Click here to Commence quiz Click here to Commence quiz © APT Initiatives Ltd UNIT 1 Markets & Market Failure 1.2 The Allocation of Resources in Competitive

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UNIT 1 Markets & Market

Failure

1.2 The Allocation of

Resources in Competitive Markets

Test 1

When the price of a product increases…

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demand will shift to the left demand will shift to the left

more will be demanded at each price more will be demanded at each price

quantity demanded will rise quantity demanded will rise

quantity demanded will fall quantity demanded will fall

A rise in price brings about a fall in the quantity demanded, otherwise known as a contraction of demand. A contraction of demand (illustrated by an upward movement along the demand curve) should be distinguished from a decrease in demand (an inward shift of the demand curve).

Incorrect

AQA AS Economics Unit 1 – Markets & Market AQA AS Economics Unit 1 – Markets & Market FailureFailureQuestion 1Question 1

A shift in a demand curve occurs when…

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there is a change in price there is a change in price

there is an increase in business costs there is an increase in business costs

there is a change in income there is a change in income

businesses become more efficient businesses become more efficient

The first response results in a movement along the demand curve. The middle two responses relate to changes in supply. Only D causes a shift of the whole demand curve.

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Which of the following statements is incorrect? A rightward shift of the demand curve can be caused by…

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a reduction in the price of the product a reduction in the price of the product

a rise in population a rise in population

a rise in the price of a substitute product a rise in the price of a substitute product

a rise in income a rise in income

A reduction in price will lead to a downward movement along the demand curve, rather than a shift of the demand curve.

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A pen manufacturer reduces the price of its latest model by 6% and, as a result, sales volume increases by 4%. Therefore, the price elasticity of demand, to two decimal places must be…

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+1.57 +1.57

-0.67 -0.67

-2.54 -2.54

-1.52 -1.52

4% / -6% = -0.67. Correct


The price elasticity of demand for a firm’s products will change when a business …

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is faced with a new competitor is faced with a new competitor

manages to reduce its costs manages to reduce its costs

experiences a rise in production costs experiences a rise in production costs

benefits from a general increase in incomes benefits from a general increase in incomes

The entry of new competitors will increase the price elasticity of demand for the products of existing firms, because buyers will have more products to choose from and will, therefore, respond more readily to price changes.

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When incomes rise by 2%, demand for UK holidays rise by 4%. The income elasticity of demand is…

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+2 +2

+20 +20

+0.5 +0.5

+0.8 +0.8

4% / 2% = 2.

Because quantity and income move in the same direction, the income elasticity is positive; hence the answer is +2.

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A greengrocer has obtained some market research data which indicates that the income elasticity of demand for potatoes is -1.56. This means that…

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demand is income inelastic, and the potatoes are a normal good demand is income inelastic, and the potatoes are a normal good

demand is price elastic, and potatoes are a necessity demand is price elastic, and potatoes are a necessity

potatoes are an inferior good, and demand is income elastic potatoes are an inferior good, and demand is income elastic

potatoes are a normal good, and demand is income elastic potatoes are a normal good, and demand is income elastic

Negative income elasticity means that the product is an inferior good. As the coefficient of elasticity is -1.56 it means that demand is income elastic, ie a 10% fall in income leads to a 15.6% rise in demand.

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Petrol retailers have noticed that when cars increase in price by 5%, demand for petrol falls by 2%. The cross elasticity of demand for petrol is…

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-2.5 -2.5

-1.0 -1.0

-0.4 -0.4

-0.5 -0.5

-2% / +5% = -0.4.

he fact that the figure is negative proves that the relationship is one of complements.

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Movement up a supply curve arises because of…

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improvements in business efficiency improvements in business efficiency

an increase in price an increase in price

a reduction in price a reduction in price

an increase in tax an increase in tax

A change in price (brought about by a rightward shift of the demand curve) leads to an upward movement along the supply curve. A change in anything else causes a shift in the whole curve.

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A supply curve for a product would shift to the right if there was…

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an increase in tax an increase in tax

a decrease in price a decrease in price

an increase in business costs an increase in business costs

an improvement in production technology an improvement in production technology

A shift to the right means more is supplied at each price (an increase in supply). This could be the result of an improvement in technology which will lead to lower business costs.

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A rightward parallel shift in a supply curve would occur when business costs …

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rise by 3% rise by 3%

fall by 10% fall by 10%

fall by £3 a unit fall by £3 a unit

rise by £3 a unit rise by £3 a unit

A rightward shift is the result of a fall in the cost of production. The correct answer hinges on the word ‘parallel’ which is why D is right and B is wrong.

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A decrease in price elasticity of supply can arise when…

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business costs rise business costs rise

business costs fall business costs fall

a business produces various goods for different markets a business produces various goods for different markets

government intervenes with more market regulation government intervenes with more market regulation

Government regulation acts as a constraint, thus reducing the possibilities for expansion of output and the entry of new firms into the market.

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A rise in price from £21 to £22 leads to a 5% rise in the quantity supplied. To two decimal places price elasticity of supply is…

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+1.05 +1.05

-1.52 -1.52

+2.52 +2.52

-1.05 -1.05

Even without any calculation we can rule out the first two responses. PES is usually positive and it certainly is in this case. PES =

5% / +4.7610 = +1.05

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Movement up a demand curve to a new equilibrium position could have been caused by…

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an increase in price of a substitute product an increase in price of a substitute product

a tax imposed on a good a tax imposed on a good

an increase in the price elasticity of demand an increase in the price elasticity of demand

a shift to the right in the supply curve a shift to the right in the supply curve

What happens here is that the tax shifts the supply curve to the left and, as a result, there is a movement along the demand curve to a higher price. A would cause a shift of the demand curve, whereas C is a shift in the supply, which causes a slide down the demand curve. D is concerned with slope of the demand curve, rather than a shift of the demand curve.

