WORKBOOK ANSWERS
Edexcel AS/A-level
Economics A
Theme 1 Introduction to markets and
market failure
This Answers document provides suggestions for some of the possible answers that might be
given for the questions asked in the workbook. They are not exhaustive and other answers
may be acceptable, but they are intended as a guide to give teachers and students feedback.
The student responses (green text) for the longer essay-style questions are intended to give
some idea about how the exam questions might be answered. The examiner comments (blue
text) have been added to give you some sense of what is rewarded in the exam and which
areas can be developed. Again, these are not the only ways to answer such questions but
they can be treated as one way of approaching questions of these types.
The abbreviation KAA stands for Knowledge, Analysis and Application.
Topic 1
Nature of economics
Economics as a social science
1 2 marks for the definition below, or similar:
The study of society (1 mark) and the manner in which people behave/influence the world
around us (1 mark).
2 2 marks for any relevant definition, such as:

A theoretical construct representing economic processes (1 mark) by a set of logical
relationships between them (1 mark).

A simplified framework (1 mark) designed to illustrate more complex processes (1
mark).
3 2 marks for any of the following points:
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
1
TOPIC 1
Nature of economics

In sciences, like chemistry, experiments are conducted on scientific particles that can
be easily tested (1 mark) and react in the same way in the same experimental
conditions (1 mark).

In social sciences, like economics, experiments often involve people/the behaviour of
individuals (1 mark) and they may not react in the same way when tested/can react in
more unpredictable ways (1 mark).

Ceteris paribus means all other things being equal (1 mark).

Application to extract (1 mark), e.g. drop in price, ceteris paribus causes an increase
in consumer demand for broadband.

Further explanation (up to 2 marks), e.g. so we are assuming that demand for
broadband will increase if price drops, assuming that no other factors influencing
broadband demand changed (1 mark), such as the speed of connections (1 mark).
4
Positive and normative economic
statements
5 Possible answers include:

Objective statement (1 mark)

Based on fact (1 mark)

Can be tested as true or false (1 mark)

Involves a scientific approach (1 mark)
6 Possible answers include:

Subjective statement (1 mark)

Based on a value judgement (1 mark)

Cannot be tested as true or false (1 mark)

A non-scientific approach (1 mark)
7 a

Normative statement (1 mark)

Includes the phrase ‘should not’ (which implies a value judgement) (1 mark)
b

Positive statement (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
2
TOPIC 1

Nature of economics
Can test whether student applications went down by 1% (after tuition fees rose) (1
mark)
The economic problem
8 What? (1 mark)/ How? (1 mark)/ For whom? (1 mark)
9 The value of the next best alternative (1 mark) forgone (or given up) (1 mark).
10 1 mark for any relevant example:
a
Wind/solar/tidal energy etc. (1 mark)
b
Oil/coal/gold etc. (1 mark)
11 Possible answers include:

There are unlimited wants (1 mark) but limited resources (1 mark), i.e. scarcity (1
mark).

Therefore decisions/choices need to be made (about resource allocation) (1 mark).
12 Explanation (4 marks). Possible answers include:

Define opportunity cost (1 mark), i.e. value of the next best alternative forgone.

By spending on the advertising campaign HMV had less money to spend on other
areas of the business (to aid its survival) (1 mark).

Examples (1 mark each, up to 3 marks), e.g. on a new website (1 mark), new
products (1 mark) or customer service training for staff (1 mark).
Production possibility frontiers
13 The maximum output/combination of goods and services that can be produced (1 mark)
with resources used efficiently (1 mark).
14 a
F (1 mark)
b
E (1 mark)
c
E (1 mark)
d
B or A (1 mark)
15 a
b
200 million – 180 million = 20 million consumer goods (2 marks)
11 million – 6 million = 5 million capital goods (2 marks)
16
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
3
TOPIC 1
Nature of economics

Inward shift in the PPF (1 mark) as fewer consumer and capital goods can be
produced (1 mark).

Explanation (up to 2 marks): e.g. destruction of factories (1 mark) would reduce
capital stock in the economy (1 mark); loss of life would (1 mark) reduce quantity of
labour in the economy (1 mark).
17 Analysis (up to 6 marks). Possible answers include:

Definition of opportunity cost (1 mark), e.g. the value of the next best alternative
forgone.

Explanation of opportunity cost:

o
More capital goods mean fewer resources available to produce consumer
goods (2 marks).
o
Reduction in current living standards but higher future growth/living
standards/consumption (2 marks).
Diagram showing:
o
Axes labelled (i.e. consumer and capital goods) (1 mark).
o
Two points shown on the PPF (1 mark).
o
Illustration/labelling of opportunity cost (i.e. loss of consumer goods) (1 mark).
NB Maximum 4/6 marks if no diagram offered.
18 Analysis (up to 6 marks). Possible answers include:

Definition of production possibility frontier (1 mark), i.e. the maximum combination of
goods and services that can be produced in a given time with available resources
used efficiently.

Identification that PPF shifting outwards is economic growth (1 mark).

Factors shifting China’s PPF outwards (up to 2 marks each):

o
Increasing (working) population (1 mark), i.e. increase in quantity of labour (1
mark)
o
Increased capital goods/investment (1 mark), i.e. increase in quantity of
capital/machines/factories/productivity (1 mark)
o
Importing foreign technology (1 mark), i.e. increase in efficiency/quality of
capital/productivity (1 mark)
o
Increased access to raw materials (1 mark), i.e. importing cheap raw
materials from Africa (1 mark)
Relevant PPF diagram (up to 3 marks), showing:
o
Original PPF (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
4
TOPIC 1
Nature of economics
o
Outward shift in PPF (1 mark)
o
Correct labelling (i.e. capital and consumer goods) (1 mark)
NB Maximum 4/6 marks if no diagram offered.
Evaluation (2 marks for one point):

Long-term problems facing China, e.g. falling population/lack of Western technology
to import

Future growth depends on ability to innovate or policies to promote education and
innovation

High magnitude of Chinese growth (reference to 7.7%)

Significance and prioritisation of reasons (with justification)
Specialisation and the division of labour
19 The process by which individuals/firms/economies concentrate on producing those goods
and services (1 mark) in which they have an advantage (1 mark).
20 1 mark per identified point, such as:
a

Medium of exchange

Store of value

Method of deferred payment
b

Greater efficiency/productivity

Higher output levels

More competitive exports

Higher economic growth/jobs
21 Analysis (3 marks). Possible answers include:

Definition of staff turnover (1 mark), e.g. total number of staff leaving divided by
number of people employed.

Application: staff turnover is 50% in call centres (1 mark).

Reasons for staff leaving/high staff turnover (1 mark each):
o
Limited range of tasks performed
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
5
TOPIC 1
Nature of economics
o
Repetitive nature of job
o
Boredom/monotony
o
Few breaks/tiring work
22 Analysis (up to 4 marks):

Definition of productivity (1 mark), e.g. output per worker/efficiency of turning inputs
into outputs.

Application: customer calls per person (1 mark)/how call centres divide labour (1
mark).

Reasons for higher productivity (up to 2 marks if point well explained):
o
Workers could specialise in what they do best (1 mark), e.g. taking calls
within their area of expertise (1 mark).
o
Workers should become better at the same task over time (1 mark), e.g. be
able to deal with customer complaints quicker (1 mark).
o
Workers do not need to move between jobs (1 mark), e.g. workers can
remain taking calls, rather than also doing the accounts (1 mark).
o
Cheaper to train workers to do one task (1 mark), e.g. highly-trained workers
should be more efficient/productive (1 mark).
Evaluation (2 marks for one point). Possible points include:

Repetitive job/boredom may reduce rate of work and lower productivity.

Productivity may remain low for other reasons:
o
Training is not effective
o
Workers unable to improve over time
o
Workers may not be specialising in their job due to it being their specialism
(i.e. it may be the only job they can get currently)

High productivity may not be the aim of the call centre (i.e. a speedy call may be good
for productivity but not help the customer).

Difficulty measuring productivity in the service sector (i.e. is it number of calls
completed per person or number of successful calls?)
Free market, mixed and command
economies
23 Where (scarce) resources are allocated (1 mark) totally by the government (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
6
TOPIC 1
24 a
Free market economy
b
Free market economy
c
Command economy
Nature of economics
25 Any possible role (1 mark) with explanation (2 marks). Possible answers include:

To solve market failure (1 mark): e.g. negative externalities (of pollution) (1 mark) by
the imposition of a (petrol) tax (1 mark); e.g. public goods (1 mark) by providing
defence/street lights (1 mark).

To promote equality (1 mark): e.g. by providing benefits (1 mark) to increase income
of low-income households (1 mark); e.g. by lowering tax on the poor (1 mark) to
increase income of low-income households (1 mark).
26 Two benefits identified (1 mark + 1 mark) with explanation (1 mark + 1 mark):

Increased competition/efficiency (1 mark), e.g. as firms will earn higher profits from
lower costs/aid survival (1 mark)

Increased innovation (1 mark), e.g. as firms that innovate could earn more
profits/more likely to survive (1 mark)

Greater choice for consumers (1 mark), e.g. as firms may offer more products to
increase profits/survive (1 mark)

Greater incentives to work (1 mark), e.g. due to lower levels of taxation or fewer
benefits from not working (1 mark)

Possible higher growth rates (1 mark), e.g. due to higher efficiency/innovation shifting
the PPF (1 mark)
Exam-style questions (multiple choice and short answer)
1 a
D (1 mark)
b
Knowledge (1 mark): definition of specialisation, e.g. focusing on the production
where there is an advantage.
Application (1 mark): application to Nigeria, e.g. fluctuating price for oil, changes in
demand for oil.
Explanation (1 mark): explanation of a problem, e.g. risk of over-specialisation and lack of
diversification; risk of falls in export revenues/GDP/employment.
Specialisation is the process by which economic agents focus on areas of
production where they have an advantage (1 mark). This can be a problem as they
face greater risk of export revenues falling (1 mark), for example in Nigeria if there
was a significant drop in the oil price, which tends to fluctuate wildly over time (1
mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
7
TOPIC 1
Nature of economics
Here the student scores 3/3 marks as she clearly defines specialisation and then applies it to
Nigeria.
2 a
Knowledge (1 mark): definition of opportunity cost, i.e. value of next best alternative
forgone.
Application (1 mark): calculation of opportunity cost, i.e. 20 capital goods.
Opportunity cost is the value of the next best alternative forgone (1 mark). Here the
opportunity cost is 20 capital goods (i.e. 80 – 60) (1 mark).
This gains 2 marks for a clear definition and application to the PPF shown with the calculation.
b
C (1 mark)
c
Knowledge (1 mark): annotation of any point outside the current PPF.
The student has clearly marked the new point outside the PPF for 1 mark.
3 a
A (1 mark)
b
Knowledge (1 mark) (identification of function), analysis (1 mark) (development of
answer). Possible answers include:

Medium of exchange (1 mark), e.g. money allows economic agents to exchange
goods without the need for barter (1 mark).

Store of value (1 mark), e.g. individuals can choose to forgo consumption in the
current time period and save to increase their spending power in the future (1 mark).

