Professional Documents
Culture Documents
Edexcel AS/A-level
Economics A
Theme 1 Introduction to markets and
market failure
This Answers document provides suggestions for some of the possible answers that might be
given for the questions asked in the workbook. They are not exhaustive and other answers
may be acceptable, but they are intended as a guide to give teachers and students feedback.
The student responses (green text) for the longer essay-style questions are intended to give
some idea about how the exam questions might be answered. The examiner comments (blue
text) have been added to give you some sense of what is rewarded in the exam and which
areas can be developed. Again, these are not the only ways to answer such questions but
they can be treated as one way of approaching questions of these types.
Topic 1
Nature of economics
Economics as a social science
1 2 marks for the definition below, or similar:
The study of society (1 mark) and the manner in which people behave/influence the world
around us (1 mark).
In sciences, like chemistry, experiments are conducted on scientific particles that can
be easily tested (1 mark) and react in the same way in the same experimental
conditions (1 mark).
Application to extract (1 mark), e.g. drop in price, ceteris paribus causes an increase
in consumer demand for broadband.
Further explanation (up to 2 marks), e.g. so we are assuming that demand for
broadband will increase if price drops, assuming that no other factors influencing
broadband demand changed (1 mark), such as the speed of connections (1 mark).
7 a
Includes the phrase ‘should not’ (which implies a value judgement) (1 mark)
Can test whether student applications went down by 1% (after tuition fees rose) (1
mark)
9 The value of the next best alternative (1 mark) forgone (or given up) (1 mark).
There are unlimited wants (1 mark) but limited resources (1 mark), i.e. scarcity (1
mark).
Define opportunity cost (1 mark), i.e. value of the next best alternative forgone.
By spending on the advertising campaign HMV had less money to spend on other
areas of the business (to aid its survival) (1 mark).
14 a F (1 mark)
b E (1 mark)
c E (1 mark)
d B or A (1 mark)
16
Inward shift in the PPF (1 mark) as fewer consumer and capital goods can be
produced (1 mark).
Definition of opportunity cost (1 mark), e.g. the value of the next best alternative
forgone.
Diagram showing:
Medium of exchange
Store of value
Greater efficiency/productivity
Definition of staff turnover (1 mark), e.g. total number of staff leaving divided by
number of people employed.
o Boredom/monotony
Application: customer calls per person (1 mark)/how call centres divide labour (1
mark).
o Workers could specialise in what they do best (1 mark), e.g. taking calls
within their area of expertise (1 mark).
o Workers should become better at the same task over time (1 mark), e.g. be
able to deal with customer complaints quicker (1 mark).
o Workers do not need to move between jobs (1 mark), e.g. workers can
remain taking calls, rather than also doing the accounts (1 mark).
o Workers may not be specialising in their job due to it being their specialism
(i.e. it may be the only job they can get currently)
High productivity may not be the aim of the call centre (i.e. a speedy call may be good
for productivity but not help the customer).
c Command economy
25 Any possible role (1 mark) with explanation (2 marks). Possible answers include:
To solve market failure (1 mark): e.g. negative externalities (of pollution) (1 mark) by
the imposition of a (petrol) tax (1 mark); e.g. public goods (1 mark) by providing
defence/street lights (1 mark).
Increased competition/efficiency (1 mark), e.g. as firms will earn higher profits from
lower costs/aid survival (1 mark)
Increased innovation (1 mark), e.g. as firms that innovate could earn more
profits/more likely to survive (1 mark)
Greater choice for consumers (1 mark), e.g. as firms may offer more products to
increase profits/survive (1 mark)
Greater incentives to work (1 mark), e.g. due to lower levels of taxation or fewer
benefits from not working (1 mark)
Possible higher growth rates (1 mark), e.g. due to higher efficiency/innovation shifting
the PPF (1 mark)
Application (1 mark): application to Nigeria, e.g. fluctuating price for oil, changes in
demand for oil.
Here the student scores 3/3 marks as she clearly defines specialisation and then applies it to
Nigeria.
2 a Knowledge (1 mark): definition of opportunity cost, i.e. value of next best alternative
forgone.
Opportunity cost is the value of the next best alternative forgone (1 mark). Here the
opportunity cost is 20 capital goods (i.e. 80 – 60) (1 mark).
This gains 2 marks for a clear definition and application to the PPF shown with the calculation.
b C (1 mark)
The student has clearly marked the new point outside the PPF for 1 mark.
3 a A (1 mark)
Store of value (1 mark), e.g. individuals can choose to forgo consumption in the
current time period and save to increase their spending power in the future (1 mark).
Method of deferred payment (1 mark), e.g. allows payment for goods and services
consumed today in a future time period (1 mark).
Improved productivity (1 mark), e.g. more efficient use of current factors of production
(1 mark)
One cause of an outward shift in the PPF is better technology (1 mark). This means
that production can become more efficient due to higher-quality capital goods
being used, hence boosting potential output (1 mark).
This student easily gains the 2 marks available for a shift factor identified and then some linked
explanation to develop the answer.
4 a Knowledge (2 marks):
Link to basic economic problem (1 mark), i.e. scarce resources lead to choices
needing to be made, each with an opportunity cost
Being able to get a job (1 mark), e.g. by going to university Sabrina must give up the
income she could have earned by starting employment after sixth form (1 mark).
An opportunity cost is the value of the next best alternative forgone (1 mark).
Sabrina faces an opportunity cost as her resources are scarce and so any choice
she makes she must give up the next best option (1 mark).
For example, Sabrina could have been able to get a job instead of going to
university (1 mark) and therefore earned income instead of going to university and
paying up to £9,000 a year on fees (1 mark).
The student here gains all 4 marks. He has defined what opportunity cost means and linked this
to the basic economic problem to explain why it exists. The explanation is backed up with a clear
example in the context of Sabrina going to university and is developed with an additional
sentence.
b D (1 mark)
Knowledge (1 mark):
Application (1 mark):
Reason for PPF shift (1 mark), e.g. BMW investing £250m to expand UK factories or BMW
has invested £250m in capital goods.
Analysis (3 marks):
You need to include a production possibility frontier in your answer and shift the curve
appropriately. This student scores 5/5 marks by using a clear diagram, a definition and
application to the case study:
BMW has invested £250 million to expand the capacity of its factory (1 mark). This
will lead to an increase in its PPF (1 mark), as shown below (2 marks):
b KAA = 6 marks
Knowledge (2 marks):
Example of normative statement (1 mark), e.g. McLaren is the producer of one of the
all-time best Formula 1 cars.
This is a normative statement as whether McLaren is one of the all-time best Formula
1 cars cannot be tested/requires a value judgement (1 mark).
