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Pearson Edexcel
Level 3 GCE

Economics A
Advanced Subsidiary
Paper 1: Introduction to Markets and Market Failure

Monday 15 May 2017 – Morning Paper Reference

Time: 1 hour 30 minutes 8EC0/01

You do not need any other materials. Total Marks

Instructions
• Fill
Use black ink or ball-point pen.
• centrein the boxes at the top of this page with your name,
number and candidate number.
• Answer
There are two sections in this question paper.
• In SectionallB,questions in Section A.
• Answer the questions
answer all of questions 6(a) to 6(e) and one question from 6(f) or 6(g).
• – there may be more space in the spaces provided
than you need.

Information
• The
The total mark for this paper is 80.
• – usemarks for each question are shown in brackets
this as a guide as to how much time to spend on each question.
• Calculators may be used.
Advice
• Read each question carefully before you start to answer it.
• Check your answers if you have time at the end.

Turn over
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P49600A
©2017 Pearson Education Ltd.
*P49600A0124*
1/1/1/1/e2
 SECTION A
Answer ALL questions. Write your answers in the spaces provided.
Some questions must be answered with a cross in a box . If you change your mind about an
answer, put a line through the box and then mark your new answer with a cross .
You are advised to spend 25 minutes on this section.
Use the data to support your answers where relevant. You may annotate and include diagrams
scarcity in your answers.
opportunity cost
1 The production possibility frontier for an economy is shown in the table below.

Capital goods output Consumer goods output

Opportunity cost
(million units) (million units)

0 42 –

10 40

20 36

30 30

40 22

50 12

60 0

(a) Explain, using marginal analysis from the table above, the concept of opportunity
cost. (You may use the last column in answering the question.)
(3)
opportunity cost: the best alternative forgone
PPC: the curve shows the maximum amount of output combination of two goods in an economy when all
its resources are fully and efficienly employed.

due to the limitation of resuorces, the opportunity cost of producing more capital goods is the resources
sacrified to produce consumer goods. as can be showned in the table, the opportunity cost is increasing
from 2 millions units to 12 millions units sonsumers goods lost.

2
*P49600A0224*
. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

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(b) Which one of the following is the most likely effect of an economy producing
more capital goods?
(1)
A Reduced specialisation of labour
B A shift in the production possibility frontier
C A reduction in marginal utility
D A shift in demand for consumer goods

(Total for Question 1 = 4 marks)

*P49600A0324*
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2 The table below shows UK wheat production between 2010 and 2015.

Index numbers of wheat

Wheat production
Year production
(‘000 tonnes)
(2010 is base year)

2010 14 878 100

2011 15 257

2012 13 261

2013 11 921 80.1

2014 16 606 111.6

2015 16 129 108.4

(Source: adapted from https://www.gov.uk/government/uploads/

system/uploadsattachment_data/file/466383/farming-
statistics-2015-wheat-and-barley-production-uk.pdf )

(a) Define the term ‘base year’.

(1)
the year with which all other values in series are compared. (benchmark year)
. . . . . . .. . .. ............ .... ... ... .. ............. ... ... . . . .. . .. . . . .. . .. . . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . .. .. .. .. .. ... . ... . ... . ... . ... . ... . ... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .... .. .... .... .... .... .... .

. . . . . . .. . .. ....... ...... .... .. ... .. ............. .. . .. . . . . .. . . . . . . .. . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . ... .. .. .. .. .. .. .. .. .. .... .. .. .. .. ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . ... . .. .... .... .... .... .... .

(b) Calculate the index numbers for 2011 and 2012, using 2010 as the base year.
(2)

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

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. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

(c) The percentage change in wheat production from 2014 to 2015 was:
(1)

A 0.03
B –2.87
C –2.95
D –477

(Total for Question 2 = 4 marks)

4
*P49600A0424*
3 In 2015 the UK government cut subsidies for the installation of solar energy panels.
(a) Define the term ‘subsidies’.
(1)

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

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(b) The most likely effect of cutting subsidies for the installation of solar panels is to:
(1)
A increase producer surplus
B decrease the provision of public goods non rival non excludable
C decrease consumer surplus
D increase government expenditure
太阳
(c) Annotate the diagram below to show the effect of removing the solar panel
installation subsidy on the equilibrium price and quantity.
(2)

Solar panel installation market diagram

Price of
solar
panels supply

Pe

demand
Quantity of
0 Qe solar panels

(Total for Question 3 = 4 marks)

*P49600A0524*
5
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4 The excess supply of carbon steel has recently caused its global price to fall below
$530 per tonne.
(Source: adapted from http://www.meps.co.uk/allproducts%20steel%20price.htm)

(a) Explain how the price mechanism responds to excess supply in a free market.
(3)
in a free market, the price of $530 is above equibrium price P2 and it cannot last. this is because at $530,
a signal would be sent to steel producers that price are too high. stock of steels. there is an incentive for
producer to liquidate stocks and make more profits by lowering price from 530 to P2 causing an extension
of demand from Q1 to Q2, and a contraction of supply from Q3 to Q2, rationing the exess supply.
equilibrium is formed at P2Q2.

6
*P49600A0624*
Steel production leads to high levels of carbon emissions.
(b) Which one of the following is likely to result in an increase in carbon emissions?
(1)
A Introducing a tradable pollution permits scheme
B Shutting down steel factories
C Subsidising the steel industry to install cleaner technology
D Reducing indirect taxes on steel products

(Total for Question 4 = 4 marks)

*P49600A0724*
7
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5 Universities UK raised concerns about the proposal to reduce the maximum tuition
fees (fee cap) for undergraduate courses in England from £9 000 to £6 000. It
stated “This unfunded proposal to reduce the fee cap would damage the quality of
experience our universities could deliver to students and remove opportunities for
those seeking to benefit from a university education”.
(Source: adapted from tuition fees 2015 Times letter Universities UK
http://www.universitiesuk.ac.uk/highereducation/
Pages/UUKboardFeesLetter.aspx#.VjoQRbfhDIU)

(a) Explain why reducing the tuition fee cap may result in excess demand for
university places.
(3)

according to the figure, tuition fee reduced from 9000 to 6000, causing an extersion of demand from Q3
to Q4 and a contraction of supply from Q4 to Q1 as a result, a shortage XY occured.

univercities now more afforable for some applcants. However, the quality of experience of univiersites
may be damaged due to lack of fund(cash) such as closing down some departments.

8
*P49600A0824*
(b) Which one of the following statements is correct?
(1)
A The marginal social benefits exceed the marginal private benefits from
university education
B University education is an inferior good
C University education is a public good
D The social optimum equilibrium quantity is less than the market
equilibrium quantity for university education

(Total for Question 5 = 4 marks)

TOTAL FOR SECTION A = 20 MARKS

*P49600A0924*
9
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 SECTION B
Read Figure 1 and the following extracts (A and B) before answering Question 6.
Answer ALL Question 6 (a) to 6 (e), and EITHER Question 6 (f) OR Question 6 (g).
You are advised to spend 1 hour and 5 minutes on this section.
Question 6
The market for cigarettes
Figure 1: Price elasticity of demand - a comparison between tobacco and
e-cigarettes

Price of packet of 20 Price of

tobacco cigarettes
£7.70–£9.50
Average price per
tobacco cigarette
48p
Price elasticity of demand
for tobacco cigarettes
–0.35
e-cigarette kit
£9.99–£19.99
Single cigarette equivalent
price of an e-cigarette
7p
Price elasticity of demand
for e-cigarettes
–1.9

(Source: adapted from https://www.blucigs.co.uk/united-kingdom/kits/all-kits)

10
*P49600A01024*
Extract A
Government intervention on tobacco
There was a time when smoking was fashionable. Television and magazine
advertisements glorified smoking. Everyone from your dad to your doctor smoked in all
places – cars, restaurants and even hospitals.
Tobacco is still the single biggest cause of cancer in the world and the leading cause
of preventable deaths. Nearly 80% of the 1 billion smokers worldwide live in low- and 5
middle-income countries.
Bans on tobacco advertising, promotion and sponsorship can reduce tobacco
consumption. Comprehensive smoking bans covering indoor workplaces, public places
and public transport have been introduced in 48 countries.
Tobacco taxes are the most cost-effective way to reduce tobacco use, especially among 10
the young and people in low-income groups. A tax increase that raises tobacco prices by
10% decreases tobacco consumption by 4% in high-income countries and 5% in low- and
middle-income countries.
However, some 8 million people are expected to die each year by 2030 – because they
have smoked tobacco or have been exposed to passive smoking. The use of alternative 15
products such as electronic cigarettes (e-cigarettes) are gaining in popularity but
information about their effects is uncertain. Little research has yet been done about
the long-term health effects of e-cigarettes and the nicotine dispensed by e-cigarettes
is highly addictive. The illegal tobacco market still counts for 1 in every 10 cigarettes
consumed globally. In addition, tobacco companies still spend tens of billions of dollars 20
each year on advertising and promoting tobacco products and sponsoring events. They
continuously challenge the regulatory measures governments are taking.
(Source: adapted from http://www.who.int/topics/tobacco/en/ and http://www.who.int/
mediacentre/commentaries/reducing-tobacco-use/en/)

*P49600A01124*
11
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Extract B
Free market approach
Are free markets incompatible with good health? If the solution to every problem
involves banning advertising, raising prices and restricting availability, you might easily
conclude that the free market is the disease and government regulation is the cure. From
this perspective, the providers of food, alcohol and tobacco are determined to push the
most unhealthy products on the public at the lowest prices. 5

Contrary to this viewpoint, the profit motive is not unhealthy. Businesses have an obvious
incentive to keep their customers alive and customers have a strong incentive to seek out
healthier options. Any company that can make a scientifically sound health claim gains
a competitive advantage over its rivals. Health sells. In contrast, government regulation
can lead to negative health outcomes. Markets can correct themselves long before 10
government failures are even acknowledged. Over a million Britons, almost all of whom
are smokers or ex-smokers, use e-cigarettes, as a less hazardous product than cigarettes
and yet e-cigarettes face increased regulations and in many countries they are banned.
It is neither consistent nor ethical to prevent smokers from switching to much safer
alternatives. Efforts to regulate e-cigarettes are a far greater threat to public health than 15
the products themselves.
We argue that the interests of consumers are nearly always better advanced by the
provision of accurate information and free choice than by prohibitions and regulations.
The government policy of small but steady tax rises on tobacco and ever-larger warning
labels is becoming less effective and leads to unintended consequences. 20

(Source: adapted from http://www.iea.org.uk/blog/free-market-solutions-in-health-

should-be-allowed-to-flourish, Christopher Snowdon, 11th July 2013)

12
*P49600A01224*
6 (a) Explain why ‘bans on tobacco advertising’ (Extract A, line 7) may result in a
decrease in the revenue of tobacco firms. Include a supply and demand diagram
in your answer.
(5)
(b) With reference to the information provided and your own knowledge, assess the
view that tobacco consumers switching to e-cigarettes is an example of rational
behaviour.
(10)
Tobacco cigarettes and e-cigarettes are considered to be substitutes.
(c) Explain how changes in the price of tobacco cigarettes may affect the demand for
e-cigarettes over time.
(6)
(d) With reference to Extract A, lines 11–13, calculate the price elasticity of demand
for tobacco cigarettes in high-income countries and in low-middle-income
countries. You are advised to show your working.
(4)
(e) With reference to Figure 1, assess the likely reasons for the difference in price
elasticity of demand for tobacco cigarettes and e-cigarettes.
(15)
EITHER
(f ) Evaluate the possible advantages of a free market approach to cigarette
consumption.
(20)
OR
(g) Evaluate the impact of government intervention in the cigarette market.
(20)

*P49600A01324*
13
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6 (a) Explain why ‘bans on tobacco advertising’ (Extract A, line 7) may result in a
decrease in the revenue of tobacco firms. Include a supply and demand diagram
in your answer.
(5)
bans on tobacoo advertising may decrease demand for the tobacoo form D to D1, causing a decrease in 　

quantity trade from Q toQ1 ande price decline from P to P1.

total revenu of tobacoo firms decline from PAQ0 to P1AQ1.
ａｃｃｏｒｄｉｎｇ ｔｏ ｔｈｅ ｌｉｎｅ ７， ｔｏｂａｃｏｏ ｃｏｎｓｕｍｐｔｉｎｇ ｃｏｕｌｄ ｂｅ ｌｉｍｉｔｅｄ ｂｙ Ｂａｎｓ ｏｎ ｔｏｂａｃｏｏ ａｄｖｅｒｔｉｚｉｎｇ， ｌｅａｄｉｎｇ
　

ｔｏ ａ ｄｅｃｒｅａｓｅ ｉｎ ｔｏｂａｃｏｏ ｆｉｒｍｓ．

14
*P49600A01424*
 (b) With reference to the information provided and your own knowledge, assess the
view that tobacco consumers switching to e-cigarettes is an example of rational
behaviour.
(10)
switching to e-cigarettes is a rational behavior of consumers. because they try to maximze their 　

ecomomic welfare and they are able to assess the economic costs and benefits to themselves of making 　

alternative chioces. firstly, smokers are rational to use the limited income to maximum the posible 　

satisfaction of their wants. they buy less of the product when its price rises as they are able to increase 　

their utility by siwtching their spending to cheaper goods. according to the abstract, a 10% rise in 　

tobacco price causes a decrease in tobacco consumption by 4% and 5% in high income countries and 　

in low and middle income countries respectively. secondly, these consumers try to make chioces which 　

will provide them with greatest benefits. according to the extract B, consumers have a strong incentive 　

to seek out healthier options and firms can be succesfully trusted by consumers only they can make a 　

sound health claim scientifically. thirdly, consumers realized that their utility may not be maximized 　

anymore even though they use e-cigarettes as a less hazrdous product as e-cigarettes faced increased 　

regulaion from the government.

However, switching to e-cigarettes may not be a rational behavior of consumers. because there is 　

bounded rationality. firstlu, smokers may lack information and computational skills to accurately 　

assess full costs and benefits of switching. switching. even they can gain information,-the information 　

may be imperfect, unclear, missing and not equally between two parties or too complex leading to an 　

irrational decision being made. +herding 　

Also, in the long run, more firms will enter into the market due to the profit motives. As 　

a result, competition may become fiercer, this can make firms produce higher quality e-
cigar with lower prices as they must reduce the costs of production as possible as they 　

can, raising consumer surplus.

In addition, dynamic efficiency could be achieved. Because firms which gain high profits 　

may reinvest back into the company in the form of R&D, leading to more innovated e-
cigar could be produced, such as a safer e-cigar with less nicotine, leading to an improvement of 　

consumer's healthy. furthermore, firm competitive market means no govornment intervention to disort 　

market outcomes, which could reduce society welfare and could creat shortages/surpluses. this is 　

because the effect of government involvement when markets are allocating resources well is 　

inefficiency, deadweight wlefare losses and govornment failure. as a consequence, one of the biggest 　

benefit of free market is that individual have liberty and are free to make their own choices without 　

coercion or undue paternalism by the government. the risk pf government failure is that the state 　

officals often lack information when setting policies tointervene in a market resulting in destructive 　

unintended consequences, where costs of intervention outweight the benefits.

however, there may be an over production and over consumption in free market due to the negative
externality without government intervention. because in a free market, individual e-cigar producers
only consider their private costs of production, they ignore the full social cost of their actions(the
negative externalty in the form of costs to the thrid party0 due to self-interests.
.
Dynamic efficiency(动态效率)
Allocative efficiency(配置效率)
productive efficiency(生产效率)

*P49600A01524*
15
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 Tobacco cigarettes and e-cigarettes are considered to be substitutes.
(c) Explain how changes in the price of tobacco cigarettes may affect the demand for
e-cigarettes over time.
(6)
cross elasticticity of demand is a measaue of the responsiveness of quantity demand of one 　

good to a change in price of another good. the XED between tobacoo cigarettes and e-
cigarettes is positive because there are substitudes. due to the substitutability, the increase in 　

the price of troditional cegarettes will lead to an increase in quantity demand of e-cigarettes.

imposing indirect tax on tobacoo may increase the costs of production, so supply of tobacco
may decrease from S to S1, leading to an increase in tobacco price from P to P1 and a fall in
quantity traded from Q to Q1.
as a result, demand for e-cegarette may increase due to an increase in the price of tobacco,
for ther are substitudes.
according to the article, a 10% rise in the price of tobacco cigarettes may lead to a greater
persentage increase in demand for e-cigarettes as they are close substitutes as they both
offer nicotine. which is highly addicitive,

16
*P49600A01624*
 (d) With reference to Extract A, lines 11–13, calculate the price elasticity of demand
for tobacco cigarettes in high-income countries and in low-middle-income
countries. You are advised to show your working.
(4)
High-income countries

-0.4

Low-middle-income countries

-0.5

*P49600A01724*
17
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 (e) With reference to Figure 1, assess the likely reasons for the difference in price
elasticity of demand for tobacco cigarettes and e-cigarettes.
(15)

18
*P49600A01824*
. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

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*P49600A01924*
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EITHER
(f ) Evaluate the possible advantages of a free market approach to cigarette
consumption.
(20)
OR
(g) Evaluate the impact of government intervention in the cigarette market.
(20)
Indicate which question you are answering by marking a cross in the box . If you change your
mind, put a line through the box and then indicate your new question with a cross .

Chosen question number: Question 6(f) Question 6(g)

Write your answer here:
(g)
Ａ ｍｏｎｏｐｏｌｙ ｍａｙ ｅｘｉｓｔ ｗｈｅｒｅ ｔｈｅｒｅ ｉｓ ｏｎｅ ｄｏｍｉｎａｎｔ －ｃｉｇａｒ ｐｒｏｄｕｃｉｎｇ ｆｉｒｍｓ ｗｉｔｈｏｕｔ 　

ｇｏｖｅｒｎｍｅｎｔ ｒｅｇｕｌａｔｉｏｎ． Ｐｒｏｆｉｔ－ｍａｘｉｍｉｚｉｎｇ ｍｏｎｏｐｏｌｉｓｔ ｗｏｕｌｄ ｕｓｅ ｉｔｓ ｐｏｗｅｒ ｔｏ ｅｘｐｌｏｉｔ 　

ｃｏｎｓｕｍｅｒｓ ｂｙ ｃｈａｒｇｉｎｇ ｅｘｃｅｓｓｉｖｅｌｙ ｈｉｇｈ ｐｒｉｃｅｓ ｏｆ ｅ－ｃｉｇａｒ（ｐｒｉｃｅ ｂｅｙｏｎｄ ｍａｒｇｉｎａｌ ｃｏｓｔ），

ｒｅｓｕｌｔｉｎｇ ｉｎ ａ ｄｅａｄｗｅｉｇｈｔ ｌｏｓｓ ｏｆ ｂｏｔｈ ｃｏｎｓｕｍｅｒ ａｎｄ ｐｒｏｄｕｃｅｒ ｓｕｒｐｌｕｓ ｉｎｄｉｃａｔｅｄ ｂｙ ｔｈｅ 　

ｔｒｉａｎｇｌｅ ｉｎ ｔｈｅ ｄｉａｇｒａｍ ｂｅｌｏｗ． Ｔｈｅ ｍｏｎｏｐｏｌｉｓｔ ｗｏｕｌｄ ｐｒｏｄｕｃｅ ｗｈｅｒｅ ＭＲ＝ＭＣ ａｔ 　

ｑｕａｎｔｉｔｙ Ｑｍ， Ｐｍ ｒｅｓｕｌｔｓ． Ｔｈｅ ｐｒｉｃｅ ｉｓ ｍｕｃｈ ｈｉｇｈｅｒ ｔｈａｎ ｔｈｅ ｃｏｍｐｅｔｉｔｉｖｅ ｐｒｉｃｅ ｏｆ Ｐｃ ｔａｋｅｎ 　

ａｔ ａｌｌｏｃａｔｉｖｅ ｅｆｆｉｃｉｅｎｃｙ ｗｈｅｒｅ ｄｅｍａｎｄ（ＡＲ） ｍｅｅｔｓ ｓｕｐｐｌｙ（ＭＣ）． ｑｕａｎｔｉｔｙ ｐｒｏｄｕｃｅｄ ｉｎ ｔｈｅ 　

ｍａｒｋｅｔ ｉｓ ｂｅｌｏｗ ｔｈｅ ｓｏｃｉａｌ ｏｐｔｉｍｕｍ ｌｅｖｅｌ ｏｆ ｏｕｔｐｕｔ ａｔ Ｑｍ ｒａｔｈｅｒ ｔｈａｎ Ｑｃ ａｎｄ ｈｅｎｃｅ 　

ｔｈｅｒｅ ｍｕｓｔ ｂｅ ａ ｍｉｓａｌｌｏｃａｔｉｏｎ ｏｆ ｒｅｓｏｕｒｃｅｓ， ａｌｌｏｃａｔｉｖｅ ｉｎｅｆｆｉｃｉｅｎｃｙ ａｎｄ ａ ｗｅｌｆａｒｅ ｌｏｓｓ ｔｏ 　

ｓｏｃｉｅｔｙ． Ｉｎ ａｄｄｉｔｉｏｎ， ｍｏｎｏｐｏｌｙ ｆｉｒｍｓ ｍａｙ ｕｓｅ ｔｈｅ ｐｏｗｅｒ ｔｏ ｉｎｆｌｕｅｎｃｅ ｔｈｅ ｍａｒｋｅｔ ｉｎ ｔｈｅ 　

ｆｏｒｍ ｆ ａｄｖｅｒｔｉｓｉｎｇ ａｎｄ ｐｒｏｐａｇａｎｄａ． the imformation cannot be equally shared betweeen 　

two parties(e-cigar produser and consumer). for instance, consumers may look to buy poor 　

quality e-cigar with high nicotine as they do not have full information over the e-cigar's 　

quality, information possessed purely by the seller. the end result is consumers making 　

irrational decision, over consuming where their total benefit is not being maximized.
therefore, too many resources being allocated to such markets causing a misallocation of 　

resources.

an indirect tax will increase the cost of production for cigarette producers shifting the 　

MPC curve from MPC to MPC+tax. the price increases in the market from P1 to P2 and
due to the law of demand, consumption is discouraged, decreasing quantity from Q1 to
Q2, the socially optimum level of output. the externality generated by the cigar had now
fully internalized with overconsumption and overproduction issues now solved. there is no
longer a misllocation of resources and hence welfare is now maximized due to this
intervention.

however, demand for cigar may be price inelastic. this is because cigar may be addictive
and there are not many sustitutes available. according to the carticle......therefore, as price
increase, quantity decreases from Q1 to Q2 due to the law of demand, but
proportionatety less than the price increase from P1 to P2. the decrease in quantity will
help to reduce the misalocation of resouces, but not by enough to fully solve the market
failue. in this sense, consumers are absorbing a large proportion of the price rise and not
reducing consumption greatly. any over consumption and over production problems will
remain.
20
*P49600A02024*
in addition, the minimum price can be used to slove the problem of externalities caused by cigar.
minimum price are price floors set above the equalibrium price in the market to discourage consumption 　

of e-cigar. the price of e-cigar can be increased above equlibrium level from P1 to P2 to intertnalize the 　

negative externality and discourage consumption, solving over consumption issues and bring the black 　

market to allocative efficient production levle from Q1 to Q2 eradicating a prior misallocation of 　

resources.

however, there can be unintended consequences of imposing a minimum price on e-cigar leading to 　

government failure where the costs of intervention outweigh the benefits. for example, a black market 　

may form where consumers can find alternative supply at a lower price or consumers may switch to legal 　

alternatives that are actually worse for them just beacuse they are cheaper than the better quality but 　

higher priced cigar. this could be dangerous for the consumers as they do not know what id in the cigar 　

they are consuming, worsening the extent of the negative externalities generated. once more, the 　

government ha created a new market failure( an unintended consequence), which needs spending to 　

police. if significant, the cost of the policy will outweigh the benefits resulting in government failure.
consumers may go cross the border and smuggle cigar where prices are lower. this will not reduce 　

consumption with overconsumption and a misallocation of resources remaining in the market.

（knowing the right level to set the minimum price is extremely difficult).
this is because putting accurate value on the negative externalities generated is highly complex in reality.
there are ways this can be done but not perfectly. as a consequence, the minimum price might be set too 　

low where exernality is not internalized thus the price increase is not large enough to reduce quantity to 　

the socially optimum level of output. if the minimum price is set too high, the unintended consequence 　

mentioned above can occur and leading to government failure. other examples include firms shutting 　

down or leaving the country causing unemployment.

the poor will sufer proportianately more than the rich as minimum price are regressive, meaning that 　

take a greater proportion of the poor's income than do of the rich, which could 　

Negative advertising or information provision in the form of TV campaigns, print adverting, changes to 　

the school curriculum or packaging changes will help to solve demerit goods, such as cigar, market 　

failure where information failure is the root cause of problem. individual consumers who are now well 　

informed when making decisions about smoking cigar will consume less, fully understanding how bad 　

the product is for them shifting the MPB curve to the left from MPB to MPB+neg advertising, which 　

now equals MSB. The market will then operate at the socially optimum level of output at O* with 　

overconsumption and production issues solved and allocative efficiency attained.

However, this is a long run policy; not as effective in the short run. Advertising will not change consumer 　

behavior immediately. It takes time to educate the public enough to alter consumption habits and for 　

consumers to react to information provided to them. As a consequence, this policy in isolation is unlikely 　

to be successful. Rather, combining information provision with taxation is more likely work where a 　

price change can act as an incentive for consumers to change their behavior whilst information 　

provision over time can make demand for the product more price elastic as consumers become aware of 　

the dangers of consuming cigar leading to a long run movement towards the socially optimum level of 　

output.
There is no guarantee that advertising or information provision will work as intended. This is because 　

the quality of the information or the advertising itself is poor, unclear and not well targeted at the mass 　

consumers. Advertising or providing information is extremely costly and if unsuccessful, there will be 　

little or no benefit derived from its use. Consequently, the cost of implementing such policies will 　

outweigh the benefit, government failure occurs. Where the pre-existing market failure remains with a 　

worsening of the misallocation of resources. however, private advertising campaign may be more 　

effective due to the profit motives, e-cigar firms may be more sensitive and responsive to consumers'
need and therefore,

Advertising information provision is very costly. This is because for it to be successful, well-targeted and
spread to the masses, all forms of media outlets and public forums need to be used increasing costs
dramatically. There is a substantial opportunity cost involved therefore if surplus tax revenue does not
exist. One can argue whether this is the most efficient use of tax payers money especially if the
advertising does not have a noticeable impact on consumer behavior. Using this money to fund other
market failure solving policies instead would be more productive.

*P49600A02124*
21
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If the risk of government failure is so high with intervention, there is rational for no intervention at
all, even if there is a market failure, a misallocation of resources and a loss of social welfare
Government failure would make these outcomes worse and thus intervention should be avoided.
Once more, if the cost of intervention is very high, questions must be asked regarding the extent of
the market failure or even whether there is a market failure and therefore whether government
intervention is justified. If the market failure and welfare loss is minimal or if there is not a market
failure at all, government intervention, which could lead to government failure, should be avoided.

22
*P49600A02224*
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. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . .................................... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ............................................................................................................................................ . . . . . . . . . . . . . . . . . . . .

(Total for Question 6 = 60 marks)

TOTAL FOR SECTION B = 60 MARKS

TOTAL FOR PAPER = 80 MARKS

*P49600A02324*
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*P49600A02424*