Trial Test

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Instructions
This Trial Test is designed to take 1 hour and 45 minutes.
• Answer ALL questions in Sections A, B and C.
• Answer ONE question in Section D.
• Answer the questions in the spaces provided.
Information
• The total mark for this paper is 80.
• The marks for each question are shown in brackets.
Use this as a guide as to how much time to spend on each question.
• Calculators may be used.
Advice
• Read each question carefully before you start to answer it.
• Check your answers if you have time at the end.
Section A
Each question is worth 1 mark.
1. Statement 1: In 2017, the Kenyan Government spent Sh172.5 billion on healthcare.
This is 8% of its annual budget.
Statement 2: The African Union believes African countries should spend 15% of their
annual budgets on healthcare.
Which one of the following best describes the two statements above? Select the
correct answer.
A Both statements are positive
B Statement 1 is positive and statement 2 is normative
C Both statements are normative
D Statement 1 is normative and statement 2 is positive
2. Which one of the following is a function of the price mechanism? Select the
correct answer.
A To create an incentive for producers to decrease the quantity supplied when
the price increases.

B To encourage government intervention to allocate scarce resources.

C To provide a signal to producers and consumers about changes in supply and

demand when prices change.
D To ration scarce resources by allowing prices to decrease when demand
increases.

3. Statement: An increase in real incomes in Country A leads to a reduction in the

demand for holidays taken in Country A. Demand for holidays abroad increases.
What one of the following can be concluded from this statement? Select the
correct answer.
A Holidays in Country A are an inferior good while holidays abroad are a
normal good.
B The demand for holidays abroad is income elastic while the demand for
holidays in Country A is income inelastic
C There is a negative cross price elasticity of demand between holidays abroad
and holidays in Country A.
D Holidays abroad have a high price elasticity of demand while holidays in
Country A have a low-price elasticity of demand.

4. Which one of the following is an example of market failure? Select the correct answer.
A Government provision of flood defences that is greater than the social
optimum output
B Doctors prescribing too many medicines because the cost is covered by
health insurance
C Lower prices creating an incentive for firms to switch production to more
profitable activities
D Unintended consequences that follow the introduction of an indirect tax
5. A government is concerned that its economy is not achieving productive efficiency. To
achieve productive efficiency the government should introduce policies that…
Finish the sentence by selecting the correct answer.
A move the economy to a point on its production possibility frontier.

B ensure that the goods and services produced match people’s needs and
preferences.
C limit the amount of profits that companies can earn.

D internalise all externalities.

6. The diagram shows the market for education in a country.

Which one of the following can be deduced from the diagram? Select the correct
answer.
A The welfare gain from removing the market failure is RUT.
B The welfare gain from removing the market failure is RUX.
C The social optimum quantity is Q1 and price is P1.
D The market equilibrium quantity is Q2 and price is P2.
 Section B
7. In 2000 the population of Qatar was approximately 592 500. By 2018 the population
had increased to 2.782 million.
Draw a diagram to illustrate the impact of this change in Qatar’s population on its
production possibility frontier.
capital goods

[4 marks]
consumer goods

8. A report identified that Hong Kong is the city with the highest risk of experiencing a
housing market bubble. House prices in Hong Kong increased by 10% per year between
2012 and 2018.
With reference to the Hong Kong housing market, explain what is meant by a ‘market
bubble’.
A market bubble refers to a situation in which the price of an asset, such as a stock or real estate,
becomes inflated beyond its intrinsic value. This can happen for a variety of reasons, such as
speculation, overconfidence, or a lack of understanding of the true value of the asset. When a
market bubble occurs, it is often followed by a sharp decline in prices, as the bubble eventually
bursts and the market corrects itself.

