Batch5

Subject CB2
Revision Notes
For the 2019 exams

Economic concepts and

introductory microeconomics
Booklet 1

covering

Module 1 Economic concepts and systems

Module 3 Supply and demand (1)
Module 4 Supply and demand (2)
Module 5 Background to demand

The Actuarial Education Company

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CONTENTS

Contents Page
Links to the Course Notes and Syllabus 2
Overview 4
Past Exam Questions 7
Solutions to Past Exam Questions 54
Final comments 92
Checklist 93
Exam Preparation Checklist 112

Copyright agreement

All of this material is copyright. The copyright belongs to Institute and

Faculty Education Ltd, a subsidiary of the Institute and Faculty of Actuaries.
The material is sold to you for your own exclusive use. You may not hire out,
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part of it. You must take care of your material to ensure it is not used or
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Legal action will be taken if these terms are infringed. In addition, we may
seek to take disciplinary action through the profession or through your
employer.

These conditions remain in force after you have finished using the course.

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LINKS TO THE COURSE NOTES AND SYLLABUS

Material covered in this booklet

Module 1 Economic concepts and systems

Module 3 Supply and demand (1)
Module 4 Supply and demand (2)
Module 5 Background to demand

The module numbers refer to the 2019 edition of the ActEd Course Notes.

Syllabus objectives covered in this booklet

1.1 Discuss the relevance of economics to the world of business.

1. Describe what is meant by opportunity cost and scarcity and their

relevance to economic choice.
2. Discuss the core economic concepts involved in choices made by
businesses relevant to the selection of outputs, inputs, technology,
location and competition.
3. Contrast microeconomics and macroeconomics.

2.1 Discuss the workings of competitive markets.

1. Discuss how markets operate.

 Explain the role of the price mechanism in a free market.
 Discuss the behaviour of firms and consumers in such markets.

2. Describe the factors that influence market demand and supply.

3. Describe and discuss how market equilibrium quantity and price are
achieved.
4. Discuss how markets react to changes in demand and supply.
5. Define and calculate price and income elasticities of demand and
price elasticity of supply.
 Calculate elasticities of demand using both original and
average quantities.
6. Discuss the factors that affect elasticity.

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7. Explain the effect of elasticity on the workings of markets in the

short and long run.
8. Discuss how firms deal with risk and uncertainty about future
market movements.
9. Describe price expectations and speculation and how price bubbles
develop.

2.2 Discuss consumer demand and behaviour.

1. Describe the concept of utility and representation of consumer

preferences as indifference curves.
2. Discuss rational choice and how optimal consumption choice is
determined by using indifference curves and budget lines.
3. Discuss the concepts of rational choice, perfect information and
irrational behaviour in behavioural economics.

2.3 Discuss the importance of advertising for a firm.

1. Explain the effects of advertising on sales and demand.

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OVERVIEW`

Economics is the study of the allocation of scarce resources. Scarcity arises

because human wants are greater than the quantity of goods and services
that can be produced to meet those wants, using the finite resources
available. Different economic systems have different ways of dealing with
scarcity. There are two extremes:
1. command economies – in which the state makes all of the economic
decisions
2. free market economies – in which the free working of the market forces
of supply and demand determines the use of resources.

In practice, most economies are a mixture of the two extremes, and within any
economy, certain choices have to be made, in particular:
 What goods and services will be produced and in what quantities?

 How are the goods and services going to be produced, ie what

resources and production methods are going to be used?

 For whom are goods and services going to be produced, ie how is the
total national income going to be distributed?

This leads on another important concept, namely opportunity cost, as doing

one things always involves a cost in terms of giving up another opportunity.

Module 1 discusses these key concepts and also outlines the scope of:
 macroeconomics – which is concerned with the economy as a whole
and studies economic aggregates, such as national income,
unemployment and the general level of prices.

 microeconomics – which is concerned with individual parts of the

economy (eg households, firms and industries) and the way they
interact to determine the pattern of production and distribution of goods
and services.

Microeconomics is reviewed in this and the next booklet, and also partly in
Booklet 6 (which cover Modules 1 and 3 to 10 in the Course Notes), whilst
macroeconomics is reviewed in Booklets 3 to 6 (which cover Modules 2 and
11 to 23 of the Course Notes).

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This booklet therefore covers the introductory module on economic concepts

and then the first part of microeconomics. As noted above, microeconomics
considers individual decision-makers in the economy, such as firms,
investors and consumers, and the markets in which they operate. Once we
understand why consumers choose to spend their income as they do and
why firms choose to produce what they do, then we can put these decisions
together to understand the whole market for particular goods and services.

Modules 3 and 4 consider the market forces of:

 demand – which reflects the wishes of the consumers

 supply – which reflects the wishes of the producers

to determine the equilibrium market price and quantity. This mechanism for
allocating resources between different uses is called the price mechanism.

Linked to this is the topic of elasticity – how responsive quantity is to a

change in one of the factors that affects demand or supply, such as price or
income. Firms need to know about these elasticities in order to estimate the
effect of changing market conditions on their revenues, costs and profits.

