Economics
Microeconomics
Student Activities
Higher
5484
Summer 1999
HIGHER STILL
Economics
Microeconomics
Student Activities
Higher
Support Materials
*+,-./
MICROECONOMICS
HIGHER ECONOMICS
STUDENT ACTIVITIES: MICROECONOMICS
Introduction
This pack contains classroom and homework activities to support the learning and
teaching process for Economics at Higher level. It covers those parts of the course
content listed under the heading of Microeconomics (H) and the material associated
with the unit specification, Microeconomics (H). ). It does not include student
activities pack for Outcome 5 of the Microeconomics unit – ‘Analyse different types
of markets.’ – which are to be issued as a separate pack containing core notes and
activities.
This pack is divided into three sections:
Section 1 Student exercises
Section 2 Multiple choice items
Section 3 Extended response items
This pack complements other material available to support Economics at Higher level
such as the course planner, the expanded syllabus, the induction pack and the student
activities for The Economy (H).
Using this Pack
Teachers and lecturers will have their own preferred ways of using the material in this
pack. Each of three sections, however, has a slightly different purpose.
Section 1 Student exercises – these are intended to complement the delivery of course
concepts. They are exercises which can be done in class or as homework to introduce
relevant knowledge, to reinforce new knowledge and understanding or to extend
existing knowledge and understanding. While their primary use is likely to be during
the actual delivery of course material, they can be used for revision purposes.
Section 2 Multiple choice items – these are primarily intended for consolidation and
revision purposes. Thus, their most likely use is towards the end of a particular topic
where they can be used as a classroom exercise or as homework. Students could be
asked to attempt them individually (or in pairs or small groups) and the responses
discussed among the whole class. Because they help students consolidate ideas and
reinforce knowledge and understanding, these questions can also serve as preparation
for internal assessment.
Section 3 –Extended response items– these are integrative essay questions which tend
to range over the whole content of this part of the course. Generally, each question
covers several parts of the course content in this area of the course. As a result, they
are particularly suited to helping students prepare for the external assessment. While
this is their primary purpose, they can be also be used in a similar way to the multiple
choice questions as a way of reinforcing and consolidating previous learning. They
are more likely to be used as homework exercises than classroom activities, although
the answers may well be discussed in class.
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Teachers and lecturers may find it helpful to refer to the course planner when deciding
exactly how to integrate these various activities into their learning and teaching
programme.
Layout of the Activities
In general, the activities have been organised in a way that matches the order of the
course content as set out in the Arrangements Document for Economics at Higher
level. This coincides with that used in the course planner, the expanded syllabus and
the induction pack.
However, the nature of the subject matter is such that it is not always possible, nor is
it always desirable, to keep a direct link with the order of the course content. This is
because there are many overlaps between different parts of the course e.g. opportunity
cost is referred to as a separate sub-heading in the course content but is also
mentioned as part of the sub-heading, ‘The nature of the economic problem’. In
addition, the layout of the activities reflects the fact that integration of subject matter
is a guiding principle behind the development of the course
The three sections of this pack have been organised in slightly different ways.
The student exercises in Section 1 have been split into a number of separate sections
which broadly follow the order of the course content. A cross-referencing grid which
relates the sections to the course content follows this introduction and should help
teachers and lecturers identify which sections are appropriate for which parts of the
course content. In this way, it should be possible for teachers and lecturers to
integrate the exercises into their preferred order of delivering the material, although it
may be necessary to adapt each section accordingly e.g. by missing some exercises
out; using some exercises from later sections at an earlier stage etc.
To a degree also the layout of the sections reflects a particular teaching order e.g.
there are references to merit goods in the allocation of resources although the phrase
‘merit goods’ is not mentioned until The Economy (H) part of the course content.
Teachers and lecturers should bear this in mind when deciding how best to make use
of the exercises in section 1. There is no implication, however, that this order should
be followed. Teachers and lecturers should feel free to determine their own delivery
sequence in line with the requirements of their students and their own personal
preferences.
The multiple choice questions in Section 2 are grouped into clusters also but they are
broader than those used in Section 1. This is to enable students to consolidate or
reinforce significant topic areas.
The integrative extended response questions in Section 3 are presented as a single
group. Because they are integrative, they cover all aspects of the relevant course
content so classification into sub-sections is not appropriate. Teachers and lecturers
will need to check through the list and decide which ones are most suitable for their
purpose e.g. in which areas do students require essay writing practice prior to the
external assessment.
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Suggested Solutions
Suggested solutions are provided for all the exercises and questions in this pack. For
section 2, the multiple choice questions, a single correct answer is possible. For all
other exercises and questions, this is not always the case and a number of possible
responses can often be made. The solutions given thus represent some of the possible
answers which could be acceptable. When using the exercises and questions, some
discretion should be used when judging responses. Students should be given credit
for responses which are an acceptable answer to the exercise or questions but which
do not appear in the suggested solutions.
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CONTENTS
Section 1 – Student Activities
Exercise
Details of Activity/Exercise
The Basic Economic Problem
A1
The nature of the economic problem/opportunity cost
A2
The nature of the economic problem/resources
A3
The nature of the economic problem
A4
Production possibility curves/choices
A5
Production possibility curves/choices
A6
Resource allocation in different economic systems
Demand
B1
Individual and market demand
B2
Utility
B3
Utility
B4
Determinants of demand
B5
Price elasticity of demand
B6
Price elasticity of demand
B7
Income elasticity of demand
Supply
C1
Determinants of supply
C2
Conditions of production
C3
Least cost combination of factors
C4
Economies of scale
C5
Costs relationships/productivity
C6
Costs
C7
Costs
C8
Costs
The Operation of Markets
D1
Equilibrium
D2
Market situations
D3
Market situations
D4
Intervention
D5
Markets
Section 2 – Objective Test Items
A
B
The Basic Economic Problem
Demand, Supply and Markets
Section 3 – Extended Response Items
A
B
The Basic Economic Problem
Demand, Supply and Markets
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SECTION 1
STUDENT ACTIVITIES
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A1 – THE BASIC ECONOMIC PROBLEM
1.
(a) What are the factors of production?
(b) Explain how the productivity of land and labour could possibly be increased?
(c) (i)
(ii)
Explain the difference between geographical mobility and occupational
mobility.
Discuss the measures that can be taken to increase the geographical
mobility of labour.
(iii) Explain how the occupational mobility of labour could be improved.
2.
(a) Explain what is meant by ‘unlimited wants’.
(b) Explain, using an example, the meaning of the term ‘opportunity cost’.
3
(a) What is meant by the term ‘economic goods’?
(b) Explain the difference between ‘economic goods’ and ‘free goods’.
4
(a) Explain a possible choice facing:
(i) an individual.
(ii) a business.
(iii) a government.
Your answer should show – how they might decide/arrive at their decision
and the possible opportunity cost involved.
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A1 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
1
(a) Factors of production – scarce resources (land, labour, capital, enterprise
which are used in the production of goods and services in an economy).
(b) Measures to increase productivity – for example land–fertilisation, labour –
increased efficiency, education and training, etc.
(c) (i)
(ii)
Geographical mobility – factor of production can be moved from place
to place (for example labour is geographically mobile, some capital is
geographically mobile, land is immobile). Occupational mobility
means that the factor of production can provide several different uses,
e.g. some labour can do different types of job, some capital equipment
can produce different goods.
Any measures which would induce labour to move from one area to
another – for example – relocation expenses paid, national advertising
of vacancies, etc.
(iii) Education, training, retraining (including government initiatives), etc.
2 (a) Individuals (people, businesses, governments) always want more (new
models on the market, greed, etc.). No matter who they are, there is always
something else which they would like but are unable to have (concept not
only confined to goods and services, but other items such as a better
environment, more leisure time, etc.).
(b) Resources have alternative uses, therefore choices have to be made.
Opportunity cost is a measure of the real cost of using scarce resources in
terms of foregone alternatives (i.e. what has to be given up in order to
achieve/attain something else (student should use example to illustrate
concept).
3. (a) Economic goods are those goods which use up scarce resources in their
production.
(b) Resources which are scarce are economic goods (opportunity cost). Not all
resources are scarce and those which are plentiful enough for everyone to
have as much as they want no one will be willing to pay for. These goods
are called free goods (have no opportunity cost). Very few free goods and
these are only free under certain conditions.
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A1 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
4. (a) (i)
(ii)
Own example of an individual’s choice – e.g. buy a CD or a T-shirt.
Individual choice based on personal preference/utility. Opportunity
cost based on students’ own example.
Own example of a business’ choice e.g. whether to increase output or
not. Extra factors of production required and their combination, cost of
extra factors, possible revenue, is there a demand for the product, etc.
Opportunity cost based on student’s own example.
(iii) Example of a decision by Government which leads to opportunity cost,
e.g. spending more on transport rather than health, cutting taxes rather
than increasing expenditure.
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A2 – THE BASIC ECONOMIC PROBLEM
Our resources are insufficient to meet all possible uses and consumer wants are
unlimited, therefore choices must be made and opportunity cost arise. Producers
decide how to use scarce resources in order to best satisfy wants. Consumers choose
those goods and services which yield the greatest satisfaction and indicate their desire
for them by their willingness to pay a price, foregoing other goods in the process.
It must be remembered, however, that there are some goods from which people obtain
satisfaction, but for which they do not always pay as they are available at zero price.
1. (a) Explain, using examples, what is meant by scarce resources, and describe
why scarcity continues to exist.
(b) Suggest ways in which the problem of scarcity can be lessened.
(c) Explain the difference between scarcity and a shortage.
2. (a) Why do producers and consumers have to make choices?
(b) Explain the basis on which the consumer choices are made.
3. ‘Choices must be made and an opportunity cost arises’ (line 2).
(a) Explain, using an example, what is meant by opportunity cost.
(b) Explain the difference between free goods and economic goods.
4. (a) Which kind of economic system does the above passage indicate?
(b) How are resources allocated in this type of economic system?
(c) What are the advantages of the type of economic system?
(d) Explain how and why the UK’s economic system differs from this type of
system?
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A2 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
1. (a)
Scarce resources – land, labour, capital and enterprise – are scarce relative to
people’s unlimited wants. There are not enough of them to make enough
goods and services to satisfy everyone’s wants. This will always continue as
peoples wants are unlimited.
(b) By increasing the efficiency of the use of our resources or by increasing the
quality and quantity of the factors of production.
(c) Scarcity means that there are insufficient resources to satisfy people’s
demands for goods and services. A shortage means that there is insufficient
supply of a product to meet the demand for it.
2. (a)
Choices are required to be made as there are insuffient resources to satisfy all
our wants and therefore choices of:
•
what to produce?
•
how to produce?
•
who is to receive the goods and services produced?
require to be made.
(b) Consumers make their choices on the basis of maximising their satisfaction
and/or minimising their opportunity costs involved.
3 (a) A person buys an apple instead of an orange, the orange is the opportunity
cost – i.e. the alternative foregone.
(b) Free goods are available to satisfy everyone’s wants and do not involve an
opportunity cost in their use. Economic goods require resources to make
them – and therefore involve an opportunity cost in their production and
consumption.
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A2 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
4.
(a)
Free market
(b)
Price mechanism – price indicates changes in wants (if demand
increases, price increases), decisions are therefore taken trough the
workings of the market. Suppliers respond to changes in wants by
moving resources to those products demanded (consumers’ ability to
pay). Resources are therefore attracted to expanding industries, away
from declining industries (more profitable).