In the case of the Hong Kong housing market, it sounds like house prices have been rising rapidly
over the past few years, potentially due to high demand or other factors. If the increase in house
prices is not supported by underlying economic fundamentals, such as the ability of buyers to pay
the higher prices or an increase in the value of the properties themselves, it could be a sign of a
market bubble. If the bubble were to burst, it could result in a significant drop in house prices,
potentially leading to financial losses for homeowners and investors.
[4 marks]

9. Singapore’s economy is highly dependent on trade with the rest of the world. In 2017,
Singapore’s exports were 173.3% of its GDP.
Explain one role of financial markets in such an economy.
One role of financial markets are to make funds
available to businesses and individuals, this means that
firms can borrow money money to be able to purchase
goods from other countries, this means that financial
markets allow firms to increase their output and be able
to sell more products.
[4 marks]
10. The table shows the gross weekly earnings of Chinese workers and the number of visits
abroad by Chinese citizens in 2016 and 2017.

Using the data in the table, calculate the income elasticity of demand for visits abroad
by Chinese citizens. Show your workings.
to do this we have to use the formula for income elasticity
of demand % change in quantity demanded divided by %
change in income

[4 marks]

11. In Ho Chi Minh City, Vietnam, the price of sand increased from VND510 000 to
VND695 000 per cubic metre between April and May 2017. This was caused by
reduced supply from Vietnamese mining companies.
Explain the likely impact of this change on producer surplus in the market for sand.
Illustrate your answer with a diagram.

producer surplus is the difference between the price of a

good and the price willing to sell for/ the gap between the
equilibrium price and supply curve/profit generated by the firm

[4 marks]
SECTION C

Study Extracts A, B and C and Figure 1 before answering Question 12.

Sources for use with Section C.

The market for oil

Extract A: Oil Prices

Oil is a commodity. This means the price is determined by supply and demand in the market.
Oil supply is dominated by a group of oil producing nations called OPEC, together with big
producers such as Russia and the USA. The demand for oil comes from its use in a range of
goods, from fuel for cars to electricity generation. It is also used extensively in the
manufacture of synthetic fibres which are used to make clothing. Oil is an actively traded
commodity in the commodity forwards market. These markets are composed of speculators
who are betting on price moves, and hedgers who are limiting risk in the production or
consumption of oil.

Figure 1 Market share of main fibres used in the manufacture of clothing

(Source: Adapted from What are our clothes made from?

https://www.commonobjective.co/uploads/?file=15-What-are-our-clothes-made-from-
983.pdf)

Extract B: A negative price for oil

The price of crude oil in the month of May fell as low as minus $40.32 a barrel. This was
negative for the first time in history. People have schemed, starved and even gone to war to
get oil. But this week they would have paid you to take it. Crude oil’s dramatic price fall
shows the depth of the current drop in demand and sheds light on the curious phenomenon of
negative prices. These are actually fairly common, occurring everywhere from electricity
markets to forward markets. They are unsettling, however, because they seem to upset the
natural order of things. Surely, an item of such obvious cost and utility as oil must always be
worth something? People tend to put more weight on a loss than an equivalent gain. It is not
surprising, therefore, that we feel a certain horror at negative prices. They suggest your assets
can turn to liabilities, losing you everything and more.

The obvious question posed by negative prices is why trade occurs at all if the price is less
than zero. Why not hold on to what you have? There are several reasons. The first is a storage
problem familiar to anybody clearing a house for sale. The grand piano may be beautiful, but
if there is going to be nowhere to put it, it turns from an asset into a liability as the day of the
move draws near. US oil traders found themselves in a similar position this week. Owning a
barrel of oil at contract expiry means taking physical delivery of the oil. So, if oil storage
tanks are full, you have a serious problem. A similar thing happens in electricity markets.
Electricity is notoriously hard to store but shutting down a coal or nuclear plant is costly and
time consuming. So, when supply exceeds demand, it can make sense to pay users to take it.

The mechanics of negative prices are straightforward enough. But what they cannot explain is
why a barrel of oil or a cash deposit would become of so little value that the cost of storage is
relevant. In the case of oil this week, the answer is clear: demand has collapsed because of
the coronavirus pandemic. So, storage, either by leaving oil in the ground or pumping it into a
supertanker, is the only option. Something similar has happened to interest rates, which
balance the supply of savings with demand for investment. In a slow-growth world, the
supply of savings is high but the demand to borrow them is not, so the price can become
negative.