In economies that are not strictly free market economies, sometimes the
government might deem it necessary to intervene in the free market, for
example using price controls and taxes / subsidies. This is covered further
in Module 10 (Booklet 6).

Module 5 looks at demand in more detail. Our aim is to understand how

consumers make choices about what to buy. Supply is considered in detail
in Module 6 (Booklet 2).

If consumers are assumed to be rational then consumer demand might be

studied using:
 marginal utility theory

 indifference curve analysis

both of which also offer explanations as to why the demand curve tends to
slope downwards.

Rational consumers may also need to make choices when faced with risk
and uncertainty. In such cases, insurance might be used to reduce the
financial risks they face.

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Finally, consumer demand is considered without the assumption of

rationality. Behavioural economics acknowledges that many real-world
decisions do not appear to be rational and it therefore seeks to understand
and explain human behaviour, which is complex and has many influences.

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PAST EXAM QUESTIONS

This section contains all the past exam questions from 2008 to 2017 that are
related to the topics covered in this booklet. These questions are taken from
the exam papers for Subject CT7. The questions are divided into three
sections – multiple-choice questions, short-answer questions and
long-answer questions.

Solutions are given later in this booklet. Answers only are provided for
multiple-choice questions. Other solutions give enough information for you
to check your answer, including working, and also show you what an
adequate examination answer should look like. Further information may be
available in the Examiners’ Report, ASET or Course Notes.

We first provide you with both a checklist of all exam questions split by
module. You can use this, if you wish, to select the questions that relate
just to those aspects that you may be particularly interested in reviewing.
Alternatively you can choose to ignore the checklist, and instead attempt the
questions without having any clues as to their content.

Exam question checklist by module

Module Multiple-choice Short- Long-

answer answer

1 1, 6, 11-15, 38, 41, 48, 53, 54, 67, 71, 1, 3, 6, 23,

72, 78, 84, 85, 91, 95, 96, 105, 106, 29, 34
111, 112, 118
3 2, 16, 18, 19, 22, 24, 27, 28, 31, 32, 7, 10, 24, 1
35, 40, 44, 47, 61, 64, 66, 73, 74, 79, 26-28, 33,
80, 86, 87, 92, 93, 97, 98, 101, 102, 35
107
4 3-5, 7-9, 17, 23, 25, 33, 34, 36, 37, 2, 11, 12,
39, 42, 43, 46, 49, 50, 55-57, 60, 62, 14-17, 20,
63, 65, 70, 75, 81-83, 90, 94, 103, 22, 30-32,
104, 108, 114, 116, 117, 119 36
5 10, 20, 21, 26, 29, 30, 45, 51, 52, 58, 4, 5, 8, 9,
59, 68, 69, 76, 77, 88, 89, 99, 100, 13, 18, 19,
109, 110, 113, 115 21, 25, 37

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Multiple-choice questions

1 Subject CT7, April 2008, Question 2

In an economy where only two goods are produced then efficiency has been
achieved when:

A the quantity of both goods produced is equal.

B it is possible to produce more of only one good.
C it is possible to produce more of one good only by sacrificing some
production of the other good.
D it is possible to produce more of both goods.

2 Subject CT7, April 2008, Question 3

Which of the following statements is FALSE?

A A change in consumer tastes may lead to a shift in a demand curve.

B A rise in the price of other goods may lead to a shift in a demand curve.
C A change in the resources required to produce a good may lead to a
shift in a demand curve.
D A fall in the price of other goods may lead to a shift in a demand curve.

3 Subject CT7, April 2008, Question 4

A firm’s supply curve for Good X is given by Q = 200 - 3P where Q is

quantity and P is price. The government now imposes a tax of 50 on each
unit of Good X sold. Which of the following represents the firm’s new supply
curve?

A Q = 150 - 3P
B Q = 350 - 3P
C Q = 250 - 3P
D Q = 200 - 3P

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4 Subject CT7, April 2008, Question 5

There are two goods, X and Y. The price of Good X changes from 4 to 5,
the price of Good Y from 10 to 11, the quantity demanded of Good X from 5
to 6 and the quantity demanded of Good Y from 3 to 4. What is the
cross-price elasticity of demand for Good X with respect to the price of
Good Y?

A 5
B 2
C 3.33
D 0.33

5 Subject CT7, April 2008, Question 6

Which of the following statements is TRUE?

A An inferior good is one for which income elasticity of demand is perfectly

inelastic, so that quantity demanded falls as income increases.
B An inferior good is one for which income elasticity of demand is positive,
so that quantity demanded increases as income increases.
C An inferior good is one for which income elasticity of demand is
negative, so that quantity demanded falls as income increases.
D An inferior good is one for which income elasticity of demand is zero, so
that quantity demanded is invariant to income changes.

6 Subject CT7, September 2008, Question 1

Which of the following will cause a production possibility frontier to shift

outward?