(c)
Advantages – freedom of choice and enterprise, businesses – max profit,
consumers - maximise utility, competition – greater variety, lower
prices, better quality, resources used to produce what people want.
(d)
UK – mixed economy i.e. there is government intervention.
How governments intervene
Why – problems with free market
Taxes/benefits
Provision of public/merit goods
Nationalisation
Location of industry
Stabilising economy
Privatisation/nationalisation
Regulation laws
consumers with most money exercise
greatest weight in spending, therefore
production devoted to those goods
where greatest profit is made
(luxuries), not necessities.
Commodities people willing to pay for may
not be those which are most useful to society
or may be unsuitable for provision.
Unemployment
Existence of externalities
Market failure
Uneven distribution of income/wealth
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A3 – THE BASIC ECONOMIC PROBLEM
1. Answer the following True or False, then check your answers.
(a) The total amount of goods and services produced in the UK today is just
sufficient to satisfy people’s wants.
(b) Economic efficiency can be described as allocating limited resources in order
to obtain the greatest possible satisfaction from them.
(c) The opportunity cost to a consumer of consuming a good is the sacrifice of
the next best alternative good.
(d) Any good for which a consumer is willing to pay is an economic good.
(e) All goods which are useful are economic goods.
(f)
In a command economy, society will always get the goods it wants.
(g) In a free market, the problem of ‘what goods shall be made’ is solved by the
pattern of consumer spending.
(h) In a mixed economy the government does not interfere with the price system.
(i)
In a free market system, the problem of who shall receive goods is solved by
rationing by the government.
(j)
An advantage of the free market system for allocating resources is that it
reduces inequality of incomes.
(k) A production possibility curve illustrates the concept of technical efficiency
and opportunity cost.
(l)
A production possibility curve illustrates the maximum amounts of two
goods that could be produced using existing resources.
(m) Choice is a basic problem of economics because money is scarce relative to
the country’s resources.
(n) Wants are infinite and resources are limited therefore resources have to be
allocated between competing uses.
(o) Economic efficiency is achieved when the minimum amount of resources
produces the maximum output.
(p) Economic efficiency exists when no one can be made better off by
transferring resources from one use to another.
(q) If an economy is at zero unemployment it is operating at its production
possibility boundary
2. Go back to the answers which are false and explain why?
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A3 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
(a)
F
(b)
T
(c)
T
(d)
T
(e)
F
Economic goods are any goods which are scarce and for which a consumer
is willing to pay (any resource which is scarce is an economic good)
(f)
F
Allocation on resources (quantities of output and methods of production)
determined by central planning. Therefore available goods are not
necessarily those that people want.
(g)
T
(h)
F
Mixed economy is a combination of free market and command.
Governments intervene in free market for various reasons – market failure,
public/merit goods etc.
(i)
F
An advantage of the free market system is that resources are allocated (via
the price mechanism) to the production of those goods for which people are
prepared to pay. Those people that can afford to pay for goods are the ones
who receive them.
(j)
F
Free market system is that it increases inequalities of income. Resources
are allocated to those with spending power. Income is allocated to those
with wealth. Those with no source of income may take very poorly paid
jobs (or be unable to get a job and depend on charity).
(k)
T
(l)
T
(m) F
(n)
T
(o)
F
(p)
T
(q)
F
No – resources are scarce/consumer wants unlimited, therefore existing
resources cannot be sufficient to satisfy people’s wants
Not money, but resources which are scarce. If there was enough money for
consumers to but anything they wanted, this would not be possible as
resources to produce these goods would be insufficient.
Economic efficiency – using minimum amount of resources to produce
maximum output to satisfy as many wants as possible.
Not necessarily at production possibility boundary – must be working
efficiently to be operating at boundary.
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A4 – THE BASIC ECONOMIC PROBLEM
1
(a) Draw a production possibility curve for an economy producing capital and
consumer goods. Clearly label the following points on your diagram:
A
B
C
D
E
where all resources are used to make consumer goods.
where all resources are used to make capital goods.
a combination of the 2 commodities attainable if all resources are fully
employed.
where there is unemployment in the economy.
a combination which cannot be attained with existing resources.
(b) With reference to the production possibility curve, explain the difference
between an ‘increase in economic activity’ and ‘economic growth’.
(c) Explain some of the main causes of economic growth.
(d) On your diagram show what happens if economic growth has taken place.
(e) Explain what is meant by the term ‘economic efficiency’.
(f)
Does a production possibility curve show economic efficiency? Explain
your answer.
2. The following table refers to the production possibilities of an economy:
CAPITAL GOODS
CONSUMER GOODS
(MILLIONS OF UNITS)
(MILLIONS OF UNITS)
8
0
7
2
6
4
5
6
4
8
3
10
2
12
1
14
0
16
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A4 – THE BASIC ECONOMIC PROBLEM
2. (a) Calculate the opportunity cost of increasing the output of capital goods from
6 million to 7 million units.
(b) What quantity of consumer goods could the country produce if it used all its
resources for consumption and produced no capital goods?
(c) What would be the likely effect of (b) on future production? Explain you
answer.
(d) What would then happen to the production possibility curve in the long run?
Show this situation on your diagram.
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A4 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
1. (a) Production Possibility curve – drawn by student and labelled.
(b) Economic activity – the use of scarce resources for the production of goods
and services in order to satisfy consumer wants. An increase in the
efficiency i.e. moving towards the production possibility frontier. Economic
growth – the growth of the real output of an economy. The ability of an
economy to produce more goods and services. Outward movement of
production possibility frontier.
(c) Increase in stock and quality of capital goods, increase in quality or quantity
of labour force, increase in quantity or quality of natural resources, more
efficient usage of existing resources (improved productivity), development of
innovative techniques/new products, etc.
(d) On student’s PPC (New PPC outside original one) – i.e. point E above.
(e) Economic efficiency – occurs when resources are used to produce the
goods/services which people demand. The production of the best
combination of output by means of the most effective combination of inputs
(that which produces at the least opportunity cost). Any reallocation of
resources will not make people better off and cannot be delivered in a
cheaper fashion (for a given quantity).
(f)
No – technical efficiency is not related to wants, therefore the economy could
be producing the wrong goods.
2. (a) 2 million units of consumer goods.
(b) 16 million units.
(c) If only consumer goods are being produced, no capital investment is taking
place. New capital is necessary to further future production. (No new
machines to replace those which break down. No development of better
more efficient machinery, etc. leads to fewer and fewer goods being
produced.)
(d) PPC would shrink – i.e. move towards the origin.
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A5 – THE BASIC ECONOMIC PROBLEM
1. (a) What combination of goods is obtained if the economy operates at point B on
the production possibility curve?
(b) What combination of goods would the economy produce at point A?
(c) Calculate the opportunity cost of increasing the output of capital goods from
12 million to 14 million units.
2. (a) Comment on the state of the economy at point C.
(b) Would there be an opportunity cost in moving from C to B? Explain your
answer.
3. (a) What quantity of consumer goods could the country produce if it used all its
resources for consumption and produced no capital goods? What would be
the likely effect of this on future production?
(b) How would this affect the production possibility curve in the long run?
4. Comment of point D and suggest ways in which this point may be reached.
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A5 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
1. (a) 32 million consumer and 12 million capital goods.
(b) 24 million consumer and 14 million capital goods.
(c) 8 million consumer goods.
2. (a) Resources are being under utilised at point C (and any other point inside the
curve).
(b) No – no resources are being sacrificed in order to produce more consumer or
capital goods, therefore there is no opportunity cost.
3. (a) 48 million units of consumer goods. Future production would slow down,
less would be produced in the long run as no investment in capital goods
(new machinery etc) is being made at present.
(b) Move inwards (i.e. shrink) – country would have lower production
possibility curve.
4. D can only be reached if economic growth takes place (increase in potential
output). Ways – any measure which would cause economic growth, for example,
any factor which would increase the quality or quantity of factors of production.
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A6 – THE BASIC ECONOMIC PROBLEM
1. (a) Explain what is meant by the term ‘basic economic problem’.
(b) (i)
(ii)
(c) (i)
(ii)
Explain how resources are allocated in a command economy.
Explain the likely disadvantages of having all economic decisions
taken by a central planning authority.
What are the main characteristics of a free market economic system?
How are production levels determined in a free market economy?
(iii) Why do governments interfere in free market economic systems?
(iv)
How do governments interfere in a free market economic system?
2. Shown below are 3 questions to be answered by any economic system. Match the
examples shown with the correct questions.
QUESTIONS
EXAMPLES
A. What goods and services should be
produced?
1.
Should Cadbury produce more diary milk or
wispa bars?
B. How should these goods and services be
produced with available resources?
2.
Should a Local Authority build a hospital or a
school?
C. How are these goods and services to be
distributed?
3.
Should a golf club manufacturer sell in the
UK market or abroad?
4.
Should Highfield Farm use more machinery
or more labourers?
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A6 – THE BASIC ECONOMIC PROBLEM
3. (a) To which type of economic system are the following statements most likely
to apply?
(b) Identify whether the statement is an advantage, a disadvantage (or both).
Explain your answers.
STATEMENT
TYPE OF SYSTEM
ADVANTAGE/
EXPLANATION
DISADVANTAGE
1.
Resources are allocated
according to need
2.
Large inequalities in
income and wealth exist
3.
Monopolies which exploit
the consumer can exist
4.
The state regulates income
inequalities
5.
The government
intervenes to try to reduce
market failure
6.
No one is responsible for
trying to eliminate
unemployment
7.
Consumers have the
greatest variety of goods
possible
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A6 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
1. (a) Scarce resources, unlimited wants (concept of relative scarcity), therefore
decisions have to be made as to allocation of resources (opportunity cost of
resources).
(b) (i)
(ii)
State owns land and capital and the government decides what to
produce and how to produce it. A plan is made up which sets target
levels of output and resources are allocated accordingly (no
consideration is given to profit). Producers do not, therefore, react to
consumer spending/non-spending.
Inflexibility – decisions regarding what is produced are taken by
planners (may be guesswork). Once plan has been implemented it is
difficult to change – even if consumer wants change.
Inefficiency in production – profit plays no part in resource allocation,
therefore there is no incentive to reduce costs by improving efficiency.
Difficulty in determining people’s wants and co-ordinating decisions.
Restriction on consumer choice.
Lack of labour mobility and choice – state inducements needed to
direct labour.
Great deal of bureaucracy.
(c) (i)
No government intervention into resource allocation – what is
produced is decide by consumers and producers via the price
mechanism. (Note: no state benefits, etc.)
Ownership of private property – no barriers prevent people from
owning private property i.e. individuals are free to own the means of
production, and undertake production themselves or hire out their
private property to others.
Freedom of choice – for consumers, workers, producers, etc.
Self interest – producers want to maximise profit, consumers want to
maximise utility, workers seek highly paid jobs.
Competition – large numbers of buyers and sellers.
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A6 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
(ii)
Consumers buy particular goods and are, in effect, casting a vote.
When particular goods become more popular, their price rises.
The higher price encourages producers to increase their output (higher
profits).
Producers move resources into the production of more popular goods.
This also works in reverse – goods become less popular – price falls –
available profit falls. Producers will therefore supply less and fewer
resources will be used to produce these goods.
NB – Students should be aware that diagrams are particularly useful
when answering this type of question.
(iii) Why – problems with the free market.
• Market failure
• Consumers with most money exercise greatest weight in spending,
therefore production may be devoted to those goods where greatest
profit is made.