(Source: Adapted from ‘Oil is not the only negative price coming to you’, Financial Times,
24 April 2020.)

Extract C: Climate change

All over the world, pollution levels are dropping fast. The lockdowns triggered by the Covid-
19 pandemic are starting to have an impact not only on the virus but also on the planet as
airlines ground their fleets, car travel grinds to a halt and industries shut down. Emissions
from transportation and power have fallen sharply. In the US, emissions of carbon dioxide are
forecast to drop 7.5% this year. In the EU, daily emissions have fallen 58% compared to pre-
crisis levels.

Global levels of nitrogen dioxide, a pollutant linked to cars, have hit a record low. Less coal
burning in Country A, in February alone, has already avoided the equivalent of the annual
emissions of a small European country. And the air quality in major cities from New Delhi to
Beijing and Los Angeles is cleaner than at any time in recent memory. Some of the
immediate changes are visible in daily life. In Venice, the waters of the canals are clear,
because boats are no longer churning up the mud. In the centre of London, birdsong can be
heard because traffic noise has all but stopped.

In March, airline CO2 emissions dropped 31%. This is the same as taking at least 6 million
cars off the road for a year. That drop is set to become even steeper. Global air traffic was
65% below pre-crisis levels in early April. In global hubs such as the UK, Hong Kong or
 Switzerland, air traffic has dropped more than 90% from last year. Petrol sales in the US have
fallen 48% year-on-year to their lowest levels for at least three decades. Global oil demand
has fallen by at least 20 million barrels per day. This is only 20% of typical consumption. Oil
typically accounts for about 40% of global CO2 emissions.

But environmental advocates say it is too early to celebrate and point out that any benefits are
likely to be short lived. “Closing down our entire economies for a period of weeks or months
is not going to get us toward decarbonising,” says Peter Betts, previously the UK’s lead
climate negotiator. “There may be some positive behavioural impact. But the real question is
what happens in the recovery phase. Do we just go back to business as usual?”
Ultimately the full impact of the virus on climate change will be determined by the shape of
the stimulus measures adopted in a post-pandemic world. In the aftermath of the 2008-
09 financial crisis, the energy intensive stimulus measures that followed boosted emissions.
Since then the prevailing wisdom has been that environmental concerns are abandoned in the
face of a huge economic shock.

The role of the state is also changing profoundly in the coronavirus era. “Now we are not
afraid of governments printing money, and now we are not afraid of governments stepping in,
so we should not be afraid of governments stepping in to avert the disaster of climate
change,” says Rachel Kyte, previously the UN’s top clean energy official.

(Source: Adapted from ‘How coronavirus stalled climate change momentum’, Financial
Times, 14 April 2020.)

12. (a) Define the term ‘forward market’. (Extract A)

In finance, a forward market is a market in which people trade contracts to buy or sell an asset at a future
date for a price agreed upon today. The contracts traded in a forward market are known as forward
contracts. These contracts are not traded on exchanges like the stock market, but are instead traded over
the counter (OTC) between two parties. Forward markets can be used to hedge against risk or to
speculate on the future price of an asset. In the context of Extract A, the forward market for oil refers to
the market in which people trade contracts to buy or sell oil at a future date for a price agreed upon today. [2 marks]
(b) Explain what is meant by ‘external costs.’ Include two examples from the extracts
to support your answer.

[4 marks]
External costs, also known as externalities, are costs that are not reflected in the market price of a good or service. These
costs are incurred by a third party who is not directly involved in the production or consumption of the good or service, and
are not compensated for by the producers or consumers.

There are two main types of external costs: negative externalities, which impose costs on third parties, and positive
externalities, which provide benefits to third parties.

Here are two examples of external costs from the extracts:

Extract C: Climate change

One example of a negative externality in Extract C is the pollution caused by transportation and power production, which
can have negative impacts on the environment and human health. These negative externalities are not reflected in the
market price of the goods and services that cause them, so the producers do not bear the full cost of their production.
Instead, the costs are passed on to third parties, such as the general public, who may suffer from health problems or other
negative impacts due to the pollution.

