2017 AS paper

Question 1

opportunity cost

Answer 1

value of the next best alternative foregone

Question 2

production possibility frontier

Answer 2

the maximum potential output combinations of two goods an economy can achieve when all its resources are fully and efficiently employed

Question 3

effect of an economy producing more capital goods

Answer 3

shift in PPF

Question 4

define ‘base year’

Answer 4

• The year with which all other values in a series are compared
• Benchmark year

Question 5

define ‘subsidies’

Answer 5

• government grant
• government policy
  designed to encourage production or consumption
• money given

Question 6

how price mechanism responds to excess supply in a free market

Answer 6

• price mechanism = reallocation of resources caused by change in price level
• excess supply in free market when P above equilibrium P
• P then lowered signalling to producers to leave the market or produce less as it is less profitable which causes a contraction in supply
• incentive to consumers to buy more as cheaper, causing extension in demand curve
• Steel supply contracts, movement back along supply curve if drawn
• Extension in demand for steel, movement forwards along demand curve if drawn
• Surplus of steel gradually removed
• New market equilibrium identified

Question 7

why reducing tuition fee cap may result in excess demand for university places

Answer 7

• lower price = more consumers willing and able to afford uni tuition

Application
1 mark for application to university education, e.g.
- Diagram indicates cut in tuition fees from £9 000 to £6 000
- Universities lack cash so close down departments
- University now more affordable for applicants

Analysis
- Lower maximum price illustrated or explained,
price below market equilibrium
- Extension in demand, movement forwards along
demand curve if drawn
- Contraction in supply of university places,
movement backwards along supply curve

Question 8

benefits from university education

Answer 8

marginal social benefits exceed the marginal private benefits from university education

Question 9

revenue

Answer 9

• quantity x price
• if demand falls, revenue falls
• original revenue = Pe x Qe
• falls to P1 x Q1

Question 10

tobacco consumers switching to e-cigarettes is an example of rational behaviour (KAA)
Reasons rational

Answer 10

o Application – price of e-cigarettes per nicotine cheaper
o Data on PED suggests some rational response to price change e.g. 10% rise causes 4% fall in demand (Extract A)

Reasons rational
 Smokers computationally aware of financial gains
of switching
 Smokers informed of private health gains (Extract B Paragraph 2)
 Reducing health external costs e.g. passive smoking (Extract A L15)
 Smokers aware that regulations will increasingly
make it difficult for them to gain utility of nicotine consumption through tobacco smoking

Question 11

tobacco consumers switching to e-cigarettes is an example of rational behaviour (Ev) Reasons against being rational

Answer 11

 Smokers lack information and computational skills to accurately assess full costs and benefits of switching. May underestimate long-term gains of switching (bounded rationality)
 Information overload
 Both products contain nicotine which is addictive and habit forming.
 If e-cigarettes were not available they may quit smoking altogether
 Switch may be only short-term (impulse buying)
 E-cigarettes complements tobacco smoking
resulting in an overall increase in nicotine consumption
 PED for tobacco remains lower than e-cigarettes
so a price rise in the latter may result in a switch back
 Peer pressure (herd mentality) pushing smokers to make the switch, may not be maximising welfare if prefer cigarettes
 difficulty in computation, if consumers only presented the negatives of cigarettes won’t be able to make an informed decision so not maximising welfare

Question 12

rational behaviour

Answer 12

idea that consumers aim to maximise their own welfare

Question 13

XED

Answer 13

• measures the responsiveness of demand for good X following a change in the price of a related good Y
• % change in quantity demand X / % change in price Y
• postive = substitutes
• negative = complements

Question 14

changes in price of tobacco cigarettes affecting the demand for e-cigarettes over time

Answer 14

 e-cigarettes seen as less harmful so become more attractive compared to tobacco
cigarettes
 tougher regulations and growing health awareness on tobacco
 they are substitutes because they offer nicotine
 applying cigarettes to diagram showing impact on e-cigarettes
 relative price differences e.g. Figure 1 or tax rises on tobacco
 use of numerical example e.g. a 10% rise in the price of tobacco cigarettes results in a less than 10% rise in demand for e-cigarettes

Analysis
 the increase in the price of traditional cigarettes is resulting in the change in quantity demanded of e-cigarettes increasing
 consideration of whether distant or close substitutes
 diagram showing relationship between price of one of the product and demand for the other
 magnitude/time

Question 15

Reasons why tobacco cigarettes being relatively price-inelastic, e-cigarettes relatively price-elastic

Answer 15

 habitual consumption
 tobacco broadly defined
 proportion of income spent on tobacco cigarettes lower than switching cost of buying
reusable e-cigarette kit
 number of close substitutes
 tobacco addictive necessity, e-cigarettes luxury (not yet addicted to).

