The Allocation of Resources: 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: The Allocation of Resources study guide

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Section A

1. Define price elasticity of demand (PED) and state the formula used to calculate it. [3]

2. Distinguish between a movement along a demand curve and a shift of a demand curve. [4]

Section B

3. The price of a good rises by 10% and the quantity demanded falls by 25%. (a) Calculate the PED for this good. [2] (b) State, with a reason, whether demand is elastic or inelastic. [2] (c) Explain what will happen to the firm’s total revenue as a result of this price rise. [3]

4. Using a demand and supply diagram, explain what happens to market equilibrium price and quantity if a new health study causes consumers to view a good more favourably. [6]

5. Distinguish between a merit good and a demerit good, giving one example of each and explaining why each causes market failure. [6]

6. Explain two ways a government could intervene in a market to correct the market failure caused by a demerit good. [6]

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Answers

3. (a) PED = %ΔQd ÷ %ΔP = −25% ÷ 10% = −2.5 (ignore sign; magnitude 2.5) [2]. (b) Elastic [1], because the percentage change in quantity demanded (25%) is greater than the percentage change in price (10%) — PED magnitude is greater than 1 [1]. (c) Because demand is elastic, the percentage fall in quantity demanded outweighs the percentage rise in price [1], so total revenue falls [1]. This is the general rule: on elastic demand, a price rise reduces revenue and a price fall increases it; the reverse holds for inelastic demand [1].

4. A health study making the good more favourably viewed is a non-price determinant of demand (a change in tastes), so it causes a rightward shift of the demand curve, not a movement along it [2]. On the diagram, the new demand curve intersects the existing supply curve at a higher equilibrium price and a higher equilibrium quantity than before [2]. Candidates should draw the original D and S curves, the new D curve further right, and label both the original and new equilibrium points clearly [2].

5. Merit good: a good that is under-consumed relative to what is socially desirable if left to the free market, e.g. healthcare or education [1] [1] — because consumers underestimate its private benefits or cannot afford it, causing under-consumption relative to the social optimum, which is a form of market failure [1]. Demerit good: a good that is over-consumed relative to what is socially desirable, e.g. cigarettes [1] [1] — because consumers underestimate the harm to themselves or ignore the external costs imposed on others (e.g. passive smoking, healthcare costs), causing over-consumption relative to the social optimum [1].

6. Any two, three marks each: Indirect taxation — raising the price of a demerit good (e.g. a tobacco tax) to reduce quantity demanded toward the socially optimal level [1] [1] [1]. Regulation — banning or restricting sale/use (e.g. minimum purchase age, advertising bans) to directly limit consumption [1] [1] [1]. Provision of information — public health campaigns that correct consumers’ underestimation of harm, shifting demand left toward the social optimum [1] [1] [1].

Section C

7. Explain two ways the market economic system differs from the mixed economic system in how resources are allocated. [6]

Answer: In a market economic system, resources are allocated entirely through the price mechanism — buyers and sellers interacting through demand and supply, with no government intervention in production or pricing decisions [1] [1] [1]. In a mixed economic system, resources are allocated through a combination of the market and government intervention — the government corrects market failures through methods such as taxation, subsidies, regulation, or by directly providing some goods and services (e.g. state healthcare or education) [1] [1] [1]. The key distinguishing feature examiners look for is not simply “more government” versus “less government,” but that a mixed system explicitly intervenes to address specific market failures the pure market system leaves uncorrected.

A note on diagram technique

Whenever a question asks you to “use a diagram,” draw one — a written description of a shift without an accompanying labelled diagram typically forfeits the marks reserved for diagram technique, even if the written explanation is otherwise correct. Always label both axes (price and quantity), the original demand and supply curves, the new curve after any shift, and both the original and new equilibrium points clearly, since examiners mark the diagram and the explanation as separate but linked components of the same answer.

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Where marks are usually lost

• Forgetting to state the direction (elastic/inelastic) with a reason after calculating PED — a bare numerical answer with no interpretation typically only earns the calculation marks, not the full question total.
• Describing a shift when the diagram scenario actually shows a movement along the curve, or vice versa.
• Naming a policy (tax, regulation) without linking it back to the specific market failure it corrects.
• Giving demand/supply diagram answers without clearly labelling both the original and new equilibrium points, which loses the diagram-technique marks even when the underlying economics is correct.