Cambridge International AS and A Level Economics

Answers to Coursebook activities

Chapter 1: Basic economic ideas and resource allocation
Self-assessment task 1.1 (page 16)
1 Opportunity cost can be defined as the cost of an activity or decision expressed in terms of the next best
alternative foregone. The trade-offs might include:
Governments – in banning food exports, the government is giving up the benefits from export earnings and so
affecting the balance of payments current account.
Farmers – in choosing to grow crops for biofuels, farmers are reducing the amount of land available for other
crops and livestock production.
Consumers – with less land being devoted to food production there might be a reduction in the supply of
foodstuffs so consumers are giving up the benefit of cheaper food.
2 Answers might include:
Costs Benefits
Consumers ■■ Higher food prices. ■■ Relatively cheaper fuel compared to petrol.
Farmers ■■ Higher oil prices and animal feed leading to ■■ Higher prices and higher earnings for sugar cane farmers.
higher production costs.
Firms ■■ Higher oil prices leading to higher production ■■ Cheaper source of energy in the short run.
costs.
Governments ■■ Social unrest leading to higher security costs for ■■ Reduced carbon emissions leading to reduced global warming.
the government. ■■ Higher export earnings for Brazil.
■■ Environmental sustainability in the long run.

Self-assessment task 1.2 (pages 16–17)

1 The projection suggests that the population is ageing and that there will be fewer younger workers to support
them as the size of the labour force declines after 2015. Thus there will be an increase in the dependency ratio.
2 With an ageing population, decisions regarding what to produce, how and for whom will be affected in the
following ways:
a what to produce
A rise in the average age of the population, with more older people and fewer younger people, will alter
the types of products being produced. It is likely, for instance, that more resources will be devoted to
providing health and residential care for elderly people and there will be more focus on providing forms of
entertainment for the over 50s. It is also possible that fewer resources will be used for making products such
as children’s toys and for building affordable housing.
b how to produce
Because there will be more retired people and proportionately fewer workers, capital-intensive methods of
production will increasingly be used. In other words, more machines and other capital goods may be used
relative to labour. In addition, the government may decide to raise the retirement age or provide tax incentives
for workers to continue working past the retirement age.
c for whom to produce
In the light of an ageing population the government may try to influence who receives these products. To
ensure that the growing number and percentage of elderly people receive an adequate supply of products,
the government may increase the taxes levied on the comparatively smaller proportion of workers and spend
more on pensions. Such actions would transfer some purchasing power from the labour force to the retired.

© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 1
 ■ government agencies regulate and control the economies to foreign investors. In this way, they hope
provision of some essential services, such as energy, to achieve forecasted growth rates of around 5–7%
Cambridge International
telecommunications AS and A Level Economics
and transportation per annum. These are very much in line with those
■ indirect support is given to various strategically important
experienced by their Asian Tiger counterparts, yet
companies.
significantly higher than those experienced in the past by
These are over and above the expected provision of more developed economies. However, global recession has
Self-assessment task 1.3 (page 21) had a significant impact on these aspirations.
external defence and internal security services.
1 In It
terms
is notofeasy
economic structure
to explain India and
the importance of aPakistan are similar although agricultural output accounts for a greater
share of total output than in India and the
government’s role in any particular mixed economy. serviceInsector accounts for less of the country’s total output than
India.cases
most Overall, Pakistan’s
the only economyisisthat
real explanation more
it isagriculturally
usually a basedTOP
andTIP
less service orientated.
Virtually all present day economies are mixed-the role
2 case of differing is
a Agriculture political philosophies.
more efficient Figure 1.4
in Pakistan provides
than in India. and importance of the market is though variable.
a largely normative assessment of where particular
b The services (tertiary) sector is more efficient in India than in Pakistan.
economies fall in terms of the relative strengths of market
■ Agriculture
3 and is more
planned systems efficientallocation.
of resource in Pakistan In than in India because a smaller proportion of Pakistan’s labour force
all cases,
accounts
except arguablyforfor
a larger
Northproportion of theare
Korea, countries country’s
moving output than in India.
towards giving the
■■ The services market mechanism
(tertiary) sector is more an ever-increasing
efficient in India than in Pakistan. A smaller proportion of India’s labour
roleforce
in their
thaneconomic
Pakistan’sstructures.
produces a similar proportion of the country’s output.
In more recent times, the experience of the newly
If under-employed
4 industrialising agricultural
countries (NICs) is workers move
interesting. into the industrial or the service sector where there is a labour
In terms
shortage,
of allocativethere will be a some,
mechanisms, rise insuch
output and incomes.
as Singapore and There is the possibility, however, that if a large number
of workers move out of agriculture quickly,
Hong Kong, opted for a strong focus on the market to agricultural output may fall significantly. Such a fall could lead to
a shortage
allocate of foodstuffs,
resources a risethis
and through in have
theircreated
price and
an an increase in the imports of foodstuffs. A large number of
economic situation where enterprise can be encouraged and tertiary sectors would also be likely to be accompanied
workers shifting from the primary to the secondary
by rural
and to urban
rewarded. Othermigration.
South EastThis,
Asianin‘Tigers’
turn, may
haveresult in pressure on education, health and housing facilities in
24
cities and
placed moremay resulton
emphasis in central
slums developing.
planning, while
China’s phenomenal growth over the past decade has
Self-assessment task 1.4management
been based on the controlled (page 25)of the economy
1 within a global
This will vary context and more
from country to recent
country,emphasis on education, defence and law and order will involve significant
but health,
freer markets.
degrees of government provision whereas food and clothes retailing, tourism and vehicle manufacturing will be
The new
largely Baltic Tiger
provided by theeconomies of Central Europe –
private sector.
Estonia, Latvia and Lithuania – have re-orientated their Central Hong Kong
2 This will depend on the country but some research will need to be undertaken regarding changes in government
spending as a percentage of GDP in order to insert into the scale shown in Figure 1.4.
UK Singapore USA

