May 2020 Econs P1

Question 1

Free Market Economy definition (1K)

Answer 1

free market economy refers to an economic system where the prices of goods and services are set freely by the forces of supply and demand (1) OR without the intervention by the government (1)

Question 2

Advantage of free market (2K)

Answer 2

• Competitive markets are responsive to consumers (1). No competition in command economies to ensure firms are efficient (1)
• Market prices Transmit information between buyers and sellers (1). No need for costly bureaucracy (1).
• Reduces risk of government failure (1) as government do not know what is demanded (1)

Question 3

Why a firm might try to reduce the price elasticity of demand for its products (1K1Ap1A)

Answer 3

K:
- Quantity demanded does not charge significantly with price.

Ap:
- Apply to question e.g if PED of -0.1 had 10% price rises, sales volume would fall by 1%

A:
- Lower product price elasticity = easier to boost revenue by increasing the price
- if firm raises it prices, it will increase value of its sales

Question 4

Explain opportunity cost of government subsidy on certain goods and products (1K1A1N)

Answer 4

K:
- Opportunity cost = the next best alternative forgone
A:
- Specific reference to government spending
N:
- Government subsidies inevitably carry an opportunity cost and in
the long run there might be better ways of saving energy.

Question 5

Explain why government imposes specific taxes on many goods and services. (1K1A1N)

Answer 5

K:
- Specific tax = set amount per unit of the product sold
A:
- Examples = sugar tax, fuel duty, alcohol and tobacco duty
N:
- Increases revenue
- To internalise the externalities to accruing to the consumption of products causing external costs
- ‘Sin taxes’…

Question 6

Define Government failure (1K)

Answer 6

Occurs when government intervention in the economy cause a net welfare loss in economic welfare

Question 7

Microeconomic reason why the government is using taxpayers’ money to infrastructure project

Answer 7

• Positive externalities resulting from people using the goods and services.
• There is risk in funding the project, therefore if the project is taken by private sector it may be less likely to happen
• There is imperfect information on the project such as long term cost, government investment would support better market decisions.