ECONOMICS

Specimen questions

MULTIPLE CHOICE QUESTIONS

AS

Question 1

If a per unit sales tax is placed on a product and the burden of the tax falls entirely on the producer then demand

A. must be perfectly elastic. B. must be unit elastic. C. must be perfectly inelastic. D. must be more elastic than supply E. and supply must both be perfectly inelastic.

Correct answer: A.

Question 2

Which of the following is most likely to lead to an increase in both savings and investment, ceteris paribus?

A. An increase in the interest rate B. An increase in the rate of unemployment C. An appreciation of the exchange rate D. An increase in income tax E. An increase in income per head

Correct answer: E

With a positive savings ratio, the total amount saved will increase when income per head rises. An increase in income will also lead to an increase in demand for goods and services, which will lead to greater profit and confidence for firms thus stimulating investment.

Question 3

An increase in injections into the circular flow of income in an economy is most likely to result from:

A. An increase in the size of the budget surplus B. A decrease in the size of the trade deficit C. A reduction in tax exemptions for foreign companies D. An increase in the rate of corporation tax E. An increase in the interest rate causing an increase in the savings ratio

Correct answer: B

A decrease in the size of the trade deficit effectively means the same as a fall in the value of imports relative to exports.

Question 4

The following policies are all related to the labour market. Which is best described as a supply side policy?

A. An increase in the National Living Wage Rate B. An increase in government spending to reduce the negative output gap C. A reduction in the rate of income tax for low earners D. A restriction on the number of visas offered to overseas workers E. An increase in the value of welfare benefits

Answer

Correct answer: C

A reduction in the rate of income tax is likely to encourage low earners to increase the number of hours worked, and also likely to entice the economically inactive into work – both of these consequences combined is likely to increase the size of the labour force and therefore shift AS to the right.

Question 5

Which of the following diagrams best illustrates a merit good?

Diagram A

Diagram B

Diagram C

Diagram D

Diagram E

Correct answer: C

A merit good is one that is better for consumers than they realise, and confers positive externalities in consumption, therefore the Marginal Social Benefit of consuming the good is greater than the Marginal Private Benefit.

MSC

MPC

MSB = MPB

MSC = MPC

MSB = MPB

MSC = MPC

MPB MSB

MSC = MPC

MPB MSB

Quantity

Quantity

Quantity

Quantity

Cost

s / b

enef

its

Cost

s / b

enef

its

Cost

s / b

enef

its

Cost

s / b

enef

its

Cost

s / b

enef

its

Quantity

MPC

MSC

MPB

MSB

A level

Question 1

The change in the yield on ten year UK government bonds/gilts over the period shown in the above data could be explained by

A. a cut in interest rates by the MPC of the Bank of England. B. an increase in the government’s fiscal (budget) deficit. C. the sale of existing government bonds by the Bank of England. D. a rise in the foreign exchange rate of the pound. E. a purchase of existing government bonds by the Bank of England.

Correct answer. E.

The purchase of existing government bonds in recent years by the Bank of England, known as quantitative easing, is the main reason for the fall in yields. The increased demand for bonds by the Bank raises their price and depresses their yield as they are inversely related.

Question 2

The following table provides information about the costs of a table tennis ball manufacturer.

Output (‘000s)

Total cost (£)

0 1200 1 1600 2 1900 3 2500 4 3200 5 4000 6 5500

Which of the following statements is true?

A. When output is 5000, the average variable cost is 80p B. Average fixed cost when output is 3000 is 40p C. The marginal cost of production is always positive and decreasing D. Average total cost when output is 2000 is equal to 60p E. The average fixed cost remains constant

Correct answer: B

Total fixed cost is equal to £1200. When £1200 is spread over 3000 units, the AFC is £0.40 or 40p

Question 3

An economy’s VAT rate rises from 10% to 12%. What is the impact on both the Consumer Price Index (CPI) and the rate of inflation?

Impact on CPI Impact on Inflation

A Permanent increase Permanent Increase

B Permanent increase One-off Increase

C One-off Increase Permanent Increase

D One-off Increase One-off Increase

E One-off increase

No impact

Correct answer: B

The price of all goods and services, relative to the base year, will be permanently higher as a result of the increase in the rate of VAT therefore the increase in the CPI will be permanent. However, the change is a one-off change, so will only cause a one-off increase in the rate of inflation i.e. the change in the CPI from one year to the next.

