O Level Economics: 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 revision notes

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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 the demand curve and a shift of the demand curve. [4]

3. State two conditions of supply that could cause the supply curve to shift. [2]

Section B

4. The market for umbrellas is initially in equilibrium. A period of unusually heavy rainfall increases consumer demand for umbrellas, while the price of a key raw material used to manufacture umbrellas also rises.

(a) Using a demand and supply diagram, show and explain the effect of the increase in demand for umbrellas on the equilibrium price and quantity, assuming supply is unchanged. [4] (b) Explain, using the concept of a condition of supply, why a rise in the price of the raw material would affect the position of the supply curve. [3] (c) State what would happen to price and quantity if both changes (the demand increase and the supply decrease) occurred at the same time. [2]

5. The price of a bus ticket rises from $2.00 to $2.20. As a result, the quantity of bus tickets demanded falls from 1,000 to 950 per day.

(a) Calculate the price elasticity of demand for bus tickets. Show your working. [3] (b) Using your answer to (a), state whether demand for bus tickets is elastic or inelastic, and explain what this means for the bus company’s total revenue after the price rise. [3] (c) Give two factors that might explain why demand for bus tickets has this elasticity. [2]

6. A market is currently in disequilibrium, with the price set above the equilibrium price.

(a) State whether this creates a surplus or a shortage, and explain your reasoning. [3] (b) Explain, step by step, how market forces would move the price back toward equilibrium. [3]

7. Explain, with an example, how a negative externality can cause market failure, and describe one way a government could intervene to correct it. [5]

8. “The market system, on its own, is the most efficient way to allocate a country’s resources.” Discuss this statement, referring to both the advantages of the market system and the case for government intervention in a mixed economy. [6]

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Answers

1. PED measures the responsiveness of quantity demanded to a change in price [1]. Formula: PED = % change in quantity demanded ÷ % change in price [2].

2. A movement along the demand curve (an extension or contraction) is caused only by a change in the good’s own price [2]. A shift of the demand curve is caused by a change in a condition of demand — such as income, tastes, or the price of a substitute or complement — and moves the whole curve to a new position [2].

3. Any two of: a change in the cost of production, a change in technology, a change in the number of firms in the market, a change in government taxes or subsidies, or (for agricultural goods) a change in the weather [2].

4. (a) An increase in demand shifts the demand curve to the right [1]; with supply unchanged, the new equilibrium is at a higher price and a higher quantity [1]; the diagram should show the original and new demand curves, the unchanged supply curve, and both equilibrium points clearly labelled [2]. (b) A rise in the price of a raw material is a condition of supply because it raises the cost of production [1]; at every price, producers are now willing to supply less than before, so the whole supply curve shifts to the left (a decrease in supply), rather than a movement along it [2]. (c) Price would rise, since both changes push price upward [1]; the effect on quantity is ambiguous without further information, because the demand increase raises quantity while the supply decrease lowers it, so the net effect on quantity depends on the relative size of each shift [1].

5. (a) % change in price = (2.20 − 2.00) ÷ 2.00 × 100 = 10% [1]. % change in quantity demanded = (950 − 1,000) ÷ 1,000 × 100 = −5% [1]. PED = −5% ÷ 10% = −0.5 (or 0.5 ignoring sign) [1]. (b) PED = 0.5, which is less than 1, so demand is price inelastic [1]. Because demand is inelastic, the percentage fall in quantity is smaller than the percentage rise in price, so total revenue increases after the price rise [2]. (c) Any two of: bus travel may be a necessity with few close substitutes for some commuters, it may take up a small proportion of income, or there may be limited alternative transport options in the short run [2].

6. (a) A surplus [1], because at a price above equilibrium the quantity supplied exceeds the quantity demanded — producers are willing to sell more than consumers are willing to buy at that price [2]. (b) Producers are left with unsold stock [1]; to clear it, they cut the price [1]; as price falls, quantity demanded rises and quantity supplied falls until they meet at the equilibrium price, where the surplus is eliminated [1].

7. A negative externality is a cost imposed on a third party not involved in the transaction — for example, a factory’s pollution harming nearby residents [2]. The market price does not reflect this external cost, so the good is overproduced relative to the socially optimal level, which is market failure [2]. A government could correct this by imposing a tax on the good, raising its price toward the true social cost and reducing the quantity produced [1].

8. Credit answers that develop both sides. For the market system: prices allocate resources efficiently by responding automatically to changes in consumer demand, without the cost or delay of central planning, and give firms strong incentives to produce what consumers want [2-3]. For government intervention: left alone, markets fail to account for externalities, under-provide public goods, and can allow monopoly power to develop, all of which justify a mixed economy where the government corrects these failures through taxes, subsidies, regulation or direct provision [2-3]. The strongest answers reach a supported judgement rather than simply listing points on each side [up to 6 overall].

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Where marks are usually lost

• Sketching a demand/supply shift without labelling the axes, the original and new curves, or the equilibrium points.
• Confusing a shift in supply (a condition of supply changes) with a movement along the supply curve (only price changes).
• Getting the PED formula the right way round but forgetting to compare the size of the two percentage changes when explaining the effect on revenue.
• Writing “surplus” or “shortage” without explaining why, in terms of quantity supplied versus quantity demanded at that price.
• On evaluation-style questions (like Q8), listing points for only one side of the argument instead of weighing both and reaching a conclusion.