Answers to exam-style questions (objective)

1 C

Explanation of answer: The production possibility curve diagram shows that when car production rises by 40, from 60 to 100 cars, productive resources must be taken away from bike production. Since the economy is producing on its production possibility frontier, there are no spare resources to use. Switching of resources away from bike production causes bike output to fall by 200.

2 D

Explanation of answer: With this type of question, it is important to read the ‘stem’ of the question carefully, taking note of the word ‘except’. All the possible answers are true except D. This is because statement D relates to consumption choices and not to production choices.

3 C

Explanation of answer: Only statement C provides a widely accepted definition of the central economic problem. Statements B and D do relate to economic problems, but not to what is usually regarded as the central economic problem. Statement A relates to an aspiration and not to an economic problem.

4 B

Explanation of answer: On first sight, statement A might appear to be the correct answer. However, it is a wrong answer because different people have different views on what is equitable (fair) and inequitable (unfair). Views on fairness cannot be scientifically tested to see if they are right or wrong. The words ought and should in statements C and D indicate that they are normative rather than positive statements. This leaves statement B as the correct answer. It is possible to measure incentive and disincentive effects.

5 A

Explanation of answer: Statement A provides a definition of opportunity cost. All the other statements have nothing to do with the meaning of opportunity cost.

Topic 2 The allocation of resources in competitive markets

1 A downward-sloping demand curve shows an inverse relationship between planned quantity demanded and the price of a good or service. (2 marks)

2 The total amount of a good or service which firms are willing to sell in the marketplace in a given time period. (2 marks)

3 Market equilibrium is when the forces of supply and demand are balanced. This occurs when planned demand is equal to planned supply. (3 marks)

4 A shift in demand occurs following a change in at least one of the conditions of demand, in which case the ceteris paribus assumption no longer holds. The demand curve shifts to a new position, sliding along the supply curve. An adjustment along the supply curve happens when the price of the good or service changes. In the following diagram, the demand curve shifts from D₁ to D₂, and at the new equilibrium at point Z, supply has adjusted from Q₁ to Q₂. Essentially, an increase in demand leads to an expansion of supply. (4 marks)

5

The diagram above, which develops Figure 1 on p. 10 in the workbook, can be used to show excess demand. Immediately after the shift of the demand curve from D₁ to D₂ shown in the diagram, quantity Q₃ is demanded at price P₁. However, at this price, firms are only willing to supply Q₁. Excess demand at this price is shown by the distance between points X and V (or between Q₁ and Q₃). This excess demand causes the price to rise until a new equilibrium is reached at point Z and price P₂. (4 marks)

6 The term refers to how scarce resources are allocated between competing uses. In the marketplace resources are allocated by the price mechanism which is guided by the forces of supply and demand. (4 marks)

7 The shift in demand was driven by speculators entering the market seeking to buy copper at a low price and sell it at a later date at a higher price, with the aim of making a considerable profit. The speculative demand increased the price of copper because of two factors that limited supply. First, stockpiles of copper were very low; second, it was difficult for new copper to be mined. This meant that the supply of copper was inelastic with respect to a price increase and thus unresponsive to the increased surge in demand. (6 marks)

8 A rapid increase in the price of copper will mean higher prices for consumers which in turn will mean that they will purchase less. Also, the higher cost of production of goods made in part from copper feeds into the general inflation figures for the economy. Higher prices will affect households negatively because they will have to pay more for goods, thus having less disposable income for other purchases. However, copper mining companies should experience higher sales revenue if demand for copper is price inelastic. The significant long-term effect of the higher price of copper will be to send a signal to the markets that copper is now an even more valuable good. This will create greater incentives for producers to increase supply in the long run. Mining companies will seek new sources of copper. Scrap metal merchants will seek to recover greater quantities of recycled copper. The high price should also create incentives for consumers to use copper more sparingly and search for alternative raw materials, e.g. plastic piping. This could cause prices to fall eventually. Additionally, a very serious cost of the high price of copper is an increase in crime, with criminal gangs stealing copper in order to sell it to scrap metal traders. This is exceptionally dangerous when it puts public safety in danger if for example railway signal wires are stolen. (10 marks)

9 Elasticity measures the responsiveness of a dependent variable following a change in an independent variable. PED measures the percentage change in the quantity demanded for a good following the change in the price. PES measures how the quantity supplied to a market responds proportionately to a change in price. (4 marks)

10 Price elasticity of demand = Percentage change in quantity demanded

Percentage change in price

Income elasticity of demand = Percentage change in quantity demanded

Percentage change in income

(4 marks)

11 The supply curve for new houses is inelastic for three main reasons. First, there are strict planning laws in the UK which prevent house builders from quickly increasing the supply of houses. Second, there is a shortage of available land to build on. The UK has a large population relative to its land mass. Third, it takes months, if not years, to build a house. (5 marks)

12 In the UK, most people finance house purchase using borrowed money (a mortgage). Low interest rates create an incentive to take out mortgages to buy houses. In 2012, interest repayments were cheap and low interest rates create a disincentive to save because of the low return on savings. However, demand for houses actually fell because although consumers wanted to borrow to finance house purchase, the banks and building societies reduced the supply of mortgages to minimise risks following the huge losses they had incurred in earlier years during the banking crisis. As a result, demand decreased because the number of consumers who could obtain mortgages to buy property fell, since they were unable to borrow sufficient funds to finance house purchase. (8 marks)