Question 4

The table below provides information regarding the costs and revenue of a firm.

Output Total Cost Total Revenue 1 10 30 2 18 48 3 28 62 4 44 74 5 64 84 6 88 92

This firm must be:

A. Operating in a perfectly competitive market with falling marginal costs B. Operating in a monopolistically competitive market with constant marginal

costs C. Operating as a monopoly with falling marginal costs D. Operating in a perfectly competitive market with rising marginal costs E. Operating in a monopolistically competitive market with rising marginal costs

Correct answer: E

Marginal costs can be calculated by looking at the difference in total cost as output rises – marginal costs are clearly rising. It is also possible to work out the average revenue at each level of output by dividing total revenue by quantity – average revenue falls as output rises, and therefore there is a downwards sloping demand curve – the firm has some price making power and therefore cannot be operating in a perfectly competitive market.

Question 5

The diagram below represents an economy operating with a negative output gap. According to the Neoclassical model, how could the economy return to its full employment equilibrium?

A. An increase in government spending to increase AD B. A sustained increase in the economy’s factor productivity C. A fall in the wage rate due to a weakening of the bargaining power of labour D. A reduction in the value of net exports E. An increase in the savings ratio

Correct answer: C

Answer A is a good “distractor” as it could indeed return the economy to the full employment level of output – but it is a Keynesian / interventionist approach and not a Neoclassical self-correcting approach. When a negative output gap exists, unemployment must necessarily be higher and this weakens the relative bargaining power of workers compared to firms. Firms can ‘bid down’ the wage rate, which causes SRAS to increase/shift downwards, returning the economy to full employment.

P1

AD

LRAS SRAS

Real National Output

Y1

General Price Level

Question 6

A sharp depreciation in an economy’s exchange rate will be most likely to improve its current account of the balance of payments if:

Answer PED for exports PED for imports A -1.3 -0.4 B -0.6 -1.1 C -0.2 -0.3 D -1 -1 E -1.2 -1.4

Correct answer: E

Based on the Marshall-Lerner condition. The fall in the exchange rate will reduce the foreign price of exports and increase the sterling price of imports, other things being equal. Therefore the higher the PED in each case, the greater the impact on the value of exports and imports.

Question 7

The table below shows the possible output per factor of production of goods and services in two economies, Georgistan and Bobland:

Goods Services Bobland 70 35 Georgistan 45 30

Which of the following statements is true:

A. Georgistan has comparative and absolute advantage in goods. B. Georgistan has comparative and absolute advantage in services. C. Georgistan has comparative advantage in goods and absolute advantage in

services. D. Georgistan has comparative advantage in services and absolute advantage in

goods. E. Bobland has absolute advantage in both goods

Correct answer is E

Because with a single unit of resource, Bobland can produce more in both sectors than Georgistan.

Question 8

In economic theory, a firm should shut down in the short run if:

A. Total revenue is lower than total fixed costs B. Average revenue is more than average variable cost C. Total revenue is lower than total variable cost D. Average revenue is lower than average cost E. Average variable cost is lower than average fixed cost

Correct answer: C

In the short run, a firm should close down if it can’t cover its variable costs, because it will have to pay its fixed costs whether it stays open or closes.

Question 9

The following table gives values for Tajikistan’s GDP and GNI in the Tajik currency, the somoni:

GDP GNI 36.163 billion somoni 45.552 billion somoni

Which of the following is likely to provide the best explanation for the difference between the two figures?

A. The data is not given at purchasing power parity (PPP) B. There are many multinational companies in Tajikistan paying profits abroad C. The level of inequality in Tajikistan is very high D. Many of Tajikistan’s workers are based abroad and pay money back home. E. Tajikistan is the world’s 33rd most corrupt country according to Transparency

International’s corruption perceptions index

Correct answer: D

GDP sows income generated within the geographical boundaries of an economy, whereas GNI shows income generated by the economy’s factors of production regardless of location. In the case of Tajikistan, many workers are based in Russia, paying remittances back home, making GNI much greater than GDP.

Question 10

Study the data in the charts below

It can be deduced on the basis of the information given that:

A. Over the period, Zambia’s real interest rate was positive B. Over the period, Zambia’s real interest rate was positive C. Before the middle of 2015, Zambia’s real interest rate was positive, but by 2016 it

was negative. D. Before the middle of 2015, Zambia’s real interest rate was negative, but by 2016

it was positive. E. Zambia’s real interest rate rose throughout the period.