• Commodities people willing to pay for may not be those which are
most useful to society, or may be unsuitable for provision
• Unemployment
• Existence of externalities
• Uneven distribution of income/wealth
(iv)
How – government intervention
•
•
•
•
•
Taxes/benefits
Provision of public/merit goods
Nationalisation/privatisation
Location of industry
Stabilising economy (interest rates, exchange rates, influencing
international trade – quotas, subsidies etc)
• Regulation/laws
• Monopolies commission/OFTEL/OFGAS etc
2. (a) 1 and 2
(b) 4
(c) 3
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MICROECONOMICS
A6 – THE BASIC ECONOMIC PROBLEM – SUGGESTED SOLUTION
3. Scope in this question for good pupils to give both advantages and disadvantages
for some of the statements. However, pupils should recognise with one advantage
or disadvantage in each of the statements.
1. Command/Planned
Advantage – degree of equality within the system,
everyone has their need satisfied.
Disadvantage – state planners decide where resources
are allocated and what they think people need may not
be the view of the people – it is difficult for them to
gauge consumer wants. Results in less consumer
choice, etc.
2. Free Market
Disadvantage – one of the problems of the free market
system is that large inequalities can occur – rich become
richer, poor become poorer and no benefits system exist
to help out. One of the reasons government intervene.
3. Free Market
Disadvantage – consumers have less/no choice and may
be exploited by monopolist – higher prices. Again, a
reason for government intervention.
4. Mixed
Advantage – state can ensure that income is reallocated
from rich to poor via a taxes/benefits system.
5. Mixed
Advantage – the Government aims to achieve both
efficiency and equity.
6. Free Market
Disadvantage – unemployment can exist even when
market is working efficiently.
7. Free Market
Advantage – greater choice increases consumer welfare.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B1 – DEMAND
1. A demand curve shows how much of a good consumers will buy at each and every
price i.e. effective demand. In most cases, as price rises quantity demanded of a
good falls (and vice versa). However, there are other factors which influence the
demand for a good even though its price remains unchanged.
(a) Explain what is meant by the term effective demand.
(b) Explain why, in most cases, ‘consumers will buy less of a good as its price
rises’.
(c) Explain why, in some cases, ‘consumers buy more of a good as its price
rises.
(d) (i)
(ii)
2.
Explain, using diagrams and examples, the ‘other factors which can
influence the demand for a good, even though its price remains
unchanged’.
Will a change in the ‘other factors’ result in a movement along the
demand curve or a shift in the curve? Using a diagram and an example,
explain your answer
Price
£15
£20
Quantity demanded of a good (units)
Consumer Alpha
Consumer Beta
3
5
2
3
(a)
Using the above information, explain the difference between individual
demand and market demand.
(b)
Does the demand curve for a particular good show individual or market
demand?
Explain your answer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B1 – DEMAND – SUGGESTED SOLUTION
1. (a) Demand for goods and services backed up with resources (money) to pay for
them. Notional demand = desire for goods and services unsupported by
ability to pay. Concept important as price mechanism is related to effective
demand, not notional demand.
(b) Substitution and income effects, marginal utility vs. price (MU basis of
demand) consumers spend money in a way which gives them the greatest
utility (very good students should be able to explain the concept of equimarginal utility).
(c) Regressive demand – for example speculation (shares), quality, ostentation.
(d) (i)
(ii)
Income, prices of other goods (substitutes/complements), advertising,
fashion, availability of credit, interest rates. Diagrams showing shifts
of demand to left and right.
Shift to the right – more will be demanded at each and every price.
Shift to the left means less will be demanded at each and every price.
A change in other factors will cause a new demand curve to be derived.
A change in the price of a good causes a movement along the same
demand curve.
2. (a) Individual – one person, firm or government’s demand for a good or service
(i.e. consumer Alpha or consumer Beta). Market demand is the sum of each
individual’s demand (i.e. consumer Alpha plus consumer Beta).
(b) Market – demand curve is based on notional demand curve from all potential
consumers of a good or service not just an individual buyer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B2 – DEMAND – UTILITY
A consumer gains utility by consuming a good or service. It is assumed that as
consumption of a good increases total utility increases (up to a point) whilst marginal
utility decreases.
GLASSES OF GINGER
BEER
1
TOTAL UTILITY
5
2
MARGINAL UTILITY
5
4
3
12
4
13
5
-4
(a) Explain what is meant by the following terms:
(i) utility
(ii) total utility
(iii) marginal utility
(b) (i)
(ii)
Copy and complete the table shown above.
Describe what happens to total utility as consumption of ginger beer
increases.
(iii) Describe what happens to marginal utility as consumption of ginger
beer increases.
(iv) Explain the relationship between total and marginal utility.
(c) (i)
(ii)
Which economic law does the above example illustrate?
How can this law be used to explain the shape of the demand curve?
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B2 – DEMAND – UTILITY – SUGGESTED SOLUTION
(a)
(i)
Utility – the satisfaction gained from the consumption of a good or
service. If a consumer gains utility from a good, then they prefer the good
to exist rather than not exist.
(ii)
The total amount of satisfaction gained from the consumption of a
combination of goods and services.
(iii) The extra satisfaction (utility) gained from the consumption of an extra
unit of a good or service.
(b)
(i)
GLASSES
TOTAL UTILITY
MARGINAL UTILITY
0
0
0
1
5
5
2
9
4
3
12
3
4
13
1
5
9
-4
(ii)
Increases to a maximum point, then decreases.
(iii) Decreases continuously, then becomes negative.
(iv) As marginal utility decreases (between one and four units), less and less is
added to total utility. However, when marginal utility becomes negative
(fifth unit), total utility falls.
(c)
(i)
Law of diminishing marginal utility.
(ii)
Marginal utility is related to price and is therefore the basis of demand. In
spending money, consumers attempt to maximise satisfaction and they
spend their money in a way which gives them the greatest utility.
When price falls a good becomes more attractive to consumers (relative to
marginal utility) and they therefore buy more.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B2 – DEMAND – UTILITY – SUGGESTED SOLUTION
Very good students should be able to explain equi-marginal utility – i.e.
maximum satisfaction is achieved when the last penny spent on each good
bought gives the same amount of satisfaction, therefore when the price of
one good falls there is consumer disequilibrium. Consumers adjust
spending to regain equilibrium and consumers adjust spending to regain
equilibrium when:
Marginal Utility of Good A Marginal Utility of Good B
=
Price A
Price B
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B3 – DEMAND – UTILITY
The following table shows the weekly amount of total utility a consumer gains from
consuming chocolate bars:
QUANTITY OF CHOCOLATE BARS
TOTAL UTILITY
(PER WEEK)
0
0
1
4
2
7
3
9
4
10
5
10
(a) (i)
(ii)
Explain what is meant by the term ‘total utility’.
Explain what happens to total utility as consumption increases.
(b) Using the above example, explain what is meant by ‘diminishing marginal
utility’.
(c) Explain the relationship between total utility and marginal utility.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B3 – DEMAND – UTILITY – SUGGESTED SOLUTION
(a) (i)
(ii)
Total amount of satisfaction gained from the consumption of a good (in
this case chocolate bars).
Total utility increases, but by a smaller amount as each additional unit
is added. The fifth bar of chocolate adds nothing to total utility.
(b) An assumption whereby the marginal utility attached to an extra unit of any
good diminishes as more and more of that good is purchased.
(c) Marginal utility decreases continuously and then becomes zero. This causes
total utility to increase, but by a smaller and smaller amount. When marginal
utility reaches zero, there is no increase in total utility.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B4 – DETERMINANTS OF DEMAND
The following diagram shows the market for ‘Shesso’ petrol.
The market for Shesso
1. Describe and explain the factors which could have caused the increase in the price
of Shesso shown in the above diagram.
2. A change in which determinant of demand does NOT cause a change in demand
(i.e. a shift in the demand curve)? Explain your answer.
3. “It is impossible to draw the demand curve for a good unless we assume ceteris
paribus”. Explain this statement.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B4 - DETERMINANTS OF DEMAND – SUGGESTED SOLUTION
1
The price of Shesso has increased because there has been an increase in the
demand for Shesso. Students must therefore show an understanding of some of
the factors which could have caused the increase in demand. (Note that the
question asks for a description and an explanation.)
The factors include:
(a) an increase in the price of another brand of petrol – causing some people to
switch to Shesso,
(b) an increase in the quantity of cars demanded (because of a fall in the price of
cars following a MMC report) – this would lead to an increase in demand for
petrol as cars and petrol are complementary goods.
(c) a rise in consumer income (because of increased economic growth,
reductions in income tax, etc) - creating an increase in the demand for
(bigger) cars and therefore an increase in the demand for petrol.
(d) an increase in the price of a substitute good e.g. public transport - which
would increase the incentive to own a car.
2 Students should show (using diagrams) an understanding of the difference
between ‘changes in demand’ and ‘changes in the quantity demanded’.
The only determinant of demand which, when it changes, does not change
demand, is PRICE. As the demand curve for a good is plotted against its price,
any change in price will simply cause a movement along the demand curve (either
a contraction or extension), and not result in a new demand curve. A change in
any one of the other determinants (incomes, tastes, other prices) will result in
either an increase in demand (the curve shifting to the right) or a decrease in
demand (the curve shifting to the left).
3. Look for an understanding of the fact that although demand curves are always
plotted against price, demand is influenced by factors other than price.
As the demand for any good is determined by a variety of factors (incomes, tastes,
the price of the good, the price of other goods etc), in order to isolate the effect on
demand of a change in any one of these, it must be assumed that all the other
determinants are not changing e.g. if a fall in the price of a good coincides with an
increase in consumer income, the demand for the good will increase, but there will
be no way of finding out how much of the increase was due to the fall in price and
how much due to the rise in income.
As a demand curve relates the demand for a good to its price, it is always drawn
on the assumption that all determinants of demand – other than the price – are not
changing ie ceteris paribus (other things being equal).
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B5 – PRICE ELASTICITY OF DEMAND
Study the following table, showing percentage changes in price and quantity
demanded for certain goods:
GOOD
PRICE CHANGE
QUANTITY DEMANDED CHANGE
(%)
(%)
1
20
40
2
20
10
3
16
4
4
27
9
5
8
8
(a)
Which of the above goods have:
(i) price elastic demand;
(ii) price inelastic demand?
(b)
Explain what is meant by the term total revenue.
(c)
(i)
Using examples, explain which types of goods tend to have price elastic
demand?
(ii)
What effect will a price change have on total revenue if price elasticity of
demand is elastic? Explain your answer.
(i)
Using examples, explain which types of goods tend to have price inelastic
demand?
(ii)
What effect will a price change have on total revenue if price elasticity of
demand is inelastic? Explain your answer.
(d)
(e)
If the demand for a good is unitary price elastic, what will happen to a
producer’s total revenue if the price of their goods was increased?
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B5 – PRICE ELASTICITY OF DEMAND
(f)
(g)
(i)
Explain why, at current prices, the demand for newspapers is price
inelastic, while the demand for a particular newspaper is price elastic.
(ii)
How might a newspaper company try to make the demand for its
newspaper more price inelastic?
Explain why an understanding of the concept of price elasticity of demand
might be useful for:
(i)
(ii)
A manufacturer of electrical goods;
The Chancellor of the Exchequer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B5 – PRICE ELASTICITY OF DEMAND – SUGGESTED SOLUTION
(a)
(i)
(ii)
(b)
Money received from total sales i.e. price per unit x quantity sold.
(c)
(i)
Luxury items, goods with many substitutes (with actual examples).