Extract A: Oil Prices

Another example of a negative externality in Extract A is the environmental pollution caused by the production and
consumption of oil. The extraction and refinement of oil can have negative impacts on the environment, such as air and
water pollution and habitat destruction, which are not reflected in the market price of oil. As a result, the producers and
consumers of oil do not bear the full cost of these negative externalities, and they are passed on to third parties who may
suffer from their impacts.
 (c) Analyse one reason why the price of oil ‘fell as low as minus $40.32 a barrel’
(Extract B).
Illustrate your answer with a supply and demand diagram.
One reason why the price of oil fell as low as minus $40.32 a barrel, as mentioned in Extract B, is due to a significant decrease in demand for oil. The extract mentions
that the dramatic price fall of oil is a result of the "depth of the current drop in demand," which suggests that the main factor contributing to the negative price of oil was a
decline in the demand for it.

There are several reasons why demand for oil may have decreased. One possible reason is the economic downturn caused by the Covid-19 pandemic, which has led to
a decrease in global economic activity and a decline in the demand for oil. Another possible reason is the shift towards renewable energy sources, which may have
reduced the demand for oil as a source of energy.

Overall, the fall in demand for oil is likely to have been the main factor contributing to the negative price of oil. When the demand for a commodity falls, the price of the
commodity tends to fall as well, as producers are willing to sell it at lower prices in order to clear their excess inventory. In the case of oil, the fall in demand was so
severe that the price fell below zero, indicating that producers were willing to pay people to take the oil off their hands rather than incur the cost of storing it.
[6 marks]
(d) With reference to the extracts, examine reasons why consumers may not aim to
maximise their utility (behave irrationally).
Consumers may not always aim to maximise their utility, or behave rationally, for a variety of reasons. Here are some examples of reasons why consumers may not behave rationally,
based on the extracts provided:

Limited information: In some cases, consumers may not have access to all the information they need to make informed decisions. For example, Extract A mentions that oil is an actively
traded commodity in the commodity forwards market, which is composed of speculators and hedgers. However, it is not clear from the extract whether consumers have access to the same
information as these market participants, and therefore may not be able to make fully informed decisions about when to buy or sell oil.

Emotional factors: Consumers may be influenced by emotional factors when making decisions, even if these factors do not contribute to their overall utility. For example, Extract C
mentions that negative prices, such as the negative price of oil in Extract B, can be unsettling because they "seem to upset the natural order of things." This emotional reaction may lead
consumers to make decisions that do not maximise their utility, such as holding on to an asset even if it is not the most rational decision.

Social influences: Consumers may also be influenced by social factors when making decisions. For example, Extract C mentions that the lockdowns triggered by the Covid-19 pandemic
have led to a reduction in pollution levels and emissions, which may be perceived as a positive outcome by some consumers. However, these consumers may still continue to use polluting
forms of transportation or energy because of social norms or peer pressure, even if it does not maximise their utility.

Overall, there are many factors that can influence consumer decision-making, and not all of these factors are rational or contribute to the consumer's overall utility. Therefore, it is not
uncommon for consumers to behave irrationally and not aim to maximise their utility in all cases.

[8 marks]
(e) With reference to Extracts A and B, and Figure 1, discuss the microeconomic
impact of the fall in the price of oil.
Illustrate your answer with an appropriate diagram.
The fall in the price of oil, as mentioned in Extracts A and B and illustrated in Figure 1, can have a number of microeconomic impacts. Here are some possible
impacts of the fall in oil prices:

Impact on producers: The fall in oil prices may have a negative impact on oil producers, as it may reduce their revenue and profitability. This is because the lower
price of oil means that producers will receive less money for their product, which may not cover their costs of production. As a result, some oil producers may
experience financial difficulties or go out of business if the fall in prices persists.

