Economics AQA AS Unit 1 WORKBOOK ANSWERS · Web viewAQA AS Economics Unit 1 Markets and Market Failure This Answers book provides answers for the questions asked in the workbook

WORKBOOK ANSWERS AQA AS Economics Unit 1 Markets and Market FailureThis Answers book provides answers for the questions asked in the workbook. They are intended as a guide to give teachers and students feedback. The candidate responses for the longer essay-style questions are intended to give some idea about how the exam questions might be answered. The examiner commentaries (underlined text) have been added to give you some sense of what is rewarded in the exam and which areas can be developed. Again, these are not the only ways to answer such questions but they can be treated as one way of approaching questions of these types.

Topic 1 The economic problem

1 The use of resources to make goods or services which have market value, or the process or set of processes which convert inputs (factor services) into outputs. (1 mark)

2 Firms use resources to produce goods or services which they sell to households who consume them. Capitalist firms engage in production in order to make profits from selling products to households, who benefit from the exchange by achieving higher living standards. (4 marks)

3 Resource depletion occurs when resources are used up in the course of production, for example energy, whereas, degradation refers to the quality of resources falling, for example as a result of pollution. (2 marks)

4 Many households reuse plastic containers and glass jars. Second-hand and charity shops provide a means for clothing, records and other household items to be reused. Local councils allow for recycling of paper, cardboard, bottles and some plastics either at recycling centres or through regular collections.(4 marks)

5 Income is limited which means that all households have to consider carefully which goods and services they choose to purchase. Consumer goods are made from scarce resources which means that people have to make a decision about which goods to buy and which goods to go without every week.(3 marks)

6 The passage mentions that Ford decided to build cars at Dagenham (where to produce), and from the 1920s onward (when to produce). How to produce is suggested by using a large site which enables production to be vertically integrated and economies of scale to be used to reduce average costs. The passage does not explicitly address the question of for whom to produce or when to produce in the sense for example of using night shifts as well as day shifts or using continuous flow production.(5 marks)

7 An excess of sales receipts over the spending by a business on the services or factors of production during a period of time, i.e. profit = revenue – costs. (2 marks)

8 Each week, or possibly each month or year, shortage of money or income means that most people have to choose between consuming their income or saving their income. The fact that income is not unlimited forces this choice. (3 marks)

9 The funds available for the British government to spend are limited. Choosing to spend more on aircraft carriers means that less tax revenue is available to spend on primary education in Africa (and vice versa). (3 marks)

AQA AS Economics Unit 1 Markets and Market Failure 1

Philip Allan, an imprint of Hodder Education © Ray Powell, James Powell

TOPIC 1 The economic problem

10 In addition to the point made in the answer to Question 9, the decision not to build aircraft carriers may mean sacrificing defence capability. (3 marks)

11 The firm would not be operating at full capacity. It would be operating inside its production possibility frontier. Maximum possible combinations of television sets and mobile phones would not be produced. (3 marks)

12 This is a positive statement, which means that it can be tested, though it is inconceivable that it would actually be tested. Economists could count the number of pensioners who have died from hypothermia after a cut to the state pension. They could then compare these figures with previous years when pensions were not cut and see whether the statement is correct or incorrect. (4 marks)

13 This is a normative statement. It is a not very pleasant opinion or value judgement which cannot be tested scientifically. (4 marks)

Answers to exam-style questions (objective)1 C

Explanation of answer: The production possibility curve diagram shows that when car production rises by 40, from 60 to 100 cars, productive resources must be taken away from bike production. Since the economy is producing on its production possibility frontier, there are no spare resources to use. Switching of resources away from bike production causes bike output to fall by 200.

2 D

Explanation of answer: With this type of question, it is important to read the ‘stem’ of the question carefully, taking note of the word ‘except’. All the possible answers are true except D. This is because statement D relates to consumption choices and not to production choices.

3 C

Explanation of answer: Only statement C provides a widely accepted definition of the central economic problem. Statements B and D do relate to economic problems, but not to what is usually regarded as the central economic problem. Statement A relates to an aspiration and not to an economic problem.

4 B

Explanation of answer: On first sight, statement A might appear to be the correct answer. However, it is a wrong answer because different people have different views on what is equitable (fair) and inequitable (unfair). Views on fairness cannot be scientifically tested to see if they are right or wrong. The words ought and should in statements C and D indicate that they are normative rather than positive statements. This leaves statement B as the correct answer. It is possible to measure incentive and disincentive effects.

5 A

Explanation of answer: Statement A provides a definition of opportunity cost. All the other statements have nothing to do with the meaning of opportunity cost.



