A Level Economics Paper 3
Covers Demand, Supply and Price Determination, Elasticity of Demand and Supply, Market Failure and Externalities and 9 more.
Questions
Question 1 [2 marks]
Labour Markets and Wage Determination
Define "derived demand" and explain why the demand for labour is described this way.
Question 2 [2 marks]
Fiscal and Monetary Policy
Define "expansionary fiscal policy" and give one example of a specific action a government could take to implement it.
Question 3 [2 marks]
Demand, Supply and Price Determination
Distinguish between a contraction of demand and a leftward shift of the demand curve, using the example of rail travel.
Question 4 [3 marks]
Market Structures and Competition
Define "contestable market", state one characteristic that makes a market contestable, and explain its effect on incumbent firms' behaviour.
Question 5 [3 marks]
International Trade and the Balance of Payments
Using one unit of resource, Country X can produce either 40 units of cloth or 20 units of wheat. Country Y can produce either 30 units of cloth or 30 units of wheat.
Calculate the opportunity cost of producing one unit of cloth in each country, in terms of wheat, and state which country has a comparative advantage in cloth.
Question 6 [5 marks]
Measuring Economic Performance
Explain two limitations of the Consumer Prices Index (CPI) as a measure of the cost of living faced by a typical household.
Question 7 [5 marks]
Aggregate Demand and Aggregate Supply
A government is deciding between increasing government spending by 40 billion pounds, or cutting taxes by the same amount. Consumers are expected to save 25% of any extra disposable income from a tax cut and spend the rest.
Calculate the initial rise in spending generated directly by each policy, and explain why the two policies are unlikely to have the same overall effect on aggregate demand, even though they cost the government the same amount.
Question 8 [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 9 [5 marks]
Money, Banking and the Financial Sector
Some financial institutions, such as certain investment funds, provide loans and credit-like products to businesses and households but are not regulated in the same way as traditional commercial banks.
Explain, using the concept of "shadow banking", why the growth of this kind of lending outside the traditional banking system could pose a risk to the wider financial system.
Question 10 [5 marks]
Supply-Side Policy and Economic Growth
A government is comparing a demand-side policy, a cut in interest rates, with a supply-side policy, a large increase in spending on vocational education and training, as ways to raise the economy's long-run growth rate.
Explain why the supply-side policy is likely to take much longer than the demand-side policy to have its full effect on the economy.
Question 11 [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 12 [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 13 [6 marks]
Elasticity of Demand and Supply
A firm faces the demand curve Qd = 200 - 4P.
Calculate the price elasticity of demand at a price of 30 pounds, and calculate the price that would maximise the firm's total revenue, given that revenue is maximised where demand is unit elastic, at the midpoint of a straight-line demand curve.
Question 14 [6 marks]
Money, Banking and the Financial Sector
A country's deposit insurance scheme guarantees each individual depositor's savings at a bank up to a limit of 85000 pounds per person, per bank, should the bank fail. A saver has 60000 pounds in one bank and 120000 pounds in another bank.
Calculate how much of the saver's total 180000 pounds would be protected if both banks failed on the same day, and analyse how a deposit insurance scheme like this helps to prevent bank runs from occurring in the first place.