Answer: C

The real interest rate is the difference between the nominal interest rate and inflation. The surge in inflation in 2016 has meant that Zambia’s real interest rate has turned negative in spite of the increase in the nominal rate.

SHORT ANSWER QUESTIONS

Q1. CLASSIC CAR BOOM Aston Martin DB4. Niche car maker Aston Martin only manufactured 1,100 models of their famous DB4 Series 3 between 1958 and 1963. Currently demand for these classic cars is rising with the price of a DB4 reaching up to £600,000 in the second hand market.

With the aid of a demand and supply diagram explain the current high price of the DB4. (4) Mark scheme AO1: 2 marks Award 2 marks for a correctly drawn diagram. Award 1 mark for a diagram with minor labelling error Demand and supply diagram drawn with a perfectly inelastic supply curve and the demand curve shifting to the right. AO3: 2 marks Award 2 marks for a clear analysis that explains the rising demand for the cars shifting the demand curve to the right and why supply is fixed (perfectly inelastic) resulting in rising prices for Aston Martins. Award 1 mark for an incomplete or brief analysis.

Q2. CALL FOR MEAT TAX TO COMBAT GLOBAL WARMING According to a recent report meat should be subject to a carbon tax to reduce emissions. The livestock sector, as a result of the flatulence of cattle, is already responsible for 15% of global greenhouse emissions, the same proportion as all of the world’s vehicles. Changing diets to healthy levels of meat consumption could generate a quarter of the remaining emission reductions needed to keep global warming below the danger level of 2C. In addition in order to breed livestock extensive deforestation has to take place, which can also contribute to climate change. If people consumed less meat as a result of the tax and followed a more vegetarian diet arguably their health would improve.

(a) With the aid of a diagram explain why meat consumption represents market failure. (4)

(b) Evaluate the effectiveness of the proposed meat tax. (8) Mark scheme (a) AO1: 2 marks Award 2 marks for a correctly drawn diagram. Award 1 mark for a diagram that has minor labelling errors. Externalities diagram showing the MSB to the left of the MPB. AO3. 2 marks Award 2 marks for a clear analysis that explains that the price of meat only reflects private costs not the external costs ie increased emissions and depletion of forests. Thus meat is under-priced and overconsumed compared to socially efficient levels. Award 1 mark for an incomplete or brief analysis.

(b)

Band AO3 AO4 4 marks 4 marks 2 3-4 marks

A good analysis of how a meat tax will reduce consumption.

3-4 marks A good evaluation. Learner evaluates this policy in order to show good appreciation of why or why not it may be effective.

1 1-2 marks A limited analysis of the impact of a meat tax on the consumption of meat.

1-2 marks Limited or brief evaluation. The evaluation may be unbalanced and focus on one issue. The evaluation is likely to be superficial.

0 0 marks Analysis is incorrect or missing

0 marks Evaluation is either incorrect or missing.

Indicative content

A meat tax will raise price and should reduce quantity demanded bring meat consumption closer to the socially efficient level.

External costs will have been internalised and market failure corrected.

Use of a demand and supply diagram to illustrate the effects of the tax.

Meat tax revenues could be used to develop less harmful forms of farming.

BUT.

Demand for meat may be price inelastic thus quantity demanded will fall very little. Use of diagram.

The level of tax is very hard to set because of the difficulty valuing the external costs of emissions.

Tax revenues may not be used to develop ways to reduce emissions from cattle.

ESSAY (a) Explain why monopoly results in market failure. (10)

AO1 AO3 Band 6 marks 4 marks

3 5-6 marks Excellent understanding of market failure as it applies to monopoly. Learner fully understands why market failure exists in monopoly developing the concept in context. For example that the price (valuation placed on the product by consumers exceeds the resource cost of production). A diagram may have been drawn to shown understanding.

2 3-4 marks Good understanding of market failure as it applies to monopoly. Learner understands market failure and can relate it to monopoly although detail may be lacking. A diagram may have been drawn to show understanding of the concept.

3-4 marks Good clear analysis of why monopoly results in market failure. A diagram may show the welfare loss of monopoly compared to perfect competition.

1 1-2 marks Limited understanding of market failure as it applies to monopoly. Some idea of market failure as a concept but little understanding shown of its links to monopoly.