Topic 2 The allocation of resources in competitive markets

1 A downward-sloping demand curve shows an inverse relationship between planned quantity demanded and the price of a good or service. (2 marks)

2 The total amount of a good or service which firms are willing to sell in the marketplace in a given time period. (2 marks)

3 Market equilibrium is when the forces of supply and demand are balanced. This occurs when planned demand is equal to planned supply. (3 marks)

4 A shift in demand occurs following a change in at least one of the conditions of demand, in which case the ceteris paribus assumption no longer holds. The demand curve shifts to a new position, sliding along the supply curve. An adjustment along the supply curve happens when the price of the good or service changes. In the following diagram, the demand curve shifts from D1 to D2, and at the new equilibrium at point Z, supply has adjusted from Q1 to Q2. Essentially, an increase in demand leads to an expansion of supply. (4 marks)

5

The diagram above, which develops Figure 1 on p. 10 in the workbook, can be used to show excess demand. Immediately after the shift of the demand curve from D1 to D2 shown in the diagram, quantity Q3 is demanded at price P1. However, at this price, firms are only willing to supply Q1. Excess demand at this price is shown by the distance between points X and V (or between Q1 and Q3). This excess demand causes the price to rise until a new equilibrium is reached at point Z and price P2.(4 marks)

6 The term refers to how scarce resources are allocated between competing uses. In the marketplace resources are allocated by the price mechanism which is guided by the forces of supply and demand.(4 marks)

7 The shift in demand was driven by speculators entering the market seeking to buy copper at a low price and sell it at a later date at a higher price, with the aim of making a considerable profit. The speculative demand increased the price of copper because of two factors that limited supply. First, stockpiles of copper were very low; second, it was difficult for new copper to be mined. This meant that the supply of copper was inelastic with respect to a price increase and thus unresponsive to the increased surge in demand. (6 marks)



TOPIC 2 The allocation of resources in competitive markets

8 A rapid increase in the price of copper will mean higher prices for consumers which in turn will mean that they will purchase less. Also, the higher cost of production of goods made in part from copper feeds into the general inflation figures for the economy. Higher prices will affect households negatively because they will have to pay more for goods, thus having less disposable income for other purchases. However, copper mining companies should experience higher sales revenue if demand for copper is price inelastic. The significant long-term effect of the higher price of copper will be to send a signal to the markets that copper is now an even more valuable good. This will create greater incentives for producers to increase supply in the long run. Mining companies will seek new sources of copper. Scrap metal merchants will seek to recover greater quantities of recycled copper. The high price should also create incentives for consumers to use copper more sparingly and search for alternative raw materials, e.g. plastic piping. This could cause prices to fall eventually. Additionally, a very serious cost of the high price of copper is an increase in crime, with criminal gangs stealing copper in order to sell it to scrap metal traders. This is exceptionally dangerous when it puts public safety in danger if for example railway signal wires are stolen. (10 marks)

9 Elasticity measures the responsiveness of a dependent variable following a change in an independent variable. PED measures the percentage change in the quantity demanded for a good following the change in the price. PES measures how the quantity supplied to a market responds proportionately to a change in price. (4 marks)

10 Price elasticity of demand = Percentage change in quantity demandedPercentage change in price

Income elasticity of demand = Percentage change in quantity demandedPercentage change in income

(4 marks)

11 The supply curve for new houses is inelastic for three main reasons. First, there are strict planning laws in the UK which prevent house builders from quickly increasing the supply of houses. Second, there is a shortage of available land to build on. The UK has a large population relative to its land mass. Third, it takes months, if not years, to build a house. (5 marks)

12 In the UK, most people finance house purchase using borrowed money (a mortgage). Low interest rates create an incentive to take out mortgages to buy houses. In 2012, interest repayments were cheap and low interest rates create a disincentive to save because of the low return on savings. However, demand for houses actually fell because although consumers wanted to borrow to finance house purchase, the banks and building societies reduced the supply of mortgages to minimise risks following the huge losses they had incurred in earlier years during the banking crisis. As a result, demand decreased because the number of consumers who could obtain mortgages to buy property fell, since they were unable to borrow sufficient funds to finance house purchase. (8 marks)

Answers to exam-style questions (data response)01 Speculation is the act of buying a product or asset with the aim of selling it at a later date so as to make

a profit from the difference between the buying and selling prices. (5 out of 5 marks)

Part 01 questions require a short snappy (but accurate) definition. The candidate has provided a good definition.




02 First, between October 2010 and September 2011 the price of gold increased. At the start of the period the price was approximately $1,375 per ounce but by the end of the period it had increased to roughly $1,680 per ounce.

Second, the price of gold rapidly increased between the end of June 2011 and the end of August 2011. It rose from $1,500 per ounce to just under $2,000 per ounce. This was a price increase of 30% in 2 months. (8 out of 8 marks)

When Extract A in a question contains just one data series (in this case, changes in the price of gold over several months), the question will ask for an identification of two significant features of the data. It is a good idea to write these in two separate paragraphs.

03

Gold is a precious metal and an extremely scarce resource. The price of gold increased in 2009 for three main reasons. First, the supply of gold was inelastic (see supply curve on the diagram) and could not respond to the increases in demand. As Extract B states: ‘only a small amount of new gold can be mined each year’. Second, demand increased dramatically, as shown by the shift of the demand curve from D1 to D2 in the diagram. The shift occurred as a result of economic uncertainty, which caused many investors to buy gold. Gold is a physical asset rather than a financial asset and ‘is regarded as a safe haven’ (Extract B, line 10) in uncertain times. The shift of the demand cause was also caused by speculators entering the market in the hope of making a profit from selling later at a higher price.(12 out of 12 marks)

The key instruction in a part 03 question is always ‘explain’. This requires application of some relevant economic theory, for example supply and demand theory, to address the issue or issues posed by the question.