A an increase in the stock of capital (machinery)

B an increase in the production of consumption goods
C a decision to fully utilise unemployed resources
D a decrease in the population

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7 Subject CT7, September 2008, Question 2

A maximum price is set for Good X at £25, which happens to be equal to the
free market price. An increase in the demand for Good X, keeping the
maximum price fixed at £25, will lead to:

A no change in price and a shortage.

B a rise in price and quantity sold.
C a rise in price and a shortage.
D a rise in price and a surplus.

8 Subject CT7, September 2008, Question 3

Good Y has a cross-price elasticity of demand with respect to Good X of 0.5

and 100 units of Good Y are demanded when Good X costs 50 pence. A
rise in the price of Good X to 75 pence will lead to a change in the demand
for Good Y to:

A 150 units.
B 125 units.
C 75 units.
D 50 units.

9 Subject CT7, September 2008, Question 4

Which of the following statements is FALSE?

A Inferior goods are goods for which the income elasticity of demand is
negative.
B Giffen goods are goods for which the own price elasticity of demand is
positive.
C Complementary goods tend to have positive cross-price elasticity of
demand.
D Substitute goods tend to have positive cross-price elasticity of demand.

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10 Subject CT7, September 2008, Question 5

An individual can consume either bananas or apples. The price of bananas

and apples is the same. The individual calculates that the marginal utility of
bananas is higher than the marginal utility of apples. The individual could be
better off by consuming:

A fewer bananas and more apples.

B fewer bananas and fewer apples.
C more bananas and more apples.
D more bananas and fewer apples.

11 Subject CT7, April 2009, Question 1

The main categories of economic resources are:

A natural resources, labour and money.

B labour, money and factories.
C natural resources, capital and factories.
D natural resources, labour and capital.

12 Subject CT7, April 2009, Question 2

In economics the concept of scarcity means:

A all resources will eventually be exhausted.

B there are unlimited resources, we just have an allocation problem.
C there are unlimited wants and limited resources.
D all of the above.

13 Subject CT7, April 2009, Question 3

The UK economy is:

A a free-market economy.
B a centrally planned economy.
C a traditional market economy.
D a mixed economy.

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14 Subject CT7, April 2009, Question 4

If the government chooses to use resources to build a nuclear power plant

instead of building new wind farms, this illustrates the concept of:

A a market system.
B macroeconomics.
C competition.
D opportunity cost.

15 Subject CT7, April 2009, Question 5

Which one of the following will have no impact on the position of the
production possibility frontier?

A increased expenditure on research and development

B a reduction in the unemployment rate
C increased immigration of skilled workers
D the discovery of new natural resources

16 Subject CT7, April 2009, Question 7

An increase in the price of eggs will:

A decrease the demand for eggs.

B increase the demand for eggs.
C increase the quantity of eggs demanded.
D decrease the quantity of eggs demanded.

17 Subject CT7, April 2009, Question 8

Which of the following statements is TRUE?

A Cross-price elasticity of demand is positive for complementary goods.

B Elasticity of supply is zero along a horizontal supply curve.
C Price elasticity of demand varies along a straight-line demand curve.
D Income elasticity of demand is positive for inferior goods.

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18 Subject CT7, April 2009, Question 9

Wheat is an essential input in the production of pasta. An increase in the

price of wheat would have an impact on the demand and supply of pasta by:

A shifting the demand curve to the left.

B shifting the supply curve to the left.
C shifting the supply curve to the right.
D shifting the demand curve to the right.

19 Subject CT7, April 2009, Question 10

If ice cream is a substitute for fruit sorbet and strawberries are a complement
to ice cream but not sorbet then a fall in the price of ice cream will:

A increase the demand for fruit sorbet and strawberries.

B decrease the demand for fruit sorbet and increase the demand for
strawberries.
C decrease the demand for fruit sorbet and strawberries.
D increase the demand for fruit sorbet and decrease the demand for
strawberries.

20 Subject CT7, April 2009, Question 11

According to the law of diminishing marginal utility, the total satisfaction that
a consumer receives from consuming Good X will:

A rise at an increasing rate as the consumption of Good X increases.

B rise at a decreasing rate as the consumption of Good X increases.
C fall at an increasing rate as the consumption of Good X increases.
D fall at a decreasing rate as the consumption of Good X increases.

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21 Subject CT7, April 2009, Question 12

In relation to insurance, the term moral hazard:

A suggests people who know they are a bad risk are more inclined to take
out insurance.
B suggests people who know they are a bad risk are less inclined to take
out insurance.
C suggests a policyholder may act in a way which makes an insured event
less likely to occur.
D suggests a policyholder may act in a way which makes an insured event
more likely to occur.

22 Subject CT7, September 2009, Question 1

What is the combined effect of an increase in the cost of production and a

rise in consumer income on the equilibrium price and quantity of a normal
good?

A The effect on price is indeterminate but quantity will fall.

B The effect on price is indeterminate but quantity will rise.
C The effect on quantity is indeterminate but price will rise.
D The effect on quantity is indeterminate but price will fall.

