Unit 7: The price system and the microeconomy · A Level Economics

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With the help of a diagram(s), assess the view that larger firms always have lower average costs than smaller firms.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 8 marks. AO3 out of 4 marks.

Indicative Content

AO1 Knowledge and understanding and AO2 Analysis Relevant diagram(s) Students may draw a long-run average cost (LRAC) curve showing economies and diseconomies of scale. Long-run average costs and firm size Illustrates economies and diseconomies of scale.

Diagram should show:

• Falling LRAC due to economies of scale.

• Minimum efficient scale (MES).

• Rising LRAC beyond the optimum due to diseconomies of scale.

Maximum Level 2 if no diagram

Knowledge and Understanding

• Definition of average cost.

• Understanding of economies of scale and diseconomies of scale.

• Understanding of minimum efficient scale (MES).

• Recognition that firm size may affect costs.

Analysis

Candidates may explain:

• Larger firms can benefit from:

• Purchasing economies.

• Technical economies.

• Financial economies.

• Marketing economies.

• Managerial economies.

• Risk-bearing economies.

• These economies lower average costs as output rises.

• Larger firms may spread fixed costs over a greater level of output, reducing average costs.

• However, as firms continue to grow:

• Communication problems may arise.

• Coordination becomes more difficult.

• Bureaucracy may increase.

• Worker motivation may fall.

• These diseconomies of scale can raise average costs.

• Some industries have a relatively low MES, meaning small firms can operate efficiently despite being smaller. Modern technology may reduce the advantages of large-scale production, allowing smaller firms to remain competitive. Indicative Analytical Chains Chain 1 Large firm → technical economies → higher productivity → lower unit costs → lower average costs. Chain 2 Firm expands excessively → management layers increase → communication failures → inefficiency → higher average costs. Minimum of three developed points for Level 3

AO3 Evaluation (6 marks)

Award up to 6 marks for evaluation. Possible evaluative points: The statement uses the word ‘always’. This is unlikely to be correct because diseconomies of scale may emerge once a firm becomes too large. The importance of firm size depends on the industry:

• Industries such as car manufacturing may have substantial economies of scale.

• Sectors such as consultancy, software development or specialist services may allow smaller firms to compete effectively.

• The extent of cost advantages depends on technology.

• Digital technologies and outsourcing can reduce the need for large-scale operations. Some firms deliberately remain small to maintain flexibility, innovation or customer service, which may offset higher costs. A distinction can be made between:

• Larger firms having the potential for lower average costs.

• Larger firms actually achieving lower average costs in practice. E6 (Highest-level Judgement) A justified conclusion such as: Larger firms often achieve lower average costs because of economies of scale, particularly up to the minimum efficient scale. However, it is incorrect to argue that they always have lower average costs since diseconomies of scale, industry characteristics and technological developments may enable smaller firms to be equally or more cost-efficient.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Third-degree price discrimination benefits the firm but not its customers. With the help of a diagram, assess the consequences of third-degree price discrimination to both the firm and its customers.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 8 marks. AO3 out of 4 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Third degree price discrimination will lead to some consumers losing their consumer surplus since they are paying higher prices that they would without price discrimination.

• Consumers who are charged the higher prices may feel unfairly treated, leading to dissatisfaction and potential backlash against the firm.

• Firms segment the market based on observable characteristics such as age, location, or income level, and charge different prices to each segment, leading to higher revenues than just a single uniform price.

• Third-degree price discrimination will enable firms to get higher supernormal profits.

• Higher profits by firms enable more reinvestments of profits which could lead to capturing further market share and entrance into new markets.

• Analysis of the price discrimination diagram.

AO3 Evaluation

• To price discriminate, firms need to accurately identify each consumer's willingness to pay, which may require costly information gathering and segmentation strategies, and the cost may outweigh the benefits.

• Higher levels of innovation by firms making more profits could provide consumers with more choices and better-quality products

• Some consumers will be charged lower prices and therefore get higher satisfaction – increasing accessibility of the product.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Evaluate whether the marginal utility theory of demand provides an adequate explanation of market demand for both normal goods and inferior goods. Use TableA: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to thisquestion.

