A Level Paper 1: Business Economics
Covers Market Structures and Competition, Labour Markets and Wage Determination, Demand, Supply and Price Determination, Market Failure and Externalities and Government Intervention in Markets.
Questions
Question 1 [2 marks]
Government Intervention in Markets
Define "government failure" and give one example of how a government intervention intended to correct a market failure could make the allocation of resources less efficient.
Question 2 [3 marks]
Demand, Supply and Price Determination
Define "composite demand" and explain, using an example, why an increase in demand for one use of a resource can create a shortage in its other use.
Question 3 [3 marks]
Market Failure and Externalities
A power station generates electricity with a private marginal cost of 40 pounds per megawatt hour. Each megawatt hour produced also creates an external cost of 15 pounds from carbon emissions.
Calculate the social marginal cost per megawatt hour, and state whether the private marginal cost overstates or understates this figure.
Question 4 [3 marks]
Market Structures and Competition
Define "non-price competition", and give two examples of how oligopolistic firms in the UK supermarket industry might compete with each other without changing price.
Question 5 [4 marks]
Market Failure and Externalities
A late-night bar plays loud music that disturbs nearby residents' sleep.
Using a diagram in words, explain how this negative consumption externality leads to a difference between the private optimum and the social optimum level of the bar's late-night activity.
Question 6 [4 marks]
Demand, Supply and Price Determination
A sharp rise in the world price of quinoa leads many farmers who previously grew oats to switch their land to growing quinoa instead, since oats and quinoa can be grown on similar land and are substitutes in production.
Explain, using economic analysis, the likely effect of this on the equilibrium price and quantity in the market for oats.
Question 7 [4 marks]
Labour Markets and Wage Determination
Explain two factors, other than the wage rate, that might increase the supply of labour to the nursing profession in the UK.
Question 8 [4 marks]
Market Structures and Competition
A monopolist currently produces where marginal cost equals marginal revenue.
Explain why this profit-maximising output is likely to be allocatively inefficient compared with the output that would occur under perfect competition.
Question 9 [5 marks]
Labour Markets and Wage Determination
Explain why the supply of qualified airline pilots is likely to be more wage inelastic in the short run than the supply of retail shop assistants.
Question 10 [5 marks]
Demand, Supply and Price Determination
A widely reported study links avocado consumption to health benefits at the same time as a series of poor harvests in producing countries.
Explain, using economic analysis, the likely effect of these combined events on the equilibrium price and quantity of avocados.
Question 11 [5 marks]
Market Failure and Externalities
A local authority estimates that each new tree planted in a park generates a private benefit to the land owner of 40 pounds and an external benefit to the wider community of 65 pounds from improved air quality and wellbeing.
Calculate the social marginal benefit of planting one tree, and the size of the government subsidy per tree that would be needed to fully correct this positive externality.
Question 12 [6 marks]
Labour Markets and Wage Determination
In a competitive labour market for fruit-picking, labour demand is Nd = 6000 - 20w and labour supply is Ns = 1000 + 30w, where w is the weekly wage in pounds. Net inward migration then increases labour supply to Ns = 2500 + 30w.
Calculate the equilibrium wage and level of employment before and after the increase in labour supply, and evaluate the likely effect of this change on existing fruit-pickers already working in this market.
Question 13 [6 marks]
Market Failure and Externalities
In a market for a chemical product, the free market equilibrium quantity is 500 units per week, but the socially efficient quantity, once the negative production externality is accounted for, is only 350 units per week. At the socially efficient quantity, the marginal external cost is 12 pounds per unit.
Analyse why the free market over-produces this chemical relative to the socially optimal level, and calculate an estimate of the annual welfare loss from producing 150 units above the social optimum each week, assuming the marginal external cost rises in a straight line from 0 pounds at the social optimum to 12 pounds per unit at the free market quantity.
Question 14 [6 marks]
Market Failure and Externalities
A council estimates that a new incinerator has a private marginal cost of production of 60 pounds per tonne of waste processed. It generates an external cost of 25 pounds per tonne from air pollution, rising to 40 pounds per tonne once processing exceeds 500 tonnes per week, as local air quality worsens further.
