A Level Paper 4: Markets and Competition
Covers Demand, Supply and Price Determination, Elasticity of Demand and Supply, Market Failure and Externalities, Government Intervention in Markets, Market Structures and Competition, Aggregate Demand and Aggregate Supply and Fiscal and Monetary Policy.
Questions
Question 1 [2 marks]
Market Structures and Competition
Define "oligopoly" and state one characteristic that distinguishes it from perfect competition.
Question 2 [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 3 [2 marks]
Elasticity of Demand and Supply
Define price elasticity of demand (PED), and state whether a PED value of -0.4 represents elastic or inelastic demand.
Question 4 [3 marks]
Market Failure and Externalities
A factory's marginal private cost of production is MPC = 20 + 0.5Q, where Q is output per day. Each unit of output also creates a marginal external cost of 6 pounds due to pollution.
Calculate the marginal social cost of producing the 100th unit of output.
Question 5 [3 marks]
Fiscal and Monetary Policy
The marginal propensity to consume (MPC) in an economy is 0.75, and there are no other withdrawals from the circular flow of income.
Calculate the value of the simple Keynesian multiplier, and the resulting change in national income from an initial increase in government spending of 8 billion pounds.
Question 6 [3 marks]
Aggregate Demand and Aggregate Supply
Define "short-run aggregate supply" (SRAS), state one factor that could cause it to shift left, and explain why.
Question 7 [3 marks]
Government Intervention in Markets
The government places an ad valorem (percentage) tax of 20% on a good with a pre-tax price of 40 pounds. After the tax, quantity sold falls to 1800 units per week.
Calculate the amount of tax revenue the government raises per week.
Question 8 [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 9 [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 10 [4 marks]
Government Intervention in Markets
Explain, using the concept of price elasticity of demand, why the incidence of an indirect tax on a good with highly inelastic demand falls mostly on consumers rather than producers.
Question 11 [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 12 [5 marks]
Market Structures and Competition
Water supply infrastructure, such as pipes and reservoirs, involves very high fixed costs that fall as more customers are connected, so average costs fall over a very large range of output.
Explain, using the concept of a natural monopoly, why it may be more efficient for a single firm to supply water in a given region rather than several competing firms.
Question 13 [5 marks]
Government Intervention in Markets
The government sets a minimum price of 220 pounds per tonne for wheat, above the free-market equilibrium price of 190 pounds per tonne. At 220 pounds, farmers wish to supply 900,000 tonnes but consumers only wish to buy 700,000 tonnes.
Calculate the resulting excess supply, and the cost to the government of buying up this surplus at the minimum price.
Question 14 [5 marks]
Elasticity of Demand and Supply
A train operating company has a PED of -0.4 for its off-peak tickets, currently priced at 12 pounds. The company is considering a 5 percent price rise.
Calculate the expected percentage change in quantity demanded, and state what will happen to the company's total revenue as a result.
Question 15 [6 marks]
Government Intervention in Markets
A specific tax of 5 pounds per unit is imposed on a good. Before the tax, 2000 units were sold per week; after the tax, 1600 units are sold per week.
Calculate the government's weekly tax revenue, and analyse why this figure alone does not capture the full cost of the tax to society.
Question 16 [6 marks]
Demand, Supply and Price Determination
A breakthrough in silicon wafer manufacturing sharply cuts the production cost of solar panels. The demand function for solar panels is Qd = 500 - 10P, where P is the price in pounds per panel and Q is thousands of panels per year. Before the breakthrough, the supply function was Qs = 50 + 15P; after the breakthrough, it becomes Qs = 200 + 15P.
Calculate the original and the new equilibrium price and quantity, and analyse the effect of this change on producer surplus in the market, referring to existing and new producers in your answer.
Question 17 [6 marks]
Market Structures and Competition
A firm operating in a monopolistically competitive market for artisan coffee shops earns total revenue of 4200 pounds and total costs of 3000 pounds per week, including normal profit, at its current output.
Calculate the firm's supernormal (abnormal) profit per week, and analyse what is likely to happen to this profit in the long run.
Question 18 [6 marks]
Government Intervention in Markets
A government is considering making bus travel completely free for under-22s, at an estimated direct cost of 900 million pounds per year, as an alternative to its current policy of a 50% subsidy on under-22 bus fares, which costs 400 million pounds per year.
Calculate the extra annual cost of making bus travel completely free compared with the current 50% subsidy, and evaluate whether this extra spending is likely to be justified.
Question 19 [6 marks]
Demand, Supply and Price Determination
The rise of video streaming services, a substitute for physical DVDs, has been accompanied by sharply falling streaming subscription prices due to increased competition between providers.
Analyse the likely effect on the equilibrium price and quantity in the market for physical DVDs, and evaluate whether firms selling DVDs are likely to remain profitable in the long run.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition, e.g. a market dominated by a small number of large, interdependent firms | 1 |
| a valid distinguishing characteristic, e.g. firms are interdependent and aware of rivals' pricing decisions, unlike price-taking firms in perfect competition | 1 |
| Final answer: Oligopoly is a market dominated by a few large, interdependent firms; unlike perfect competition, firms are aware of and react to rivals' decisions. | |
| Question 2[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 3[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of PED as the responsiveness of quantity demanded to a change in price | 1 |
| correctly identifying -0.4 as inelastic demand, since its magnitude is less than 1 | 1 |
| Final answer: PED measures the responsiveness of quantity demanded to price changes; a PED of -0.4 is inelastic because its magnitude is below 1. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating MPC at Q = 100, MPC = 20 + 0.5(100) = 70 | M1 |
| adding the marginal external cost of 6 pounds | M1 |
| a marginal social cost of 76 pounds | A1 |
| Final answer: Marginal social cost = 76 pounds. | |
| Question 5[3 marks] | |
|---|---|
| Answer or working | Marks |
| using the multiplier formula, k = 1 / (1 - MPC) | M1 |
| calculating k = 1 / (1 - 0.75) = 4 | M1 |
| the resulting change in national income = 8 x 4 = 32 billion pounds | A1 |
| Final answer: Multiplier = 4; national income rises by 32 billion pounds. | |
| Question 6[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of SRAS as the total output producers are willing and able to supply at a given price level in the short run, when at least one factor of production is fixed | 1 |
| a valid factor causing a leftward shift, e.g. a rise in the cost of raw materials, energy or wages | 1 |
| explaining that higher production costs reduce firms' profitability at each price level, so they supply less at every price, shifting SRAS left | 1 |
| Final answer: SRAS is the total output firms are willing to supply at each price level in the short run; a rise in costs such as energy or wages raises production costs and shifts SRAS to the left. | |
| Question 7[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the tax per unit as 20% of the original price, 0.20 x 40 = 8 pounds | M1 |
| identifying that tax revenue equals tax per unit multiplied by the new quantity sold | M1 |
| tax revenue = 8 x 1800 = 14400 pounds | A1 |
| Final answer: Tax revenue = 14400 pounds per week. | |
| Question 8[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 9[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 10[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that inelastic demand means quantity demanded barely falls as price rises | 1 |
| explaining that producers can therefore pass most of the tax on to consumers through a higher price without losing many sales | 1 |
| explaining that if demand were elastic, raising price would cause a large fall in quantity demanded, discouraging producers from passing on the tax | 1 |
| concluding that the more inelastic the demand, the greater the consumer's share of the tax burden | 1 |
| Final answer: Inelastic demand allows producers to raise price with little loss of sales, so most of the tax is passed on to consumers. | |
| Question 11[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 12[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a natural monopoly exists where economies of scale are so large relative to market demand that average costs keep falling over the entire relevant range of output | 1 |
| identifying that this means a single large firm can supply the whole market at a lower average cost than if output were split between several smaller firms | 1 |
| explaining that if two or more firms each built their own duplicate network of pipes and reservoirs, each would produce at a smaller scale with higher average costs | 1 |
| concluding that having a single supplier avoids this costly duplication of infrastructure, making the market more productively efficient overall | 1 |
| identifying a related concern, e.g. without competition or regulation this single firm may still be able to charge a price well above cost, so the government may need to regulate the natural monopoly rather than rely on competition | 1 |
| Final answer: Because average costs keep falling as more customers share the fixed cost of pipes and reservoirs, one firm can supply the whole market more cheaply than several firms duplicating this infrastructure; this natural monopoly still needs regulation, since without competition the firm could charge a price well above cost. | |
| Question 13[5 marks] | |
|---|---|
| Answer or working | Marks |
| calculating excess supply = 900,000 - 700,000 | M1 |
| excess supply = 200,000 tonnes | A1 |
| cost = excess supply x minimum price | M1 |
| cost = 200,000 x 220 = 44,000,000 pounds | A1 |
| identifying this cost is a burden on the government (taxpayer) in addition to the higher price paid by consumers | 1 |
| Final answer: Excess supply = 200,000 tonnes; buying this at the minimum price costs the government 44 million pounds, a burden on the taxpayer alongside the higher price paid by consumers. | |
| Question 14[5 marks] | |
|---|---|
| Answer or working | Marks |
| using %change in Qd = PED x %change in P | M1 |
| substituting -0.4 x 5% | M1 |
| a 2% fall in quantity demanded | A1 |
| correctly stating total revenue will rise | 1 |
| explaining that this is because demand is price inelastic, so the percentage fall in quantity is smaller than the percentage rise in price | 1 |
| Final answer: Quantity demanded falls by 2%; total revenue increases because demand is price inelastic, so the percentage fall in quantity is smaller than the percentage rise in price. | |
| Question 15[6 marks] | |
|---|---|
| Answer or working | Marks |
| tax revenue = tax per unit x post-tax quantity | M1 |
| tax revenue = 5 x 1600 = 8000 pounds per week | A1 |
| identifying that the fall in quantity traded, from 2000 to 1600, represents mutually beneficial transactions that no longer take place | 1 |
| explaining this creates a welfare (deadweight) loss to society, since neither consumers, producers nor the government gain from the 400 units no longer traded | 1 |
| identifying that this deadweight loss represents lost consumer and producer surplus on those foregone units | 1 |
| a developed point that the size of the deadweight loss depends on the price elasticities of demand and supply, being larger the more elastic they are | 1 |
| Final answer: Weekly tax revenue = 5 x 1600 = 8000 pounds; this does not capture the deadweight loss from the 400 units (2000 to 1600) no longer traded, representing lost consumer and producer surplus, which would be larger the more elastic demand and supply are. | |
| Question 16[6 marks] | |
|---|---|
| Answer or working | Marks |
| setting the original Qd equal to Qs, 500 - 10P = 50 + 15P | M1 |
| the original equilibrium, P = 18 and Q = 320 | A1 |
| setting the new Qd equal to Qs, 500 - 10P = 200 + 15P | M1 |
| the new equilibrium, P = 12 and Q = 380 | A1 |
| identifying that producer surplus is affected by both a lower price received per panel and a higher quantity sold | 1 |
| a developed explanation, e.g. producers receive a lower price on every panel, which could reduce surplus for existing producers, but the fall in costs and the rise in quantity sold, including new lower-cost producers now able to enter, are likely to raise total producer surplus overall | 1 |
| Final answer: Original equilibrium: P = 18 pounds, Q = 320 thousand panels. New equilibrium: P = 12 pounds, Q = 380 thousand panels. Existing producers receive a lower price per panel, but falling costs and rising quantity, including new lower-cost producers entering, likely raise total producer surplus overall. | |
| Question 17[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating supernormal profit = total revenue minus total cost | M1 |
| supernormal profit = 4200 - 3000 = 1200 pounds per week | A1 |
| identifying that monopolistic competition is characterised by low or no barriers to entry | 1 |
| explaining that supernormal profit attracts new firms to enter the market | 1 |
| explaining that entry increases the number of coffee shops, shifting demand for the existing firm's output to the left as customers are shared among more sellers | 1 |
| concluding that in the long run supernormal profit is competed away and the firm earns only normal profit | 1 |
| Final answer: Supernormal profit = 1200 pounds per week; because entry barriers are low, new firms will enter, competing this profit away until only normal profit remains in the long run. | |
| Question 18[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the extra cost as 900 - 400 | M1 |
| an extra cost of 500 million pounds per year | A1 |
| identifying a potential benefit of full free travel, e.g. removing the remaining half-price fare could significantly increase bus use among under-22s from low-income households for whom even the subsidised fare was a barrier | 1 |
| identifying a potential drawback, e.g. much of the extra 500 million pounds may go to under-22s who would have paid the subsidised fare anyway, providing them little extra benefit relative to the cost | 1 |
| an evaluative point, e.g. the case for full free travel is stronger if bus use is highly responsive to the remaining fare, and weaker if most under-22s would travel by bus regardless of the small remaining charge | 1 |
| a reasoned overall judgement, e.g. without clear evidence on how much more bus use the final subsidy step would generate, the extra 500 million pounds may represent poor value for money compared with directing it toward under-22s who do not currently use buses at all | 1 |
| Final answer: The extra cost of full free travel is 500 million pounds per year; this may only modestly increase bus use if most under-22s already travel regardless of the small remaining fare, so whether the extra spending is justified depends on how responsive bus use actually is to the final price cut, and the money might otherwise be better targeted. | |
| Question 19[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that streaming and DVDs are substitutes | 1 |
| explaining that a fall in the price of streaming raises demand for streaming and reduces demand for DVDs, shifting the DVD demand curve left | 1 |
| explaining that this lowers both the equilibrium price and equilibrium quantity of DVDs | 1 |
| identifying that if revenue falls below total costs (including normal profit), firms may exit the market in the long run | 1 |
| a valid evaluative point, e.g. firms could differentiate through collectors' editions or special packaging to sustain a smaller niche market rather than exiting entirely | 1 |
| a reasoned overall judgement, e.g. the mainstream DVD market is likely to shrink substantially in the long run, though a smaller niche market may survive | 1 |
| Final answer: As streaming becomes cheaper it draws demand away from DVDs, so DVD price and quantity both fall; in the long run many DVD sellers are unlikely to remain profitable and may exit or move to a smaller niche market such as collectors' editions. | |