Former
Soviet Union
before 1986
North Hungary Pakistan France
Korea Albania

Command Market
economy economy

Weak Market as a means Strong

of allocating resources

Strong Government control Weak

over the allocation
of resources

Figure 1.4 Mixed economic systems

3 Government spending as a percentage of GDP is an important indicator since the greater the relative proportion
of government spending the greater its influence will be over economic decision making. In Scandinavian
countries, for example, this proportion is likely to be close to 60% whereas in the US this figure will be closer to
40%. Although
9781107679511c01_p012-037.indd 24 the US is often cited as the most free market economy in the world this still means that around 7/28/2014 5:06
40% of total spending in the economy is undertaken by the state (local and national). Most economies are mixed
but it is the degree of mix that varies.

© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 2
 Cambridge International AS and A Level Economics

Self-assessment task 1.5 (page 26)

1 a Public sector utilities such as gas and electricity provision.
b Corporation or profit tax, capital gains tax.
c Subsidies to farmers.
2 The role of the government will change as it moves away from direct provision and price controls, for example,
towards enforcing property rights, structural reforms, greater liberalisation and privatisation. Output from
the private sector will become a more significant component of total output (i.e., GDP). With the emergence
of entrepreneurs and a growing banking sector, increased commercial lending and consumer credit (financial
widening and deepening), employment opportunities in the private sector will increase.
3 Responses should include arguments for and against a greater role of free markets in the short run and the long
run. Answers might include:
For Against
Households ■■ More choice and a wider range of goods and services ■■ Higher prices and essentials might become less
affordable
Workers ■■ More choice regarding where to work ■■ Less job security and lower pay
Firms ■■ Access to new sources of capital, e.g., shares and loans ■■ More competition – least efficient will exit the market
to finance growth, innovation and expansion
■■ Opportunities for entrepreneurs to enter markets

Government ■■ Less government spending and higher tax revenue ■■ Higher inflation and unemployment, especially in the
(assuming an effective collection method is in place) short term. Possibly hyperinflation
■■ Attract foreign direct investment (FDI) ■■ Debt incurred due to transition

Self-assessment task 1.6 (page 30)

1
Soybean Oil Seed (millions of tonnes)

0
Corn (millions of tonnes)

2 a See diagram above

b In producing fewer soya beans, Brazilian farmers can devote more land to corn production. However,
reducing soya bean production could lead to less animal feed as soya beans are a significant protein used in
pig feed thereby increasing the price of soya beans.

© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 3
 Cambridge International AS and A Level Economics

3 a 
Soybean Oil Seed (millions of tonnes)
100
90
80
70
60
50 2012
40 2008
30
20
10

0 10 20 30 40 50 60 70 80 90 100
Corn (millions of tonnes)

b A PPC can shift outwards with an increase in the quantity or quality of factors of production. Technological
improvements in production of both commodities, e.g., greater mechanisation, use of fertilisers, GPS and
genetically modified crops can raise yields per hectare and thereby increase the productivity of land. Brazil
has increased the amount of land available for farming through deforestation thereby increasing the amount
of land available on which to grow crops. Brazil also removed price controls on agriculture in 1985 creating
greater incentives for farmers to plant crops. Finally, a better skilled workforce will raise productivity.

