A Level Economics: Markets in Action — Practice Questions

These are original questions written for Marlbridge, in the style and at the standard of the examination. They are not reproduced past-paper questions — examination boards hold copyright in their own papers. Use these alongside the official past papers available free from your board.

Related: Markets in Action revision notes

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Section A

1. Define price elasticity of demand and state what a value of 0.3 indicates. [3]

2. Distinguish between adverse selection and moral hazard, with an example of each. [4]

3. Explain what is meant by government failure. [2]

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Section B

4. A government considers a tax on sugary drinks. PED is estimated at 0.6.

(a) Explain who bears most of the tax burden, and why. [3]

(b) Describe the diagram you would draw to show the welfare effect of the negative externality, listing every curve and area you would label. [4]

(c) Explain why the tax raises substantial revenue but cuts consumption only slightly. [3]

(d) Evaluate the use of this tax as a policy for reducing obesity. [8]

5. Automatic enrolment into workplace pensions raised participation from about 55% to over 85%.

(a) Explain, using behavioural economics, why changing the default had such a large effect. [4]

(b) Explain what is meant by bounded rationality. [2]

(c) Evaluate the use of nudges compared with regulation. [6]

6. A supermarket notices that when household income falls, demand for its own-brand bread rises, while demand for a premium organic bread falls.

(a) Calculate and interpret the income elasticity of demand implied for each product if a 10% fall in income raises own-brand demand by 4% and lowers organic demand by 6%. [4]

(b) Explain what this tells the supermarket about how the two goods should be classified. [2]

7. Explain why a public good will not be provided by a free market, and describe one way a tradable permit scheme addresses a negative externality differently from a fixed indirect tax. [6]

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Answers

1. The responsiveness of quantity demanded to a change in price [1], calculated as %ΔQd ÷ %ΔP [1]. A value of 0.3 means demand is price inelastic — quantity changes proportionally less than price [1].

2. Adverse selection occurs before the transaction — the party with more information selects in, so worse risks are over-represented [1]; e.g. people who know they are ill are most likely to buy health insurance [1]. Moral hazard occurs after — behaviour becomes riskier once covered [1]; e.g. an insured driver taking less care [1].

3. Where government intervention leaves the outcome worse than the market would have [1], through information gaps, administrative cost, unintended consequences or regulatory capture [1].

4. (a) Consumers [1]. Demand is inelastic, so quantity falls proportionally less than the price rises [1], allowing producers to pass most of the tax on without losing significant volume [1].

(b) Label MPC and MSC, with MSC above MPC and the vertical gap representing the external cost [1]; label MPB / MSB [1]; mark the free-market equilibrium (MPB = MPC) and the social optimum (MSB = MSC) [1]; shade the welfare loss triangle between the two output levels [1]. An unlabelled diagram earns nothing.

(c) Because demand is inelastic, the tax is collected on almost the same quantity as before [1], so revenue is large and stable [1]. For exactly the same reason consumption falls only marginally, so the health objective is largely missed [1]. These are the same fact viewed from two ends — not a contradiction.

(d) Indicative content:

For [up to 3]: it internalises the external cost, moving output towards the social optimum; it raises revenue that could fund health education or treatment; it signals the product’s harm.

Against [up to 3]: demand is inelastic, so it is weak at its stated aim; it is regressive, taking a larger share of poorer households’ income; it may cause substitution to other unhealthy products; producers may reformulate or shrink portions rather than meaningfully cut sugar; government failure — the optimal rate is very difficult to identify.

Judgement [2]: effective as a revenue-raiser and a signal, weak as a behaviour-change tool alone. Pairing it with education, which shifts demand left and makes it more elastic over time, addresses the information failure the tax cannot. The judgement depends on the size of the external cost and on whether the revenue is hypothecated to health.

5. (a) People are subject to inertia and tend to accept the default [1]. Opting out requires effort and an active decision, which many defer indefinitely [1]. Changing the default means doing nothing now produces the desired outcome [1], so inertia works for enrolment rather than against it [1].

(b) People have limited information, time and computational capacity [1], so they cannot fully optimise and instead use rules of thumb to reach a satisfactory rather than an optimal decision [1].

(c) For nudges [up to 2]: very cheap; preserve freedom of choice, since opting out remains possible; can be highly effective, as the pension case shows. Against [up to 2]: effects may be small or fade; raise the question of who chooses the default; cannot address structural causes such as poverty. Regulation [up to 1]: more certain and enforceable, but removes choice, costs more to monitor, and can create black markets. Judgement [1]: nudges suit barriers of inertia or information; regulation suits harms that are serious and certain. The choice depends on the nature of the market failure.

6. (a) Own-brand: YED = %ΔQd ÷ %Δincome = +4% ÷ −10% = −0.4 [1]; negative YED means own-brand bread is an inferior good [1]. Organic: YED = −6% ÷ −10% = +0.6 [1]; positive YED means organic bread is a normal good (and, being below 1, a necessity rather than a luxury) [1]. (b) The supermarket should expect demand for own-brand bread to fall as incomes recover, since consumers switch back to preferred alternatives once they can afford to [1], while demand for organic bread should rise with incomes, making it more sensitive to the economic cycle than the own-brand line [1].

7. A public good is non-excludable (a supplier cannot stop a non-payer from consuming it) and non-rival (one person’s consumption does not reduce what is available to others) [1] [1]. Because non-payers cannot be excluded, a free-rider problem arises: no one has an incentive to pay, so a private firm cannot profitably supply it, and the market provides none [1] [1]. A tradable permit scheme sets a cap on total output or emissions and lets firms buy and sell permits within it, so the market finds the cheapest way to reduce the externality across firms with different abatement costs [1]; a fixed indirect tax instead sets a price on the externality but leaves the resulting quantity of pollution uncertain, whereas a permit scheme fixes the quantity and leaves the price to the market [1].

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Where marks are usually lost

• Unlabelled externality diagrams.
• Confusing adverse selection with moral hazard.
• Claiming a tax on inelastic demand will substantially cut consumption.
• Omitting government failure from an evaluation of intervention.
• A conclusion with no criterion.
• Giving only one property of a public good.
• Confusing what a tax fixes (price) with what a tradable permit scheme fixes (quantity).