aqa a level economics microeconomics challenge book

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MicroEconomicsAQA A LEvel economics

CHAllenge Book

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Not to be photocopied / Copyright Tutor2u Limitedwww.tutor2u.net/economics

AQA A Level Economics: Microeconomics Challenge book

4.1.1 Economic methodology and the economic problem Page 4

4.1.1.1 Economic methodology Page 4 4.1.1.2 The nature and purpose of economic activity Page 5 4.1.1.3 Economic resources Page 7 4.1.1.4 Scarcity, choice and the allocation of resources Page 8 4.1.1.5 Production possibility diagrams Page 10

4.1.2 Individual economic decision-making Page 12

4.1.2.1 Consumer behaviour Page 12 4.1.2.2 Imperfect information Page 14 4.1.2.3 Aspects of behavioural economic theory Page 16 4.1.2.4 Behavioural economics and economic policy Page 18

4.1.3 Price determination in a competitive market Page 21

4.1.3.1 The determinants of the demand for goods and services Page 21 4.1.3.2 Price, income and cross elasticities of demand Page 23 4.1.3.3 The determinants of the supply of goods and services Page 26 4.1.3.4 Price elasticity of supply Page 29 4.1.3.5 The determination of equilibrium market prices Page 31 4.1.3.6 The interrelationship between markets Page 33

4.1.4 Production, costs and revenue Page 35

4.1.4.1 Production and productivity Page 35 4.1.4.2 Specialisation, division of labour and exchange Page 37 4.1.4.3 The law of diminishing returns and returns to scale Page 39 4.1.4.4 Costs of production Page 41 4.1.4.5 Economies and diseconomies of scale Page 43 4.1.4.6 Marginal, average and total revenue Page 45 4.1.4.7 profit Page 47 4.1.4.8 Technological change Page 48

4.1.5 Perfect competition, imperfectly competitive markets and monopoly Page 49

4.1.5.1 Market structures Page 49

4.1.5.2 The objectives of firms Page 49 4.1.5.3 Perfect competition Page 51 4.1.5.4 Monopolistic competition Page 52 4.1.5.5 Oligopoly Page 53

CONTENTS

Copyright Tutor2u Limited / Not to be photocopied www.tutor2u.net/economics

AQA A level Economics: Microeconomics Challenge book

4.1.5.6 Monopoly and monopoly power Page 55 4.1.5.7 Price discrimination Page 56 4.1.5.8 The dynamics of competition and competitive market processes Page 57 4.1.5.9 Contestable and non-contestable markets Page 58 4.1.5.10 Market structure, static efficiency, dynamic efficiency and resource allocation Page 59 4.1.5.11 Consumer and producer surplus Page 60

4.1.6 The labour market Page 62

4.1.6.1 The demand for labour, marginal productivity theory Page 62 4.1.6.2 Influences upon the supply of labour to different markets Page 63 4.1.6.3 The determination of relative wage rates and levels of employment in perfectly competitive labour markets Page 64 4.1.6.4 The determination of relative wage rates and levels of employment in imperfectly competitive labour markets Page 65 4.1.6.5 The Influence of trade unions in determining wages and levels of employment Page 66 4.1.6.6 The National Minimum Wage Page 67 4.1.6.7 Discrimination in the labour market Page 69

4.1.7 The distribution of income and wealth: poverty and inequality Page 70

4.1.7.1 The distribution of income and wealth Page 70

4.1.7.2 The problem of poverty Page 71 4.1.7.3 Government policies to alleviate poverty and to influence the distribution of Income and wealth Page 71

4.1.8 The market mechanism, market failure and government intervention in markets Page 72

4.1.8.1 How markets and prices allocate resources Page 72

4.1.8.2 The meaning of market failure Page 73

4.1.8.3 Public goods, private goods and quasi-public goods Page 74

4.1.8.4 Positive and negative externalities in consumption and production Page 75

4.1.8.5 Merit and demerit goods Page 76

4.1.8.6 Market imperfections Page 77

4.1.8.7 Competition policy Page 78

4.1.8.8 Public ownership, privatisation, regulation and deregulation of markets Page 79

4.1.8.9 Government intervention in markets Page 80

4.1.8.10 Government failure Page 81


AQA A Level Economics: Microeconomics Challenge book

4.1.1 Economic methodology and the economic problem

4.1.1.1 Economic methodology

Task 1 Some initial thoughts on the economic problem

The fundamental economic problem is how best to allocate scarce resources in a world of infinite wants. It seems that product innovation in particular is increasing the range of possibilities ever more quickly and although there has been talk of “peak stuff” perhaps limiting the appetite of consumers, this is far from widespread. While much progress has been made against poverty worldwide, stubborn pockets remain and concerns grow about the damaging impact of relative poverty both in terms of fairness but also as a significant factor slowing economic growth. While economic growth generally increases the possibilities for improving welfare, environmental concerns seem ever more pressing.

Although economists have new and exciting areas of theory and research to draw on in making their policy recommendations, economics is far from an exact science. There are vigorously opposing debates as to the best way forward. Value judgments are central in many cases and people’s views are influenced by moral and political judgments.

Drawing on your real-world knowledge and your knowledge of economics, answer the following questions:

1 In what specific ways is economics different to other forms of scientific enquiry, such as the natural sciences?

2 What is the consequence of this for economic debate and policy making?

3 Why are value judgments so important in economics?

4 What is the most pressing economic problem to solve in the world today and why?


AQA A Level Economics: Microeconomics Challenge book Page 8

4.1.1.4

0 20 40 60 80 100LosAngeles,USMoscow,RussiaNewYork,US

SaoPaulo,BrazilSanFrancisco,USBogota,Columbia

London,BritainAtlanta,US

Paris,FranceMiami,USBangkok,Thailand

Jakarta,IndonesiaWashingtonDC,USBoston,US

Istanbul,TurkeyMexicoCity,Mexico

Chicago,USMedellin,ColumbiaKrasnodar,Russia

SeaQle,USStPetersburg,Russia

Dallas,USZurich,SwitzerlandRiodeJaneiro,Brazil

Munich,Germany

LosthoursandlostmoneyCongesToninciTes,2017

Drivers’)mespentinpeaktrafficconges)onHours

Averagecostofconges)onperdriver,topfive2017,$’000

Inrichcountries,city-dwellerslosenearly$1,000ayearwhilesi7ngintraffic

UnitedStates

Totalcosttocity,%bn

0 1 2 3 4

NewYork

LosAngeles

SanFrancisco

Atlanta

Miami

33.7

19.2

10.6

7.1

6.3

Britain0 1 2 3 4

London

Lincoln

Manchester

Birmingham

Braintree

12.2

0.2

0.4

0.8

0.06

Germany0 1 2 3 4

Munich

Berlin

Hamburg

StuQgart

Ruhrgebeit

3.1

7.5

3.8

1.0

2.4

ThehiddencostofcongesTon

Source:INRIXResearch/Economist

Scarcity means that choices need to be made between how resources are allocated between different uses and users. Almost all choices are associated with opportunity costs.

The chart below shows the costs of congestion according to an article from the Economist. Study the chart and then answer the questions that follow.

Task 8 Opportunity costs

4.1.1.4 Scarcity, choice and the allocation of resources

Factor of production

Factor reward

Examples

Source: https://www.economist.com/graphic-detail/2018/02/28/the-hidden-cost-of-congestion



1 Look at the cartoon below. Which aspects of irrational behaviour highlighted by behavioural economics are being shown?

Your answer:

2 Find as many examples as you can of nudges which target irrationalities such as altruism, herd behaviour, cognitive biases and so on.

Type of nudge Type of irrationality targeted

Further details

Task 7 Real-life applications

4.1.2.4 Behavioural economics and economic policy


AQA A level Economics: Microeconomics Challenge book Page 27

Case study 3 - Online retailersWest End retailers call for online tax to address business rates inequality. The New West End Company has called on the government to introduce a business rates reform plan that would eliminate the inequality that exists between bricks-and-mortar and online retailers.

The organisation, which represents over 600 retailers in London’s West End district, has published a report that recommended replacing business rates with a revenue-based tax for businesses that are wholly or largely online.It said the extra money raised through this could be used to reduce the rates burden for other businesses.Source: https://www.retailgazette.co.uk/blog/2018/07/west-end-retailers-call-for-online-tax-to-address-business-rates-inequality/

Case study 4 – All businessesThe oil market is becoming increasingly dangerous, analysts say — and crude prices are feeling the pressure. The oil market is likely to become progressively more unpredictable over the coming months, analysts have told CNBC, in the latest sign dynamics shaping crude futures have dramatically shifted since the crude rally began.“Political and economic events are shaping the oil market in a way that they have not shaped for quite some time,” Tamas Varga, senior analyst at PVM Oil Associates, said in a research note published Thursday.

“The amount of uncertainties surrounding the global supply (and) demand balance is growing almost by the day,” he added.Source: https://www.cnbc.com/2018/07/19/oil-prices-energy-market-is-becoming-increasingly-dangerous-analysts.html

How would the supply curve be affected: How would the supply curve be affected:

How large is the likely impact on supply? Why? How large is the likely impact on supply? Why?



Task 10 Tennis balls and PES

The infographic below shows the production process of a Wimbledon tennis ball.

MATERIALS

01 05USA SOUTHKOREA

Clay Sulphur

8710miles 1630miles

02 06 09NEWZEALAND JAPAN PHILIPPLINES(BASILAN)

Wool MagnesiumCarbonate Glue

11815miles 1880miles 560miles

03 07 10UK(STROUD) GREECE MALAYSIA

FeltWeaving Silica Rubber

6720miles 5960miles 1505miles PRODUCTION PACKAGING DESTINATION

04 08 11 12 13 14CHINA Thailand PHILIPPINES(BASILAN) PHILIPPINES(BATAAN) INDONESIA WIMBLEDON

PetroleumNaphthalene ZincOxide Rubber Tins 6600miles

2085miles 1335miles 560miles 1750miles

01 03

14 0704

05

08

06

1110 12

13

02

09

Wimbledon'sTennisBallProduc)onMilesTotalJourney:50,570miles

Wimbledon'stennisballsmake+5o,ooomilejourneyPostedon27Jun2013

ThetennisballsusedatWimbledonwillhavetravelled50,570milesaroundtheworldvia11countriesbeforetheylandonplayers'racquetsonCentreCourt.

4.1.3.4

What can be deduced about the likely price elasticity of supply? Justify your answer with reference to relevant concepts. And don’t forget to distinguish between short and long run factors!


AQA A level Economics: Microeconomics Challenge book Page 37

4.1.4.2 Specialisation, division of labour and exchange

Task 4 Early division of labour

The following photographs show the early days of division of labour and specialisation at a Ford car factory. Ford was one of the first manufacturers to adopt this approach.

Study the photographs and note down any examples of division of labour and specialisation that you can see.

Research the advantages gained as a result of this style of production, and some of the measures taken by Ford to avoid some of the downsides to specialisation.



Objective Profit maximisation Revenue maximisation

Normal profit / increase market

share

Allocative efficiency

Condition / formula

Example

Task 3 Real world application

For each of the business objectives listed below, write the correct ‘condition’ (formula) and carry outyour own research to find an example of a business that you think might have that particular businessobjective.

Especially for large firms, another reason they may not maximise profit is a consequence of a marriage of ownership and control. For very small firms, the owner and the manager may be one and the same person, but for a large complex firm, perhaps with shareholders, this is no longer the case. Managers at different levels, who may well have different objectives to the shareholders, will take decisions. Managers have a monopsony of technical information and this symmetry of information may lead to different objectives (such as revenue maximisation) being adopted. It is possible too that moral horizon and incentives may lead managers to take excessive risk and jeopardise profit maximisation. Managers are an example of a shareholder. This is someone or a group of people with an interest in how the business is run. Other examples are shareholders, employees, customers, suppliers and in some cases, the government.

The different stakeholder groups will have different, and often conflicting objectives. Against this background, the firm may profit satisfy – earn sufficient profit to satisfy shareholders but subject to the constraints of the remaining stakeholders. Depending on the firm in question, some of the stakeholders may be more powerful than others. A trade union reduces the power of labour for example. Transport unions are good examples of such groups attempting to influence objectives. In the case of the nationalised industries, the regulatory authorities are powerful stakeholders and will be vigilant to businesses maximising profit at the expense of customers for example.

Finally, a business may simply be seeking to survive, perhaps necessitating decisions to maintain cash flow. In markets such as oligopsony, profit maximisation may be a longer-term goal with greater emphasis placed on market share. Any number of shorter term objectives might be adopted to achieve this goal.



Task 10 Contrasting contestability in the bus and airline industries

The following is a quote from December 2011 after the competition authorities had concluded their investigation into the regional bus industry.

In contrast, is the following comment about airline deregulation written in 2015:

Jeremy Peat, Chairman of the local bus market investigation Group, said:

Competition and potential competition can drive standards up for passengers —that was the intention behind deregulation. We have seen evidence how competition can, for example, increase service frequencies but the reality is that in too many areas of the country, competition has stagnated, and the incumbent providers know that they face little in the way of serious challenge.

As such, the incentive to increase services, innovate and even lower fares is absent. On the occasions when there are outbreaks of rivalry, they don’t tend to last, and passengers are quickly returned to something like the status quo without any enduring improvement in services.

Source: http://webarchive.nationalarchives.gov.uk/20140402170858/http://www.competition-commission.org.uk/assets/competitioncommission/docs/2011/media-centre/66-11_buses_final.pdf

a Why were the outcomes in the two markets so different?

Deregulation resulted in the rise of a new kind of airline—the low-cost carrier (LCC). At the time of deregulation, Southwest Airlines was a small regional airline, prevented by CAB rules from flying outside of Texas. Today, Southwest is the largest domestic U.S. carrier in terms of passenger traffic, something no one could have foreseen in 1978.

Southwest is a success story, but deregulation allowed airlines to innovate new business models. People Express may have come and gone (and may someday be revived) but it, and others like it shook up the white-glove world of the U.S. airline industry and democratized travel.

Deregulation left the international carriers, like Pan Am and Braniff, and to a lesser extent Trans World Airlines, without robust domestic feeder networks, and it allowed domestic carriers, like Delta Air Lines, to apply for international routes. Pan Am and Braniff scrambled to create domestic networks but ultimately were unsuccessful, although it took until 2000 for TWA to be absorbed into American Airlines.And some argue that the massive consolidation of the U.S. airline industry in the last decade, which has resulted in three large carriers —four, when Southwest is included—is deregulation’s final act. The network carriers that survive—Delta, United and American—learned to be tough competitors, and combined existing domestic networks with the international networks acquired in large part from carriers like Pan Am that didn’t make it.

Source: http://aviationweek.com/blog/law-changed-airline-industry-beyond-recognition-1978

4.1.5.9 Contestable and non-contestable markets



4.1.7 The distribution of income and wealth: poverty and inequality

4.1.7.1 The distribution of income and wealth

Task 1 A recent article by The Economist included this headline in response to government claims thatinequality had fallen to its lowest level for 30 years:

Included in this article was this chart

The ONS measure is based on a Gini coefficient calculated from an annual survey of 5,000 households. Every participant aged 15 and over keeps a detailed record of their spending for two weeks. About 50 of these households will be in the top 1%. The DWP measure (Department for Work and Pensions) supplements their data with information from tax returns.

4.1.7.1

0.40

0.35

0.30

0.25

0.20

1977 2000 05 10 15

Moreunequal

Sources:ONS;DWP;IFS;TheEconomist

Takenote,ChancellorBritain,inequality,Ginicoefficient*Householddisposableincome

ONSmeasure

85 90 95

DWPmeasure

FiscalyearsbeginningAprilfrom1994*0=completeequality1=completeinequality

What reasons can you think of as to why the two measures (ONS v DWP) differ? Which is the most accurate? What are the implications of this?

“Some measures are more equal than othersIs inequality rising or falling? The government’s optimistic claim is probably false”

You can read the original article here if you want to:



Task 5 The Higher Education debate

Education is traditionally thought of as a good example of a merit good – something better for us than we realise and which we should have access to irrespective of our ability to pay.

More recently, however, serious questions have been asked about the benefits from higher education and certainly as currently financed. Are these concerns so serious that higher education would be better thought of as a demerit good? Present the arguments below, making specific reference to the cartoon and the chart. You might also like to read this article from the Guardian:

4.1.8.5 Merit and demerit goods

Merit good? Demerit good?

4.1.8.5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

PercentofStudentsreceivingFirstClassDegrees

25

20

15

10

UKUniversiTes.Source;HESA

4.1.8.5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

PercentofStudentsreceivingFirstClassDegrees

25

20

15

10

UKUniversiTes.Source;HESA

aqa a level economics microeconomics challenge book

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