WORKBOOK ANSWERS
AQA AS Economics Unit 1
Markets and Market Failure
This Answers book provides answers for the questions asked in the workbook. They are intended as a
guide to give teachers and students feedback. The candidate responses for the longer essay-style
questions are intended to give some idea about how the exam questions might be answered. The
examiner commentaries (underlined text) have been added to give you some sense of what is rewarded in
the exam and which areas can be developed. Again, these are not the only ways to answer such
questions but they can be treated as one way of approaching questions of these types.
Topic 1 The economic problem
1 The use of resources to make goods or services which have market value, or the process or set of
processes which convert inputs (factor services) into outputs.
(1 mark)
2 Firms use resources to produce goods or services which they sell to households who consume them.
Capitalist firms engage in production in order to make profits from selling products to households, who
benefit from the exchange by achieving higher living standards.
(4 marks)
3 Resource depletion occurs when resources are used up in the course of production, for example
energy, whereas, degradation refers to the quality of resources falling, for example as a result of
pollution.
(2 marks)
4 Many households reuse plastic containers and glass jars. Second-hand and charity shops provide a
means for clothing, records and other household items to be reused. Local councils allow for recycling
of paper, cardboard, bottles and some plastics either at recycling centres or through regular collections.
(4 marks)
5 Income is limited which means that all households have to consider carefully which goods and services
they choose to purchase. Consumer goods are made from scarce resources which means that people
have to make a decision about which goods to buy and which goods to go without every week.
(3 marks)
6 The passage mentions that Ford decided to build cars at Dagenham (where to produce), and from the
1920s onward (when to produce). How to produce is suggested by using a large site which enables
production to be vertically integrated and economies of scale to be used to reduce average costs. The
passage does not explicitly address the question of for whom to produce or when to produce in the
sense for example of using night shifts as well as day shifts or using continuous flow production.
(5 marks)
7 An excess of sales receipts over the spending by a business on the services or factors of production
during a period of time, i.e. profit = revenue – costs. (2 marks)
8 Each week, or possibly each month or year, shortage of money or income means that most people
have to choose between consuming their income or saving their income. The fact that income is not
unlimited forces this choice. (3 marks)
9 The funds available for the British government to spend are limited. Choosing to spend more on aircraft
carriers means that less tax revenue is available to spend on primary education in Africa (and vice
versa).
(3 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
1
© Ray Powell, James Powell
TOPIC 1
The economic problem
10 In addition to the point made in the answer to Question 9, the decision not to build aircraft carriers may
mean sacrificing defence capability. (3 marks)
11 The firm would not be operating at full capacity. It would be operating inside its production possibility
frontier. Maximum possible combinations of television sets and mobile phones would not be
produced. (3 marks)
12 This is a positive statement, which means that it can be tested, though it is inconceivable that it would
actually be tested. Economists could count the number of pensioners who have died from hypothermia
after a cut to the state pension. They could then compare these figures with previous years when
pensions were not cut and see whether the statement is correct or incorrect. (4 marks)
13 This is a normative statement. It is a not very pleasant opinion or value judgement which cannot be
tested scientifically. (4 marks)
Answers to exam-style questions (objective)
1 C
Explanation of answer: The production possibility curve diagram shows that when car production
rises by 40, from 60 to 100 cars, productive resources must be taken away from bike production. Since
the economy is producing on its production possibility frontier, there are no spare resources to use.
Switching of resources away from bike production causes bike output to fall by 200.
2 D
Explanation of answer: With this type of question, it is important to read the ‘stem’ of the question
carefully, taking note of the word ‘except’. All the possible answers are true except D. This is because
statement D relates to consumption choices and not to production choices.
3 C
Explanation of answer: Only statement C provides a widely accepted definition of the central
economic problem. Statements B and D do relate to economic problems, but not to what is usually
regarded as the central economic problem. Statement A relates to an aspiration and not to an
economic problem.
4 B
Explanation of answer: On first sight, statement A might appear to be the correct answer. However, it
is a wrong answer because different people have different views on what is equitable (fair) and
inequitable (unfair). Views on fairness cannot be scientifically tested to see if they are right or wrong.
The words ought and should in statements C and D indicate that they are normative rather than
positive statements. This leaves statement B as the correct answer. It is possible to measure incentive
and disincentive effects.
5 A
Explanation of answer: Statement A provides a definition of opportunity cost. All the other statements
have nothing to do with the meaning of opportunity cost.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
2
© Ray Powell, James Powell
Topic 2 The allocation of resources in
competitive markets
1 A downward-sloping demand curve shows an inverse relationship between planned quantity
demanded and the price of a good or service.
(2 marks)
2 The total amount of a good or service which firms are willing to sell in the marketplace in a given time
period.
(2 marks)
3 Market equilibrium is when the forces of supply and demand are balanced. This occurs when planned
demand is equal to planned supply. (3 marks)
4 A shift in demand occurs following a change in at least one of the conditions of demand, in which case
the ceteris paribus assumption no longer holds. The demand curve shifts to a new position, sliding
along the supply curve. An adjustment along the supply curve happens when the price of the good or
service changes. In the following diagram, the demand curve shifts from D1 to D2, and at the new
equilibrium at point Z, supply has adjusted from Q1 to Q2. Essentially, an increase in demand leads to
an expansion of supply.
(4 marks)
5
The diagram above, which develops Figure 1 on p. 10 in the workbook, can be used to show excess
demand. Immediately after the shift of the demand curve from D1 to D2 shown in the diagram, quantity
Q3 is demanded at price P1. However, at this price, firms are only willing to supply Q1. Excess demand
at this price is shown by the distance between points X and V (or between Q1 and Q3). This excess
demand causes the price to rise until a new equilibrium is reached at point Z and price P2.