Example of positive statement (1 mark), e.g. since December 2011 McLaren has also
been producing high-end sports cars and this provides 350 jobs to the UK technology
sector.
This is a positive statement as it can be tested whether 350 jobs were created or not
referring to available evidence/it is a statement that is based in fact (1 mark).
The skill with positive versus normative questions is being able to pick out which statements are
which. Here providing a definition of each, an example and some explanation of why you chose
each statement is enough to earn full marks.
A positive statement is an assertion of fact, which can be tested and verified using
available evidence (1 mark): for example, the fact that McLaren’s production of
high-end sports cars ‘provides 350 jobs in the UK technology sector’(1 mark).
Whether 350 jobs were created can be tested by looking at employment statistics
at the company after the expansion (1 mark).
c KAA = 6 marks
Define division of labour, i.e. the process whereby the production process is broken
down into a sequence of stages with workers assigned to particular stages
Application to cars, e.g. assembly lines used in production of cars; workers split into
different tasks, such as painting/welding
increased productivity
allows macro benefits, e.g. higher exports, higher UK growth and jobs
Evaluation (4 marks):
Possible downsides of repetitive work, e.g. higher staff turnover, lower-quality work,
lower productivity, strike action
Risk of assembly line breaking down, e.g. if suppliers are unreliable, if workers are
away/on strike
Long-term arguments, e.g. if the world economy recovers more expansion could
occur, increasing jobs/growth further
The key to this question is to understand the benefits and drawbacks of division of labour in the
context of the car industry. The extract gives two different car manufacturers; comparing these
is a good route to evaluation marks.
Division of labour is the process whereby the production process is broken down
into a sequence of stages with workers assigned to particular stages.
Another benefit is that it will be easier and cheaper to train workers as they are
only performing one task in the production process, such as welding or painting.
This should allow car companies to create high-quality products with fewer errors
and mistakes, boosting profits.
KAA = 6/6 marks (for two benefits explained in context; full marks would have been gained).
The benefits of division of labour will depend on the car firm in question. For
example, McLaren as a high-quality sports car manufacturer will hope to gain
consistently high quality by dividing labour between highly-skilled engineers.
This will help maintain its brand image. BMW is likely to focus on much larger-
scale production to gain lower average costs and compete on price.
Car manufacturers may also see downsides, such as high staff turnover, as
workers carry out repetitive, monotonous work every day, such as always doing
welding rather than contributing to all aspects of the car, which may be more
rewarding. This low morale could also damage the high quality and high
productivity, which division of labour can arguably bring.
Evaluation 4/4 marks for two evaluation points with relevant reasoning in context. Critical use of
the evidence is shown by comparing the impact on different car companies.
Topic 2
How markets work
Rational decision-making
1 2 marks for definition, such as:
Attempting to get the largest difference between total revenue and total cost (2
marks).
Even though the new bran flakes are cheaper and this should improve her welfare (1
mark) there may be other factors that make the new bran flakes less desirable (1 mark),
such as lower quality (1 mark).
Diminishing marginal utility means that as output increases, the amount of welfare
gained from the next unit is less (1 mark).
Therefore as quantity increases, consumers will be less willing to pay a higher price
for a product (1 mark) due to the lower utility they gain from the next unit (1 mark).
Application (1 mark), e.g. fall in oil prices in 2012 and fall in Shell share price by 1%.
Link between oil prices and Shell’s share price (1 mark each):
o Increased supply due to less political tension in Iran and Israel and US
stockpiles
Price mechanism
10 Where the free markets allocate resources (1 mark) through the interaction of demand and
supply/the invisible hand of the market (1 mark).
There is a shortage of roads/excess demand of road space (1 mark), e.g. traffic jams
on the M4 in Wales currently (1 mark).
A higher price for road usage (on a toll road) will exclude those who are not willing
and able to pay (1 mark) as they will find alternative means of transport (1 mark),
meaning fewer people using the road/contraction in demand (1 mark).
A lower price will lead to an expansion of demand (1 mark) while supply will remain
fixed (1 mark), allowing equilibrium to be reached/demand to equal supply (1 mark).
When income rises there will be more demand for normal goods (1 mark) and less
demand for an inferior good (1 mark).
When income falls there will be less demand for normal goods (1 mark) and more
demand for an inferior good (1 mark).
Normal goods will have a positive YED (1 mark) and inferior goods have a negative
YED (1 mark).
Demand for normal goods is positively correlated with income (1 mark) whereas
demand for inferior goods is negatively correlated (1 mark).
16 1 mark for correct answer, 2 marks for explanation. Possible answers include:
If the price of one complement falls then there will be a rise in demand for the other
complement (1 mark).
Numerical example (up to 2 marks), e.g. dishwasher tablets increase in price by 10%
and then demand for dishwashers falls by 5% (1 mark) implies XED of negative 0.5
(1 mark).
Definition of inelastic demand or PED (1 mark), e.g. where demand changes less
than proportionately than quantity demanded or the responsiveness of quantity
demanded to a change in price.
Definition of total revenue (1 mark), e.g. price × quantity or the money a company
earns from selling goods and services.
Identification that demand is inelastic and therefore a rise in price will boost revenue
(1 mark).
Further explanation (which could include a numerical example) (2 marks), e.g. the
loss of customers from the higher fare will be more than compensated for by the
higher fare paid by the remaining customers.
Because when incomes fell in the UK, quantity demand for cars also fell (2 marks).
Explanation of inferior goods (1 mark), e.g. inferior goods would have seen a rise in
demand when incomes fell or have a negative YED or buses and rail journeys were
inferior goods.
If the price (cost) of car journeys increased then quantity demanded for bus journeys
would increase (2 marks) as travellers will switch to the cheaper form of transport (1
mark).
Buses and cars are weak substitutes (1 mark) and explanation (1 mark), e.g. car
users still prefer the convenience/comfort of their car even if it costs more or car
users may not switch due to public transport being viewed as unreliable etc. or
reference to XED figure of close to zero in the extract.
In the long term more switching may occur (1 mark) and explanation (1 mark), e.g.
time to find public transport information/time to switch or public transport may improve
over time, making switching more likely.
There may need to be a significant increase in car journey prices (1 mark) to give
enough of an incentive to switch to buses (especially if bus journeys are seen as
lower quality) (1 mark).
The short run is a time period where at least one factor (of production) is fixed (1
mark).
The long run is a time period where all factors (of production) are variable (1 mark).
23
Analysis (4 marks):
More firms are able to supply now in response to a change in the gold price due to
greater capacity (2 marks).
Greater exploration should lead to more gold discoveries, meaning more supply of
gold is available to respond to changes in price (2 marks).
The increase in PES depends on the success of exploration of gold (1 mark) with
explanation (1 mark), e.g. lack of new discoveries as gold becomes scarce or
possible inability to extract new gold profitably due to the cost of extraction.
