ASRJC 2020 H1 econs CSQ1 Answers

© Anderson Serangoon Junior College Econ dept 2020 A Level Paper 8823/1 Question 1: The role of government in resource allocation Suggested answers (a) Using information in Extract 1, compare the government spending as a percentage of GDP in the UK to that in other countries. [3] Difference • UK government spending as a percentage of GDP is 3rd highest of all the countries shown in Table 1 whilst Singapore is the lowest. • Over the period 2008 to 2016, UK government spending as a % of GDP has fallen but Singapore government spending as % of GDP was relatively constant. Similarity From 2009 to 2011, both UK and Singapore’s government spending as % of GDP fell. (b) Using information from Extract 2A, identify and explain three factors that have caused the demand for passenger transport in the UK to change. [6] Evidence Factor Explanation Population size Population size Increase in population size means there was a greater number of people who need to commute → Demand increases. Level of economy activity Changes in income level During the financial crisis in 20007 —2008, there was a fall in the level of economic activity and thus a fall in national incomes and rise in unemployment. Hence, fewer people travel either to work, for business or leisure purposes. This led to a fall in demand for passenger transport as train and bus trips are normal goods. Train and bus fares went up Price of related goods (Substitutes) Motor vehicles and public transport are close substitutes. When public transport fares increased, this led to a fall in quantity demanded for public transport as people switched over to the relatively cheaper alternative. Thus demand for travel by cars/motor vehicles increased. 1m for evidence + 1m for explanation (c) Using supply and demand analysis, explain the conclusion reached in Extract 2B that ‘the usual market adjustment process simply does not work’ in the UK housing market. [6] Usual Market adjustment process Why it did not work… • With rising prices, perhaps due to an increase in demand, at current price P 0, there will be a shortage of QdQs. • Consumers will bid up prices. • Producers are incentivised to step up production because of the higher prices and profits and so quantity supplied of However, with rising prices, instead of causing a fall in quantity demanded, “it has instead caused an increase in demand” due to a change in expectations of future prices. Buyers expect future housing prices to increase and so they would rather buy now at a lower price rather than have to fork out more to buy the

© Anderson Serangoon Junior College Econ dept housing increases. Quantity demanded falls as some consumers are unable or unwilling to pay the higher prices. • This adjustment process will continue until quantity supplied = quantity demanded at a new equilibrium at E 1 where equilibrium price and quantity of housing has increased to P1 and Q1 respectively. same unit later. The rise in demand caused further shortages and also further increases in prices. Secondly, expectation of future prices has also caused homeowners to withhold (decrea se) supply currently, which again reinforces shortages and increases prices. Price Thirdly, Britain’s strict planning laws made it S0 “difficult for supply to increase in response to E1 increases in demand”. P1 In short, the conclusion was reached based on the observation that the increase in housing prices did not seem to reduce the shortage P0 E0 D1 problem when in fact, there were other demand and supply factors that change at the same time and this resulted in a persistent shortage D0 of housing. Qty Q0 Q1 (d) Given the relationship that exists between price elasticity of demand (PED) and total revenue, explain and comment on the claim in Extract 2C that the rate of indirect tax on scotch whisky should be cut. [8] Introduction The SWA called for a cut in tax rate on whisky and claimed that the tax cut would increase the government’s tax revenue. In addition, the action would help to support a large number of jobs and support exports and economic growth of Scottish and the UK economies. Body Extract 2C states that “when government increase tax by 3.9%, UK demand fell so much”. This indicates that the demand for whisky is price elastic. This is because wh en government increase tax, cost of production rise and producers reduce supply, leading to a shortage and increase in price. “Demand fell so much” indicates more than proportionate fall in quantity demanded, indicating that demand is price elastic. Therefore, SWA claims that a cut in tax rate on whisky will increase government tax revenue. This is beca use when the government cuts the tax rate, this will lead to lower costs and hence increase in supply as producers find it more profitable to do so. The increase in supply of whisky will lead to surplus and lower prices of whisky. Since demand for whisky is price elastic, there will be more than proportionate increase in the quantity demanded, which will increase government tax revenue (tax per unit x qty) more than the loss in tax revenue from the fall in per unit tax. Hence extra ct states that in 2015, “when the government cut tax by 2%, the government tax revenue increased by 4%”. There are other reasons put forward to support the tax cut. The whisky industry plays a significant role in the economy. According to Ext 2C, the industry supports 40,000 jobs and accounts for more than $4 billion in exports. The tax cut would lower whisky prices and increase consumption thereby stimulating the growth of this industry.

© Anderson Serangoon Junior College Econ dept However, the claim that the tax rate should be cut might not be substantiated. This is because the claim is based on the PED analysis with the assumption of ceteris paribus. In reality, other factors can be changing concurrently and a cut in tax rate may not increase gov ernment's tax revenue nor producers' total revenue. For example, if there is a change in taste and pref erence away from whisky, demand would fall and equilibrium price and eq uilibrium quantity would fall. Both producers' revenue and government tax revenue would fall, even with a cut in the tax on whisky. In addition, the observation made by SWA that demand is price elastic was in the year 2015. There are many factors that have changed since then that could have changed the value of price elasticity of demand or supply of whisky. As such, its claim that a cut in tax could increase tax revenue could no longer be supported. Furthermore, the t ax rate should not be cut despite the possibl e job creations. This is because consumption of whisky generates negative externalities which are not taken into acco unt by consumers and producers, leading to over -consumption of whisky and over -allocation of resources to the industry. Hence from the efficiency perspective, the tax rate should not be cut Conclusion The tax cut would certainly benefit whisky producers and the industry as a whole as well as its employees because of an increase in consumption and total revenue due to its lower prices. Nonetheless the effect of the tax cut on government’s tax revenue is uncertain. The government must have sufficient accurate data on the values of PED to be sure of the effect of the tax cut on tax revenue. Even if the tax cut leads to an increase in tax revenue, the other effects of consuming alcohol on society must be considered and weighed against the benefits on employment before a decision is made. Hence overall the claim is not substantiated.

© Anderson Serangoon Junior College Econ dept (e) The UK government regards ‘sustainable transport’ such as bus travel and rail travel as generating positive externalities. (i) Taking bus trave