Self-assessment task 1.7 (page 31)

Decision-makers must choose between current consumption and capital consumption. By allocating resources
towards current consumption, standards of living would increase, thus allowing the population to meet their basic
needs. But the economy would be forgoing capital or investment goods thereby limiting the economy’s ability to
grow significantly in the longer term as equipment would wear out and reduce labour productivity. With limited
resources the government could invite foreign firms in to fill the investment gap, e.g., Chinese farmers have taken
over some farms and are building roads and power stations in Angola. Alternatively, the government could ask for
external assistance, e.g., foreign aid to help subsidise the replacement and/or purchase of capital equipment

Self-assessment task 1.8 (page 34)

■■ the local police service quasi-public as it benefits others (non-excludable) but is rivalrous
■■ a chocolate bar private as it is excludable and rivalrous
■■ a public park quasi-public as it is non-excludable and non-rivalrous but if too many people use it, it can become rivalrous
■■ a firework display quasi-public as it might be difficult to exclude those in the local community who have not paid from benefitting,
e.g., they might have a good vantage point from their homes or gardens
■■ a stretch of road public but could be quasi-public as more drivers use the road and it becomes congested. Drivers can be excluded
through the use of tolls and charges
■■ street lighting public
■■ a public cricket pitch quasi-public since it is rivalrous as additional consumers make use of the facility
■■ a museum private since users can easily be excluded by charging an entrance fee but looking at artefacts does not
diminish the benefit received by additional users so it is non-rivalrous. But once again, at busy times this can be
diminished and so it could be argued that it has the characteristics of a quasi-public good

Self-assessment task 1.9 (page 36)

■■ compulsory secondary merit – benefits individual as it increases productivity and potential earnings, benefits firms from higher
education productivity and government in the long run through higher taxes
■■ wearing a seat belt merit – benefits individual as less likely to die or be severely injured in an accident, reducing health care
costs to the state, too
■■ emergency health services merit – benefits individual as less likely to die or be severely injured in an accident and prolonging life could
raise productivity. However, costs to the state might be greater than benefits
■■ chewing gum demerit – can cause tooth decay requiring expensive dental treatment plus additional costs to society from
cleaning up litter it creates

© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 4
 Cambridge International AS and A Level Economics

■■ visiting a museum merit – improves knowledge and level of human capital

■■ playing loud music and for the perpetrator it might be increasing their enjoyment but it has negative side effects for other
shouting at a cricket match spectators who are trying to enjoy the match

Exam-style questions Capital goods

1 a Opportunity cost can be defined as
the cost of an activity or decision K1
expressed in terms of the next best
alternative foregone [2].

K2

0 C1 C2
Consumer goods

The production possibility curve shows what levels of output an economy can achieve with its existing
resources [2]. As can be seen in the diagram above, in order to produce more C1-C2 consumer goods the
economy will sacrifice K1-K2 capital goods [2]. The benefit of producing more consumer goods today is that
it raises standards of living in the short term but, as capital goods can be used to produce both capital and
consumer goods, the benefit of higher standards of living in the future are given up [2].
b Problems include:
In a command or planned economy, resource allocation decisions are taken by a central body, e.g., government,
and in a transition to a free market economy, unemployment is likely to rise and GDP fall as former state-owned
industries are closed down or privatised. There will be less job security and a rise in inflation as price controls are
removed and therefore a fall in the average standards of living and the increased risk of social unrest.
However, there will be greater efficiency in the long run as there is a shakeout of inefficient industries, as well
as lower prices and more consumer choice as entrepreneurs and new firms enter the market. Foreign direct
investment might be attracted in the search for lower costs and higher returns. With greater private sector
investment and less government intervention it should lead to lower government spending and higher tax revenue.
[Up to 6 marks for each side of the argument]
2 a Public goods have two characteristics: non-excludable and non-rival. Non-excludable means that once the
good has been provided for one consumer, it is impossible to stop all other consumers from benefitting from
the good. Non-rival means that as more and more people consume the good, the benefit to those already
consuming the product must not be diminished. Take the example of a lighthouse: once a lighthouse is
built to warn one ship at sea away from a dangerous area of rocks then, by its very nature, this service will
automatically be provided to all ships that sail within a certain distance of the lighthouse. It is non-excludable.
Equally, the fact that other ships see the light given by the lighthouse and are warned away from the dangerous
rocks does not reduce the benefit that any one particular ship receives from that warning. It is non-rival.
A merit good is a good that has positive side effects associated with it. Thus, an inoculation against a contagious
disease might be seen as a merit good. This is because others who may not now catch the disease from the
inoculated person also benefit.
[Definition of public goods up to 2 marks. Examples up to 2 marks. Definition of merit goods up to 2 marks.
Examples up to 2 marks]
b Private goods are excludable and rivalrous. Certain types of education such as universities or post-16 provision
might be deemed to be rivalrous since consumption by one individual can reduce the quantity available to
others. For example, a seat taken in a lecture theatre by one individual reduces the spaces available for others,
and the bigger the class size the less individual attention each student may receive, therefore diminishing
the benefit to those already receiving the education. This applies to all education. However, in the case of
© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 5
 Cambridge International AS and A Level Economics