Calculate the social marginal cost per tonne at outputs of 400 tonnes and 600 tonnes, and analyse why a single uniform per-tonne tax might not fully correct this market failure.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of government failure as a situation where government intervention leads to a net welfare loss, or a less efficient allocation of resources than before the intervention | 1 |
| a valid example, e.g. a subsidy intended to support struggling farmers instead being used to expand production of a crop already in surplus, wasting government resources | 1 |
| Final answer: Government failure occurs when an intervention makes resource allocation less efficient than before, e.g. a farm subsidy intended to help struggling farmers instead expanding output of an already oversupplied crop. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of composite demand as demand for a good that has more than one use | 1 |
| a valid example, e.g. milk is demanded both for drinking and for making cheese | 1 |
| explaining that a rise in demand for one use (e.g. cheese) leaves less of the good available for the other use (e.g. drinking milk), raising its price and creating a shortage there | 1 |
| Final answer: Composite demand is demand for a good with more than one use, e.g. milk for drinking and for cheese; a rise in demand for one use leaves less available (and raises price) for the other. | |
| Question 3[3 marks] | |
|---|---|
| Answer or working | Marks |
| identifying social marginal cost = private marginal cost + external cost | M1 |
| social marginal cost = 40 + 15 = 55 pounds per megawatt hour | A1 |
| correctly stating the private marginal cost understates the social marginal cost | 1 |
| Final answer: Social marginal cost = 55 pounds per MWh; private marginal cost understates this by 15 pounds. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of non-price competition as firms competing for customers using methods other than lowering price | 1 |
| a valid example, e.g. loyalty card schemes offering points and personalised discounts | 1 |
| a second valid example, e.g. advertising, in-store experience, or product range and quality | 1 |
| Final answer: Non-price competition means competing without cutting price, e.g. supermarkets using loyalty card schemes, advertising, or improving in-store experience and product range. | |
| Question 5[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the marginal social benefit (MSB) of the bar's late-night activity is less than the marginal private benefit (MPB) enjoyed by customers, because of the external cost (disturbed sleep) imposed on residents | 1 |
| describing, in words, that the MSB curve lies below the MPB curve by the amount of the marginal external cost at every level of activity | 1 |
| explaining that the private optimum occurs where MPB equals marginal cost, whereas the social optimum occurs at the lower level of activity where MSB equals marginal cost | 1 |
| concluding that the bar's late-night activity is overprovided relative to the socially efficient level, representing a welfare loss | 1 |
| Final answer: Because MSB is below MPB due to the external cost to residents, the socially efficient level of late-night activity is lower than the level chosen by the bar based on private benefit alone, so the activity is overprovided and there is a welfare loss. | |
| Question 6[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that oats and quinoa are substitutes in production, since farmers can switch land between growing them | 1 |
| explaining that a rise in the profitability of quinoa causes farmers to switch land away from oats, reducing the supply of oats | 1 |
| explaining that the supply curve for oats shifts to the left | 1 |
| concluding that the equilibrium price of oats rises and the equilibrium quantity of oats falls | 1 |
| Final answer: The supply of oats falls as farmers switch land to quinoa (substitutes in production), shifting the oat supply curve left, so the equilibrium price of oats rises and quantity falls. | |
| Question 7[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying a valid factor, e.g. an increase in the number of nursing training places or degree apprenticeships | 1 |
| explaining how this factor increases labour supply, e.g. more qualified entrants become available to join the profession | 1 |
| identifying a second valid factor, e.g. improved non-monetary benefits such as flexible shift patterns, pension terms, or the social status of nursing | 1 |
| explaining how this factor increases labour supply, e.g. non-wage benefits make the profession more attractive relative to alternative careers, drawing in more workers | 1 |
| Final answer: Supply could rise due to more nursing training places and improved non-wage benefits or working conditions making the profession more attractive. | |
| Question 8[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that a profit-maximising monopolist produces where MC = MR | 1 |
| explaining that price is set above marginal revenue on the downward-sloping demand curve, so price exceeds marginal cost | 1 |
| explaining that allocative efficiency requires price to equal marginal cost, which a monopolist does not achieve | 1 |
| concluding the monopolist restricts output and charges a higher price than under perfect competition, causing a welfare loss | 1 |
| Final answer: A profit-maximising monopolist sets price above marginal cost, breaching the condition for allocative efficiency, so output is restricted and price is higher than under perfect competition. | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that becoming a qualified airline pilot requires several years of specialist training at significant cost, which cannot be completed quickly | 1 |
