A Level Economics H3 Policy Evaluation Quiz

A-Level Economics H3 Quiz - Policy Evaluation: Answer Key

Total Marks: 50

Section A: Rationality and Behavioural Policy (Questions 1–5)

1. (a) [3 marks]

• Status quo bias refers to the tendency of individuals to prefer the current state of affairs and resist change. [1]
• Policy X uses a default option (automatic enrolment). Since individuals are biased towards the status quo, they are likely to stick with the default and remain enrolled. [1]
• Policy Y requires individuals to actively change their behaviour (seek information and sign up), which requires effort and goes against the status quo bias. Therefore, Policy X is more effective. [1]

(b) [2 marks]

• Ethical criticism: Policy X may be seen as paternalistic as it manipulates individuals' choices without their active consent. [1]
• It may infringe on individual autonomy and freedom of choice, even if it is for their own good. [1]
• Marking note: Accept other valid ethical criticisms, such as concerns about manipulation or lack of transparency.

2. (a) [3 marks]

• Salience bias is the tendency to focus on information that is more prominent or emotionally striking. [1]
• A price increase may be a less salient change, as it is a small change in a monthly bill. [1]
• Comparative feedback is highly salient because it makes the individual's behaviour visible relative to others, triggering a social comparison and a desire to conform. This makes the nudge more effective in changing behaviour. [1]

(b) [2 marks]

• Limitation: The nudge relies on social norms and may not be effective for all households (e.g., those who do not care about social comparison). [1]
• The effect may be temporary, and the nudge may not be sufficient to achieve a large reduction target, especially during a severe drought. A price increase provides a stronger and more sustained incentive. [1]
• Marking note: Accept other valid limitations, such as the nudge being less effective for low-income households who cannot afford to reduce usage.

3. (a) [1 mark]

• Sunk cost fallacy. [1]

(b) [2 marks]

• The sunk cost fallacy occurs when individuals continue a behaviour because of past investments (time, money, effort) that cannot be recovered. [1]
• Employees may stick with the old system because of the time they have already invested, even if the new system is more efficient. This leads to suboptimal decision-making as the firm fails to adopt a more productive system, reducing overall efficiency and profitability. [1]

4. [3 marks]

• Bounded will-power refers to the tendency of individuals to give in to short-term temptations and procrastinate on decisions that require effort or have long-term benefits. [1]
• In an opt-in system, individuals must actively register to become a donor, which requires effort and can be postponed. Many people procrastinate and never sign up. [1]
• In an opt-out system, the default is to be a donor. Since individuals are biased towards the status quo and procrastinate on changing it, they are more likely to remain donors. This leads to higher donation rates. [1]

5. (a) [2 marks]

• The endowment effect is the tendency for individuals to value an item more highly once they own it. [1]
• By giving a gift, the charity creates a sense of ownership in the potential donor. The donor then feels a loss if they do not donate, as they would be giving up the gift. This increases the likelihood of donating. [1]

(b) [2 marks]

• Bounded self-interest suggests that individuals are not purely selfish but are also influenced by social norms, fairness, and reciprocity. [1]
• The charity's strategy appeals to the norm of reciprocity: the donor feels obligated to give back because they have received a gift. This is not pure altruism (giving without expectation of return) but a reciprocal exchange. [1]

Section B: Firms' Strategies and Market Failure (Questions 6–10)

6. (a) [3 marks]

• The Coase Theorem states that if property rights are clearly defined and transaction costs are low, private bargaining can lead to an efficient outcome regardless of the initial allocation of rights. [1]
• Policy A assigns individual transferable quotas (ITQs), which are a form of property rights over a share of the fish stock. [1]
• With ITQs, fishermen have an incentive to manage the resource sustainably because they own a long-term asset. If a fisherman wants to catch more, they can buy quotas from others. This creates a market for quotas, and the price of quotas reflects the scarcity of the resource, leading to an efficient allocation. [1]

(b) [2 marks]

• Reason: Transaction costs may be high in the real world. It may be difficult and costly to negotiate and enforce agreements among many fishermen. [1]
• Information may be incomplete, and it may be difficult to monitor and enforce quota compliance. This can lead to the Coase Theorem not applying effectively. [1]
• Marking note: Accept other valid reasons, such as the problem of free-riding or the difficulty of defining property rights for a mobile resource like fish.

7. (a) [2 marks]

• Moral hazard occurs when one party takes on more risk because they are protected from the consequences. [1]
• A co-payment requires the policyholder to pay a fixed amount for each claim. This means they bear some of the cost of their actions, giving them an incentive to be more careful and avoid making claims. This reduces the moral hazard problem. [1]

(b) [2 marks]

• Drawback of Policy Y (monitoring): Monitoring is costly and may be intrusive. [1]
• It may be difficult to observe all relevant behaviour, and the monitoring itself may create resentment or a lack of trust. Policy X (co-payment) is a simpler, market-based mechanism that aligns incentives without the need for costly monitoring. [1]
• Marking note: Accept other valid drawbacks, such as monitoring being ineffective if the policyholder's behaviour is unobservable.

