Economics Unit 4

IAL Economics Unit 4
Assorted Questions
June 2016
1)
a) Discuss the likely impact of the rapid growth of emerging and developing economies on world
trade patterns.
• Understanding of world trade patterns

• Understanding of the emerging and the developing economies / rapidly growing economies (e.g.
China, India, other SE Asian nations, many of the Sub-Saharan economies etc.)
Possible impacts could include:

• Changes in the countries that are net exporters and net importers as these countries run trade
surpluses, and perhaps more developed countries run trade deficits
• Rapidly growing economies in Asia tend to produce and export manufactured goods (secondary
sector), whereas those in Sub-Saharan Africa have tendency to produce and export primary products
• More developed economies respond by specialising more in high-tech secondary sector, tertiary and
quaternary sector goods and services
• More developed economies tend to move to importing more goods and exporting more services
• an increase in overall size of trade flows
• an increase in proportion of world trade conducted by developing / emerging economies;
• an increase in trade deficits and surpluses for individual countries;
• an increase in investment flows to and from developing/emerging countries.
Evaluative comments could include:

• Prioritisation of impacts
• Different impacts more or less important for different rapidly growing economies
• SR vs LR distinction between likely impact
• There are some exceptions to the above generalisations, and different regions of countries may vary
‘China has specialised in manufacturing while India has specialised in services.’
b) Evaluate the possible benefits of such specialisation to a country or countries of your choice.
• Understanding of specialisation (on macro scale)
Possible benefits could include:

• If specialisation is according to the law of comparative advantage, trade will allow economies to
access points outside their PPFs
o Diagrammatic or mathematical illustration of the Law of Comparative Advantage
• Increased economies of scale results in lower LRAC for a country, leading to increased international
competitiveness
• Lower prices for goods and services, leading to lower global inflation rates (welfare gain through
trade)
• To the extent that this leads to more international trade, this may improve a country's trade balance,
and generate economic growth and employment
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• Prioritisation of benefits
• Weaknesses in the comparative advantage model; e.g. ignores transport costs
• Increased vulnerability to external shocks (e.g. changes in commodity prices)
• If the countries are specialising in primary products, the Singer-Prebisch Hypothesis implies that
terms of trade in LR will fall
• Discussion of the extent to which whole countries can specialize
• Benefits might depend on whether it is a developing or developed economy, and hence what it is
specialising in
• Danger of structural unemployment
• Over-dependency on imports of other products; countries may lack finance to pay for imports e.g.
foreign currency gap
• Possibility of deteriorating terms of trade for some countries
• Trade will only mutually benefit China and India after specialisation if terms of trade lies between
two opportunity cost ratios
2) Coffee beans account for 28% of Ethiopia’s exports and 19% of Uganda’s exports.
a) Evaluate the possible economic benefits to Ethiopia and Uganda of the expansion of fair trade
schemes for their coffee industries.
• Understanding of fair trade schemes

• Higher prices paid to coffee producers: increasing their average incomes and standard of living, and
reducing rates of absolute poverty
• Minimum order quantities and minimum prices agreed in advance: give producers more confidence
and leading to increased investment
• Enforcement/education as to more ethical production methods, e.g. no child labour, leading to more
schooling / much higher standards of living or development
• If the fair trade premium is spent by the community on any chosen community project, it might
improve the standards of human capital, technology, infrastructure. This would lead to higher levels
of human development for these communities
• Fewer negative production externalities as less damage to the environment will occur through
producing coffee beans
• Producers receive quicker payment for their produce
• Sustainable production techniques/organic farming methods
• An increase in employment and reduction in extreme poverty
• Fair trade premium can help farmers to diversify e.g. into tourism or move up value chain.
Possible evaluative comments could include:

• Coffee is only one of the products the countries produce, therefore any effect may not be that
significant
• The effect depends on how much of the extra money paid by the end consumer reaches the farmers;
much may be kept by the retailer
• Could create a dependency culture as the farmers become dependent on the extra earnings received
from the fair trade scheme
• The cooperatives incur certification and inspection fees, and costs in meeting the fair trade political
standards, while the farmers incur additional production costs, e.g. not using GM crops
• Farmers are often unable to sell all of their harvest as fair trade certified
• Fair trade farmers forced to sell through monopsonist cooperative, which may be inefficient or
corrupt; they cannot choose the buyer who offers the best price
• In order to join fair trade, cooperatives must meet quality and political standards which means
farmers must be relatively skilful, educated and rich. This may lead to exclusion of the poorest
farmers from the scheme who then find it hard to find markets for their produce if supermarkets
increasingly only stock fair trade coffee
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• Corruption within cooperatives may limit the positive impact of fair trade
• If fair trade farmers are paid higher prices and given advice on better techniques, it will lead to
increased supply being sold on the global market. As demand for coffee is highly price inelastic an
increase in supply means large fall in market price, so while a minority of fair trade farmers get
higher price, far more receive a lower price.
In 2014 Ethiopia and Uganda decided to join the Common Market for Eastern and Southern Africa
(COMESA) free trade area.
b) Assess the likely economic effects on these countries of joining COMESA.
• Understanding of free trade area
Likely effects of joining COMESA could include:

• Reduction in trade barriers with the other member countries, leading to increased trade between
Ethiopia, Uganda and the other members
• If net exports increase, this leads to an increase in aggregate demand, and likely economic growth
and development
• Jobs may be created in export industries, leading to higher average incomes
• Growth leads to an improvement in government finances, which could be spent on the population
• Increased variety of products available for consumers in the countries, leading to a higher standard
of living
• More competition from foreign firms forces Ugandan and Ethiopian firms to become allocatively
and productively efficient
• Ethiopia and Uganda may see a rise in inward FDI
• Lower price of imports from member countries, may increase consumers’ purchasing power and
consumer surplus. Firms who import raw materials will experience a fall in production costs
• More economies of scale available to the Ethiopian and Ugandan firms as they can sell to a larger
market
• Possible trade creation – increased specialisation according to comparative advantage across the
whole trade bloc, leading to higher production
• Membership might bring improvements in government, the rule of law and state institutions. This
aids development and reduces barriers to development
Possible evaluation points could include:

• It depends on which economies increased trade is with. Neighbours in COMESA are likely to be poor
countries, producing few similar goods, reducing its effectiveness
• It depends on what trade is in: increased production of raw, unprocessed primary products may not
be so beneficial
• The gains will depend on what proportion of trade, for Ethiopia and Uganda, will be within
COMESA compared to the rest of the world after joining
• Gains from free trade may be limited due to weaknesses of the law of comparative advantage model
• May cause a rise in imports relative to exports
• Trade may create economic growth, but this is not the same as development
• Infant industries in Ethiopia and Uganda may be out-competed by the established firms in other
member countries
• Possible trade diversion
• SR vs LR effects
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3) From 1993 to 2014, public expenditure as a proportion of GDP rose from 35% to around 42% in Japan,
but fell from over 55% to below 50% in Italy.
a) Discuss possible reasons for an increase in the level of public expenditure as a proportion of GDP
in an economy.
• Understanding of public expenditure
Possible reasons could include:

• Changes in level of GDP: during periods of economic downturn, public expenditure as a proportion
of GDP would increase, even if it stayed the same or declined at slower rate than GDP
• Automatic stabilisers: when GDP falls, the public expenditure is expected to rise, as more people
become eligible for means-tested and unemployment benefits
• Discretionary fiscal policy: government may decide to spend more on a specific area, e.g. education
or healthcare
• Ageing population: may require greater public spending, for example on state pensions, healthcare
and social care
• Increase in size of the population: puts pressure on public services
• Increased expectations: populations may expect a higher standard of healthcare or education - these
things may be normal or luxury goods (income elastic)
• Increased interest payments: as national debt accrues, governments have to make higher interest
payments on their debt • Global financial crisis: may have had to bail-out banks
• Changes in ideological view about role of state vs role of the market in an economy
• Rise in the tax base (reducing tax evasion and avoidance) allowing greater spending as a proportion
of GDP
Possible evaluation points could include:

• Changes in level of GDP would explain SR changes only, as when the economic cycle changes,
country could face reverse effect
• Ageing populations imply less spending is required on education and healthcare for children; falling
spending in other areas
• Interest payments depend on the interest rate as well as the amount owing. This is determined by
additional factors
• Reasons vary from country to country and at different points in time
b) Evaluate the likely economic effects of a reduction in the level of public expenditure as a proportion
of GDP in Italy or another country of your choice
• Understanding of public expenditure
Possible effects could include:

• As government spending is a component of aggregate demand, it may decrease - negative multiplier
effect
• Possible negative effects on growth, employment, average incomes and standard of living
• Income inequality increases as austerity measures may reduce transfer payments
• Less inflationary pressures
• Government budget balance may improve / less borrowing required / economy may be able to begin
to repay national debt
• If spending on infrastructure/education/ health is cut, the productive potential of the
economy/aggregate supply may fall
• Less resource and financial crowding out
• Less productivity in the public sector
• Lower quality/quantity of public services
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• Significance depends on how much public expenditure decreases by, and how great a component of
aggregate demand it was to start with
• Size of the multiplier effect
• Public expenditure may still increase, it may just be that GDP increases at a quicker rate
• Effects on the real economy depend on level of spare capacity in the economy
• If tax revenue also falls, government budget balance may not improve
• Less crowding out could mean aggregate demand does not fall; private investment and consumption
increase
• It depends on what areas of government spending are cut
• If spending on benefits (transfer payments) is cut, individuals may have more of an incentive to
work, leading to a decrease in unemployment
NB Award a maximum of 20 marks (Level 4) if a candidate does not refer to Italy or another country in
their response.
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Jan 2016
1) In August 2014, the USA introduced tariffs of between 20% and 40% on solar panel products imported
from China and Taiwan.
a) Discuss the possible reasons for the introduction of such restrictions on free trade.
• Understanding/definition of restrictions on free trade or types of restrictions, e.g. tariffs, quotas etc.
• Candidates may draw a tariff diagram to show the likely effects, and/or may use AS/AD analysis
Reasons for introducing the restrictions could include:
• To raise tariff revenue for the US government

• To protect domestic employment in the solar panel industry
• To improve the US' balance of payments position: they currently have a sizeable current account
deficit
• To help to maintain a diversified industrial base in the US: reduce risk by protecting against
exogenous shocks
• To protect essential or strategic industries, e.g. power generation
• To protect infant/sunrise industries: perhaps the US firms need time to grow to gain economies of
scale to be able to compete effectively
• To prevent dumping by other countries
• To manage the decline of senile/sunset industries
• Ethical or political grounds
• Retaliation

• Tariff revenue is a very small proportion of total government revenue in developed economies; this
is more likely to be a reason in developing economies
• Significance of the size of the tariffs: 20-40% is large
• But the solar panel industry is relatively small as a proportion of the US economy, so any effects on
employment, trade balance, diversification and economic growth are likely to be relatively
insignificant
• Solar power is a relatively new technology, so far more likely to be an infant industry than a senile
industry
• Consideration of the extent to which solar panels are part of an essential/strategic industry for the
US (given its other sources of power, perhaps)
• Prioritisation of different reasons
• Credit for reasons against a protectionist policy NB Candidates do not need to refer to the US tariff
on solar panels in particular in their answer.
b) Evaluate the like economic effects of an increase in protectionism on the global economy
• Understanding/definition of protectionism
• Candidates may draw a tariff diagram to show the likely effects, and/or may use AS/AD analysis
Likely effects of an increase in protectionism may include:
• A decrease in international trade

• Less FDI inflows
• Less specialisation according to comparative advantage, leading to less efficient global production
• Less choice and variety of goods and services available to consumers
• An increase in prices of goods and services - global inflation
• Deadweight welfare losses from the introduction/increase of tariffs/quotas
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• Countries that were running trade surpluses are likely to see these reduce, leading to lower
aggregate demand, falling real GDP, rising unemployment
• Countries that were running trade deficits are likely to see these reduce, leading to higher aggregate
demand, rising real GDP, falling unemployment
• Retaliation and trade wars
Other evaluative comments could include:
• Prioritisation of different effects

• Different effects at different points in time (SR/LR distinction)
• It depends on how much protectionism increases by, how many countries increase it, and what form
this takes
• The importance of government intervention/regulation to correct any effects
• The importance of other factors in determining overall effects, e.g. other determinants of the rate of
inflation etc. (questioning of the ceteris paribus assumption)
• WTO intervenes to reduce trade barriers
NB Candidates must answer in terms of the effects on the global economy, not just on one country.
2)
a) ‘Macroeconomic policies rarely achieve their intended objectives’
Discuss the problems facing policy makers when applying macroeconomic policies.
• Understanding of macroeconomic objectives and/or policies, and the policy makers responsible for
them
Possible problems could include:

• Inaccurate information - issues with sampling, time delays/lags, inadequacy of information
gathering systems and processes, shadow economy/black economy/informal sector/subsistence
farming/undeclared information
• Risks and uncertainties - the effects of policies may be difficult to predict either due to a lack of
information (e.g. quantitative easing as a relatively new policy) or uncertainty as to
consumers'/firms' reactions
• Inability to control external shocks - external shocks (e.g. changes in commodity prices, exchange
rates, economic conditions in trade partners' economies) may occur while policies are being
implemented and/or having their full impact, changing economic conditions
• Conflicts between macroeconomic objectives – cannot achieve multiple objectives at one time. For
example:
o Low, stable inflation and low unemployment;
o Low, stable inflation and sustainable economic growth;
o Sustainable economic growth and balance of payments equilibrium;
o Sustainable economic growth and environment;
o Sustainable economic growth and reduction in income inequality.
• Conflicts between macroeconomic policies
• Influence of powerful firms and TNCs

• Prioritisation of factors
• Different factors will be more important in different economies, e.g. developing countries, or those
with proportionally larger shadow economies, less likely to have accurate information etc.
• Different factors will be more important for different macroeconomic policies, e.g. longer time lag
for full effect of supply side policies to be felt, means more time for external shocks to occur etc.
• Information may be becoming more accurate over time as technology and economic understanding
improves
• Different economies more or less likely to be affected by external shocks.
• Reasons why conflicts between macroeconomic objectives might not occur
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• Historical data/information available on policy impact in the past, so not an issue to policy makers
b) ‘Cutting taxes is the most effective way for the government to reduce unemployment’
Critically examine this statement in relation to a country or countries of your choice.
• Understanding of a cut in tax rates (and different taxes)

• Understanding of unemployment (may include different types of unemployment, and/or measures)
• Cutting taxes is a part of fiscal policy
• It is an expansionary/reflationary policy
Possible arguments for cutting tax rates could include:
Supply-side effects
• Cutting income tax rates might provide increased incentives to work

• Cutting corporation tax rates would increase firms' incentives to expand and hire more workers
• Cutting other production taxes (e.g. 'green' taxes) would reduce firms' production costs, increasing
their incentives to supply and hence hire more workers
Demand-side effects
• Cutting income tax rates would increase disposable incomes, leading to increased consumption, and
hence increased (derived) demand for labour to produce goods and services
• Cutting indirect tax rates (e.g. VAT, excise duties) would increase consumers' purchasing power,
leading to increased consumption, and hence increased (derived) demand for labour to produce
goods and services
Possible arguments of how other policies may be more effective in reducing unemployment to be
credited

• Other policies may be more effective in reducing unemployment - this should not be the 'main'
policy • Cutting different taxes are more or less effective in reducing unemployment
• Cutting taxes not the most effective way if it leads to problems with other macroeconomic objectives
• Effectiveness depends on the type of unemployment, e.g. structural unemployment more difficult to
reduce through this policy
• Reducing import taxes (tariffs) would increase international competition, perhaps increasing
domestic unemployment
• Importance of other factors in determining the effects of the policy, e.g. consumer and business
confidence, the size of the multiplier etc.
3)
a) Before April 2014, the Tunisian government intervened in the currency market to stabilize the
value of its currency, the dinar.
Assess the policies a government could use to stabilize the value of its currency.
• Understanding of government intervention in currency markets
Possible policies might include:

• Sale/purchase of foreign currency (or gold etc.) reserves in order to increase demand/supply for the
dinar
• Pegging currency against more stable currency
• Changes in the money supply in the Tunisian economy
• Changes in the (relative) interest rates in Tunisia
• Other policies to encourage/restrict the inflow of FDI and/or portfolio investment into Tunisia
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• Other policies to encourage/restrict the outflow of funds from Tunisia (e.g. through remittances,
repatriation of profits, capital flight etc.)
• Ability of the government to sell reserves/dinar depends on the value of reserves/dinar held, and the
international value of them
• Possible political/ethical issues surrounding the selling off of reserves
• Use of monetary policies may cause conflicts with other macroeconomic objectives
• Relative interest rate more important than interest rate in determining hot money flows
• Prioritisation/comparison of the effectiveness of different policies
• Problems of currency stabilisation
NB Candidates do not need to answer in relation to Tunisia/the dinar
b) After April 2014, the Tunisian government reduced its intervention in the currency market, in the
following four months the Tunisian dinar depreciated 6% against the euro and 9% against the US
dollar.
To what extent might the depreciation of the dinar be beneficial to the Tunisian economy?
• Understanding of a depreciation of a currency
• Decrease in the relative price of exports, leading to an increase in export sales

• Growth in Tunisia's tourism industry
• Increase in the relative price of imports, leading to a decrease in import sales
• Improvement in Tunisia's trade balance and hence its current account on the balance of payments
• Increase in Tunisia's aggregate demand, generating economic growth and increases in employment,
particularly in exporting industries
• Increase in inward FDI and decrease in outward FDI, so improving the financial account position

• Prioritisation of benefits
• Role of PED in determining the effect on the value of imports and exports / Marshall-Lerner
condition / 'Jcurve' effect
• Significance of the depreciation -6% and 9% over four months
• Fall against both the euro and the US dollar, but exchange rates against neighbours' currencies
might be more important
• Depends on what proportion of AD is made up by net trade
• Cost-push and demand-pull inflationary pressures may reduce the increased export competitiveness
• Effects on growth and unemployment depend on the level of spare capacity in the Tunisian
economy, the size of the multiplier effect, any time lags etc.
• Depreciation of the dinar may reduce confidence in the Tunisian economy, leading to negative
economic effects
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June 2015
1)
a) To what extent does the theory of comparative advantage explain the increased globalization over
the past 40 years?
The theory of comparative advantage states that some countries are able to produce some types of goods
and services with less opportunity cost. This would encourage countries to specialize in the production
of a type of good where they have a comparative advantage in. This country would be able to export the
surplus while importing other goods from countries that have a comparative advantage in those goods.
This is beneficial for all the countries involved as the total output of goods and services increases while
each country has access to more types of goods which increases the standard of living. Thus, countries
have significant motivation to trade between countries, so globalization increases.
However other factors may have been more significant towards increasing globalization. These include
the development of cheaper, lower and faster transportation around the world, as well the creation of
multinational corporations which greatly increase trade.
Comparative advantage also allows countries to increase exports of their specialized goods to other
countries. This increase in trade encourages the development of industries in a country as firms grow
with increased revenue. These firms create more jobs with better wages for workers, so unemployment
can be reduced. This also slows the government to collect greater tax revenue from income tax and
corporate tax. As such, many countries would find it beneficial to increase trade and this leads to
globalization.
It should be noted that the theory of comparative advantage does not take transportation costs into
account. A country may have cheaper goods than others, but high transportation costs might mitigate
the lower prices, so exports will not increase.
The theory of comparative advantage encourages globalization because countries are able to increase
their growth. By specializing in a good and exporting surpluses, export X will increase, so (X-M)
increases. Since (X-M) is a component of aggregate demand Ad, Ad also increases, thus export-led
growth will increase. This growth is much faster than other types of growth.
However, barriers to trade may prevent a country’s exports from penetrating foreign markets. These
barriers include tariffs and non-tariff barriers, and restrict the entry of imports from another country to
protect domestic employment or to prevent dumping. The exporting country is unable to increase its
exports, so trade will decrease and globalization is restricted.
Examiner’s comment:
This is a good response to the question which shows very clearly an understanding of both
'globalisation' and 'comparative advantage'. The link between the two concepts is clearly explained, and
some other possible causes of increased globalisation are also identified. There is some good evaluative
content in terms of an understanding of the limitations of the model of comparative advantage as
presented. This response was therefore given a Level 4 score of 11 marks.
Examiner’s tip:
In order to improve this answer, the candidate could have: expanded upon the explanation of
comparative advantage by giving a numerical or diagrammatic example; included more application in
the response, perhaps by giving examples of countries who specialise according to comparative
advantage and then trade internationally; developed the explanation of another possible cause of
increased globalisation.
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Mark scheme points:
• Understanding/definition of globalization
The theory of comparative advantage:

• Understanding/definition of comparative advantage
• Use of numerical and diagrammatic examples
• Application of specialisation/comparative advantage to particular countries
• Specialisation according to comparative advantage leads to more international trade, increasing
globalisation
• Allows developing countries (who may not have an absolute advantage in the production of any
goods/services) to trade internationally, furthering globalisation
• Such trade requires the liberalisation of international capital markets, leading to financial
globalisation
Other factors have been more important in explaining increased globalisation, e.g.:
• Trade liberalisation
• Political change (e.g. breakdown of Soviet system and opening up of China)
• Reduced cost of transport (e.g. containerisation) and communications (e.g. international phone
calls, the internet, teleconferencing, mobile phones etc.)
• Increased significance of transnational companies
• The rise in world skill levels
• The liberalisation of global capital/financial markets
• Enhanced role of international economic institutions (e.g. the IMF, the World Bank, etc.)
General evaluative comments could include:

• Difference factors have been most important at different times over the past 40 years
• Difficulties of separating the factors, e.g. increased significance of transnational companies in order
to take advantage of differences in comparative advantages
• Assumptions and limitations of the model of comparative advantage
b) Evaluate whether globalization has been beneficial for both developed and developing countries.
Globalization occurs as global trade increases and movement of labour is also increased between
countries. Markets become more integrated. Developing countries can benefit from increased
globalization as they can now export their goods to obtain revenue. The increase in exports causes a rise
in aggregate demand and stimulates export-led growth. The Government of such countries also collect
more tax revenue which can be used to invest in development, which increases standard of living for the
population.
However developed countries tend to implement barriers to trade to limit imports. Tariffs such as the
Common Agricultural policy will limit the ability of exports from developing countries to penetrate
foreign developed markets, so they may not benefit.
Increased globalization also allows firms in developing countries to have access to bigger markets. This
is especially beneficial for small countries with small domestic markets. Bigger markets allow firms to
expand and exploit the markets. Bigger markets allow firms to expand and exploit economies of large
scale production and become more productive. Growing firms would also increase available jobs, so
unemployment will decrease.
It should be noted that developing countries to become primary product dependent as they specialize in
only a few types of goods to export. These commodities tend to be subject to volatile prices. So if prices
fall, these developing countries may suffer from decreased growth.
In addition, globalization usually involves multinational corporations that operate in developing

countries. These corporations bring in foreign direct investment which fills the saving gap for these
countries. According to the Harrod-Domar theory, capital accumulation is essential for growth, so as the
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FDI fills the developing countries savings gap, capital accumulation increases. This stimulates growth in
the country as well increased corporate tax revenue for the government.
However multinational corporations tend to exploit the looser labour laws of developing countries. This
may lead to the exploitation of workers which may include low wages, unsafe working environment, and
long working hours, Thus the costs may outweigh the benefits.
Developed countries may benefit since they are able to import many different types of goods. The
increase in the amount and diversity of available goods increases the standard of living in a developed
country. This would also increase exports to other developed countries also encourages the growth in
other countries.
However, a more integrated market means that a financial crisis can be transmitted quickly through
many developed markets. This can lead to many developed countries to face recessions at once if a
financial crisis in another country.
This is another strong response which covers a good number of points and addresses all the key aspects
of the question by discussing both the costs and benefits to developed and developing countries of
increased globalisation. There is a good level of depth and breadth in the points presented, and the
candidate shows a good knowledge of economic concepts and theories, for example by the references to
the Harrod-Domar model and savings gaps. The depth and breadth of both analysis and evaluation was
sufficient to earn this response a Level 4 score of 18 marks.
Examiner’s tip:
The one major thing missing from this response is application. To improve it, the candidate needed to
have included more of this, for example by giving examples of countries which have, or which might,
experience of the costs and benefits identified in the answer.
Mark scheme points:
Candidates may be rewarded for argument that globalisation has been beneficial, or that it has not, and
use reverse arguments in evaluation.
• Understanding/definition of developed and developing countries
Globalisation has been beneficial:

• Allows greater specialisation in areas of comparative advantage, leading to increased global
efficiency - increasing global output, meaning that there are more goods and services available for
consumption for all people
• Gains in efficiency lead to economic growth and higher average incomes, raising the standard of
living for all
• Increased economies of scale result in lower priced goods and services, increasing consumer surplus
globally
• International competition reduces national monopoly power, leading to lower prices for consumers,
and more non-price competitive goods and services too
• Higher rates of growth have led to reductions in the number of people living in absolute poverty
globally (but particularly in developing countries)
• Increased choice when buying goods and services for consumers in all countries
• Spread of transnational companies has led to more jobs, training and infrastructure investment in
developing countries
Globalisation has not been beneficial:

• Rising income inequality between developed and developing countries, and also within countries,
particularly between those living in rural and urban areas in developing countries
• Growing demand for raw materials has caused large rises in commodity prices. The rise in food
prices has been particularly damaging to people living in developing countries
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• Environmental concerns: deforestation, loss of biodiversity, global warming etc. These may
particularly affect people living in developing countries where there is less government regulation of
activities
• Exploitation of natural resources and/or labour in developing countries by more developed
countries / transnational corporations
• A loss of economic and cultural diversity as goods and services become homogenised
• Unemployment in developed economies as companies outsource / move production to lower wage
economies, which may cause pressure on government budgets

• Prioritisation of different effects
• Discussion of whether globalisation has been of more benefit to developed or developing economies
• Different effects on different countries
• Different effects at different points in time (SR/LR distinction also)
• The importance of government intervention/regulation to correct any resulting market failures
NB Award a maximum of 20 marks (Level 4) if a candidate does not refer to both developed and
developing countries in their response.
2) From March 2012 to June 2012, Argentina’s terms of trade worsened by 13% while from November to
December 2012, Taiwan’s terms of trade improved by 29%.
a) Assess the factors that cause a worsening of a country’s terms of trade.
Terms of trade is the measure of exchange of one good to another when two countries trade with each
other. It is simply average price of exports divided by average price of imports times hundred percent. If
a country’s terms of trade worsen, it simply means that it requires them to sell more exports to buy the
same amount of imports such as capital.
One of the factors for worsening of a country’s terms of trade is simply due to having low inflation rate.
Low relative inflation rate than their partners will cause the cost of production to be lower. This will
result in a cheaper price of exported goods. Argentina had lower inflation rates as compared to their
main trading partners. This causes their export price of goods to fall and this will worsen their country’s
terms of trade.
However, a fall in inflation rates may not affect their terms of trade if exporters decide to maintain
higher prices to increase their profit margin. This in return will not reduce the price of exports and thus
will maintain the country’s terms of trade.
Other than that, exchange rates also play an important part in determining the country’s terms of trade.
A fall in exchange rate will cause Argentina’s exports price to fall. This is simply because of people less
demand of our currency, the exchange rate will fall. Thus, when exchange rate falls, it will result in a
cheaper exchange rate in foreign currency to buy Argentina’s exports. This results in their price to
become relatively cheaper. Thus, a decrease in price of export signals worsen Argentina’s terms of trade.
However, it depends upon the exchange rate system that the country has. If the country is using fixed
exchange rate like China, thus the exchange rate would not cause a shock to the terms of trade of the
country as the rate is fixed and stable.
In conclusion, even though Argentina is suffering from a fall in their terms of trade, they also gain in
terms of improvement in their current account as exports rise and imports has fallen.
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This is a sound response to the question which shows good knowledge of the terms of trade and two
factors which may have caused a worsening of it: relative inflation rates and the exchange rate. The
candidate is also able to attempt to evaluate both of these factors. This response was therefore given a
Level 4 score of 11 marks.
Mark scheme points:
• Understanding of terms of trade

• Understanding of a worsening (deterioration) of the terms of trade
Possible factors could include

• A depreciation / devaluation of the exchange rate
• Low relative inflation rates
• Higher relative productivity rates
• Lower relative labour costs (wage and non-wage costs)
• Higher relative levels of capital investment
• Change in the price of commodities, e.g. oil (a rise in the price of commodities for net importers, and
a fall in the price of commodities for net exporters)
• Primary product dependency may lead to a worsening of terms of trade over time
• Increased globalisation and the industrialisation of China, India and Latin American countries
• Increased competition in the markets of a country's main exports / reduced competition in the
markets of a country's main imports
• Protectionist policies

• Different factors will be more important in different economies, e.g. the price of oil will be highly
important in Saudi Arabia, but not in other countries
• Different factors will be more important at different times, e.g. whilst we would expect countries
that specialise in primary products to face a worsening terms of trade, the rapid growth of the BRIC
economies has actually led to a favourable movement in their terms of trade over the past 10 years
• The importance of labour costs will depend on whether a country tends to import and export labour-
intensive or capital-intensive goods and services
b) Evaluate the effects of a significant improvement in a country’s terms of trade on the achievement
of its macroeconomic objectives.
Macroeconomic objectives are basically the four most important goals which is low inflation, low
unemployment, balance of payment, high economic growth and two side objectives which is equality
and environment protection. Improvement in a country’s terms of trade simply mean that same amount
of exports can finance more amount of imports abroad.
First and foremost, when Taiwan’s terms of trade improve, they can import more capital goods and
machinery from abroad at a cheaper price. Thus, with more spending on capital and machinery, it will
lead to higher economic growth for Taiwan as productivity increases. Thus, as Taiwan can increase their
output of goods and services this will lead to an increase in GDP and thus will increase Taiwan’s
economic growth.
However, as Taiwan increases their imports and assuming that their exports remain the same, this may
cause a shift in aggregate demand(AD) to the left. As shown on diagram A. As real output produced falls
because of the fall in net exports, this will cause Taiwan to not gain any significant change to their
economic growth as it is offset by the fall in economic growth caused by reduction on aggregate demand.
Other than that, as their terms of trade improves, Taiwan’s citizens can enjoy cheaper imports.
Consumers can now enjoy a more variety imported goods which offer higher quality type of goods.
14
Furthermore, this will also increase consumer choice which will increase consumer utility and thus
increase standard of living.
However, when exports become more expensive, it will cause a reduction in demand for Taiwan’s
exports. This will decrease net exports following a fall in AD. As shown in diagram A, when output
decreases from Y1 to Y2, it will cause firms to cut on their production. As labour is derived demand, thus
firms can lay off workers due to a smaller production of output. This will cause more of Taiwan’s citizens
to lose jobs and decrease their disposable income. This will result in lower standard of living which will
also increase their unemployment level.
Moreover, an improvement in terms of trade will also reduce inflation level of the country. As export
prices become more expensive and imports become cheaper, this will help to reduce the level of
aggregate demand in their economy. Thus, following the diagram A, price level will fall from P1 to P2
which will help to decrease the CPI level and thus reduces inflation.
However, the fall in level of inflation for Taiwan depends on their state of economy. If they are operating
at full capacity, a fall in net exports which will cause a fall in AD, which will cause a higher impact on
price as shown in Diagram B. It can be seen that price level has reduced greatly while real output stays
at Y. Thus, this will greatly result in reduced inflation and will not affect their economic growth.
In conclusion, it largely depends upon whether net exports represent a high proportion of GDP or not. If
the country only had net exports which is only 3% of their GDP, thus an improvement in terms of trade
would not bring a significant impact on their country’s macroeconomic objectives.
This is a good response, which considers a range of likely effects of an improvement in the terms of
trade and is also able to effectively evaluate these. On the first page, third paragraph, the candidate
considers the likely negative effect on the trade balance and hence aggregate demand (ceteris paribus).
This was awarded as KAA, rather than evaluation, as this led onto the analysis on the second page. The
second paragraph on the first page was therefore awarded as evaluation. On the second page, we should
note that the first paragraph analyses the likely effect of the improvement of the terms of trade on the
standard of living, which is not a generally accepted macroeconomic objective and hence is not tightly
focused on answering the question. The candidate does then return to relevant points however and, on
the third page, presents two valid evaluative points. Given the strong economic knowledge shown, the
range of points presented and the presence of some evaluative points, this response was given a Level 4
score of 18 marks.
Mark scheme points:
• Understanding of a rise (favourable movement) in a country's terms of trade

