Labour Market Forces and Government Intervention: five questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
A country maintains its foreign exchange rate against the United States dollar, within a narrow but changing band.
What is this type of exchange rate?
Answer: C.
The correct answer is C: managed float.
A managed float lies between the two pure systems. The rate is allowed to move within a band, so market forces do some of the work, but the central bank intervenes to keep it inside the band, and the band itself can be shifted over time. The question's description of a "narrow but changing band" against the dollar captures both features: constrained movement, and a target that is periodically adjusted rather than permanently fixed.
Why the other options are wrong:
A managed float lies between the two pure systems. The rate is allowed to move within a band, so market forces do some of the work, but the central bank intervenes to keep it inside the band, and the band itself can be shifted over time. The question's description of a "narrow but changing band" against the dollar captures both features: constrained movement, and a target that is periodically adjusted rather than permanently fixed.
Why the other options are wrong:
- A, fixed, means the rate is held at a single announced parity and defended indefinitely. A band that changes is not a fixed parity, and a narrow band still permits movement that a true peg would not.
- B, floating, means the rate is determined entirely by supply and demand with no intervention. The existence of a band and of official intervention to maintain it rules this out.
- D, trade-weighted, is not an exchange rate system at all. A trade-weighted index measures a currency's value against a basket of partners' currencies weighted by trade volumes, a measurement device, and in any case this currency is managed against a single currency, the dollar.
Question 2
A government imposes a maximum price for electricity.
Which statement justifying this measure might be considered valid on economic grounds?
Answer: C.
A maximum price is normally an inefficient intervention, so it can only be justified where the market price is already too high for a reason the market will not correct, and monopoly power is that reason. If a single supplier is restricting output to hold the price above the competitive level, a ceiling set near that competitive level can raise output and protect consumers at the same time, which is the exception that makes the policy defensible. A, B and D are the standard COSTS of a price ceiling stated as though they were benefits. Holding the price down reduces the revenue available to fund new capacity, so investment is discouraged rather than encouraged; a lower price weakens rather than strengthens the incentive to conserve energy; and a price held below the market-clearing level creates excess demand, which is precisely what power cuts are, so a ceiling makes rationing more likely rather than preventing it.
Question 3
What is not a valid comment economists may make regarding the need to subsidise a green energy market that uses solar and wind power?
Answer: B.
The correct answer is B: markets will become more efficient.
The question asks which comment is not valid, and this one is not. A subsidy is an intervention in the price mechanism: it moves price away from the free-market level and requires taxation elsewhere to fund it. The justification for subsidising green energy is that the unsubsidised market is already inefficient, because it fails to price the external costs of fossil fuels and the external benefits of clean generation. The claim that markets become more efficient in general is too broad to serve as an argument, the case rests on correcting a specific market failure, not on improving market efficiency as such, and the subsidy itself introduces distortions of its own.
Why the other options are valid comments:
The question asks which comment is not valid, and this one is not. A subsidy is an intervention in the price mechanism: it moves price away from the free-market level and requires taxation elsewhere to fund it. The justification for subsidising green energy is that the unsubsidised market is already inefficient, because it fails to price the external costs of fossil fuels and the external benefits of clean generation. The claim that markets become more efficient in general is too broad to serve as an argument, the case rests on correcting a specific market failure, not on improving market efficiency as such, and the subsidy itself introduces distortions of its own.
Why the other options are valid comments:
- A, that coal is cheaper, is a genuine observation about private costs and the core of the problem: fossil fuels appear cheap precisely because their external costs are not paid by the user.
- C, that positive externalities cannot be estimated, is a real practical objection. If the external benefit of clean energy cannot be valued, the correct size of the subsidy cannot be calculated, and government failure becomes likely.
- D, that negative externalities cannot be estimated, raises the same valuation difficulty on the cost side, how much damage carbon emissions cause is genuinely contested.
Question 4
What is a part of Keynesian economic analysis?
Answer: A.
The correct answer is A: a liquidity trap below which interest rates are ineffective.
The liquidity trap is a Keynesian idea. Once interest rates approach zero, further cuts cannot stimulate spending: people prefer to hold cash rather than bonds, and firms will not invest however cheap credit becomes because they expect weak demand. Monetary policy therefore loses traction, which is a central part of Keynes's argument that fiscal policy is needed to lift a depressed economy.
Why the other options are wrong:
The liquidity trap is a Keynesian idea. Once interest rates approach zero, further cuts cannot stimulate spending: people prefer to hold cash rather than bonds, and firms will not invest however cheap credit becomes because they expect weak demand. Monetary policy therefore loses traction, which is a central part of Keynes's argument that fiscal policy is needed to lift a depressed economy.
Why the other options are wrong:
- B, an equilibrium price that always clears the market, is a classical assumption. Keynes argued that wages and prices are sticky, so markets, especially the labour market, can fail to clear, leaving involuntary unemployment persisting.
- C, a small government expenditure multiplier, is the opposite of the Keynesian position. Keynesians hold the multiplier to be large, which is what makes fiscal expansion an effective instrument; critics of fiscal policy argue it is small.
- D, a vertical short-run aggregate supply curve, is again classical. A vertical SRAS would mean extra demand raised only prices and never output. Keynesian analysis has an SRAS that is flat or gently rising where there is spare capacity, which is precisely why demand management can raise real output.
Question 5
What is the essential feature of nudge theory?
Answer: D.
The correct answer is D: the idea of persuasion.
Nudge theory comes from behavioural economics and works by changing how choices are presented rather than by removing or repricing them. It relies on persuasion and on exploiting predictable features of human decision-making, the pull of defaults, the power of social comparison, the salience of vivid information. Crucially it preserves freedom of choice: the individual can always ignore the nudge, which is why the approach is sometimes called libertarian paternalism.
Why the other options are wrong:
Nudge theory comes from behavioural economics and works by changing how choices are presented rather than by removing or repricing them. It relies on persuasion and on exploiting predictable features of human decision-making, the pull of defaults, the power of social comparison, the salience of vivid information. Crucially it preserves freedom of choice: the individual can always ignore the nudge, which is why the approach is sometimes called libertarian paternalism.
Why the other options are wrong:
- B, establishing a legal requirement, is regulation. It removes options by compulsion, which is the opposite of a nudge.
- A, satisficing, is an objective a firm might pursue, settling for a satisfactory rather than a maximum outcome. It is a behavioural idea, which makes it tempting, but it describes how decisions are made rather than how a policymaker influences them.
- C, a contestable market, is a market structure defined by free entry and exit. It has nothing to do with behavioural intervention.
What this practice covers
These questions are drawn from past CIE 9708 papers. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on labour market forces and government intervention, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Asserting that a minimum wage always reduces employment without identifying market structure.
- Confusing marginal physical product with marginal revenue product.
- Drawing MCL below the supply curve for a monopsonist, or equal to it.
- Reading the monopsony wage off the MRPL curve rather than the supply curve.
- Saying diminishing returns begin where MRPL falls below the wage rather than where marginal product first falls.
- Treating the individual's backward bending supply curve as the market supply curve.
- Forgetting that demand for labour is derived, so a fall in product demand reduces labour demand regardless of the wage.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Labour Market Forces and Government Intervention revision notes.