| explaining that this long qualification period means the number of qualified pilots cannot rise much in the short run even if wages rise sharply, making supply wage inelastic | 1 |
| identifying that becoming a retail shop assistant typically requires little or no specific training or qualification | 1 |
| explaining that many people already possess the general skills needed for retail work, so a wage rise can attract many additional workers relatively quickly, making supply more wage elastic | 1 |
| a further valid point, e.g. workers may be able to transfer into retail work from a wide range of other jobs, whereas few workers can transfer into piloting without lengthy retraining | 1 |
| Final answer: Becoming a pilot requires years of costly specialist training, so the number of pilots cannot rise quickly even if wages rise, making supply wage inelastic; retail work needs little specific training, so a wage rise can attract many more workers quickly, making supply more elastic. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the health study raises demand for avocados, shifting the demand curve right | 1 |
| identifying that poor harvests reduce supply of avocados, shifting the supply curve left | 1 |
| explaining that both shifts raise the equilibrium price | 1 |
| explaining that the effect on equilibrium quantity is ambiguous, since the demand shift raises quantity while the supply shift lowers it | 1 |
| a developed point that the actual change in quantity depends on the relative size of the two shifts | 1 |
| Final answer: Equilibrium price rises because both effects push price up; the effect on equilibrium quantity is ambiguous, depending on the relative size of the demand and supply shifts. | |
| Question 11[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying social marginal benefit = private marginal benefit + external marginal benefit | M1 |
| social marginal benefit = 40 + 65 = 105 pounds | A1 |
| identifying the subsidy should match the size of the external benefit to align private and social incentives | M1 |
| a subsidy of 65 pounds per tree | A1 |
| explaining that this subsidy raises the private incentive to plant trees toward the socially optimal quantity | 1 |
| Final answer: Social marginal benefit = 105 pounds per tree; a subsidy of 65 pounds per tree (matching the external benefit) would align private incentives with the social optimum. | |
| Question 12[6 marks] | |
|---|---|
| Answer or working | Marks |
| setting the original Nd equal to Ns, 6000 - 20w = 1000 + 30w | M1 |
| the original equilibrium, w = 100 pounds and N = 4000 | A1 |
| setting the new Nd equal to Ns, 6000 - 20w = 2500 + 30w | M1 |
| the new equilibrium, w = 70 pounds and N = 4600 | A1 |
| identifying that the increase in labour supply lowers the equilibrium wage and raises the equilibrium level of employment overall | 1 |
| an evaluative point on existing workers, e.g. existing fruit-pickers see their wage fall from 100 to 70 pounds per week, a real cost to them, even though total employment in the sector rises and employers or consumers may benefit from lower labour costs | 1 |
| Final answer: Original equilibrium: w = 100 pounds, N = 4000. New equilibrium: w = 70 pounds, N = 4600. The wage falls for existing fruit-pickers even though total employment in the market rises, illustrating that a labour market change can benefit the market overall while still imposing a real cost on incumbent workers. | |
| Question 13[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that in a free market, output is set where marginal private benefit equals marginal private cost, ignoring the external cost imposed on third parties | 1 |
| explaining that once the marginal external cost is added, marginal social cost exceeds marginal private cost at the free market quantity, so the socially efficient quantity is lower | 1 |
| identifying that this divergence is why the free market produces 500 units, above the socially efficient 350 units | 1 |
| calculating the weekly deadweight loss as the area of a triangle, 0.5 x 150 x 12 | M1 |
| a weekly welfare loss of 900 pounds | A1 |
| an annual welfare loss of 900 x 52 = 46800 pounds | A1 |
| Final answer: The free market ignores the external cost and produces where MPB equals MPC, above the socially efficient quantity where MSC would also be covered; producing 150 units above the social optimum each week creates a deadweight welfare loss of 900 pounds per week, or about 46800 pounds per year. | |
| Question 14[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating social marginal cost at 400 tonnes, 60 + 25 = 85 pounds per tonne | M1 |
| calculating social marginal cost at 600 tonnes, 60 + 40 = 100 pounds per tonne | A1 |
| identifying that the external cost rises at higher output, so the marginal externality is not constant | 1 |
| explaining that a single, uniform tax rate is normally set equal to the external cost at one chosen output level | 1 |
| analysing that a uniform tax based on the lower external cost would under-correct the market failure once output exceeds 500 tonnes | 1 |
| a valid alternative or refinement, such as a rising or tiered tax rate, or a cap-and-trade style quantity limit | 1 |
| Final answer: SMC = 85 pounds/tonne at 400 tonnes and 100 pounds/tonne at 600 tonnes; because the external cost rises with output, a single uniform tax cannot fully correct the externality at both output levels. | |