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The conditions of demand and supply of a luxury car brand are shown in the diagram below. The supply curve could have shifted to the left because…

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there was a decrease in the price of petrol

there was a decrease in the price of petrol

the government has imposed a special tax on luxury cars

the government has imposed a special tax on luxury cars

the costs of manufacture have fallen

the costs of manufacture have fallen

the price has risen the price has risen

Supply has decreased and this can only be explained by a rise in producer’s costs. A tax on cars is seen in the same light as a rise in costs; to protect profits, both changes would require a corresponding rise in price. Hence, B is the correct answer. A concerns the demand for cars. C is illustrated by a movement along the supply curve. D would cause a rightward shift of the supply curve.

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Quantity O

S1

S2

D1

Price

The table below shows the demand and supply schedules for pizzas sold by a local takeaway. Following a rise in production costs, supply falls by 80 pizzas at all prices. The new equilibrium price would be…

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£2.25 £2.25

£2.50 £2.50

£3.00 £3.00

£2.75 £2.75

Construct a new supply schedule with 80 fewer pizzas supplied at each price. At price £2.75, 400 pizzas are demanded and 400 are supplied.

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Price per Pizza Quantity demanded per week

Quantity supplied per week

£3.00 350 510 £2.75 400 480 £2.50 450 450 £2.25 500 420

Supply in agriculture is typically price inelastic because…

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farmers cannot alter output at short notice farmers cannot alter output at short notice

farmers rely on the weather farmers rely on the weather

farmers can use stocks in response to changes in price farmers can use stocks in response to changes in price

there are few substitutes for food there are few substitutes for food

Supply is inelastic because agricultural output is subject to the growing cycle and seasons of the year.

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The price elasticity of supply of houses is estimated to be less than 1. This means that…

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supply is price elastic supply is price elastic

builders cannot easily build more houses in a booming economy builders cannot easily build more houses in a booming economy

builders benefit from increased revenue when prices rise builders benefit from increased revenue when prices rise

producer revenue will remain unchanged producer revenue will remain unchanged

By definition inelasticity of supply means that it is difficult to respond to changes in the market.

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Which one of the following products or services is not complementary to owner occupied houses?

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MortgagesMortgages

Home improvementsHome improvements

Furniture Furniture

Rented accommodationRented accommodation

Rented accommodation is a substitute for owner occupation.

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The introduction of high definition television can be expected to result in the following with the exception of…

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increased demand for new TV setsincreased demand for new TV sets

increased supply of second hand TV sets increased supply of second hand TV sets

increased demand for satellite television services increased demand for satellite television services

increased price of second hand TV sets increased price of second hand TV sets

HD will increase the demand for new sets and, at the same time, increase the supply of second hand sets as people upgrade. The new HD television increases the attractiveness of digital satellite services which should be seen as a complementary service. The one thing it will not lead to is a rise in the price of used sets. If anything, it will put downward pressure on the price of used sets.

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Coffee and tea are substitute products. A rise in the price of coffee will lead to…

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an increase in demand for tea an increase in demand for tea

an increase in the quantity demanded of tea an increase in the quantity demanded of tea

no change in the demand for tea no change in the demand for tea

a contraction in the demand for tea a contraction in the demand for tea

As the two products are substitutes for each other it is to be expected that a rise in the price of coffee will mean people switch to tea. The only issue in dispute is whether it is an increase in demand, or an increase in the quantity demanded. By custom, we use the term “an increase in quantity demanded” (alternatively an extension of demand) to mean a change brought about by a reduction in the price of the product. The phrase “increase in demand” is reserved for an increase brought about by something other than a change in the price of the product.

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The motor industry uses steel to make cars. This relationship is an example of products in …

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joint supply joint supply

derived demand derived demand

competitive demand competitive demand

substitute demand substitute demand

As the car industry is a major user of steel we can conclude that the demand for steel is, in part, derived from the demand for cars.

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Which of the following is not a feature of price?

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It rations available resourcesIt rations available resources

It signals market conditionsIt signals market conditions

It allocates resources fairlyIt allocates resources fairly

It incentivises buyers and sellersIt incentivises buyers and sellers

The price mechanism allocates resources, but not necessarily fairly. However, it does definitely ration, signal and incentivise. Therefore, D is the correct answer to the question.

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When resources are allocated through the price mechanism…

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prices must fall prices must fall

prices are typically determined by central government prices are typically determined by central government

business costs are more likely to be competitive business costs are more likely to be competitive

production costs will determine prices production costs will determine prices

Competition will force firms to keep down costs and, therefore, D is correct.

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Which of the following statements is true about a market economy?

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Economic decision makers act in ways which will maximise social welfareEconomic decision makers act in ways which will maximise social welfare

The government has a crucial role to play in ensuring that economic outcomes are fair

The government has a crucial role to play in ensuring that economic outcomes are fair

Producers determine what is produced, and for whom it is producedProducers determine what is produced, and for whom it is produced

Prices help buyers make rational judgements about the value of what they buy

Prices help buyers make rational judgements about the value of what they buy

Economic theory is based on the assumption that consumers and others make rational decisions. A is certainly not true since economic agents act in their own self interest. B is not true since governments play a minimal role in a market economy. D is not true since producers respond to consumer demand.

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