Practice Paper 3 style question
Here is a practice question written in the style of Edexcel Economics A.
It features a short extract, followed by the question.
Extract A: House prices in the UK
There is some evidence that the rate of growth of house prices has slowed or that house prices are even falling in some areas of the UK. In October 2025, average house prices fell 0.1%, compared to September. The effect was stronger in London, where house prices came down 1.9% in the same period. On an annual basis, London house prices fell by 2.4% while nationally house prices increased by 1.4% on average.
Relief on house prices may only prove temporary. The long-term trend has been for house prices to increase. For instance, house prices have increased by 74% on average from 2005 to 2025 in the UK, with the rate of increase even higher at 119% over the same period for London.
Even so, housing developers may decide to delay building new homes, fearing lower revenues from the sale of buildings. Other construction companies are less concerned. Several infrastructure projects such as HS2, East West Rail and the Northern Powerhouse Rail are likely to provide steady sources of demand for rail infrastructure.
For the period April 2020 to March 2022, housing wealth made up 40% of total wealth in Great Britain. Yet it is proving more difficult for first-time buyers to get on the property ladder. As of 2022-23, only 39% of adults aged 25-34 owned a home, compared to 59% in 2000.
Sources: ONS, UK Government, HM Land Registry, miscellaneous others.
Question:
Evaluate the microeconomic and macroeconomic consequences of a decline in house prices (25 marks).
Essay plan
Here is a detailed plan for the essay:
Microeconomic consequence:
- Falling revenues and profits for housebuilders.
- Could lead to housebuilders shutting down.
Evaluation point 1:
- Construction companies may build other projects that are not housing, such as infrastructure, where prices may not be falling.
- This could reduce the extent to which revenue falls.
Macroeconomic consequence:
- Slowdown in economic growth.
- Less C due to negative wealth effect.
- Less I due to lower profits for housebuilders.
- Negative multiplier effect.
Evaluation point 2:
- An increase in consumer confidence for potential house buyers could offset the negative wealth effect.
- This could reduce the extent to which consumption falls.
Conclusion:
- Micro effect is likely large due to low profit margins of some construction companies.
- Macro effect is likely large, as housing wealth is a large proportion of total wealth in the UK, however this depends on whether the house price changes are temporary or permanent.
Full model answer
Microeconomic effect
A microeconomic effect is construction companies shutting down. A fall in house prices of 0.1% from September to October 2025, particularly the fall in London house prices of 2.4% in the 12 months to October 2025, could reduce the revenue for house builders. This shifts the average revenue and marginal revenue for the construction firm to the left from AR to AR1 and from MR to MR1. This reduces the profit-maximising level of output from q to q1. So the firm’s supernormal profits fall from (p-c)q to (p1-c1)q1. This moves the construction firms closer to their long-run shutdown point (where AR < ATC), making these firms more likely to shut down in the long run if their average revenue falls below their average total cost. Lower profit margins for construction companies would make firms less likely to be dynamically efficient. So firms have less profit to invest in the quality of homes being built, so home quality may decline or may not rise as quickly over time.
Evaluation point 1
However construction companies, seeing falling house prices, may pivot to build other structures. This could include building infrastructure such as train lines and train stations for HS2 or East West Rail, where prices have not necessarily fallen. This would allow construction companies to reduce the extent to which their revenues fall. So profits may not fall as much for construction companies, making them less likely to shut down and more likely to remain dynamically efficient.
Macroeconomic effect
A macroeconomic effect of falling house prices is slower economic growth. “For the period April 2020 to March 2022, housing wealth made up 40% of total wealth in Great Britain”, suggesting housing makes up a large part of wealth in Great Britain. Falling house prices lead to a fall in the wealth of homeowners. This may lead to lower consumer confidence among homeowners, so consumption falls – this is a negative wealth effect. Moreover, given construction firms are making reduced profits after house prices fall and revenue from house-building falls, they have less profit to reinvest. So investment falls. As consumption and investment are components of aggregate demand (AD = C + I + G + X – M), AD shifts left from AD to AD1. The fall in investment creates a negative multiplier effect, as the fall in investment means less revenue for companies selling goods to other firms. So there are less funds to pay workers, so workers’ disposable incomes fall. So consumption falls again, leading to a second leftward shift in AD from AD1 to AD2. Altogether, this results in real GDP falling from Y to Y2, resulting in slower short-run economic growth for the UK economy.
Evaluation point 2
However, the fall in C for homeowners may be compensated for with a boost in confidence for those looking to buy homes. As house prices fall, buying the first house becomes more affordable for a first-time buyer. Over 23 years there has been a 20 percentage point fall in the proportion of 25-34 year olds owning a home. So these potential buyers become more confident, as any future mortgage is likely to take up a small percentage of their disposable income. So these consumers may spend more, which could partly offset the fall in consumption from the negative wealth effect. This results in a smaller fall in consumption, so that AD falls to a lesser extent and there is less of a slowdown in economic growth.
Conclusion
Overall, the microeconomic effect of construction companies shutting down is likely to be large. Construction companies may already operate with low profit margins, so even a small fall in house prices could lead to the shutdown of construction companies. The macroeconomic effect of slower economic growth could be large, given that housing makes up a large proportion of the wealth of UK residents. So any negative wealth effect from falling house prices is likely to be large, resulting in a larger fall in consumption and AD. However, the macroeconomic effect depends on whether the fall in house prices is expected to be temporary or permanent. If consumers believe house prices will carry on rising in the future, as has been the general trend over the last two decades in the UK, then despite a temporary fall today, then consumers may remain confident and consumption may not fall as much.
Commentary on the answer
This answer contains many of the ingredients for a top-level response:
- Detailed chains of reasoning, including effective use of graphs.
- Evaluation points that identify reasons may the impacts may not be as large.
- Use of the context to support the answer.
- A conclusion that justifies why some of the effects may be large and others small.
As a result, this answer would likely score full marks or close to this.
This is a relatively long response, covering several different points. In the Paper 3 test, where time is particularly limited, the answers can be slightly shorter than the above and still score full marks.
Related resources for Edexcel Economics A
About the author