Method of deferred payment (1 mark), e.g. allows payment for goods and services
consumed today in a future time period (1 mark).
One function of money is a medium of exchange (1 mark). This allows consumers
to buy goods and services without the need for barter, as money is accepted as
payment (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
8
TOPIC 1
Nature of economics
The student gains full marks for a clear function identified and explained.
c
Knowledge (1 mark) (identification of cause of PPF shift), analysis (1
mark)(development of answer). Possible answers include:

Education (1 mark), e.g. improved human capital/quality of labour/productivity (1
mark)

Investment (1 mark), e.g. increased quantity of capital goods/improved productivity (1
mark)

Improved productivity (1 mark), e.g. more efficient use of current factors of production
(1 mark)

Larger workforce (1 mark), e.g. greater quantity of labour (1 mark)

Better technology (1 mark), e.g. higher-quality capital goods/higher productivity (1
mark)

Discovery of raw materials (1 mark), e.g. greater land/resources to produce goods
and services (1 mark)
One cause of an outward shift in the PPF is better technology (1 mark). This means
that production can become more efficient due to higher-quality capital goods
being used, hence boosting potential output (1 mark).
This student easily gains the 2 marks available for a shift factor identified and then some linked
explanation to develop the answer.
4 a
Knowledge (2 marks):

Definition of opportunity cost (1 mark)

Link to basic economic problem (1 mark), i.e. scarce resources lead to choices
needing to be made, each with an opportunity cost
Application (1 mark) (example of opportunity cost for Sabrina), analysis (1 mark).
Possible answers include:

Being able to get a job (1 mark), e.g. by going to university Sabrina must give up the
income she could have earned by starting employment after sixth form (1 mark).

Increasing her savings (1 mark), e.g. by spending money on living at university/fees,
Sabrina has less money available to save for her future (1 mark).

Spending on leisure items (1 mark), e.g. by spending money on living at
university/fees, Sabrina has less money available to spend on cinema trips/on a new
car etc. (1 mark).
An opportunity cost is the value of the next best alternative forgone (1 mark).
Sabrina faces an opportunity cost as her resources are scarce and so any choice
she makes she must give up the next best option (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
9
TOPIC 1
Nature of economics
For example, Sabrina could have been able to get a job instead of going to
university (1 mark) and therefore earned income instead of going to university and
paying up to £9,000 a year on fees (1 mark).
The student here gains all 4 marks. He has defined what opportunity cost means and linked this
to the basic economic problem to explain why it exists. The explanation is backed up with a clear
example in the context of Sabrina going to university and is developed with an additional
sentence.
b
D (1 mark)
Exam-style questions (data response)
5 a
KAA = 5 marks
Knowledge (1 mark):
Definition of production possibility frontier (1 mark), i.e. the maximum combination of
goods and services that can be produced in a given time with available resources used
efficiently.
Application (1 mark):
Reason for PPF shift (1 mark), e.g. BMW investing £250m to expand UK factories or BMW
has invested £250m in capital goods.
Analysis (3 marks):

Identification that the PPF shifts outwards/economic growth (1 mark)

Relevant PPF diagram (up to 2 marks), showing:
o
original PPF (1 mark)
o
outward shift in PPF (1 mark)
You need to include a production possibility frontier in your answer and shift the curve
appropriately. This student scores 5/5 marks by using a clear diagram, a definition and
application to the case study:
A production possibility frontier shows the maximum combination of goods and
services that can be produced in a given time with available resources used
efficiently (1 mark).
BMW has invested £250 million to expand the capacity of its factory (1 mark). This
will lead to an increase in its PPF (1 mark), as shown below (2 marks):
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
10
TOPIC 1
Nature of economics
b KAA = 6 marks
Knowledge (2 marks):

Definition of a normative statement (1 mark), e.g. a subjective statement/based on a
value judgement/that cannot be tested and verified.

Definition of a positive statement (1 mark), e.g. an objective statement/an assertion of
fact/that can be tested and verified.
Application (2 marks), analysis (2 marks):

Example of normative statement (1 mark), e.g. McLaren is the producer of one of the
all-time best Formula 1 cars.

This is a normative statement as whether McLaren is one of the all-time best Formula
1 cars cannot be tested/requires a value judgement (1 mark).

Example of positive statement (1 mark), e.g. since December 2011 McLaren has also
been producing high-end sports cars and this provides 350 jobs to the UK technology
sector.

This is a positive statement as it can be tested whether 350 jobs were created or not
referring to available evidence/it is a statement that is based in fact (1 mark).
The skill with positive versus normative questions is being able to pick out which statements are
which. Here providing a definition of each, an example and some explanation of why you chose
each statement is enough to earn full marks.
A positive statement is an assertion of fact, which can be tested and verified using
available evidence (1 mark): for example, the fact that McLaren’s production of
high-end sports cars ‘provides 350 jobs in the UK technology sector’(1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
11
TOPIC 1
Nature of economics
Whether 350 jobs were created can be tested by looking at employment statistics
at the company after the expansion (1 mark).
A normative statement is a subjective statement based on a value judgement (1
mark): for example, McLaren producing ‘one of the all-time best Formula 1 cars’
(1 mark). People could disagree whether McLaren is the all-time best F1 car; it will
depend on their own value judgement (1 mark).
c KAA = 6 marks
Knowledge (2 marks), application (2 marks), analysis (2 marks):

Define division of labour, i.e. the process whereby the production process is broken
down into a sequence of stages with workers assigned to particular stages

Identification of benefits of division of labour

Application to cars, e.g. assembly lines used in production of cars; workers split into
different tasks, such as painting/welding
Benefits of division of labour:

increased productivity

lower cost per unit

more competitive prices

higher-quality cars/worker specialisation

higher revenue and profit

lower training costs

more effective use of capital

allows macro benefits, e.g. higher exports, higher UK growth and jobs
Evaluation (4 marks):

Possible downsides of repetitive work, e.g. higher staff turnover, lower-quality work,
lower productivity, strike action

Risk of assembly line breaking down, e.g. if suppliers are unreliable, if workers are
away/on strike

Risk for workers of overspecialising, e.g. chance of structural unemployment and
labour immobility if machines used instead of workers or factories close/downturn in
demand

Significance of benefits gained depends on type of car manufacturer, e.g. McLaren
will use division of labour to ensure high quality and justify brand and pricing,
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
12
TOPIC 1
Nature of economics
whereas BMW is producing on a larger scale to gain productivity and competitive
prices

Magnitude arguments, e.g. millions produced by BMW compared to thousands by
McLaren could show larger magnitude of productivity benefits in Mini production

Long-term arguments, e.g. if the world economy recovers more expansion could
occur, increasing jobs/growth further
The key to this question is to understand the benefits and drawbacks of division of labour in the
context of the car industry. The extract gives two different car manufacturers; comparing these
is a good route to evaluation marks.
This student gains well over the maximum 10/10 marks:
Division of labour is the process whereby the production process is broken down
into a sequence of stages with workers assigned to particular stages.
One potential benefit of division of labour is higher productivity. This is because
workers in the car factory can make use of the assembly line at the Cowley
factory. This should help companies lower their cost per unit and be able to gain
more competitive prices.
Another benefit is that it will be easier and cheaper to train workers as they are
only performing one task in the production process, such as welding or painting.
This should allow car companies to create high-quality products with fewer errors
and mistakes, boosting profits.
KAA = 6/6 marks (for two benefits explained in context; full marks would have been gained).
The benefits of division of labour will depend on the car firm in question. For
example, McLaren as a high-quality sports car manufacturer will hope to gain
consistently high quality by dividing labour between highly-skilled engineers.
This will help maintain its brand image. BMW is likely to focus on much largerscale production to gain lower average costs and compete on price.
Car manufacturers may also see downsides, such as high staff turnover, as
workers carry out repetitive, monotonous work every day, such as always doing
welding rather than contributing to all aspects of the car, which may be more
rewarding. This low morale could also damage the high quality and high
productivity, which division of labour can arguably bring.
Evaluation 4/4 marks for two evaluation points with relevant reasoning in context. Critical use of
the evidence is shown by comparing the impact on different car companies.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
13
TOPIC 2
How markets work
Topic 2
How markets work
Rational decision-making
1 2 marks for definition, such as:
Attempting to get the highest amount of welfare possible (2 marks).
2 2 marks for definition, such as:

Attempting to get the largest difference between total revenue and total cost (2
marks).

Setting marginal cost equal to marginal revenue (2 marks).
3 Possible answers include:
Even though the new bran flakes are cheaper and this should improve her welfare (1
mark) there may be other factors that make the new bran flakes less desirable (1 mark),
such as lower quality (1 mark).
4

The new product is the best option (1 mark).

As the profit is higher by £3 million (1 mark) or £5 million is higher than £2 million (1
mark).
Demand, supply and price determination
5 The price and quantity (1 mark) where demand equals supply (1 mark)
6 a
Increased demand (1 mark) meaning higher house prices (1 mark)
b
Decreased supply (1 mark) meaning higher house prices (1 mark)
7 Possible answers include:

Diminishing marginal utility means that as output increases, the amount of welfare
gained from the next unit is less (1 mark).

Therefore as quantity increases, consumers will be less willing to pay a higher price
for a product (1 mark) due to the lower utility they gain from the next unit (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
14
TOPIC 2

How markets work
This means that demand is downward sloping (1 mark).
8 Possible answers include:

Application (1 mark), e.g. fall in oil prices in 2012 and fall in Shell share price by 1%.

Relevant diagrammatical analysis (up to 4 marks):
o
Original and new equilibrium price (1 mark + 1 mark)
o
Decrease in demand (1 mark)
o
Increase in supply (1 mark)
 Link between oil prices and Shell’s share price (1 mark each):
o
Less demand for shares due to less potential return/profits/dividends for
investors/lower oil prices (1 mark)
o
More supply of shares as Shell shareholders selling their shares in order
to invest in other companies (1 mark)
9 Analysis (6 marks). Possible answers include:

Application (1 mark), e.g. fell to $108.17

Diagram (up to 4 marks):
o
Original demand and supply with equilibrium price (1 mark)
o
Reduced demand (1 mark)
o
Increased supply (1 mark)
o
New lower equilibrium price (1 mark)
NB Award a maximum of 2 marks for diagram if just one curve shifted.

Reasons for lower price (1 mark + 1 mark):
o
Reduced demand from China/Europe/weak world growth
o
Increased supply due to less political tension in Iran and Israel and US
stockpiles
Evaluation (2 marks for one developed point):

Magnitude of oil price fall

Impact on price depends on magnitude of shifts or PED/PES

Long-term price or short-term decline?

Prioritisation between factors
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
15
TOPIC 2
How markets work
Price mechanism
10 Where the free markets allocate resources (1 mark) through the interaction of demand and
supply/the invisible hand of the market (1 mark).
11 Possible answers include:

Application (1 mark), e.g. charging on M6 toll or proposed M4 relief road.

There is a shortage of roads/excess demand of road space (1 mark), e.g. traffic jams
on the M4 in Wales currently (1 mark).

A higher price for road usage (on a toll road) will exclude those who are not willing
and able to pay (1 mark) as they will find alternative means of transport (1 mark),
meaning fewer people using the road/contraction in demand (1 mark).
12 Possible answers include:

Definition of excess supply (1 mark), i.e. where supply exceeds demand.

Application: the M6 toll being largely empty (1 mark).

A lower price will lead to an expansion of demand (1 mark) while supply will remain
fixed (1 mark), allowing equilibrium to be reached/demand to equal supply (1 mark).
Price, income and cross elasticities of
demand
13 Possible answers include:

When a % change in price leads to an infinite percentage change in quantity
demanded (2 marks).

PED has a value of infinity (1 mark) with numerical example (1 mark).

Demand curve is perfectly horizontal (1 mark) with diagram (1 mark).
14 Possible answers include:

When income rises there will be more demand for normal goods (1 mark) and less
demand for an inferior good (1 mark).

When income falls there will be less demand for normal goods (1 mark) and more
demand for an inferior good (1 mark).