(4 marks)
6 The term refers to how scarce resources are allocated between competing uses. In the marketplace
resources are allocated by the price mechanism which is guided by the forces of supply and demand.
(4 marks)
7 The shift in demand was driven by speculators entering the market seeking to buy copper at a low
price and sell it at a later date at a higher price, with the aim of making a considerable profit. The
speculative demand increased the price of copper because of two factors that limited supply. First,
stockpiles of copper were very low; second, it was difficult for new copper to be mined. This meant that
the supply of copper was inelastic with respect to a price increase and thus unresponsive to the
increased surge in demand. (6 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
3
© Ray Powell, James Powell
TOPIC 2
The allocation of resources in competitive markets
8 A rapid increase in the price of copper will mean higher prices for consumers which in turn will mean
that they will purchase less. Also, the higher cost of production of goods made in part from copper
feeds into the general inflation figures for the economy. Higher prices will affect households negatively
because they will have to pay more for goods, thus having less disposable income for other purchases.
However, copper mining companies should experience higher sales revenue if demand for copper is
price inelastic. The significant long-term effect of the higher price of copper will be to send a signal to
the markets that copper is now an even more valuable good. This will create greater incentives for
producers to increase supply in the long run. Mining companies will seek new sources of copper. Scrap
metal merchants will seek to recover greater quantities of recycled copper. The high price should also
create incentives for consumers to use copper more sparingly and search for alternative raw materials,
e.g. plastic piping. This could cause prices to fall eventually. Additionally, a very serious cost of the
high price of copper is an increase in crime, with criminal gangs stealing copper in order to sell it to
scrap metal traders. This is exceptionally dangerous when it puts public safety in danger if for example
railway signal wires are stolen.
(10 marks)
9 Elasticity measures the responsiveness of a dependent variable following a change in an independent
variable. PED measures the percentage change in the quantity demanded for a good following the
change in the price. PES measures how the quantity supplied to a market responds proportionately to
a change in price.
(4 marks)
10
Price elasticity of demand = Percentage change in quantity demanded
Percentage change in price
Income elasticity of demand = Percentage change in quantity demanded
Percentage change in income
(4 marks)
11 The supply curve for new houses is inelastic for three main reasons. First, there are strict planning laws
in the UK which prevent house builders from quickly increasing the supply of houses. Second, there is
a shortage of available land to build on. The UK has a large population relative to its land mass. Third,
it takes months, if not years, to build a house.
(5 marks)
12 In the UK, most people finance house purchase using borrowed money (a mortgage). Low interest
rates create an incentive to take out mortgages to buy houses. In 2012, interest repayments were
cheap and low interest rates create a disincentive to save because of the low return on savings.
However, demand for houses actually fell because although consumers wanted to borrow to finance
house purchase, the banks and building societies reduced the supply of mortgages to minimise risks
following the huge losses they had incurred in earlier years during the banking crisis. As a result,
demand decreased because the number of consumers who could obtain mortgages to buy property
fell, since they were unable to borrow sufficient funds to finance house purchase.
(8 marks)
Answers to exam-style questions (data response)
01 Speculation is the act of buying a product or asset with the aim of selling it at a later date so as to make
a profit from the difference between the buying and selling prices.
(5 out of 5 marks)
Part 01 questions require a short snappy (but accurate) definition. The candidate has provided a good
definition.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
4
© Ray Powell, James Powell
TOPIC 2
The allocation of resources in competitive markets
02 First, between October 2010 and September 2011 the price of gold increased. At the start of the period
the price was approximately $1,375 per ounce but by the end of the period it had increased to roughly
$1,680 per ounce.
Second, the price of gold rapidly increased between the end of June 2011 and the end of August 2011.
It rose from $1,500 per ounce to just under $2,000 per ounce. This was a price increase of 30% in
2 months. (8 out of 8 marks)
When Extract A in a question contains just one data series (in this case, changes in the price of gold over
several months), the question will ask for an identification of two significant features of the data. It is a
good idea to write these in two separate paragraphs.
03
Gold is a precious metal and an extremely scarce resource. The price of gold increased in 2009 for
three main reasons. First, the supply of gold was inelastic (see supply curve on the diagram) and could
not respond to the increases in demand. As Extract B states: ‘only a small amount of new gold can be
mined each year’. Second, demand increased dramatically, as shown by the shift of the demand curve
from D1 to D2 in the diagram. The shift occurred as a result of economic uncertainty, which caused
many investors to buy gold. Gold is a physical asset rather than a financial asset and ‘is regarded as a
safe haven’ (Extract B, line 10) in uncertain times. The shift of the demand cause was also caused by
speculators entering the market in the hope of making a profit from selling later at a higher price.
(12 out of 12 marks)
The key instruction in a part 03 question is always ‘explain’. This requires application of some relevant
economic theory, for example supply and demand theory, to address the issue or issues posed by the
question.
04 The regional economy in the Scottish Highlands could benefit significantly from the opening of new
gold mines. The mine owners should be able to make significant profits as long as the price of gold
remains high. They would be able to sell their gold on the world markets and generate revenues which
they could in turn use to purchase assets, capital goods and consumer goods. They would also need to
employ workers to operate the mines. This would be a valuable boost to local levels of employment.