Question 16

determinants of price elasticity of demand (responsiveness of quantity demanded in relation to a change in price)

Answer 16

1. The availability of close substitutes (more=more elastic)
2. cost of switching between products (higher = inelastic)
3. degree of necessity/if good is a luxury (necessities = inelastic, luxuries = elastic)
4. proportion of a consumer’s income allocated to spending on the good (high % = more elastic)
5. time period allowed following a price change (more price elastic the longer consumers have to respond to a price change)
6. whether good is subject to habitual consumption (become less sensitive to the price if bought out of habit)
7. peak and off-peak demand (demand inelastic at peak times, elastic off-peak)
8. breadth of definition for a g/s (if broadly defined demand often inelastic but specific brands more elastic following price change)

Question 17

Reasons why tobacco cigarettes being relatively price-inelastic, e-cigarettes relatively price-elastic (Ev)

Answer 17

 significance of determinant
 e-cigarettes habit forming
 tobacco cigarettes narrowly defined
 proportion of income spent on tobacco cigarettes is rising
 becoming closer substitutes
 tobacco addiction waning as lost glamour and health warnings, e-cigarettes nicotine
addiction.
 longer term response to rising tobacco prices

Question 18

possible advantages of a free market approach to cigarette consumption (KAA)

Answer 18

Functions of the price mechanism to allocate resources:
 rationing
 incentive
 signalling

Market diagrams for tobacco and e-cigarettes, making use of supply and demand analysis.

• Consumers with knowledge of the potential harm of cigarette smoking may quit smoking.
• Smokers will maximise their private utility
• Consumers will decide what is in their best interests
• Reduction in smoking will happen automatically, without government intervention, as e-cigarettes become popular.

Candidates may refer to Adam Smith
Consumers free to pursue own self interest
Profit incentive will mean firms will want their consumers to live long – so move out of tobacco and into e-cigarette market.
Without government regulations e-cigarettes market will be easier for new firms to enter thus improving competition.
Competition between e-cigarette manufacturers to maximise profits will drive health improvements and lower costs making them more price competitive.

Candidates may refer to Friedrich Hayek
Resource allocation from tobacco to e-cigarettes will be brought about by market forces, which will be far superior to any state planning system. Individuals do not have perfect information on cigarettes but have the best knowledge of their own situation. The price mechanism acts as a communication network, markets are self- correcting. Government lacks sufficient information about everything happening in the cigarettes market to be able to make informed decisions.

Question 19

possible advantages of a free market approach to cigarette consumption (Ev)

Answer 19

Failings of the price mechanism
 Information gaps
 Asymmetric information
 Externalities
 Peer pressure ignores utility
 Habit forming distorts utility

Possible different disadvantages or approaches :
* While consumers may maximise their private
utility MSC > MSB, with explanation. e.g. passive smoking/health care costs
* Without government intervention the oligopolistic/monopolistic power of cigarette firms, in the form of advertising and propaganda, will go unchecked

Candidates may refer to Karl Marx
Consumers exploited in past by misinformation on tobacco and due to being addictive they become dependent.
Competition and the need to profit maximise will mean firms cut costs risking consumers health and increase prices thus reducing consumer surplus. Nature of free market is for powerful monopolies to emerge that can further exploit consumers.

Question 20

free market

Answer 20

• where resources are publicly owned and allocated to those who are willing to pay the most with no gov intervention
• producers decide how much they produce, for whom and at what price

Question 21

impact of gov intervention in the cigarette market (KAA)

Answer 21

Positive/negative effects of government intervention on tobacco cigarettes and or e-cigarettes with reference to market failure and using diagrams in various contexts:
 Indirect taxation (ad valorem and specific)
 Subsidies for tobacco replacements
 Minimum cigarette price
 Provision of information e.g. public health campaign
 Regulation e.g. banning smoking in public places or advertising.
 Direct provision – nicotine patches and e-cigarettes on NHS prescription

Question 22

impact of gov intervention in the cigarette market (Ev)

Answer 22

Negative or unsuccessful impact of the intervention methods.
Understanding of government failure as intervention that results in a net welfare loss – tobacco cigarette tax revenue exceeding tobacco related NHS expenditure.

Causes of government failure:
 Distortion of price signals – harm reduction instead of prevention, consuming e-cigarettes rather than quitting
 Unintended consequences – e-cigarettes draw in new users acting as a gateway to smoking; regulating e-cigarettes protect tobacco from competition; tobacco smuggling, black market
 Excessive administrative costs – slow down e-cigarette innovation
 Information gaps – little research on long term effects of e-cigarettes
 Ineffective as PED <1; diminishing returns of tax and regulations. Price inelastic demand diagram.

Other evaluation approaches include:
 Consideration of the extent of government intervention e.g. could it be more regulated
 Free market approach might be more effective
 Depends on the country being considered
 Short run and long run

Question 23

government intervention

Answer 23

when the gov changes the law/intervenes in the free market to correct market failure

Question 24

ad valorem tax

Answer 24

tax that is a percentage of the price for every unit

Question 25

if demand inelastic, tax...

Answer 25

will not have a great impact on consumption so quantity demanded will not decrease by much, negative externalities will remain

Question 26

tax revenue raised on cigarettes

Answer 26

- subsidise e-cigarettes or used to advertise negative externalities of smoking - help reduce demand for cigarettes which could decrease the welfare loss as it would bring MPC closer to MSC via the tax and use of the tax revenue

Question 27

black market for cigarettes

Answer 27

- decrease tax revenue for gov - more harmful chemicals could be used in cigarettes as no regulation - worse health issues - increased costs for NHS

Question 28

tax for cigarettes conc

Answer 28

- may not be most efficient means of gov intervention as could cause black market - and may not work due to inelastic PED - depends on if tax can raise enough revenue and reduce overconsumption of cigarettes