AO1 and AO2 out of 14marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Assumptions of marginal utility analysis including:

• rational consumers who prefer more to less,

• a two-good world,

• the goods can be substituted for each other,

• perfect knowledge of the market.

• Definition of marginal and total utility.

• Explanation of diminishing marginal utility.

• The analysis of the change in the price of a good and the explanation of how much the consumer will purchase as the price changes.

• The use of the equi-marginal principle to establish how consumers ‘balance’ their expenditure on goods as the price of one of them changes. MU /P = MU /P x x y y

• The horizontal addition of individuals’ demand curves to achieve the market demand curve.

AO3 Evaluation

• Consumer rationality: marginal utility theory assumes that consumers act rationally. They are of a calculating mind, carrying numerous combinations of different commodities in their heads, can substitute one for the other, compare their total utilities and make a rational choice between various combinations of goods.

• Marginal utility theory has no provision for income and substitution effects so does not explain inferior goods.

• It is difficult to compare the concept of changing the demand for expensive goods which are purchased infrequently with goods such as consumables. which are one-off indivisible purchases and the choice is between, for example, 1 fridge and 4 weeks’ food.

• A consumer is faced with a much more complex world than the two-good world of the model because a consumer buys not just two but many commodities to satisfy their innumerable wants.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation

• Goods can be classified as either normal or inferior.

• Explain how public transport would be classified in Czechia.

• Use of bus and rail travel appears to be declining as incomes rise (1)

• They are not normal goods/they are inferior goods (1) Explain how private cars would be classified in Czechia.

• Use of private cars appears to be increasing as incomes rise (1)

• They are normal goods/they are not inferior goods (1)

Consider, with the help of a diagram, whether electricity generation in Czechia creates a deadweight welfare loss.

• Diagram, with axes (1) and curves correctly labelled (1)

• Diagram, with DWL appropriately indicated/identification DWL in the text

(1)

Diagram is worth (3) marks in total

• Electricity generation has negative production externalities/external costs

(1)

• Marginal social cost is greater than/above marginal private cost/supply curve (1)

• MSC does not equal MSB at the (market) outcome (1)

• Market outcome is too high/overallocation of production (1)

• There is market failure (1) Discussion is worth (3) marks in total

Assess the extent to which marginal utility theory explains the downward sloping market demand curve for a good.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Definition of marginal utility/total utility and their relationship.

• Explanation of diminishing marginal utility.

• Analysis of the equi-marginal principle to show how change in price affects the quantity demanded for an individual’s demand curve.

• Explanation and analysis to show a market demand curve stating/showing the horizontal summation of the individuals demand curves.

AO3 Evaluation

• Not possible to measure utility.

• Assumes that consumers are rational, but there may be cases where expensive goods are consumed in order for the consumer to be conspicuous.

• There may be Giffen goods.

• Assumes perfect knowledge of prices for substitutes.

• Many choices between two goods occur when they are not easily substitutable for each other.

• Consumer preferences change over time.

• The use of indifference curves to analyse demand may be more effective.

• Collection of sets might mean utility increases as the sets near completion.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Although firms in an oligopolistic market may be in competition with each other, they will find it advantageous to collude. With the help of a diagram or a pay-off matrix, evaluate this statement.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Explanation of an oligopolistic market, with reference to the concentration ratio.

• An explanation of different types of collusion, such as tacit collusion, price- leadership, cartels.

• An explanation of how the firms are interdependent/consider other firms’ possible reactions when making pricing or output or other decisions.

• Explanation of how the kinked demand price set by price leadership

• Analysis of the kinked demand curve diagram and/or the payoff matrix.

• Payoff matrix analysis used to explain why collusion takes place.

• An explanation of how price ‘wars’ might occur.

• Analysis of a ‘monopoly’ diagram for the joint output and price when firms collude.

• Analysis of non-price/price competition.

AO3 Evaluation

• Collusive agreements are likely to break down, when firms act to maximize their own profits.

• Collusive agreements may infringe government regulations which are aimed at increasing competition.

• Cartels would need to be approved by a government agency.