Normal goods will have a positive YED (1 mark) and inferior goods have a negative
YED (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
16
TOPIC 2

15 a
How markets work
Demand for normal goods is positively correlated with income (1 mark) whereas
demand for inferior goods is negatively correlated (1 mark).
Any relevant examples — possible answers include:

Domestic holiday (1 mark)

Supermarket value products (1 mark)
b
Any relevant examples, possible answers include:

Sky and Virgin Media (1 mark)

Cars and public transport (1 mark)
16 1 mark for correct answer, 2 marks for explanation. Possible answers include:

Complements have a negative XED (1 mark).

If the price of one complement falls then there will be a rise in demand for the other
complement (1 mark).

Therefore there is a negative relationship/correlation between the price of one good
and the quantity demanded of the other (1 mark).

Numerical example (up to 2 marks), e.g. dishwasher tablets increase in price by 10%
and then demand for dishwashers falls by 5% (1 mark) implies XED of negative 0.5
(1 mark).
17 2 marks for each calculation (1 mark workings, 1 mark answer):

−0.4 × 5% = −2% (buses)

−0.5 × 5% = −2.5% (rail)
18 Possible answers include:
Diagram (up to 4 marks), showing:

Inelastic demand curve (1 mark)

Increase in price and fall in quantity (1 mark)

Old revenue shaded/annotated/referred to in answer (1 mark)

New revenue shaded/annotated/referred to in answer (1 mark)
Explanation (up to 4 marks):

Definition of inelastic demand or PED (1 mark), e.g. where demand changes less
than proportionately than quantity demanded or the responsiveness of quantity
demanded to a change in price.

Definition of total revenue (1 mark), e.g. price × quantity or the money a company
earns from selling goods and services.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
17
TOPIC 2
How markets work

Identification that demand is inelastic and therefore a rise in price will boost revenue
(1 mark).

Further explanation (which could include a numerical example) (2 marks), e.g. the
loss of customers from the higher fare will be more than compensated for by the
higher fare paid by the remaining customers.
19 Possible answers include:

Car journeys are a normal good (1 mark).

Because when incomes fell in the UK, quantity demand for cars also fell (2 marks).

Reference to UK car figures (e.g. 3.5% fall in car demand) (1 mark).

Car journeys would have a positive YED (1 mark).

Explanation of inferior goods (1 mark), e.g. inferior goods would have seen a rise in
demand when incomes fell or have a negative YED or buses and rail journeys were
inferior goods.
20 Possible answers include:
Analysis (up to 4 marks):

If the price (cost) of car journeys increased then quantity demanded for bus journeys
would increase (2 marks) as travellers will switch to the cheaper form of transport (1
mark).

Buses and cars are substitutes (1 mark).

Buses and cars will have a positive XED (1 mark).

Application (1 mark): XED between cars and public transport is +0.04.
Evaluation (up to 2 marks for one point):

Buses and cars are weak substitutes (1 mark) and explanation (1 mark), e.g. car
users still prefer the convenience/comfort of their car even if it costs more or car
users may not switch due to public transport being viewed as unreliable etc. or
reference to XED figure of close to zero in the extract.

In the long term more switching may occur (1 mark) and explanation (1 mark), e.g.
time to find public transport information/time to switch or public transport may improve
over time, making switching more likely.

There may need to be a significant increase in car journey prices (1 mark) to give
enough of an incentive to switch to buses (especially if bus journeys are seen as
lower quality) (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
18
TOPIC 2
How markets work
Price elasticity of supply
21 Possible answers include:

The responsiveness of quantity supplied to a change in price (2 marks)

= % change quantity supplied/% change in price (2 marks)
22 Possible answers include:

The short run is a time period where at least one factor (of production) is fixed (1
mark).

The long run is a time period where all factors (of production) are variable (1 mark).

3%/25% = 0.12 (2 marks)

PES is inelastic (as it is less than +1) (1 mark)
23
24 Possible answers include:
Analysis (4 marks):

Define PES (responsiveness of quantity supplied to a change in price) (1 mark).

PES will become more elastic or greater responsiveness of quantity supplied to a
change in the gold price (1 mark).

Application, e.g. to Cornish mine re-opening (1 mark)

More firms are able to supply now in response to a change in the gold price due to
greater capacity (2 marks).

Greater exploration should lead to more gold discoveries, meaning more supply of
gold is available to respond to changes in price (2 marks).
Evaluation (2 marks for one point):

The increase in PES depends on the success of exploration of gold (1 mark) with
explanation (1 mark), e.g. lack of new discoveries as gold becomes scarce or
possible inability to extract new gold profitably due to the cost of extraction.

In the long run PES may become even more elastic (1 mark) with explanation (1
mark), e.g. a high gold price for many years may make even costly gold profitable to
extract or even more firms entering the market to take advantage of high gold prices.

In the very long run PES may become inelastic (1 mark) with explanation (1 mark),
e.g. as it is a non-renewable/scare resource (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
19
TOPIC 2
How markets work
Consumer and producer surplus
25 2 marks per definition:

Consumer surplus is the difference between what consumers are willing and able to
pay and the market price (2 marks).

Producer surplus is the difference between the market price and what producers are
willing and able to supply at (2 marks).

For description of areas only (1 mark each), e.g. consumer surplus is the area below
the demand curve and above the market price (1 mark), producer surplus is the area
above the supply curve and below the market price (1 mark).
26 a
P1EA and CEP1 (2 marks)
b
P2FA and BFP2 (2 marks)
c

PS fallen (1 mark) by P1EFP2 (1 mark)

Gained P1GFP2 (1 mark) but lost CEGB (1 mark); overall consumer surplus has fallen
(1 mark)
27 Possible answers to max. 4 marks include:

Define price inelastic demand, i.e. where quantity demanded responds less than
proportionately to a change in price (1 mark).

Explanation of why cigarettes tend to have inelastic demand (e.g. habit-forming good)
(1 mark).

If demand is more price inelastic then consumer surplus would increase/be larger (1
mark) relative to producer surplus (1 mark) as producer surplus would stay
unchanged (1 mark).

Any appropriate diagram showing consumer and producer surplus with inelastic
demand (2 marks).
Indirect taxes and subsidies
28 Possible answers include:

Grant/money given by the government to firms (1 mark) and one other point (1 mark),
e.g. to reduce production costs or to increase supply/production or to reduce price.
29
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
20
TOPIC 2
How markets work

Ad valorem tax is a levy charged by the government as a percentage of the price (1
mark).

A specific (or unit tax) is a levy charged by the government set at a constant amount
per unit (1 mark).

Figure 1 shows a specific tax (as it is a parallel shift) (1 mark).
30 a
The line P1P2 (or AB) (1 mark)
b
The box (P1BCD) (1 mark)
c
The line AC or P1D (1 mark)
d
The box P2ACD (1 mark)
31 Possible reasons include:

To encourage production of certain goods and services (1 mark), e.g. subsidising
renewable energy (1 mark) to reduce the demand for non-renewable energies and
therefore reduce pollution (1 mark).

To support a failing industry (1 mark), e.g. supporting the UK car industry (1 mark) in
order to protect employment (1 mark).
32 Possible answers include:
Analysis (6 marks):
Subsidy diagram (up to 4 marks), showing:

Original demand and supply and equilibrium (1 mark)

Increase in supply (1 mark)

New lower equilibrium price and higher quantity (1 mark)

Subsidy area (1 mark)
1 mark for any benefit and 1 mark for further development (up to 4 marks):

Lower price of medical drugs for LEDC citizens

Higher availability of medical drugs for LEDC citizens

Benefits of greater medical use (e.g. higher life expectancy, lower infant mortality)

External benefits: healthier workforce, higher GDP

Higher consumer surplus

Higher producer surplus
Evaluation (4 marks): one or two evaluation points (up to 4 marks for each if well
developed). Evaluation points include:
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
21
TOPIC 2
How markets work

Impact on price and quantity depends on elasticity of demand.

Impact depends on magnitude of subsidy and the number of countries subsidised
(extract mentions 7 countries in pilot study).

Long-term arguments, e.g. controversy may mean that the subsidy is scrapped and
therefore only a short-term benefit or early signs are of the scheme working so it
could be expanded to more countries or it will take a long time to assess any medical
benefits (no data yet).

Prioritising/significance of benefits.

Counter-points, e.g. medical aid from charities would be provided at a lower price
(free) and possibly in higher quantities or Oxfam concerned over whether the drugs
will be administered properly.
Alternative views of consumer behaviour
33 a
2 marks for any of the following:

Mitchell and Mark may prefer to stick to O2 as it is what they have always done (1
mark)/and therefore is a habit to always purchase O2 (1 mark).

E.g. due to brand loyalty or due to convenience (1 mark)
b
2 marks for any of the following:

Mitchell and Mark may not be able to work out the best deal for mobile phones (1
mark) as there are too many calculations to make to find it (1 mark).

E.g. due to the high number of tariffs or contract options available (1 mark)
c
2 marks for any of the following:

Mitchell and Mark may buy O2 as that is what other people buy (1 mark)/and
therefore they assume this is the best deal for them too (1 mark).

e.g. Mitchell may always use the same phone provider as Mark (1 mark)
34 Analysis (6 marks). Possible reasons why it may be irrational:

Understanding of irrationality, i.e. consumers may not be maximising their own utility
(1 mark)

Application (up to 2 marks), e.g. may not get the most welfare from their book
purchase by only buying from the best-seller list
Possible reasons why buying from the best-seller list may not be rational (up to 3 marks
per point):

Influence of other people’s behaviour, i.e. may be buying books that other people like,
which they do not
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
22
TOPIC 2
How markets work

Habitual behaviour, i.e. may continue to just buy from the best-seller list out of habit
even if the books they find do not maximise their welfare

Computational difficulties, i.e. cannot shop around to find the best book as so many to
choose from and therefore go to the best-seller list

Not shopping around, i.e. not undertaking a proper analysis of the books available
and therefore may not find the best book for them
Evaluation points (up to 2 marks for one point):

The best-seller list may contain books that are more likely to meet their needs, as
critically acclaimed/bought by many others.

The best-seller list may save time and be more convenient, saving time and
improving welfare.