23 Subject CT7, September 2009, Question 2

If the price elasticity of demand for a product is -2, a reduction in its price
from 20 pence to 19 pence will result in an increase in demand of:

A 2.0 per cent.

B 2.5 per cent.
C 10 per cent.
D 38 per cent.

24 Subject CT7, September 2009, Question 3

If rail travel is an inferior good, which one of the following will lead to a shift
of its demand curve to the left?

A an increase in incomes
B a rise in car prices
C an increase in petrol prices
D a rise in the price of rail travel

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25 Subject CT7, September 2009, Question 8

A price ceiling set below the free market price results in:

A excess demand and shortages.

B excess supply and surpluses.
C excess demand and surpluses.
D excess supply and shortages.

26 Subject CT7, September 2009, Question 13

A movement along a consumer’s indifference curve from left to right means

that the consumer’s:

A marginal utility will rise.

B total utility will be unchanged.
C marginal utility will fall.
D money income is unchanged.

27 Subject CT7, April 2010, Question 15

The demand equation for Good X is Qd = 15 - 0.5P and the supply equation
for Good X is Qs = 3 + 2P , where P is the price. When the price is £6 there
will be a:

A surplus of Good X and the price will rise.

B shortage of Good X and the price will fall.
C surplus of Good X and the price will fall.
D shortage of Good X and the price will rise.

28 Subject CT7, April 2010, Question 16

Which of the following events would shift the demand curve for Good X,
which is a normal good, to the right?

A a decrease in the price of Good X

B an increase in the price of a substitute good
C an increase in the price of a complementary good
D a decrease in consumer income

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29 Subject CT7, April 2010, Question 17

According to the law of diminishing marginal utility, the total satisfaction that
a consumer gets from consuming Good X will:

A rise at an increasing rate as consumption of Good X increases.

B rise at a decreasing rate as consumption of Good X increases.
C fall at an increasing rate as consumption of Good X increases.
D fall at a decreasing rate as consumption of Good X increases.

30 Subject CT7, April 2010, Question 18

Adverse selection refers to a situation where:

A having insurance makes an individual less careful.

B having insurance makes an individual more careful.
C the people taking out the insurance are those who have the highest risk.
D the people taking out the insurance are those who have the highest risk
aversion.

31 Subject CT7, April 2010, Question 19

A consumer’s demand curve for Good X is represented by the equation:

Qdx = 50 - 0.2Px

where Qdx is the quantity of Good X demanded and Px is the price of

Good X.

A producer’s supply curve for Good X is represented by the equation:

Qsx = 10 + 0.6Px

where Qsx is the quantity of Good X supplied and Px is the price of Good X.

Demand and supply are in equilibrium when:

A quantity is 20 and price is 150.

B quantity is 30 and price is 100.
C quantity is 35 and price is 75.
D quantity is 40 and price is 50.

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32 Subject CT7, April 2010, Question 20

If Goods X and Y are substitutes, a fall in the price of Good X causes the:

A quantity demanded of Good X to increase and the demand curve for

Good Y to shift toward the right.
B quantity demanded of Good X to increase and the demand curve for
Good Y to shift toward the left.
C demand curve for Good X to shift to the right and the demand curve for
Good Y to shift toward the left.
D demand curve for Good X to shift to the right and the demand curve for
Good Y to shift toward the right.

33 Subject CT7, April 2010, Question 21 (amended)

The total revenue from the sale of a good will fall if:

A price rises and demand for the good is price-elastic.

B price rises and demand for the good is price-inelastic.
C consumer income falls and the good is inferior.
D consumer income rises and the good is a Giffen good.

34 Subject CT7, April 2010, Question 22 (amended)

A consumer always spends one quarter of his income on travel. What are
his price elasticity of demand for travel and his income elasticity of demand
for travel respectively?

A 1 and 0.25.
B –1 and 0.25.
C 1 and 0.
D –1 and 1.

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35 Subject CT7, September 2010, Question 3

If Goods X and Y are substitutes, an increase in the price of Good X causes

the:

A quantity demanded of Good X to fall and the demand curve for Good Y
to shift to the left.
B quantity demanded of Good X to fall and the demand curve for Good Y
to shift to the right.
C quantity demanded of Good X to remain constant, but the demand for
Good Y to fall.
D demand curves for both Good X and Good Y to shift to the right.

36 Subject CT7, September 2010, Question 4

Which of the following is NOT a characteristic of an inferior good?

A The income elasticity of demand is negative.

B The income elasticity of demand is between zero and one.
C The demand for the good increases as income falls.
D The demand will rise if its price falls.

37 Subject CT7, September 2010, Question 5

The price elasticity of demand for beer is –2. If beer increases in price by
15 per cent the quantity demanded falls by:

A 7.5 per cent.

B 15 per cent.
C 17 per cent.
D 30 per cent.

38 Subject CT7, April 2011, Question 1

Which of the following statements below is always TRUE?

A Opportunity cost is equal to total revenue minus total variable cost.

