AS LEVEL QP/21N14

1. Using a supply and demand diagram, explain how the imposition of a subsidy on a good would
affect the surplus enjoyed by the producers of that good. [8]

- A subsidy is a direct payment

done by the government to a
producer for the production of
goods and services . Many
times a subsidy is given for es-
sential goods, merit goods, to
raise producers incomer etc.

- providing a subsidy to a sup-

plier will benefit them in reduc-
ing costs , leading to higher
production of goods . This will
show a right ward shift in the
supply as producers are moti-
vated to produce more goods

and services . However, introducing

a subsidy would also lead to an op-
portunity cost for the government as
this would increase costs and these
finances could’ve been spent else-
where.

- subsidies would also lead to a pro-

ducer surplus, this means the
amount they were willing to receive
verses how much they actually re-
ceived by selling the good or ser-
vice.A subsidy usually reduces the
producer surplus as it reduces production costs, leading to an increase in
supplyThis also depends on the elasticity of the product . If the product is
more elastic then the supplier will have to charge prices considering the
change in demand to gain a higher benefit/ profits and hence has a higher
chance to pass on profits to the consumer resulting in more consumer sur-
plus , however, if the product is inelastic this gives the supplier a higher
chance to keep the profits and reduces consumer surplus.

2. Negative externalities arise from the consumption of a good. (up to 8 marks) ?

- negative externalities Is the cost that is needed to be borne by a third
party who is neither a consumer nor a producer. Ex- passive smoking
can lead to air pollution that is borne by individuals due to others
smoking . This may in the long run cause health issues to them even
though they don't smoke .

- The government can install , taxations and price flooring to avoid

such costs. Charging these on demerit goods ex- alcohol and cigars
might help reduce the consumption as fewer people will be able to af-
ford the good .Higher taxes will discourage individuals to buy the
product and suppliers to produce due to high costs of production .
Minimum pricing , also called as price flooring , keeping high rates will
also lead to discouragement of production and hence may not be
available at all. Demerit goods are those which are harmful for the in-
dividual however, are over consumed for various reasons. These in-
clude- addiction, information failure etc.

- Another way government can reduce the consumption of these is in-

creasing information available and educating the population of the
harmful effects. With proper knowledge ex- putting warnings on such
demerit goods can reduce the consumption, leading to a lower risk of
negative externalities.

- Furthermore, negative externalities don’t occur only if an individual

consumes the good or service. The negative effect can also be
passed on to the environment and surroundings . To conclude , in-
creasing taxes

3. Explain the factors that determine whether the price elasticity of demand for a product has a
high
value or a low value. [8]
- price elasticity is the percentage change in demand of a good
or service due to a percentage change in price. High price
elastic goods are those who have a higher percentage of
change in demand due to a change in the price fluctuations
ex- clothing or usually luxury goods . Inelastic goods are those
who have little or no change in the demand even if the prices
change ex- basic necessities such as rice and wheat . if the
value is >1 then it is said to be price elastic and if its <1 then inelastic
- PED is calculated using the formula:

- % change in quantity demanded

- —————————————————-
- % change in price

- there are various factors that determine the elasticity:

- The availability of substitutes- the greater number of substitutes a
product has the more price elastic the product will be since if the price
of one increases the consumer can quickly switch to the other with
multiple choices . However if there are fewer substitutes the product is
more price inelastic. As there are fewer options, even If the prices in-
crease the consumer will have no choice but to pay high prices for the
good.
- Another factor is the expense of the product ,A rise in price reduces
the purchasing power of a person’s income and their ability to pay for
products. Hence if the prices are low and fit under the proportion the
consumer is willing to pay the product is inelastic however, if the
prices increase excessively one may not be willing to pay more than
their set budget making the product highly price elastic.
-

4. Discuss whether it is both possible and beneficial for a business to change the price
elasticity of demand for its product. [12]

- price elasticity of demand measures the responsiveness of the quantity demanded for a product
following a change in the price of the product
5. With the use of a diagram, explain how prices allocate scarce resources in a market
economy. [8]

- A market economy is where goods and services are produced de-

pending on forces of demand and supply, with no government inter-
 vention. A market economy is handled by private individuals and pro-
duce goods and services with the aims of making profits .
- If theres excess supply the producers may reduce prices to en-
courage consumers to buy . However , if there is excess
de- mand and low supply , the suppliers will increase prices
to discourage consumption and this may continue in
a cycle.