• Both the kinked demand curve model and the pay-off matrix depend upon a particular set of assumptions about firms’ behavior, which may not occur in the real world.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Training workers improves their human capital and increases productivity. This benefits the workers, their employers and government. Consider the extent to which training fees should be paid for only by workers. Use TableA: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses this question.

AO1 and AO2 out of 14marks. AO3 out of 6 marks.

Indicative Content: Responses may include:

AO1 Knowledge and Understanding and AO2 Analysis

• Differences between education and training might be explained.

• Trained workers are likely to have higher productivity and this will increase the demand for this labour

• For workers, higher demand for skilled labour is likely to lead to higher wages.

• MRP theory might be used in conjunction with a supply of and demand for labour diagram, to illustrate the impact on wages of an increase in productivity

• For workers, highly skilled labour is more likely to produce an inelastic supply and therefore increase wages.

• Employers might pay fees because they are likely to benefit through an increase in profits.

• Government’s might contribute towards fees because they are likely to benefit in the long run due to an increase in real GDP

AO3 Evaluation

• Wealthier families can afford to pay.

• Fear of significant debt for lower paid individuals.

• Government funding might lead to less well-off workers subsiding those benefiting from government financial support

• low paid workers may not be able to cover self-financing their fees.

• Workers may be subsequently employed by other firms who do not bear the initial costs.

• Government funding of fees for some groups at the expense of others may be politically unpopular.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

The fashion industry employs around 75 million workers, many of whom earn very low wages and work up to 16 hours a day. The industry contributes to 20% of global wastewater and 8% of all carbon emissions. 60% of clothes are made from plastics, 83 million tonnes of the 100 billion garments produced are sent to landfill, and only 20% are collected for recycling. Consider to what extent an equitable solution can be found for market failures in the fashion industry.

Use Table A: AO1 Knowledge and Understanding, AO2 Analysis, and Table B: AO3 Evaluation, to mark candidate responses to this question

AO1 and AO2 are out of 14 marks. AO3 is out of 6 marks.

Indicative Content Responses may include:

AO1 Knowledge and Understanding and AO2 Analysis

• definition of market failure/allocative inefficiency

• explanation and example of a negative externality of production

• might draw a diagram to illustrate the link between negative externality of production and market failure

• the use of indirect taxation could be used to reduce the output of fashion clothes/the subsequent cost of the tax would be shared between consumers and producers

• use of advertising and education to raise public awareness of the negative impact of the production of fashion clothes upon society

• the provision of subsidies to those producers who use less plastic

• increase the cost of using landfill sites

AO3 Evaluation

• the use of indirect taxation might lead to unemployment in the fashion industry

• the use of indirect taxation might have a negative effect upon the export of fashion goods

• subsidies are costly and will lead to a re-distribution of income within the economy

• the rising cost of using landfill sites might lead to illegal dumping of waste products

Accept all valid responses

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Market failure is to blame for climate change and the inefficient allocation of resources. The only solution is for governments to intervene to improve resource allocation. Assess the extent to which you agree with this statement

AO1 Knowledge and understanding and AO2 Analysis

• Climate change can be regarded as a form of market failure can be explained by linking this to the requirement to allocate resources to maximise consumer satisfaction. This can be supported by a diagram illustrating a level of output where AR = MC or MSB = MSC which is consistent with an outcome that achieves allocative efficiency.

• Negative externalities occur when the consumption/use of a good produces a cost to society which is greater than that received by an individual producer MPB ⩾ MSB or MSC ⩾MPC. This is sometimes described as a negative ‘spill-over’ effect. The negative externality leads to an over production of the good carbon dioxide or other greenhouse gas.

• Government intervention takes place to address the failure of market forces to allocate resources efficiently. In this case positive externalities would lead to under–consumption of a good or service.

• Different types of government intervention can be used to correct the under-production of output to enable consumer satisfaction to be maximised.

• Forms of government intervention might include: the use of subsidies for consumers to move to less polluting forms of consumption and also producers to change productionmethods, use of positive advertising; the direct provision of goods and services such as alternative transport methods. Alternatively indirect taxation might be applied to the CO 2 producing source. Nudge theory effects.

• A clearly labelled, accurate diagram can be used to show the impact of a positive/negative externality on the level of outputand the welfare change will be identified.