04 The regional economy in the Scottish Highlands could benefit significantly from the opening of new gold mines. The mine owners should be able to make significant profits as long as the price of gold remains high. They would be able to sell their gold on the world markets and generate revenues which they could in turn use to purchase assets, capital goods and consumer goods. They would also need to employ workers to operate the mines. This would be a valuable boost to local levels of employment. Furthermore, the wages paid would invariably be spent in the local economy and local businesses would thrive. This should result in higher growth and living standards in Scotland. The gold mines would also increase the overall supply of gold on the global markets which might calm commodity markets and reduce feverish speculation. These are the possible benefits for the Scottish economy and the wider UK and global economies.




However, the opening of new mines would also impose significant costs on the local environment. Gold mining has many dirty side effects and would result in pollution being dumped into local rivers and springs. This is unavoidable, and as Extract C, line 8, states, it would ‘affect adversely the quality of drinking water in Scottish cities’. This is extremely worrying because it would have an effect on public health, although by contrast high levels of unemployment can also have a significant effect on the mental health of a community.

The mining process would create ‘eyesores’ and it may harm an area of outstanding natural beauty. This is a powerful argument because although economic growth and employment are important it is also the duty of government to preserve the environment for future generations. This is a difficult trade-off: economic growth versus environmental preservation. Ultimately the decision to open new gold mines is desirable because growth and employment are much needed but it should only go ahead if the extent of environmental damage is limited and any change in the quality of drinking water will have no significant effects on public health.

Finally, if the price of gold were to fall on the world gold market, the high-cost Scottish mines might become uneconomic and have to close. ‘Eyesore’ pollution would continue, but derelict mines would no longer produce any benefits for the Scottish economy. In the long run, whether the benefits of Scottish mining exceed the costs depends in large part on the future viability of mines if world demand and supply conditions for gold change. (16 out of 25 marks)

This answer has been awarded a mark at the top of Level 3 in the AQA mark scheme. The Levels descriptors in the mark scheme are used for all part 04 and 08 Context data response questions at AS). The Level 3 descriptor is:

AS

LEVELS OF RESPONSE

AO1

KNOWLEDGE and UNDERSTANDING of theories, concepts and terminology

AO2

APPLICATION of theories, concepts and terminology

AO3

ANALYSIS of economic problems and issues

AO4

EVALUATION of economic arguments and evidence, making informed judgements

Level 3

10–16 marks(mid-point 13)

Reasonable answer, including some correct analysis but very limited evaluation

Satisfactory but some weaknesses shown

Reasonable application to issues

Reasonable use of data to support answer

Reasonably clear but may not be fully developed and is perhaps confused in places with a few errors present

Superficial, perhaps with some attempt to consider both sides of the issue(s)

Although there is evaluation in the answer, good evaluation must first be preceded by focused analysis. It is the lack of such analysis, mainly analysis of external costs and benefits accompanied by at least one relevant diagram, that constrains this answer to the top of Level 3.



Topic 3 Production and efficiency

1 Welfare derived from external benefits resulting from economic activity such as the pleasure enjoyed from looking at a beautiful building; welfare derived from the company of family and friends.(2 marks)

2 Land earns rent; labour earns wages or salaries; capital earns interest; enterprise earns profit.(2 marks)

3 The total cost of production divided by the number of units produced. (1 mark)

4 Capital goods, for example an engineer’s drill, are intended for use in production. By contrast, consumer goods are intended for final consumption by households. Two examples are DAB radio and a bottle of wine. (4 marks)

5 Just as labour productivity is output per worker, so capital productivity is output per unit of capital.(1 mark)

6 By measuring the number of essays written or chapters of a book read in a given time period.(2 marks)

7 A learning effect occurs when workers become more efficient and skilled at performing particular production task(s) as they learn from previous experience of performing the task(s). In a sense it relates to the view that ‘practice makes perfect’. Likewise managers learn from previous experience.(2 marks)

8 At a microeconomic level, productive efficiency is achieved when the average costs of production are minimised. The concept of economies of scale is based on the notion that as a firm increases its scale of production, it will benefit from greater specialisation, which will result in productivity gains and lower average costs. However, if a firm becomes too big, inefficiency and mismanagement will set in and average costs will start to rise (diseconomies of scale). (4 marks)

9 As the word indicates, specialisation means concentrating on a narrow range of tasks. Division of labour means that different workers (in this case shop workers) perform different tasks. The tasks include: answering customer queries, selling games, ordering new stock and security. These are usually four separate jobs performed by different employees. This enables them to specialise and develop the skills appropriate for the task they are performing. (4 marks)

10 Barter is the most primitive and basic method of exchange. Goods and services are exchanged directly by buyers and sellers. In this example the worker sells labour in exchange for a valued item provided by the shopkeeper. Modern economies are of course monetary economies in which money rather than barter provides the medium of exchange. (3 marks)

Answers to exam-style questions (data response)01 A firm is productively efficient when it minimises its average production costs. The firm is operating at

the lowest point on its average cost curve. (5 out of 5 marks)

Each of the two sentences on its own would earn all five of the available marks.

02 The data show changes in labour productivity rather than output per worker at the different points of time covered by the graphs. A first significant point of comparison is that changes in whole economy labour productivity and service sector labour productivity are both cyclical, with the two cycles more or less correlating with each other. There are slight lags involved, for example the change in service sector labour productivity fell to zero (compared with the previous quarter) at the beginning of the fourth quarter of 2008. By contrast, for the whole economy, zero was reached 3 months later.



