2025 ASR-VJC-TJC H3 Economics Prelim Suggested Answers

[Turn over 2025 ASRJC H3 prelim paper Suggested answers Question 1 (a) With reference to Extract 1, explain how different risk attitudes influence individuals’ decisions towards cryptocurrency investments. Assume the following payoffs: 1. An individual gets a guaranteed investment income of $5,000 from a fixed deposit commitment. 2. There is a 50 per cent chance he gets absolutely nothing, and a 50 percent chance that he gets $10,000 from cryptocurrency investment. In the second scenario, his expected investment income is thus 0.5 × $0 + 0.5 × $10,000 = $5,000. There are three types of individuals: (i) risk-averse, (ii) risk-neutral, and (iii) risk- loving. Note: risk-neutral not discussed here. Risk-averse individuals prefer outcomes with lower uncertainty and tend to avoid high levels of risk, even if the potential rewards are significant. Risk- averse individuals have a concave utility function. The individual has a higher level of utility from an investment income of $5000 (utility at 12) with certainty from fixed deposit than if he had to take a chance with cryptocurrency investment (utility at 10). His risk premium is $1500. Decisions towards cryptocurrency investments: These individuals tend to avoid investing in cryptocurrencies due to their high volatility and uncertain returns. They are more likely to prefer traditional, lower- risk investments like government bonds or savings accounts. The utility derived from potential high returns does not outweigh the disutility caused by the perceived high risk and potential for losses. This aligns with the diminishing marginal utility of (investment) income — the additional satisfaction from gains in income decreases as income increases, making losses more impactful. Extract 1 suggested that lower income individuals tend to be more risk-averse. Risk-loving individuals prefer investments with higher risk as they derive utility from taking risks. Moreover, these investors are drawn by the lure of potentially higher returns in a “lottery-style payoff” than investors expect with traditional investments. Risk-seeking individuals have a convex utility function. [6]

[Turn over 2 The risk-loving individual has an increasing marginal utility of (investment) income. This means that the additional utility per dollar (investment) income gained gets higher and higher. The risk-loving individual thus always prefers the uncertain outcome (utility of 10) from crypto investments than the certain outcome (utility of 5) from fixed deposit. Decisions towards cryptocurrency investments: These individuals are attracted to the speculative nature of cryptocurrency markets, including high-risk, high-reward investments, or investments in unproven cryptocurrencies. Mark scheme Level Knowledge, Application, Understanding and Analysis Mark L3 For a well-developed answer that has: • good scope – explain how different risk attitudes (high risk and low risk) influence individuals’ decisions towards cryptocurrency investments; and • good rigour – uses economic concepts like utility functions (and/or numerical examples) to explain individuals’ decisions towards cryptocurrency investments; and • good application – explains with reference to extract, referring to risk-loving and risk-averse individuals. 5-6 L2 For an under-developed answer that: • lacks scope – explains only one type of risk attitude towards cryptocurrency investments; and/or • lacks rigour – provides a descriptive explanation on how different risk attitudes influence individuals’ decisions towards cryptocurrency investments.; and/or • lacks application – explains with little or no reference from extract. 3-4 L1 An answer that does little more than identify the two possible reasons, with no application of economic analysis. 1-2

[Turn over 3 (b) With reference to the extracts, explain two different types of market failure associated with Bitcoin. Requirement 1: Negative externalities associated with the production (mining) of Bitcoin. These include high energy consumption, often powered by fossil fuels leading to carbon emissions, noise pollution from mining rigs and cooling systems, strain on local power grids, affecting other users or e-waste due to rapid hardware obsolescence. To have the usual explanation of 3rd party effects with application to extract information + CBA diagram and explanation of deadweight loss. Requirement 2: Information asymmetry associated with the trading (buy and sell) of Bitcoin. Information asymmetry emerges when traders are segmented into two categories: more informed traders who actively engage with social media, and less informed traders who do so infrequently (or not at all). Traders in this case refer to both buyers and sellers in the financial (Bitcoin) market. Information asymmetry occurs between the buyer and the seller. The more informed trader can be a buyer or a seller, depending on the circumstances. In a particular scenario, a trader may receive certain insider information that prompts him to sell, and in this case another trader who is willing to buy the Bitcoin must be someone who does not share the same insider information; thus adverse selection occurs where the seller has more information than the seller. Conversely, a trader who sold and finds out later the Bitcoin has made large gains could mean the buyer had insider information on the prospective gains. This again is a display of adverse selection. Such dynamics lead to transactions occurring in the Bitcoin market to be based on guesswork and expectated returns of traders, and transaction prices do not reflect the true value of Bitcoin. These inefficient transactions diminish overall market welfare, where buyers will be wary of the sellers (thinking that they could be letting go of the crypto due to insider info.) and vice versa. The outcome will be less transactions that could have occurred, and less liquidity from these assets. (This asymmetry is compounded by bounded rationality, where decision-making is constrained by cognitive limitations and bounded willpower, a focus on short- term outcomes rather than long-term utility maximisation. In addition, traders may be influenced by behavioral biases such as loss aversion and salience bias, which further distort rational judgment. In the context of Bitcoin's speculative nature, some traders are drawn by the "lottery effect," wherein the prospect of unusually high returns motivates participation despite high volatility.) Level Knowledge, Application, Understanding and Analysis Mark L3 For a well-developed answer that has: • good scope – explain two different types of market failure associated with Bitcoin; and • good rigour – applies economic models such as cost- benefit analysis where appropriate, and incorporates relevant economic terminology and explanations of 5-6 [6]

[Turn over 4 market failure, particularly when diagrams are not feasible; and • good application – explains with reference to extract. L2 For an under-developed answer that: • lacks scope – explains only one type of market failure associated with Bitcoin; and/or • lacks rigour – provides a descriptive explanation of market failure associated with Bitcoin; and/or • lacks application – explains with little or no reference from extract. 3-4 L1 An answer that does little more than identify the two possible types of market failure, with no application of economic analysis. 1-2 (c) Discuss the extent to which issues arising from Bitcoin mining in Kazakhstan can be resolved by allocating property rights to the parties involved. Command word: Discuss the extent (balanced view)… can be resolved (remove the welfare loss associated with Bitcoin mining) Content: Application of the Coase Theorem Context: Bitcoin mining