universities the benefits to the individual might outweigh the benefits to the rest of society and students are old
enough to understand and appreciate those benefits. A degree, for example, can lead to much higher returns
to an individual in the form of higher earnings and so they should contribute towards the cost of this type of
education. Many would argue, though, that there are significant positive spillover effects to the rest of society
from a more educated population, e.g., higher taxes paid by graduates, lower incidence of smoking, decreased
likelihood of unemployment and domestic violence, and so should be treated as merit goods.
Health care might include dental treatment, opticians, alternative medicine and fertility treatment. If
such services were provided by the state there might be overconsumption of them, which would lead to a
waste of resources and with limited state budgets choices need to be made. Dental treatment displays the
characteristics of a private good since the consumption by one individual reduces the time a dentist can
devote to other patients and the benefits will be felt by the individual consumer. Therefore, once again, the
benefits to the individual might outweigh the benefits to society. However, there is a danger of information
failure in choosing dental treatment as the consumer lacks the essential technical knowledge to understand
the best course of treatment for him or herself and so, it can be argued, would be overconsumed as a result of
exploitation or, more likely, underconsumed as consumers avoid the financial burden of treatment.
As can be seen, education and health care can be viewed as private goods but the decision as to whether to
treat them as merit goods will depend largely on public sector finances and affordability of provision. In some
countries, governments might treat certain goods as private but recognise that they do present wider benefits
to society. However, that income would be a major barrier to their consumption so they might choose to
subsidise lower income households to consume them in greater quantities than they would otherwise.
[Up to 6 marks for each side of the argument]
3 a Information failure occurs where people do not have full or complete information. This arises because
consumers do not perceive how good or bad a particular product is for them: either they do not have the right
information or they simply lack some relevant information. For example, smoking, education or pension
provision. Many of the benefits might only occur in the distant future or, as in the case of financial products,
they can be quite technical and difficult to understand.
[Up to 2 marks for a definition and 3 marks for relevant examples]
b A merit good is one that has positive side effects when consumed, whereas a demerit good is one that has
adverse side effects when consumed.
Merit goods will often be underconsumed because of information failure, i.e., the individual does not understand
or underestimates the private as well as the external benefits that can be gained from consuming the good or
service. For example, children might not be able to appreciate the benefits of a school education if left to their
own devices and so, if given the freedom to choose, might choose not to go to school at all. This would limit their
opportunities in the labour market, reduce productivity and create greater inequality in the longer run. Thus, the
government might need to intervene to ensure that a more socially desirable outcome is produced.
In the case of demerit goods, the individual underestimates the private and external costs arising from the
consumption of the good or service. The health risks resulting from smoking might be underestimated by
individuals or not clearly understood especially since many smokers take up the habit in their teens. The link
between smoking and lung cancer has only been understood by consumers in some countries in recent years
as a result of more accessible information and public education programmes. However, in some developing
countries this information might not have been as widely disseminated.
[Definition of merit and demerit goods up to 2 marks each. Up to 4 marks for the application of information
failure to merit goods, e.g., education. Up to 4 marks for the application of information failure to demerit
goods, e.g., gambling, alcohol and tobacco]

© Cambridge University Press 2015  Cambridge International AS and A Level Economics Chapter 1 Coursebook activities 6