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UK GCSE 2007 : Higher Tier, Economics Paper 1

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Paper 1 Higher Tier [G2703] G2703 Economics *G2703* General Certificate of Secondary Education 2010 MONDAY 7 JUNE, MORNING TIME 1 hour 30 minutes. INSTRUCTIONS TO CANDIDATES Write your Centre Number and Candidate Number on the Answer Booklet provided. Answer all eight questions. This paper is accompanied by a Case Study. You must not use your own annotated copy of this Case Study. INFORMATION FOR CANDIDATES The total mark for this paper is 80. Quality of written communication will be assessed in questions 4, 5, 6, 7 and 8. Figures in brackets printed down the right-hand side of pages indicate the marks awarded to each question or part question. ADVICE TO CANDIDATES You are recommended to study the mark allocation for each question and part question and to allocate your time accordingly. 5511 Using the source material in the Case Study provided, and any other relevant information you have studied, answer the following questions. 1 [3] (b) Using Source 1 identify two possible causes of the credit crunch in the UK. [4] (a) Explain how Northern Rock was owned and controlled before February 2008. [3] (b) How did this change when the business was nationalised? 2 (a) Briefly explain what is meant by the credit crunch . [3] 3 Source 1 refers to the wide range of services and financial products provided by banks and other financial institutions . Briefly describe four examples of these services and products. [8] 4 Using a suitable demand and supply diagram, explain how the credit crunch has affected the housing market. [8] 5 Using Source 2, discuss the effects of the credit crunch on consumer spending and businesses. 6 5511 [12] Using Source 3, explain how the performance of the UK economy has been affected by the credit crunch. [12] 2 7 [6] (b) Has this regulation been effective in recent years? Explain your answer. 8 (a) Explain why the government regulates the financial service sector. [6] Evaluate the effectiveness of the government s response to the credit crunch and the recession. THIS IS THE END OF THE QUESTION PAPER 5511 3 [15] 5511 General Certificate of Secondary Education Case Study for use with Paper 1 Foundation Tier and Higher Tier [G2701] [G2703] monday 7 junE, morninG G2701G2703 Economics *G2701G2703* 2010 You must use this clean copy of the Case Study in the examination and not your own annotated copy. 5513.01 [Turn over Source 1 What caused the credit crunch? The credit crunch seems to have been with us for ever. It s hard to believe that it s only a few years since the UK economy was enjoying economic success. Now it is facing very difficult times. What exactly is the credit crunch, and what caused it? The credit crunch was first reported in August 2007 when economic conditions began to change and credit became harder to obtain. Commentators are generally agreed that it originated in the USA in 2007, when a rise in interest rates caused many people to default on their mortgage payments. This led to many homes being repossessed. The problems were particularly acute in the sub-prime market, a risky sector of the market where too many loans had been made to people with poor credit histories or low incomes. 5 The credit crunch spread across the Atlantic to the UK, and quickly became a global problem. Consumers in the UK had enjoyed a high standard of living. For several years it had been cheap and easy to borrow money to buy houses and to fund excessive spending habits. First-time buyers were encouraged to get on the property ladder, while many individuals became buy-to-let investors. 10 One of the main causes of the credit crunch was the fact that banks were undertaking risky business activities. Many of the bad debts from the USA were repackaged with some good-quality mortgages and sold as new investment assets. These new assets were sold on in the financial markets and many were bought by UK banks and financial institutions. 15 For many years the UK s financial sector made high profits by providing customers with a wide range of financial services and products. All financial institutions should have balanced the risk and return associated with borrowing and lending. However, some extended their activities and placed considerable assets in the sub-prime and buy-to-let markets exposing their business activities to much greater risk. Northern Rock became the first major UK casualty of the credit crunch. Consumers lost confidence in Northern Rock after it asked the Bank of England for emergency financial help. In September 2007, over a million customers queued to withdraw their savings amidst fears that the bank might collapse. After much speculation and uncertainty, the Government nationalised Northern Rock in February 2008 at a cost of 110 billion to the taxpayer. In late 2008, the Government announced a multi-million pound support package for the high street banks. The Treasury also increased the guarantee threshold to 50,000 for bank depositors, if their bank collapses. 