Explain how changes in price work to reallocate resources in a market.

[10]

Answers may include:

Definition of reallocation of resources

Diagrams to show how changes in price alter the equilibrium quantity and therefore reallocate
resources

Theory to explain the signalling and incentive functions of the price mechanism

Examples of markets where price change has led to a reallocation of resources, such as through
government intervention.

Using diagram(s), explain the signalling and incentive functions of price. [10 marks]

Answers may include:  definition of price mechanism  diagram(s) (supply and demand) to illustrate the
signalling and incentive functions of price  an explanation of the price mechanism to show how
changes in supply and demand ration scarce resources through the signalling and incentive functions of
price  examples of price providing a signalling and incentive function.

Explain two reasons why governments impose indirect taxes. [10 marks]

Answers may include: • definition of an indirect tax • diagram showing the effect of an indirect tax •
an explanation that indirect taxes are a source of government revenue, a method to correct negative
externalities of production and consumption, a way to redistribute income if levied on luxury goods,
and a method of trade protection • examples of the imposition of indirect taxes.

Discuss the consequences for consumers, producers and the government of imposing a specific tax on
cigarettes. [15 marks]

N.B. It should be noted that definitions, theory, and examples that have already been given in part (a),
and then referred to in part (b) should be rewarded.

Answers may include: • definitions of demerit goods and specific tax • diagram to show the imposition
of a specific tax on cigarettes • an explanation of how the indirect tax raises the price to consumers and
reduces the quantity demanded of cigarettes; the indirect tax increases the cost of production, resulting
in less supply of cigarettes; the low PED for cigarettes will affect the effectiveness of the policy and the
revenue raised by government • examples of when a specific tax is used on cigarettes • synthesis or
evaluation (discuss).

Command term “Discuss” requires candidates to offer a considered and balanced review that includes a
range of arguments, factors or hypotheses.

Discussion may include: the advantages and disadvantages for the different stakeholders and the overall
effectiveness of the policy.

Explain why the price elasticity of supply (PES) for primary commodities tends to be relatively low, while
the PES for manufactured products tends to be relatively high. [10 marks]

Answers may include: • definition of price elasticity of supply • diagram to illustrate PES of
manufactured goods and primary commodities • an explanation of the various determinants of PES
(including time, mobility of factors of production, unused capacity and ability to store stocks) leading to
an explanation of why the PES for primary commodities tends to be relatively low and PES for
manufactured products tends to be relatively high • examples of PES for primary and manufactured
goods, or examples of primary and manufactured products.

Discuss possible consequences of a government imposing a price floor on an agricultural product. [15
marks]

N.B. It should be noted that definitions, theory, and examples that have already been given in part (a),
and then referred to in part (b) should be rewarded.

Answers may include: • definition of price floor • diagram showing a price floor • an explanation of the
impact of the price floor on market outcomes including: surpluses, government measures to dispose of
surpluses, inefficient allocation of resources and welfare impacts on various stakeholders • examples of
a price floor or of its consequences • synthesis or evaluation (discuss).

Command term “Discuss” requires candidates to offer a considered and balanced review that includes a
range of arguments, factors or hypotheses.
Discussion may include: the advantages and disadvantages to different stakeholders of price floors.

Explain why governments impose indirect taxes. [10 marks]

Answers may include:  a definition of indirect tax  an explanation of possible reasons for the
application of indirect taxes, to collect revenue, to correct externalities or discourage the consumption
of demerit goods  a diagram showing the application of an indirect tax  examples of the use of indirect
taxes.

Using diagrams, explain how the incidence of an indirect tax may be affected by the price elasticity of
demand. [10 marks]

Answers may include: • definitions of an indirect tax, price elasticity of demand, incidence

of taxation • theory of how relative price elasticities influence the proportionate sharing of an indirect
tax burden between producers and consumers • diagrams to show incidence of an indirect tax on
consumers and producers for goods with elastic and inelastic demand curves, showing that the more
elastic the demand, the greater the incidence on the producer, and vice versa • examples of goods with
differing price elasticities of demand and the resulting differences in their incidence of taxation.

