.
Consumption is the largest component of AD in the UK and so if C falls then AD falls, ceteris paribus,
and there is downwards pressure on the price level on the economy. This is likely to be the case In this answer,
because the data suggests that the UK economy is operating close to full employment (unemployment the candidate
is at its lowest level since 1975). However, as AD falls this could cause a real GDP to fall (and possibly considers two
cause a recession) and could lead to an increase in cyclical unemployment; as demand for goods and possible conflicts
services falls, the demand for labour also falls. If this is prolonged, then the longer term impact on as a result of
unemployment could be significant. There could, therefore, be a conflict between the objectives of policies to
inflation and unemployment. reduce inflation,
and evaluates
The Bank of England should not be too worried by unemployment though. Because the UK economy the likelihood of
recently recorded the lowest rate of unemployment since 1975, this suggests that a leftwards shift of both, considering
the AD curve will not necessarily plummet the economy into recession, especially if the changes to different
monetary policy are slow and gradual. Extract C suggests that the reserve ratio is only increasing from perspectives e.g.
0 to 0.5% to a further 1%, which indeed shows that the changes will be gradual. different types of
household, the
If the Bank of England raises interest rates to try and curb inflation then there could be a potential current position
conflict with inequality. Rising interest rates raise the incentive to save and reduce the incentive to of the economy
borrow, as well as causing the exchange rate to appreciate, thus overall causing AD to fall Since 2016, etc.
the Bank Rate has been raised from 0.25% to 0.75% and this trend looks sets to continue. Many
people in the UK have variable rate loans – especially on long-term borrowing like mortgages and car
financing. This is true of firms too. When the Bank Rate rises, many people (and firms) may suddenly
find that they are unable to make the repayments on their loans and they may declare themselves
bankrupt. This can have longer term consequences for inequality as those people may be unable to
borrow again for many years.

So far the rate rises have been relatively small (0.25% to 0.75% is only 0.5 percentage points over 3
years(!!)) and so it has not had a significant impact on borrowers. The Bank of England’s move to
increase reserve assets also means that the commercial banks should be insulated from a large
number of their clients defaulting. Moreover, the interest rate rise won’t affect everyone in a negative
way. Households with savings might actually benefit from the higher interest on their savings; these
people might include pensioners who are often poorer than those in work.

1
https://qualifications.pearson.com/content/dam/pdf/A%20Level/economics-a/2015/teaching-materials/National-happiness-
Theme-2.pdf

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Question 6 (e) – 15 marks

In 2007/08, many Governments ‘bailed out’ failing banks with taxpayers’ money. In the UK, the result
of such as policy meant that the Government had a large fiscal deficit and built up a huge national
debt. For example, the Government used £65bn to save the RBS and Lloyds Banking Group. One
benefit of this was, of course, that banks did not collapse and savers’ money was not lost. If the bank
collapsed, then many people would have lost savings and pensions. This would have immediately
pushed many people in poverty which, in turn, would have led to a huge burden on the Government’s
welfare budget. Therefore, providing support to banks was a sensible response by the government. This answer
directly tackles
On the other hand, the economy fell into a large recession anyway, many people were pushed into the question
poverty anyway and the Government’s welfare burden increased anyway. The £65bn+ of bailouts asked and is
may have saved the banks and savers’ money but it did not stop the Great Recession and it certainly structured in a
did not stimulate the economy. It may, however, have created a moral hazard where banks are more very neat way
inclined to be reckless in the future now because they know that the Government has a history of that makes it
coming to their rescue. Ten years later, commercial banks continue to lend recklessly and personal easy to mark.
debt levels are worrying. Therefore, maybe the government should have allowed banks to fail. There is also
excellent
Indeed, Sir John Cunliffe suggests that banks should be allowed to fail in the same way that traditional reference to the
companies collapse. Instead of taxpayers taking the burden, shareholders and investors in that bank data as well as
should take the hit. This is known as a bail-in. To some extent, traditional economic theory would strong use of the
agree with this viewpoint: firms should shut down when they cease to be profitable because they are candidate’s own
inefficient and the resources could be re-allocated somewhere else. In addition, the Government independent
would not have to run a large fiscal deficit and get into a large debt. knowledge about
the UK economy
On the other hand, allowing banks to fail would hit consumer and business confidence very hard and this sector,
indeed. People may be inclined to withdraw their savings from other banks quickly (runs on the bank), which helps to
whereas firms may halt investments, move overseas and withdraw their funds from the UK too. The strengthen the
Government may also suffer if they are unable to sell Government bonds on capital markets due to arguments
loss of confidence. If that were the case, they might even be unable to repay their own debt made.
obligations. With such a dramatic fall in confidence, AD would decline quickly and the country would
be plunged into a far more serious recession.