Prioritisation of arguments or justified conclusions.
Exam-style questions (multiple choice and short answer)
1 a
b
B (1 mark)
Knowledge (2 marks):
1 mark for a partial definition:

A measure of producer welfare

The area above the supply curve but below the equilibrium price
2 marks for a full definition:

The difference between the market price which firms receive and the price at
which they are willing and able to supply
Producer surplus is the difference between the market price the firm receives and
the price at which it is willing and able to supply (2 marks).
On these questions, a clear definition such as the one given here is enough for 2 marks.
c
1 mark for knowledge: shading of the increase in producer surplus area on the
diagram.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
23
TOPIC 2
How markets work
The student has clearly annotated the change in producer surplus for 1 mark.
2 a
B (1 mark)
b
Knowledge (1 mark): definition/understanding of utility maximisation, i.e. decisions
made in order to gain the most welfare.
Application (1 mark): application of utility to energy customers, e.g. better deals on
energy bills/better value for money.
Analysis (1 mark): development of point made, e.g. by shopping around energy
customers could gain around £100 a year or switching energy providers may allow
customers to save money and maximise utility.
Utility maximisation means that consumers make decisions in order to gain the
most welfare possible (1 mark). Here energy customers could improve their welfare
by getting better value for money on their energy tariffs (1 mark). This can be done
by shopping around for the best deal, which Ofgem says could save them £100 on
average a year (1 mark).
The student gains full marks here as the answer defines utility maximisation clearly and applies
utility to the energy customer scenario. The final mark was gained by developing the argument
further, i.e. the need to shop around to get better deals.
3 a
b
A (1 mark)
Application (2 marks): 1 mark for working and 1 mark for final answer
= 100,000 × (£4 – £2) = £200,000
NB If £200,000 stated then full marks should be given.
The subsidy will cost £200,000, i.e.100,000 × £2.
The student gains full marks here and would have done if they had just stated £200,000.
However, on calculations it is best to show workings in case you make an arithmetic error.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
24
TOPIC 2
c
How markets work
Knowledge (2 marks):

1 mark for producer subsidy area

1 mark for consumer subsidy area
The student has clearly annotated the producer and consumer subsidy areas and gains 2 marks.
4 a
Application (2 marks):
1 mark for applying the formula, 1 mark for answer:

−0.6 = %∆QD/+15% (1 mark)

%∆QD = −9% or fall by 9% (1 mark)
NB Full marks for answer, but only if clearly noted as a fall/negative %∆ in QD.
PED = %∆QD/%∆P
−0.6 = %∆QD/+15% (1 mark)
−0.6 × 15% = −9% (1 mark)
Quantity demanded fell by 9%
Here the student gains full marks for applying the formula and gaining the correct answer. The
student benefited from writing out the formula, clear workings and underlining the correct
answer.
b
Knowledge (1 mark): tobacco cigarettes and e-cigarettes are substitutes or have
positive XED.
Application (1 mark): a relevant example, e.g. a fall in the price of e-cigarettes would lead
to a fall in demand for tobacco cigarettes.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
25
TOPIC 2
How markets work
Tobacco and electronic goods are substitutes for one another (1 mark). Therefore, if
the price of electronic cigarettes rose, the demand for tobacco cigarettes should
rise too (1 mark).
The student gains 2 marks for clear use of XED theory and application to the example of
cigarette types.
c
C (1 mark)
Exam-style questions (data response)
5 a
KAA = 5 marks
Knowledge (1 mark): identification that nightclub tickets are a normal good (1 mark).
Application (2 marks): use of the extract (2 marks), e.g. incomes falling in the recession
(1 mark) and customers ‘can no longer afford a night out’ (1 mark).
Analysis (2 marks): up to 2 marks for some of the following:

Definition of YED (1 mark)

Explanation of a normal good, e.g. a good demanded more (less) when income rises
(falls) or normal goods have a positive YED (1 mark)

Diagram illustrating a normal good (1 mark)

Explanation of an inferior good (1 mark), e.g. a good demanded more (less) when
income falls (rises) or negative YED(1 mark)
On this question only analysis is required. All answers must include the answer and application
to the case study. Then further analysis marks are gained by explaining what normal and/or
inferior goods are.
This student easily scores 5/5 marks:
Here tickets to a nightclub are a normal good (1 mark) as fewer club tickets were
demanded when incomes fell in the recession (2 marks).
A normal good is one where, if income falls, the demand will also fall (1 mark), i.e.
YED will be positive (1 mark). In contrast, an inferior good is one where, if income
falls, the demand will rise, which is not the case here (1 mark).
b
KAA = 6 marks
Knowledge (2 marks), application (2 marks), analysis (2 marks):

Definition of PES, i.e. responsiveness of quantity supplied to a change in price or
formula

Definition of elastic supply, i.e. where quantity supplied responds more than
proportionately to a change in price

Identification of reason for more elastic supply over time
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
26
TOPIC 2

How markets work
Application of PES to cider
Reasons:

More firms switching production to cider

GM apples may mean more raw materials available to produce cider

Cider takes time to make and so, over time, more will be produced
Evaluation (4 marks):

Weather is still a limiting factor (as stated in the extract) and therefore could limit
increases in supply.

The perishability of apples means they are hard to stockpile and therefore could limit
the ability of cider producers to respond even with more firms or more harvests.

Barriers to entry (e.g. advertising, branding) may limit the ability of more firms
entering over time (especially small firms).

Issues of new firms facing capacity constraints as they expand (although in the long
run they could expand further).

Depends on magnitude of price increase in cider, how much supply expands (i.e. if
significant then more firms more likely to enter and follow Stella’s lead) in the long
run.
Students find PES questions harder than most elasticity questions and often confuse it with
PED. The key is to focus on producers not consumers, i.e. can cider producers increase supply
to meet the higher price (from rising demand)?
To gain full marks, ensure you apply your analysis and evaluation points to the context of cider.
This student scores 10/10 marks:
PES measures the responsiveness of quantity supplied to a change in price.
For cider specifically, more firms are entering the market such as Stella launching
Stella Cider to compete with Magners and therefore there will be more firms able
to supply cider as the price of it increases.
Also, there should be more harvest of apples over time then apple harvests will
increase, meaning more raw materials for cider producers to increase supply with
following a price rise.
This provides a clear analysis of the question: a definition and then two reasons well applied to
cider get the rest of the marks.
However, despite more firms and GM apples there has been bad weather in apple
growing regions. This means that even if firms try to expand they may be unable
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
27
TOPIC 2
How markets work
to do so due to a lack of apples. Even with GM apples, some weather conditions
are too harsh to grow in.
Moreover, in the long term it is not certain whether new firms, such as Stella, will
be able to compete due to strong branding of existing cider producers. Therefore,
if Stella discontinues its cider, there will be fewer firms to produce, making the
price elasticity of supply for cider more inelastic.
Here the student scores full marks for two well-considered evaluation points in the context of
cider.
c
KAA = 9 marks
Knowledge (3 marks), application (3 marks), analysis (3 marks):

Define consumer surplus, i.e. difference between consumer’s willingness and ability
to pay and the market price or area under the demand curve above the equilibrium
price

Link between club closures and reduced supply of clubs (1 mark) and therefore a fall
in consumer surplus

Application to nightclubs, e.g. Luminar closing or 79 clubs closing, although 55
remain open after a buyer found or due to the recession/lack of profits

Diagram showing:
o
Original demand and supply equilibrium
o
Reduced supply and new equilibrium
o
Original consumer surplus
o
New consumer surplus
Evaluation (6 marks):

Impact on consumer surplus (CS) depends on elasticity of demand, e.g. change in
CS will be more significant if demand is inelastic.

Impact on consumer surplus depends on the magnitude of club closures, e.g.
reference to largest club closing or magnitude reduced as Luminar was bought out by
another firm.

Long-term arguments, e.g. will club closures continue with the economic climate
unlikely to brighten for a while or will club closures be reduced in the long term as
clubs could offset reduction in revenue from club tickets with revenue from
food/comedy or via cost savings?

Other factors may affect CS apart from club closures, e.g. higher tax on alcohol may
reduce supply and CS further or increased advertising by clubs may increase
demand and CS.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
28
TOPIC 2
How markets work
For 15-mark questions there are 9 KAA marks. Here a diagram is asked for and so should be part
of your analysis; 6 marks are for evaluation of two or more issues. This student scores 15/15
marks.
Consumer surplus measures the difference between what consumers are willing
and able to pay and what they actually pay.
Clubs such as Luminar have closed due to a lack of profits in the recession. This
has left 79 club closures, although 55 remain open after a buyer was found.
Club closures will reduce supply from S1 to S2 on the diagram:
As a result consumer surplus falls (1 mark) from P1ZX (1 mark for ref to diagram)
to P2YX (1 mark for ref to diagram).
The student easily scores 9/9 marks for showing knowledge of consumer surplus and why it will
fall when supply decreases, as well as clear, integrated application.
However, the amount of consumer surplus after the shift in supply depends on the
PED of nightclubs. If demand is elastic then the consumer surplus will be a lot
smaller than if it were inelastic. PED is likely to be elastic in this case as there are
many different forms of entertainment that young people could do instead of
nightclubs (e.g. cinema, cafés, bowling).
In the longer term, the situation may get worse for nightclubs as tuition fees may
continue to rise (reducing student numbers) and the UK economy is not expected
to recover fully for several years. Therefore more clubs may go out of business as
demand falls further and profits suffer. Therefore the magnitude of the fall in
supply and fall in consumer surplus may increase in the coming years.
Two well-developed evaluation points easily earn 6 marks, as they show a critical understanding
of the question and are well contextualised.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
29
TOPIC 2
d
i
How markets work
1 mark for workings, 1 mark for correct answer:

55/79 × 100

= 69.6% (3s.f.) or 70% (2s.f.)
Award 2/2 marks if correct answer given, even without workings.
ii
1 mark for workings, 1 mark for correct answer:

50p/£3.10 × 100

= 16.1% (3s.f.) or 16% (2s.f.)
Award 2/2 marks if correct answer given, even without workings.
e
KAA = 14 marks
Knowledge (4 marks), application (4 marks), analysis (6 marks):

Define tax (or type of tax, i.e. specific tax), i.e. a levy charged by the government (set
at a constant amount per item)

Identification of effects of tax on alcohol

Application, e.g. makes up 16% of cost of a pint or 2% above inflation/with
explanation or the Treasury estimated in 2011 that tax per unit of alcohol was 17p
and 18p for beer and wine respectively but a lot lower for cider (7p) and a lot higher
for spirits (24p) or reference to Health Alcohol Alliance

Diagram showing:
o
Original demand and supply and equilibrium
o
Reduction in supply (accept parallel or pivot shift) and change in equilibrium
o
Incidence on consumers and producers or total tax revenue
NB Accept negative externality with shifting MPC.
Possible effects:

Higher price of alcohol

Reduced quantity of alcohol sold

Reduced external costs of alcohol (e.g. crime, NHS cost)

Impact on business profit (e.g. nightclubs, alcohol manufacturers)

Lower consumer surplus/producer surplus

Accept macro arguments (e.g. tax revenue, budget, growth, jobs, inflation)
Evaluation (6 marks):
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
30
TOPIC 2
How markets work

Significance of inelastic demand for alcohol, e.g. means tax can be passed onto
consumers, less impact on external costs

Incremental changes in tax may have little impact if consumers adapt to the regular
tax increases (mentioned in extract)

Difficulty setting the tax at the right level to internalise external costs

Impact more on those on lower incomes (regressive nature of indirect taxation)

Different alcohol having different rates of tax (2% increase for all but could be more
significant for spirits as already highly taxed)

Depends on the magnitude of tax increase, e.g. may need to be high magnitude to
reduce demand (mentioned in extract)

Long-term arguments, e.g. long-term trend in indirect tax increase/‘sin’ taxes?