• The diagram could show the market equilibriumpoint which does not take into account the existence of anegative consumption externality and may compare this with the allocatively efficient level of output when the negative externality is taken into account. The diagram may be amended or re-drawn to show the impact of achosen policy(ies) and the impact on consumption or production shown.

• Reference to the diagram and the outcomes it illustrates is made in the text.

AO3 Evaluation

• A government might introduce a subsidy to encourage producers to increase output to enable allocative efficiency, however it is difficult to measure the precise valueof the subsidy. Subsidies are costly in that the funds might have been used by governments for other purposes. This means governments will have to make a value judgement when deciding whether to provide a subsidy. Thereare opportunity costs of the subsidy.

• Also, the impact on price and output in some circumstances takes a long time to become effective.

• Advertising is often costly and it is not always certain that it will have a sufficiently persuasive effect to ensure the correct level of output/ consumption is reached.

• Direct provision is also costly and sometimes less efficient than that provided through market forces.

• It is possible to show that government intervention can reduce the level of inefficiency caused by the existence of positive externalities but it is not clear whether the net effect of government intervention will always be positive. Some types of intervention will be more effective than others depending on the nature of the good/service under consideration.

• Government failure. Concluding point which considers ‘only’ aspect.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation

The degree of competition a firmexperiencesis determined only by the barriers to entry into its market. With the aid of diagrams, evaluate this statement. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• A discussion of types of barriers to entry.

• The impact of barriers to entry on market structures.

• A detailed analysis of at least 2 forms of market structure one with no barriers (perfect competition or monopolistic competition) and one with barriers to entry (oligopoly or monopoly) to include reference to product, knowledge levels, profit levels.

• Diagrams are correctly labelled and accurately drawn.

• with correct labelling and relevant reference to it/them in the answer.

• Max L2 if no diagram

• Max L2 if only one type of structure

AO3 Evaluation

• Competition is linked to the number of firms who can access a market, so the simple answer is yes because barriers to entry preventfirms entering a market.

• Perfect competition and monopolistic competition with their lack of barriers are both highly competitive.

• Competition takes place in oligopoly through product differentiation and sales and marketing.

• Monopolies are subject to limitations on their ability to exploit the consumer by the limitations of contestable markets.

• Regulation

Accept all valid responses

Explain one possible benefit ofhorizontal integration and one possible benefit of vertical integration. Horizontal integration definition (1) + Benefit (1) Vertical integration definition (1) + Benefit (1)

Describe how the market structure in which individual farmers operate is likely to differ from the market structure in which the commodity traders operate. Farmers: monopolisticcompetition (1) many sellers (1), similar product (1), no barriers to entry (1), price maker (1) Max 3 Traders: oligopoly(1) and a few sellers (4) (1) and barriers to entry (1) price maker (1) product differentiation (1) Max 3 Market structure must be correct to gain explanation marks.

Traffic congestion is a cause of allocative inefficiency. Evaluate, with the help of diagram(s) two policies that a government may introduce to reduce the problem of allocative inefficiency caused by traffic congestion.

AO1 Knowledge and understanding and AO2 Analysis

• Market failure regarding this question would relate to allocative inefficiency. Market failure can be explained by defining allocative efficiency and linking this to the requirement to allocate resources to maximise consumer satisfaction. This can be supported by a diagram illustrating a level of output where AR = MC or MSB = MSC which is consistent with an outcome that achieves allocative efficiency.

• Negative externalities occur when the consumption/use of agood produces a cost to society which is greater than that received by an individual consumer MPB > MSB. This is sometimesdescribed as a negative ‘spill-over’ effect. The negative externality leads to an over production of the good.

• Government intervention takes place to address the failure of market forces to allocate resources efficiently.

• Different types of governmentinterventioncan be used to correct the over consumption to enable consumer satisfaction to be maximised.

• Forms of government intervention might include: the use of subsidies for consumers to increase consumption of alternative forms of transport, use of positive advertising of alternatives; the direct provision of goods and services such as alternative transport methods. Indirect taxation. Nudge theory effects.