Impact on consumers: The fall in oil prices may have a positive impact on consumers, as it may reduce the cost of goods and services that use oil as an input. For
example, lower oil prices may lead to lower transportation costs, as fuel prices may fall. This may benefit consumers by lowering the prices of goods that are
transported by truck or shipped by boat, such as food and clothing. Lower oil prices may also lead to lower electricity prices, as oil is used to generate electricity in
some countries.

Impact on employment: The fall in oil prices may also have an impact on employment in the oil industry. If the lower prices lead to reduced revenue and profitability
for oil producers, they may be forced to lay off workers or cut back on hiring. This may lead to a decline in employment in the oil industry, which may have negative
impacts on the workers and their families.

Impact on the balance of trade: The fall in oil prices may also have an impact on the balance of trade for countries that are major oil exporters. If the lower prices lead
to a decline in revenue for oil producers, this may reduce the amount of money that these countries earn from exporting oil. This may have negative impacts on the
economies of these countries, as they may have less money to spend on imports or to invest in domestic industries.
[14 marks]
Impact on inflation: The fall in oil prices may also have an impact on inflation. If the lower prices lead to lower costs for goods and services that use oil as an input,
this may reduce the overall level of prices in the economy. This may lead to lower inflation, which may be beneficial for consumers who have to pay lower prices for
goods and services. However, lower inflation may also have negative impacts on producers, as it may reduce their revenue and profitability.

Overall, the fall in oil prices can have a range of microeconomic impacts, both positive and negative, depending on the perspective of the producers, consumers, and
workers in the oil industry.
 SECTION D
Answer ONE question from this section.

EITHER

13. In October 2019 the government of Country A withdrew its subsidies for electric cars,
whereas the government of Country B increased them. Country B currently offers a
subsidy of €6000 for models costing up to €40 000. For models costing more than
€40 000, the subsidy is €5000.
Evaluate the economic effects of subsidising electric cars.
[Total for Question 13 = 20 marks]
OR

14. The European Union (EU) operates a tradeable pollution permit scheme which affects
12 000 businesses including energy producers, airlines and the steel industry.
Evaluate the use of tradeable pollution permits to reduce pollution.
[Total for Question 14 = 20 marks]

Subsidies are government financial assistance provided to support the production or consumption of certain goods or services. In the context of electric cars,
subsidies can be used to encourage the adoption and use of electric vehicles as a way to reduce greenhouse gas emissions and improve air quality.

There are several economic effects of subsidizing electric cars that can be considered.

Increased demand: Subsidies can increase the demand for electric cars by making them more affordable to consumers. By reducing the price of electric cars,
subsidies can make them more competitive with traditional gasoline-powered vehicles and encourage more people to switch to electric transportation. This can
lead to increased sales of electric cars and increased revenue for electric car manufacturers and dealers.

Improved efficiency: Subsidies can also encourage the development of more efficient electric car technologies. By providing financial support to manufacturers
and innovators, subsidies can stimulate research and development efforts that can lead to the creation of more advanced and efficient electric car designs. This
can help to reduce the cost of electric car production and improve the performance and range of electric vehicles, making them more attractive to consumers.

Environmental benefits: Subsidies can also have positive environmental impacts by reducing the amount of greenhouse gas emissions produced by the
transportation sector. Electric cars do not emit carbon dioxide or other pollutants when they are being driven, so promoting their use can help to reduce air
pollution and mitigate the negative effects of climate change.

Cost to the government: While subsidies can have positive economic effects, they can also have costs to the government. Subsidies must be funded through
taxes or other means, and providing financial assistance to support the production or consumption of certain goods or services can put a strain on the
government's budget. In addition, subsidies can create a burden for taxpayers, who may be required to pay higher taxes to fund the financial assistance.

Impact on competition: Subsidies can also impact the level of competition in the electric car market. By providing financial assistance to certain manufacturers or
consumers, subsidies can create an uneven playing field and give an advantage to certain firms or products. This can discourage competition and limit the ability
of new firms to enter the market.

Overall, subsidizing electric cars can have both positive and negative economic effects. While subsidies can increase the demand for electric cars, improve
efficiency, and have environmental benefits, they can also have costs to the government and taxpayers.