AS Paper 1: How Markets Work
Covers Demand, Supply and Price Determination, Elasticity of Demand and Supply, Market Failure and Externalities, Government Intervention in Markets and Measuring Economic Performance.
Questions
Question 1 [3 marks]
Measuring Economic Performance
Define "underemployment", and explain why a country's official unemployment rate might understate the true amount of spare capacity in its labour market.
Question 2 [3 marks]
Demand, Supply and Price Determination
In the market for takeaway pizzas in a town, the demand function is Qd = 600 - 40P and the supply function is Qs = 100 + 60P, where P is the price in pounds and Q is the number of pizzas sold per week.
Calculate the equilibrium price and quantity, and calculate total consumer expenditure on pizzas per week at this equilibrium.
Question 3 [3 marks]
Government Intervention in Markets
Distinguish between a specific tax and an ad valorem tax, giving one example of a good taxed using each method in the UK.
Question 4 [3 marks]
Elasticity of Demand and Supply
When the price of a litre of milk rises from 0.80 pounds to 0.88 pounds, the quantity supplied by dairy farmers rises from 20 million litres to 21 million litres per week.
Calculate the price elasticity of supply.
Question 5 [4 marks]
Market Failure and Externalities
Using a diagram in words, explain how the existence of a negative production externality leads to a misallocation of resources when a good is left to the free market.
Question 6 [5 marks]
Demand, Supply and Price Determination
An oil refinery jointly produces petrol and diesel from crude oil in a fixed ratio: refining 100 barrels of crude produces 60 barrels of petrol and 40 barrels of diesel.
A rise in demand for diesel from freight companies leads refineries to process more crude oil overall.
Explain, using the concept of joint supply, the likely effect on the equilibrium price and quantity in the market for petrol, and calculate how many additional barrels of petrol would be produced if refineries process an extra 500 barrels of crude oil per day.
Question 7 [5 marks]
Elasticity of Demand and Supply
The price of coffee rises by 8%, causing the quantity demanded of tea to rise by 3%.
Calculate the cross price elasticity of demand between tea and coffee, and state whether tea and coffee are substitutes or complements, and how strong this relationship appears to be.
Question 8 [5 marks]
Measuring Economic Performance
A country has a working-age population of 40 million, of whom 26 million are in the labour force. Of those in the labour force, 24.5 million are in employment.
Calculate the labour force as a percentage of the working-age population, and the unemployment rate.
Question 9 [5 marks]
Government Intervention in Markets
The government is deciding between an outright ban on single-use plastic carrier bags and a small charge per bag as ways to reduce plastic waste.
Explain one advantage and one disadvantage of using a ban (regulation) rather than a charge to achieve this aim.
Question 10 [6 marks]
Elasticity of Demand and Supply
The table below shows the percentage change in income and the percentage change in quantity demanded for two goods over the same period.
Own-brand pasta: income +5%, quantity demanded -2%
Foreign holidays: income +5%, quantity demanded +12%
Calculate the income elasticity of demand (YED) for each good, classify each good, and analyse what this suggests about how demand for each might change during a recession.
Question 11 [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 12 [6 marks]
Measuring Economic Performance
The Human Development Index (HDI) combines a measure of income (GNI per capita) with measures of life expectancy and education, expected and mean years of schooling, into a single index between 0 and 1.
Evaluate whether the HDI is likely to give a more complete picture of a country's economic development than GDP per capita alone.
Question 13 [6 marks]
Demand, Supply and Price Determination
The launch of a highly anticipated new smartphone model coincides with a global shortage of the semiconductor chips used to manufacture it, caused by a fire at a major chip factory.
Analyse the likely effect of these combined events on the equilibrium price and quantity in the market for this smartphone model, and identify what would need to be true for the equilibrium quantity to end up higher than before either event occurred.
Model solutions
| Question 1[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of underemployment as a situation where a worker is employed but would like to work more hours, or is working in a job that does not fully use their skills or qualifications | 1 |
| explaining that the official unemployment rate only counts people with no job at all who are actively seeking and available for work, so it does not include underemployed workers | 1 |
| explaining that if underemployment is widespread, for example many part-time workers wanting full-time hours, the true amount of spare labour market capacity is greater than the unemployment rate alone suggests | 1 |
| Final answer: Underemployment is when a worker has a job but wants more hours, or is overqualified for their role. Since the unemployment rate only counts people with no job at all, widespread underemployment means the true spare capacity in the labour market is greater than the unemployment rate alone suggests. | |
| Question 2[3 marks] | |
|---|---|
| Answer or working | Marks |
| setting Qd equal to Qs, 600 - 40P = 100 + 60P | M1 |
| solving to find P = 5 and Q = 400 | A1 |
| calculating total expenditure as price x quantity = 5 x 400 = 2000 pounds per week | A1 |
| Final answer: Equilibrium price = 5 pounds, equilibrium quantity = 400 pizzas per week, total consumer expenditure = 2000 pounds per week. | |
| Question 3[3 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a specific tax is a fixed amount of tax charged per unit of a good, regardless of its price, e.g. fuel duty on a litre of petrol | 1 |
| explaining that an ad valorem tax is charged as a percentage of the price of a good, so the amount of tax rises as the price rises, e.g. VAT on most consumer goods | 1 |
| correctly identifying a key difference, e.g. a specific tax shifts the supply curve upward by a constant amount at every quantity, while an ad valorem tax shifts it upward by a proportionally larger amount at higher prices, making the after-tax supply curve diverge increasingly from the original | 1 |
| Final answer: A specific tax is a fixed amount per unit, e.g. fuel duty; an ad valorem tax is a percentage of price, e.g. VAT, so its effect grows in pounds as price rises, making the post-tax supply curve diverge increasingly from the original as price rises. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating the percentage change in quantity supplied, 1 / 20 x 100 = 5% | M1 |
| calculating the percentage change in price, 0.08 / 0.80 x 100 = 10% | M1 |
| PES = 0.5 | A1 |
| Question 5[4 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that firms equate output to where private marginal cost equals private marginal benefit (demand) | 1 |
| explaining that this ignores the external cost, so social marginal cost lies above private marginal cost | 1 |
| explaining that the free market output is therefore higher than the socially optimal output | 1 |
| concluding this represents overproduction and a welfare loss to society | 1 |
| Final answer: Firms ignore external costs, so free-market output exceeds the socially optimal level, causing overproduction and a welfare loss. | |
| Question 6[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that petrol and diesel are in joint supply, since both are produced from the same process of refining crude oil | 1 |
| explaining that processing more crude oil to meet higher diesel demand also increases the supply of petrol as a joint product | 1 |
| explaining that the supply curve for petrol shifts to the right | 1 |
| concluding that the equilibrium price of petrol falls and the equilibrium quantity of petrol rises | 1 |
| calculating the additional petrol produced as 500 x 60 / 100 = 300 barrels per day | M1 |
| Final answer: Increased diesel demand raises overall refining, increasing petrol supply too as a joint product, so petrol's equilibrium price falls and quantity rises; processing an extra 500 barrels of crude produces an additional 300 barrels of petrol. | |
| Question 7[5 marks] | |
|---|---|
| Answer or working | Marks |
| using XED = % change in quantity demanded of tea / % change in price of coffee | M1 |
| substituting 3 / 8 | M1 |
| XED = 0.375 (positive) | A1 |
| correctly stating a positive value means tea and coffee are substitutes | 1 |
| correctly stating that, since the magnitude (0.375) is well below 1, this is a relatively weak substitute relationship | 1 |
| Final answer: XED = 0.375 (positive), so tea and coffee are substitutes, though the low magnitude indicates a relatively weak substitute relationship. | |
| Question 8[5 marks] | |
|---|---|
| Answer or working | Marks |
| labour force participation rate = 26 / 40 x 100 | M1 |
| participation rate = 65% | A1 |
| unemployed = 26 - 24.5 = 1.5 million, and unemployment rate = 1.5 / 26 x 100 | M1 |
| unemployment rate = approximately 5.8% | A1 |
| correctly noting the unemployment rate is calculated as a percentage of the labour force, not the whole working-age population | 1 |