TOPIC 3 Production and efficiency

A second significant point of comparison is in the range of the fluctuations. For the whole economy, the peak of labour productivity in mid-2007 was about a plus 3.5% change in labour productivity, with the trough (at the end of 2008) at a –5.25% change in labour productivity, a range of 8.75%. For the service sector, the peak of labour productivity (also in mid-2007) was about a plus 4.5% change in labour productivity, with the trough (at the beginning of the fourth quarter in 2008) at a –4.5% change in labour productivity, a range of 9%. In other words, the range was about the same.(8 out of 8 marks)

When Extract A in a question contains two data series (in this case, changes in labour productivity for the whole economy and for the service sector within the economy), the question will ask for an identification of two significant points of comparison between information in the two series. It is important to compare across (or between ) the two data series, rather than just along one of the data series.

03 The first reason for different levels of labour productivity stems from the quality of investment in a firm’s capital infrastructure. Workers are more productive if they are using the most up-to-date technology and capital equipment, such as the robots mentioned in Extract C (line 9). Labour productivity will improve because better capital equipment will allow workers to make better quality cars at a faster rate. Automoted robots can be programmed to perform complex repetitive tasks without getting tired, only needing a technician to monitor their work. This makes modern car factories more efficient and in turn this brings down costs. However, if workers are using out-dated equipment in old factories they will work more slowly and the quality of the cars produced will be inferior. More workers are employed to produce fewer cars.

A second reason is different management practices which significantly affect the productivity of workers. British industry historically has a bad reputation for poor management. This could explain why the Rover workers’ productivity was as low as 30 cars per year (Extract C, lines 2–3). The managers at Rover simply did a bad job of organising the factories and getting the best out of the workforce. In contrast, Japanese companies have an excellent reputation for innovating and motivating their workers. Toyota for example has developed the model of ‘last minute delivery’ which makes all workers feel valued. If they do not perform their tasks properly, the entire production line grinds to a halt. This also enables managers to identify problems quickly. This is reflected in Extract B which shows that Nissan car workers build on average 99 cars per worker and Toyota 88 cars per worker.(12 out of 12 marks)

This is an excellent answer which fully obeys the instruction in the question, namely to explain two reasons . Part 03 and 07 questions only ask for explanation. They never ask for evaluation. Candidates who are otherwise good often waste time by drifting into evaluation, but this candidate does not make this mistake.

04 A main argument for government intervention in the UK car industry, in the context of saving manufacturing jobs, is to provide emergency help in an economic crisis. The 2008 economic crisis hit the UK economy particularly hard and saw consumer demand for ‘big ticket’ goods such as new cars fall dramatically. As a result, car companies in the UK responded to this sudden fall in consumer demand by significantly cutting back on production.

In this situation there is a strong case for government intervention to help distressed firms in the worst parts of a crisis. This involved schemes like the ‘car scrappage scheme’, where the British government gave consumers £2,000 towards a new car if they traded in an old car over 10 years old. In this situation it makes sense for the government to use taxpayers’ money to create market incentives to encourage spending in the economy. Demand for cars did not fall because of the poor quality of the cars but due to the wider macroeconomic crisis. It would have made little economic sense for the government to allow good companies to go bust in a crisis with the long-term consequence of skilled workers becoming unemployed.



TOPIC 3 Production and efficiency

Government intervention is justified in the short run to head off the negative effects of an economic crisis. However, government intervention is not justified in the long run to save jobs. This is because it would simply lead to taxpayers’ money being used to prop up poorly run and inefficient companies, such as Rover which ran some of the ‘worst’ plants in Britain (Extract C, line 5). The global car market is very competitive and consumers choose to buy the best cars at the best prices. Market discipline ensures that inefficient plants are ‘closed down, or reorganised to improve their efficiency’ (Extract C, line 6). This form of government intervention may ‘save’ jobs but only by imposing higher taxes in the rest of society. As the economist in Extract D (line 4) says, this would be a ‘government failure’ because taxpayers are subsiding firms to make cars that consumers do not want to buy. This is a misallocation of scarce resources and an unacceptable situation. (15 out of 25 marks)

Just like with the answer to part 04 of the Topic 2 data response question on gold mining, this answer is constrained to Level 3, earning 15 of the available 25 marks. The answer suffers from the same problems as the gold mining answer, principally lack of developed analysis that must precede in-depth evaluation. The analysis in this answer is too thin. Mention could be made of the fact that all cars that are mass-produced in the UK are the product of Japanese and US car companies. Obviously such companies would enjoy receiving subsidies from the UK government, but by contrast they might be driven off-shore by other types of government intervention, for example a requirement that cars must be manufactured solely from components produced in the UK.



