A Level Economics: Government Microeconomic Intervention — Practice Questions (Cambridge 9708)

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

Related: Government microeconomic intervention study guide and revision notes

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Section A

1. Distinguish between a merit good and a demerit good, giving one example of each. [2]

2. State the key difference between income and wealth. [2]

3. Name the six methods of government intervention in markets covered by this topic. [3]

Section B

4. A government sets a minimum price for milk above the current free-market equilibrium price, in order to protect dairy farmers’ incomes.

(a) Explain the likely effect of this minimum price on the market for milk, using demand and supply analysis. [4] (b) Explain how a buffer stock scheme could be used to manage the resulting surplus. [3]

5. A government introduces an indirect tax on sugary drinks and a subsidy for public bus travel.

(a) Explain why the government might use an indirect tax in the case of sugary drinks and a subsidy in the case of bus travel. [4] (b) The demand for sugary drinks is relatively price inelastic, while the demand for bus travel is relatively price elastic. Explain how this difference affects who bears the burden of the tax and who receives the greater benefit of the subsidy. [4]

6. Explain two named policies a government could use to redistribute income and wealth, and state which specific problem each addresses. [4]

7. A government publishes clear nutritional labelling on all packaged food, without changing any prices. Explain what type of market failure this policy addresses, and why the government might choose this approach over an indirect tax. [3]

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Answers

1. A demerit good is one that is over-consumed relative to the socially optimal level if left to the free market, such as cigarettes [1]. A merit good is one that is under-consumed relative to the socially optimal level if left to the free market, such as healthcare [1].

2. Income is a flow concept — money received over a period of time, such as wages or dividends [1]. Wealth is a stock concept — the value of assets owned at a point in time, such as property or savings [1].

3. Indirect taxes, subsidies, direct provision of goods and services, maximum and minimum prices, buffer stock schemes, provision of information [3] (one mark per two correctly named, up to three).

4. (a) At a minimum price set above the free-market equilibrium, quantity supplied exceeds quantity demanded at that price [1–2], creating a surplus of milk [1], since farmers are willing to supply more at the higher guaranteed price than consumers are willing to buy [1]. (b) A buffer stock agency could buy up the surplus milk (or a storable dairy product derived from it) at the minimum price, removing it from the market and storing it [1–2], and could later sell from this stock if the price ever fell too low or supply fell short, helping stabilise farmers’ incomes over time rather than only in the current surplus period [1].

5. (a) An indirect tax on sugary drinks raises their price, discouraging the over-consumption of a demerit good [1–2]. A subsidy on bus travel lowers its price, encouraging the consumption of a good the government judges to be under-consumed relative to the social optimum (for example, because it reduces congestion or pollution compared with private car use) [1–2]. (b) Because demand for sugary drinks is price inelastic, consumers continue buying similar quantities even as price rises, so consumers bear the larger share of the tax burden [1–2]. Because demand for bus travel is price elastic, a given price fall from the subsidy causes a proportionately larger increase in quantity demanded, so consumers receive the greater benefit of the subsidy in the form of significantly increased usage at the lower price [1–2].

6. Any two of, with the problem addressed identified for each: minimum wage — addresses low earned income directly by legally raising the wage floor for low-paid workers [2]; transfer payments — redistribute income after it has already been generated, addressing hardship among those with low or no income by providing benefits without a corresponding exchange of goods or services [2]; progressive taxation — redistributes income and wealth after generation by taxing a rising proportion of income or wealth as the amount taxed rises, reducing after-tax inequality [2]; state provision of essential goods and services — addresses unequal access to essentials such as healthcare or education regardless of a household’s market income [2].

7. This policy addresses market failure caused by consumers lacking the information needed to make efficient decisions [1] — provision of information does not directly alter price, unlike an indirect tax [1]. A government might prefer this approach where it wants to help consumers make better-informed choices themselves, rather than imposing a cost through taxation, particularly where policymakers are uncertain about the most appropriate size of tax to correct the market failure [1].

A note on exam technique for this topic

Question 5(b) illustrates the specific link between price elasticity (Topic 2) and tax/subsidy incidence (Topic 3) that the study guide identifies as essential: the side of the market with the more inelastic response bears the larger share of a tax’s burden or captures the larger share of a subsidy’s benefit. Stating this rule in the abstract earns partial credit at best — full marks require applying it explicitly to the specific elasticities given in the scenario, exactly as demonstrated in the worked answer above.