• Aclearly labelled, accurate diagram can be used to show the impact of a negative externality on the level of output and the welfare change will be identified.

• The diagram could show the market equilibriumpoint which does not take into account the existence of anegative consumption externality and may compare this with the allocatively efficient level of output when the negative externality is taken into account. The diagram may be amended or re-drawn to show the impact of achosen policy(ies) and the impact on consumption or production shown.

• Reference to the diagram and the outcomes it illustrates is made in the text.

AO3 Evaluation

• A government might introduceasubsidy for alternative forms of transport e.g. mass rapid transport to encourage production to enable allocative efficiency, however it is difficult to measure the precise value of the subsidy. Subsidies have opportunity costs and are costly in that the funds might have been used by governments for other purposes. This means governments will have to make a value judgement when deciding whether to provide a subsidy.

• Consumer demand for alternatives may be low due to the reluctance to price in-elasticity of demand for public transport/alternatives.

• The impact on price and output in some circumstances takes along time to become effective.

• Advertising of alternative methods of transportis often costly and it is not always certain that it will have a sufficiently persuasive effect to ensure the correct level of consumption is reached.

• Public sector provision is costly and sometimes less efficient than that provided through market forces.

Accept all valid responses.

With the help of a diagram, evaluate the impact on consumers and producers of an increase in market contestability.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Market contestability should be explained by referring to how open a market might be to new competition.

• Existing factors which might limit contestability can be identified, including examples of barriers to entry, particularly high sunk costs.

• Recognition and description of the conditions that will exist when a market is not contestable. A clearly labelled, accurate diagram should be provided showing profit maximization price and output. (accept either Oligopoly or Monopoly diagram)

• Analysis should examine the impact on consumers when barriers to entry are removed. A diagram could be used to indicate that consumers might benefit from lower prices and more choice

• Analysis can be used to assess the impact of an increase in contestability on firms. It is likely that abnormal profits might be reduce.

• Analysis could also be used to indicate why contestability might create incentives for a business to reduce their unit costs by avoiding any X- inefficiencies

AO3 Evaluation

• The removal of barriers to entry and a subsequent loss of market share might mean that a firm cannot benefit from economies of scale to the same extent. It is possible that as a result of this lower prices might not be passed on to the consumer.

• The respective impact on consumers and producers will be determined by the degree of contestability introduced and how well it can be maintained.

• The type of industry will also determine whether an increase in contestability will have a positive effecton consumers and producers. For example, natural monopolies by their nature, are unlikely to become more efficient when barriers to entry are removed.

• Firms with high barriers to entry may lose the opportunity to make sufficient abnormal profits to ensure dynamic efficiency is maintained. This may lead to higher prices for some consumers.

• A conclusion should be attempted which examines the net benefits that might be gained by introducing more contestable markets to either/or consumers/producers

Accept all valid responses. No diagram L2 Max

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Explain the meaning of ‘allocative and productive efficiency’. Allocative efficiency is when firms produce what consumers want (1) MC=AR/MC =P. (1) Productive efficiency is producing goods and services with the least use of resources. (1) Production on the lowest average cost curve/ minimum average cost/AC =minimum (1) Producing on the PPC 1

Explain what is meant by a negative production externality. A cost 1 that is born by someone other than the producer of the good/a third party 1 Identify from the extract, a negative production externality resulting from steel production. Noise, dirt or polluted air 1

Max 1 mark Explain, with the aid of a diagram, the consequences for output and price if the steel market is required to take into consideration negative production externalities. 1(b)(ii) cost/benefit MPB MSC MPC Negative P Externally P Q Q Quantity 1 Labels 1 Axes 1 and explicit indication of negative externality 1 Comment: Quantity falls from Q to Q 1 and Price increases from P to P 1 1 1 Welfare loss explained 1

Considerwhether‘a monopolyalways operates against the interests of the consumer’. In favour of monopoly :

• Economies of scale 1, + explanation 1

• Investment in research and development 1, + explanation 1 Natural monopoly e.g. railways 1, + development 1

Max 4 Against monopoly: Loss of productive efficiency 1 + explanation 1 Loss of allocative efficiency 1 + explanation 1 Lack of dynamic efficiency1 + explanation Or: A diagram showing the loss of allocative and productive efficiency Axes/Labels 1 correct costs and revenues 1 loss of AE 1 loss of PE 1

Max 4

Max 7 for argument Conclusion: 1 essay

Evaluate, with the aid of a diagram whether the diminishing marginal utilitytheoryof demand provides an adequate explanationof the market demand curve for all goods and services. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis Assumptions of marginal utility analysis including:

• rational consumers who prefer more to less, atwo-good world, the goods can be substituted for each other, perfect knowledge of the market.