Topic 4 Market failure

1 When consumers see the price of a good, such as a new car, they can see the value of the good and immediately know how much money they would have to pay in order to buy the car. The car’s price signals information to the consumer, though other information, for example about the quality of the car, is also needed before making the decision whether or not to buy the car. (3 marks)

2 The price has decreased by £300 which immediately creates an incentive to buy the good. The iPhone is cheaper, which means that the consumer can enjoy using it and still have a considerable amount of money to spend on other purchases. However, if the price cut signals that a new and better version of the iPhone will soon be launched, some potential buyers may decide not to purchase the now cheaper current version of the iPhone. (4 marks)

3 The textbook example of a public good with non-excludability characteristics is a lighthouse. The lighthouse provides an invaluable service to ships, warning them of hazards and rocks, but it cannot prevent ships that do not pay from seeing the light beam that it creates. Hence ships can use the invaluable service provided but do not have to pay because there is no mechanism to make them pay for seeing light. Ships can ‘free-ride’ and benefit without having to pay, which is a market failure. Thus it is not profitable for lighthouses to operate in the marketplace because they cannot charge for their service, hence the missing market. In the UK lighthouses are funded through charitable donations.(6 marks)

4 Non-rivalry (or non-diminishability and non-exhaustability) is a property which, along with non-excludability, is a defining characteristic of a public good. Non-rivalry means that when one extra person benefits from a pure public good such as national defence, he or she does not reduce the quantity of the good available to other people. (2 marks)

5 This is a public good service. Although the majority of citizens pay for the police force through general taxation, the service provided benefits the whole of society, even those who have not paid the taxes which finance the provision of the service. The very existence of the police force creates a deterrent that limits burglaries and street riots. The police force protects the whole of society and cannot, and should not, distinguish between those who contribute towards taxation and those who do not. Hence, the protection of the police force is non-excludable and citizens who do not pay taxation can free ride. However, policing can have private good properties when provided, for example, by a private security firm guarding a shopping mall. (5 marks)

6 An example of a positive externality is the benefit received by others when a person is educated. Society benefits from producing educated citizens because they add value to society. The many benefits received by third parties throughout society from education cannot be included in the price mechanism. Many of the benefits received from education are external from the price mechanism which is of course a market failure. (4 marks)



TOPIC 4 Market failure

7

The diagram above illustrates the costs incurred and the benefits generated when a commercial forestry company plants trees. Tree planting produces a number of positive externalities, which include improved water retention in the soil. This means the marginal social benefit (MSB) of tree growing is greater than the marginal private benefit (MPB) accruing to the forestry company. In the diagram, the MSB curve is positioned above the MPB curve. The vertical distance between the two curves shows marginal external benefit (MEB) at each level of tree planting.

In order to maximise its private benefit, the commercial forestry plants Q1 trees. Q1 is immediately below point X, where MPC= MPB. However, Q1 is less than the socially optimal level of output Q2, located below point Y, where MSC= MSB The diagram illustrates the fact that, when positive production externalities are generated, the market fails because too little of the good is produced and consumed. Underproduction and under-consumption are depicted by the distance Q2–Q1.

(8 marks)

8 At the present day, because of a lack of economies of scale and the high price of parts for the car, electric cars are considerably more expensive to build than petrol and diesel alternatives.

There are only a limited number of recharging points across the UK. This generally makes it impossible to drive electric cars over long distances or to remote destinations. (4 marks)

9 Museums; libraries; art galleries (3 marks)

10 Market failure occurs whenever a market performs inefficiently. An example occurs when firms produce and/or consumers buy, the ‘wrong’ quantity of a good. The answer to Question 7 explains that because forestry companies gain no benefit from the positive externalities produced by the trees they plant, in a market environment they plant too few trees. In the case of healthcare, which is a merit good, other people benefit when a person consumes healthcare services. Consumption of healthcare produces positive externalities which benefit the whole community. As a result, the social benefit of consumption exceeds the private benefit enjoyed by the consumer. The community benefits because a healthy population means there are fewer ill people to catch diseases from. (6 marks)

11 A pure monopoly is when one firm has control of 100% of a product supplied to a market and can maintain this situation in the long run. (3 marks)

12 There is no doubt that Sky uses the monopoly power it has gained from buying up the rights to screen live Premiership football games to raise the price that viewers pay. As a result, fewer people choose to subscribe to Sky and to Sky’s sport channels than would watch live matches if the price was lower or if they could watch free.




Sky’s response is that this does not represent abuse of monopoly power. Sky claims that by paying a lot of money for exclusive rights to broadcast live matches, it has ‘invested’ in the Premier League, allowing clubs to use television revenues to buy expensive players that they would not have been able to afford without television revenues. In this way, Sky has improved the quality of the product. In any case, people can watch live match broadcasts in pubs and bars without having to pay.

However, there is a case for using regulation to reduce Sky’s monopoly power, and to a certain extent this has been achieved. ESPN, another ‘pay to view’ broadcasting company, can now buy the rights to broadcast a limited number of Premiership matches. It can be argued that regulation should go one stage further, by allowing football fans and pubs to buy Sky sports services from companies that possess the right to broadcast matches in other EU countries. This surely is the purpose of the Single European Market. (6 marks)

Answers to exam-style questions (data response)01 A negative externality is a public bad which stems from either the production or consumption of a good

or service and which is dumped on third parties without their consent. The negative externality is delivered outside of the price mechanism. (5 out of 5 marks)

Although this answer earns full marks, the fact that the word ‘externalities’ in the question is in the plural might have prompted the candidate to give two examples of negative externalities.