Furthermore, the wages paid would invariably be spent in the local economy and local businesses
would thrive. This should result in higher growth and living standards in Scotland. The gold mines
would also increase the overall supply of gold on the global markets which might calm commodity
markets and reduce feverish speculation. These are the possible benefits for the Scottish economy and
the wider UK and global economies.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
5
© Ray Powell, James Powell
TOPIC 2
The allocation of resources in competitive markets
However, the opening of new mines would also impose significant costs on the local environment. Gold
mining has many dirty side effects and would result in pollution being dumped into local rivers and
springs. This is unavoidable, and as Extract C, line 8, states, it would ‘affect adversely the quality of
drinking water in Scottish cities’. This is extremely worrying because it would have an effect on public
health, although by contrast high levels of unemployment can also have a significant effect on the
mental health of a community.
The mining process would create ‘eyesores’ and it may harm an area of outstanding natural beauty.
This is a powerful argument because although economic growth and employment are important it is
also the duty of government to preserve the environment for future generations. This is a difficult tradeoff: economic growth versus environmental preservation. Ultimately the decision to open new gold
mines is desirable because growth and employment are much needed but it should only go ahead if
the extent of environmental damage is limited and any change in the quality of drinking water will have
no significant effects on public health.
Finally, if the price of gold were to fall on the world gold market, the high-cost Scottish mines might
become uneconomic and have to close. ‘Eyesore’ pollution would continue, but derelict mines would no
longer produce any benefits for the Scottish economy. In the long run, whether the benefits of Scottish
mining exceed the costs depends in large part on the future viability of mines if world demand and
supply conditions for gold change. (16 out of 25 marks)
This answer has been awarded a mark at the top of Level 3 in the AQA mark scheme. The Levels
descriptors in the mark scheme are used for all part 04 and 08 Context data response questions at AS).
The Level 3 descriptor is:
AS
AO1
AO2
AO3
AO4
LEVELS OF
RESPONSE
KNOWLEDGE and
UNDERSTANDING
of theories,
concepts and
terminology
APPLICATION of
theories, concepts
and terminology
ANALYSIS of
economic
problems and
issues
EVALUATION of
economic
arguments and
evidence, making
informed
judgements
Level 3
Satisfactory but
some weaknesses
shown
Reasonable
application to
issues
Reasonably clear
but may not be
fully developed
and is perhaps
confused in places
with a few errors
present
Superficial,
perhaps with some
attempt to consider
both sides of the
issue(s)
10–16 marks
(mid-point 13)
Reasonable
answer, including
some correct
analysis but very
limited evaluation
Reasonable use of
data to support
answer
Although there is evaluation in the answer, good evaluation must first be preceded by focused analysis.
It is the lack of such analysis, mainly analysis of external costs and benefits accompanied by at least one
relevant diagram, that constrains this answer to the top of Level 3.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
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© Ray Powell, James Powell
Topic 3 Production and efficiency
1 Welfare derived from external benefits resulting from economic activity such as the pleasure enjoyed
from looking at a beautiful building; welfare derived from the company of family and friends.
(2 marks)
2 Land earns rent; labour earns wages or salaries; capital earns interest; enterprise earns profit.
(2 marks)
3 The total cost of production divided by the number of units produced. (1 mark)
4 Capital goods, for example an engineer’s drill, are intended for use in production. By contrast,
consumer goods are intended for final consumption by households. Two examples are DAB radio and
a bottle of wine.
(4 marks)
5 Just as labour productivity is output per worker, so capital productivity is output per unit of capital.
(1 mark)
6 By measuring the number of essays written or chapters of a book read in a given time period.
(2 marks)
7 A learning effect occurs when workers become more efficient and skilled at performing particular
production task(s) as they learn from previous experience of performing the task(s). In a sense it
relates to the view that ‘practice makes perfect’. Likewise managers learn from previous experience.
(2 marks)
8 At a microeconomic level, productive efficiency is achieved when the average costs of production are
minimised. The concept of economies of scale is based on the notion that as a firm increases its scale
of production, it will benefit from greater specialisation, which will result in productivity gains and lower
average costs. However, if a firm becomes too big, inefficiency and mismanagement will set in and
average costs will start to rise (diseconomies of scale).
(4 marks)
9 As the word indicates, specialisation means concentrating on a narrow range of tasks. Division of
labour means that different workers (in this case shop workers) perform different tasks. The tasks
include: answering customer queries, selling games, ordering new stock and security. These are
usually four separate jobs performed by different employees. This enables them to specialise and
develop the skills appropriate for the task they are performing.
(4 marks)
10 Barter is the most primitive and basic method of exchange. Goods and services are exchanged directly
by buyers and sellers. In this example the worker sells labour in exchange for a valued item provided
by the shopkeeper. Modern economies are of course monetary economies in which money rather than
barter provides the medium of exchange.
(3 marks)
Answers to exam-style questions (data response)
01 A firm is productively efficient when it minimises its average production costs. The firm is operating at
the lowest point on its average cost curve.
(5 out of 5 marks)
Each of the two sentences on its own would earn all five of the available marks.
02 The data show changes in labour productivity rather than output per worker at the different points of
time covered by the graphs. A first significant point of comparison is that changes in whole economy
labour productivity and service sector labour productivity are both cyclical, with the two cycles more or
less correlating with each other. There are slight lags involved, for example the change in service
sector labour productivity fell to zero (compared with the previous quarter) at the beginning of the fourth
quarter of 2008. By contrast, for the whole economy, zero was reached 3 months later.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
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© Ray Powell, James Powell
TOPIC 3
Production and efficiency
A second significant point of comparison is in the range of the fluctuations. For the whole economy, the
peak of labour productivity in mid-2007 was about a plus 3.5% change in labour productivity, with the
trough (at the end of 2008) at a –5.25% change in labour productivity, a range of 8.75%. For the
service sector, the peak of labour productivity (also in mid-2007) was about a plus 4.5% change in
labour productivity, with the trough (at the beginning of the fourth quarter in 2008) at a –4.5% change in
labour productivity, a range of 9%. In other words, the range was about the same.