B Opportunity cost is constant.
C Opportunity cost is the cost in terms of the best foregone alternative.
D Opportunity cost is equal to a firm’s supernormal profits.

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39 Subject CT7, April 2011, Question 2

Despite an increase in the minimum price of admission from £15.00 to

£18.00, a football club finds that attendance at home matches increased by
20%. Which of the following could most effectively explain this situation?

A Demand to watch football has a high price elasticity.

B Consumer preference has changed in favour of watching football.
C Demand to watch football has a very low price elasticity.
D The prices of alternative attractions have fallen.

40 Subject CT7, April 2011, Question 3

If the demand and supply for a commodity both increase at each price, the
market price will tend to:

A rise.
B be indeterminate.
C fall.
D remain unchanged.

41 Subject CT7, April 2011, Question 4

In a free market economy the basic function of the price mechanism is to:

A provide a means of allocating resources.

B ensure that consumer wants are satisfied.
C enable the government to control prices.
D ensure the goods that society needs are produced.

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42 Subject CT7, April 2011, Question 5

If the government fixed a minimum price of bread above the equilibrium price
and there was no further government intervention in the market for bread,
which of the following would result?

A There would be a surplus on the market and bread producers’ income

would fall.
B There would be an equilibrium in the market but the change in bread
producers’ income would be uncertain.
C There would be a shortage on the market and bread producers’ income
would rise.
D There would be a surplus on the market but the change in bread
producers’ income would be uncertain.

43 Subject CT7, April 2011, Question 6

If a firm increases its output and this results in an equal proportionate

increase in its revenue, which of the following can be deduced about the
price elasticity of demand for the firm’s product?

A It is −1.
B It is infinite elasticity.
C It is +1.
D It is zero elasticity.

44 Subject CT7, April 2011, Question 7

Which of the following would NOT explain why, when the price of a good
rises, the quantity supplied will also rise?

A Firms expect future prices to rise.

B At higher levels of output firms will incur higher costs.
C The higher the price the more profitable it becomes to produce.
D The price of a good remains high over a given time period.

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45 Subject CT7, April 2011, Question 8

Diminishing marginal utility of income implies:

A people are risk-lovers.

B people are risk-averse.
C people are risk-diversifiers.
D people are risk-neutral.

46 Subject CT7, April 2011, Question 9

A firm’s decision to reduce its expenditure on advertising is most likely to

have the following impact on its demand curve:

A The curve will shift to the left and become more inelastic.
B The curve will shift to the right and become less elastic.
C The curve will shift to the left and become more elastic.
D The curve will shift to the right and become less inelastic.

47 Subject CT7, September 2011, Question 1

What is the combined effect of an increase in the cost of production and a

rise in consumer income on the equilibrium price and quantity of a normal
good?

A The effect on price is indeterminate but quantity will fall.

B The effect on price is indeterminate but quantity will rise.
C The effect on quantity is indeterminate but price will rise.
D The effect on quantity is indeterminate but price will fall.

48 Subject CT7, September 2011, Question 2

Which one of the following accurately describes the opportunity cost of

producing Good X?

A the cost of producing Good X in money terms

B the next best alternative use to which the factors of production used to
produce Good X could be put
C the stream of services provided by Good X over its entire lifetime
D the production of Good X foregone in the previous year to enable
Good X to be produced this year

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49 Subject CT7, September 2011, Question 5

Following an increase in the price of fuel there is a 20% increase in the price
of air travel tickets which results in a 20% decrease in total revenue. Which
of following statements is TRUE about the demand for air travel?

A The demand for air travel is price-inelastic.

B The demand for air travel is price-elastic.
C The demand for air travel is infinitely price-elastic.
D The demand for air travel has zero price inelasticity.

50 Subject CT7, September 2011, Question 10

The demand for Good X has a price elasticity of minus unity while the supply
curve has a positive slope. If the government decided to impose a tax of
£10 per unit on Good X this would:

A shift the supply curve for Good X up by less than £10 and increase the
price by less than £10.
B shift the supply curve for Good X up by less than £10 and increase the
price by more than £10.
C shift the supply curve for Good X up by £10 and increase the price by
£10.
D shift the supply curve for Good X up by £10 and increase the price by
less than £10.

51 Subject CT7, September 2011, Question 11

Which one of the following illustrates the problem of adverse selection?

A A bank, by raising its interest rates, will tend to increase the proportion
of borrowers in its loan portfolio who do not intend to repay their loans.
B An insurance company by inserting extra clauses into an insurance
contract will tend to reduce its customer base.
C Bank directors will tend to act in their own interests rather than that of
their shareholders.
D An insurance policy with a 2-year time horizon is more likely to have a
claim made against it than an insurance policy with a 1-year time
horizon.

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52 Subject CT7, September 2011, Question 15

Which of the following statements defines moral hazard in relation to

insurance?

A Moral hazard describes the fact that people who know that they are a
particularly bad risk are more inclined to take out insurance.
B Moral hazard describes the fact that a policyholder may act in a way
which makes the insured event more likely to occur.
C Moral hazard describes the fact that people who know that they are a
particularly bad risk are less inclined to take out insurance.
D Moral hazard describes the risk that an insurance company will face
false insurance claims.