| Final answer: Labour force participation rate = 65%; unemployment rate = approximately 5.8% (1.5 million unemployed out of a labour force of 26 million). | |
| Question 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying an advantage of a ban, e.g. it guarantees a large and immediate reduction in the use of the banned item, since consumers have no legal option to keep using it regardless of how strongly they want to | 1 |
| developing this advantage, e.g. this makes the outcome more certain than a charge, whose effectiveness depends on how responsive demand for bags is to the size of the charge | 1 |
| identifying a disadvantage of a ban, e.g. it removes consumer choice entirely and may push some consumers toward a more harmful substitute, such as buying thicker reusable bags that are then rarely reused | 1 |
| developing this disadvantage, e.g. unlike a charge, a ban raises no revenue that could be used to fund environmental projects or enforcement | 1 |
| a further valid point, e.g. a ban may also be harder and more costly to enforce against retailers who continue supplying banned bags informally, compared with simply collecting a charge at the till | 1 |
| Final answer: A ban guarantees a large, certain reduction in plastic bag use regardless of how price-sensitive consumers are, but it removes consumer choice, may push some people toward a more harmful substitute, raises no revenue, and can be harder to enforce than a simple charge collected at the till. | |
| Question 10[6 marks] | |
|---|---|
| Answer or working | Marks |
| calculating YED for pasta, -2 / 5 = -0.4 | M1 |
| correctly classifying pasta as an inferior good, since YED is negative | A1 |
| calculating YED for foreign holidays, 12 / 5 = 2.4 | M1 |
| correctly classifying holidays as a normal, income-elastic (luxury) good, since YED is positive and greater than 1 | A1 |
| analysing that in a recession, falling incomes would be expected to increase demand for pasta but sharply reduce demand for holidays | 1 |
| developed analysis linking this to firms' exposure to the economic cycle, e.g. holiday firms face greater cyclical risk than pasta producers | 1 |
| Final answer: YED(pasta) = -0.4 (inferior good); YED(holidays) = 2.4 (income-elastic luxury). A recession would likely raise demand for pasta but sharply cut demand for holidays. | |
| Question 11[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 12[6 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that GDP per capita measures only average income, and does not directly capture health or education outcomes | 1 |
| explaining that by including life expectancy and education, the HDI can reveal a broader picture, for example if two countries have the same GDP per capita but very different life expectancy or literacy | 1 |
| identifying that the HDI can therefore highlight cases where growth in income has not translated into improved health or education outcomes for the population, which GDP per capita alone would miss | 1 |
| identifying a limitation, e.g. the HDI still excludes important aspects of wellbeing, such as income inequality within a country, environmental sustainability, or political freedom | 1 |
| a further evaluative point, e.g. combining very different measures, income, health and education, into a single number can also obscure trade-offs between them, since a rise in one component could mask a fall in another | 1 |
| a reasoned overall judgement, e.g. the HDI is a genuine improvement on GDP per capita alone for capturing broader development, but is still an incomplete measure of overall wellbeing and should be read alongside other indicators such as inequality measures | 1 |
| Final answer: By adding life expectancy and education to income, the HDI captures a broader picture of development than GDP per capita alone and can reveal cases where income growth has not improved health or education; however, it still excludes factors such as inequality and environmental sustainability, and combining different measures into one number can mask trade-offs between them, so it remains an incomplete, though improved, measure of wellbeing. | |
| Question 13[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that strong anticipation for the new model represents a rightward shift in demand | 1 |
| identifying that the chip shortage is a rise in a key production cost, shifting supply to the left | 1 |
| explaining that both shifts unambiguously 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 |
| correctly identifying that quantity would end up higher only if the rightward shift in demand is proportionately larger than the leftward shift in supply | 1 |
| a developed point describing, in words, how this would appear on a diagram, with the new equilibrium lying to the right of the original quantity because the demand curve has shifted further right than the supply curve has shifted left | 1 |
| Final answer: Price rises unambiguously because both shifts push it up; quantity is ambiguous and depends on the relative size of the shifts, ending up higher than before only if the rightward demand shift outweighs the leftward supply shift. | |