Model solutions
| Question 1[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of derived demand as demand for a factor of production that arises from the demand for the good or service it helps produce | 1 |
| explaining that labour is demanded not for its own sake but because of the demand for the goods or services labour helps to produce | 1 |
| Final answer: Derived demand is demand for a factor that arises from demand for the good it produces; labour is demanded because of demand for the output workers help create. | |
| Question 2[2 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition, e.g. a deliberate increase in government spending and/or cut in taxation designed to raise aggregate demand | 1 |
| a valid example, e.g. increasing spending on infrastructure projects, or cutting income tax rates | 1 |
| Final answer: Expansionary fiscal policy raises AD through higher government spending and/or lower taxes, e.g. cutting income tax rates. | |
| Question 3[2 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a contraction of demand is a fall in quantity demanded caused by a rise in the price of the good itself, e.g. fewer rail journeys demanded as rail fares rise, shown as a movement along the demand curve | 1 |
| explaining that a leftward shift of the demand curve is a fall in demand at every price, caused by a factor other than the good's own price, e.g. a fall in average income reducing demand for rail travel as a normal good | 1 |
| Final answer: A contraction of demand is a movement along the curve caused by a price rise (e.g. higher rail fares); a leftward shift is caused by a non-price factor such as falling income. | |
| Question 4[3 marks] | |
|---|---|
| Answer or working | Marks |
| a correct definition of a contestable market as one with low barriers to entry and exit, particularly low sunk costs | 1 |
| a valid characteristic, e.g. low sunk costs, meaning firms can leave with little loss of capital if unsuccessful | 1 |
| explaining that the threat of hit-and-run entry disciplines incumbent firms into keeping prices closer to competitive levels | 1 |
| Final answer: A contestable market has low barriers to entry and exit, especially low sunk costs; this makes hit-and-run entry a real threat, disciplining incumbent firms to keep prices close to competitive levels even without many current competitors. | |
| Question 5[3 marks] | |
|---|---|
| Answer or working | Marks |
| calculating Country X's opportunity cost of 1 unit of cloth as 20 / 40 = 0.5 units of wheat | M1 |
| calculating Country Y's opportunity cost of 1 unit of cloth as 30 / 30 = 1 unit of wheat | M1 |
| correctly identifying Country X as having the comparative advantage in cloth, since its opportunity cost is lower | A1 |
| Final answer: Country X's opportunity cost of cloth is 0.5 units of wheat, versus 1 unit of wheat for Country Y, so Country X has the comparative advantage in cloth. | |
| Question 6[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the CPI is based on a fixed basket of goods and services with weights that are only updated periodically | 1 |
| explaining that this means the CPI can be slow to reflect changes in actual spending patterns, such as a rapid rise in spending on a new type of good, e.g. streaming subscriptions | 1 |
| identifying that the CPI represents an average household, but individual households have very different spending patterns | 1 |
| explaining that this means the CPI may understate the true inflation experienced by, for example, a low-income household that spends a much larger share of its budget on energy and food than the average household | 1 |
| a further valid limitation, e.g. the CPI does not include costs associated with owner-occupied housing, such as mortgage interest payments, understating housing cost inflation for many households | 1 |
| Final answer: The CPI's basket weights are updated only periodically, so it can be slow to reflect changing spending patterns; it also reflects an average household's spending, so it may understate inflation for groups spending unusually heavily on items like food, energy or housing costs not fully captured in the index. | |
| Question 7[5 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the full 40 billion pounds of extra government spending enters the economy directly as spending | M1 |
| identifying that only the proportion of the tax cut that is spent, rather than saved, enters the economy directly as spending | 1 |
| calculating that consumers spend 75% of the tax cut, 0.75 x 40 = 30 billion pounds, directly, with the remaining 10 billion pounds saved | A1 |
| explaining that because government spending injects the full 40 billion pounds directly, while the tax cut only injects 30 billion pounds directly, with some leaking into saving, the government spending policy is likely to have a larger initial and overall effect on aggregate demand | 1 |
| a developed point, e.g. after this initial round, both policies could still generate further rounds of spending through the multiplier process, but the tax cut's overall effect on AD is likely to remain smaller because more of the initial injection leaks into saving | 1 |
| Final answer: The full 40 billion pounds of extra government spending enters the economy directly, whereas only 30 billion pounds of the tax cut is spent directly, with 10 billion pounds saved, so government spending is likely to have a larger effect on aggregate demand than an equal-sized tax cut, since less of it leaks into saving at the first round. | |
