OCR A Level Economics: Microeconomics — 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: Microeconomics revision notes

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Section A

1. Distinguish between positive and normative economic statements, giving an example of each. [4]

2. Explain what is meant by a merit good and why it is underconsumed. [3]

Section B

3. Explain how a positive consumption externality leads to underconsumption, and explain how a subsidy corrects it. [7]

4. Explain the effect of a maximum price set below equilibrium in the rental housing market, including two unintended consequences. [7]

5. In the labour market:

(a) Explain the factors determining the demand for labour. [4] (b) Explain why wages differ between occupations, giving three reasons. [6]

6. Evaluate whether a national minimum wage reduces poverty. [12]

7. Explain the difference between adverse selection and moral hazard as forms of information failure, using an example of each. [6]

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Answers

1. A positive statement is objective and testable against evidence, e.g. “a rise in the minimum wage increased unemployment among 18–24 year olds by 2%” [1] [1]. A normative statement is a value judgement containing an opinion about what ought to be, e.g. “the government should raise the minimum wage” [1] [1].

2. A merit good is one whose benefits to the individual and to society are greater than consumers realise [1]. It is underconsumed because of information failure — consumers underestimate the private benefit — and because there are positive externalities they do not take into account [1] [1].

3. With a positive consumption externality, the marginal social benefit exceeds the marginal private benefit [1] [1]. Consumers choose the quantity where MPB = MPC, which is below the social optimum where MSB = MSC [1], so the good is underconsumed and there is a welfare loss [1]. A subsidy reduces the price paid by the consumer [1], shifting supply to the right and increasing the quantity consumed towards the social optimum [1]; ideally the subsidy per unit equals the value of the external benefit at the optimum [1].

4. A maximum price below equilibrium means quantity demanded exceeds quantity supplied, creating a shortage of rental housing [1] [1]. Tenants who obtain a tenancy pay less, gaining consumer surplus, but many others cannot find housing at all [1]. Unintended consequences: a black market develops, with illegal payments above the ceiling, so some tenants pay more than the free-market rent [1] [1]; landlords withdraw property from the rental market or allow it to deteriorate, since maintenance is no longer worthwhile at the controlled rent, so the long-run supply and quality of housing fall [1] [1]. (Also accept: non-price rationing such as queues or discrimination in tenant selection.)

5. (a) Demand for labour is derived from the demand for the product the labour produces [1]; it depends on the marginal revenue product of labour — its productivity multiplied by the price of the output [1]; on the wage rate relative to the cost of capital, since firms substitute machinery for labour when wages rise [1]; and on non-wage employment costs such as national insurance and regulation [1]. (b) Any three, 2 marks each: differences in the marginal revenue product — more productive workers generate more revenue, so employers will pay more [1] [1]; barriers to entry such as long training or professional qualification restrict supply to some occupations, raising the wage [1] [1]; compensating differentials — dangerous, unpleasant or unsociable work must pay more to attract workers [1] [1]; trade union or professional body power restricting supply or bargaining collectively [1] [1]; labour immobility, geographical or occupational, preventing workers moving to higher-paid work [1] [1].

6. For: a minimum wage raises the incomes of the lowest-paid in work, directly lifting some households above the poverty line [1]; it may increase motivation and productivity (efficiency wage theory), so the employment cost is smaller than the simple model predicts [1]; higher incomes for those with a high marginal propensity to consume raise aggregate demand and can create jobs elsewhere [1]; it reduces in-work benefit spending, shifting the cost from taxpayer to employer [1]. Against: in a competitive labour market a minimum wage above equilibrium causes excess supply of labour — unemployment [1], and those who lose their jobs are the least skilled, precisely the group the policy targets [1]; many poor households contain nobody in work at all, so a minimum wage does not reach them [1]; some low-paid workers are second earners in comfortable households, so the policy is poorly targeted [1]; firms may respond by cutting hours, training or non-wage benefits, or by raising prices, which erodes the real gain [1]. Judgement: the effect depends on how far above the equilibrium wage it is set, the elasticity of demand for labour, and whether employers have monopsony power [1] [1]. In a monopsonistic labour market a minimum wage can raise both wages and employment [1]. It is best judged as one instrument among several — combined with tax credits and training it reduces in-work poverty, but on its own it cannot address poverty among the workless [1].

7. Adverse selection occurs before a transaction, when one party holds information the other lacks and this affects who chooses to take part [1] [1] — for example, in a second-hand car market, sellers know more about a vehicle’s faults than buyers do, so buyers assume the worst and offer only an average price; this pushes good-quality cars out of the market and leaves mostly poor-quality ones, the so-called “lemons problem” [1] [1]. Moral hazard occurs after a transaction, when one party’s behaviour changes because they no longer bear the full consequences of it [1] [1] — for example, a driver with fully comprehensive insurance may take fewer precautions against theft or damage, since the insurer now bears most of the cost of anything going wrong [1] [1]. Both are forms of asymmetric information and both justify government intervention — for instance compulsory disclosure or vehicle history checks to reduce adverse selection, and no-claims discounts or excess payments to reduce moral hazard [1].

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Where marks are usually lost

• Giving a normative statement that merely sounds factual.
• Not distinguishing MPB from MSB explicitly.
• Describing a price ceiling without unintended consequences.
• Ignoring monopsony in the minimum wage evaluation.
• Confusing adverse selection (an information problem before the transaction) with moral hazard (a behaviour change after it).