In the long run PES may become even more elastic (1 mark) with explanation (1
mark), e.g. a high gold price for many years may make even costly gold profitable to
extract or even more firms entering the market to take advantage of high gold prices.
In the very long run PES may become inelastic (1 mark) with explanation (1 mark),
e.g. as it is a non-renewable/scare resource (1 mark).
Consumer surplus is the difference between what consumers are willing and able to
pay and the market price (2 marks).
Producer surplus is the difference between the market price and what producers are
willing and able to supply at (2 marks).
For description of areas only (1 mark each), e.g. consumer surplus is the area below
the demand curve and above the market price (1 mark), producer surplus is the area
above the supply curve and below the market price (1 mark).
Gained P1GFP2 (1 mark) but lost CEGB (1 mark); overall consumer surplus has fallen
(1 mark)
Define price inelastic demand, i.e. where quantity demanded responds less than
proportionately to a change in price (1 mark).
Explanation of why cigarettes tend to have inelastic demand (e.g. habit-forming good)
(1 mark).
If demand is more price inelastic then consumer surplus would increase/be larger (1
mark) relative to producer surplus (1 mark) as producer surplus would stay
unchanged (1 mark).
Any appropriate diagram showing consumer and producer surplus with inelastic
demand (2 marks).
Grant/money given by the government to firms (1 mark) and one other point (1 mark),
e.g. to reduce production costs or to increase supply/production or to reduce price.
29
A specific (or unit tax) is a levy charged by the government set at a constant amount
per unit (1 mark).
To support a failing industry (1 mark), e.g. supporting the UK car industry (1 mark) in
order to protect employment (1 mark).
Analysis (6 marks):
1 mark for any benefit and 1 mark for further development (up to 4 marks):
Benefits of greater medical use (e.g. higher life expectancy, lower infant mortality)
Evaluation (4 marks): one or two evaluation points (up to 4 marks for each if well
developed). Evaluation points include:
Long-term arguments, e.g. controversy may mean that the subsidy is scrapped and
therefore only a short-term benefit or early signs are of the scheme working so it
could be expanded to more countries or it will take a long time to assess any medical
benefits (no data yet).
Prioritising/significance of benefits.
Counter-points, e.g. medical aid from charities would be provided at a lower price
(free) and possibly in higher quantities or Oxfam concerned over whether the drugs
will be administered properly.
Mitchell and Mark may prefer to stick to O2 as it is what they have always done (1
mark)/and therefore is a habit to always purchase O2 (1 mark).
Mitchell and Mark may not be able to work out the best deal for mobile phones (1
mark) as there are too many calculations to make to find it (1 mark).
E.g. due to the high number of tariffs or contract options available (1 mark)
Mitchell and Mark may buy O2 as that is what other people buy (1 mark)/and
therefore they assume this is the best deal for them too (1 mark).
e.g. Mitchell may always use the same phone provider as Mark (1 mark)
Understanding of irrationality, i.e. consumers may not be maximising their own utility
(1 mark)
Application (up to 2 marks), e.g. may not get the most welfare from their book
purchase by only buying from the best-seller list
Possible reasons why buying from the best-seller list may not be rational (up to 3 marks
per point):
Influence of other people’s behaviour, i.e. may be buying books that other people like,
which they do not
Habitual behaviour, i.e. may continue to just buy from the best-seller list out of habit
even if the books they find do not maximise their welfare
Computational difficulties, i.e. cannot shop around to find the best book as so many to
choose from and therefore go to the best-seller list
Not shopping around, i.e. not undertaking a proper analysis of the books available
and therefore may not find the best book for them
The best-seller list may contain books that are more likely to meet their needs, as
critically acclaimed/bought by many others.
The best-seller list may save time and be more convenient, saving time and
improving welfare.
b Knowledge (2 marks):
The area above the supply curve but below the equilibrium price
The difference between the market price which firms receive and the price at
which they are willing and able to supply
Producer surplus is the difference between the market price the firm receives and
the price at which it is willing and able to supply (2 marks).
On these questions, a clear definition such as the one given here is enough for 2 marks.
c 1 mark for knowledge: shading of the increase in producer surplus area on the
diagram.
The student has clearly annotated the change in producer surplus for 1 mark.
2 a B (1 mark)
Utility maximisation means that consumers make decisions in order to gain the
most welfare possible (1 mark). Here energy customers could improve their welfare
by getting better value for money on their energy tariffs (1 mark). This can be done
by shopping around for the best deal, which Ofgem says could save them £100 on
average a year (1 mark).
The student gains full marks here as the answer defines utility maximisation clearly and applies
utility to the energy customer scenario. The final mark was gained by developing the argument
further, i.e. the need to shop around to get better deals.
3 a A (1 mark)
b Application (2 marks): 1 mark for working and 1 mark for final answer
c Knowledge (2 marks):
The student has clearly annotated the producer and consumer subsidy areas and gains 2 marks.
4 a Application (2 marks):
NB Full marks for answer, but only if clearly noted as a fall/negative %∆ in QD.
PED = %∆QD/%∆P
Application (1 mark): a relevant example, e.g. a fall in the price of e-cigarettes would lead
to a fall in demand for tobacco cigarettes.
Tobacco and electronic goods are substitutes for one another (1 mark). Therefore, if
the price of electronic cigarettes rose, the demand for tobacco cigarettes should
rise too (1 mark).
The student gains 2 marks for clear use of XED theory and application to the example of
cigarette types.
c C (1 mark)
Knowledge (1 mark): identification that nightclub tickets are a normal good (1 mark).
Application (2 marks): use of the extract (2 marks), e.g. incomes falling in the recession
(1 mark) and customers ‘can no longer afford a night out’ (1 mark).
Explanation of a normal good, e.g. a good demanded more (less) when income rises
(falls) or normal goods have a positive YED (1 mark)
Explanation of an inferior good (1 mark), e.g. a good demanded more (less) when
income falls (rises) or negative YED(1 mark)
On this question only analysis is required. All answers must include the answer and application
to the case study. Then further analysis marks are gained by explaining what normal and/or
inferior goods are.
Here tickets to a nightclub are a normal good (1 mark) as fewer club tickets were
demanded when incomes fell in the recession (2 marks).
A normal good is one where, if income falls, the demand will also fall (1 mark), i.e.
YED will be positive (1 mark). In contrast, an inferior good is one where, if income
falls, the demand will rise, which is not the case here (1 mark).
b KAA = 6 marks
Definition of elastic supply, i.e. where quantity supplied responds more than
proportionately to a change in price
Reasons:
Cider takes time to make and so, over time, more will be produced
Evaluation (4 marks):
Weather is still a limiting factor (as stated in the extract) and therefore could limit
increases in supply.