8. (a) [3 marks]

• Adverse selection occurs when one party in a transaction has more information than the other, leading to a market where low-quality goods drive out high-quality goods. [1]
• A warranty is a signal because it is a costly action that only a seller of a high-quality car can credibly afford to offer. A low-quality car seller would face high costs from honouring the warranty. [1]
• By offering a warranty, the high-quality seller signals their confidence in the product, allowing buyers to distinguish between high and low quality, thus overcoming the information asymmetry. [1]

(b) [2 marks]

• Reason: The signal may not be credible if the seller can easily renege on the warranty (e.g., if the firm goes bankrupt, or if the warranty has many loopholes). [1]
• If the cost of offering the warranty is not sufficiently high for low-quality sellers, they may also offer it, making the signal ineffective. [1]
• Marking note: Accept other valid reasons, such as the signal being too weak or the market being unregulated.

9. [4 marks]

• Game theory analyses strategic interactions between firms. A deterrent must be credible to be effective. [1]
• Strategy A (aggressive price-cutting) is not credible because it is a non-credible threat. Once a new entrant has entered the market, the incumbent firm faces a choice: fight (price-cut and lose profits) or accommodate (share the market). Since fighting is costly for the incumbent, the rational choice is to accommodate. The new entrant knows this, so the threat is not credible. [1]
• Strategy B (building excess capacity) is a credible commitment. By building excess capacity, the incumbent has already incurred the cost. This signals to the new entrant that the incumbent is prepared to increase output and cut prices if entry occurs. [1]
• Because the cost is sunk, the incumbent's threat to fight is now credible. The new entrant, anticipating a price war, is deterred from entering. [1]

10. (a) [2 marks]

• Advantage of permits: When the government is uncertain about the marginal cost of abatement, a tradeable permit system sets a quantity of pollution, which directly controls the total level of emissions. [1]
• A tax sets a price on pollution, but the resulting quantity of pollution is uncertain. If the government's goal is to achieve a specific environmental target, the permit system is more certain. [1]

(b) [2 marks]

• Advantage of tax: A tax is simpler to administer and provides a predictable price signal for firms. [1]
• It also generates government revenue, which can be used to reduce other taxes or fund environmental programs. A permit system can be more complex to set up and monitor, and the price of permits can be volatile. [1]
• Marking note: Accept other valid advantages, such as the tax being less prone to lobbying and rent-seeking.

Section C: Sustainable Development and Policy (Questions 11–15)

11. [4 marks]

• The Capital Approach defines sustainable development as maintaining or increasing the total stock of capital (financial, produced, natural, human, and social) over time. [1]
• Strategy A (sovereign wealth fund): This converts natural capital (oil) into financial capital. If the financial capital is invested wisely and generates a return, the total capital stock is maintained, allowing future generations to consume the returns without depleting the principal. [1]
• Strategy B (education and healthcare): This converts natural capital into human capital. A healthier, more educated workforce is more productive, leading to higher future income and well-being. This also maintains the total capital stock. [1]
• Both strategies are consistent with the Capital Approach because they transform one form of capital into another, ensuring that the productive base of the economy is not depleted. [1]

12. (a) [3 marks]

• Inclusive growth refers to economic growth that benefits all segments of society, particularly the poor. [1]
• Policy Y is targeted at low-income families and addresses a specific barrier to their participation in the economy: lack of skills. [1]
• By providing vocational training, it enhances their human capital, enabling them to secure better jobs and increase their earning potential. This is a more sustainable path out of poverty than a UBI, which provides income but does not address the root cause of low earnings. [1]

(b) [2 marks]

• Drawback: Policy Y may suffer from targeting errors (e.g., some deserving families may be excluded, while some undeserving ones may be included). [1]
• It may also be subject to moral hazard or dependency, as families may become reliant on the subsidy and not seek to improve their skills. [1]
• Marking note: Accept other valid drawbacks, such as the administrative cost of targeting or the potential for the training to be mismatched with labour market demand.

13. (a) [3 marks]

• A carbon tax is a price-based policy that internalises the negative externality of carbon emissions. It addresses the symptom (pollution) by making it more expensive to pollute. [1]
• A circular economy strategy addresses the root cause of environmental degradation by redesigning production and consumption systems to minimise waste and resource use. [1]
• It focuses on keeping materials in use for as long as possible, reducing the need for virgin resources and the generation of waste, thus tackling the problem at its source. [1]

(b) [2 marks]

• Challenge: Implementing a circular economy requires significant coordination across the entire value chain, from product design to waste management. [1]
• It may also be costly for firms to redesign products and processes, and consumers may be resistant to changes in consumption patterns. [1]
• Marking note: Accept other valid challenges, such as the lack of infrastructure for recycling or the difficulty of changing consumer behaviour.