(8 out of 8 marks)
When Extract A in a question contains two data series (in this case, changes in labour productivity for the
whole economy and for the service sector within the economy), the question will ask for an identification of
two significant points of comparison between information in the two series. It is important to compare
across (or between) the two data series, rather than just along one of the data series.
03 The first reason for different levels of labour productivity stems from the quality of investment in a firm’s
capital infrastructure. Workers are more productive if they are using the most up-to-date technology
and capital equipment, such as the robots mentioned in Extract C (line 9). Labour productivity will
improve because better capital equipment will allow workers to make better quality cars at a faster rate.
Automoted robots can be programmed to perform complex repetitive tasks without getting tired, only
needing a technician to monitor their work. This makes modern car factories more efficient and in turn
this brings down costs. However, if workers are using out-dated equipment in old factories they will
work more slowly and the quality of the cars produced will be inferior. More workers are employed to
produce fewer cars.
A second reason is different management practices which significantly affect the productivity of
workers. British industry historically has a bad reputation for poor management. This could explain why
the Rover workers’ productivity was as low as 30 cars per year (Extract C, lines 2–3). The managers at
Rover simply did a bad job of organising the factories and getting the best out of the workforce. In
contrast, Japanese companies have an excellent reputation for innovating and motivating their
workers. Toyota for example has developed the model of ‘last minute delivery’ which makes all workers
feel valued. If they do not perform their tasks properly, the entire production line grinds to a halt. This
also enables managers to identify problems quickly. This is reflected in Extract B which shows that
Nissan car workers build on average 99 cars per worker and Toyota 88 cars per worker.
(12 out of 12 marks)
This is an excellent answer which fully obeys the instruction in the question, namely to explain two
reasons. Part 03 and 07 questions only ask for explanation. They never ask for evaluation. Candidates
who are otherwise good often waste time by drifting into evaluation, but this candidate does not make this
mistake.
04 A main argument for government intervention in the UK car industry, in the context of saving
manufacturing jobs, is to provide emergency help in an economic crisis. The 2008 economic crisis hit
the UK economy particularly hard and saw consumer demand for ‘big ticket’ goods such as new cars
fall dramatically. As a result, car companies in the UK responded to this sudden fall in consumer
demand by significantly cutting back on production.
In this situation there is a strong case for government intervention to help distressed firms in the worst
parts of a crisis. This involved schemes like the ‘car scrappage scheme’, where the British government
gave consumers £2,000 towards a new car if they traded in an old car over 10 years old. In this
situation it makes sense for the government to use taxpayers’ money to create market incentives to
encourage spending in the economy. Demand for cars did not fall because of the poor quality of the
cars but due to the wider macroeconomic crisis. It would have made little economic sense for the
government to allow good companies to go bust in a crisis with the long-term consequence of skilled
workers becoming unemployed.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
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© Ray Powell, James Powell
TOPIC 3
Production and efficiency
Government intervention is justified in the short run to head off the negative effects of an economic
crisis. However, government intervention is not justified in the long run to save jobs. This is because it
would simply lead to taxpayers’ money being used to prop up poorly run and inefficient companies,
such as Rover which ran some of the ‘worst’ plants in Britain (Extract C, line 5). The global car market
is very competitive and consumers choose to buy the best cars at the best prices. Market discipline
ensures that inefficient plants are ‘closed down, or reorganised to improve their efficiency’ (Extract C,
line 6). This form of government intervention may ‘save’ jobs but only by imposing higher taxes in the
rest of society. As the economist in Extract D (line 4) says, this would be a ‘government failure’
because taxpayers are subsiding firms to make cars that consumers do not want to buy. This is a
misallocation of scarce resources and an unacceptable situation.
(15 out of 25 marks)
Just like with the answer to part 04 of the Topic 2 data response question on gold mining, this answer is
constrained to Level 3, earning 15 of the available 25 marks. The answer suffers from the same problems
as the gold mining answer, principally lack of developed analysis that must precede in-depth evaluation.
The analysis in this answer is too thin. Mention could be made of the fact that all cars that are massproduced in the UK are the product of Japanese and US car companies. Obviously such companies would
enjoy receiving subsidies from the UK government, but by contrast they might be driven off-shore by other
types of government intervention, for example a requirement that cars must be manufactured solely from
components produced in the UK.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
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© Ray Powell, James Powell
Topic 4 Market failure
1 When consumers see the price of a good, such as a new car, they can see the value of the good and
immediately know how much money they would have to pay in order to buy the car. The car’s price
signals information to the consumer, though other information, for example about the quality of the car,
is also needed before making the decision whether or not to buy the car.
(3 marks)
2 The price has decreased by £300 which immediately creates an incentive to buy the good. The iPhone
is cheaper, which means that the consumer can enjoy using it and still have a considerable amount of
money to spend on other purchases. However, if the price cut signals that a new and better version of
the iPhone will soon be launched, some potential buyers may decide not to purchase the now cheaper
current version of the iPhone.
(4 marks)
3 The textbook example of a public good with non-excludability characteristics is a lighthouse. The
lighthouse provides an invaluable service to ships, warning them of hazards and rocks, but it cannot
prevent ships that do not pay from seeing the light beam that it creates. Hence ships can use the
invaluable service provided but do not have to pay because there is no mechanism to make them pay
for seeing light. Ships can ‘free-ride’ and benefit without having to pay, which is a market failure. Thus it
is not profitable for lighthouses to operate in the marketplace because they cannot charge for their
service, hence the missing market. In the UK lighthouses are funded through charitable donations.