The perishability of apples means they are hard to stockpile and therefore could limit
the ability of cider producers to respond even with more firms or more harvests.
Barriers to entry (e.g. advertising, branding) may limit the ability of more firms
entering over time (especially small firms).
Issues of new firms facing capacity constraints as they expand (although in the long
run they could expand further).
Depends on magnitude of price increase in cider, how much supply expands (i.e. if
significant then more firms more likely to enter and follow Stella’s lead) in the long
run.
Students find PES questions harder than most elasticity questions and often confuse it with
PED. The key is to focus on producers not consumers, i.e. can cider producers increase supply
to meet the higher price (from rising demand)?
To gain full marks, ensure you apply your analysis and evaluation points to the context of cider.
For cider specifically, more firms are entering the market such as Stella launching
Stella Cider to compete with Magners and therefore there will be more firms able
to supply cider as the price of it increases.
Also, there should be more harvest of apples over time then apple harvests will
increase, meaning more raw materials for cider producers to increase supply with
following a price rise.
This provides a clear analysis of the question: a definition and then two reasons well applied to
cider get the rest of the marks.
However, despite more firms and GM apples there has been bad weather in apple
growing regions. This means that even if firms try to expand they may be unable
to do so due to a lack of apples. Even with GM apples, some weather conditions
are too harsh to grow in.
Moreover, in the long term it is not certain whether new firms, such as Stella, will
be able to compete due to strong branding of existing cider producers. Therefore,
if Stella discontinues its cider, there will be fewer firms to produce, making the
price elasticity of supply for cider more inelastic.
Here the student scores full marks for two well-considered evaluation points in the context of
cider.
c KAA = 9 marks
Define consumer surplus, i.e. difference between consumer’s willingness and ability
to pay and the market price or area under the demand curve above the equilibrium
price
Link between club closures and reduced supply of clubs (1 mark) and therefore a fall
in consumer surplus
Diagram showing:
Evaluation (6 marks):
Long-term arguments, e.g. will club closures continue with the economic climate
unlikely to brighten for a while or will club closures be reduced in the long term as
clubs could offset reduction in revenue from club tickets with revenue from
food/comedy or via cost savings?
Other factors may affect CS apart from club closures, e.g. higher tax on alcohol may
reduce supply and CS further or increased advertising by clubs may increase
demand and CS.
For 15-mark questions there are 9 KAA marks. Here a diagram is asked for and so should be part
of your analysis; 6 marks are for evaluation of two or more issues. This student scores 15/15
marks.
Consumer surplus measures the difference between what consumers are willing
and able to pay and what they actually pay.
Clubs such as Luminar have closed due to a lack of profits in the recession. This
has left 79 club closures, although 55 remain open after a buyer was found.
As a result consumer surplus falls (1 mark) from P1ZX (1 mark for ref to diagram)
to P2YX (1 mark for ref to diagram).
The student easily scores 9/9 marks for showing knowledge of consumer surplus and why it will
fall when supply decreases, as well as clear, integrated application.
However, the amount of consumer surplus after the shift in supply depends on the
PED of nightclubs. If demand is elastic then the consumer surplus will be a lot
smaller than if it were inelastic. PED is likely to be elastic in this case as there are
many different forms of entertainment that young people could do instead of
nightclubs (e.g. cinema, cafés, bowling).
In the longer term, the situation may get worse for nightclubs as tuition fees may
continue to rise (reducing student numbers) and the UK economy is not expected
to recover fully for several years. Therefore more clubs may go out of business as
demand falls further and profits suffer. Therefore the magnitude of the fall in
supply and fall in consumer surplus may increase in the coming years.
Two well-developed evaluation points easily earn 6 marks, as they show a critical understanding
of the question and are well contextualised.
55/79 × 100
50p/£3.10 × 100
e KAA = 14 marks
Define tax (or type of tax, i.e. specific tax), i.e. a levy charged by the government (set
at a constant amount per item)
Diagram showing:
Possible effects:
Accept macro arguments (e.g. tax revenue, budget, growth, jobs, inflation)
Evaluation (6 marks):
Significance of inelastic demand for alcohol, e.g. means tax can be passed onto
consumers, less impact on external costs
Incremental changes in tax may have little impact if consumers adapt to the regular
tax increases (mentioned in extract)
Difficulty setting the tax at the right level to internalise external costs
Different alcohol having different rates of tax (2% increase for all but could be more
significant for spirits as already highly taxed)
Depends on the magnitude of tax increase, e.g. may need to be high magnitude to
reduce demand (mentioned in extract)
Here, KAA is 14 marks. You need to explain the effects, with a diagram, and then evaluate them
to gain the final 6 evaluation marks.
Here the government is imposing a specific tax, i.e. a levy from government
charged to firms at a constant amount per unit.
This has been set at a rate of 2% above inflation, meaning that there will be an
increase in real terms by 2%.
Furthermore, if the price of alcohol was higher then this would discourage
excessive drinking and the external costs associated with it such as crime near
pubs. This is because the higher costs will be passed onto the consumer as 16% of
every pint is tax.
It would also lead to a loss of profits for alcohol sellers, such as beer
manufacturers, as their costs of production would increase. Tax per unit (for
example, 18p for beer in 2011) could mean more job losses and hit UK GDP
growth.
Here the student scores 14/14 marks for KAA. There is clear analysis of the issue with the
diagram and reference to it, as well as some effects explained in the context of a tax on alcohol.
Also, alcohol producers can help minimise the impact of the tax by passing the
burden onto the consumer due to demand being inelastic, as alcohol is a habit
forming good. This means the incidence of the tax falls more on the consumer
(P2ABP1) than the producer (P1BCD) as consumers will not switch away as much
from a habit-forming good like alcohol and profits will not fall as much.
The extract also warned that any reductions in alcohol consumption will be
minimal due to the incremental nature of the tax increase. Alcohol drinkers may
adapt to the marginally higher prices over time rather than switching away and
therefore external costs may not fall.
Overall, due to the inelastic nature of demand for alcohol, this means that
consumers have been hit hardest by the tax, especially those drinkers on low
incomes. They face the burden of higher taxes in the form of an increased price
from producers. While the government may not have reduced external costs, they
still gain a substantial amount of tax revenue to reduce their budget deficit.
Here the student scores all 6 marks for evaluation. The evaluation points are well reasoned and
well contextualised, using the extract to help. To gain the top level there must be a substantiated
judgement, weighing up which economic agents are affected most.
Topic 3
Market failure
Types of market failure
1 2 marks for a correct definition:
Externalities
3 a 2 marks per difference:
Private costs are direct costs to consumers and producers (1 mark) whereas external
costs are costs to third parties/negative spill-over effects (1 mark).