Prioritisation and significance of arguments (with justification), e.g. significance of job
losses in a recessionary economy or tax revenue importance with such high levels
and national debt
Here, KAA is 14 marks. You need to explain the effects, with a diagram, and then evaluate them
to gain the final 6 evaluation marks.
Here the government is imposing a specific tax, i.e. a levy from government
charged to firms at a constant amount per unit.
This has been set at a rate of 2% above inflation, meaning that there will be an
increase in real terms by 2%.
This can be shown below:
The government would gain revenue from the tax of P2ACD.
Furthermore, if the price of alcohol was higher then this would discourage
excessive drinking and the external costs associated with it such as crime near
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
31
TOPIC 2
How markets work
pubs. This is because the higher costs will be passed onto the consumer as 16% of
every pint is tax.
It would also lead to a loss of profits for alcohol sellers, such as beer
manufacturers, as their costs of production would increase. Tax per unit (for
example, 18p for beer in 2011) could mean more job losses and hit UK GDP
growth.
Here the student scores 14/14 marks for KAA. There is clear analysis of the issue with the
diagram and reference to it, as well as some effects explained in the context of a tax on alcohol.
However, indirect taxation on alcohol is an example of a regressive tax. This
means that it hits those on lower incomes more as tax paid on alcohol makes up a
higher percentage of their income and they are the ones who may be forced to
switch or cut down.
Also, alcohol producers can help minimise the impact of the tax by passing the
burden onto the consumer due to demand being inelastic, as alcohol is a habit
forming good. This means the incidence of the tax falls more on the consumer
(P2ABP1) than the producer (P1BCD) as consumers will not switch away as much
from a habit-forming good like alcohol and profits will not fall as much.
The extract also warned that any reductions in alcohol consumption will be
minimal due to the incremental nature of the tax increase. Alcohol drinkers may
adapt to the marginally higher prices over time rather than switching away and
therefore external costs may not fall.
Overall, due to the inelastic nature of demand for alcohol, this means that
consumers have been hit hardest by the tax, especially those drinkers on low
incomes. They face the burden of higher taxes in the form of an increased price
from producers. While the government may not have reduced external costs, they
still gain a substantial amount of tax revenue to reduce their budget deficit.
Here the student scores all 6 marks for evaluation. The evaluation points are well reasoned and
well contextualised, using the extract to help. To gain the top level there must be a substantiated
judgement, weighing up which economic agents are affected most.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
32
TOPIC 3
Market failure
Topic 3
Market failure
Types of market failure
1 2 marks for a correct definition:
When the price mechanism/free markets (1 mark) fails to deliver efficiency/results in a
misallocation of resources (1 mark).
2 1 mark each to maximum of 2: market power/inequality/imperfect information/positive
externalities.
Externalities
3 a
2 marks per difference:

Private costs are direct costs to consumers and producers (1 mark) whereas external
costs are costs to third parties/negative spill-over effects (1 mark).

Private costs are costs internal to an exchange (1 mark) whereas external costs are
external to an exchange (1 mark).

Private costs are costs taken into account by the price mechanism (1 mark) whereas
external costs are ignored by the price mechanism (1 mark).
b
2 marks per difference:

Private benefits are direct benefits to consumers and producers (1 mark) whereas
external benefits are benefits to third parties/positive spill-over effects (1 mark).

Private benefits are benefits internal to an exchange (1 mark) whereas external
benefits are external to an exchange (1 mark).

Private benefits are benefits taken into account by the price mechanism (1 mark)
whereas external benefits are ignored by the price mechanism (1 mark).
4 1 mark for identification of external benefit or cost and 1 mark for example:
a
External benefit (1 mark), e.g. less spread of disease/productive UK workforce/higher
economic growth/less absenteeism for firms (1 mark)
b
External cost (1 mark), e.g. congestion/air pollution/noise pollution/contribution to
climate change/accidents (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
33
TOPIC 3
Market failure
c
External cost (1 mark), e.g. anti-social behaviour/crime/litter/strain on
healthcare/impact on labour productivity/absenteeism from work (1 mark)
5 1 mark for correct letter representation, 1 mark for brief explanation:
a
Q1 (1 mark) as MPC = MPB (1 mark)
b
Q2 (1 mark) as MSC = MSB (1 mark)
c
AEB (or equivalent) (1 mark) as this is the excess of social benefit above social
cost/as this is the welfare that would be gained from moving from Q1 to Q2 (1 mark)
6 Possible answers include (up to 4 marks):

Definition of market failure, e.g. when the price mechanism fails to deliver an efficient
allocation of resources (1 mark)

People ignore the external benefits and therefore there is underconsumption (1
mark).

As the free market equilibrium is below the social optimum (1 mark); reference to
diagram, i.e. Q1<Q2 (1 mark); further explanation of equilibriums, e.g. Q1 at MPC =
MPB and Q2 at MSC = MSB (1 mark).

At the free market equilibrium Q1 social benefit exceeds social cost (1 mark);
reference to diagram, i.e. E is greater than A (1 mark) and therefore welfare can be
gained from moving to the social optimum Q2 (1 mark) equal to AEB (1 mark).
7 Possible analysis points (up to 6 marks):

Definition of social benefits (1 mark), e.g. the combination of private and external
benefits

Explanation of any external benefits of London 2012 (up to 3 marks per benefit):
o
Improvements in transport
o
Tourism
o
Affordable housing and improved labour mobility
o
Benefits to UK economic growth, e.g. via business links/reputation
o
Regeneration of east London and positive multipliers
 Explanation of any private benefits of London 2012 (up to 3 marks per benefit):
o Jobs created at the Olympics
o Revenue gained from Olympics (e.g. ticket sales, merchandise, TV rights)
Possible evaluation points (4 marks for up to two evaluation points):

There will be social costs as well as social benefits, such as:
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
34
TOPIC 3
Market failure
o
External costs of construction, waste and transport/although these have been
reduced due to government policies
o
Private costs of setting up and running the Olympics(e.g. constructing
stadia)/which have gone over-budget/making it the most expensive of all time
 Counter-points for external benefits:
o Will all transport be useful, e.g. Thames Cable Car?
o Some tourists will have stayed away due to the Olympics being on
o Small magnitude of housing compared to demand
 Magnitude arguments, e.g. reference to tourism figures/private cost of Olympics
 Long-term versus short-term arguments: short-term gain for tourism but long-term
benefits of transport/reputation of London
 Prioritising arguments/conclusions with justification, i.e. considering if the social
benefits exceeded the social costs of the Olympics
Public goods
8 2 marks for a definition, such as:
A public good is one which is non-rival (1 mark) and non-excludable (1 mark).
9 1 mark for identification:
a
Public good (1 mark)
b
Private good (1 mark)
10 Possible answers include (up to 4 marks):
 A public good is non-rival (1 mark).
 Application to Trident (1 mark), i.e. it is non-rival because by one citizen being
protected by national defence it does not mean another citizen cannot be protected.
 A public good is non-excludable (1 mark).
 Application to Trident (1 mark), i.e. it is non-excludable because no one can be
excluded from benefiting from Trident’s defence system if they live in the
country/even if they haven’t paid for its construction.
11 Possible answers include (up to 4 marks):

The free-rider problem is that it is possible for people to consume a good without
paying for it once it is provided (1 mark).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
35
TOPIC 3
Market failure

Therefore there is little incentive for producers to provide public goods (1 mark), plus
further explanation (1 mark).

Public goods are underprovided/not provided by free markets (1 mark).

Therefore an inefficient allocation of resources (allow definition of market failure for
final mark) (1 mark).
Information gaps
12 Symmetric information is where all parties have the same information (1 mark), whereas
asymmetric information is (a type of imperfect information) where one party has more
information than another (1 mark).
13 a
The private dentist has more information (than the patient) (1 mark) because they
have a medical qualification/training (or patients do not have dentistry training) (1 mark).
b
The property owner has more information (then insurance company) (1 mark)
because they know their history of losing their phone/how careful they will be with their
phone (1 mark).
14 a

Employee pensions not making adequate pension provision/underinvested in (1
mark)

Any reason, e.g. employees unaware of how much is needed for
retirement/employees lacking an understanding of the pension system (1 mark)
b

Overconsumption of cigarettes (1 mark)

Any reason, e.g. consumers unaware of the health risk/external costs of cigarette
consumption (1 mark)
15 Analysis (4 marks). Possible answers include:

Definition of asymmetric information, i.e. when one party has more information than
another (1 mark)

Asymmetric information as second-hand car dealers have more information than car
customers (1 mark)

Examples (up to 2 marks for each point if well developed), such as:

o
Customers being unaware of faults when buying cars
o
Customers being unaware of the number of miles a car had done
Asymmetric information as car drivers have more information than insurance
companies (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
36
TOPIC 3

Market failure
Examples (up to 2 marks for each point if well developed), such as:
o
Drivers more aware of their previous accident history
o
Drivers more aware of their risk/driving ability
Evaluation (2 marks for one well-developed point). Possible answers include:

The OFT is providing guidelines to try to help second-hand car buyers (e.g. providing
questions to ask); this could reduce the information asymmetry in the longer term.

Other policies may help reduce the second-hand car information asymmetry, such as
warranties.

Less likely to be information asymmetry when buying new cars rather than secondhand cars.

Insurance companies will try to reduce the information asymmetry by trying to
ascertain driver histories, e.g. through questionnaires or client interviews.

Magnitude arguments, e.g. 40,000 complaints a year showing a high magnitude of
information asymmetry.

Prioritisation/conclusion with justification, e.g. whether information asymmetry is
greatest in insuring or buying cars or the extent to which there is information
asymmetry in the car industry.
Exam-style questions (multiple choice and short answer)
1 a
Knowledge (1 mark): definition of asymmetric information, i.e. where one party has
more information than another.
Application (1 mark): application to healthcare, i.e. patients have less information than
doctors.
Analysis (1 mark): development of argument to outline one problem, e.g. possible
exploitation of patients to gain profit or possible underconsumption of healthcare or cause
of market failure.
Asymmetric information means where one party has more information than
another (1 mark). In this case the doctors and medical professionals are the more
informed party and patients the less informed about medical issues (1 mark). This
could lead to exploitation of patients, such as doctors being able to prescribe
unnecessarily to gain more profit (1 mark).
This student scores full marks for a clear definition of asymmetric information in the context of
healthcare markets and goes on to explain one clear problem of this.
b
C (1 mark)
2 a
A (1 mark)
b
Knowledge (2 marks):
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
37
TOPIC 3
Market failure
1 mark for partial definition:

Positive third-party effect (1 mark)

Ignored by the price mechanism (1 mark)

Benefit external to the exchange (1 mark)
2 marks for accurate definition:

Positive third-party effect (1 mark) ignored by the price mechanism (1 mark) or
external to an exchange (1 mark)
External benefits are positive third-party effects (1 mark) ignored by the price
mechanism (1 mark).
The student gains 2 mark for a clear definition.
c
Knowledge (1 mark):
The student has clearly indicated the welfare gain triangle for 1 mark.
3 a
b
D (1 mark)
Knowledge (1 mark): definition of public good.
Application (1 mark): application to flood defences, e.g. benefits of flood defences, such
as less chance of flood-damaged housing or one characteristic of public goods applied to
flood defences.
Analysis (2 marks):

Explanation of the free-rider problem (1 mark), e.g. once provided no one can be
excluded from benefiting.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
38
TOPIC 3

Market failure
Further analysis (1 mark), e.g. no business can profitably provide the service or this
is an example of market failure or need for government to provide public goods via
taxation.
Public goods are both non-rival and non-excludable (1 mark). They are
underprovided by free markets due to the free-rider problem, as once provided no
one can be excluded from benefiting (1 mark). For example, if residents did not pay
for the flood defence in London, they would still benefit from less risk of their
house being damaged in bad weather (1 mark). Therefore, no business can
profitably provide the service and it will be underprovided (1 mark).
Here the student scores full marks as she has clearly explained what a public good is and then
developed her answer by outlining the free-rider problem and further analysis linked to
underprovision, in the context of flood defence systems.
4 a
Knowledge (2 marks):
1 mark for partial definition:

Includes benefits to third parties/external benefits (1 mark)

Includes benefits to first and second parties/private benefits (1 mark)
2 marks for complete definition:

Social benefits are the addition of private benefits to those involved in the transaction
(1 mark) and external benefits to third parties (1 mark).
Social benefits is the addition of external benefits (benefits to third parties) (1
mark) and private benefits (benefits to those involved in the transaction) (1 mark).
A clear definition scores the student both marks here.
b
Application (2 marks):
1 mark for workings, 1 mark for answer:

=

= 17% (accept other answers with more decimal places)
× 100
15.3
(15.3 + 75.5)
NB Correct answer will score full marks even with no workings.
= 15.3× 100
90.8
(1 mark)
= 16.9% (1 d.p.) (1 mark)
The student scores full marks on the calculation question and demonstrates good exam skills by
showing workings, underlining the correct answer and stating how the answer was rounded.
c
A (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
39
TOPIC 3
Market failure
Exam-style questions (data response)
5 a
KAA = 5 marks
Knowledge (1 mark): identification that clean air is a public good (1 mark).
Application (2 marks), analysis (2 marks):

Clean air can be considered a public good as it is non-rival (1 mark).