(6 marks)
4 Non-rivalry (or non-diminishability and non-exhaustability) is a property which, along with nonexcludability, is a defining characteristic of a public good. Non-rivalry means that when one extra
person benefits from a pure public good such as national defence, he or she does not reduce the
quantity of the good available to other people.
(2 marks)
5 This is a public good service. Although the majority of citizens pay for the police force through general
taxation, the service provided benefits the whole of society, even those who have not paid the taxes
which finance the provision of the service. The very existence of the police force creates a deterrent
that limits burglaries and street riots. The police force protects the whole of society and cannot, and
should not, distinguish between those who contribute towards taxation and those who do not. Hence,
the protection of the police force is non-excludable and citizens who do not pay taxation can free ride.
However, policing can have private good properties when provided, for example, by a private security
firm guarding a shopping mall.
(5 marks)
6 An example of a positive externality is the benefit received by others when a person is educated.
Society benefits from producing educated citizens because they add value to society. The many
benefits received by third parties throughout society from education cannot be included in the price
mechanism. Many of the benefits received from education are external from the price mechanism
which is of course a market failure. (4 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
10
© Ray Powell, James Powell
TOPIC 4
Market failure
7
The diagram above illustrates the costs incurred and the benefits generated when a commercial
forestry company plants trees. Tree planting produces a number of positive externalities, which include
improved water retention in the soil. This means the marginal social benefit (MSB) of tree growing is
greater than the marginal private benefit (MPB) accruing to the forestry company. In the diagram, the
MSB curve is positioned above the MPB curve. The vertical distance between the two curves shows
marginal external benefit (MEB) at each level of tree planting.
In order to maximise its private benefit, the commercial forestry plants Q1 trees. Q1 is immediately
below point X, where MPC= MPB. However, Q1 is less than the socially optimal level of output Q2,
located below point Y, where MSC= MSB The diagram illustrates the fact that, when positive
production externalities are generated, the market fails because too little of the good is produced and
consumed. Underproduction and under-consumption are depicted by the distance Q2–Q1.
(8 marks)
8 At the present day, because of a lack of economies of scale and the high price of parts for the car,
electric cars are considerably more expensive to build than petrol and diesel alternatives.
There are only a limited number of recharging points across the UK. This generally makes it impossible
to drive electric cars over long distances or to remote destinations.
(4 marks)
9 Museums; libraries; art galleries
(3 marks)
10 Market failure occurs whenever a market performs inefficiently. An example occurs when firms produce
and/or consumers buy, the ‘wrong’ quantity of a good. The answer to Question 7 explains that because
forestry companies gain no benefit from the positive externalities produced by the trees they plant, in a
market environment they plant too few trees. In the case of healthcare, which is a merit good, other
people benefit when a person consumes healthcare services. Consumption of healthcare produces
positive externalities which benefit the whole community. As a result, the social benefit of consumption
exceeds the private benefit enjoyed by the consumer. The community benefits because a healthy
population means there are fewer ill people to catch diseases from. (6 marks)
11 A pure monopoly is when one firm has control of 100% of a product supplied to a market and can
maintain this situation in the long run.
(3 marks)
12 There is no doubt that Sky uses the monopoly power it has gained from buying up the rights to screen
live Premiership football games to raise the price that viewers pay. As a result, fewer people choose to
subscribe to Sky and to Sky’s sport channels than would watch live matches if the price was lower or if
they could watch free.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
11
© Ray Powell, James Powell
TOPIC 4
Market failure
Sky’s response is that this does not represent abuse of monopoly power. Sky claims that by paying a
lot of money for exclusive rights to broadcast live matches, it has ‘invested’ in the Premier League,
allowing clubs to use television revenues to buy expensive players that they would not have been able
to afford without television revenues. In this way, Sky has improved the quality of the product. In any
case, people can watch live match broadcasts in pubs and bars without having to pay.
However, there is a case for using regulation to reduce Sky’s monopoly power, and to a certain extent
this has been achieved. ESPN, another ‘pay to view’ broadcasting company, can now buy the rights to
broadcast a limited number of Premiership matches. It can be argued that regulation should go one
stage further, by allowing football fans and pubs to buy Sky sports services from companies that
possess the right to broadcast matches in other EU countries. This surely is the purpose of the Single
European Market. (6 marks)
Answers to exam-style questions (data response)
01 A negative externality is a public bad which stems from either the production or consumption of a good
or service and which is dumped on third parties without their consent. The negative externality is
delivered outside of the price mechanism.
(5 out of 5 marks)
Although this answer earns full marks, the fact that the word ‘externalities’ in the question is in the plural
might have prompted the candidate to give two examples of negative externalities.
02 The first significant feature is that in every age group shown in Extract A more people choose not to
smoke than to smoke. The 21–25 year age group are the most likely to smoke with 41.2% of people
smoking, whereas the 12–13 year age group are the least likely to smoke with only 2.4% smoking.
The second significant feature is that after the age of 25 there is a gradual reduction in the percentage
of people in each age group smoking. In the age group 21–25 as many as 41.2% of the people smoke
but this figure falls and in the 65+ age group only 10% of people smoke.
(8 out of 8 marks)
Two significant features of the data are correctly identified, with identification backed up in each case with
evidence from the data. Mark schemes for part 02 and 06 questions award 2 marks for each point of
identification (provided the examiner deems it to be significant) and 2 marks for statistical back-up. With
the latter, it is important to include accurate units of measurement (in this case % signs).
