2012 H1 Prelims answer

Question 1 Debt Time Bomb (a) Compare the fiscal balance of Greece and Spain in 2010. [2] For comparison question, answers need to be p resented in a horizontal format, showing one similarity (where relevant) and one difference. Similarity [1m] both in deficit Difference [1m] size of deficit as a % of GDP larger in Greece than in Spain (b) Explain what determines the effectiv eness of the tax increases outlined in Extract 3 in raising tax revenues. [2] The taxes outlined in Extract 3 are indirect taxes, i.e. taxes on goods and services as opposed to taxes on incomes and wealth. Indi rect taxes are levied on producers but may be passed on to the consumers. To calculate indirect tax revenue, tax revenue = tax per unit × number of units Identify the determinant [1m] (any one) price elasticity of demand (or supply) Explain the determinant [1m] The more price inelastic the demand, the lesser responsive the consumers to price changes  smaller fall in quantity transacted  greater the revenue with larger number of units taxed The more price inelastic the supply, the lesser the producers are able to respond to the indirect tax  smaller the fall in quantity transacted  greater the revenue with larger number of units taxed Accept other relevant factors (c) With reference to Extract 3, using a supply and demand diagram, explain the effect of the austerity drive on the market for alcohol in Greece. [5] This is a question that tests candidates on the determination of market outcome – equilibrium price and quantity transacted. Using demand-supply analysis, candidates are to identify and explain how the auste rity drive could have impacted the demand and/or supply of alcohol in Greece and fr om there, analyse th e effect on market equilibrium. Where demand and supply change simultaneously, it is important to consider the direction and relative magnitude of the shifts to determine the overall effect on market outcome.

Max of 3m Explain the effect of an increase in excise tax on supply [2m] An increase in excise tax will reduce the market supply Reasoning: increase marginal cost of production  increase in minimum price that firms are willing and able to accept to supply the given quantity of output  upward shift of the supply curve Explain the effect of scrapping bonus payments for public sector workers on demand [2m] Scrapping bonus payments for public sector workers will reduce the market demand Reasoning: reduce disposable income, reduce purchasing power  reduce willingness and ability of consumers to buy alcohol (assume normal good)  reduce Qd at each and every price level, shifting the entire demand curve to the left Effect of market outcome by combining the demand and supply changes [2m] Diagram to show decrease in dd + decrease in ss  fall in equilibrium quantity,  effect on price indeterminate, depends on relative extent of the shift. Explain the