Explain the factors which might influence the cross price elasticity of demand between different
products. [10 marks]

Answers may include:  definitions of cross price elasticity of demand  theory to include explanation of
formula, significance of positive and negative coefficient of cross price elasticity. Emphasis is likely to be
on complements and substitutes.  diagrams to show markets where the change in price of one good
influences demand for another good positively (substitutes) or negatively (complements)  examples of
substitutes, complements and unrelated goods

Examine the importance of income elasticity of demand for the producers of primary products,
manufactured goods and services. [15 marks]

N.B. It should be noted that definitions, theory and examples that have already been given in part (a),
and then referred to in part (b), should be rewarded.
Answers may include:  definitions of income elasticity of demand, primary products  theory of the
importance of income elasticity for producers of primary products, manufactured goods and services 
diagrams to show the effect of differing coefficients of income elasticity of demand  examples of
different types of primary products, manufactured goods and services  synthesis and evaluation
(examine).

Examination may include: knowledge that a change in income will have differing effects on the three
types of products specified in the question necessitating different strategies for the producers of these
products, for example, diversification, value added.

Explain how a government could bring about a more equal distribution

of income.

Answers should include: • a definition of a more equal distribution of income • an explanation of viable
methods which might be used such as progressive taxation.

Answers may include: • explanation of methods of government intervention that give a more equal
distribution of income: – progressive taxation – spending on merit goods and public goods – transfer
payments – subsidies – price controls – minimum wages • use of diagrams such as the Lorenz curve •
reference to the Gini coefficient.

Evaluate the effectiveness of government policies designed to reduce inequalities in income. [15
marks]

Answers may include: • when it may be effective: – progressive taxation – fairness, ability to pay, raises
tax revenue – spending on merit goods and public goods – used by people on

low incomes, positive externalities – transfer payments – direct benefit to the neediest, automatic
stabilizer – the use of subsidies – reduces the cost and increases consumption – price ceilings –
affordability to people on low incomes – price floors – income support for farmers – minimum wages –
incentives, reasonable pay • where it may not be effective: – progressive taxation – disincentives,
avoidance, tax evasion, cost of administration, the Laffer curve – spending on merit goods and public
goods – expensive to provide – transfer payments – cost of provision, can be paid to people who don’t
need it, reduces incentive to work – the use of subsidies – cost of provision, allocative inefficiency –
price ceilings – distorts markets, shortages, allocative inefficiency, costs of administration – price floors –
distorts markets, surpluses, allocative inefficiency, costs of administration – minimum wages – distorts
the labour market, raises business costs.
Effective evaluation may be to: • consider short term versus long term consequences • examine the
impact on different stakeholders • discuss advantages and disadvantages • prioritize the arguments.

Explain the importance of price elasticity of demand and cross-elasticity of demand for business
decision-making. [10 marks]

Answers should include: a definition of PED a definition of XED the link between PED, price changes
and changes in total revenue the importance of XED in terms of changes in price of substitutes and
complements examples of PED and XED in real life (products with high/low elasticities; products related
are complements or substitutes).

Answers may include: an explanation that PED and XED are extremely difficult to accurately measure in
reality use of diagrams to show the relationship between PED, price changes and changes in total
revenue use of diagrams to illustrate the complement/substitute relationship.

Answers may include: cigarettes as an example of market failure having the characteristics of demerit
goods use of an MSC/MSB diagram to show the negative externalities associated with the consumption
of cigarettes, candidates may use a simple supply and demand diagram an explanation of inelastic
demand and the implications for a tax on cigarettes; low PED means a tax may not lead to a significant
decrease in quantity of cigarettes demanded distinction between inelastic demand for tobacco in
general and elastic demand for particular brands the incidence of taxation may be considered
consideration of the extent of the tax increase; tax may have to increase a lot to have a major impact
the problem of relating the tax to the value of the external costs the impact on government revenues
and spending possibilities; revenue will increase a lot in view of the low PED an assessment of
alternative policies such as negative/positive advertising and direct controls.