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
12
© Ray Powell, James Powell
TOPIC 4
Market failure
03 The diagram below depicts the marginal private, external and social costs and benefits incurred and
received in a free market for tobacco products such as cigarettes.
Tobacco is a demerit good, which means that is it over-produced and over-consumed if provided in a
free market. This occurs for two reasons.
First, when smoked tobacco dumps harmful negative externalities into the immediate atmosphere.
Non-smokers do not choose to breath in this passive smoke but could suffer severe health effects such
as lung cancer (Extract B, line 5). The market has no mechanism for charging smokers for the harm
that they are inflicting on the health of non-smokers. Hence the true price of smoking is not reflected in
the price. When left to the free market, smoking is under-priced and over-consumed. Overconsumption is shown by Q2–Q1 on the diagram.
Second, when people start smoking they fail to appreciate the true health effects of smoking. This is
known as the information problem because humans cannot appreciate the long-term costs of smoking,
which may take over 30 years to appear. Teenagers who start smoking often ‘ignore and downplay
information’ about how addictions may be dangerous but they only fully comprehend the actual
consequences of their actions in later life. As a result they over-consume tobacco because they make
decisions based on short-term benefits but ignore long-term costs. This effect is not shown on the
diagram.
(12 out of 12 marks)
More often than not, part 03 and 07 questions ask for inclusion of an ‘appropriate diagram’. For questions
on a market, such as the Topic 2 question on the gold market, the ‘appropriate diagram’ is almost always
a supply and demand diagram. For questions on a market failure, including this question, the appropriate
diagram is likely to be a marginal private, external and social cost and benefit diagram.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
13
© Ray Powell, James Powell
TOPIC 4
Market failure
04 The justification for raising taxation on tobacco is that tobacco is a demerit good which is under-priced
by the free market, hence its price is too low and it is over-consumed.
By increasing the level of taxation the government will be increasing the costs of production of firms
supplying tobacco in the market. This is illustrated in the diagram below, as supply shifts to the left from
S1 to S2. The suppliers will in turn pass the cost of the tax increase onto consumers. The government
hopes that the higher price will create a disincentive for consumers not to buy tobacco.
The main problem with this argument is that most smokers develop an addiction to cigarettes when
they are young (Extract B, line 9). Once smokers are addicted to tobacco their demand is often
inelastic, as can be seen in the diagram. This means that the increase in the level of taxation on
tobacco is ineffective at reducing demand.
Anti-smoking campaigners argue that even if the tax increase is ineffective it is still justified on the
grounds that it will raise revenues for the government worth billions of pounds each year that can be
used to treat people with smoking-related diseases. This is a powerful argument. Smoking tobacco is
harmful for both the individual who chooses to consume cigarettes and third parties who unintentionally
passive smoke. Hence, increased taxation can be used to help correct the immense damage caused
by smoking.
The tobacco industry disputes part of this argument. As can be seen in Extract C, tobacco firms warn
that excessive taxation actually reduces government tax revenues because it leads to higher levels of
smuggling (line 5) which deprives the UK exchequer of £3 billion per year.
Although this is a strong argument it is not a reason for not taxing tobacco heavily. The government
should use the police and revenue and customs agencies to enforce the law and prevent illegal
smuggling. However, if the government really wants to decrease the level of smoking it needs a policy
that discourages young people from starting smoking. Taxation can be effective by making cigarettes
expensive but to be truly effective an educational government policy is needed to make young smokers
fully aware of the long-term cost of smoking. (19 out of 25 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
14
© Ray Powell, James Powell
TOPIC 4
Market failure
This answer reaches Level 4, for which the descriptor is:
AS
AO1
AO2
AO3
AO4
LEVELS OF
RESPONSE
KNOWLEDGE and
UNDERSTANDING
of theories,
concepts and
terminology
APPLICATION of
theories, concepts
and terminology
ANALYSIS of
economic
problems and
issues
EVALUATION of
economic
arguments and
evidence, making
informed
judgements
Level 4
Good throughout
the answer with
few errors and
weaknesses
Good application
to issues
Relevant and
precise with a
clear and logical
chain of reasoning
Limited but
showing some
appreciation of
alternative points
of view
17–21 marks
(mid-point 19)
Good analysis but
limited evaluation
Good use of data
to support answer
or
Reasonable
analysis and
reasonable
evaluation
Good throughout
much of the
answer with few
errors and
weaknesses
Some good
application to
issues
Some good
application to
issues
Largely relevant
and well organised
with reasonable
logic and
coherence
Reasonable,
showing an
appreciation of
alternative points
of view
Some good use of
data to support
answer
To reach Level 5, a winding-up concluding paragraph is necessary, linking back to, but not merely
repeating, arguments stated earlier in the answer. It is often a good idea to ‘save’ one important argument
until the conclusion and then to use it as the ‘killer’ argument which sways you in favour of either ‘the case
for’ or ‘the case against’.
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
15
© Ray Powell, James Powell
Topic 5 Government intervention in the market
1 An example of a market functioning inefficiently is the international airline industry. International air
flights do not pay fuel duty but they emit carbon dioxide emissions, which are negative externalities,
into the atmosphere. This is a market failure because the airlines do not pay the full costs of
production. This is inefficient because the market price does not reflect the true costs of air travel. As a
result the free market price is too low, too many people travel by air and resource misallocation occurs.
(5 marks)
2 Fuel taxation could be used to raise the price of air travel. The revenues raised could be used to
correct the damage caused by the negative externalities. The higher price will discourage consumption.