Private costs are costs internal to an exchange (1 mark) whereas external costs are
external to an exchange (1 mark).
Private costs are costs taken into account by the price mechanism (1 mark) whereas
external costs are ignored by the price mechanism (1 mark).
Private benefits are direct benefits to consumers and producers (1 mark) whereas
external benefits are benefits to third parties/positive spill-over effects (1 mark).
Private benefits are benefits taken into account by the price mechanism (1 mark)
whereas external benefits are ignored by the price mechanism (1 mark).
4 1 mark for identification of external benefit or cost and 1 mark for example:
c AEB (or equivalent) (1 mark) as this is the excess of social benefit above social
cost/as this is the welfare that would be gained from moving from Q1 to Q2 (1 mark)
Definition of market failure, e.g. when the price mechanism fails to deliver an efficient
allocation of resources (1 mark)
As the free market equilibrium is below the social optimum (1 mark); reference to
diagram, i.e. Q1<Q2 (1 mark); further explanation of equilibriums, e.g. Q1 at MPC =
MPB and Q2 at MSC = MSB (1 mark).
At the free market equilibrium Q1 social benefit exceeds social cost (1 mark);
reference to diagram, i.e. E is greater than A (1 mark) and therefore welfare can be
gained from moving to the social optimum Q2 (1 mark) equal to AEB (1 mark).
Definition of social benefits (1 mark), e.g. the combination of private and external
benefits
Explanation of any external benefits of London 2012 (up to 3 marks per benefit):
o Improvements in transport
o Tourism
Explanation of any private benefits of London 2012 (up to 3 marks per benefit):
o Some tourists will have stayed away due to the Olympics being on
Long-term versus short-term arguments: short-term gain for tourism but long-term
benefits of transport/reputation of London
Public goods
8 2 marks for a definition, such as:
The free-rider problem is that it is possible for people to consume a good without
paying for it once it is provided (1 mark).
Therefore there is little incentive for producers to provide public goods (1 mark), plus
further explanation (1 mark).
Information gaps
12 Symmetric information is where all parties have the same information (1 mark), whereas
asymmetric information is (a type of imperfect information) where one party has more
information than another (1 mark).
13 a The private dentist has more information (than the patient) (1 mark) because they
have a medical qualification/training (or patients do not have dentistry training) (1 mark).
b The property owner has more information (then insurance company) (1 mark)
because they know their history of losing their phone/how careful they will be with their
phone (1 mark).
14 a
Any reason, e.g. consumers unaware of the health risk/external costs of cigarette
consumption (1 mark)
Definition of asymmetric information, i.e. when one party has more information than
another (1 mark)
Asymmetric information as second-hand car dealers have more information than car
customers (1 mark)
Examples (up to 2 marks for each point if well developed), such as:
Examples (up to 2 marks for each point if well developed), such as:
The OFT is providing guidelines to try to help second-hand car buyers (e.g. providing
questions to ask); this could reduce the information asymmetry in the longer term.
Other policies may help reduce the second-hand car information asymmetry, such as
warranties.
Less likely to be information asymmetry when buying new cars rather than second-
hand cars.
Application (1 mark): application to healthcare, i.e. patients have less information than
doctors.
Asymmetric information means where one party has more information than
another (1 mark). In this case the doctors and medical professionals are the more
informed party and patients the less informed about medical issues (1 mark). This
could lead to exploitation of patients, such as doctors being able to prescribe
unnecessarily to gain more profit (1 mark).
This student scores full marks for a clear definition of asymmetric information in the context of
healthcare markets and goes on to explain one clear problem of this.
b C (1 mark)
2 a A (1 mark)
b Knowledge (2 marks):
External benefits are positive third-party effects (1 mark) ignored by the price
mechanism (1 mark).
The student gains 2 mark for a clear definition.
c Knowledge (1 mark):
The student has clearly indicated the welfare gain triangle for 1 mark.
3 a D (1 mark)
Application (1 mark): application to flood defences, e.g. benefits of flood defences, such
as less chance of flood-damaged housing or one characteristic of public goods applied to
flood defences.
Analysis (2 marks):
Explanation of the free-rider problem (1 mark), e.g. once provided no one can be
excluded from benefiting.
Further analysis (1 mark), e.g. no business can profitably provide the service or this is
an example of market failure or need for government to provide public goods via
taxation.
Public goods are both non-rival and non-excludable (1 mark). They are
underprovided by free markets due to the free-rider problem, as once provided no
one can be excluded from benefiting (1 mark). For example, if residents did not pay
for the flood defence in London, they would still benefit from less risk of their
house being damaged in bad weather (1 mark). Therefore, no business can
profitably provide the service and it will be underprovided (1 mark).
Here the student scores full marks as she has clearly explained what a public good is and then
developed her answer by outlining the free-rider problem and further analysis linked to
underprovision, in the context of flood defence systems.
4 a Knowledge (2 marks):
Social benefits are the addition of private benefits to those involved in the transaction
(1 mark) and external benefits to third parties (1 mark).
Social benefits is the addition of external benefits (benefits to third parties) (1 mark)
and private benefits (benefits to those involved in the transaction) (1 mark).
A clear definition scores the student both marks here.
b Application (2 marks):
= 15.3 × 100
(15.3 + 75.5)
= 15.3× 100
90.8 (1 mark)
c A (1 mark)
For example, if you take a walk outside and breathe clean air, you are not reducing
the amount of clean air available for someone else (1 mark).
For example, no one can be stopped from going outside for a walk and breathing
clean air (even if they have not paid) (1 mark).
The key to this question is to apply the characteristics of a public good to clean air. The
following answer gets 5/5 marks:
Clean air is best considered a public good (1 mark). A public good is both non-rival
(1 mark) and non-excludable (1 mark). Clean air can be considered a public good as
no one can be excluded from benefiting from clean air when they go outside (1
mark) and it is non-rival as someone breathing clean air does not reduce the
amount of clean air available for someone else (1 mark).
= 36.3% − 39.4%
= 3.1% decrease
= 15:1
i 3.1% decrease
ii 15:1, Russia:EU
Here the student gets full marks for the correct answer without any workings.
c KAA = 9 marks
o Visual pollution/eyesore
o Global warming
Evaluation (6 marks):
Long-term trend of coal power stations closing (in the UK) will reduce external
costs.
Long-term nature of many of the impacts, e.g. climate change and global
warming.
This question requires a diagram to gain full analysis marks (9 KAA) with the rest for defining
and explaining external costs of nuclear power. Evaluation (6 marks for two or more points) can
be accessed by thinking of the benefits of coal power, as well as the standard economic
evaluation techniques such as long term versus short term, magnitude and prioritisation of
arguments.
