1.2.5 The Wider Economic Environment — Practice Questions

Eight original multiple-choice questions on what changes in interest rates, exchange rates, taxation, unemployment and inflation mean for a firm's costs, sales and investment.

8 questions Edexcel B A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 1.2.5 The Wider Economic Environment revision notes.

1. 1. A haulage firm has two debts: an £80,000 loan at a fixed rate of 6% with three years left, and a £160,000 overdraft at a variable rate. After a rise in Bank Rate, the interest rate on the overdraft goes up from 7.5% to 9.0%. The extra interest the firm pays over the next year is

   Calculation

   Select one answer

   A £2,400

   B £3,600

   C £14,400

   D £21,600
   Show model answer

   Answer: A (£2,400). Only the variable-rate overdraft is affected. The fixed-rate loan is protected until its deal ends.
   Rise in the overdraft rate: 9.0% − 7.5% = 1.5 percentage points.
   Extra interest: 1.5% × £160,000 = £2,400 a year.
   How much a rate rise hurts depends on how much a firm borrows and whether its borrowing is fixed or variable.

   Why the other options are wrong

   • B — This applies the 1.5-point rise to all £240,000 of borrowing. The £80,000 loan is at a fixed rate, so its interest does not change.
   • C — This is the total interest on the overdraft at the new rate, 9.0% × £160,000. The stem asks for the extra interest.
   • D — This applies the new 9.0% rate to all the borrowing. It is neither the extra interest nor right for the fixed-rate loan.

2. 2. Table 1 describes four businesses. Interest rates then rise by one percentage point.
   Using Table 1, the business most likely to be hit through both its costs and its sales is

   Data interpretation

   Table 1: Four businesses

   	Type of business	Its borrowing	What it sells
   Business 1	Corner shop	None	Everyday groceries, paid for at the till
   Business 2	Plumber	A large overdraft at a variable rate	Emergency repairs, paid for on completion
   Business 3	Car dealer	None, and a large cash balance	New cars, mostly bought on finance
   Business 4	Furniture showroom	A large loan at a variable rate	Sofas and beds, mostly bought on credit

   Select one answer

   A Business 1.

   B Business 2.

   C Business 3.

   D Business 4.
   Show model answer

   Answer: D (Business 4.). A rate rise reaches a firm through its costs, if it borrows at a variable rate, and through its sales, because households spend less. The fall in spending is worst for goods often bought on credit. Business 4 has both: a variable-rate loan whose interest goes up, and customers who buy its sofas and beds on credit and now face higher repayments.

   Why the other options are wrong

   • A — The shop has no borrowing, and everyday groceries are paid for at the till. It is hit by neither route, beyond any general fall in spending.
   • B — The overdraft is variable, so its costs rise. But emergency repairs are a necessity that customers pay for on completion, so its sales are unlikely to fall much.
   • C — Car sales are hit hard, because most cars here are bought on finance. But the dealer has no debt, and its cash earns more interest, so its costs are not hit.

3. 3. A UK firm buys components from the US for $36 a unit and sells each finished unit in the US for $120. It keeps both dollar prices unchanged when the pound strengthens from £1 = $1.20 to £1 = $1.50. In pounds, the amount each unit earns over the cost of its components is now

   Calculation

   Select one answer

   A £50

   B £56

   C £70

   D £76
   Show model answer

   Answer: B (£56). Convert each dollar amount into pounds at the new rate.
   Revenue per unit: $120 ÷ 1.50 = £80 (it was $120 ÷ 1.20 = £100).
   Component cost per unit: $36 ÷ 1.50 = £24 (it was $36 ÷ 1.20 = £30).
   Amount earned over components: £80 − £24 = £56, down from £70.
   A strong pound makes imports cheap and exports dear. This firm gains £6 on its imported components but loses £20 on its export revenue. Because it exports more than it imports, the net effect is a loss.

   Why the other options are wrong

   • A — This converts the revenue at the new rate but leaves the components at the old one: £80 − £30.
   • C — This is the figure before the change. Holding the dollar prices fixed does not hold the pound amounts fixed.
   • D — This converts the components at the new rate but leaves the revenue at the old one: £100 − £24.

4. 4. The pound weakens sharply against the euro. For a UK bicycle maker that buys its frames from Italy and sells only in the UK, the most likely effect is that

   Applied reasoning

   Select one answer

   A Its costs fall, so it can cut its UK prices.

   B Its costs rise, so its margin shrinks unless it raises prices.

   C Its export sales rise, because its bikes are cheaper abroad.

   D Its sales fall, because imported rival bikes get cheaper.
   Show model answer

   Answer: B (Its costs rise, so its margin shrinks unless it raises prices.). A weaker pound buys fewer euros, so each Italian frame costs more in pounds. The bicycle maker's unit costs rise. It can absorb them and accept a smaller margin, or pass them on and charge its UK customers more.