P
P1 D1

Q Q1

- As long as the price mechanisms working the government has no role

or intervention, however can step in in cases where there is market fail-
ure. Here markets fail to provide efficiently for the customers, leading to
government intervention. The government can provide goods such as
merit goods ex- healthcare at cheaper rates for people who are unable
to afford services at higher prices.

5. Discuss whether prices are less important in allocating scarce resources in a

mixed economy compared with a market economy. [12]
- A mixed economy is one where private sector and public sector both play
an important role in the allocation of resources.Prices are less important in
allocating scarce resources in a mixed economy, because not only prices
determine the allocation or resources but other factors such as government
regulation,these may include taxations and provision of subsidies.

- A government may collect taxes from firms in turn to redistribute the in-
come . Additionally this form of income to the government can be used in
social welfare to help prevent negative externalities and a firm that is mixed
economy will always be socially ethical.

- Subsidies are a direct form of payment given to produces for allocation of

resources. A mixed firm is more likely no not have excess financial issues
as the government is always available to support and may not have high fi-
nancial restrictions. In case of increasing efficiency ex- a firm may want to
purchase a new machine, this can be done in the short run due to high cap-
ital levels.

- Their main aims would be to provide for individuals at lower prices and
hence may not supply products depending entirely on price however will
keep prices that are able to cover their COP

- In a mixed economy they are more likely to produce merit goods these are
goods that are high essential for an individual than they themselves realize
and are often underproduced ex- healthcare.

- However, A market economy is where goods and services are produced

depending on forces of demand and supply, with no government interven-
tion.

- As they have limited capital and are supposed to cover all their costs charg-
ing prices accordingly would be essential
- costs like production costs, external costs and taxes that are needed to be
paid
- they also provide goods and services to make profits keeping high prices
would be essential in this case as will allow them to earn higher incomes.

- In a market economy they might supply demerit goods, these are goods
that aren’t beneficial for a consumers consumption but are often over pro-
duced.ex- junk food or alcohol .This is because they would be able to
change higher prices and such goods usually have higher demand .

-
6. Explain why the value of income elasticity of demand for a good can be positive,
negative or zero, while the value of its price elasticity of demand is most likely to be
negative. [8]

- income elasticity of demand is the percentage change in demand

due to the percentage change in income of a consumer. This is
usually helpful to predict future demand .This also depends on
the kind of goods being sold, in case of normal goods the YED is
greater than 1, for such goods as the income increases the de-
mand for such goods also Increases . Ex- fresh high quality
foods.
- However , incase of inferior goods the YED is usually negative
because as the income increases the demand decreases and
sales tend to decline as the consumer now has the purchasing
power to buy better quality goods. Ex- frozen foods .
- The YED can many times also be 0 this means there is no
change in demand due to a change in come . Examples of these
goods would be necessities ex- rice a household if needs 1 kg of
rice would but 1 kg even if they had high income or low income to
sustain their needs.
- However , price elasticity of demand is the percentage change in
demand of goods and services due to a percentage change in
price .When demand is price inelastic, a business is able to in-
crease price in order to increase its revenue. When demand is
price elastic, the business should decrease price to increase the
quantity demanded and therefore revenue.
- This usually has an inverse effect , if the prices increase the de-
mand for the good reduces as every household has a fixed pro-
portion of income they would spend hence PED being negative.