14. [4 marks]

• Dynamic comparative advantage suggests that a country's comparative advantage can change over time through investment, learning, and innovation. [1]
• The resource curse refers to the paradox where resource-rich countries often have slower economic growth and development. This can be due to an over-reliance on a single resource, which crowds out other sectors. [1]
• The government can justify intervention to promote new industries because the market may fail to invest in them due to coordination failures or information spillovers. [1]
• By actively promoting new industries (e.g., through subsidies, infrastructure, or education), the government can help the country develop a new comparative advantage in higher-value-added sectors, reducing its dependence on the volatile resource sector and promoting long-term sustainable growth. [1]

15. (a) [2 marks]

• A cap-and-trade system sets a limit (cap) on total emissions and creates a market for emission permits. [1]
• Firms that can reduce emissions cheaply will do so and sell their excess permits. Firms that face high abatement costs will buy permits. The price of permits reflects the scarcity of the right to pollute, creating a price signal that incentivises all firms to reduce emissions. [1]

(b) [2 marks]

• Technological spillovers are positive externalities from R&D in renewable energy. The social benefit of developing renewable energy exceeds the private benefit. [1]
• A subsidy (Policy X) directly encourages investment in renewable energy, which can lead to innovation and cost reductions that benefit the entire economy. A cap-and-trade system (Policy Y) only prices carbon and may not provide sufficient incentive for the development of new, cleaner technologies. [1]

Section D: Integrated Policy Evaluation (Questions 16–20)

16. (a) [2 marks]

• Bounded rationality suggests that individuals have limited cognitive ability and often use heuristics (mental shortcuts) when making decisions. [1]
• Policy B works by making the healthy choice the default or most salient option. By placing healthy food at eye level, it exploits the tendency of individuals to choose the most prominent option without much thought, leading to healthier choices without requiring significant cognitive effort. [1]

(b) [2 marks]

• Reason: A sugar tax changes the relative price of unhealthy food, providing a continuous and universal incentive to reduce consumption. [1]
• Nudges may have a smaller and more temporary effect, as they rely on changing behaviour in a specific context. A tax can also generate revenue that can be used to fund public health campaigns. [1]
• Marking note: Accept other valid reasons, such as the tax being more effective for individuals who are not responsive to nudges.

17. (a) [2 marks]

• Status quo bias is the tendency to prefer the current state of affairs. [1]
• In an opt-out system, the default is to be a donor. Since individuals are biased towards the status quo and are unlikely to actively change their status, they will remain donors. This significantly increases the number of potential donors. [1]

(b) [2 marks]

• Ethical objection: Financial incentives for organ donation may be seen as commodifying the human body, which is ethically problematic. [1]
• Economic objection: It may lead to adverse selection, where only individuals with poor health or desperate financial circumstances are incentivised to donate, potentially leading to lower-quality organs. [1]
• Marking note: Accept either a valid ethical or economic objection.

18. [4 marks]

• Porter's Five Forces includes the threat of substitutes, which refers to the availability of alternative products that can satisfy the same customer need. [1]
• Strategy B (differentiation) creates a unique product that is perceived as having no close substitutes. [1]
• By building brand loyalty and creating a unique value proposition, the firm makes it difficult for customers to switch to a substitute product. [1]
• This reduces the threat of substitutes, giving the firm more pricing power and a stronger competitive advantage. [1]

19. (a) [2 marks]

• The principal-agent problem arises when the agent (civil servant) has different objectives from the principal (the government/public). [1]
• Performance-based pay aligns the agent's incentives with the principal's goals. If the civil servant is rewarded for achieving specific outcomes, they are more likely to work towards those outcomes, reducing the conflict of interest. [1]

(b) [2 marks]

• Unintended consequence: Performance-based pay can lead to gaming or teaching to the test. Civil servants may focus on easily measurable targets at the expense of more important but harder-to-measure objectives. [1]
• It may also create a culture of short-termism and reduce intrinsic motivation, as employees become focused on external rewards rather than the public good. [1]
• Marking note: Accept other valid unintended consequences, such as increased stress or reduced collaboration.

20. (a) [3 marks]

• The Capital Approach to sustainable development requires maintaining the total stock of capital (financial, produced, natural, human, and social) over time. [1]
• A green growth strategy aims to promote economic growth while reducing environmental impact. This is consistent with the Capital Approach if the growth is achieved by increasing human and produced capital while preserving or enhancing natural capital. [1]
• For example, investing in renewable energy (produced capital) reduces reliance on fossil fuels (natural capital), maintaining the total capital stock. [1]

(b) [2 marks]

• Argument for degrowth: A degrowth strategy argues that continuous economic growth is unsustainable because it places an ever-increasing strain on finite natural resources. [1]
• It advocates for a deliberate reduction in consumption and production to reduce environmental impact and improve well-being, focusing on quality of life rather than GDP growth. This may be necessary to avoid catastrophic climate change. [1]
• Marking note: Accept other valid arguments, such as the idea that GDP is a poor measure of well-being and that degrowth could lead to a more equitable society.

END OF ANSWER KEY