Section C
Question 7 – 25 marks
A trading bloc is a group of countries - often within a particular geographical region - that have
agreed to trade freely with each other (or at least reduce their tariffs on one another) whilst protecting
themselves from the imports of non-members. There are a number of large trading blocs in the world
such the EU and NAFTA, and now the TFTA.

The key economic argument for a trading bloc is that member countries, knowing that they have free
access to each other's markets, are not only encouraged to trade more but also to specialise. This It would be very
means that, at the regional level, there is a wider application of the principle of comparative easy to turn this
advantage. That is to say: if all countries specialise in the production of the goods and services they essay into one
have the least opportunity cost in, total output increases and high cost domestic producers are on pros and cons
of trading blocs
replaced by lower cost, and more efficient imports. Therefore, welfare across the trading bloc
– but this is not
increases. The global trading patterns reflect this idea: countries around the world are much less what the
economically diverse than they ever were and they have ended up specializing in specific areas. For question asks.
example, Nigeria – Oil, UK – financial services, South Korea – tech goods. In some cases, the global This candidate
supply chain has been broken up such that some countries produce small parts for bigger products has focused on
which are assembled elsewhere i.e. there is more trade in intermediate and semi-finished parts. the specific
question asked in
Unfortunately, this will not be beneficial for all members of the trading area. The Prebisch-Singer relation to trade
hypothesis states that the value of primary products deteriorates over time relative to secondary and blocs and the
pattern of global
tertiary goods and service, partly because increased specialisation in primary products causes their

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price to fall (as supply increases in the face of price inelastic demand). As a result, the benefits of trade. Answering
Trading Blocs are not shared equally. Those countries that end up specialising in primary products will the specific
see their terms of trade decline over the years and they will end up having to produce more output in question asked is
absolutely vital to
order to import the same amount. In the EU, Germany has specialised in high end manufactured
success.
goods like cars and jet engines, whereas Spain and Italy are large agricultural producers. Food prices
have deteriorated considerably over the last decade and the economies of Spain and Italy,
unsurprisingly, have become weaker. Germany, on the other hand, is thriving. Without income to The use of
develop their industries away from primary sector goods/services, the changes in the global pattern of relevant real-
trade are set to intensify. world examples
throughout the
Another effect of the growth of trading blocs is that trade has increased between members but
answer really
helps to improve
decreased between countries that are members of different FTAs. For example, cheap imports from
the quality of the
places such as China and India can have huge negative consequences for any economy unless they arguments
are controlled at some level. A trading bloc like the EU enables this. Member countries no longer made.
need to worry that a low-cost outside producer is going to flood their markets with cheap imports and
threaten jobs. In fact, trading blocs actually create jobs since there are more opportunities for trade
and the (trading bloc) market is so much bigger than any one country’s own domestic market. The EU
is now the largest economy in the world (even larger than the USA) and the economies are so inter-
dependent that 19 of them share the same currency and, after 2008, German taxpayers were asked to
bail out the Greek Government.

However, the fact that the UK (as a member of the EU) cannot negotiate its own trade deal with a
non-member country is a significant reason for Brexit. A free trade area does not, in and of itself,
prevent trade negotiations with non-members but a Customs Union – only one stage more integrated
- would. Economists are likely to bemoan the fact that non-member countries will find trade with
member countries much harder now. These countries might still have a comparative advantage but
The use of
that advantage is lost if they are operating behind an import tariff wall. As a result, the non-member technical
country is likely to retaliate and impose its own tariffs. Indeed, more countries are likely to try and language and
form their own trading bloc as a way of retaliating against the protectionism policies of the initial economic theory
trading bloc. The proliferation of free trade areas has been a feature of recent global trading patterns; is very good.
the TFTA is but yet another example. The problem of inter trading-bloc rivalry is only likely to get
worse as well since disgruntled countries will look to form their own trading blocs in response to being
shut-out by another. This can lead to trade wars and, as a result, higher prices and a restriction in
choice.