• Definition of marginal and total utility.

• Explanation of diminishing marginal utility.

• The analysis of the change in the price of a good and the explanation of how much the consumer will purchase as the price changes.

• The use of the equi-marginal principle to establish how consumers ‘balance’ their expenditure on goods as the price of one of themchanges.

• The horizontal addition of individuals’ demand curves to achieve the market demand curve.

AO3 Evaluation

• Consumer rationality: marginal utility theory assumes that consumers act rationally. They are of a calculating mind, carrying numerous combinations of different commodities in their heads, can substitute one for the other, compare their total utilities and make a rational choice between various combinations of goods.

• Marginal utility theory has no provision for income and substitution effects so does not explain inferior goods.

• It is difficult to compare the concept of changing the demand for expensive goods which are purchased infrequently with goods such as consumables. which are one-off indivisible purchases and the choice is between, for example, 1 fridge and 4 weeks’ food.

• A consumer is faced with a much more complex world than the two-good world of the model because a consumer buys not just two but a large number of commodities to satisfy their innumerable wants.

• Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

Subnormal and supernormal profits are only experienced in the short run and only by firms in perfect competition. With the help of diagrams, evaluate this statement.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Definition of short run, subnormal and supernormal profits.

• Statement of the conditions for perfect competition.

• Analysis of the applicability of the concepts of subnormal and supernormal profits in the context of perfect competition.

• The resolution of subnormal and/or supernormal profits to equilibrium normal profits in perfect competition in the long run.

• A relevant diagram to show the analysis.

AO3 Evaluation

• The analysis of monopolistic competition to show subnormal and supernormal profits and their resolution to normal profit.

• Monopoly analysis to show that supernormal profits may exist in the long run.

• Analysis of oligopoly to show that there may or not be subnormal or supernormal profits in the both the short run and the long run.

Accept all valid responses.

AO1 Knowledge and understanding and AO2 Analysis

AO3 Evaluation

With the help of a diagram, evaluate the use of indifference curve analysis to explain the relationship between a change in the price of a product and the change in an individual consumer’s demand for this product.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• An explanation of what is meant by an indifference curve and an indifference curve map.

• Explanation of a budget line and understanding of how a change in price or how a change in real income will affect a budget line

• Demonstration of an understanding of consumer equilibrium.

• Use of a diagram to analyse the links between indifference curves, budget lines and consumer equilibrium.

• Analysis of how a change in price might affect consumer equilibrium. This can be supported by a clear, accurately labelled diagram.

• Analysis of each element of the price effect on individual consumer demand. Both substitution effects and real income effects should be considered to attain Level 3 No diagram-highest mark is L2 – 8

AO3 Evaluation

• Recognise that the key assumptions regarding human behaviour will determine the shape of the indifference curve. For example, it is assumed that all consumers attempt to maximise satisfaction.

• Although the analysis only considers ‘bundles’ of two good consumed, it still assumes the consumer can correctly distinguish between different levels of satisfaction between different ‘bundles’.

• The analysis only considers a choice between two goods. Consumers have the opportunity to consider alternative prices of a wide range of goods before choosing what to purchase.

• Other factors such as advertising might change consumer taste, which in turn, will change the shape of the indifference curve and, ultimately the final impact of a price change on consumer demand.

• A conclusion should be attempted which examines the effectiveness of the use of indifference curve analysis to predict the impact of a price change on individual consumer demand.

Accept all valid responses

The growth of a firm using a takeover is desirable because it enables consumers to benefit from lower prices and the firm to gain additional profits. Evaluate this statement.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2 Analysis

• Recognition that a takeover can be classified as a factor determining the external growth of a firm

• Differentiates between a takeover, which occurs when one firm buys another firm and a merger which takes place when two firms unite to form one new company

• Takeovers can relate to different stages of production. For example, horizontal, vertical integration.