(2 marks)
3 The word ‘equitable’ means ‘fair’ or ‘just’ and the word ‘inequitable’ means ‘unfair’ or ‘unjust’. Many,
though not all, economists believe that a highly unequal distribution of income should be deemed a
market failure, on the ground of inequity. However, inequity and equity are normative words, so not all
economists agree. Make sure that you do not confuse inequity with inequality (a positive word). Some
say the market for bank workers is inequitable as the pay of top bankers is hundreds per cent higher
than the pay of bank cashiers.
(6 marks)
4 Progressive taxation could make the market for bank workers function more equitably. An income tax is
progressive if a progressively larger proportion of income is paid in tax as income increases.
(2 marks)
5
The diagram above is nearly identical to the diagram drawn in the answer to part 04 of the data
response question on tobacco as a demerit good in Topic 4 (see page 31). In this case, however, the
demand curve has been drawn elastic, showing a more than proportionate fall in demand following the
increase in price that results from the imposition of the indirect tax. Given this assumption about the
elasticity of demand (which may be unrealistic), the indirect tax successfully reduces demand for
alcoholic drink from Q1 to Q2.
(8 marks)
6 Imposing a price ceiling on the fees universities can charge for higher education would keep the price
down, but it could leave to excess demand and too few higher education places being made available
by the universities. This means, to be successful, the price ceiling would need to be supported by
another policy such as granting subsidies to universities.
(4 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
16
© Ray Powell, James Powell
TOPIC 5
Government intervention in the market
7 A tradable market in permits to pollute in the electricity market works in the following way. Coal-burning
power stations able to reduce pollution by more than the law requires sell their ‘spare’ permits to other
power stations which, for technical or other reasons, decide not to, or cannot, reduce pollution below
the maximum limit. The latter still comply with the law, even when exceeding the maximum emission
limit, because they buy the ‘spare’ permits sold by the former group of power stations. In the long run,
even power stations that find it difficult to comply with the law, have an incentive to reduce pollution, so
as to avoid the extra cost of production created by the need to buy pollution permits. (8 marks)
8 The issue here is ‘fairer for whom’? Government provision of healthcare is certainly fairer for poor
people who could not afford to buy market-provided healthcare but who now receive free stateprovided healthcare. But is it fairer for somebody who in the current system lives in a part of the UK
where local NHS hospitals are poor. Is it fairer for people whose health deteriorates while languishing
on NHS waiting lists, or who suffer from a ‘postcode lottery’ in which similarly ill people living 50 miles
away are prescribed expensive drugs denied to them.
Neither the current NHS provision nor market provision is fair, though arguably state provision is fairer.
Hospital care could be provided through a state-guaranteed private insurance system. Healthy people
never know whether they will be ill in the future and will require expensive hospital treatment many
years ahead. But while an individual seldom knows whether a future operation will be required, insurers
can predict, using the ‘law of large numbers’, how many people in an age group are likely to suffer a
serious disease in the future. Private but state-backed health insurance, which forces everybody to pay
insurance premiums and insurance companies to accept contributions from everybody, is the way
forward.
(10 marks)
9 The passage mentions three forms of rationing healthcare other than rationing through prices. These
are: quantity rationing, which results in queues and waiting lists; rationing by lottery; and rationing
through the notion of blame. This answer is going to evaluate the first of these, quantity rationing.
Rationing by queues and by waiting lists occurs when the price of a good is set below the marketclearing price, which creates excess demand and a shortage. This can happen if the government
introduces a maximum price law, or, in the case of events such as football matches, rock concerts and
art exhibitions when the promoter of the event sets admission prices that are too low. Rationing by
queues and waiting lists leads to black markets. Some economists believe that black markets perform
a useful economic function, bringing together buyers and sellers, with the black market price clearing
the market. Others argue that black markets lead to criminal behaviour and racketeering.
In the health service, quantity rationing has the adverse effect of patients dying while they wait several
weeks or even months for treatment. It also leads to queue jumping when patients who can afford to
choose private treatment instead, often in NHS hospitals. However, defenders of the system argue that
this frees scarce resources within the NHS, which can be used to treat patients who cannot afford to
queue jump.
(10 marks)
10 Market failure occurs when markets function badly or unsatisfactorily. Market failure occurs when
banks function inequitably or inefficiently, and in the latter case, when one of the three functions prices
perform in a market breaks down. In an extreme case, when all three functions (signalling, incentive
and rationing) break down, a market ceases to function at all. In this situation, there is a ‘missing
market’.
Government failure, by contrast, occurs when government intervention in the economy, sometimes to
correct market failure, is ineffective. In extreme cases, government intervention may create new
problems worse than those the intervention was supposed to cure. For example, government
intervention through high taxation to make incomes more equal may reduce incentives to work hard
and this may harm economic growth.
(10 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
17
© Ray Powell, James Powell
TOPIC 5
Government intervention in the market
Answers to exam-style questions (data response)
01 Imperfect information is when either a supplier or a buyer lacks sufficient information about a
transaction to make an informed efficient choice. In everyday markets economic agents frequently
make decisions based on imperfect information but as information becomes more limited the
probability of a poor decision increases.
(5 out of 5 marks)
This is a correct answer. The question does not require an example but it is often useful to include one as
it will pick up a mark (provided it is correct) if the definition is a little imprecise or fuzzy.
02 First, the percentage of obese and overweight men and women increased steadily throughout the
period. In 1994 14% of men and 18% of women were obese yet by 2008 levels of obesity for both men
and women had reached 25%. Likewise, in 1994 49% of women and 58% of men were overweight. By
2008 these figures had risen to 57% and 66% respectively.