02 The first significant feature is that in every age group shown in Extract A more people choose not to smoke than to smoke. The 21–25 year age group are the most likely to smoke with 41.2% of people smoking, whereas the 12–13 year age group are the least likely to smoke with only 2.4% smoking.

The second significant feature is that after the age of 25 there is a gradual reduction in the percentage of people in each age group smoking. In the age group 21–25 as many as 41.2% of the people smoke but this figure falls and in the 65+ age group only 10% of people smoke. (8 out of 8 marks)

Two significant features of the data are correctly identified, with identification backed up in each case with evidence from the data. Mark schemes for part 02 and 06 questions award 2 marks for each point of identification (provided the examiner deems it to be significant) and 2 marks for statistical back-up. With the latter, it is important to include accurate units of measurement (in this case % signs).




03 The diagram below depicts the marginal private, external and social costs and benefits incurred and received in a free market for tobacco products such as cigarettes.

Tobacco is a demerit good, which means that is it over-produced and over-consumed if provided in a free market. This occurs for two reasons.

First, when smoked tobacco dumps harmful negative externalities into the immediate atmosphere. Non-smokers do not choose to breath in this passive smoke but could suffer severe health effects such as lung cancer (Extract B, line 5). The market has no mechanism for charging smokers for the harm that they are inflicting on the health of non-smokers. Hence the true price of smoking is not reflected in the price. When left to the free market, smoking is under-priced and over-consumed. Over-consumption is shown by Q2–Q1 on the diagram.

Second, when people start smoking they fail to appreciate the true health effects of smoking. This is known as the information problem because humans cannot appreciate the long-term costs of smoking, which may take over 30 years to appear. Teenagers who start smoking often ‘ignore and downplay information’ about how addictions may be dangerous but they only fully comprehend the actual consequences of their actions in later life. As a result they over-consume tobacco because they make decisions based on short-term benefits but ignore long-term costs. This effect is not shown on the diagram. (12 out of 12 marks)

More often than not, part 03 and 07 questions ask for inclusion of an ‘appropriate diagram’. For questions on a market, such as the Topic 2 question on the gold market, the ‘appropriate diagram’ is almost always a supply and demand diagram. For questions on a market failure, including this question, the appropriate diagram is likely to be a marginal private, external and social cost and benefit diagram.




04 The justification for raising taxation on tobacco is that tobacco is a demerit good which is under-priced by the free market, hence its price is too low and it is over-consumed.

By increasing the level of taxation the government will be increasing the costs of production of firms supplying tobacco in the market. This is illustrated in the diagram below, as supply shifts to the left from S1 to S2. The suppliers will in turn pass the cost of the tax increase onto consumers. The government hopes that the higher price will create a disincentive for consumers not to buy tobacco.

The main problem with this argument is that most smokers develop an addiction to cigarettes when they are young (Extract B, line 9). Once smokers are addicted to tobacco their demand is often inelastic, as can be seen in the diagram. This means that the increase in the level of taxation on tobacco is ineffective at reducing demand.

Anti-smoking campaigners argue that even if the tax increase is ineffective it is still justified on the grounds that it will raise revenues for the government worth billions of pounds each year that can be used to treat people with smoking-related diseases. This is a powerful argument. Smoking tobacco is harmful for both the individual who chooses to consume cigarettes and third parties who unintentionally passive smoke. Hence, increased taxation can be used to help correct the immense damage caused by smoking.

The tobacco industry disputes part of this argument. As can be seen in Extract C, tobacco firms warn that excessive taxation actually reduces government tax revenues because it leads to higher levels of smuggling (line 5) which deprives the UK exchequer of £3 billion per year.

Although this is a strong argument it is not a reason for not taxing tobacco heavily. The government should use the police and revenue and customs agencies to enforce the law and prevent illegal smuggling. However, if the government really wants to decrease the level of smoking it needs a policy that discourages young people from starting smoking. Taxation can be effective by making cigarettes expensive but to be truly effective an educational government policy is needed to make young smokers fully aware of the long-term cost of smoking. (19 out of 25 marks)




This answer reaches Level 4, for which the descriptor is:

AS

LEVELS OF RESPONSE

AO1


AO2


AO3


AO4


Level 4


Good analysis but limited evaluation

or

Reasonable analysis and reasonable evaluation

Good throughout the answer with few errors and weaknesses

Good throughout much of the answer with few errors and weaknesses

Good application to issues

Good use of data to support answer

Some good application to issues

Some good application to issues

Some good use of data to support answer

Relevant and precise with a clear and logical chain of reasoning

Largely relevant and well organised with reasonable logic and coherence

Limited but showing some appreciation of alternative points of view

Reasonable, showing an appreciation of alternative points of view

To reach Level 5, a winding-up concluding paragraph is necessary, linking back to, but not merely repeating, arguments stated earlier in the answer. It is often a good idea to ‘save’ one important argument until the conclusion and then to use it as the ‘killer’ argument which sways you in favour of either ‘the case for’ or ‘the case against’.