5513.01 2 20 25 30 AFP/BenStansall In the UK consumers had been encouraged to use cheap credit to finance spending. Household debt, including mortgages, was estimated at 1.44 trillion and thought to be 180% of disposable income. This was the highest proportion of any country in the G7, the so-called club of rich countries. Some economists had warned for several years that it would all end in tears. The Citizens Advice Bureau, an organisation that helps people with financial problems, said that the banks were mainly to blame for the problems in the economy. It claimed that the banks tempted the poorest in society to take out large loans and to use credit cards. These people were bound to have trouble paying back debt. 35 40 The Financial Services Authority (FSA) regulates the banking sector but concerns have been expressed about how well it has done this job. MPs criticised the FSA for failing to ensure that companies addressed the serious risks within their business. They claimed that the FSA s procedures were inadequate to supervise banks whose business grew so rapidly. 5513.01 3 [Turn over Source 2 Who are the winners and losers from the credit crunch? The credit crunch has taken its toll throughout the financial sector and has made things difficult for both lenders and consumers. Many banks are finding it more difficult and more expensive to borrow from one another and this has severely affected their ability to lend. After years of easy credit, consumers are finding it hard to get any kind of credit. Lenders have tightened up on their lending criteria and are taking a much closer look at customers credit ratings before they agree the terms of any loans or credit facilities. The mortgage sector has been particularly hard hit by the effects of the credit crunch. The number of mortgage products has fallen by two thirds, leaving consumers with very little choice. First-time buyers have been badly affected as it is no longer possible to get 100% and 125% mortgages. Now they have to save for a deposit to buy a house which could be as high as 10%, or more of the purchase price. Banks have significantly increased the fees they charge to arrange new mortgages. Some of the changes in the UK mortgage market are detailed in Fig. 1 below. 5 10 Council of mortgage Lenders market analysis 2006 2007 2008 2009 Residential property transactions (millions) 1.685 1.627 0.90 0.70 Total mortgage lending ( billions) 346 363 258 145 Number of mortgage customers with arrears over 3 months 115500 129600 210000 500000 Fig. 1 Industry experts have stated that the problems in the housing market are likely to continue for some time. House sales have slowed down as would-be buyers struggle to find finance. In 2008 UK house prices fell by an average of 15.9% following the changed market conditions. Many people who took out mortgages during the housing boom have negative equity as their houses are no longer worth the money they still owe on their loan. In shops, homes and workplaces across the UK, the credit crunch has had a profound effect. Supermarkets and shops report that shoppers have been cutting back on their spending. Food prices have risen at a faster rate than inflation and this has caused consumers to change their shopping habits. The big supermarkets have switched the emphasis of their advertising away from green and ethical products to focussing on price. In 2008 Sainsbury reported that its family meal for a fiver campaign was the most popular promotion it has ever run. Sales in discount supermarkets, such as Iceland and Lidl, have increased by 25%. 5513.01 4 15 20 25 Newspapers, the media and consumer organisations have lots of advice for consumers to survive the credit crunch and the impact of rising bills. Some consumers are feeling the effects of the credit crunch more than others. Those with cash savings are better placed to cope with the financial turmoil. However, even the luxury end of the consumer goods market has been adversely affected. The sudden downturn in spending on goods ranging from watches to perfumes and leather goods to sports cars, was a clear signal that the credit crunch had already started to hurt the affluent as well as the poor. As people watch how they spend their pennies, some businesses are feeling the pinch while others are busier. Retailers generally report falling sales and profits. Repair shops are enjoying a new lease of life. Sales of champagne in the UK are down by 6.3% while sales of cheaper sparkling wine have risen. Bookings are down for long-haul holidays but there is more interest in holidays at home . McDonald s is creating four thousand new jobs in the UK and Domino s Pizza reports that it has never been busier as people choose to order in rather than eat out. Business is also good for auctioneers selling repossessed homes and household contents. There are 10% more pawnbrokers operating in the UK. There is greater demand for the expertise and forecasting skills of economists. 