O Level Economics: The Allocation of Resources — Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs — 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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These questions represent Cambridge O Level Economics (2281) Paper 2, whose live paper opens with a Section A of one compulsory question worth 30 marks, which requires candidates to interpret and analyse previously unseen source material, and continues with a Section B in which candidates answer three questions from a choice of four, each worth 20 marks and each introduced by its own stimulus material.

Section A — Compulsory Question (30 marks)

Source Material: The rice market in Velmora

Velmora is a middle-income country where rice is the main food staple, and almost all rice sold there is grown domestically. In August 2023, unusually heavy monsoon flooding destroyed around a fifth of the standing rice harvest. The Ministry of Agriculture estimates that when the price Velmoran farmers can get for rice rises by 10%, the quantity of rice they supply rises by 15%, reflecting the large areas of unused farmland available for rice cultivation.

	Before the floods (July 2023)	After the floods (October 2023)	After the subsidy (2024)
Average market price ($ per tonne)	320	400	300
Quantity bought and sold (million tonnes per year)	9.0	8.0	9.6

Concerned about food security and the price rise, the government introduced a subsidy of $40 per tonne, paid directly to domestic rice farmers, from January 2024, funded from general taxation. A government minister argued that “the subsidy has brought the price down and even increased the harvest beyond its level before the floods.” A nutrition charity welcomed the lower price but pointed out that rice farming also causes a negative externality: fertiliser run-off from rice paddies is a major cause of pollution in Velmora’s rivers, a cost not reflected in the $300 price consumers now pay.

1. (a) Using the information in the source, calculate the price elasticity of supply (PES) of rice, and state whether supply is elastic or inelastic. [4]

(b) Using a demand and supply diagram, show and explain the effect of the floods described in the source on the equilibrium price and quantity in the rice market. [6]

(c) Explain, using the source, why fertiliser run-off from rice paddies is an example of a negative externality. [4]

(d) Using a demand and supply diagram, show and explain how the subsidy described in the source affected the equilibrium price and quantity of rice in 2024. [6]

(e) Discuss whether the subsidy is an effective way for the Velmoran government to address both food security and the externality identified in the source. [10]

Section B — Answer three of the following four questions (20 marks each)

Source: Wet season in Bay City

Bay City normally has a dry climate, but in 2024 it experienced its wettest year on record. Local umbrella retailers reported a surge in customers. At the same time, a key raw material used to manufacture umbrella frames became more expensive after a supplier’s factory closed unexpectedly.

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

(b) Using a demand and supply diagram, show and explain the effect of the wetter weather described in the source on the market for umbrellas in Bay City, assuming supply is unchanged. [4]

(c) Explain, using the concept of a condition of supply, how the rise in the price of the raw material described in the source would affect the position of the supply curve for umbrellas. [4]

(d) Discuss whether Bay City’s umbrella retailers were right to expect the price of umbrellas to rise, given that both changes described in the source occurred at the same time. [8]

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Source: Fare rise on the Number 12 bus route

The Number 12 bus route is the only public transport service connecting a suburb of Velmora’s capital to the city centre; the nearest alternative service requires a 25-minute walk to a different route. In 2024 the operator raised the single fare from $2.00 to $2.20. Passenger numbers on the route fell from 1,000 to 950 journeys per day.

3. (a) Calculate the price elasticity of demand (PED) for journeys on the Number 12 bus route, using the figures in the source. Show your working. [4]

(b) Using your answer to (a), state whether demand for journeys on this route is elastic or inelastic, and explain what this means for the operator’s total revenue after the fare rise. [4]

(c) Explain, using the source, two reasons why demand for journeys on this route has this price elasticity. [4]

(d) Discuss whether the bus operator should raise the fare again, based on what the source suggests about demand for journeys on this route. [8]

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Source: The market for milk in Velmora

To support dairy farmers’ incomes, the Velmoran government has set a minimum price for milk at $1.20 per litre, above the price of $0.95 per litre at which the quantity farmers wish to supply would exactly equal the quantity consumers wish to buy. At the $1.20 minimum price, dairy farmers supply 40 million litres a month, but consumers are willing to buy only 32 million litres a month.

4. (a) Identify, using the figures in the source, whether the minimum price has created a surplus or a shortage in the milk market, and explain your reasoning. [4]

(b) Explain what would happen to the price and quantity of milk bought and sold if the government’s minimum price were removed. [4]

(c) Explain one way the government could dispose of, or make use of, the surplus milk created by the minimum price described in the source. [4]

(d) Discuss whether a minimum price is the best way for the government to support dairy farmers’ incomes. [8]

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Source: Traffic congestion in Velmora City

Velmora City’s roads are among the most congested in the region. Each extra car journey made during the rush hour slows down every other road user, and city-centre air quality regularly falls below World Health Organization guidelines. A think tank has proposed that the city introduce a congestion charge — a fee drivers pay to enter the city centre at busy times — and use the revenue to expand free public bus services.