• Analysis should refer to the benefits associate with gaining economies of scale via horizontal integration. For example, lower costs and lower prices for the consumer

• Analysis could also be used by referring to backward/forward vertical integration which might lead to further cost savings which can be passed on to the consumer.

• Firms might also increase profits by increasing their market share and increasing their total revenue

AO3 Evaluation

• The cost benefits of economies of scale might not be passed on to the consumer through lower prices

• An increase in market share might increase monopoly power and allow the firm to control output and charge higher prices to the consumer.

• Some takeovers can be very costly in the long run and this may decrease profits in the long run.

• A takeover will create a much larger organization which may have to deal with unexpected communication problems which increase costs and reduce profits

• Some takeovers might lead to intervention by the competition authorities which might result in price regulation

• Culture clashes may arise within firms involved which may lead to diseconomies of scale and rising consumer prices

• A conclusion should attempt to address each element of the statement. The key words ‘low consumer prices and ’increased profits’ should be considered in the light of the preceding argument.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation essay

Use the information to comment on the possible effects on the economies of the countries that refused to sign the carbon policy agreement. Those countries are some of the top producers of coal. (1) Advantages: Cheapness as a power source 1 enabling them to increase/maintaining GDP/Economic Growth 1. Reliable source of power1 enabling continuity of production 1. Coal supplies can be stored and managed 1 to meet demand for electricity 1. Disadvantages: Coal is a finite resource 1 and therefore there are future costs of switching 1. Continuation of the output of negative externalities 1 e.g. carbon dioxide/greenhouse/toxic gases/lower air quality 1. 4 max

With the help of a marginal social cost and benefit diagram discuss whether the continued use of coal to produce electricity makes the achievement of allocative efficiency less likely. Definitions of: private cost 1, external cost/social cost, 1 allocative efficiency 1. External costs of coal/‘dirty fuel’/greenhouse gases/pollution 1 3 countries produce 52% of global CO emissions from coal use 1 2 Correct axes with Discussion: correct drawing and $/P/C/B MSC MPC labels of MPB/MSB and MPB/MSB MSC, MPC 1 Indication of Externality/Welfare loss 1 Correct identification Q* of Q* and Q 1 Q Output/Quantity Coal production/burning has negative externalities which mean MSC is greater than MPC. 1 Conclusion: This means the allocative efficient output is Q* not Q/allocative efficiency is not achieved 1.

Monopolies restrict output to raise prices and exploit consumers. With the help of a diagram, assess the extent to which a government should intervene in monopoly markets.

Use Table A: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2Analysis

• The key characteristics of a monopoly market structure should be identified.

• The aim of profit maximization should be explained and an accurately labelled supporting diagram should be provided to illustrate this situation.

• Analysis should be provided, based on a diagram, which shows the links between low output, high prices and allocative inefficiency.

• Alternative government policies to reduce the power of monopolies should be explained.

• Diagram(s) may be provided to illustrate monopoly equilibrium and/or the policy suggested.

• Analysis of how alternative types of government intervention can be used to address some of the negative outcomes associated with monopoly firms. No monopoly diagram Max L2 8 marks.

AO3 Evaluation

Accept all valid responses.

• A government can use taxation to reduce monopoly profits and control market power. However, this might reduce the incentive to invest by monopoly firms and lead to X inefficiency

• Maximum pricing might be introduced to control high prices but this might lead to shortages and/or the operation of underground markets.

• Some types of product/service can be described as natural monopolies, therefore any attempt to introduce more competition is simply likely to lead to more inefficient outcomes.

• Direct government intervention by regulation/legislation might reduce a monopoly market share but this would also make it more difficult for a monopoly to benefit from economies of scale. Hence, costs and prices might subsequently rise.