For example, if you take a walk outside and breathe clean air, you are not reducing
the amount of clean air available for someone else (1 mark).

Clean air can be considered a public good as it is non-excludable (1 mark).

For example, no one can be stopped from going outside for a walk and breathing
clean air (even if they have not paid) (1 mark).
The key to this question is to apply the characteristics of a public good to clean air. The
following answer gets 5/5 marks:
Clean air is best considered a public good (1 mark). A public good is both non-rival
(1 mark) and non-excludable (1 mark). Clean air can be considered a public good as
no one can be excluded from benefiting from clean air when they go outside (1
mark) and it is non-rival as someone breathing clean air does not reduce the
amount of clean air available for someone else (1 mark).
b
i
1 mark for workings, 1 mark for correct answer:

= 36.3% − 39.4%

= 3.1% decrease
Award 2/2 marks if correct answer given, even without workings.
ii
1 mark for workings, 1 mark for correct answer:

= 45% (Russia) : 3% (EU)

= 15:1
Award 2/2 marks if correct answer given, even without workings.
i
3.1% decrease
ii 15:1, Russia:EU
Here the student gets full marks for the correct answer without any workings.
c
KAA = 9 marks
Knowledge (3 marks), application (3 marks), analysis (3 marks)

Define external costs, e.g. negative spill-over effects/costs external to an
exchange/costs ignored by the price mechanism/costs external to an exchange.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
40
TOPIC 3


Market failure
Examples of external costs applied to coal-powered fire stations:
o
Air pollution/carbon dioxide emissions
o
Noise pollution of production
o
Visual pollution/eyesore
o
Global warming
Diagram showing external costs:
o
Original MB and MPC curves
o
MSC curve (allow parallel or diverging MSC curve)
o
Identification of market and social optimum equilibrium quantities
o
Identification of welfare loss triangle
Evaluation (6 marks):

Long-term trend of coal power stations closing (in the UK) will reduce external
costs.

Impact on climate change may be reduced by government policies, e.g. clean
coal stations/although the technology is still unproven or global climate change
agreements/policies to meet targets, such as pollution permits.

Benefits of coal-fired power stations may offset/outweigh external costs, such as
employment provided, relatively cheap electricity generation for UK power grid,
tax revenue etc.

Magnitude of arguments, e.g. power station voted as third biggest eyesore.

Long-term nature of many of the impacts, e.g. climate change and global
warming.

Prioritisation/significance of different external costs with justification.

Difficulty in attaching monetary values to the external costs of factors such as
visual pollution and climate change.
This question requires a diagram to gain full analysis marks (9 KAA) with the rest for defining
and explaining external costs of nuclear power. Evaluation (6 marks for two or more points) can
be accessed by thinking of the benefits of coal power, as well as the standard economic
evaluation techniques such as long term versus short term, magnitude and prioritisation of
arguments.
External costs are negative spill-over effects, i.e. costs external to the exchange
ignored by the price mechanism. Here the spill-over effects will be on local
communities who live near the power station; they are the third parties.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
41
TOPIC 3
Market failure
In terms of coal-fired power stations there will be atmospheric pollution due to the
carbon dioxide released into the atmosphere from burning coal, which some claim
will increase climate change.
A second external cost will be visual pollution. The extract claims that Country
Life magazine voted the Didcot power station as Britain’s third worst eyesore.
External costs can be shown diagrammatically. Here the market equilibrium is Qe
and the social optimum Q1 and the welfare loss triangle is ABC:
The student easily scores 9/9 marks for KAA with a diagram and explanation of external costs,
well applied throughout to coal-fired power stations.
However, the external costs of coal-fired power stations must be weighed up
against the benefits. For example, coal is a relatively cheap way of generating
electricity, which will benefit consumers with lower prices. It also provides
employment and income for employees.
The external cost from coal-fired power stations should also reduce over time.
This is because the UK government is planning to close a third of them in the next
10 years as it looks to invest in renewable energy. Furthermore, coal-fired power
stations that were opened under the last government have technology to reduce
carbon dioxide emissions, although this is yet to be proven.
Finally, I believe the impact on air pollution has larger impacts than visual
pollution. Although the Didcot power station was voted Britain’s third worst
eyesore, the impact of air pollution could contribute to dramatic global issues,
such as climate change. This will impact on not only this but future generations of
the UK.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
42
TOPIC 3
Market failure
The student scores all 6 evaluation marks for three developed points in the context of coal-fired
power stations, taking a critical view of the external costs.
Exam-style questions (A2 essay)
6 Knowledge (4 marks), application (4 marks), analysis (8 marks), evaluation (9 marks):

Definition of private costs

Definition of external costs

Application of private costs of expanding Heathrow:
o
Cost of materials
o
Cost of labour
o
Cost of land/planning permission
 Application of external costs of expanding Heathrow:
o Impact on noise pollution
o Impact on air pollution
o Impact on visual pollution
o Impact on climate change
o Destruction of local habitats
 Reward use of diagrams (e.g. negative externality diagram)
Evaluation:

Counter points, e.g. planes may become more fuel efficient/quieter and therefore
less external cost or policies could be used to reduce the external costs of flights.

There may also be private benefits, e.g. more flights available for consumers or
more profits for airlines and airports or provision of jobs in construction.

There may also be external benefits (award diagrammatical analysis), e.g.
positive impact on UK trade or positive impact on UK tourism or positive impact
on UK growth and positive multipliers.

It is hard to measure external costs precisely, e.g. hard to value destruction of
habitats/impact on nature.

Magnitude of arguments.

Long-term versus short-term impacts, e.g. noise pollution of construction in short
term but also long term as more planes or long-term impacts on UK economy of
climate change.

Prioritisation of external benefits with justification.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
43
TOPIC 3

Market failure
Conclusion: is Heathrow beneficial overall? (with justification)
Heathrow is London’s main airport, allowing travellers to come into and out of
Britain for a variety of reasons, such as going on holiday and for business reasons.
Currently, the airport is close to full capacity, meaning that in the future it may not
be able to meet all passengers’ needs. Therefore, in recent years there have been
calls to expand Heathrow to meet growing demand for air travel. However, there
are private and external costs associated with this expansion as this essay will
outline before going on to assess the extent of such costs and whether they
outweigh the benefits gained from expansion.
Private costs are costs to first and second parties in an exchange that are taken into
account by the price mechanism. Here the first and second parties are the airports,
airlines and their passengers.
The major private costs of expanding Heathrow will fall on the construction of the
runway itself. First, there will be a need for raw materials to construct the runway,
such as tarmac. Second, there will be a need to pay for workers to design and
build the runway — this would mean the paying of wages and salaries to them.
Finally, there will be the cost of the land itself and the planning permission that is
needed. On top of this the airport may need to pay compensation to local residents
who are affected by the construction or who need to be relocated as a result.
In contrast, external costs are costs to third parties, external to an exchange, that
are not taken into account by the price mechanism. Here third parties could
include local residents, the environment and the impact on the UK economy as a
whole.
The significant external costs of building the runway come in the form of
environmental impacts. First, during the construction of the runway there will be
significant noise and air pollution that will affect local residents and the
environment. Second, even once built, there could still be greater noise and air
pollution from the extra flights that will run from the new third runway. This air
pollution could have a knock-on effect on climate change. Finally, the
construction of the runway could disrupt local nature and habitats if it is
constructed in areas where wildlife and animals previously flourished.
These private and external costs can be illustrated diagrammatically. The diagram
below illustrates the market for flights, assuming there are no external benefits
present (i.e. MPB = MSB). However, external costs are present and are ignored by
the price mechanism. This is because at the free market equilibrium (Qe)
passengers only take into account the private costs and benefits (MPC = MPB). In
contrast, at the social optimum (Q1) society would want them to take into account
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
44
TOPIC 3
Market failure
the full social costs and benefits (MSC = MSB) and not ignore external costs, such
as the impact on the environment discussed earlier.
This therefore makes the case against the expansion of Heathrow as it would mean
an overconsumption of flights from society’s point of view and a welfare loss of
ABC.
The significance of some costs will be greater than others. For example, the
impact of greater flights and air pollution can have significant impacts on climate
change in the long term in the form of rising sea levels and more severe weather.
However, the private costs themselves will be very much short term and once the
airport has been expanded these costs will have been covered (such as
construction costs and the cost of labour).
Furthermore, the extent to which external costs are an issue will depend heavily
on other policies put in place by policymakers. For example, the government
could put regulations in place in terms of the number of night flights that can be
flown and the fuel-efficiency of planes. These policies would minimise the
external cost of noise pollution for local residents at night, as well as reduce the
impact airlines have in terms of air pollution if they are more fuel efficient.
However, any decision about Heathrow needs to consider not only the private and
external costs but also the private and external benefits. If the social benefits
overall outweigh the social costs then society would gain welfare as a result of
Heathrow’s expansion, rather than the welfare loss shown on the diagram above,
where external benefits were ignored.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
45
TOPIC 3
Market failure
Some examples of private benefits (benefits to first and second parties) could
include the increased availability of flights for consumers, and airlines themselves
should be able to make more profits if they meet consumer demand. Moreover, in
the construction process itself there is greater employment for these workers and
incomes. In terms of external benefits, there could be a significant boost to the UK
economy in terms of extra trade, tourism, growth and positive multiplier effects
helping boost GDP further.
In conclusion, there are likely to be not only private and external costs, but also
private and external benefits from the expansion of Heathrow and their
significance needs to be quantified. Therefore, the government is likely to
undertake a cost–benefit analysis before making any decision to expand
Heathrow. It would be sensible to compare this to other projects, such as
improving other forms of transport, expanding other UK airports or creating new
airports like the one proposed on the Thames Estuary (Boris Island). This will not
be without difficulties as putting a precise monetary value on social costs and
benefits is difficult, such as the value of the environment, and many estimates may
have a large margin for error, like the cost of building the runway or the actual
increase in GDP from an expanded Heathrow. In my opinion, it is likely that such
airport expansion is likely to go ahead as there is now cross-party support but this
may be due to political short-termism, i.e. looking to gain a stronger economy in
the coming years and neglecting the longer-term issues like climate change that
will span current and future generations.
This student’s essay will gain 25/25 marks.
This is because in terms of analysis there is clear logical reasoning, drawing on precise
knowledge of economic models (such as externality theory). It is also applied throughout to the
context, using relevant examples (16/16 marks).
In terms of evaluation, all judgements made are backed up with solid reasoning and well
embedded in the context of Heathrow. There is a clear critical look at the private and external
costs (e.g. using methods such as long term versus short term and counter-points), as well as
looking at different points of view (e.g. the view that Heathrow could have benefits as well as
costs). The conclusion shows an informed judgement, drawing on the analysis presented and is
well backed up (9/9 marks).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
46
TOPIC 4
Government intervention
Topic 4
Government intervention
Government intervention in markets
1 1 mark for any relevant solution. Possible answers include:
a
State provision (1 mark)
b
Taxation/advertising/subsidising alternatives (e.g. e-cigarettes)/minimum
price/alcoholic-related illnesses not being treated on the NHS/regulation/ban on alcohol (1
mark)
c
Subsidies/state provision/advertising (1 mark)
d
Provision of information/advertising (1 mark)
2 Explanation of how the method reduces external costs, 1 mark for each point (up to 3
marks max. for each part of question):
a

Permits can be applied to pollution from air travel (1 mark).