5513.01 5 30 35 40 [Turn over Source 3 The Effect of the Credit Crunch on the Economy In November, 2008 the Governor of the Bank of England confirmed what everyone had feared, the economy was in recession. The motor vehicle and electronics industries were among the first to feel the downturn in the economy. Sales of new cars fell by 27% in 2008 while Nissan shed one quarter of its UK workforce. Other companies cut back on investment plans and unemployment started to rise. The UK s inflation rate slowed and the pound fell to a record low against the euro. Some of the main indicators of the UK s economic performance since 2006 are shown in Fig. 2 below. Economic Growth unemployment 3.5 October 2008 2.00 3 Million people 2.5 2 1.5 1 0.5 1.75 1.50 1.25 0 1.00 1.0 2.0 2006 2007 2008 2009 Percentages Inflation Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Euros to Pound 2.0 6 1.8 5 1.6 1.4 4 1.2 3 1.0 CPI 5 5 5 5 5 5 5 0.8 2 0.6 0.4 1 0.2 0 Feb May Aug 2007 Nov Feb May Aug 2008 Nov 0 Jan July Jan July Jan July Jan July Jan 06 06 07 07 08 08 09 09 10 Feb 2009 CPI: Consumer Prices Index Graphs on Economic Growth, Unemployment and Inflation are all Crown Copyright/Office of National Statistics Fig. 2 5513.01 6 5 Source 4 What are the best policy choices to help the economy? In March 2009 the Bank of England reduced interest rates to a record 0.5% in an effort to help households and firms struggling to pay their mortgages and loans. Banks were asked to pass on rate reductions to borrowers. The Government also wanted homeowners facing repossession to have more time to get their financial affairs in order. The Chancellor planned to bring forward spending plans, paid for by borrowing, to stimulate the economy. VAT was temporarily reduced to 15% 5 Some of the Government s fiscal options are outlined in Fig. 3 below. income Tax and Tax Credits reduce the tax burden on lower income families by increasing tax credits increase the personal allowance threshold cut the basic 20% rate of tax introduce a 50% tax band for those on over 150,000 per year Business Taxes cut Corporation Tax from 28% cut National Insurance contributions for firms reduce business rates Capital Gains Tax, Stamp Duty holiday on all houses up to 175,000 until end of Stamp duty, 2009 inheritance Tax increase in thresholds for Capital Gains Tax and Inheritance Tax Excise duties Government Spending 2% increase in tobacco tax rise in fuel duty by 2p per litre from September 2009 capital spending projects subsidies to employers to assist with hiring workers increased levels of benefits especially for pensions and children investment fund for businesses to support important projects, especially those with a low carbon impact temporary scheme to enable consumers to scrap vehicles older than 10 years and replace them with brand new vehicles at a discount of 2000 guaranteed job, training or work placement for 18 24 year olds who reach 12 months unemployed support for low carbon industries Crown Copyright/HM Treasury and BBC News at bbc.co.uk Fig. 3 One of the most controversial aspects of Government tax and spend policies has been their willingness to provide hundreds of billions of pounds to support the banking sector. With unemployment rising and tax receipts from workers and companies falling, the cost of providing benefits is expected to rise. Government borrowing is set to rise sharply over the next few years. There are concerns that if the Government s fiscal measures are too generous and add substantially to the national debt, this may cause further uncertainty in an already volatile market. Furthermore, consumers and businesses may not respond in the way the Government anticipates. 5513.01 7 10 15 Permission to reproduce all copyright material has been applied for. In some cases, efforts to contact copyright holders may have been unsuccessful and CCEA will be happy to rectify any omissions of acknowledgement in future if notified. 5513.01/1

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