53 Subject CT7, April 2012, Question 1

The main categories of economic resources are:

A natural resources, labour and money.

B labour, money and factories.
C natural resources, capital and factories.
D natural resources, labour and capital.

54 Subject CT7, April 2012, Question 2

In economics the concept of scarcity means:

A all resources will eventually be exhausted.

B there are unlimited resources, we just have an allocation problem.
C there are unlimited wants and limited resources.
D all of the above.

55 Subject CT7, April 2012, Question 3

Good Y has a cross elasticity of demand with respect to Good X of 0.5 and
100 units of Good Y are demanded when Good X costs 50 pence. A rise in
the price of Good X to 75 pence will lead to a change in the demand for
Good Y to:

A 150 units.
B 125 units.
C 75 units.
D 50 units.

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56 Subject CT7, April 2012, Question 4

The demand equation for Good X is Qd = 15 - 0.5P and the supply equation
for Good X is QS = 3 + 2P , where P is the price. When the price is £6
there will be:

A a surplus of Good X and price will rise.

B a shortage of Good X and price will fall.
C a surplus of Good X and price will fall.
D a shortage of Good X and price will rise.

57 Subject CT7, April 2012, Question 5

A demand curve which has price elasticity of minus one throughout its length
will be:

A vertical.
B horizontal.
C upward-sloping.
D downward-sloping.

58 Subject CT7, April 2012, Question 6

According to the law of diminishing marginal utility, the total satisfaction that
a consumer gets from consuming Good X will:

A rise at an increasing rate as consumption of Good X increases.

B rise at a decreasing rate as consumption of Good X increases.
C fall at an increasing rate as consumption of Good X increases.
D fall at a decreasing rate as consumption of Good X increases.

59 Subject CT7, April 2012, Question 7

Adverse selection refers to a situation where:

A having insurance makes an individual less careful.

B having insurance makes an individual more careful.
C the people taking out the insurance are those who have the highest risk.
D the people taking out the insurance are those who have the highest risk
aversion.

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60 Subject CT7, April 2012, Question 13

If the demand for Good X is price-elastic then the burden of a sales tax on
Good X will be borne:

A equally by buyers and sellers.

B more heavily by buyers.
C more heavily by sellers.
D by neither buyers nor sellers.

61 Subject CT7, April 2012, Question 16

What is the combined effect of an increase in the cost of production and a

rise in consumer income on the equilibrium price and quantity of an inferior
good?

A The effect on price is indeterminate but quantity will fall.

B The effect on price is indeterminate but quantity will rise.
C The effect on quantity is indeterminate but price will fall.
D The effect on quantity is indeterminate but price will rise.

62 Subject CT7, October 2012, Question 1

Which of the following will result from the imposition of a 9 per cent sales tax
on household fuel, the demand for which has an absolute price elasticity of
demand equal to 1.5?

A a rise in the price of fuel by 10.5 per cent

B a rise in the price of fuel by 9 per cent
C a rise in the price of fuel by 12 per cent
D a rise in the price of fuel by less than 9 per cent

63 Subject CT7, October 2012, Question 2

A minimum price is set for Good X at £10 which happens to coincide with the
free market price. An increase in the demand for Good X keeping the
minimum price fixed at £10 will lead to:

A no change in price and a shortage.

B a rise in price and quantity sold.
C a rise in price and a shortage.
D a rise in price and a surplus.

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64 Subject CT7, April 2013, Question 1

Which of the following statements explains how price, demand and supply
respond to a shortage?

A Price rises, quantity demanded falls and quantity supplied rises.

B Price rises, quantity demanded falls and quantity supplied falls.
C Price rises, quantity demanded rises and quantity supplied falls.
D Price rises, quantity demanded rises and quantity supplied rises.

65 Subject CT7, April 2013, Question 2

If the price of a product rises from £3 to £4 and demand falls from 100 to 80
units, then using the average price elasticity of demand method the price
elasticity of demand is:

A 0.60
B 0.78
C 1
D 0.05

66 Subject CT7, April 2013, Question 3

If Goods X and Y are substitutes, an increase in the price of Good X causes

the:

A demand curve for Good X to shift to the left, and the demand curve for
Good Y to shift to the left.
B demand curve for Good X to shift to the left, and the demand curve for
Good Y to shift to the right.
C quantity demanded of Good X to fall, and the demand curve for Good Y
to shift to the right.
D quantity demanded of Good X to fall, and the demand curve for Good Y
to shift to the left.

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67 Subject CT7, April 2013, Question 4

A student studying a one-year Masters degree in Actuarial Science has

course fees of £12,000 and could otherwise have had a job paying an
after-tax income of £20,000. The cost of her accommodation is £7,000
whether she studies or works and the food bill is £3,000 whether she studies
or works. The opportunity cost of studying for the Masters degree is:

A £12,000.
B £20,000.
C £32,000.
D £42,000.