(ii)
Revenue will decrease if price is raised, revenue will increase if price is
lowered. Students should use diagrams/examples to illustrate answer and
explain why i.e. price change is proportionally smaller than quantity
change.
(i)
Necessities, goods which have few substitutes (with actual examples).
(ii)
Revenue increases if price is increased and decreases if price is decreased.
Students should use diagrams/example to illustrate answer and explain
why i.e. price change is proportionately larger than quantity change.
(d)
1
2, 3 and 4
(e)
Stays the same.
(f)
(i)
Newspapers in general have no close substitute, therefore their demand
tends to be price inelastic. A particular newspaper has close substitutes
within the same price range, therefore demand is more price elastic.
(ii)
Competitions e.g. collect tokens from the newspaper, weekly magazines
included e.g. several Sunday newspapers have magazines, free tries on the
national lottery, free gifts e.g. a newspaper may include a token for a free
packet of seeds for the garden.
(i)
Understanding of the concept would help manufacturers in pricing
decisions and how these affect total revenue and profits.
(ii)
Understanding of the concept would help Chancellor when making
decisions regarding increasing/lowering taxes and how this would affect
government revenue.
(g)
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B6 – PRICE ELASTICITY OF DEMAND
Demand for new cars in mainly determined by prices. It has been estimated that price
elasticity of demand can range from approximately –0.2 to –0.9. However, price
elasticity of demand for particular models of new cars can vary from –2.5 to –6.5.
(a)
(b)
(i)
Explain why the price elasticity of demand for particular models of cars is
considerably higher than price elasticity of demand for cars in general.
(ii)
Describe the ways in which a car manufacturer might try to make the
demand for their product more inelastic.
The government have decided to increase the sales tax on new cars. Explain,
using diagrams, how this would affect the market for:
(i)
new cars in general;
(ii)
particular models of new car?
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B5 – PRICE ELASTICITY – SUGGESTED SOLUTIONS
(a)
(b)
(i)
Cars in general have a certain degree of necessity – lack of substitutes
therefore the price elasticity of demand tends to be relatively inelastic.
However, one particular model of car can easily be substituted for another,
therefore price elasticity of demand tends to be more elastic.
(ii)
After sales service, free insurance/road tax/servicing, free gifts, for
example, air miles.
(i)
Supply shifts upwards by full amount of tax. PED for new cars is relatively
price inelastic, therefore suppliers are able to pass most of the tax on to
consumers in the form of higher prices, i.e. equilibrium price rises from P1 to P2.
(ii)
Again the supply shifts upwards by full amount of tax. PED for particular
models of new car is relatively price elastic, therefore suppliers are unable to
pass most of the tax on to consumers in the form of higher prices and must bear
most of the tax burden themselves.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B6 – INCOME ELASTICITY OF DEMAND
The following table shows what happens to the quantity demanded of 5 different
goods when consumers’ real incomes change:
CHANGE IN INCOME (£)
(a)
CHANGE IN QUANTITY DEMANDED
From
To
From
To
1
8000
9000
40
50
2
4000
5000
10
12
3
5000
6000
50
40
4
16000
15000
60
60
5
9000
10000
60
40
(i)
Explain what is meant by the term ‘real income’.
(ii)
What factors may cause a change in consumers’ real incomes?
(iii) Describe what has happened to average real incomes in the UK over the
past 10 years.
(b)
Which of the goods in the above table have an income elasticity of demand
which is:
(i) positive
(ii)
Negative
(iii) zero?
(c)
Which of the goods in the above table, which have positive income elasticity of
demand, are:
(i) income elastic.
(ii)
(d)
income inelastic.
Explain how a knowledge of income elasticity of demand could influence the
production decisions of a frozen food manufacturer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
B5 - INCOME ELASTICITY OF DEMAND – SUGGESTED SOLUTION
(a)
(i)
Income, not in monetary terms, but in terms of the quantity of goods and
services it can actually buy.
(ii)
Changes in money incomes and prices.
(iii) Increasing constantly over past 10 years (even during recession).
(b)
(i)
1 and 2
(ii)
3 and 5
(iii) 4
(c)
(e)
(i)
1
(ii)
2
It would help frozen food manufacturers to know whether to move out of
production of goods with low income elasticity to those with a high income
elasticity. It enables producers to make decisions regarding product range,
whether to move to ‘upmarket’ products, etc.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C1 – DETERMINANTS OF SUPPLY
A supply curve slopes upwards from left to right and shows how much of a good or
service producers are willing to sell at any particular price over a period of time.
Price, however, is not the only factor which determines the level of supply as there are
also other important factors to consider.
(a)
If the price of a good increases, how will producers react?
(b)
Explain, using diagrams, the ‘other important factors’ which determine the
supply of a good.
(c)
Will a change in the price of a good cause a shift in the supply curve or a
movement along the supply curve? Explain your answer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C1 – DETERMINANTS OF SUPPLY – SUGGESTED SOLUTION
(a)
This will cause an increase in production due to increase in profit margins.
Increased profit margins also attract new suppliers, which again will increase
supply.
(b)
Other factors cause a shift in the supply curve, for example, costs of
production (or any factor which affects these), technology, prices of other
goods, government legislation, stockpiling, weather, ease of entry/exit of firms
to an industry. These would cause the entire supply curve to shift to the left or
the right.
(c)
Movement-price is the only factor which causes a movement along a supply
curve (extension/contraction of supply). If any other factor changes more/less
will be supplied at every price therefore a new supply curve will be derived.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C2 – RETURNS TO FACTORS OF PRODUCTION
Most businesses aim to maximise profits and many believe that if they increase
output they can achieve that aim. However, to increase output a business will use
more factors of production which may mean an increase in costs. The following table
shows the relationship between the input of factors of production of a business and the
resultant output:
Land
(Units)
Labour
(Units)
Total Product
1
1
1
1
1
1
1
2
3
4
5
6
8
18
30
44
55
60
(a)
Complete the above table.
(b)
Explain what is meant by the following phrases:
(c)
(d)
Marginal
Product of
Labour
Average
Product of
Labour
(i)
maximise profits;
(ii)
costs.
(i)
What is meant by the term average product of labour and how is it
calculated?
(ii)
What is meant by the term marginal product of labour and how is it
calculated?
Using the table above, as more units of labour are employed, what happens to:
(i)
marginal product of labour;
(ii)
average product of labour.
(e)
Explain the relationship between average product and marginal product.
(f)
Explain what will happen to the labour cost per unit of the product if, all units of
labour receive the same wage.
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MICROECONOMICS
C2 – RETURNS TO FACTORS OF PRODUCTION
(g)
(i)
Explain the difference between the short run and long run in economics.
(ii)
Does the information in the table represent the short run or the long run
situation of this firm?
(iii) What economic law does the above data illustrate?
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C2 – RETURNS TO FACTORS OF PRODUCTION – SUGGESTED
SOLUTION
(a)
(b)
(c)
(d)
Land
(Units)
Labour
(Units)
Total Product
1
1
1
1
1
1
1
2
3
4
5
6
8
18
30
44
55
60
Marginal
Product of
Labour
8
10
12
14
11
5
Average
Product of
Labour
8
9
10
11
11
10
(i)
Profit = revenue-costs. Maximise profits means that a firm seeks to make
the highest profit it can i.e. maximum total revenue/minimum total cost.
(ii)
Two types of cost – fixed and variable (plus examples), when added
together give total cost. Normal profit is included in a firm’s costs
(reward to entrepreneur for risk involved).
(i)
The amount that each worker produces. Total product divided by number
of workers.
(ii)
The extra output obtained by employing one extra unit of a given input
(factor of production). In the above example – marginal product of
labour.
(i)
Increases up to four units of labour and then decreases.
(ii)
Increases up to four units of labour, constant for fifth unit, then decreases.
(e)
While marginal product is greater than average product, the average product is
pulled up, when marginal product equals average product, the average product
remains constant, then when marginal product is less than average product the
average product is pulled down. Marginal product cuts average product at its
highest point.
(f)
Cost per unit will decrease up to the addition of the fourth worker, stay constant
and then increase.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C2 – RETURNS TO FACTORS OF PRODUCTION – SUGGESTED
SOLUTION
(g)
(i)
Short run – at least one factor of production is fixed (usually land/capital).
In the long run all factors of production are variable.
(ii)
Short run situation – at least one factor (land) is fixed.
(iii) Law of Diminishing (Marginal) Returns – when increasing quantities of a
variable factor are added to fixed quantities of some other factor, first the
marginal and then the average returns to the variable factor will after some
point diminish.
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MICROECONOMICS
C3 - LEAST COST COMBINATION OF FACTORS
Shown below are three different production techniques an entrepreneur could use to
produce one unit of their product.
Land costs £10 per unit used, labour £20 per unit used and capital £16 per unit used.
METHOD
LAND
LABOUR
CAPITAL
(UNITS)
(UNITS)
(UNITS)
1
5
1
5
2
4
2
4.5
3
3
5
4
(a)
What is meant by the term ‘production techniques’?
(b)
(i)
Which production techniques would the above firm be advised to use?
Explain your answer.
(ii)
If the above firm were in a competitive market, what would happen if the
firm failed to use this method?
(c)
If the price of capital doubled, what would the entrepreneur be advised to do?
Explain your answer.
Economics Support Materials: Microeconomics (Higher)
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MICROECONOMICS
C3 – LEAST COST COMBINATION OF FACTORS – SUGGESTED
SOLUTION
(a)
Different ways in which factors of production can be combined (capital
intensive/labour intensive) in order to produce the final good or service.
(b)
(i)
Method 1 – lowest cost (i.e. £150 as opposed to other two methods which
cost £152 and £194 respectively).
(ii)
Firm would probably be uncompetitive, see a reduction in profit and
possibly go out of business. If other firms were using least cost
combination they would be able to produce at lower cost per unit.
(c)
Change to production method 2 as this has now become the least cost method.
If firm did not respond to the change in price of factors of production it would
become uncompetitive and therefore profits would be lowered as other firms
may become more competitive. Dynamic situtaion and in reality, firms do
substitute more expensive factors for cheaper ones.
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MICROECONOMICS
C4 – ECONOMICS OF SCALE
The following data relates to a firm whose only factor inputs are labour and capital:
LABOUR
CAPITAL
TOTAL OUTPUT
(UNITS)
(UNITS)
3
30
1,000
6
60
3,000
9
90
4,800
12
120
6,400
15
150
7,680
18
180
8,448
(a) Explain what is meant by the following terms:
(i) Increasing returns to scale;
(ii) Constant returns to scale;
(iii) Decreasing returns to scale.
(b) Over what output range does the above firm experience:
(i) Increasing returns to scale;
(ii) Constant returns to scale;
(iii) Decreasing returns to scale.
(c) Explain what happens to the firm’s average total cost of production when it is
experiencing:
(i) Increasing returns to scale;
(ii) Constant returns to scale;
(iii) Decreasing returns to scale.
(d) (i)
Explain, using examples, what is meant by economies of scale.
(ii) Explain why a business may experience diseconomies of scale.
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MICROECONOMICS
C4 – ECONOMICS OF SCALE – SUGGESTED SOLUTION
(a) (i)
If factor inputs are increased, there is a more than proportionate increase in
output (returns). For example, capital is increased by 100% and total output
increases by more than 100%.
(ii) If factor inputs are increased, there is the same proportionate increase in
output (returns). For example if capital is increased by 100% then total
output would increase by 100%.
(iii) If factor inputs are increased, there is a less than proportionate increase in
output (returns). For example capital is increased by 100% but total output
increases by less than 100%.