1-2 marks Limited analysis of why monopoly results in market failure.

0 0 marks No knowledge of market failure present.

0 marks No valid analysis present.

Indicative content

Understanding of the concept of market failure shown.

Knowledge of allocative and productive efficiency demonstrated.

Understanding of why monopoly is allocatively and productively inefficient.

Price (valuation) exceeds the resource cost of products bought.

Average costs are not at their lowest.

Welfare loss of monopoly compared to perfect competition.

(b) Discuss the view that all monopolies do more harm than good in an economy. (20)

AO1 AO3 AO4 Band 6 marks 6 marks 8 marks 3 5-6 marks

Excellent understanding of reasons why monopolies do harm and are undesirable.

5-6 marks Excellent analysis of why monopolies are harmful.

6-8 marks An excellent critical evaluation which develops a number of benefits of monopoly and may also include a synoptic approach. Diagrams may also be used effectively.

2 3-4 marks Good understanding of reasons why monopolies do harm and are undesirable.

3-4 marks A good analysis of why monopolies are harmful.

3-4 marks A good evaluation which demonstrates the benefits of monopoly. Points are well developed and diagrams may be used.

1 1-2 marks Limited understanding of reasons why monopolies do harm and are undesirable.

1-2 marks A limited analysis of why monopolies are harmful.

1-2 marks A limited evaluation showing that monopolies may sometimes be good for markets. Only one point may be made or a number of superficially developed points.

0 0 marks No knowledge or understanding present.

0 marks No valid analysis present.

0 marks No valid evaluation present.

Indicative content

Definition of monopoly.

Monopoly produces a welfare loss/market failure compared to perfect competition. Higher prices/ lower output/ lower consumer surplus.

Less choice for consumers/lower quality/less incentive to innovate.

Allocative/ Productive/X-inefficiency.

Engage in anti-competitive practices ie price discrimination, predatory pricing, limit pricing.

Potential for diseconomies of scale.

Abuse of dominance on suppliers ie late payment etc

But

Potential economies of scale benefits passed on to consumers in lower prices.

Dynamic efficiency – link to innovation.

Abnormal profits can fund innovation and R&D.

Natural monopoly.

Domestic monopolies are needed to compete internationally in global markets.

Monopolies can exists for the benefit of the wider society if there is adequate regulation to control abuse of dominance.

Credit use of examples Network Rail, National Grid, Apple, Microsoft and Amazon etc.

Essay Exemplars

Exemplar 1

(a) Market failure occurs when a market fails to deliver an efficient allocation of resources resulting in a loss of economic welfare. A monopoly is a single firm acting alone in an industry, dominating over 25% of the market share. Monopolies create large barriers to entry preventing new entrants from joining the industry and reducing the contestability of the market, possibly due to high start-up costs, patents or predatory pricing. As a result monopolies aren't faced with competition, thus allowing them to charge high prices and produce low output, thus reducing consumer surplus as consumers have less purchasing power, choice and quality of good. In addition they become productively inefficient due to the lack of competition as they don't have to produce at a lower point on the average cost curve. Market failure may also arise from asymmetry of information as the producer can exploit consumers with their additional knowledge of the production process and costs. Monopolies may also create negative externalities to the environment due to high levels of fossil fuel consumption as they are X-inefficient and have no incentives to cut costs. Furthermore monopolies create a welfare loss as shown in the following diagram (triangle between P1, Q1, Q) as a result of the higher prices effecting lower income earning households.

(b) A monopoly is a single firm acting alone in an industry dominating 25% more of the market share. A monopoly has significant barriers to entry, preventing new competitors from joining the industry and resulting in there being no actual or potential substitutes for the goods. Due to the lack of contestability monopolies are able to raise prices to P1 which is above the competitive price P and also reduce output to Q1 from Q. Thus the consumer surplus falls as consumers have less purchasing power and poorer quality and choice of goods. Monopolies are also not productively efficient (AC=MR) or allocatively efficient (AR=MC) and when comparing with perfectly competitive markets they create a welfare loss (as shown above as ABC). Also shown in the diagram, monopolies aim for profit maximisation (MR=MC) and they also have the ability to make abnormal profits (AC<AR). If profits are invested into innovating the production process (eco-friendly packaging) and research and development, this will benefit consumers and make the monopoly more productively and allocatively efficient, as the firm is producing at a lower cost and consumer satisfaction is being maximised due to the new products with more advanced technology (Apple software). However if investments are spent on machinery which replace workers this may create problems for the economy due to rising levels of unemployment and additional expenditure from the government on benefits.