68 Subject CT7, April 2013, Question 5

Which of the following is a measure of total consumer surplus?

A marginal utility minus the price of the good

B the total utility consumers get from the consumption of the good
C the total utility consumers get from consumption of the good less the
total expenditure on the good
D marginal utility times the price of the good

69 Subject CT7, April 2013, Question 7 (amended)

Which of the following is implied by the principle of diminishing marginal

utility of income:

A Total utility increases at a decreasing rate as income increases.

B Marginal utility increases at a decreasing rate as income increases.
C Marginal utility decreases at an increasing rate as income falls.
D Total utility decreases at an increasing rate as income increases.

70 Subject CT7, April 2013, Question 10

Which of the following is NOT a motive for advertising by an existing firm in

an industry?

A to make the demand for the product more price-elastic

B to shift the demand for the firm’s product to the right
C to increase barriers to entry
D to increase sales and so help the firm exploit economies of scale

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71 Subject CT7, September 2013, Question 1

The main categories of economic resources are:

A natural resources, labour and money.

B labour, money and factories.
C natural resources, capital and factories.
D natural resources, labour and capital.

72 Subject CT7, September 2013, Question 2

The solution to the economic problem of deciding which goods to produce

requires:

A a choice between the production of consumer goods and the sacrifice of

alternatives.
B the establishment of freedom of entry and exit.
C the establishment of a system of market prices.
D a decision to be made on the degree to which capital will be used in the
production process rather than labour.

73 Subject CT7, September 2013, Question 3

If rail travel is an inferior good, which one of the following will lead to a shift
of its demand curve to the left?

A an increase in incomes
B a rise in car prices
C an increase in petrol prices
D a rise in the price of rail travel

74 Subject CT7, September 2013, Question 4

The demand equation for Good X is Qd = 15 – 0.5P and the supply equation
for Good X is Qs = 3 + 2P, where P is the price in pounds. When the price is
£6 there will be a:

A surplus of Good X and the price will rise.

B shortage of Good X and the price will fall.
C surplus of Good X and the price will fall.
D shortage of Good X and the price will rise.

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75 Subject CT7, September 2013, Question 5

Given a linear downward-sloping demand curve, higher prices along the

demand curve are associated with a:

A higher absolute price elasticity.

B lower absolute price elasticity.
C constant price elasticity.
D unitary price elasticity.

76 Subject CT7, September 2013, Question 7

Consumer A has a higher income than Consumer B but they have identical
marginal utility functions and pay the same prices for the goods which they
consume. If they both maximise utility then the marginal utility from each
good consumed will be:

A higher for A than for B and A will have a higher total utility.
B higher for A than for B and A will have a lower total utility.
C lower for A than for B and A will have a higher total utility.
D lower for A than for B and A will have a lower total utility.

77 Subject CT7, September 2013, Question 8

Adverse selection refers to a situation where:

A having insurance makes an individual less careful.

B having insurance makes an individual more careful.
C the people taking out the insurance are those who have the highest risk.
D the people taking out the insurance are those who have the highest risk
aversion.

78 Subject CT7, April 2014, Question 2

If an economy moves from producing 10 units of Good X and 5 units of

Good Y to producing 8 units of Good X and 6 units of Good Y, the
opportunity cost of the 6th unit of Good Y is:

A 8 units of Good X.
B 10 units of Good X.
C 2 units of Good X.
D 1.25 units of Good X.

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79 Subject CT7, April 2014, Question 3

The demand curve for Good X, which is a normal good, will shift to the right
if:

A its price decreases.

B the price of a substitute rises.
C the price of a complement rises.
D consumers’ incomes fall.

80 Subject CT7, April 2014, Question 4

Which of the following best describes an annual supply curve?

A the quantity that producers would like to sell annually

B the quantity that producers are willing and able to sell at each income
over the next year
C the quantity that producers are willing and able to produce over the next
year
D the quantity that producers are willing and able to sell at each price
annually

81 Subject CT7, April 2014, Question 5

If a maximum price for Good X is fixed above the market equilibrium price
there will be:

A an excess supply of Good X.

B an excess demand for Good X.
C no tendency for the market price of Good X to change.
D an upward pressure on the price of Good X.

82 Subject CT7, April 2014, Question 7

A maximum price is set for Good X at £30 which happens to coincide with
the free market price. A downward shift in the supply of Good X keeping the
maximum price fixed at £30 will lead to:

A no change in price and a surplus.

B no change in price and a shortage.
C a fall in price and a fall in the quantity sold.
D a fall in price and a rise in the quantity sold.

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83 Subject CT7, April 2014, Question 13

If the own price elasticity of demand for Good X is −0.8 and the income
elasticity of Good X is −0.3, which of the following is correct?

A Demand for Good X is price-elastic.

B A cut in the price of Good X will increase revenue for a firm producing
Good X.
C Good X is a luxury good.
D Good X is an inferior good.

84 Subject CT7, September 2014, Question 1

The main categories of economic resources are:

A natural resources, labour and money.