External costs are negative spill-over effects, i.e. costs external to the exchange
ignored by the price mechanism. Here the spill-over effects will be on local
communities who live near the power station; they are the third parties.
In terms of coal-fired power stations there will be atmospheric pollution due to the
carbon dioxide released into the atmosphere from burning coal, which some claim
will increase climate change.
A second external cost will be visual pollution. The extract claims that Country
Life magazine voted the Didcot power station as Britain’s third worst eyesore.
The student easily scores 9/9 marks for KAA with a diagram and explanation of external costs,
well applied throughout to coal-fired power stations.
The external cost from coal-fired power stations should also reduce over time.
This is because the UK government is planning to close a third of them in the next
10 years as it looks to invest in renewable energy. Furthermore, coal-fired power
stations that were opened under the last government have technology to reduce
carbon dioxide emissions, although this is yet to be proven.
Finally, I believe the impact on air pollution has larger impacts than visual
pollution. Although the Didcot power station was voted Britain’s third worst
eyesore, the impact of air pollution could contribute to dramatic global issues,
such as climate change. This will impact on not only this but future generations of
the UK.
The student scores all 6 evaluation marks for three developed points in the context of coal-fired
power stations, taking a critical view of the external costs.
o Cost of materials
o Cost of labour
Evaluation:
Counter points, e.g. planes may become more fuel efficient/quieter and therefore
less external cost or policies could be used to reduce the external costs of flights.
There may also be private benefits, e.g. more flights available for consumers or
more profits for airlines and airports or provision of jobs in construction.
Magnitude of arguments.
Heathrow is London’s main airport, allowing travellers to come into and out of
Britain for a variety of reasons, such as going on holiday and for business reasons.
Currently, the airport is close to full capacity, meaning that in the future it may not
be able to meet all passengers’ needs. Therefore, in recent years there have been
calls to expand Heathrow to meet growing demand for air travel. However, there
are private and external costs associated with this expansion as this essay will
outline before going on to assess the extent of such costs and whether they
outweigh the benefits gained from expansion.
Private costs are costs to first and second parties in an exchange that are taken into
account by the price mechanism. Here the first and second parties are the airports,
airlines and their passengers.
The major private costs of expanding Heathrow will fall on the construction of the
runway itself. First, there will be a need for raw materials to construct the runway,
such as tarmac. Second, there will be a need to pay for workers to design and
build the runway — this would mean the paying of wages and salaries to them.
Finally, there will be the cost of the land itself and the planning permission that is
needed. On top of this the airport may need to pay compensation to local residents
who are affected by the construction or who need to be relocated as a result.
In contrast, external costs are costs to third parties, external to an exchange, that
are not taken into account by the price mechanism. Here third parties could
include local residents, the environment and the impact on the UK economy as a
whole.
The significant external costs of building the runway come in the form of
environmental impacts. First, during the construction of the runway there will be
significant noise and air pollution that will affect local residents and the
environment. Second, even once built, there could still be greater noise and air
pollution from the extra flights that will run from the new third runway. This air
pollution could have a knock-on effect on climate change. Finally, the
construction of the runway could disrupt local nature and habitats if it is
constructed in areas where wildlife and animals previously flourished.
These private and external costs can be illustrated diagrammatically. The diagram
below illustrates the market for flights, assuming there are no external benefits
present (i.e. MPB = MSB). However, external costs are present and are ignored by
the price mechanism. This is because at the free market equilibrium (Qe)
passengers only take into account the private costs and benefits (MPC = MPB). In
contrast, at the social optimum (Q1) society would want them to take into account
the full social costs and benefits (MSC = MSB) and not ignore external costs, such
as the impact on the environment discussed earlier.
This therefore makes the case against the expansion of Heathrow as it would mean
an overconsumption of flights from society’s point of view and a welfare loss of
ABC.
The significance of some costs will be greater than others. For example, the
impact of greater flights and air pollution can have significant impacts on climate
change in the long term in the form of rising sea levels and more severe weather.
However, the private costs themselves will be very much short term and once the
airport has been expanded these costs will have been covered (such as
construction costs and the cost of labour).
Furthermore, the extent to which external costs are an issue will depend heavily
on other policies put in place by policymakers. For example, the government
could put regulations in place in terms of the number of night flights that can be
flown and the fuel-efficiency of planes. These policies would minimise the
external cost of noise pollution for local residents at night, as well as reduce the
impact airlines have in terms of air pollution if they are more fuel efficient.
However, any decision about Heathrow needs to consider not only the private and
external costs but also the private and external benefits. If the social benefits
overall outweigh the social costs then society would gain welfare as a result of
Heathrow’s expansion, rather than the welfare loss shown on the diagram above,
where external benefits were ignored.
Some examples of private benefits (benefits to first and second parties) could
include the increased availability of flights for consumers, and airlines themselves
should be able to make more profits if they meet consumer demand. Moreover, in
the construction process itself there is greater employment for these workers and
incomes. In terms of external benefits, there could be a significant boost to the UK
economy in terms of extra trade, tourism, growth and positive multiplier effects
helping boost GDP further.
In conclusion, there are likely to be not only private and external costs, but also
private and external benefits from the expansion of Heathrow and their
significance needs to be quantified. Therefore, the government is likely to
undertake a cost–benefit analysis before making any decision to expand
Heathrow. It would be sensible to compare this to other projects, such as
improving other forms of transport, expanding other UK airports or creating new
airports like the one proposed on the Thames Estuary (Boris Island). This will not
be without difficulties as putting a precise monetary value on social costs and
benefits is difficult, such as the value of the environment, and many estimates may
have a large margin for error, like the cost of building the runway or the actual
increase in GDP from an expanded Heathrow. In my opinion, it is likely that such
airport expansion is likely to go ahead as there is now cross-party support but this
may be due to political short-termism, i.e. looking to gain a stronger economy in
the coming years and neglecting the longer-term issues like climate change that
will span current and future generations.
This student’s essay will gain 25/25 marks.
This is because in terms of analysis there is clear logical reasoning, drawing on precise
knowledge of economic models (such as externality theory). It is also applied throughout to the
context, using relevant examples (16/16 marks).
In terms of evaluation, all judgements made are backed up with solid reasoning and well
embedded in the context of Heathrow. There is a clear critical look at the private and external
costs (e.g. using methods such as long term versus short term and counter-points), as well as
looking at different points of view (e.g. the view that Heathrow could have benefits as well as
costs). The conclusion shows an informed judgement, drawing on the analysis presented and is
well backed up (9/9 marks).
Topic 4
Government intervention
Government intervention in markets
1 1 mark for any relevant solution. Possible answers include:
2 Explanation of how the method reduces external costs, 1 mark for each point (up to 3
marks max. for each part of question):
Can limit amount of air pollution from air travel (1 mark) by restricting the number of
permits (1 mark).
Incentive for airlines to invest in renewable energy (1 mark) and then sell permits (1
mark).
Permits may increase costs for firms (1 mark) and therefore cause higher prices for
consumers, lowering demand (1 mark).
Regulations on night flights (1 mark) and levels of noise during take-off and landing (1
mark) would reduce noise pollution for local residents (1 mark).
Regulations likely to increase costs for firms (1 mark) and therefore cause higher
prices for consumers, lowering demand (1 mark).
This increases the costs of production for airlines (1 mark), so they may pass these
costs onto the consumer in terms of higher prices (1 mark).
Higher airline prices will deter people from flying and reduce external costs (1 mark)
as they switch to alternative forms of transport, like high-speed rail (1 mark).
The subsidy will lower costs of production for train companies (1 mark).
This will lower the price of train journeys (1 mark) and consumers will switch away
from air travel to train journeys (1 mark).
This will lower external costs of air travel due to fewer flights/will lower external costs
as trains are more environmentally friendly (1 mark).
A price set by the government which a good/service cannot fall below (2 marks).
6 a
Reason for revenue drop (1 mark + 1 mark), e.g. lower price due to maximum price
legislation or lower quantity as less incentive due to supply at lower price
Lower penalty charges, i.e. will never pay more than twice/limit on charges to £15
Consumers may need to switch to other high-rate options (loan sharks) if no payday
loans available
Government failure
9 1 mark for a definition, 1 mark for any relevant example:
Any example, e.g. excess supply caused by the common agricultural policy (1 mark).
Unintended consequences
Information gaps
11 Analysis (6 marks):
Define government failure, i.e. when governments intervene to solve market failure
but it results in a further misallocation of resources and a net welfare loss (1 mark).
Analysis (1 mark): further development, e.g. permits can then be traded between firms or
fines are given to firms that do not have enough permits or aims to reduce external costs
of pollution or attempt to solve environmental market failure.
b A (1 mark)
2 a Application (2 marks)
The excess demand is calculated as demand (5.4 million) minus supply (4.8
million). This leaves 0.6 million excess demand.
The student here scores full marks for a clear, worked-out answer.
Switch to markets (1 mark) where they can earn more profits (1 mark)
One impact on producers from the maximum rent will be a fall in revenue (1 mark).
This is because there is a lower maximum rental price, so any property they rent
now earns them less total revenue (1 mark).
A clear impact identified and explained earns the student 2 marks for this question.
c D (1 mark)
For each limitation, 1 mark for identification, 1 mark for application and 1 mark for
development. Possible answers include:
Consumers may have inelastic demand for junk food and not switch.
For this question the key is to identify two problems with the regulations and explain them in the
context of publishing calories on menus.
One limitation of the regulations would be that not all customers will understand
what the calories on the menu mean (1 mark). Therefore, consumers may not know
how many calories they should consume in a day and still consume at similar
levels as before (1 mark). The government may need to provide education for
consumers but this will cost money to provide (1 mark).
A second limitation of the regulation is the cost to firms (1 mark). It will cost firms
to research the calories in each meal and change their menus (1 mark). This will
reduce the profit of firms and could have knock-on effects on employment and tax
revenue for the UK economy (1 mark).
b KAA = 6 marks
Evaluation (4 marks):
Depends on the reliability of research/hard to tell if the tax is a success from small
amount of research/as tax was only in place for a year.
Magnitude of arguments, e.g. research showed that 48% of Danes doing some cross-
border shopping.
NB Allow students to argue that it is not government failure as analysis and then to evaluate that
point of view.
Government failure evaluation questions will often get you to assess the evidence of
government failure and success of a particular policy, applied to a particular market. Using the
case study is therefore essential.
One reason why there could be government failure is the existence of secondary
markets. Nearly 50% of Danish shoppers have engaged in cross-border shopping
and therefore they have continued to buy high-calorie foods and the external costs
associated with them.
This will also mean lower tax revenue. This is because shopping takes place
outside of the country and shoppers are avoiding the tax in Denmark. This lower
tax revenue will impact on the Danish economy as less will be available to spend
on public services, such as healthcare and education.
The student provides knowledge of government failure via a definition and identification of
causes of government failure before explaining them in context, easily achieving 6/6 KAA marks.
However, the tax should reduce external costs of people who continue to shop in
Denmark. Indeed, Extract 2 estimates that in the first few months consumption of
high-calorie foods was down 10–20% on the previous year. This would be a sign
of government success.
Overall, it may be hard to tell if the Danish food tax was government failure as it
was only around for one year. This means the amount of research into its effects
may be limited and even the research that is conducted may or may not be
representative of the whole Danish population.
The student gains all 4 evaluation marks for two developed points in the context of the Danish
fat tax. The student’s answer recognises different points of view to come to a reasoned, critical
conclusion.
= 2%/−10%
= −0.2
= 8%/−10%
= −0.8
d KAA = 9 marks
Application:
A drop in the price of healthy food should lead to a drop in demand for junk food
Subsidy diagram:
Evaluation (6 marks):
Healthy and unhealthy food may be weak substitutes (low positive XED)/as
consumers are addicted to junk food/have inelastic demand for unhealthy food
Subsidising healthy food may mean consumers have more money to spend on
unhealthy food/research suggested that consumption of both healthy and unhealthy
food may rise/although only one study so may not be accurate
Would other solutions be better at reducing demand for unhealthy food? e.g. tax/with
justification
For a subsidy question it is important to draw an accurate demand and supply diagram. This
question also requires reference to cross-price elasticity of demand to help analyse the impact
on junk food. Evaluation marks can be accessed by discussing the limitations of such a scheme
and using the usual evaluation toolkit. Again, there are often some hints in the case study, which
can be developed into strong, developed evaluation points.
A 10% reduction in price from the subsidy will increase consumption of fruit and
veg by between 2 and 8% and therefore reduce the demand for junk food. This is
because products like burgers and fruit are substitute snack foods for consumers
with a positive XED value.
The student gains full marks for analysis due to excellent use of theory via definitions and
diagrams, as well as strong application to the case study.
However, research has suggested that because the subsidy reduces the price of
healthy food, then this leaves consumers with more money to buy junk food. This
could mean that the subsidy has an unintended effect of increasing the calorie-
content of an overall shopping basket.
Furthermore, the subsidy itself will cost the government money to fund ($300m a
year). This money could have been used to fund other solutions to unhealthy
eating, such as an advertising campaign promoting healthy eating. There is an
opportunity cost.
Finally, it may not be the case that consumers switch between healthy and junk
food as they are weak substitutes. This is because some consumers may be
addicted to unhealthy food and will not switch due to having price inelastic
demand.
The student scores all 6 evaluation marks for three developed, critical, applied points.
e KAA = 14 marks
Define minimum price, i.e. a floor price/a price set by the government that it cannot
fall below.
Application, e.g. aim to drive up the price of fatty/sugary foods or examples of foods
it will be applied to, such as burgers/fizzy drinks or application to external costs of
obesity.
Diagram:
Possible effects:
o Increase/expansion in supply
o Decrease/contraction in demand
o Excess supply
o Higher price
Evaluation (6 marks):
Would not discriminate between nutritious food which is high in calories and
sugar-dense sweets and drinks, as indirect taxation could.
No impact if minimum price set too low, i.e. below the equilibrium price.
Would other solutions be better than minimum price (e.g. subsidies for healthy
food)/would it work well with other solutions (e.g. education about healthy diets)?
This question requires a relevant diagram to aid your analysis. For economic effects questions,
remember these can be both positive and negative, then these can be evaluated to get the final 6
marks.
A minimum price is a floor price. Here the minimum price is on high-calorie foods
in order to discourage consumption of fatty and sugary foods such as fizzy drinks.
One impact of the minimum price would be excess supply. This is because with a
higher price for high-calorie food consumers will contract their demand but
producers will expand supply.
However, the minimum price will have no impact if it is set too low. If the
minimum price is set below the equilibrium price then the price will remain the
same. This means that consumption of unhealthy food would remain at the same
level.
Finally, demand for some high-calorie food, such as high-street takeaways, may
have inelastic demand. This means that these consumers won’t switch to low-
calorie food even if the price of high-calorie food increases. The impact on
external cost reduction will be minimised, although so will the excess supply.
Overall, for the scheme to be effective it must be set high enough to switch
behaviour of consumers, who may be addicted to junk food. This, coupled with
subsidising alternatives and educating shoppers about calories, will allow
consumers to switch away from junk food as they would have a cheaper
alternative and understand the need for a healthier lifestyle. Without an integrated
approach, simply pushing the price up won’t work and will certainly hit the
poorest and most vulnerable in society most.
Here the student easily gets full evaluation marks for two developed, applied points. Students
must make a substantiated judgement to gain full evaluation marks, which is given in the final
paragraph.
Evaluation:
Will congestion charge change behaviour, e.g. if PED for car journeys is inelastic or if
cars and public transport are weak substitutes or will consumers avoid paying the
charge?
Long-term versus short-term impacts, e.g. long-term taxes can be invested in public
transport by the government or over time more consumers may have time to switch
Counter-points, e.g. consumers may use the tube or public transport and still shop in
London or will they be able to solve market failure if exact external costs figure is
unknown? or government may gain revenue but cost of implementing scheme
Other factors, e.g. other factors affect the cost of motoring, such as petrol prices or
other factors impact on government budget (e.g. austerity cuts)
The diagram above shows the market for travelling to London by car, assuming no
external benefits. Before a congestion charge is imposed, motorists will decide on
the number of journeys they will take based on the private cost of motoring (e.g.
fuel, car insurance) and the private benefits (e.g. of a convenient journey).
Therefore the market equilibrium is at Qe, where MPC = MPB.
However, motorists ignore the external costs of travelling by car (e.g. congestion,
air pollution). Society would want them to take into account the full social costs
and benefits in their decision making, i.e. setting MSC = MSB, as at Q1. This
means from society’s point of view there is overconsumption of car journeys into
London and a welfare loss of ABC.
The rationale of the congestion charge is to increase the marginal private cost of a
journey, i.e. shifting MPC to the left. This is because motorists would now have to
pay an extra charge to go to London, typically £10. This would therefore
internalise the negative externality of driving to London and drivers would be
forced to take this into account. This has several economic effects.
First, setting the congestion charge equal to the external cost would solve the
market failure and motorists would drive the socially optimum amount into
London (at Q1) and eliminate the welfare loss. Due to this there would be a
reduction in the external costs imposed on society, such as traffic jams, air
pollution and the impact those extra car journeys would have on climate change.
However, the effectiveness of the congestion charge depends on how many people
will be willing to switch their behaviour and stop driving to London. Some drivers
will have very price inelastic demand, especially those on higher incomes, and
may continue to drive and just pay the congestion charge. This may especially be
the case if they believe cars and public transport are weak substitutes (with a low,
positive XED), as buses and trains take longer or are less comfortable and
convenient. If this is true and few drivers switch, the congestion charge may not
lead to the social optimum being reached and some welfare loss may remain or the
charge will need to be increased to achieve it.
Second, the government would benefit from higher revenue from the congestion
charge. Those who continue to go into London will be paying the congestion
charge. This means the government could use this money to fund improved public
transport — for example, meaning more Londoners would be able to switch to
public transport in future.
However, there are costs of implementing the scheme for the government too in
terms of monitoring and enforcing the scheme, such as licence place recognition.
This means some of the revenue may be spent on this rather than improving public
services, such as public transport. Even with such enforcement schemes being in
place, there may be some motorists who manage to get away with avoiding the
tax, which would reduce the revenue the government gains too.
Finally, there is an impact on London businesses. If people are unable to drive into
London, there may be fewer customers willing to purchase their goods and
services. This is especially the case with the rise of online shopping on sites such
as Amazon. Therefore revenue could fall for these firms and therefore profits too.
However, the congestion charge has been altered in recent years to cover a smaller
area and therefore the impact on businesses in this area may not be as great.
In conclusion, the impact that the congestion charge has fundamentally depends
on how motorists respond. Many on higher incomes may continue to use their car
if it is more convenient as the charge will make up a small percentage of their
income. However, some will be happy to switch to public transport, such as
shoppers getting the tube to Oxford Circus. However, policy makers can play a
part here by using revenue gained not only to enforce the scheme better but to
make public transport a viable alternative by spending on this. Therefore, in the
long term the problem of congestion will hopefully be solved and businesses will
not be negatively impacted if shoppers can get to their stores conveniently without
the use of a car.
This student gains the full 25/25 marks.
In terms of analysis there is detailed knowledge of externality and tax theory, including a
diagram, to illustrate the impacts of the congestion charge. There is also very good use of
context, with analysis paragraphs covering a range of factors, all well embedded in the context
of London travel, to gain the application marks (16/16 marks).
Evaluation is critical and gives opposing viewpoints with sound reasoning and use of theory
(e.g. PED, XED) to assess whether all drivers will switch and whether governments and
businesses will be affected as first thought. This leads to a well-considered conclusion, drawing
from the analysis and the context of London travel, to give an informed opinion about the
congestion charge and what its success depends on (9/9 marks).