Topic 5 Government intervention in the market

1 An example of a market functioning inefficiently is the international airline industry. International air flights do not pay fuel duty but they emit carbon dioxide emissions, which are negative externalities, into the atmosphere. This is a market failure because the airlines do not pay the full costs of production. This is inefficient because the market price does not reflect the true costs of air travel. As a result the free market price is too low, too many people travel by air and resource misallocation occurs.(5 marks)

2 Fuel taxation could be used to raise the price of air travel. The revenues raised could be used to correct the damage caused by the negative externalities. The higher price will discourage consumption.(2 marks)

3 The word ‘equitable’ means ‘fair’ or ‘just’ and the word ‘inequitable’ means ‘unfair’ or ‘unjust’. Many, though not all, economists believe that a highly unequal distribution of income should be deemed a market failure, on the ground of inequity. However, inequity and equity are normative words, so not all economists agree. Make sure that you do not confuse inequity with inequality (a positive word). Some say the market for bank workers is inequitable as the pay of top bankers is hundreds per cent higher than the pay of bank cashiers. (6 marks)

4 Progressive taxation could make the market for bank workers function more equitably. An income tax is progressive if a progressively larger proportion of income is paid in tax as income increases.(2 marks)

5

The diagram above is nearly identical to the diagram drawn in the answer to part 04 of the data response question on tobacco as a demerit good in Topic 4 (see page 31). In this case, however, the demand curve has been drawn elastic, showing a more than proportionate fall in demand following the increase in price that results from the imposition of the indirect tax. Given this assumption about the elasticity of demand (which may be unrealistic), the indirect tax successfully reduces demand for alcoholic drink from Q1 to Q2. (8 marks)

6 Imposing a price ceiling on the fees universities can charge for higher education would keep the price down, but it could leave to excess demand and too few higher education places being made available by the universities. This means, to be successful, the price ceiling would need to be supported by another policy such as granting subsidies to universities. (4 marks)



TOPIC 5 Government intervention in the market

7 A tradable market in permits to pollute in the electricity market works in the following way. Coal-burning power stations able to reduce pollution by more than the law requires sell their ‘spare’ permits to other power stations which, for technical or other reasons, decide not to, or cannot, reduce pollution below the maximum limit. The latter still comply with the law, even when exceeding the maximum emission limit, because they buy the ‘spare’ permits sold by the former group of power stations. In the long run, even power stations that find it difficult to comply with the law, have an incentive to reduce pollution, so as to avoid the extra cost of production created by the need to buy pollution permits. (8 marks)

8 The issue here is ‘fairer for whom’? Government provision of healthcare is certainly fairer for poor people who could not afford to buy market-provided healthcare but who now receive free state-provided healthcare. But is it fairer for somebody who in the current system lives in a part of the UK where local NHS hospitals are poor. Is it fairer for people whose health deteriorates while languishing on NHS waiting lists, or who suffer from a ‘postcode lottery’ in which similarly ill people living 50 miles away are prescribed expensive drugs denied to them.

Neither the current NHS provision nor market provision is fair, though arguably state provision is fairer. Hospital care could be provided through a state-guaranteed private insurance system. Healthy people never know whether they will be ill in the future and will require expensive hospital treatment many years ahead. But while an individual seldom knows whether a future operation will be required, insurers can predict, using the ‘law of large numbers’, how many people in an age group are likely to suffer a serious disease in the future. Private but state-backed health insurance, which forces everybody to pay insurance premiums and insurance companies to accept contributions from everybody, is the way forward. (10 marks)

9 The passage mentions three forms of rationing healthcare other than rationing through prices. These are: quantity rationing, which results in queues and waiting lists; rationing by lottery; and rationing through the notion of blame. This answer is going to evaluate the first of these, quantity rationing. Rationing by queues and by waiting lists occurs when the price of a good is set below the market-clearing price, which creates excess demand and a shortage. This can happen if the government introduces a maximum price law, or, in the case of events such as football matches, rock concerts and art exhibitions when the promoter of the event sets admission prices that are too low. Rationing by queues and waiting lists leads to black markets. Some economists believe that black markets perform a useful economic function, bringing together buyers and sellers, with the black market price clearing the market. Others argue that black markets lead to criminal behaviour and racketeering.

In the health service, quantity rationing has the adverse effect of patients dying while they wait several weeks or even months for treatment. It also leads to queue jumping when patients who can afford to choose private treatment instead, often in NHS hospitals. However, defenders of the system argue that this frees scarce resources within the NHS, which can be used to treat patients who cannot afford to queue jump. (10 marks)

10 Market failure occurs when markets function badly or unsatisfactorily. Market failure occurs when banks function inequitably or inefficiently, and in the latter case, when one of the three functions prices perform in a market breaks down. In an extreme case, when all three functions (signalling, incentive and rationing) break down, a market ceases to function at all. In this situation, there is a ‘missing market’.

Government failure, by contrast, occurs when government intervention in the economy, sometimes to correct market failure, is ineffective. In extreme cases, government intervention may create new problems worse than those the intervention was supposed to cure. For example, government intervention through high taxation to make incomes more equal may reduce incentives to work hard and this may harm economic growth. (10 marks)




Answers to exam-style questions (data response)01 Imperfect information is when either a supplier or a buyer lacks sufficient information about a

transaction to make an informed efficient choice. In everyday markets economic agents frequently make decisions based on imperfect information but as information becomes more limited the probability of a poor decision increases. (5 out of 5 marks)

This is a correct answer. The question does not require an example but it is often useful to include one as it will pick up a mark (provided it is correct) if the definition is a little imprecise or fuzzy.