| Question 8[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 9[5 marks] | |
|---|---|
| Answer or working | Marks |
| a correct explanation of shadow banking as financial activity that performs bank-like functions, such as lending, without being subject to the same regulation as traditional banks | 1 |
| explaining that because these institutions do not hold the same regulatory capital or liquidity buffers required of banks, they may be more vulnerable to a sudden loss of confidence or a rush of withdrawals | 1 |
| explaining that shadow banking institutions are often closely connected to traditional banks and other parts of the financial system, for example through lending to or borrowing from them | 1 |
| explaining that a failure or crisis at a large shadow banking institution could therefore spread to the wider, regulated financial system through these connections | 1 |
| identifying that because shadow banking activity is less visible to regulators, risks may be able to build up unnoticed until a crisis actually occurs | 1 |
| Final answer: Shadow banking institutions perform bank-like lending without holding the same regulatory capital or liquidity buffers as banks, making them more vulnerable to a loss of confidence; because they are often closely connected to the regulated banking system, a crisis there could spread more widely, and because shadow banking is less visible to regulators, such risks can build up unnoticed. | |
| Question 10[5 marks] | |
|---|---|
| Answer or working | Marks |
| explaining that a cut in interest rates can affect consumption and investment decisions relatively quickly, often within months, as borrowing becomes cheaper | 1 |
| explaining that vocational education and training takes years to complete before newly trained workers enter the workforce with improved skills | 1 |
| explaining that even once trained, it then takes further time for these workers to be matched with, and become fully productive in, suitable jobs | 1 |
| identifying that supply-side policies more broadly often involve long-term structural changes, such as building new infrastructure or changing institutions, which naturally take years rather than months to complete and have effect | 1 |
| a developed point, e.g. this means demand-side policy is often used to manage the economy in the short run, while supply-side policy is aimed at raising the economy's performance gradually over a much longer time horizon | 1 |
| Final answer: An interest rate cut can affect spending decisions within months, but training workers takes years to complete before they enter the workforce with new skills and become fully productive, and supply-side policies often involve long-term structural change; this is why demand-side policy tends to manage the economy in the short run while supply-side policy aims at improvement over a much longer time horizon. | |
| Question 11[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 12[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 13[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying dQ/dP = -4 from the demand equation | M1 |
| calculating P / Q at P = 30, where Q = 200 - 4(30) = 80, giving 30 / 80 | M1 |
| PED = -4 x (30 / 80) = -1.5 (elastic) at P = 30 | A1 |
| identifying that the demand curve's price intercept is at P = 50 (when Q = 0), so the revenue-maximising midpoint price is P = 25 | M1 |
| confirming at P = 25, Q = 100, so PED = -4 x (25 / 100) = -1 (unit elastic) | A1 |
| correctly stating that since demand at P = 30 is elastic, the firm should lower its price toward 25 pounds to raise total revenue | 1 |
| Final answer: PED at P = 30 is -1.5 (elastic); total revenue is maximised at P = 25 (where Q = 100 and PED = -1), so the firm should lower its price from 30 pounds toward 25 pounds to raise revenue. | |
| Question 14[6 marks] | |
|---|---|
| Answer or working | Marks |
| identifying that the 60000 pounds in the first bank is fully protected, since it is below the 85000 pound limit | M1 |
| 60000 pounds protected in the first bank | A1 |
| identifying that only 85000 pounds of the 120000 pounds in the second bank is protected, since this is the maximum limit per bank | M1 |
| a total of 60000 + 85000 = 145000 pounds protected across both banks, leaving 35000 pounds unprotected | A1 |
| explaining that because most depositors know their savings are protected up to this limit, they have much less reason to panic and rush to withdraw their money at the first sign of trouble at their bank | 1 |
| explaining that this removes much of the incentive behind a bank run, since a saver's rational response to bad news about their bank's health no longer needs to be an immediate withdrawal, helping to prevent the self-fulfilling panic that can otherwise cause a bank run | 1 |
| Final answer: 145000 pounds of the saver's total 180000 pounds would be protected, 60000 pounds fully covered at the first bank and 85000 pounds of the 120000 pounds at the second bank, leaving 35000 pounds unprotected. Because depositors know their savings are protected up to this limit, they have far less reason to panic and withdraw at the first sign of trouble, removing much of the self-fulfilling panic that causes a bank run. | |