• A conclusion should attempt to examine alternative types of government intervention to try and establish the extent to which governments should intervene in monopoly markets.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation

The passage states that the RMG industry ‘uses significant division of labour’ takes place. Explain how this is likely to affect the average costs of firms in Bangladesh’s RMG industry. Division of labour increasing labour productivity/Increased efficiency (1) Definition of division of labour e.g. cutting, sewing zips, (1), and hence reduces average total costs (1).

Identify the probable market structure of the RMG industry in Bangladesh and with the help of a diagram, consider the likely effect on the level of long-run profits of firms in this industry. Identification of Monopolistic Competition 1

Diagram 3 marks: Labels and axes 1 Identification of MC=MR for profit maximisation 1 Average cost and revenue/marginal costs and revenue curves 1 Explanation of why Normal Profits 1 in long run equilibrium 1 If correct analysis but market mis-identified as monopolistically up to 5

With the help of a diagram, consider whether economic efficiency can be achieved without government intervention in a market economy Use TableA: AO1 Knowledge and understanding and AO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14marks.

AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2Analysis

• Definition and demonstration of productive efficiency in terms of minimum AC and allocative efficiency MC=MR.

• Candidates may approach the question from a number of points of view

• Comparison of equilibrium in Perfect Competition with reference to definitions of efficiency.

• Negative externalities (e.g. the effects of environmental pollution) causing the social cost of production to exceed the private cost or positive externalities (e.g. the provision of education and health care) causing the social benefit of consumption to exceed the private benefit

• Imperfect information or information failure means that merit goods are under-produced while demerit goods are over-produced or over- consumed.

• The lack of supply of pure public goods and quasi-public goods issue that are needed to meet people's needs and wants.

• Market dominance by monopolies can lead to under-production and higher prices than would exist under conditions of competition and the effect on price and quantity produced and consumer welfare.

• Factor immobility causes unemployment and a loss of productive efficiency.

• Equity (fairness) issues. Markets can generate an 'unacceptable' distribution of income and consequent social exclusion which the government may choose to change.

• A choice of government policy to address a market failure from:

• specific and ad valorem indirect taxes, subsidies, price controls, production quotas, prohibitions and licences, regulation and deregulation, direct provision, pollution permits property rights, nationalisation and privatization, provision of information or behavioural insights and ‘nudge’ theory. No Diagram Max L2 8

AO3 Evaluation

• Opportunity costs of the policy that has been chosen, what are the alternative uses of the resources and how does it affect efficiency.

• Can the government accurately measure the extent of the market failure.

• Unintended consequences on, regulator capture, cost of bureaucracy, political interference.

• Evaluation may be based on an example cited by candidates.

• Implications for the government budget increase in tax revenues/costs of subsidies.

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation

Oligopolies are able to avoid price competition while maintaining supernormal profits in the long run. Evaluate this statement. Use TableA:AO1 Knowledge and understanding andAO2 Analysis and Table B: AO3 Evaluation to mark candidate responses to this question.

AO1 and AO2 out of 14 marks. AO3 out of 6 marks.

Indicative content Responses may include:

AO1 Knowledge and understanding and AO2Analysis

• Key characteristics of an Oligopoly market structure.

• Explanation of the kinked demand curve and price rigidity.

• Recognition that Game theory might predict stable prices through Nash equilibrium.

• Analysis of how barriers to entry might enable abnormal profits to be maintained in the long run.

• Analysis of how collusion might enable abnormal profits to be maintained in long run.

• Analysis of use of limit pricing to maintain abnormal profits in long run.

• Alternatives such as non-price competition might be used to maintain profits in long run

AO3 Evaluation

• Collusion to establish common prices is often illegal and also in some circumstances, difficult to maintain.

• It might be difficult to maintain barriers to entry if agovernment introduces legislation to promote more contestable markets.

• The extended use of limit pricing might have a significant negative impact on profitability in the short run which might reduce investment and dynamic efficiency in the long run.

• The use of non-price competition based on advertising and/or product differentiation might be costly and significantly reduce profits.

• Some Oligopolies might prefer to adopt abreak-even pricing policy in the long run to increase market share, rather than maximizing profits.

• A conclusion should be attempted which uses the precedingdiscussionto evaluate the statement under consideration

Accept all valid responses.

AO1 Knowledge and understanding and AO2Analysis

AO3 Evaluation