Monopolies are also able to benefit from economies of scale, reducing average costs thus making the firm more productively efficient. In addition firms have the opportunity to compete with oversea corporations due to the large size, this will create great benefits for the economy as more income will enter the economy. Furthermore monopolies avoid unnecessary duplication of goods due to there only being a single provider, as a result consumers can pick their good (single brand of ketchup) with greater ease and wastage is prevented.

Monopolies may also create problems for the Government as large corporations may choose to tax evade as they can employ expensive tax consultants, as a result the budget deficit is not aided or reduced. Monopolies are also X-inefficient as they have no incentive to cut costs due the lack of competition and as a result more harm may be done to the environment due to high fossil fuel consumption. However the Government can prevent this with pollution permits and regulation. However regulation may be ineffective due to asymmetry of information over the production process or regulatory capture. Workers may also receive lower wages because their is only one employer in the industry for their set skill, thus reducing living standards due to lower incomes. However this may not be a problem if the monopoly is regulated and production costs are minimised and wages monitored. However regulation is expensive for the Government and may result in budgetary difficulties

and there is an opportunity cost over Government expenditure (education, health care over regulation).

Natural monopolies may not harm the economy as it makes economic sense for there to be no more than one firm in the industry due to large sunk costs (can't be recovered after leaving the industry-Royal Mail). They are also more efficient (use less resources) and benefit from long run economies of scale. However they may charge high prices and not be allocatively efficient due to the lack of competition.

Monopolies may harm an economy if they chose to price discriminate (sales of identical goods and services sold at different prices from the same provider), however for this to occur there must be two separate markets and arbitrage must be prevented. Some consumers may also benefit from the lower prices and firms may create additional profit which can be invested into research and technology (more allocative/productive efficient).

Overall Monopolies may not be harmful to the economy if regulated efficiently and natural monopolies are more resourceful. Monopolies may also reduce unemployment if growth is significant and the production process is labour intensive, however wages may be low. Monopolies may also benefit the economy with their ability to compete overseas with large multinational corporations and they may be more innovative than other firms due to their ability to produce abnormal profits.

Exemplar 2

Exemplar 3

Specimen essays commentary

Exemplar 1

Part (a)

There is good knowledge, understanding and analysis shown in this essay and it reaches band 2 in both AOs. The main omission is the lack of an explicit reference to allocative efficiency although the diagram covers it to some degree. Productive efficiency could have been explained more clearly too.

AO1 Band 2 4 marks

AO3 Band 2 3 marks

Total 7 marks

Part (b)

The candidate makes many points and attempts to evaluate each as he/she goes along which is encouraging. However there are too many points made which leads to a lack of depth and a rather superficial analysis of each point. It is often better to make fewer points in depth and evaluate thoroughly rather than cover many points superficially. Nonetheless this is a good attempt.

AO1 Band 3 5 marks

AO3 Band 3 5 marks

AO4 band 3 6 marks

Total 16 marks

Overall 23/30 marks

Exemplar 2

Part (a)

Although the diagrams are carelessly drawn the analysis of allocative inefficiency is good. There is nothing on productive inefficiency though.

AO1 Band 2 3 marks

AO3 Band 1 2 marks

Total 5 marks

Part (b)

The candidate covers allocative and productive inefficiency reasonably well although the diagram is poor. The dynamic inefficiency point could have been argued the other way. There is a little on X-inefficiency and inequality followed by some fairly minimal evaluation.

AO1 Band 2 3 marks

AO3 Band 2 3 marks

AO4 Band 1 2 marks

Total 8 marks

Overall 13/30 marks

Exemplar 3

Part (a)

There is some coverage of allocative inefficiency and a fairly unsophisticated diagram. The answer overall is quite limited but worth some marks in the lower band.

AO1 Band 1 2 marks

AO3 Band 1 2 marks

Total 4 marks

Part (b)

This is a very weak answer which is both superficial and in places inaccurate. There is hardly any evaluation to speak of.

AO1 Band 1 2 marks

AO3 Band 1 2 marks

AO4 Band 1 1 mark

Total 5 marks

Overall 9/30 marks.