In conclusion, trading blocs have had an enormous effect on global trading patterns and they look set
to continue in the future (despite Brexit). In particular, trading blocs have led to increased
specialisation in the world which has not had equal benefits for everyone and it has led to a more
Reaching a
vulnerable global economy overall. It has also led to more trade between member countries but less
judgement is a
trade between non-members.
vital aspect for
25 mark essay
questions.
Question 8 – 25 marks
A fiscal deficit occurs when a government spends more than it collects in tax revenue during the year.
It usually borrows the money by selling Government bonds in capital markets. A national debt is the
money owed by the Government to bondholders (that is, people/firms/other Governments who have
bought Government bonds in the past) Whilst starting
with definitions is
A large national debt means that the Government will have to repay bondholders throughout the year not essential, it
which creates a large opportunity cost (this is money that could have been spent more effectively can really help

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elsewhere). In the case of Japan, its national debt is enormous – the highest in the world – at 250% of candidates to be
GDP. It can be assumed, therefore, that the repayments are also substantial and that the Japanese clear about
citizens lose out because this is money that could have been spent in their economy on the provision exactly what an
essay is asking
of merit and public goods, which would improve living standards.
them to do.

It matters who the debt is owed to though. For example, if it owed to the World Bank/IMF then there
is a strong likelihood that conditions may be attached and the country may lose some fiscal
sovereignty. This is the situation that Greece found itself in in 2015. Japan’s debt, however, is held by
its own citizens and so the risk of defaulting is much lower. Japan’s citizens are less likely to see
detrimental impacts on their living standards compared to those in Greece.
Excellent use of
That said, high national debt levels could mean that future borrowing becomes even more expensive. illustrative
A large debt makes capital markets “suspicious” of the government’s activities and creditworthiness, examples to
support the
and therefore less willing to buy bonds. As a result, credit ratings fall, bond yields rise and the cost of
argument made.
borrowing increases in the future. Japan has already been downgraded from AAA to AA, so this
process has already started to an extent. Higher interest rates will increase an already-large debt, and
an increasing amount of tax revenue will have to be spent on debt repayment; the opportunity cost of
this is government spending on other areas such as education.

On the other hand, Japan Is still the 3rd largest economy in the world and, despite struggles with
deflation, its GDP has been growing steadily. With so much other economic uncertainty in the world
like Brexit, Italy’s possible bankruptcy, US-China trade wars and Russian sanction, many investors may
still see Japanese bonds as a good investment and so bond yields may not rise so much.

This is even more true if the fiscal deficit is being used to stimulate the economy as part of a Keynesian
(expansionary) fiscal policy programme. This was certainly the case in Japan when Government
spending peaked in 2016 when President Shinzo Abe committed an extra $114bn (£75bn) to fix schools
and roads and reinforce earthquake defences. Foreign investors may consider this as a positive sign
for the Japanese economy and be willing to buy Government bonds. In fact, it hypothetically possible
that the extra tax revenue, that is gained from the resultant economic growth, may even counter-
balance the spending and the budget may balance.

Unfortunately, this is unlikely. Instead, there is a very real risk that the banking system will suffer from
crowding out. If the private sector is funding a large fiscal deficit, that implies there is less money
available for private investment. Private Investment falls and drags AD down at the same time. In
addition, it may actually hurt confidence in the economy is people believe that the Government may
use austerity policies (such as tax increases and spending cuts) to claw back the debt at some point in
the future.

In conclusion, national debts and fiscal deficits are not always bad. It will depend on the context of the
country and also the relative size of both deficit and debt. For example, if the fiscal deficit is being
used as an economic stimulus and the country does not have a large debt, then this could be
beneficial short-term measure. In Japan’s case, however, its national debt is already high and a fiscal
deficit of 4.6% - at a time when GDP growth is weak and inward investment is poor – is likely to cause
more problems of creating market uncertainty and crowding out.

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