5. (a) Explain, with reference to the source, how a car journey made during the rush hour can be an example of a negative externality. [4]

(b) Explain why, without government intervention, a good that creates negative externalities of this kind tends to be overproduced relative to the socially optimal level. [4]

(c) Explain how the congestion charge described in the source could help to correct this market failure. [4]

(d) Discuss whether a congestion charge is likely to be more effective than direct provision of free public transport, described in the source, at reducing Velmora City’s congestion problem. [8]

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Answers

1. (a) % change in quantity supplied = 15% [1]; % change in price = 10% [1]. PES = 15% ÷ 10% = 1.5 [1]. Since PES is greater than 1, supply is elastic [1].

(b) The floods destroyed a fifth of the standing harvest, so at every price farmers are able to supply less rice than before: the supply curve shifts to the left (a decrease in supply) [1] [1]. With demand unchanged, the diagram should show the original supply curve, the new (leftward) supply curve, the unchanged demand curve, and both equilibrium points [2]. The new equilibrium is at a higher price ($320 → $400) and a lower quantity (9.0m → 8.0m tonnes), which matches the figures in the source [1] [1].

(c) A negative externality is a cost imposed on a third party who is not involved in the transaction between rice buyers and rice farmers [1]. Fertiliser run-off pollutes Velmora’s rivers, which harms people who use or depend on the rivers (for example for drinking water or fishing) but who neither buy nor sell rice, and who are not compensated for this harm [2]. Because the $300 price does not include this cost, it reflects only the private cost of growing rice, not the full social cost [1].

(d) The subsidy of $40 per tonne lowers farmers’ costs of production at every level of output, so the supply curve shifts to the right (an increase in supply) [1] [1]. The diagram should show the post-flood supply curve, the new (further right) post-subsidy supply curve, the unchanged demand curve, and both equilibrium points [2]. Because the source shows the price falling to $300 (below even the pre-flood price of $320) and the quantity rising to 9.6m tonnes (above the pre-flood 9.0m), the rightward shift caused by the subsidy must be larger than the leftward shift caused by the floods, taking the market beyond its original position rather than merely back to it [2].

(e) For the subsidy: it directly lowers the price consumers pay, addressing the food-security concern the source describes, and the minister’s own figures show output rising above its pre-flood level, which increases the domestic supply available regardless of future weather shocks [1] [2]. Against, on food security: a subsidy funded from general taxation has an opportunity cost elsewhere in the government’s budget, and does nothing to make the harvest itself more resilient to future flooding [1] [2]. On the externality: the subsidy makes rice cheaper without doing anything to address the pollution the charity describes — if anything, a subsidy that increases the quantity of rice grown, as the source confirms it has, is likely to increase the amount of fertiliser run-off, worsening the externality rather than correcting it [1] [2]. A policy aimed more directly at the externality, such as a tax on fertiliser use or a regulation limiting run-off, would target that problem without the same side effect. Judgement: the subsidy is a reasonable short-term response to the food-security problem the source describes, but on the evidence given it is a poor tool for the externality, since it rewards exactly the activity that causes the pollution, so a second, more targeted policy would be needed to address that half of the problem [1].

2. (a) A movement along the demand curve is caused only by a change in the good’s own price [1] [1]; 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 related good) and moves the whole curve to a new position [1] [1].

(b) Wetter weather is not a change in the price of umbrellas, so it changes a condition of demand: the demand curve shifts to the right [1] [1]. With supply unchanged, the diagram should show the original and new demand curves, the unchanged supply curve, and both equilibrium points [1]. The new equilibrium has a higher price and a higher quantity than before [1].

(c) The rise in the price of the raw material is a condition of supply, because it raises the cost of producing umbrellas [1] [1]. At every price, producers are now willing and able to supply fewer umbrellas than before, so the whole supply curve shifts to the left (a decrease in supply), rather than moving along it [1] [1].

(d) Retailers were right to expect the price to rise, since both changes push price in the same direction: higher demand and lower supply both raise the equilibrium price on their own, so together they raise it further still [1] [2]. The effect on quantity, however, is ambiguous from the source alone: the demand increase raises quantity while the supply decrease lowers it, so whether more or fewer umbrellas are actually sold depends on which shift is larger, which the source does not say [1] [2]. A stronger answer notes that retailers can be confident about the direction of the price change without being able to predict the change in sales volume, and that this uncertainty matters for stock-ordering decisions [2].

3. (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 (0.5 ignoring sign) [2].

(b) PED = 0.5, which is less than 1, so demand is price inelastic [1] [1]. Because demand is inelastic, the percentage fall in quantity (5%) is smaller than the percentage rise in price (10%), so total revenue increases after the fare rise [1] [1].

(c) Any two of, each explained: the route has no close substitute for most passengers, since the nearest alternative requires a 25-minute walk [1] [1]; bus fares are likely to be a small proportion of income for most commuters, making a 20-cent rise easy to absorb [1] [1]; the journey may be a necessity (for example, travel to work) that passengers cannot simply choose not to make [1] [1].