Can limit amount of air pollution from air travel (1 mark) by restricting the number of
permits (1 mark).

Incentive for airlines to invest in renewable energy (1 mark) and then sell permits (1
mark).

Permits may increase costs for firms (1 mark) and therefore cause higher prices for
consumers, lowering demand (1 mark).
b

Regulations on night flights (1 mark) and levels of noise during take-off and landing (1
mark) would reduce noise pollution for local residents (1 mark).

Regulation of types of aircraft that can fly in UK/specifications of planes (1 mark)
encouraging more efficient planes/less air pollution (1 mark).

Regulations likely to increase costs for firms (1 mark) and therefore cause higher
prices for consumers, lowering demand (1 mark).
c
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
47
TOPIC 4
Government intervention

Taxation may be placed on fuel or on airline journeys (1 mark).

This increases the costs of production for airlines (1 mark), so they may pass these
costs onto the consumer in terms of higher prices (1 mark).

This internalises the negative externality of air travel (1 mark).

Higher airline prices will deter people from flying and reduce external costs (1 mark)
as they switch to alternative forms of transport, like high-speed rail (1 mark).
d

The subsidy will lower costs of production for train companies (1 mark).

This will lower the price of train journeys (1 mark) and consumers will switch away
from air travel to train journeys (1 mark).

This will lower external costs of air travel due to fewer flights/will lower external costs
as trains are more environmentally friendly (1 mark).
3 2 marks for a definition:
A price set by the government which a good/service cannot fall below (2 marks).
4 a
Falls/contracts from Q2 (1 mark) to Q1 (1 mark)
b
Rises/expands from Q3 (1 mark) to Q4 (1 mark)
c
Increases from CD (or Q2Q3) (1 mark) to AB (or Q1Q4) (1 mark)
5 Government expenditure is Q2CDQ3 at P1 (1 mark) and Q1ABQ4 at P2 (1 mark)
6 a

Excess supply will be smaller (1 mark)

Demand will contract less as PED is inelastic (1 mark)

Supply will expand less as PES is inelastic (1 mark)
b

Excess supply will be/fall to zero (1 mark)

Equilibrium price will be Pe (1 mark)

As the minimum price is set below the equilibrium (1 mark)
7 Analysis (6 marks). Possible answers include:

Definition of maximum price (1 mark), i.e. a ceiling price

Definition of total revenue (1 mark), i.e. price × quantity

Identification that total revenue will drop (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
48
TOPIC 4

Government intervention
Reason for revenue drop (1 mark + 1 mark), e.g. lower price due to maximum price
legislation or lower quantity as less incentive due to supply at lower price
Diagram (up to 4 marks):

Original demand and supply equilibrium (1 mark)

Original revenue box annotated or shaded (1 mark)

Maximum price set below equilibrium (1 mark)

New revenue box annotated or shaded (1 mark)
8 Analysis (6 marks), up to 3 marks per benefit to consumers, including:

Lower prices of loans, i.e. maximum price of 0.8%

Lower penalty charges, i.e. will never pay more than twice/limit on charges to £15

Higher consumer surplus/welfare, i.e. £200 better off
NB Reward diagrammatical analysis as part of analysis.
Evaluation (2 marks for one developed point):

Possible lower choice of firms if many go out of business due to regulations

Consumers may need to switch to other high-rate options (loan sharks) if no payday
loans available

Prioritisation of arguments, long-term versus short-term issues and justified
conclusions
Government failure
9 1 mark for a definition, 1 mark for any relevant example:

Government failure is when governments intervene to solve market failure but it
results in a further misallocation of resources and a net welfare loss (1 mark).

Any example, e.g. excess supply caused by the common agricultural policy (1 mark).
10 1 mark per cause identified, such as:

Distortions to price signals

Unintended consequences

Excessive administration costs

Information gaps
11 Analysis (6 marks):
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
49
TOPIC 4

Government intervention
Define government failure, i.e. when governments intervene to solve market failure
but it results in a further misallocation of resources and a net welfare loss (1 mark).
Reasons for government failure (up to 3 marks for each point):

Pressure on prisons and police service from ‘war on drugs’ policy

Drugs unregulated and therefore causing more damage to health of users

Drugs traded on secondary markets have increased

Loss of potential tax revenue if legalised and taxed
Exam-style questions (short-answer questions)
1 a
Knowledge (1 mark): definition of tradable permit scheme, e.g. a scheme where a
limit is placed on firms’ carbon emissions through the issue of permits.
Application (1 mark): examples in EU/China looking to implement a scheme soon.
Analysis (1 mark): further development, e.g. permits can then be traded between firms or
fines are given to firms that do not have enough permits or aims to reduce external costs
of pollution or attempt to solve environmental market failure.
A tradable permit scheme is a scheme where a limit is placed on firms’ carbon
emissions through the issue of permits (1 mark). These permits are then tradable
between firms (1 mark). For example, large polluters in the EU can buy permits
from more efficient producers to ensure they have enough permits for their
pollution (1 mark).
This student easily scores full marks. He has explained how tradable permit schemes work and
developed this in the second sentence, before applying it to the EU.
b
2 a
A (1 mark)
Application (2 marks)
1 mark for workings, 1 mark for answer:

= 5.4 million – 4.8 million (1 mark)

= 0.6 million or 600,000 (1 mark)
NB A correct answer will score full marks even with no workings.
The excess demand is calculated as demand (5.4 million) minus supply (4.8
million). This leaves 0.6 million excess demand.
The student here scores full marks for a clear, worked-out answer.
b
Knowledge (1 mark) (identification of impact), analysis (1 mark) (development).
Possible answers include:

Contraction in supply (1 mark) as less incentive to supply (1 mark)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
50
TOPIC 4
Government intervention

Fall in revenue (1 mark) as lower maximum price (1 mark)

Fall in producer surplus (1 mark) as lower maximum price (1 mark)

Switch to markets (1 mark) where they can earn more profits (1 mark)
One impact on producers from the maximum rent will be a fall in revenue (1 mark).
This is because there is a lower maximum rental price, so any property they rent
now earns them less total revenue (1 mark).
A clear impact identified and explained earns the student 2 marks for this question.
c
D (1 mark)
Exam-style questions (data response)
3 a
KAA = 6 marks
Knowledge (2 marks), application (2 marks), analysis (2 marks):
For each limitation, 1 mark for identification, 1 mark for application and 1 mark for
development. Possible answers include:

Consumers may ignore/not notice calories put on menus.

Consumers may not understand the information/need to spend on education.

Cost to firms of implementing regulation.

Consumers may have inelastic demand for junk food and not switch.
For this question the key is to identify two problems with the regulations and explain them in the
context of publishing calories on menus.
The following answer scores 6/6 marks:
One limitation of the regulations would be that not all customers will understand
what the calories on the menu mean (1 mark). Therefore, consumers may not know
how many calories they should consume in a day and still consume at similar
levels as before (1 mark). The government may need to provide education for
consumers but this will cost money to provide (1 mark).
A second limitation of the regulation is the cost to firms (1 mark). It will cost firms
to research the calories in each meal and change their menus (1 mark). This will
reduce the profit of firms and could have knock-on effects on employment and tax
revenue for the UK economy (1 mark).
b
KAA = 6 marks
Knowledge (2 marks), application (2 marks), analysis (2 marks):
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
51
TOPIC 4
Government intervention

Definition of government failure, i.e. when governments intervene to solve market
failure but in the process cause a further misallocation of resources/a net welfare
loss.

Application to Danish fat tax/extract

Possible reasons for government failure:
o
Secondary markets/cross-border shopping
o
Loss of tax revenue
o
Negative impacts on businesses (especially small businesses like butchers)
o
Little impact if consumers have inelastic PED for high-calorie food
Evaluation (4 marks):

Tax could be seen as a success as it should reduce consumption of fatty foods/e.g.
first 3 months sales of margarine, butter and cooking oil had fallen by 10–20% over
the previous year/although this could have been due to people stocking up before the
tax was introduced.

Depends on the reliability of research/hard to tell if the tax is a success from small
amount of research/as tax was only in place for a year.

Depends on the magnitude of the tax put in place on fatty foods.

Magnitude of arguments, e.g. research showed that 48% of Danes doing some crossborder shopping.

Conclusions with justification, i.e. is it government failure overall and why?
NB Allow students to argue that it is not government failure as analysis and then to evaluate that
point of view.
Government failure evaluation questions will often get you to assess the evidence of
government failure and success of a particular policy, applied to a particular market. Using the
case study is therefore essential.
The following answer scores 10/10 marks:
Government failure is where government intervenes in a market but in the process
causes a further misallocation of resources and a net welfare loss.
One reason why there could be government failure is the existence of secondary
markets. Nearly 50% of Danish shoppers have engaged in cross-border shopping
and therefore they have continued to buy high-calorie foods and the external costs
associated with them.
This will also mean lower tax revenue. This is because shopping takes place
outside of the country and shoppers are avoiding the tax in Denmark. This lower
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
52
TOPIC 4
Government intervention
tax revenue will impact on the Danish economy as less will be available to spend
on public services, such as healthcare and education.
The student provides knowledge of government failure via a definition and identification of
causes of government failure before explaining them in context, easily achieving 6/6 KAA marks.
However, the tax should reduce external costs of people who continue to shop in
Denmark. Indeed, Extract 2 estimates that in the first few months consumption of
high-calorie foods was down 10–20% on the previous year. This would be a sign
of government success.
Overall, it may be hard to tell if the Danish food tax was government failure as it
was only around for one year. This means the amount of research into its effects
may be limited and even the research that is conducted may or may not be
representative of the whole Danish population.
The student gains all 4 evaluation marks for two developed points in the context of the Danish
fat tax. The student’s answer recognises different points of view to come to a reasoned, critical
conclusion.
c
i
1 mark for workings, 1 mark for correct answer:

= 2%/−10%

= −0.2
Award 2/2 marks if correct answer is given, even without workings.
ii
1 mark for workings, 1 mark for correct answer:

= 8%/−10%

= −0.8
Award 2/2 marks if correct answer is given, even without workings.
i
PED = % change QD/% change in price
PED = 2%/−10% = −0.2
ii PED = % change QD/% change in price
PED = 8%/−10% = −0.8
Here the student gets full marks for correct answers and benefits from a logical approach using
the formula.
d
KAA = 9 marks
Knowledge (3 marks), application (3 marks), analysis (3 marks):

Definition of a subsidy, i.e. government grant to increase production or lower price
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
53
TOPIC 4
Government intervention

Definition or formula of cross-price elasticity of demand

Application:
o
10% from a subsidy on fruit and vegetables could increase consumption by
between 2% and 8%
o
Reduced demand for unhealthy food as customers switch from burgers to
cheaper fruit, as they are substitute snack items
o
$300m a year to pay for the subsidy
 Subsidies will reduce costs of production for producers of healthier food
 A drop in the price of healthy food should lead to a drop in demand for junk food
 Healthy and unhealthy food have positive XED
 Subsidy diagram:
o Shift in supply curve to the right for healthier foods (1 mark)
o New equilibrium price and quantity (1 mark)
o Subsidy area (1 mark)
o Diagram showing a decrease in demand for unhealthy food (1 mark)
Evaluation (6 marks):

Opportunity cost of subsidy/approximately $300m a year/less to spend on other areas
of the economy, advertising campaigns on benefits of a healthy diet