(b) (i)
Increasing returns to scale – between 1000 and 4800 units.
(ii) Constant returns to scale – between 4800 and 6400 units.
(iii) Decreasing returns to scale – between 6400 and 8448 units.
(c) (i)
Average total cost falls.
(ii) Average total cost remains constant.
(iii) Average total cost rises.
(d) (i)
Falling long run average cost due to – specialisation/division of labour,
technical, marketing, financial, managerial, risk-bearing economies (with
some explanation of relationship to average cost).
(ii) Business becomes too large – managerial problems, lower morale, increased
factor costs, etc.
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C5 – COSTS
Study the following table, which shows the short run and long run situation of a firm.
FIXED
FACTOR
VARIABLE
FACTOR
TOTAL
PRODUCT
Short run
1
1
6
Short run
1
2
18
Short run
1
3
24
Short run
1
4
24
Long run
2
8
60
FIXED
COST
VARIABLE
COST
TOTAL
COST
AVERAGE
TOTAL
COST
(a) Copy and complete the above table assuming the cost of the fixed factor is £300
per unit and the cost of the variable factor is £12 per unit.
(b) What is the effect on total product of increasing the variable factor in the short
run? Explain why this happens.
(c) Explain, using examples, what is meant by the terms:
(i)
fixed cost;
(ii) variable cost.
(iii)
(d) Describe what happens to average cost as the variable factor is increased in the
short run.
(e) What effect does doubling the scale of production in the long run have on
productivity? Explain why this happens.
(f) What effect does doubling the scale of production in the long run have on average
cost? Explain why this happens.
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C5 – COSTS – SUGGESTED SOLUTION
(a)
FIXED
FACTOR
VARIABLE
FACTOR
TOTAL
PRODUCT
FIXED
COST
VARIABLE
COST
TOTAL
COST
AVERAGE
TOTAL
COST
Short run
1
1
6
300
12
312
52
Short run
1
2
18
300
24
324
27
Short run
1
3
24
300
36
336
14
Short run
1
4
24
300
48
348
14.5
Long run
2
8
60
600
96
696
11.6
(b) Rises at an increasing rate, then eventually slows down due to diminishing returns.
(c) (i)
Costs which remains the same in the short run due to the fact that at least one
factor is fixed in this time period. Fixed cost does not vary with production
(i.e. total product).
(ii) Costs which vary directly with the amount produced (total product).
(d) Falls, then rises. Increasing returns to the variable factor (average cost falls), then
diminishing returns (average cost begins to rise). Average fixed cost falls
continuously, however the increase in average variable cost eventually outweighs
the fall in average fixed cost and this pulls average total cost up.
(e) Increases productivity. Increasing returns to scale – economies of scale.
(f) Long run average to total costs fall. Students should link economies of scale, e.g.
bulk buying, etc. to falling long run average total cost.
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C6 –COSTS
Shown below are a firm’s short run cost curves:
Average Total Cost
Average Variable Cost
Average Fixed Cost
(a) Explain why average fixed cost continues to fall at all levels of output.
(b) (i)
Explain what happens to average variable cost as output increases?
(ii) Explain the shape of the average total cost in the short run?
(c) (i)
Explain, using a diagram, what happens to average total cost in the long run.
(ii) At which output will the firm be at its most efficient? Explain your answer.
(d) Explain how specialisation and division of labour would help to lower a firm’s
average cost.
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MICROECONOMICS
C6 – COSTS
(a) Average fixed cost (fixed cost per unit) = total fixed cost divided by output. As
output increases total fixed cost is spread over a larger and larger number of units,
therefore average fixed cost falls continuously.
(b) (i)
Average variable cost falls and then rises. Falls when firm is experiencing
increasing average returns to the variable factor, then rises when firm is
experiencing diminishing average returns to the variable factor.
(ii) Average total cost comprises average fixed and average variable costs.
Average fixed costs fall continuously over the range of output and average
variable costs fall initially. This causes the average total cost curve to slope
downwards. When diminishing returns set in average variable costs begin to
rise. Initially the fall in average fixed cost may outweigh the rise in average
variable cost meaning that average total cost will still fall. However, at some
point the increase in average variable cost outweighs the fall in average fixed
cost causing average total cost to rise – average total cost curve slopes
upwards.
(c) (i)
Diagram showing LRAC curve. Long run firm can achieve economies of
scale, therefore falling long run average total cost. However eventually,
diseconomies of scale may set in therefore increasing long run average total
cost.
(ii) At lowest point on LRAC curve. Productivity at this point is at its maximum
and cost per unit is at its lowest.
(d) Explanation of how specialisation and division of labour increase productivity
and relationship between an increase in productivity, falling average variable cost
and therefore falling average total cost.
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C7 – COSTS
OUTPUT
TOTAL
COST
MARGINAL
COST
AVERAGE
TOTAL
COST
AVERAGE
FIXED
COST
2
AVERAGE
VARIABLE
COST
TOTAL
VARIABLE
COST
£30
3
4
5
£290
6
£12
(a) Copy and complete the above table using the information in the table, as well as
the following clues:
•
•
•
•
Total cost is increased by £27 when the third unit of out put is added.
Average total cost of 4 units of output is the same as the average total cost of
3 units of output.
Total variable cost is increased by £100 when the sixth unit of output is
added.
Total cost increases by £8 when the second unit of output is added.
(b) What are the reasons for the shape of the average fixed cost curve?
(c) What are the main reasons for the shape of the average variable cost curve?
(d) Explain the relationship between the marginal cost and the average variable cost
curve?
(e) Explain the shape of the average total cost curve.
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C7 – COSTS
(a)
OUTPUT
TOTAL
COST
MARGINAL
COST
AVERAGE
TOTAL
COST
AVERAGE
FIXED
COST
AVERAGE
VARIABLE
COST
TOTAL
VARIABLE
COST
2
132
8
66
36
30
60
3
159
27
53
24
29
87
4
212
53
53
18
35
140
5
290
78
58
14.40
43.60
218
6
390
100
65
12
53
318
(b)
Fixed costs remain the same in the short run, therefore as output increases, fixed
costs are spread over a larger and larger number of units. This means that
average fixed cost (fixed cost per unit) falls continuously.
(c)
Variable costs per unit fall, then rise. When a firm is experiencing increasing
returns to the variable factor, variable cost per unit falls. However, at some
point diminishing returns set in and variable cost per unit will, therefore rise.
(d)
When the marginal cost (cost of producing one more unit) is less than the
average variable cost, this pulls the average variable cost down. However,
when the marginal cost is higher than the average variable cost this causes the
average variable cost to rise. For example, when the third unit of output is
produced the marginal cost is 27. As this is below the previous average variable
cost of 30, the average variable cost falls to 29. However, with the addition of
the fourth unit marginal cost rises to 53 – well above the average variable cost.
This pulls the average variable cost up to 35.
(e)
Average total cost comprises average fixed and average variable costs. Average
fixed costs fall continuously over the range of output and average variable costs
fall initially. This causes the average total cost to slope downwards. When
diminishing returns set in average variable costs begin to rise. Initially, the fall
in average fixed cost may outweigh the rise in average variable cost meaning
that average total cost will still fall. However, at some point the increase in
average variable cost outweighs the fall in average fixed cost causing average
total cost to rise – average total cost curve slopes upwards.
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C8 – COSTS
The following diagram shows the short run unit cost curves for a firm:
(a)
(b)
(c)
(d)
Explain what is meant by:
(i)
Marginal cost.
(ii)
Average variable cost.
(i)
Explain what is meant by average total cost.
(ii)
Why might a business want to know its average total cost?
(i)
Explain how average fixed costs are affected by changes in output.
(ii)
Explain how average fixed costs could be shown on the above diagram.
Explain the relationship between marginal cost and average total cost.
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MICROECONOMICS
C8 – COSTS – SUGGESTED SOLUTION
(a)
(b)
(c)
(d)
(i)
Cost of producing one extra unit of a product.
(ii)
Variable cost per unit i.e. total variable cost divided by number of units.
(i)
Total cost per unit (fixed cost per unit plus variable cost per unit).
(ii)
So that decisions can be made regarding the price of the product and break
even point and profit margins can be ascertained (average total cost
includes normal profit).
(i)
As output increases, average fixed cost per unit falls continuously as fixed
costs are spread out over a greater and greater number of units.
(ii)
Difference between average total cost and average variable cost for
example B minus C.
When marginal cost is falling, the average total cost is pulled down (due to
effect on average variable cost – fixed cost falls continuously). However when
marginal cost increases average variable cost is pulled upwards and therefore
average total cost increases (when increase in average variable cost outweighs
the fall in average fixed cost). Marginal cost cuts AVC and ATC curves at their
lowest points.
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D1 – EQUILIBRIUM
1.
Read the passage below, then answer the questions which follow:
Buyers and sellers come together in markets. Goods and services are exchanged for a
price. Prices will be forced up or down depending on the state of the market.
Demand and supply diagrams provide a tool for analysing the effects of supply and
demand on equilibrium price and quantity.
(a)
Explain what is meant by the term ‘markets’.
(b)
Describe some of the different markets in operation in the UK.
(c)
Explain what is meant by ‘equilibrium price and quantity’.
(d)
Using diagrams, explain why, in a competitive market, price will settle at
equilibrium.
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MICROECONOMICS
D1 – EQUILIBRIUM – SUGGESTED SOLUTION
1
(a)
Any context in which the purchase and sale of goods or services takes
place (buyers and sellers need not meet face to face e.g. fax, telephone,
etc.).
(b)
Stock market, money markets, foreign exchange market, open air market,
markets for goods and services.
(c)
Equilibrium – a state of balance i.e. no tendency for change. Equilibrium
price and quantity i.e. price and quantity at which all goods made
available by suppliers is wanted by consumers – supply equals demand.
(d)
Diagram showing excess supply and demand with explanation of why
price will settle at equilibrium – if there is excess supply (supply greater
than demand) there will be a surplus of products on the market and
producers will reduce price until equilibrium is reached. If there is an
excess demand (demand greater than supply) there will be shortage of
products on the market and suppliers will increase price (increase
supply/new suppliers enter the market – profit motive) until equilibrium is
reached.
Excess Supply
Excess Demand
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D2 – MARKET SITUATIONS
The price of a good is determined by the forces of demand and supply. However,
some markets are related and an event in one market can affect another market.
(a)
Explain how ‘the price of a good is determined by the forces of supply and
demand’.
Study the following diagrams, then answer the questions which follow:
(b)
Diagram 1 – Assume Strawberries and Cream are complementary goods.
Market for Strawberries
Market for Cream
(i)
What is meant by the term ‘complementary goods’?
(ii)
What factors might have caused the shift in the supply curve for
strawberries from S1 to S2?
(iii) Explain what effect the changes in supply of strawberries has on the
market for cream.
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D2 – MARKET SITUATIONS
(c)
Diagram 2 – Assume Chicken and Turkey are substitute goods.
Market for Chicken
Market for Turkey
(i)
What is meant by the term ‘substitute goods’?
(ii)
What factors might have caused the shift in the supply curve for chicken
from S1 to S2?
(iii) Explain the effects the change in supply of chicken has on the market for
turkey?
(d)
Diagram 3 – Assume the demand for steel is derived from the demand for
buses.
Market for Buses
Market for Steel
(i)
Explain what is meant by ‘derived demand’.
(ii)
What factors might have caused the shift in the demand curve for buses
from D1 to D2?
(iii) Explain the effects the change in the demand for buses has on the market
for steel.