   Why the other options are wrong

   • A — This reverses the effect. A weaker pound makes imports dearer, not cheaper: it is a strong pound that makes imports cheap.
   • C — A weaker pound does make UK goods cheaper abroad, but this firm sells only in the UK, so it has no exports to gain.
   • D — A weaker pound makes imported bikes dearer in UK shops, not cheaper. If anything, that helps a UK producer at home.

5. 5. Employers pay National Insurance on each employee's earnings above a threshold. In April 2025 the rate rose from 13.8% to 15%, and the threshold fell from £9,100 to £5,000 a year. A café employs a part-time waiter who earns £9,000 a year. Ignoring any allowances, the rise in the café's yearly employer National Insurance bill for this waiter is

   Calculation

   Select one answer

   A £108

   B £552

   C £600

   D £1,350
   Show model answer

   Answer: C (£600). Before: the waiter's £9,000 is below the £9,100 threshold, so the café pays nothing.
   After: earnings above the threshold are £9,000 − £5,000 = £4,000, and 15% × £4,000 = £600.
   Rise: £600 − £0 = £600.
   Lowering the threshold matters far more than the rate rise for low-paid and part-time staff. That is why shops and restaurants were hit hardest.

   Why the other options are wrong

   • A — This applies only the 1.2-point rise in the rate, to all £9,000 of earnings. It misses the threshold, which is the bigger change here.
   • B — This applies the lower threshold at the old rate: 13.8% × £4,000. After April 2025 the rate is 15%.
   • D — This charges 15% on all £9,000 and ignores the threshold. National Insurance is due only on earnings above £5,000.

6. 6. Unemployment rises sharply over a year. For a restaurant chain that sells expensive tasting menus, the most likely effects are

   Applied reasoning

   Select one answer

   A Higher sales, and easier recruitment.

   B Higher sales, and harder recruitment.

   C Lower sales, and easier recruitment.

   D Lower sales, and harder recruitment.
   Show model answer

   Answer: C (Lower sales, and easier recruitment.). When unemployment rises, people who lose their jobs, and others who worry about theirs, spend less. Spending on luxuries such as expensive meals out falls most, so sales fall. At the same time more people apply for each vacancy, so the restaurant finds it easier to recruit and faces less pressure to raise wages.

   Why the other options are wrong

   • A — Recruitment does get easier, but sales are unlikely to rise. Shoppers trading down helps discount firms, not an expensive restaurant.
   • B — Both halves are reversed. Spending on luxuries falls, and with more people looking for work, staff are easier to find.
   • D — Sales do fall, but recruitment gets easier, not harder, when more people are looking for work.

7. 7. Inflation rises, and two bakeries both face a 10% rise in their energy and wage costs. One is a well-known artisan bakery with loyal customers. The other supplies standard bread to supermarkets that compete hard on price. The most likely outcome is that

   Applied reasoning

   Select one answer

   A Both keep their margins by raising prices by 10%.

   B Neither can raise prices, so both margins shrink equally.

   C The artisan protects its margin better than the supplier.

   D The supplier protects its margin better than the artisan.
   Show model answer

   Answer: C (The artisan protects its margin better than the supplier.). How much inflation hurts depends on pricing power. The artisan bakery's loyal customers will pay more without buying much less, so it can pass its higher costs on. The supplier sells a standard product to buyers who compete on price, so it cannot raise prices easily and has to absorb more of the rise. Its margin shrinks.

   Why the other options are wrong

   • A — Only a firm with pricing power can pass a cost rise on in full. The supplier's customers would switch to a cheaper baker.
   • B — The artisan can raise its prices, because its customers are loyal. The two bakeries are in very different positions.
   • D — This reverses it. A standard product sold to price-conscious buyers gives the least power to pass costs on.

8. 8. Bank Rate rises, but a furniture retailer whose customers are mostly homeowners with mortgages sees little change in its sales for the first few months. The most likely explanation is that

   Applied reasoning

   Select one answer

   A Furniture is a necessity that households rarely buy on credit.

   B Higher interest rates make saving less attractive to households.

   C Its own business loan is at a fixed rate for two more years.

   D Many households' mortgage rates are fixed for now.
   Show model answer

   Answer: D (Many households' mortgage rates are fixed for now.). Many households have fixed-rate mortgages, so their repayments do not change until their deal ends. They have no less to spend at first, and the fall in spending builds up over months, not weeks, as deals end and are renewed at the higher rate.

   Why the other options are wrong

   • A — Furniture is not a necessity: it is one of the purchases households put off when their repayments rise, and much of it is bought on credit. That makes its sales more sensitive to interest rates, not less.
   • B — This reverses it. Higher rates make saving more attractive, which would cut spending, not protect it.
   • C — A fixed-rate loan protects the retailer's costs, not its sales. The stem is about customers' spending.