• Understanding of macroeconomic objective
• Price of exports rises relative to price of imports. This would tend to worsen the economy's trade
balance, failing to meet the objective of a healthy balance of payments position
o Although this depends on the PED fo r a country's imports and exports (may be extended to a
discussion of the Marshall-Lerner condition / 'J-curve' effect)
o Although the current account on the balance of payments has two additional components,
which may move in the opposite direction
• A worsening trade balance may constrain aggregate demand in the country, leading to lower
economic growth, and/or rising unemployment, particularly in export industries.
o Although relatively cheaper imports may lead to an increase in (SR)AS, offsetting the
negative effects on economic growth
o Although changes in the other components of AD may more than compensate for this,
meaning that unemployment does not rise
• Inflation in the economy is likely to fall, as both demand pull and cost push (imported raw
materials) inflationary pressures subside
o This depends on the level of spare capacity in the economy, the size of the multiplier effect,
and all other things being equal
15
• If there is rising unemployment, this is likely to have a negative effect on the government budget
balance, as transfer payments rise (automatic stabilisers) and tax revenue falls
o Such a cyclical budget deficit may be less damaging to an economy than a structural budget
deficit. It depends on how long the terms of trade rise for, and how great the rise is
• Lower/negative rates of economic growth may have a positive effect on the environment, as fewer
non-renewable resources are used, and fewer negative productive externalities occur
o For most developed countries, growth has a positive effect on the environment, as improved
green technology is developed, and energy intensity falls
• Lower/negative rates of economic growth may have a positive effect on income inequality in the
economy, as less high returns accrue to the owners of the factors of production

• Different factors more or less important for different countries
• Different countries may have/prioritise different macroeconomic objectives
3)
a) Discuss the likely causes of income inequality between countries of your choice.
Income inequality measures the extent to which income is distributed in an uneven manner. One reason
that causes income inequality between countries is the specializing in commodities may have a lower
income than those specializing in manufacturing goods. When income rises, demand for commodities
will change very little compared to manufactured goods like clothing. Also, commodities are low value
added, they are usually at the bottom of the chain. Therefore, not much jobs will be created. For
example, income in China will be higher than that in Sub Saharan African countries like Nigeria because
about 90% of Nigeria are oil while China exports manufactured goods.
Another reason may be the wealth inequality between countries. Wealth are usually in the form of stock,
bonds and property. These are income generating assets. Therefore, a country with more wealth can
yield more income compared to countries like Sub Saharan Africa where poverty level is high and people
only earn wages.
Also, difference in development of infrastructure is a likely reason for income inequality between
countries. Countries with well-developed infrastructure like airports harbour and road infrastructure
can engage themselves in more international trade and they can attract FDI better. For example, Hong
Kong and Singapore when compared with Sub- Saharan African countries. Poor infrastructure in Sub-
Saharan African countries like Ethiopia add around 30% to 40% of costs to the cost of goods. Therefore,
countries who engage more in international trade may see a higher income.
However, countries with more wealth will be more vulnerable to financial crisis because they tend to
involve themselves more in the financial market. Therefore, income inequality between countries may
narrow during financial crisis.
Also, because commodities have low YED, country exporting commodities will feel less impact when
global income falls. Therefore, income inequality may actually decrease and terms of trade of the
country exporting commodities may improve.
This is a sound response to the question which covers several valid points, such as specialisation in
different goods, differences in wealth (a weaker point), and differences in infrastructure. There is some
application, although the candidate could have included more of this if they wanted to improve the
response, and on the second page there are two (although related) evaluation points. These are
identified, but could have been developed in more depth. Overall, this response was given a Level 4
score of 11 marks.
16
Mark scheme points:
• Different levels of education / skills / qualifications

• Sectoral make-up of the economy (including primary product dependency)
• Resource endowment (quality and quantity of factors of production) leading to different levels of
growth
• Globalisation
• Different levels of infrastructure
• Foreign trade relationships and membership of trade blocs
• Civil war
• Government policy
• Corruption / weak or ineffective institutions
• Labour flight

• Different factors will be more important between different economies
• It may be difficult to assign exact causes, as many of these factors may be in play at the same time
NB Award a maximum of 12 marks (Level 4) if a candidate does not refer to countries in their response.
b) Evaluate the economic impact of a significant decrease in income inequality within the country.
• Understanding of income inequality
• A rise in the economy's MPC, and hence domestic consumption and aggregate demand are likely to
rise
• Increase in the size of the multiplier effect, as the economy's MPS and hence MPW fall
• This is likely to lead to higher levels of economic growth in the economy
• Economic growth may lead to improvement in public sector finances
• An increase in aggregate demand may lead to demand pull inflationary pressures in the economy
• An increase in the trade deficit, as rising consumption is on both domestically produced and
imported goods and services
• Redistribution of spending from goods and services / changes in expenditure patterns within the
economy
• If the decrease in income inequality is achieved through higher levels of progressive taxation and/or
higher transfer payment, this may create a disincentive effect, reducing the incentive to work /
causing capital and/or labour flight
• More equal access to / years of education in the economy
• Less variation in life expectancy in the economy
• Less emigration from the economy / more immigration into the economy

• A lower savings ratio in the economy may cause a savings gap, restricting investment, and hence
potential economic growth
• The multiplier may not rise if the economy's MPT and MPM rise more than the MPS falls
• The effects on growth and employment depend on to what extent demand rises for domestically
produced goods as opposed to imports
• The effect on inflation depends on the level of spare capacity in the economy
• All other things may not be equal, e.g. changes in the exchange rate may cause greater effects on the
trade balance etc.
• Significance: the question says a 'significant' decrease, so any effects are likely to be fairly large
17
Jan 2015
1)
a) Evaluate the macroeconomic policies that a government could implement in response to a
recession in one of the country’s main trading partners?
• Understanding that this would reduce the demand for exports from the country, constraining
aggregate demand
The government could use fiscal policy:

• An increase in government spending could compensate for the decrease in aggregate demand caused
by the worsening of the trade balance
• The effectiveness of this would be determined by the size of the multiplier, there may be a time lag
(depending on what the government spent on), and the government spending would have an
opportunity cost. If it was in the form of export subsidies, it may break agreements with trade blocs
or the WTO. Additionally, it could worsen government finances (fiscal deficit and national debt) -
these are already very high for many countries and so such a policy may be unacceptable - and/or be
inflationary.
• The government could reduce tax rates:
o A reduction in income tax/VAT could lead to greater consumer spending in the country,
allowing firms to sell to domestic consumers, rather than to international consumers. A
reduction in corporation tax/tax breaks for R&D etc. could lead to higher levels of
investment, raising firms' price and non-price competitiveness, helping them to sell more
goods both domestically and abroad.
o Depending on consumers' YED for imports, they may respond to a tax cut by buying more
imports, rather than domestically produced goods. Alternatively, depending on consumer
confidence levels, they may save the money. Firms may not increase investment if their
confidence levels are low, or if credit is difficult to obtain. The effect of a fall in price of
goods would depend on consumers' PED for the goods
• The government could impose tariffs on imports, leading to a lower value of imports, maintaining
the trade balance, and reducing the level of competition that firms face from foreign companies
• The effectiveness of this would depend on domestic consumers' PED for imports, domestic
producers' PES, and the response of other countries, e.g. they may retaliate / lead to a trade war
The government could use monetary policy:

• A decrease in the interest rate / increase in the money supply would encourage spending by
domestic consumers, reduce firms' production costs, and lead to a weakening of the currency,
making exports relatively cheaper, and imports relatively more expensive
• Alternatively exchange rate policy may be used - devaluation of the currency.
• This depends on consumer confidence, relative interest rates, domestic consumers' PED for imports
and foreign consumers' PED for our export. It may also lead to competitive devaluations / currency
wars. In some economies, the central bank controls monetary policy rather than the government.
The government could use supply-side policies:

• Free market and/or interventionist measures could be used to increase the economy's productive
capacity, lowering cost-push inflationary pressures, and increasing the price and non-price
competitiveness of the country's goods and services
• Many of these policies are expensive, and are only effective with a significant time lag.
Also allow suggestions that the government should focus on increasing trade with its other partners to
offset the loss of trade with the partner in recession (with appropriate evaluation).
18
b) To what extent does a country engaging in more international trade lead to a higher rate of
economic growth in that country?
• Understanding of economic growth
Increased international trade leads to economic growth:

• Increased trade allows more specialisation according to comparative advantage, raising efficiency,
and allowing both countries to reach points outside of their PPFs. This means more goods and
services for their populace to consume (candidates may illustrate this diagrammatically or with a
numerical example)
• If a country's exports increase by more than its imports, then aggregate demand may increase,
leading to economic growth (candidates may use AS/AD diagram/analysis here)
• Larger economies of scale mean more efficient production, which may lead to an increase in LRAS
• Firms face more competition, giving them more incentive to produce efficiently, leading to an
increase in LRAS
• A higher rate of technological diffusion, means that efficient production methods and innovative
products are more widely available / used, meaning an increase in LRAS
• Increased trade may lead to increased rates of (inward) investment.
• May lead to increased availability of foreign currency.
Increased international trade does not lead to economic growth:

• If imports increase by more than exports, the country's trade balance will worsen, aggregate demand
may fall, leading to constrained economic growth
• Increased specialisation according to comparative advantage reduces risk diversification, leading
economies to be more vulnerable to external shocks, perhaps meaning lower rates of growth if a
shock hits
• Infant industries may be out-competed, and particularly in terms of developing economies, this may
prevent industrialisation taking place / creation of global monopolies, limiting future growth
• If developing countries are mainly exporting primary products, this may lead to a worsening of their
terms of trade, hindering their growth and development
• More trade into developing countries may involve developed countries dumping goods on them,
making it more difficult for domestic producers to become established and expand
General evaluative points could include:

• Consideration of the limitations of the model of comparative advantage
• Prioritisation of points
• The answer may be different for different countries, particularly developed and developing countries
• Effects on growth depend on the all other things being equal, the size of the multiplier, and the level
of spare capacity in the economy
• Long run effects on growth may be greater than the short run effects
2)
a) Assess the importance of international institutions and non-governmental organisations (NGOs)
in promoting economic growth in developing countries?
Candidates may be rewarded for argument that international institutions and NGOs have been
successful, or that they have not, and use reverse arguments in evaluation.
• Understanding of international institutions

• Understanding of NGOs
• Understanding of economic growth
• Understanding of developing countries
19
International institutions:
• The World Bank - provides low-interest loans, interest-free credit and grants to developing
countries for education, health, infrastructure etc. projects. Also offers debt relief.
• The IMF - promotes international monetary co-operation, exchange rate stability, and orderly
exchange rate arrangements; to foster economic growth and high levels of employment; and to
provide temporary financial assistance to countries to help ease balance of payments adjustment.
Also offers debt relief.
• The WTO - promotes the liberalisation of international trade, allowing developing countries to
compete in international markets, and provides advice and assistance to developing countries in
settling trade disputes etc.
NGOs:
• Candidates may consider a range of different pressure groups, charities and community action
groups, and a variety of different policies, e.g. aid, debt relief, fair trade, microfinance

• Criticisms of international institutions, e.g. of the IMF's Poverty Reduction Strategies, extent of debt
relief offered
• Failure of the development agenda part of the WTO's Doha round
• Developing countries with small delegations still find it difficult to participate in the WTO
• Significance of individual NGOs' impact
• May such organisations be perpetuating low levels of development by enabling poor governments,
and not forcing Africa to compete?
• To what extent do foreigners know what is best for developing countries - aren't the countries
themselves best placed to know what the most urgent problems, and best solutions are?
• Problems of aid - the type of aid, tied aid, aid fatigue etc.
NB Award a maximum of 12 marks (Level 4) if a candidate does not consider both international
institutions and NGOs in their response.
b) Discuss the factors that constrain the economic development of a developing country or countries
of your choice.
• Understanding of economic development
Possible factors could include:

• Primary product dependency
• Savings gap
• Inadequate capital accumulation
• Foreign currency gap
• Capital flight
• Rapid population growth
• Ageing population
• Debt
• Inadequate provision of credit and banking services
• Corruption
• Poor governance
• Absence of property rights
• Civil war
• Inadequate levels of human capital (poor education and/or healthcare)
20
• Different factors affect different countries, at different times
• Some of the factors may also have a positive effect on a country, e.g. rapid population growth
• As development has different aspects, several of these factors may work in combination to constrain
progress
3) In 2012, China recorded an annual surplus in its current account of Balance of payments equal to
2.3% of its GDP, while the USA had an annual deficit in its current account of the balance of payments
equivalent to 3% of its GDP.
a) Discuss the likely causes of a country running a surplus on its current account of balance of
payments.
• Understanding of a surplus on the current account of the balance of payments
• Low levels of consumer spending, perhaps due to high levels of saving, leads to low value of imports
• Large deposits of a commodity, e.g. oil
• The use of protectionist policies by the country, e.g. subsidies to producers, tariffs applied to imports
etc.
• High levels of price competitiveness, may be due to:
o a weak (or perhaps under-valued) exchange rate
o low levels of inflation
o low relative unit labour costs
• High level of non-price competitiveness, may be due to:
o High levels of human capital
o High levels of capital investment / R&D spending

• Distinction between reasons for a structural and a cyclical surplus (SR/LR causes)
• Different countries tend to have different reasons for running a surplus (e.g. compare Saudi Arabia,
China and Germany)
• WTO rules prevent protectionism to some extent
• Discussion of whether price or non-price competitiveness is the most important factor
b) With reference to China and the USA, or other countries of your choice, assess the significance to
the global economy of large current account imbalances.
Candidates may approach the question in a variety of ways: a general approach; a consideration of the
significance of trade deficits; or a consideration of the significance of trade surpluses.
• Understanding of current account imbalances.
A general approach:
• Danger of increased use of protectionist measures by countries with current account deficits
o WTO rules might prevent protectionism
• Financial inflows from surplus countries to western capital markets led to asset price bubbles and to
financial institutions taking excessive risks (could count as two points)
o This could perhaps be countered by government regulation of markets
• Financial crisis led to deep falls in GDP of surplus countries who were heavily reliant on export-led
growth
o World trade declined for a relatively short period of time
21
In the case of current account deficits, analysis could include:
• Might indicate a lack of competitiveness
o But might be desirable if it reflects a trade imbalance caused by imports of capital goods
• Might imply rising unemployment in manufacturing industries
o If labour is sufficiently mobile, this will be a SR problem only
• Might be difficult to finance
o Inflows into the financial account have meant that this hasn't been a problem for e.g. USA
and UK
• Might cause a depreciation of the exchange rate, with possible inflationary consequences
o But this might bring about a correction of the deficit
In the case of current account surplus, analysis could include:

• Implies other countries have deficits, which might result in the adoption of protectionist measures
by these countries
o WTO rules might prevent protectionism
• Implies a lack of consumption within the country
• If a country isn't importing, it implies that it isn't allowing other countries to exploit their
comparative advantages, preventing mutually beneficial trade
o The current account surplus could be a result of surplus balances in the investment income
and international transfers components, rather than the trade balance
• Might cause an appreciation of the exchange rate, reducing future price competitiveness -
particularly a problem for developing countries seeking to diversify out of primary product
production
o But this might bring about a correction of the surplus
NB Award a maximum of 20 marks (Level 4) if a candidate does not refer to a country or countries in
their response.
22
June 2014
1)
a) To what extent is rapid population growth a constraint on a country’s economic development?
Candidates may be rewarded for argument that population growth is a constraint on development, or
that it is not, and use reverse arguments in evaluation.
• Understanding/definition of economic development
Population growth is a constraint on development:

• A larger population means that per capita incomes fall
• Even if national output increases, diminishing marginal returns to labour imply that output will rise
at a slower rate than population when the population grows, so per capita incomes will still decrease
• A higher dependency ratio will limit the ability of households to save, worsening the problem of a
savings gap
• High population growth puts a large strain on education and healthcare resources
• More parents staying at home to raise children reduces the size of the labour force available to work
• Rapid population growth may lead to an increase in income inequality in the economy, if birth and
death rates differ across socioeconomic groups
Population growth is not a constraint on development:

• More people to produce goods and services, so output will rise in line with population, so per capita
incomes will not necessarily fall
• Population growth may spur technical progress out of the pressures created by a higher population
density
• Population growth creates a larger pool of potential innovators and therefore a larger stock of ideas
and innovations that can be put into economic use
• Development includes more aspects than just per capita incomes
• Even if per capita incomes fall, development could occur if this led to a more equal distribution of
income in the economy
b) ‘Providing debt relief for developing countries is the best way to promote their economic growth.’
Critically examine this statement in relation to a developing country or countries of your choice.
Candidates may be rewarded for argument that debt relief is the best way to promote growth, or that it
is not, and use reverse arguments in evaluation.
• Understanding of debt relief
• Understanding/definition of economic growth
Debt relief is the best way:
• Opportunity cost of making debt repayments – money could be spent on
education/healthcare/infrastructure etc. which would create LR growth + possible AS/AD analysis
• Debt repayments are a withdrawal from the circular flow of income, so limit SR growth
• Debt relief would help to reduce the problem of foreign currency gap
• Debt relief means that countries are no longer vulnerable to law suits from vulture funds
• Most countries have repaid capital sum, and are now only paying back interest, which is often many
times more than the sum borrowed
Debt relief is not the best way:
• Debt relief would help to perpetuate corrupt/bureaucratic/unaccountable governments, and so
constrain growth
• Debt relief would mean interest rates on loans would increase hugely in the future, or finance would
be unobtainable
• Debt relief may encourage more irresponsible borrowing in the future, constraining future growth
• Debt relief would be unfair to those countries that have managed their public finances in a fiscally
prudent manner
23
• Candidates may contrast the effectiveness of debt relief with other measures to promote
development (i.e. debt relief is not 'the best' way).
• Candidates may compare and contrast the effectiveness of debt relief in different countries, i.e. debt
relief would be a more effective method of promoting growth in some economies than in others.
• Candidates may consider the effects of the conditions that have been placed on debt relief, e.g.
Poverty Reduction Strategies.
• It depends on the proportion of debt which is forgiven.
• Other factors may counteract the positive impact of debt relief, e.g. exogenous shocks.
NB Award a maximum of 20 marks (Level 4) if a candidate does not refer to a developing country in
their response.
2) Between January 2013 and August 2013, the Indian rupee depreciated against other currencies by an
average of 20%. In August 2013 India’s annual current account deficit on the balance of payments
was 4.9% of its GDP.
a) Evaluate the likely effects of this depreciation on India’s economy.
• Understanding of a depreciation of the currency
Possible effects could include:

• Improvement in the trade balance/current account on the balance of payments
• Export-led economic growth
• Reduction in unemployment as more jobs created within the export industry
• Possible improvement in living standards as average incomes rise
• Inflation: demand-pull inflationary pressures rise, and to the extent that India imports raw
materials, so may cost-push pressures

• Effect on the trade balance depends on the price elasticity of demand for Indian imports and exports
/ Marshall-Lerner condition / ‘J-curve’ effect
• In the longer run, inflationary pressures created by the depreciation may reduce India's
international price competitiveness
• Effect on the trade balance depends on the price elasticity of supply of Indian goods and services
• Current account deficit still appears to be large
• Significance: a 20% depreciation over a six-month period is very significant, so magnitude of effects
may be high
• Which currencies has the rupee depreciated against - this figure is only an average
• Effects on growth, unemployment and inflation depend on the level of spare capacity in the Indian
economy
• Effects on growth, unemployment and inflation depend on the size of the multiplier in the Indian
economy
24
b) Apart from the depreciation of the rupee, assess measures that India could take to reduce its
current account deficit on the balance of payments.
• Understanding of a current account deficit on the balance of payments
Policies may include:
Expenditure reducing/dampening policies

• Increase income tax rates to reduce disposable incomes
• Decrease government spending to reduce disposable incomes (and possibly lower average price
level)
• Increase in interest rates to reduce consumer spending (and possibly lower average price level)
o Effectiveness depends on the YED of imports
o Reduction in output and increased unemployment, may inhibit long-term growth
o Effect on price level depends on the level of spare capacity in the Indian economy
o Increase in interest rates will also cause rupee to appreciate, reducing price competitiveness
Expenditure switching policies

• Protectionism: the use of tariffs, quotas and other non-tariff barriers
• Subsidies to domestic producers
o The use of tariffs entails a misallocation of resources in society and a deadweight loss
o May not be possible given membership of WTO/trade blocs
o May result in retaliation from other countries
o Effectiveness depends on PED of imports and exports (level of non-price competitiveness
etc.)
• Measures to decrease inflation rate below that of competitors
o May have a significant time lag
o If achieved through a tighter monetary policy, will also cause the rupee to appreciate,
reducing price competitiveness
• Other supply side policies to improve the international competitiveness of the Indian economy, for
example, on education and training, tax breaks for R&D etc.
o Time lag of such policies
o Effectiveness depends on the PED of India's imports and exports
• Diversification/industrialisation/deindustrialisation of the Indian economy to produce exports with
more value-added
o Issues with how this could be done - time, cost, skill levels etc.
NB Candidates do not need to refer to 'Expenditure reducing/switching policies' in their responses
3)
a) With reference to a country of your choice, discuss the factors that might cause its economy to
have a fiscal deficit.
• Understanding of a fiscal deficit
• The recession/global economic crisis has meant lower rates of economic growth, which has reduced
all sources of government tax revenue
• At the same time, for developed economies, transfer payments (automatic stabilisers) have
increased in value
• Interest repayments on existing debt add to the fiscal burden
• Some countries used fiscal stimulus packages to generate growth in the years following 2008
• Some countries had to privatise/bail out banks etc. in the years following 2008
• Effect of an ageing population
• Political control of government expenditure, means that prior to 2010 it has been difficult for
governments to reduce spending on education, healthcare etc. and remain in power
• Increasing use of transfer payments to the relatively poor in western economies
• An increasing YED for some areas of government expenditure (e.g. healthcare, education etc.)
25
• Distinction between reasons for a structural and a cyclical deficit
• Developing and developed countries tend to have different reasons for running a deficit
• Austerity policies in many developed countries have controlled the increase in government spending
in recent years, and some tax rates have been raised (possible Laffer curve analysis)
• An ageing population would have a gradual effect on the fiscal balance
NB Award a maximum of 12 marks (Level 4) if a candidate does not refer to a country in their response.
b) To what extent is a large public sector debt harmful to an economy?
Candidates may be rewarded for argument that a large public sector debt is harmful, or that it is not,
and use reverse arguments in evaluation.
• Understanding of public sector (fiscal) debt.
A large public sector debt is harmful:

• Debt servicing has a large opportunity cost for governments
• Crowding out theory (financial crowding out and resource crowding out)
• A downgrading of a country's credit rating increases its borrowing costs
• Intergenerational equity issues
• If firms/households fear that taxes may rise/government spending may fall:
o Capital flight may occur
o Inward FDI may fall
o Reduction in risk-taking and entrepreneurship
• Tight fiscal policy to allow the government to reduce the debt may lead to lower rates of economic
growth/increased unemployment/falling standards of living
• In most developed economies, independent/more tightly controlled monetary policy reduces the
chance of the real value of the debt being eroded by a high rate of inflation
• Other economic variables may be affected, e.g. the exchange rate may depreciate
A large public sector debt is not harmful:

• For Keynesian economists, during economic downturns/recessions, the LR benefits of adding to
national debt by running a fiscal deficit outweigh the SR costs of the greater debt
• The liberalisation of international capital markets has reduced the extent to which crowding out will
occur. Even if it does exist to some extent, it would very rarely (if ever) be 100%

• Significance: it depends on the meaning of 'large', whether it is large in monetary terms or as a
percentage of GDP, and how long it stays at this level
• It depends on whether it is a developing or developed economy
• It depends what the money was spent on - if the debt is due to greater capital expenditure, we would
expect fewer LR negative effects than if it were due to greater current expenditure and/or transfer
payments
26
Jan 2014
1)
a) To what extent has the growth of trading blocs contributed to globalisation?
Candidates may be rewarded for argument that trading blocs have been important or insignificant and
use reverse arguments in evaluation.
• Understanding of trading blocs
• Understanding/definition of globalisation in the economic sense - increased economic
interdependence between countries e.g. increased trade as a % of GDP; more FDI.
Trading blocs significant:

• Trade creation in trading blocs: analysis of impact of removal of trade barriers
• Analysis of comparative advantage
• Growth in number and size of trading blocs illustrated by appropriate examples
Trading blocs less significant than:

• Reduction in transport costs
• Reduction in cost of communications
• Opening up and industrialisation of low wage countries e.g. China into global economy
• Growth of transnational companies
Also:
• Trade diversion resulting from growth on trading blocs
• Diverts countries' focus from WTO agreements
• Trading blocs tend to be regional - limited integration of developed and developing economies
b) Evaluate the view that trading blocs have been a major constraint on economic development in
developing economies.
Candidates may take either view and use counter arguments as evaluation.
Trading blocs as a major constraint on development:

• Limited access to markets
• Analysis of common external tariffs
• Dumping of surpluses by trading blocs: lowers world price of products on which developing
countries are dependent
• Subsidies by members of trading blocs distort comparative advantage
• Members of trading blocs often exploit developing countries for their raw materials
• Monopsony power of members of trading blocs forces down prices paid to producers of primary
products
Trading blocs not the major constraint:

• Primary product dependency
• Savings gap, leading to lack of investment
• Foreign exchange gap
• Poor human capital
• Poor infrastructure
• Corruption; poor governance
• Political instability; civil war
27
Also:
• Regional trading blocs allow developing countries to take advantage of economies of scale / increase
their market size
• Some trading blocs include developing and developed countries (with examples)
• Stalling of WTO negotiations has meant that trading blocs have been the main way of developing
economies increasing their international trade
2)
a) Examine the causes of income inequality within a country of your choice.
Possible causes include:

• Differences in ownership of assets
• Differences in education
• Differences in health
• Inheritance
• Differences in skills reflected in wage differentials
• Differences in drive, entrepreneurship and risk-taking
• Differences in pensions

• Changes in inequality over time
• Differences may be explained by lifestyle rather than more obvious factors above
NB Level 5 responses must make reference to a specific county. If a response makes no reference to a
specific country, it can earn a maximum of 12 marks.
b) Evaluate policies which might be used to reduce income inequality.
Policies include:
• Increase in progressive taxation
But: may lead to more tax evasion and tax avoidance
• Reduction in regressive taxes
But might lead to reduction in government revenue and less spending on measures which could
reduce inequality
• Increase in means-tested benefits
But could act as a disincentive to work
• Measures to reduce unemployment
But could have inflationary consequences
• Improvements in state provision of public services such as healthcare, education, social housing
But this might have a relatively insignificant effect in developed countries, as provision is already
extensive
• Increase in national minimum wage
But this has no impact on the unemployed, pensioners, students etc
3)
a) Assess the view that a structural fiscal deficit is a more serious issue for a country than a cyclical
fiscal deficit.
• Meaning of structural fiscal deficit: one which will remain even when the economy returns to its
trend rate of economic growth
• Meaning of cyclical fiscal deficit: usually caused by a deficiency in aggregate demand e.g. when the
economy is in recession
28
• Structural deficit could be permanent if no measures are taken to reduce/eliminate it
• This would imply continuous fiscal deficits and an increasing national debt
• Analysis of problems of a rising national debt include:
o crowding out
o reduction in credit rating with implications for cost of servicing the debt
o danger of increased inflationary pressure
o cost for future generations
• Cyclical deficit likely to be temporary

• Cyclical deficit may be necessary to generate economic growth during a recession
However:
• It depends how large either type of deficit is (both in money terms and as a % of GDP), and how long
they last for
• Cyclical debt might be considerable and last for a long time if a world recession continues
• Might require tax increases and/or cuts in public expenditure
• Might not be easy to determine whether debt is structural or cyclical
b) Evaluate the economic effects of government policies aimed at reducing a fiscal deficit.
Measures likely to involve increases in taxes and reductions in public expenditure.
Effects of higher taxes include:

• Disincentive to work (income tax): Laffer curve analysis
• Disincentives for businesses (corporation tax): lower investment; lower productivity; decrease in
competitiveness
• Lower foreign direct investment
• Reduction in risk-taking and entrepreneurship
Effects of lower public expenditure include:

• Poorer public services
• Lower welfare payments
• Increased inequality
• Job losses in the public sector
Combined effects include:

• Reduction in aggregate demand
• Lower real output and employment
• Reduction in inflationary pressures
Evaluation:
• These measures could make the fiscal deficit worse, at least in the short run
• Magnitude of effect depend on size of tax increases/cuts in public expenditure
• Relative impact of different measures
• Effects depend on the state of the economy / other economic policies (all other things are not equal)
29

Economics Unit 4

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Economics Unit 4

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IAL Economics Unit 4

• Understanding of world trade patterns

Possible impacts could include:

Evaluative comments could include:

‘China has specialised in manufacturing while India has specialised in services.’

• Understanding of specialisation (on macro scale)

Possible benefits could include:

• Understanding of fair trade schemes

Possible benefits could include:

Possible evaluative comments could include:

b) Assess the likely economic effects on these countries of joining COMESA.

• Understanding of free trade area

Likely effects of joining COMESA could include:

Possible evaluation points could include:

• Understanding of public expenditure

Possible reasons could include:

Possible evaluation points could include:

• Understanding of public expenditure

Possible effects could include:

Reasons for introducing the restrictions could include:

• To raise tariff revenue for the US government

Evaluative comments could include:

Likely effects of an increase in protectionism may include:

• A decrease in international trade

Other evaluative comments could include:

• Prioritisation of different effects

Possible problems could include:

Evaluative comments could include:

• Understanding of a cut in tax rates (and different taxes)

Possible arguments for cutting tax rates could include:

• Cutting income tax rates might provide increased incentives to work

Other evaluative comments could include:

• Understanding of government intervention in currency markets

Possible policies might include:

Evaluative comments could include:

NB Candidates do not need to answer in relation to Tunisia/the dinar

• Understanding of a depreciation of a currency

Possible benefits could include:

• Decrease in the relative price of exports, leading to an increase in export sales

Evaluative comments could include:

The theory of comparative advantage:

General evaluative comments could include:

In addition, globalization usually involves multinational corporations that operate in developing

Mark scheme points:

Globalisation has been beneficial:

Globalisation has not been beneficial:

Other evaluative comments could include:

a) Assess the factors that cause a worsening of a country’s terms of trade.

Mark scheme points:

• Understanding of terms of trade

Possible factors could include

Evaluative comments could include:

Mark scheme points:

• Understanding of a rise (favourable movement) in a country's terms of trade

Other evaluative comments could include:

• Different levels of education / skills / qualifications

Evaluative comments could include:

• Understanding of income inequality

Evaluative comments could include:

The government could use fiscal policy:

The government could use monetary policy:

The government could use supply-side policies:

• Understanding of economic growth

Increased international trade leads to economic growth: