Answers to exam-style questions (data response)
01 A firm is productively efficient when it minimises its average production costs. The firm is operating at the lowest point on its average cost curve. (5 out of 5 marks)
Each of the two sentences on its own would earn all five of the available marks.
02 The data show changes in labour productivity rather than output per worker at the different points of time covered by the graphs. A first significant point of comparison is that changes in whole economy labour productivity and service sector labour productivity are both cyclical, with the two cycles more or less correlating with each other. There are slight lags involved, for example the change in service sector labour productivity fell to zero (compared with the previous quarter) at the beginning of the fourth quarter of 2008. By contrast, for the whole economy, zero was reached 3 months later.
A second significant point of comparison is in the range of the fluctuations. For the whole economy, the peak of labour productivity in mid-2007 was about a plus 3.5% change in labour productivity, with the trough (at the end of 2008) at a –5.25% change in labour productivity, a range of 8.75%. For the service sector, the peak of labour productivity (also in mid-2007) was about a plus 4.5% change in labour productivity, with the trough (at the beginning of the fourth quarter in 2008) at a –4.5% change in labour productivity, a range of 9%. In other words, the range was about the same. (8 out of 8 marks)
When Extract A in a question contains two data series (in this case, changes in labour productivity for the whole economy and for the service sector within the economy), the question will ask for an identification of two significant points of comparison between information in the two series. It is important to compare across (or between) the two data series, rather than just along one of the data series.
03 The first reason for different levels of labour productivity stems from the quality of investment in a firm’s capital infrastructure. Workers are more productive if they are using the most up-to-date technology and capital equipment, such as the robots mentioned in Extract C (line 9). Labour productivity will improve because better capital equipment will allow workers to make better quality cars at a faster rate. Automoted robots can be programmed to perform complex repetitive tasks without getting tired, only needing a technician to monitor their work. This makes modern car factories more efficient and in turn this brings down costs. However, if workers are using out-dated equipment in old factories they will work more slowly and the quality of the cars produced will be inferior. More workers are employed to produce fewer cars.
A second reason is different management practices which significantly affect the productivity of workers. British industry historically has a bad reputation for poor management. This could explain why the Rover workers’ productivity was as low as 30 cars per year (Extract C, lines 2–3). The managers at Rover simply did a bad job of organising the factories and getting the best out of the workforce. In contrast, Japanese companies have an excellent reputation for innovating and motivating their workers. Toyota for example has developed the model of ‘last minute delivery’ which makes all workers feel valued. If they do not perform their tasks properly, the entire production line grinds to a halt. This also enables managers to identify problems quickly. This is reflected in Extract B which shows that Nissan car workers build on average 99 cars per worker and Toyota 88 cars per worker. (12 out of 12 marks)
This is an excellent answer which fully obeys the instruction in the question, namely to explain two reasons. Part 03 and 07 questions only ask for explanation. They never ask for evaluation. Candidates who are otherwise good often waste time by drifting into evaluation, but this candidate does not make this mistake.
04 A main argument for government intervention in the UK car industry, in the context of saving manufacturing jobs, is to provide emergency help in an economic crisis. The 2008 economic crisis hit the UK economy particularly hard and saw consumer demand for ‘big ticket’ goods such as new cars fall dramatically. As a result, car companies in the UK responded to this sudden fall in consumer demand by significantly cutting back on production.
In this situation there is a strong case for government intervention to help distressed firms in the worst parts of a crisis. This involved schemes like the ‘car scrappage scheme’, where the British government gave consumers £2,000 towards a new car if they traded in an old car over 10 years old. In this situation it makes sense for the government to use taxpayers’ money to create market incentives to encourage spending in the economy. Demand for cars did not fall because of the poor quality of the cars but due to the wider macroeconomic crisis. It would have made little economic sense for the government to allow good companies to go bust in a crisis with the long-term consequence of skilled workers becoming unemployed.
Government intervention is justified in the short run to head off the negative effects of an economic crisis. However, government intervention is not justified in the long run to save jobs. This is because it would simply lead to taxpayers’ money being used to prop up poorly run and inefficient companies, such as Rover which ran some of the ‘worst’ plants in Britain (Extract C, line 5). The global car market is very competitive and consumers choose to buy the best cars at the best prices. Market discipline ensures that inefficient plants are ‘closed down, or reorganised to improve their efficiency’ (Extract C, line 6). This form of government intervention may ‘save’ jobs but only by imposing higher taxes in the rest of society. As the economist in Extract D (line 4) says, this would be a ‘government failure’ because taxpayers are subsiding firms to make cars that consumers do not want to buy. This is a misallocation of scarce resources and an unacceptable situation. (15 out of 25 marks)
Just like with the answer to part 04 of the Topic 2 data response question on gold mining, this answer is constrained to Level 3, earning 15 of the available 25 marks. The answer suffers from the same problems as the gold mining answer, principally lack of developed analysis that must precede in-depth evaluation. The analysis in this answer is too thin. Mention could be made of the fact that all cars that are mass-produced in the UK are the product of Japanese and US car companies. Obviously such companies would enjoy receiving subsidies from the UK government, but by contrast they might be driven off-shore by other types of government intervention, for example a requirement that cars must be manufactured solely from components produced in the UK.
Topic 4 Market failure
1 When consumers see the price of a good, such as a new car, they can see the value of the good and immediately know how much money they would have to pay in order to buy the car. The car’s price signals information to the consumer, though other information, for example about the quality of the car, is also needed before making the decision whether or not to buy the car. (3 marks)
2 The price has decreased by £300 which immediately creates an incentive to buy the good. The iPhone is cheaper, which means that the consumer can enjoy using it and still have a considerable amount of money to spend on other purchases. However, if the price cut signals that a new and better version of the iPhone will soon be launched, some potential buyers may decide not to purchase the now cheaper current version of the iPhone. (4 marks)
3 The textbook example of a public good with non-excludability characteristics is a lighthouse. The lighthouse provides an invaluable service to ships, warning them of hazards and rocks, but it cannot prevent ships that do not pay from seeing the light beam that it creates. Hence ships can use the invaluable service provided but do not have to pay because there is no mechanism to make them pay for seeing light. Ships can ‘free-ride’ and benefit without having to pay, which is a market failure. Thus it is not profitable for lighthouses to operate in the marketplace because they cannot charge for their service, hence the missing market. In the UK lighthouses are funded through charitable donations. (6 marks)
4 Non-rivalry (or non-diminishability and non-exhaustability) is a property which, along with non-excludability, is a defining characteristic of a public good. Non-rivalry means that when one extra person benefits from a pure public good such as national defence, he or she does not reduce the quantity of the good available to other people. (2 marks)
5 This is a public good service. Although the majority of citizens pay for the police force through general taxation, the service provided benefits the whole of society, even those who have not paid the taxes which finance the provision of the service. The very existence of the police force creates a deterrent that limits burglaries and street riots. The police force protects the whole of society and cannot, and should not, distinguish between those who contribute towards taxation and those who do not. Hence, the protection of the police force is non-excludable and citizens who do not pay taxation can free ride. However, policing can have private good properties when provided, for example, by a private security firm guarding a shopping mall. (5 marks)
6 An example of a positive externality is the benefit received by others when a person is educated. Society benefits from producing educated citizens because they add value to society. The many benefits received by third parties throughout society from education cannot be included in the price mechanism. Many of the benefits received from education are external from the price mechanism which is of course a market failure. (4 marks)
7
The diagram above illustrates the costs incurred and the benefits generated when a commercial forestry company plants trees. Tree planting produces a number of positive externalities, which include improved water retention in the soil. This means the marginal social benefit (MSB) of tree growing is greater than the marginal private benefit (MPB) accruing to the forestry company. In the diagram, the MSB curve is positioned above the MPB curve. The vertical distance between the two curves shows marginal external benefit (MEB) at each level of tree planting.
In order to maximise its private benefit, the commercial forestry plants Q1 trees. Q1 is immediately below point X, where MPC= MPB. However, Q1 is less than the socially optimal level of output Q2, located below point Y, where MSC= MSB The diagram illustrates the fact that, when positive production externalities are generated, the market fails because too little of the good is produced and consumed. Underproduction and under-consumption are depicted by the distance Q2–Q1. (8 marks)
8 At the present day, because of a lack of economies of scale and the high price of parts for the car, electric cars are considerably more expensive to build than petrol and diesel alternatives.
There are only a limited number of recharging points across the UK. This generally makes it impossible to drive electric cars over long distances or to remote destinations. (4 marks)
9 Museums; libraries; art galleries (3 marks)
10 Market failure occurs whenever a market performs inefficiently. An example occurs when firms produce and/or consumers buy, the ‘wrong’ quantity of a good. The answer to Question 7 explains that because forestry companies gain no benefit from the positive externalities produced by the trees they plant, in a market environment they plant too few trees. In the case of healthcare, which is a merit good, other people benefit when a person consumes healthcare services. Consumption of healthcare produces positive externalities which benefit the whole community. As a result, the social benefit of consumption exceeds the private benefit enjoyed by the consumer. The community benefits because a healthy population means there are fewer ill people to catch diseases from. (6 marks)
11 A pure monopoly is when one firm has control of 100% of a product supplied to a market and can maintain this situation in the long run. (3 marks)
12 There is no doubt that Sky uses the monopoly power it has gained from buying up the rights to screen live Premiership football games to raise the price that viewers pay. As a result, fewer people choose to subscribe to Sky and to Sky’s sport channels than would watch live matches if the price was lower or if they could watch free.
Sky’s response is that this does not represent abuse of monopoly power. Sky claims that by paying a lot of money for exclusive rights to broadcast live matches, it has ‘invested’ in the Premier League, allowing clubs to use television revenues to buy expensive players that they would not have been able to afford without television revenues. In this way, Sky has improved the quality of the product. In any case, people can watch live match broadcasts in pubs and bars without having to pay.
However, there is a case for using regulation to reduce Sky’s monopoly power, and to a certain extent this has been achieved. ESPN, another ‘pay to view’ broadcasting company, can now buy the rights to broadcast a limited number of Premiership matches. It can be argued that regulation should go one stage further, by allowing football fans and pubs to buy Sky sports services from companies that possess the right to broadcast matches in other EU countries. This surely is the purpose of the Single European Market. (6 marks)