Second, the gap between overweight men and women remained relatively stable over the 12-year
period. In both 1994 and 2008 approximately 9% more men are overweight than women. By contrast,
the gap between obese men and obese women closes over the period. In 1994 there is a gap of about
4% but by 2008 both genders have levels of obesity at roughly 25%. (8 out of 8 marks)
This answer meets all the requirements of part 02 or 06 questions and earns full marks. There is sufficient
comparison across the different data series, all the comparative points are significant, and accurate
statistical back-up is provided.
03 The central problem in this situation is that consumers are not being provided with sufficient information
to make an informed choice. The food packets that customers are buying do not provide sufficient
information about the number of calories contained. As a result individuals are making choices based
on imperfect information, which leads to overeating and raised levels of obesity. As can be seen from
the trends in Extract A, overeating and obesity have been steadily increasing in the last 20 years in the
UK.
This is a market failure because consumers cannot make an informed choice and therefore behave in
a manner that does not maximise their welfare. The figure above includes two curves, each showing
the marginal benefits enjoyed by a person as a result of eating food. The inner curve is labelled
marginal benefits (with full information). Full or perfect information includes information about the
adverse health consequences of overeating, and/or eating the wrong kinds of foods. Given full
information, the person chooses to eat Q2 food. But in real life, the problem is that many people ignore
or downplay the long-term adverse consequences of overeating and/or consuming the wrong kinds of
foods. The level of food consumption of a person whose eating habits are shown in the figure are
determined where the curve labelled marginal benefits (with imperfect information) intersects the MPC
curve. Q1 food is eaten, and overeating is shown by Q1 minus Q2.
(12 out of 12 marks)
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
18
© Ray Powell, James Powell
TOPIC 5
Government intervention in the market
Pay special attention to the ‘appropriate diagram’ in this answer. Exam questions that focus on perfect and
imperfect information are increasingly appearing in the ECON1 exam, but not all exam candidates seem
to be familiar with the meanings of, and the difference between, the two concepts.
04 The debate about the role of government in an economic system is central to the study of economics.
At present the UK has a mixed economy which is tilted in favour of markets. The dominant view among
policy makers since 1979 is that markets are more efficient at allocating scarce resources than
governments. Nevertheless, in 2012 the British state still accounts for 44% of GDP and large command
structures, such as the NHS, still allocate billions of pounds of resources every year.
In terms of food markets, most economists believe food should be provided by markets because the
profit incentive drives farmers to produce higher crop yields. However, the balance of market power
between producers (farmers) and buyers (large supermarket firms) is tilted very much on the side of
the supermarkets. Arguably, supermarkets use the market power that their size gives them to force
farmers, who individually possess very little market power, to accept very low prices for the foods they
are selling. At the moment, the UK government does very little, apart from trying to persuade the
supermarkets to be fairer in their dealings with farmers, to alter this asymmetry in market power. Some
people believe that the government should intervene in food markets in other ways to correct this
market failure, for example by introducing and then enforcing minimum legal prices, or price floors, for
agricultural produce. Others disagree, arguing that such intervention will lead to government failure, for
example by creating excess supply which in a free market is corrected automatically by a fall in market
prices. However, price floors would allow farmers to make sufficient profit to invest in new production
techniques that might increase domestic supply of foods in the long run.
When it comes to the issue of food labelling rather than replacing the market mechanism for setting
prices, economists are more divided. As Extract B explains, a government agency, the FSA, believes
that food labels provide consumers with too little information about additives in processed foods. The
FSA would like to correct the problem by introducing better food labels which will properly inform
consumers about the qualities of the food that they buy. However, if food labels better inform
customers about the food that they buy then demand for certain types of processed food will decrease
because consumers will better understand the consequences of eating high fat and high salt foods.
However, many free-market economists reject the call for further regulation on food labelling, arguing
that it is unnecessary regulation that will increase food costs. In their view, self-regulation by the food
industry is preferable to external regulation. On balance, the case for further external regulation is
stronger, for the simple reason that self-regulation has simply not provided consumers with sufficient
accurate information about the foods they buy.
(21 out of 25 marks)
Very often, the preamble to a part 04 or 08 question is: Making use of the data and your economic
knowledge … This answer makes use of both, but misses the opportunity to draw on characteristics of
food markets, other than those set out in the Extracts, which might call for intervention by governments.
While it is not vital to do this, these could include the health and safety aspects of food markets, and the
monopoly power that food processing companies and large supermarket chains my exercise at the
expense of small farmers (and/or consumers).
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
19
© Ray Powell, James Powell
TOPIC 5
Government intervention in the market
This answer has been placed at the top of Level 4, though a lack of formal analysis and use of diagrams,
may mean the answer has been over-marked. Either way, the answer does not reach Level 5, for which
the grade descriptor is:
AS
AO1
AO2
AO3
AO4
LEVELS OF
RESPONSE
KNOWLEDGE and
UNDERSTANDING
of theories,
concepts and
terminology
APPLICATION of
theories, concepts
and terminology
ANALYSIS of
economic
problems and
issues
EVALUATION of
economic
arguments and
evidence, making
informed
judgements
Level 5
Good throughout
the answer with
few errors and
weaknesses
Good application
to issues
Relevant and
precise with a
clear and logical
chain of reasoning
Good with a clear
final judgement
22–25 marks
(mid-point 24)
Good analysis and
good evaluation
Good use of data
to support answer
AQA AS Economics Unit 1 Markets and Market Failure
Philip Allan, an imprint of Hodder Education
20
© Ray Powell, James Powell