(d) For raising the fare again: since demand is inelastic, a further fare rise would again raise total revenue, and the source gives no reason to think this would change while the route remains the only convenient service [1] [2]. Against: demand does not become inelastic without limit — repeated fare rises make the 25-minute walk to the alternative route relatively more attractive each time, so elasticity is likely to rise as the fare climbs, at some point turning further rises into revenue-reducing ones [1] [2]. Passenger goodwill and the risk of local authority intervention on an essential service are also relevant, since a bus operator dependent on a captive market may face reputational or regulatory costs the source does not capture [1] [1]. Judgement: a further small rise is likely to be safe on the evidence given, but the operator cannot assume inelastic demand holds indefinitely, so it should monitor passenger numbers closely rather than treat this single result as a permanent licence to raise fares [1].

4. (a) The minimum price has created a surplus [1], because at $1.20 the quantity farmers wish to supply (40 million litres) exceeds the quantity consumers wish to buy (32 million litres) [1] [2].

(b) Without the minimum price, the surplus of unsold milk would push the price down towards the equilibrium of $0.95 [1] [1]; as price fell, quantity supplied would fall and quantity demanded would rise until they met at equilibrium, eliminating the surplus [1] [1].

(c) Any one, explained: the government could buy the surplus itself (for example for storage, export, or distribution to low-income households), which removes it from the domestic market without lowering the price farmers receive [2] [2].

(d) For the minimum price: it guarantees farmers a price above the free-market equilibrium, directly raising their income and protecting them from price volatility, which is the government’s stated aim [1] [2]. Against: the source shows it creates a persistent surplus of 8 million litres a month, which is wasteful unless the government pays to store, dispose of, or export it, adding a further cost on top of the higher price consumers already pay [1] [2]. It also raises the price for all milk consumers, including lower-income households, which works against any wider goal of affordable nutrition [1] [1]. Alternative: a direct subsidy per litre paid to farmers, funded from general taxation, could raise farmers’ income by the same amount without creating an unsold surplus or raising the price consumers pay, since it would not need to hold the market price above equilibrium [1] [1]. Judgement: a minimum price is a blunt way to support farmers’ incomes precisely because it must create excess supply to work, so unless the government has a genuine use for the surplus milk, a direct subsidy is likely to support farmers at a lower overall cost to the economy [1].

5. (a) A car journey made during the rush hour imposes a cost on other road users — through the extra congestion described in the source and through the effect of vehicle emissions on the air quality other people breathe — that the driver making the journey does not pay for and does not take into account when deciding whether to travel [2] [2].

(b) The driver’s private cost of the journey (fuel, time, wear on the car) is lower than the full social cost, which also includes the delay imposed on other drivers and the harm from pollution [1] [2]. Because drivers base their decisions only on their own private cost, more journeys are made during the rush hour than would be made if the full social cost were reflected in the price of travelling, which is why the good (road space at peak times) is overproduced relative to the socially optimal level [1] [1].

(c) A congestion charge makes drivers pay directly for entering the city centre at busy times, which raises the private cost of a rush-hour journey closer to its true social cost [1] [2]. Facing this higher cost, some drivers will switch to travelling outside the charged hours, use public transport instead, or not make the journey at all, reducing the number of car journeys during the rush hour and moving the market closer to the socially optimal quantity [1] [1].

(d) For the congestion charge: it directly raises the cost of the activity causing the externality, giving every driver an individual financial incentive to change behaviour, and it raises revenue at the same time, which the source says would fund the alternative (free buses) [1] [2]. For direct provision of free public transport: it removes cost as a barrier to switching away from cars, which may work better for drivers who are price-insensitive about the charge but would readily switch given a genuinely free, convenient alternative, and it avoids penalising drivers who have no realistic alternative to driving [1] [2]. Against relying on free buses alone: without also raising the cost of driving, drivers who value speed or convenience over cost may not switch even with a free bus service available, so congestion may persist [1] [2]. Judgement: the source’s own proposal combines both — a charge that funds free buses — which plays to each policy’s strength: the charge changes the incentive to drive, while the free buses ensure an alternative genuinely exists, so the combination is more likely to reduce congestion than either policy alone [1].

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Where marks are usually lost

• Treating price elasticity of supply as if it can be read off two equilibrium points on a demand-and-supply diagram, rather than from data on how quantity supplied responds to price alone.
• Sketching a demand/supply shift without labelling the axes, the original and new curves, and both equilibrium points.
• Confusing a shift in a curve (a condition of demand or supply changes) with a movement along it (only price changes).
• Getting the PED or PES formula the right way round but forgetting to state whether the result means demand or supply is elastic or inelastic.
• On the Section A source question, writing an answer that could apply to any market rather than referring explicitly to the figures and context the source gives.
• On the extended, evaluative parts, listing points for only one side of the argument instead of weighing both and reaching a supported judgement.