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D2 – MARKET SITUATIONS
(e)
Diagram 4 – Assume mutton and wool are in joint supply.
Market for Mutton
Market for Wool
(i)
Explain what is meant by ‘joint supply’.
(ii)
What factors might have caused the shift in the demand curve for mutton
from D1 to D2?
(iii) Explain the effects the change in the demand for mutton has on the market
for wool.
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D2 – MARKET SITUATIONS – SUGGESTED SOLUTION
(a)
Explanation of how equilibrium price is reached, i.e. suppliers supply goods to
the market, consumers demand goods, price at which demand equals supply –
equilibrium price. At any price above equilibrium supply exceeds demand,
therefore price must fall till equilibrium is reached. At any price below
equilibrium demand exceeds supply, therefore price will rise until equilibrium is
reached.
(b)
(i)
A good which tends to be bought when another good is purchased since it
‘complements’ (goes along with) the original good.
(ii)
Good harvest, weather, use of better fertilisers, insecticides, etc.
(iii) Increased demand (demand curve shifts to the right), equilibrium price
and quantity increases.
(c)
(i)
Goods which are similar to each other and can, therefore, easily replace
each other.
(ii)
Increase costs of production, disease, government tax or withdrawal of
subsidy.
(iii) Demand increases for turkey (i.e. shifts to the right), causing an increase
in equilibrium price and quantity.
(d)
(i)
The demand for a good occurs because it produces another good, therefore
its demand stems from the demand for the final good it is producing. The
demand for steel occurs due to the demand for buses, it is not demanded in
itself.
(ii)
Promotion of ‘green’ schemes, increased park and ride facilities, road
taxing schemes, increased parking charge in city centres, etc.
(iii) Demand increases for steel (i.e. shifts to the right), causing an increase in
equilibrium price and quantity.
(e)
(i)
Supply of one good automatically lead to supply of another.
(ii)
BSE scare, health promotion, positive advertising.
(iii) Increased supply of wool (i.e. supply shifts to the right), causing a
decrease in equilibrium price and an increase in equilibrium quantity.
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D3 – MARKET SITUATIONS
The following diagram shows the market for videoskinnies, a type of children’s toy:
For each of the following, explain, using diagrams, what would happen to the market
for videoskinnies:
(a)
The government imposes a tax on all children’s toys.
(b)
A shortage develops of the rubber required in the manufacture of
videoskinnies.
(c)
The demand for videoskinnies increases, but manufacturers have offset any
effect on price by increasing productivity.
(d)
There is a sudden rush to buy videoskinnies, however at the same time
manufacturers have reported an increase in production costs.
(e)
Malaysian rubber plantation workers go on strike due to poor working
conditions.
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D3 – MARKET SITUATIONS – SUGGESTED SOLUTION
(a)
Tax causes supply to decrease, increase in equilibrium price and fall in equilibrium
quantity. Extent of price increase depends on PED.
(b)
Increase in cost of production causing Equilibrium Price to rise and equilibrium
quantity to fall. Extent of price rise dependent on PED.
(c)
Demand has increased, which would cause equilibrium price to rise and equilibrium
quantity to fall. However, at the same time producers have increased productivity
therefore supply has increased. This would cause equilibrium quantity to rise and
equilibrium price to fall, therefore in this instance no change in equilibrium price.
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D3 – MARKET SITUATIONS – SUGGESTED SOLUTION
(d)
Increase in demand which would cause equilibrium price and quantity to rise. At the
same time production costs have increased, causing supply to decrease. This would
cause equilibrium price to rise and equilibrium quantity to fall.
(e)
Decrease in supply (increase in costs of production), equilibrium price rises and
equilibrium quantity falls.
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MICROECONOMICS
D4 – INTERVENTION
For various reasons, it is sometimes necessary for governments to intervene in the
markets for goods and services. Forms of government intervention include the setting
of maximum and minimum prices and the granting of subsidies. However, the most
popular tool used by government is through the use of indirect taxes. For example,
VAT has been placed on goods and services which has previously been zero rated.
1.
2.
3.
4.
(a)
Explain, using a diagram how the imposition of a ‘maximum price’ can
disrupt the market.
(b)
Explain, using a relevant example, why a government might wish to see a
maximum price on a particular good or service.
(c)
What problems might arise if a government sets a maximum price on a
particular good or service?
(a)
Explain, using a diagram how the setting of a ‘minimum price’ can disrupt
a market.
(b)
Explain, using a relevant example, why a government might wish to set a
minimum price for a particular good or service?
(c)
What problems might arise if a government sets a minimum price on a
particular good or service?
(a)
Explain what is meant by ‘the granting of subsidies’.
(b)
Explain the effects a subsidy would have on the market for a particular
good or service.
(c)
Explain, using examples, why a government may want to subsidise a
particular product?
(a)
Explain, using an example other than VAT, what is meant by the term
‘indirect taxes’.
(b)
(i)
Explain what is meant by the term ‘zero rated’.
(ii)
Explain why some goods are ‘zero rated’.
(c)
Explain, using a diagram, what happens when VAT is placed on a good or
service which had previously been zero rated.
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MICROECONOMICS
D4 – INTERVENTION – SUGGESTED SOLUTION
1
(a)
Maximum Price
Price limit set by the government below equilibrium (to keep price down). If
price set above equilibrium, then no effect on the market.
(b) Equitable distribution of a scarce resource. Restrict supply to release factors
of production for other uses. To help consumers afford a product. To set
limits on the returns producers can make.
(c) Artificial shortages (suppliers cut back on production), excess demand.
Black market develops (illegal and uncontrolled) and prices may be higher
than the free market price. Therefore consumers able to obtain goods at
maximum price will benefit, however consumers who are willing to pay a
higher price are disadvantaged as they may be unable to obtain it due to a
shortage of supply.
2
(a)
Minimum Price
Price limits set by government above equilibrium to encourage production
results in a surplus. A minimum price set below equilibrium price will not
affect the market.
(b) To help producers increase their incomes. (If price increases, suppliers
increase supply – greater profits). To guarantee incomes to producers.
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MICROECONOMICS
D4 – INTERVENTION – SUGGESTED SOLUTION
(c) Excess supply (producers are willing to sell more than consumers are
prepared to buy. Producers will be under strong pressure to reduce price
below the minimum (to clear the market). Therefore, government must
intervene again by (i) buying up the surplus or (ii) forcing or paying suppliers
to restrict the production. Both of these measures cost the taxpayer – public
finance used to pay for these measures.
3
(a) A subsidy is an allowance (grant) given by the government to producers to
encourage the production (or consumption) of a particular good or service.
(b) A subsidy will lead to an increase in supply causing a shift downwards (to
the right) of the supply curve. Equilibrium price will fall and equilibrium
quantity will rise. (PED will determine by how much of the actual price
reduction will be passed on to the consumer).
(c) Sometimes given to producers of essential items (for example milk) – to
encourage production. They may also be given to producers in the home
market to help them become more competitive (relative to imported goods).
4
(a) Indirect taxes are taxes on goods and services (taxes on expenditure), for
example excise duties.
(b) VAT is not charged (paid) on some goods and services – these goods and
services are, therefore, termed as ‘zero rated’ for example children’s clothes
and shoes, essential food items – no VAT is charged on these items. All
other items attract VAT (most at 17.5%).
(c) Supply curve shifts upwards by full amount of tax. Equilibrium price will
rise and equilibrium quantity will fall. (The amount of the tax actually
passed on to the consumer depends on the PED for the particular good – if
inelastic most of the tax will be passed on to the consumer).
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MICROECONOMICS
D5 – MARKETS
Scottair is considering starting an extra transatlantic flight from Prestwick to
Baltimore. At present the airline has the following costs per flight.
Fuel
£5,000
Insurance
£200
Airport Landing Charges
£300
Interest
£500
Wages
£5,000
Other fixed costs
£3,000
(a)
Using the above information, distinguish between fixed and variable costs.
(b)
Explain what is meant by the short run and the long run in economics.
(c)
If the seating capacity of the aircraft is 250 people, what is the minimum price
per seat that the airline must charge to remain in business?
(i)
(ii)
in the short run;
in the long run.
(d)
What factors are likely to determine the actual price charged by Scottair?
(e)
How might Scottair try to increase the demand for flights on their aircraft?
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D5 – MARKETS – SUGGESTED SOLUTION
(a)
Fixed – costs which remain fixed in the short term, no matter how much is
produced/independent of the number of flights made. For example, insurance,
interest and other fixed costs. Variable costs which vary directly with the
amount produced/number of flights made (due to a firm’s ability to increase
variable factor in the short run). For example, fuel, airport landing charges and
wages.
(b)
Short run – at least one factor of production is fixed. Long run – all factors of
production are variable. No set time period – depends on the length of time it
takes for all factors of production to become variable.
(c)
(i)
In the short run a business will continue to operate as long as variable
costs are covered. Therefore the minimum price per seat that Scottair
will charge in the short run is £41.20 (£10,3000 ÷ 250).
(ii)
In the long run all costs must be covered, therefore the minimum that
Scottair must charge to stay in business is £56 (£14,000 ÷ 250).
However, it must be remembered that £56 does not cover the
entrepreneur for the risk they have taken and an amount will be added
to the total cost to cover normal profit.
(d)
The percentage of normal profit added to the basic cost of the flight, the
amount of competition and competitors’ prices, the average number of seats
sold (not every flight may be filled to capacity).
(e)
Quality of service, not price competition e.g. free flight bags, free meals on
flights e.g. some airlines provide free meals on flights whilst other airlines you
have to pay for any meals consumed during the flight, free airport parking, etc.
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SECTION 2
OBJECTIVE TEST ITEMS
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THE BASIC ECONOMIC PROBLEM – MULTIPLE CHOICE ITEMS
1. A country achieves economic efficiency when:
A
B
C
D
the maximum amount of consumer wants is satisfied using existing
resources.
monetary growth is adjusted to match the growth in output.
a satisfactory level of economic growth is achieved without a net reduction in
the value of resources.
injections into the circular flow of income are made equal to withdrawals
from it.
2. The following production possibility curve relates to economy X.
For economy X, the opportunity cost of producing one more unit of capital goods:
A
B
C
D
is always two units of consumer goods.
increases as more capital goods are produced.
decreases as more capital goods are produced.
is always half a unit of consumer goods.
3. For a good to be considered scarce in the economic sense, it is necessary for it to:
A
B
C
D
confer utility on the consumer.
be unavailable in the shops.
command a price.
exist in small quantities.
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THE BASIC ECONOMIC PROBLEM – MULTIPLE CHOICE ITEMS
4. Factor inputs can produce the following possible combinations of products X and
Y per day.
COMBINATION
UNITS OF X
UNITS OF Y
1
1000
0
2
750
125
3
500
250
4
250
375
5
0
500
The opportunity cost of producing 1000 units of X will be:
A
B
C
D
zero
125 units of Y
250 units of Y
500 units of Y
5. Which one of the following is an example of a firm experiencing an increase in
technical efficiency?
A
B
C
D
reducing its price but maintaining its profit level.
producing its usual output but with fewer factors.
increasing its output and its profits.
reducing its total cost by using cheaper suppliers.
6. The diagram below shows the production possibility curve of a country.
Which one of the points shown will yield the highest growth rate in potential
output?
A
B
C
D
Point W
Point X
Point Y
Point Z
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THE BASIC ECONOMIC PROBLEM – MULTIPLE CHOICE ITEMS
7. The following diagram shows a production possibility curve of Country A.
In the above diagram an increase in potential output is represented by:
I
II
a movement from X to Y.
a movement from X to Z.
Which of the following is correct?
A
B
C
D
I only
II only
Both I and II
Neither I nor II
8. The following statements concern efficiency:
I
II
If a production process is technically efficient, it must also be economically
efficient.
If a production process is economically efficient, it must also be technically
efficient.
Which of the following is correct?
A
B
C
D
I only
II only
Both I and II
Neither I nor II
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THE BASIC ECONOMIC PROBLEM – MULTIPLE CHOICE ITEMS
9. The following diagram shows the production possibility curve of Country Z
The opportunity cost of producing OB capital goods is:
A
B
C
D
10.
OA consumer goods
AX consumer goods
OX consumer goods
BY capital goods
Jane Smith purchased a mountain bike for £150. A year later she notices that
the same model costs £200 but second-hand her bike will only sell for £60. What
is the opportunity cost to Jane of keeping her bike?
A
B
C
D
£50
£60
£90
£200
11. In a market economy, the main economic function of the price mechanism is:
A
B
C
D
to increase the level of competition in throughout the economy.
to ensure that factors of production can be easily transferred from one use to
another.
to allocate scarce resources for the purposes most demanded by society.
to assist the government to achieve its economic aims.
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12. The following diagram shows the production possibility of a firm.
The shift in the firm’s production possibility curve from PP1 to PP2 could have
been caused by:
I
II
III
a switch of existing factor resources from the production of refrigerators to
that of freezers.
the installation of a more efficient assembly-line for freezer production.
an increase in the weekly market demand for freezers.
Which of the following is correct?
A
B
C
D
I and II only
II only
II and III only
I, II and III
13. The following have been described as characteristics of public goods.
I
II
III
They have no opportunity cost.
Consumers can benefit from them without having to pay for them.
Their costs must be met from taxation revenue.
Which of the above is correct?
A
B
C
D
I only
II only
I and II only
I, II and III
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14. In the UK economy today, which of the following would be described by an
economist as being scarce?
I
II
III
bread
city parks with no admission charge
hospitals and schools
A
B
C
D
I only
I and III only
I, II and III
Neither I nor II nor III
15. The table below shows how the factors of production may be combined to produce
100 units of a certain good. Using only the information in the table, which
combination can be dismissed by the producer on the grounds of technical
inefficiency?
LAND
UNITS OF
LABOUR
CAPITAL
A
10
20
10
B
10
30
6
C
10
40
6
D
10
50
4
16. Which of the following statements would an economist regard as being correct?
I
II
If something is scarce, it must be limited in supply.
If something is limited in supply it must be scarce.
A
B
C
D
I only
II only
Both I and II
Neither I nor II
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17. The following production possibility curve relates to a particular country.
If the actual production moves from point X to point Y, this will:
A
B
C
D
Result in a short-term fall in living standards with the prospect of higher rates
of economic growth in the longer term.
Result in an immediate and continuing rise in both living standards and
economic growth rates.
Result in a short-term rise in living standards with the prospect of lower rates
of economic growth in the longer term.
Have no impact on living standards and growth, either in the short-term or in
the longer term.
18. The following table shows those combinations of cars and lorries which an
economy can produce per day.
Cars
Lorries
40
0
32
4
24
8
16
12
8
16
0
20
As the output of lorries rises, the opportunity cost of producing lorries in terms of
cars:
A rises then falls.
B rises continuously.
C falls continuously.
D remains constant.
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1. A
2. A
3. C
4. D
5. B
6. D
7. D
8. B
9. B
10. B
11. C
12. B
13. B
14. C
15. C
16. A
17. A
18. D
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1. The following diagram shows the demand for good B in relation to the price of
good A.
For most consumers, the above demand curve could represent the relationship
between:
A
B
C
D
tea and coffee
cameras and film
freezers and washing machines
mutton and wool.
2. The following table shows the price of a commodity and the quantity sold in a
competitive market during two time periods.
PRICE
QUANTITY
(PENCE)
(UNITS)
Period 1
50
10 000
Period 2
60
12 000
It is known that the quantity demanded is inversely (negatively) related to price
and the quantity supplied is directly (positively) related to price. Which one of
the following could explain the changes in price and quantity sold in Period 2?
A
B
C
D
An increase in the price of a complementary commodity
A reduction in the cost of an input used by supplying firms
The imposition of a selective excise tax on the commodity
An increase in the price of a substitute commodity.
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3. If all Brazilian coffee growers agree to restrict the supply of coffee and thereby
force up the price, the growers as a result would experience an increase in total
revenue if:
I the demand for Brazilian coffee is price inelastic.
II world income is rising.
III there are no economies of scale in growing coffee beans.
Which of the following is correct?
A
B
C
D
I only
I and II only
II and III only
I, II and III
4. As a firm increases its output in the short run, its average variable costs will
eventually start to rise because of:
A
B
C
D
diseconomies of scale
diminishing returns to the variable factor
increasing technical inefficiency
increasing economic inefficiency.
5. The following diagram shows what happens in the market for good X when the
producers receive a government subsidy.
The subsidy on good X is represented by the distance:
A P1-P2
B P1-P3
C P1–P2
D P2-P3
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6. The following table shows the average output of labour in a particular firm.
LABOUR
AVERAGE OUTPUT
(NUMBER OF MEN)
(UNITS PER WEEK)
1
2
2
6
3
12
From the above table, it can be correctly deduced that the weekly marginal output
of the third man is:
A
B
C
D
2 units
6 units
8 units
24 units
7. The curves which are cut at their lowest points by the marginal cost curve are:
I average total cost
II average variable cost
III average fixed cost
Which of the following is correct?
A
B
C
D
I only
I and II only
II and III only
I, II and III
8. If a firm increases its output and its average total cost rises,
I
II
its average variable cost must also have risen.
its marginal cost must be greater than its average total cost.
Which of the following is correct?
A
B
C
D
I only
II only
Both I and II
Neither I nor II
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9. The following diagram illustrates the market for loaves of bread which is in
equilibrium at a price of 50p.
If the government were to impose a maximum price of 40p per loaf, the short run
result would be:
A
B
C
D
unsold loaves in the market.
a loss to the producers of 10p per loaf.
an increase in the number of loaves bought per week.
a shortage of loaves in the market.
10. In economics, normal profit is defined as:
A
B
C
D
the minimum amount necessary to keep a firm in an industry.
the maximum amount left over after all the costs have been met.
the average amount earned by all firms in an industry.
the minimum amount necessary to cover variable costs.
11. As a result of increasing the price of its good from £1 to £1.10, a firm finds that its
total revenue from sales falls by 10%. It can therefore be concluded that, between
these two prices, the demand for its good is:
A
B
C
D
price elastic.
price inelastic.
unitary price elastic.
regressive.
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12. The following table shows the weekly amount of total utility a consumer receives
from consuming apples.
QUANTITY OF APPLES PER WEEK
TOTAL UTILITY
0
0
1
4
2
7
3
9
4
10
5
10
As the number of apples consumed per week increases from 0 to 5, this consumer’s
marginal utility:
A
B
C
D
decreases, then remains constant
increases, then remains constant
decreases continuously
eventually equals his total utility
13. The following diagram shows some cost curves of a firm.
MC = Marginal Cost
ATC = Average Total Cost
AVC = Average Variable Cost
AFC = Average Fixed Costs
To continue to produce in the long run, the above firm must receive a price of at
least:
A
B
C
D
£100
£60
£50
£40
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14. As part of a rehabilitation programme, some of the inmates at the local prison pick
strawberries in a neighbouring farm. The only cost to the farmer is providing a
meal for each prisoner; the cost to the farmer of each meal is £4.
The following data shows the strawberry output per day for different numbers of
pickers (prisoners).
NO. OF PRISONERS
VALUE OF STRAWBERRY OUTPUT
1
£20
2
£30
3
£38
4
£44
5
£49
6
£50
7
£50
The strawberry farmer is a profit maximiser and can have as many prisoners as he
wants. How many should he request?
A
B
C
D
1 prisoner
3 prisoners
5 prisoners
6 prisoners.
15. The following table shows alternative methods of producing 100 units of good X
per week
UNITS OF CAPITAL
UNITS OF LABOUR
Method 1
3
100
Method 2
5
75
Method 3
10
50
Which of the above methods is the most efficient?
A
B
C
D
Method 1
Method 2
Method 3
It is impossible to tell from the information given.
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16. The following diagram shows the total utility a certain consumer receives from
consuming packets of crisps
For this consumer, marginal utility begins to decline after consumption of the:
A
B
C
D
first packet of crisps.
second packet of crisps.
fourth packet of crisps.
eighth packet of crisps.
17. When a tax is imposed on a commodity, this will cause that commodity’s:
A
B
C
D
supply curve to shift to the right.
demand curve to shift to the right.
supply curve to shift to the left.
demand curve to shift to the left.
18. If a firm increases all its factor inputs by 50% and, as a result its long run
average total costs rise by 50% it has experienced:
A
B
C
D
constant returns to scale.
internal economies of scale.
internal diseconomies of scale.
a 50% increase in total output.
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19. ‘These new cheese biscuits are really addictive – the more I eat, the more I want.’
For the above consumer, the more cheese biscuits he eats the higher is his:
I
II
total utility.
marginal utility.
Which of the following is correct?
A
B
C
D
I only
II only
Both I and II
Neither I nor II
20. The following diagram shows the market for bread in which OP is the government
enforced maximum price.
If this market price were removed, and the market allowed to operate freely, there
would be:
I
II
III
IV
an increase in the quantity demanded.
a decrease in the quantity demanded.
an increase in the quantity supplied.
a decrease in the quantity supplied.
Which of the following is correct?
A
B
C
D
I and III only
I and IV only
II and III only
II and IV only
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21. The diagram below represents the short run average fixed cost, average total cost
and average variable cost curves of a firm. Curves I, II and III represent,
respectively
A
B
C
D
average variable cost, average total cost, average fixed cost.
average fixed cost, average total cost, average variable cost.
average total cost, average fixed cost, average variable cost.
average total cost, average variable cost, average fixed cost.
22. In a given time period, a rational consumer will go on consuming a free good until
total utility is:
A
B
C
D
equal to its marginal utility.
zero.
at a maximum.
equal to its average utility.
23. ‘The recent poor apple harvest combined with a government report on the healthgiving properties of apples explains the recent rise in the price of apples.’
According to this statement, the price of apples rose because of:
A
B
C
D
a shift to the right of the demand curve and a shift to the left of the supply
curve.
a shift to the left of the demand curve and a shift to the right of the supply
curve.
a shift to the left of both the demand and supply curves.
a shift to the right of both the demand and supply curves.
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24. The following diagram relates to the market for milk.
If the government imposes a minimum price of P2 what quantity of milk would be
sold per week?
A
B
C
D
OQ1
OQ2
OQ3
O1Q2
25. The recent price war in the newspaper industry has resulted in the price of
newspapers falling. As a result the total revenue from newspaper sales has also
fallen.
It follows that the demand for newspapers:
A
B
C
D
is price elastic.
is price inelastic.
has fallen.
must have stayed the same.
26. Fred Smith sells apples in a Sunday market. Given that any apples left on the
Sunday evening are thrown away, in order to maximise profit/minimise loss he
should set price which:
A
B
C
D
gives the greatest profit per apple.
ensures that all apples are sold.
maximise total receipts, i.e. price times quantity sold.
is greater than his cost of buying the apples.
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27. The following diagram shows the monthly demand for unleaded petrol.