02 First, the percentage of obese and overweight men and women increased steadily throughout the period. In 1994 14% of men and 18% of women were obese yet by 2008 levels of obesity for both men and women had reached 25%. Likewise, in 1994 49% of women and 58% of men were overweight. By 2008 these figures had risen to 57% and 66% respectively.

Second, the gap between overweight men and women remained relatively stable over the 12-year period. In both 1994 and 2008 approximately 9% more men are overweight than women. By contrast, the gap between obese men and obese women closes over the period. In 1994 there is a gap of about 4% but by 2008 both genders have levels of obesity at roughly 25%. (8 out of 8 marks)

This answer meets all the requirements of part 02 or 06 questions and earns full marks. There is sufficient comparison across the different data series, all the comparative points are significant, and accurate statistical back-up is provided.

03 The central problem in this situation is that consumers are not being provided with sufficient information to make an informed choice. The food packets that customers are buying do not provide sufficient information about the number of calories contained. As a result individuals are making choices based on imperfect information, which leads to overeating and raised levels of obesity. As can be seen from the trends in Extract A, overeating and obesity have been steadily increasing in the last 20 years in the UK.

This is a market failure because consumers cannot make an informed choice and therefore behave in a manner that does not maximise their welfare. The figure above includes two curves, each showing the marginal benefits enjoyed by a person as a result of eating food. The inner curve is labelled marginal benefits (with full information). Full or perfect information includes information about the adverse health consequences of overeating, and/or eating the wrong kinds of foods. Given full information, the person chooses to eat Q2 food. But in real life, the problem is that many people ignore or downplay the long-term adverse consequences of overeating and/or consuming the wrong kinds of foods. The level of food consumption of a person whose eating habits are shown in the figure are determined where the curve labelled marginal benefits (with imperfect information) intersects the MPC curve. Q1 food is eaten, and overeating is shown by Q1 minus Q2. (12 out of 12 marks)




Pay special attention to the ‘appropriate diagram’ in this answer. Exam questions that focus on perfect and imperfect information are increasingly appearing in the ECON1 exam, but not all exam candidates seem to be familiar with the meanings of, and the difference between, the two concepts.

04 The debate about the role of government in an economic system is central to the study of economics. At present the UK has a mixed economy which is tilted in favour of markets. The dominant view among policy makers since 1979 is that markets are more efficient at allocating scarce resources than governments. Nevertheless, in 2012 the British state still accounts for 44% of GDP and large command structures, such as the NHS, still allocate billions of pounds of resources every year.

In terms of food markets, most economists believe food should be provided by markets because the profit incentive drives farmers to produce higher crop yields. However, the balance of market power between producers (farmers) and buyers (large supermarket firms) is tilted very much on the side of the supermarkets. Arguably, supermarkets use the market power that their size gives them to force farmers, who individually possess very little market power, to accept very low prices for the foods they are selling. At the moment, the UK government does very little, apart from trying to persuade the supermarkets to be fairer in their dealings with farmers, to alter this asymmetry in market power. Some people believe that the government should intervene in food markets in other ways to correct this market failure, for example by introducing and then enforcing minimum legal prices, or price floors, for agricultural produce. Others disagree, arguing that such intervention will lead to government failure, for example by creating excess supply which in a free market is corrected automatically by a fall in market prices. However, price floors would allow farmers to make sufficient profit to invest in new production techniques that might increase domestic supply of foods in the long run.

When it comes to the issue of food labelling rather than replacing the market mechanism for setting prices, economists are more divided. As Extract B explains, a government agency, the FSA, believes that food labels provide consumers with too little information about additives in processed foods. The FSA would like to correct the problem by introducing better food labels which will properly inform consumers about the qualities of the food that they buy. However, if food labels better inform customers about the food that they buy then demand for certain types of processed food will decrease because consumers will better understand the consequences of eating high fat and high salt foods. However, many free-market economists reject the call for further regulation on food labelling, arguing that it is unnecessary regulation that will increase food costs. In their view, self-regulation by the food industry is preferable to external regulation. On balance, the case for further external regulation is stronger, for the simple reason that self-regulation has simply not provided consumers with sufficient accurate information about the foods they buy. (21 out of 25 marks)

Very often, the preamble to a part 04 or 08 question is: Making use of the data and your economic knowledge … This answer makes use of both, but misses the opportunity to draw on characteristics of food markets, other than those set out in the Extracts, which might call for intervention by governments. While it is not vital to do this, these could include the health and safety aspects of food markets, and the monopoly power that food processing companies and large supermarket chains my exercise at the expense of small farmers (and/or consumers).




This answer has been placed at the top of Level 4, though a lack of formal analysis and use of diagrams, may mean the answer has been over-marked. Either way, the answer does not reach Level 5, for which the grade descriptor is:

AS

LEVELS OF RESPONSE

AO1


AO2


AO3


AO4


Level 5


Good analysis and good evaluation

Good throughout the answer with few errors and weaknesses

Good application to issues

Good use of data to support answer

Relevant and precise with a clear and logical chain of reasoning

Good with a clear final judgement



Documents

Economics AQA AS Unit 1 WORKBOOK ANSWERS · Web viewAQA AS Economics Unit 1 Markets and Market Failure This Answers book provides answers for the questions asked in the workbook