Inefficiency of healthy food producers/due to reliance and dependence on subsidy

Healthy and unhealthy food may be weak substitutes (low positive XED)/as
consumers are addicted to junk food/have inelastic demand for unhealthy food

Subsidising healthy food may mean consumers have more money to spend on
unhealthy food/research suggested that consumption of both healthy and unhealthy
food may rise/although only one study so may not be accurate

Depends on magnitude and time-scale of subsidy/may need to be large in order to
change behaviour/especially as some unhealthy food can be substantially cheaper

Would other solutions be better at reducing demand for unhealthy food? e.g. tax/with
justification
For a subsidy question it is important to draw an accurate demand and supply diagram. This
question also requires reference to cross-price elasticity of demand to help analyse the impact
on junk food. Evaluation marks can be accessed by discussing the limitations of such a scheme
and using the usual evaluation toolkit. Again, there are often some hints in the case study, which
can be developed into strong, developed evaluation points.
The following answer scores the full 15/15 marks:
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
54
TOPIC 4
Government intervention
A subsidy is a grant given by governments to firms to reduce price and increase
production. This will cost the government $300m a year.
Cross-price elasticity of demand measures the responsiveness of quantity
demanded for one good to the change in price for another.
A 10% reduction in price from the subsidy will increase consumption of fruit and
veg by between 2 and 8% and therefore reduce the demand for junk food. This is
because products like burgers and fruit are substitute snack foods for consumers
with a positive XED value.
The impact of the subsidy can be shown in the diagram below:
The student gains full marks for analysis due to excellent use of theory via definitions and
diagrams, as well as strong application to the case study.
However, research has suggested that because the subsidy reduces the price of
healthy food, then this leaves consumers with more money to buy junk food. This
could mean that the subsidy has an unintended effect of increasing the caloriecontent of an overall shopping basket.
Furthermore, the subsidy itself will cost the government money to fund ($300m a
year). This money could have been used to fund other solutions to unhealthy
eating, such as an advertising campaign promoting healthy eating. There is an
opportunity cost.
Finally, it may not be the case that consumers switch between healthy and junk
food as they are weak substitutes. This is because some consumers may be
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
55
TOPIC 4
Government intervention
addicted to unhealthy food and will not switch due to having price inelastic
demand.
The student scores all 6 evaluation marks for three developed, critical, applied points.
e
KAA = 14 marks
Knowledge (4 marks), application (4 marks), analysis (6 marks):

Define minimum price, i.e. a floor price/a price set by the government that it cannot
fall below.

Application, e.g. aim to drive up the price of fatty/sugary foods or examples of foods
it will be applied to, such as burgers/fizzy drinks or application to external costs of
obesity.

Diagram:
o
Original demand and supply equilibrium (1 mark)
o
Minimum price (1 mark)
o
Excess supply (1 mark)
 Possible effects:
o Increase/expansion in supply
o Decrease/contraction in demand
o Excess supply
o Higher price
o Reduced consumer surplus
o Reduction in external costs of high-calorie food
Evaluation (6 marks):

Regressive impact of minimum price scheme, as those on low income spend a
higher percentage of their income on food.

Would not discriminate between nutritious food which is high in calories and
sugar-dense sweets and drinks, as indirect taxation could.

Different effects on different foods (e.g. depending on calorie content).

Impact depends on the PED/PES and magnitude of minimum price introduced
(e.g. if PED is inelastic then demand will not fall and external costs may remain
high).

No impact if minimum price set too low, i.e. below the equilibrium price.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
56
TOPIC 4

Government intervention
Would other solutions be better than minimum price (e.g. subsidies for healthy
food)/would it work well with other solutions (e.g. education about healthy diets)?
This question requires a relevant diagram to aid your analysis. For economic effects questions,
remember these can be both positive and negative, then these can be evaluated to get the final 6
marks.
A minimum price is a floor price. Here the minimum price is on high-calorie foods
in order to discourage consumption of fatty and sugary foods such as fizzy drinks.
One impact of the minimum price would be excess supply. This is because with a
higher price for high-calorie food consumers will contract their demand but
producers will expand supply.
This can be illustrated on the diagram below:
A second impact would be a reduction in external cost from unhealthy food
consumption. If the price of high-calorie food increases due to the minimum price
then consumers could switch to cheaper, low-calorie food. Examples of these
external costs are the burden on health services and the taxpayer or possibly lower
productivity and higher absenteeism of UK workers, damaging economic growth
for the economy as a whole.
A final impact would be a reduction in consumer surplus as the price of highcalorie food increases. Therefore there will be a smaller difference between what
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
57
TOPIC 4
Government intervention
consumers are willing to pay and what they actually pay for junk food. This will
reduce the welfare of those consumers who buy junk food and do not switch away.
The student scores full marks for analysis as the answer shows good knowledge with definitions
and diagrams, as well as clear application in the introduction and the final impact.
However, the minimum price will have no impact if it is set too low. If the
minimum price is set below the equilibrium price then the price will remain the
same. This means that consumption of unhealthy food would remain at the same
level.
Finally, demand for some high-calorie food, such as high-street takeaways, may
have inelastic demand. This means that these consumers won’t switch to lowcalorie food even if the price of high-calorie food increases. The impact on
external cost reduction will be minimised, although so will the excess supply.
Overall, for the scheme to be effective it must be set high enough to switch
behaviour of consumers, who may be addicted to junk food. This, coupled with
subsidising alternatives and educating shoppers about calories, will allow
consumers to switch away from junk food as they would have a cheaper
alternative and understand the need for a healthier lifestyle. Without an integrated
approach, simply pushing the price up won’t work and will certainly hit the
poorest and most vulnerable in society most.
Here the student easily gets full evaluation marks for two developed, applied points. Students
must make a substantiated judgement to gain full evaluation marks, which is given in the final
paragraph.
Exam-style questions (A-level essay)
4 Knowledge (4 marks), application (4 marks), analysis (8 marks), evaluation (9 marks):

Understanding of the congestion charge as a tax

Rationale for the congestion charge (i.e. to reduce external costs)

Possible economics effects:
o
Increased cost of motoring/private cost
o
Incentive for car drivers to switch to substitutes (e.g. buses)
o
Revenue for the government (e.g. to invest in public transport)
o
Reduced external costs
o
Solving market failure
o
Impact on London businesses
o
Inequality issues (e.g. rich can pay higher charge)
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
58
TOPIC 4
Government intervention
 Reward use of diagrams (e.g. demand and supply, negative externalities)
Evaluation:
 Will congestion charge change behaviour, e.g. if PED for car journeys is inelastic or if
cars and public transport are weak substitutes or will consumers avoid paying the
charge?
 Long-term versus short-term impacts, e.g. long-term taxes can be invested in public
transport by the government or over time more consumers may have time to switch
 Counter-points, e.g. consumers may use the tube or public transport and still shop in
London or will they be able to solve market failure if exact external costs figure is
unknown? or government may gain revenue but cost of implementing scheme
 Other factors, e.g. other factors affect the cost of motoring, such as petrol prices or
other factors impact on government budget (e.g. austerity cuts)
 Depends on magnitude of the congestion charge
 Prioritisation of effects with justification
 Conclusions, e.g. is it beneficial overall (with justification) or would other policies be
better (with justification)?
The London Congestion Charge is a charge levied on motorists, with some
exceptions, for coming to London during certain parts of the day. The rationale
behind this is to try to reduce the amount of congestion in the capital by increasing
the cost of driving into central London and encouraging travellers to use other
means of transport.
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
59
TOPIC 4
Government intervention
The diagram above shows the market for travelling to London by car, assuming no
external benefits. Before a congestion charge is imposed, motorists will decide on
the number of journeys they will take based on the private cost of motoring (e.g.
fuel, car insurance) and the private benefits (e.g. of a convenient journey).
Therefore the market equilibrium is at Qe, where MPC = MPB.
However, motorists ignore the external costs of travelling by car (e.g. congestion,
air pollution). Society would want them to take into account the full social costs
and benefits in their decision making, i.e. setting MSC = MSB, as at Q1. This
means from society’s point of view there is overconsumption of car journeys into
London and a welfare loss of ABC.
The rationale of the congestion charge is to increase the marginal private cost of a
journey, i.e. shifting MPC to the left. This is because motorists would now have to
pay an extra charge to go to London, typically £10. This would therefore
internalise the negative externality of driving to London and drivers would be
forced to take this into account. This has several economic effects.
First, setting the congestion charge equal to the external cost would solve the
market failure and motorists would drive the socially optimum amount into
London (at Q1) and eliminate the welfare loss. Due to this there would be a
reduction in the external costs imposed on society, such as traffic jams, air
pollution and the impact those extra car journeys would have on climate change.
However, the effectiveness of the congestion charge depends on how many people
will be willing to switch their behaviour and stop driving to London. Some drivers
will have very price inelastic demand, especially those on higher incomes, and
may continue to drive and just pay the congestion charge. This may especially be
the case if they believe cars and public transport are weak substitutes (with a low,
positive XED), as buses and trains take longer or are less comfortable and
convenient. If this is true and few drivers switch, the congestion charge may not
lead to the social optimum being reached and some welfare loss may remain or the
charge will need to be increased to achieve it.
Second, the government would benefit from higher revenue from the congestion
charge. Those who continue to go into London will be paying the congestion
charge. This means the government could use this money to fund improved public
transport — for example, meaning more Londoners would be able to switch to
public transport in future.
However, there are costs of implementing the scheme for the government too in
terms of monitoring and enforcing the scheme, such as licence place recognition.
This means some of the revenue may be spent on this rather than improving public
services, such as public transport. Even with such enforcement schemes being in
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
60
TOPIC 4
Government intervention
place, there may be some motorists who manage to get away with avoiding the
tax, which would reduce the revenue the government gains too.
Finally, there is an impact on London businesses. If people are unable to drive into
London, there may be fewer customers willing to purchase their goods and
services. This is especially the case with the rise of online shopping on sites such
as Amazon. Therefore revenue could fall for these firms and therefore profits too.
However, the congestion charge has been altered in recent years to cover a smaller
area and therefore the impact on businesses in this area may not be as great.
Therefore, the magnitude of the area covered by the congestion charge is
important. Even so, given the popularity of the tube network in London, many
travellers will go into central London by public transport to visit the large number
of high-street names that are available in areas such as Oxford Street.
In conclusion, the impact that the congestion charge has fundamentally depends
on how motorists respond. Many on higher incomes may continue to use their car
if it is more convenient as the charge will make up a small percentage of their
income. However, some will be happy to switch to public transport, such as
shoppers getting the tube to Oxford Circus. However, policy makers can play a
part here by using revenue gained not only to enforce the scheme better but to
make public transport a viable alternative by spending on this. Therefore, in the
long term the problem of congestion will hopefully be solved and businesses will
not be negatively impacted if shoppers can get to their stores conveniently without
the use of a car.
This student gains the full 25/25 marks.
In terms of analysis there is detailed knowledge of externality and tax theory, including a
diagram, to illustrate the impacts of the congestion charge. There is also very good use of
context, with analysis paragraphs covering a range of factors, all well embedded in the context
of London travel, to gain the application marks (16/16 marks).
Evaluation is critical and gives opposing viewpoints with sound reasoning and use of theory
(e.g. PED, XED) to assess whether all drivers will switch and whether governments and
businesses will be affected as first thought. This leads to a well-considered conclusion, drawing
from the analysis and the context of London travel, to give an informed opinion about the
congestion charge and what its success depends on (9/9 marks).
Edexcel Economics A
© Peter Davis
Theme 1 Introduction to markets and market failure
Philip Allan for Hodder Education
61