The shift in demand, from D1D1 to D2D2 shown above, could have been caused by
which of the following?
A
B
C
D
a decrease in the price of unleaded petrol.
an increase in the subsidy paid to producers of unleaded petrol.
a decrease in the price of public transport.
an increase in the tax on leaded petrol.
28. A firm buys and sells 9 TV sets per day. It pays its supplier £120 per TV. Due to
rising demand it is able to increase its order to 10 TVs per day and receives a
discounted price of £110 per TV.
When the firm increases its order from 9 TVs to 10 TVs, the marginal cost of the
tenth TV is:
A
B
C
D
£10
£20
£110
£120
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1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
B
D
A
B
B
D
B
C
D
A
A
C
A
C
D
A
C
C
A
C
D
D
A
A
B
C
D
B
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SECTION 3
EXTENDED RESPONSE ITEMS
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THE BASIC ECONOMIC PROBLEM – EXTENDED RESPONSE ITEMS
1. (a) Explain what is meant by the problem of scarcity in economics.
7
(b) Suggest ways in which the problem of scarcity can be lessened.
8
(c) Explain how resources are allocated in a mixed economy.
10
2. (a) Explain what is meant by an economically efficient allocation of
resources.
8
(b) Explain why an economically efficient allocation of resources is
desirable.
4
(c) Explain how a free market economic system might achieve an
economically efficient allocation of resources.
13
3. (a) Explain the difference between technical and economic efficiency.
8
(b) Describe four measures that could be taken to increase the level
of technical efficiency in an economy and explain how these
measures would help to increase the level of economic growth.
17
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1. (a) Explain what is meant by the problem of scarcity in economics.
Explanation should be given of the nature of scarce resources (examples) in
relation to unlimited wants (individuals, firms, governments).
Why wants are unlimited – greed.
Students must explain that scarcity is a relative concept.
Difference between scarcity and a shortage.
(b) Suggest ways in which the problem of scarcity can be lessened.
Scarcity cannot be removed, although the use of scarce resources in the most
economically efficient way can alleviate the problem (for example
specialisation, full utilisation of resources).
Promotion of economic growth and ways this can be promoted;
government’s role in pursuit of economic growth – especially capital
creation, new technology, discovery of new resources.
Reference to individual factors –
• Land (reclamation, conservation, making land more efficient).
• Labour (increase in total population, increase in working population,
increase efficiency of labour, reduce frictions in labour market – for
example retraining).
• Capital – forgo present consumption (investment).
(c) Explain how resources are allocated in a mixed economy.
Definition of mixed economy (in terms of a mixture of market and planned
economies).
Free enterprise (private sector) – resources allocated by the price mechanism,
decisions taken through the workings of the market.
• Goods and services produced in response to consumer demand/ability to
pay.
• Factor of production attracted to expanding industries, away from
declining industries.
• Role of profit as signal to firms.
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Planned (public) state sector – government regulation in certain areas and
key industries run by the state for the benefit of other people.
Provision of social services regardless of ability to pay as free market may
not produce these effectively.
General state intervention is private sector – subsidies, acts affecting health
and safety, mergers, working conditions.
Students should use examples whenever possible.
2. (a) Fundamental problem of any economy is to make the best use of scarce
resources (definition and examples of resources).
Scarce resources have an opportunity cost (examples), therefore decisions
must be made about how they are allocated in order to make the best use of
them.
Maximum production of goods and services from available resources.
Using all resources and using them most efficiently (production possibility
frontier).
(b) Why an economically efficient allocation of resources desirable.
• To satisfy as many wants as possible.
• To improve living standards.
• Can allow a more equitable distribution of resources.
(c) Free Market System – limited government involvement in the economy.
• Economic decisions reached through the workings of the market.
• Prices signal the value of individual resources.
• Resources flow to where they yield the highest profit.
• High degree of competition represents the working of the free market
system.
• In the long run firms are producing at the lowest point on the average cost
curve and at this point the quantity of resources needed to produce a unit
of a commodity are minimised.
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• If all firms operated under these conditions it would follow that there
would be an optimum allocation of resources and every commodity would
be produced at a minimum cost per unit.
• All firms would be producing to consumers’ demand curves, therefore
they would not only be producing at minimum cost, but they would also
be the goods which people desired.
• High degree of competition would force prices down.
3. (a) Technical (productive efficiency refers to how goods are produced and
occurs when maximum output is being achieved from any given inputs (or a
given output is being produced from minimum inputs. Goods are therefore
being produced at minimum average total cost and minimum opportunity
cost.
Economic efficiency occurs when resources are being used to satisfy as many
wants as possible and therefore refers to what is being produced as well as
how. To be economically efficient production must, first of all be technically
efficient but in addition, the goods being produced must be those which
society wants most. (Technical efficiency is therefore a necessary but
insufficient condition for economic efficiency).
(b) Measures include: greater specialisation, increased spending on research and
development (through, for example, higher tax allowance, etc.), increased
vocational training, educational improvements, increased capital investment
(through reduced interest rates, increased capital allowances, etc.).
Students must relate above measures to economic growth, for example:
Greater specialisation leading to increased labour productivity (practice
makes perfect and so on); increased spending on research and development
leading to improved technology; increased vocational training leading to a
more skillful workforce and fewer skill shortages; educational improvements
leading to a better educated and more productive workforce; increased
capital investment leading to increased production of consumer goods.
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1.
2.
3.
4.
(a)
Explain why people generally consume more of a product as its price falls.
11
(b)
Show how factors other than price might affect the demand for a product.
14
(a)
Explain why more of a product is supplied when its price rises.
5
(b)
Other than price, explain the main determinants of supply.
12
(c)
Explain what is meant by price elasticity of supply and describe the factors 8
which affect it.
(a)
Explain how the price of a good in a free market will settle at the
equilibrium level.
8
(b)
(i)
Explain how the granting of a government subsidy on a good will
affect the equilibrium price and quantity of a good.
8
(ii)
Explain how the imposition of a maximum price can disrupt the
market for a good.
6
(iii)
Give one reason why governments might grant a subsidy and one
reason why they might impose a maximum price.
3
(i)
What is meant by fixed and variable costs.
4
(ii)
Describe and explain what happens to average fixed costs and
average variable costs as output increases in the short run.
10
(iii)
Explain why a firm may continue to produce in the short run even
when it is not earning enough revenue to cover all its costs.
4
(a)
(b)
Explain why economies of scale affect a firm’s long run average total
costs.
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5.
6.
(a)
Explain what is meant by price elasticity of demand and describe the
factors which affect it.
(b)
Explain the importance of price elasticity of demand for:
(i)
Sellers, when thinking of changing the price of their products.
13
(ii)
Producers of agricultural products when faced with fluctuating
harvests.
(iii)
Chancellors, when thinking about increasing VAT on certain goods
and services.
12
Explain why, when firms increase their level of output, they may face:
(a)
Rising average total costs in the short run.
10
(b)
Falling average total costs in the long run.
8
(c)
Rising average total costs in the long run.
7
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1.
2.
(a)
Income effect, substitution effect and diminishing marginal utility theory.
Use of diagrams is expected.
11
(b)
Description of effects of income (level and distribution), prices of
substitutes, prices of compliments, advertising, population, interest rates,
population, fashion, seasonal demand, government influence. Diagram
showing shifts in demand curve and relevant examples.
14
(a)
Increase in price – higher profits for producers, therefore more is supplied.
Also in a competitive market, new firms enter industry increasing supply.
5
(b)
Cost of factors of production, technology/technical efficiency, exogenous
factors e.g. weather, floods, taxes and subsidies, management/worker
efficiency, expectation of price changes, producer preference. Diagram
showing shifts in supply curve, and relevant examples.
12
(c)
Price elasticity of supply – degree of responsiveness of quantity supplied
to changes in price. It can be perfectly inelastic, inelastic, unitary, elastic
or perfectly elastic.
8
Factors which affect elasticity of supply, particularly time.
Producer substitutes.
3.
(a)
Explanation of how a market clearing price will be established in a free
market (if price is above equilibrium, the resultant surplus will pull down
price and if price is below equilibrium, the resultant shortage will push up
price). Relevant, well labelled diagrams should be included in the answer.
8
(b)
(i)
Explanation of how and why a subsidy affects supply. Explanation
(with diagrams) of how the resultant increase in supply will reduce
equilibrium price and lead to more being bought and sold.
8
(ii)
Price maximum – imposed below equilibrium price. Leads to
shortages and possible black markets and queues. Relevant, well
labelled diagrams should be included in the answer.
6
(iii)
Subsidy – to encourage production and/ or consumption etc.
Max Price – to keep price low, reduce inflation etc. Examples
should be included in the answer.
3
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4.
(a)
(i)
Fixed costs – do not vary with output.
4
Variable costs vary directly with output.
Examples of each type of cost should be included in the answer.
(ii)
Short run – the period of time over which at least one factor input
cannot be varied.
10
Average fixed costs – fixed costs divided by output. AFC decline
continuously since fixed costs are being spread over a bigger and
bigger output.
Average variable cost – variable cost divided by output. AVC
(usually) fall at first – because firm is experiencing increasing
returns to the variable factor, but then rise, when diminishing returns
to the variable factor set in. (Law of diminishing returns). This
question does not refer to economies/diseconomies of scale – long
run situation.
(iii)
5.
Short run – a firm will produce provided it can cover variable costs.
Or alternatively there are advantages to staying in production in the
short run e.g. customer goodwill, labour loyalty, etc.
4
(b)
Two economies of scale and explanation of how they will result in falling
long run average total cost.
7
(a)
PED – degree of responsiveness of quantity demanded of a good or service 13
to changes in its price. Not measured by the slope of the curve – elasticity
different at different prices. Diagrams expected of
elastic/inelastic/unitary/perfectly elastic/perfectly inelastic demand.
Factors which affect price elasticity:
Availability of substitute within a similar price range.
Degree of habit or necessity.
Proportion of income spent on good.
Time-price elasticity greater in the long run than the short run.
Durability.
Frequency of purchase of the good.
Formula unnecessary, however examples help show understanding and
help student clarify explanations.
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MICROECONOMICS
DEMAND, SUPPLY AND MARKETS – SUGGESTED SOLUTION
5.
6.
(b)
(a)
(i)
Explanations of relationship between PED and total revenue, i.e.
when PED is elastic and price rises, total revenue falls. When PED
is inelastic and price rises, total revenue rises.
(ii)
Understanding of how PED determines the extent to which price
changes when there is a change in supply.
(iii)
Purposes of VAT to raise revenue for government, therefore placed
on goods which have a price inelastic demand.
Law of diminishing returns. In short run at least one fixed factor,
therefore output can only be increased or changed by using more of the
variable factor.
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10
ATC=AVC+AFC. AFC falls as output is increased because FC are spread
over a larger and larger output.
However, fixed factor eventually becomes overworked. This creates
diminishing returns to the variable factor. When the increase in AVC
outweighs the decrease in AFC, ATC increases.
Students should use diagrams/examples to clarify explanations.
(b)
Long run all factors are variable. ATC falls because of increasing returns
to scale (economies of scale). Students should explain some of the
economies of scale and link them to falling average total cost.
8
Students should use diagrams/examples to clarify explanations.
(c)
In the long run, firms experience decreasing returns to scale (diseconomies
of scale). Students should explain some of the diseconomies of scale and
link them to rising average total cost.
Students should use diagrams/examples to clarify explanations.
Economics Support Materials: Microeconomics (Higher)
107
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