B labour, money and factories.
C natural resources, capital and factories.
D natural resources, labour and capital.

85 Subject CT7, September 2014, Question 2

The problem of scarcity in economics:

A exists only in economies which rely on the market mechanism.

B could be eliminated if we force prices to fall.
C means that there are shortages of some goods.
D exists because there are insufficient resources to satisfy human wants.

86 Subject CT7, September 2014, Question 3

Which of the following will NOT cause a shift in the demand curve for
Good X?

A a change in the price of Good X

B a change in the price of other goods
C a change in consumer incomes
D a change in consumer tastes

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87 Subject CT7, September 2014, Question 4

What is the combined effect of an increase in the cost of production and a

rise in consumer income on the equilibrium price and quantity of an inferior
good?

A the effect on price is indeterminate but quantity will fall

B the effect on price is indeterminate but quantity will rise
C the effect on quantity is indeterminate but price will rise
D the effect on quantity is indeterminate but price will fall

88 Subject CT7, September 2014, Question 5

Consumer X has a higher income than Consumer Y but they have identical
preferences and pay the same prices for the goods which they consume. If
they both maximise utility then:

A the marginal utility from each good consumed will be higher for X than
for Y and X will have a higher total utility.
B the marginal utility from each good consumed will be higher for X than
for Y and X will have a lower total utility.
C the marginal utility from each good consumed will be lower for X than for
Y and X will have a higher total utility.
D the marginal utility from each good consumed will be lower for X than for
Y and X will have a lower total utility.

89 Subject CT7, September 2014, Question 6

Adverse selection refers to a situation where:

A having insurance makes an individual less careful.

B having insurance makes an individual more careful.
C the people taking out the insurance are those who have the highest risk.
D the people taking out the insurance are those who have the highest risk
aversion.

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90 Subject CT7, September 2014, Question 14

The demand for Good X has a price elasticity of −1. If the government
decided to impose a sales tax of £3 per unit on Good X this would:

A shift the supply curve for Good X up by less than £3 and increase the
price by less than £3.
B shift the supply curve for Good X up by less than £3 and increase the
price by more than £3.
C shift the supply curve for Good X up by £3 and increase the price by £3.
D shift the supply curve for Good X up by £3 and increase the price by
less than £3.

91 Subject CT7, April 2015, Question 1

A company makes economic profits of 10%. The risk premium for the
company’s line of business is 5%. If the banks offer a rate of interest on
savings accounts of 3%, the opportunity cost to the owners of the company
is:

A 5%.
B 7%.
C 8%.
D 10%.

92 Subject CT7, April 2015, Question 2

Good X is an inferior good. A rise in consumer income when the supply

curve for Good X is positively sloped will cause which one of the following?

A the demand for Good X to fall and the price of Good X to fall
B the demand for Good X to fall and the price of Good X to rise
C the demand for Good X to rise and the price of Good X to fall
D the demand for Good X to rise and the price of Good X to rise

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93 Subject CT7, April 2015, Question 3

What is the combined effect of a decrease in the cost of production and a

rise in consumer income on the equilibrium price and quantity of a normal
good?

A The effect on price is indeterminate but quantity will fall.

B The effect on price is indeterminate but quantity will rise.
C The effect on quantity is indeterminate but price will rise.
D The effect on quantity is indeterminate but price will fall.

94 Subject CT7, April 2015, Question 5

If the income elasticity of demand for Good X is 2, a rise in all consumers’

disposable incomes from £50 million to £52 million will increase the quantity
demanded of Good X by:

A 2%.
B 4%.
C 6%.
D 8%.

95 Subject CT7, October 2015, Question 1

Scarcity exists if:

A prices are too high.

B human wants cannot be satisfied.
C there are shortages of some goods.
D markets are not perfectly competitive.

96 Subject CT7, October 2015, Question 2

Which of the following statements is always TRUE?

A Opportunity cost is constant.

B Opportunity cost is equal to total revenue minus total variable cost.
C Opportunity cost is equal to a firm’s supernormal profits.
D Opportunity cost is the cost in terms of the best foregone alternative.

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97 Subject CT7, October 2015, Question 3

Which of the following will NOT cause a shift in the demand curve for
Good X?

A a change in consumer tastes

B a change in consumer incomes
C a change in the price of Good X
D a change in the price of other goods

98 Subject CT7, October 2015, Question 4

If public transport is an inferior good, which of the following will cause its
demand curve to shift to the left?

A a rise in the price of cars

B an increase in the price of petrol
C an increase in consumers’ incomes
D an increase in the price charged to use public transport

99 Subject CT7, October 2015, Question 5

Consumer A has a higher income than Consumer B but they have identical
preferences and pay the same prices for the goods which they consume. If
they both maximise utility then the marginal utility from each good consumed
will be:

A higher for A than for B and A will have a higher total utility.
B higher for A than for B and A will have a lower total utility.
C lower for A than for B and A will have a higher total utility.
D lower for A than for B and A will have a lower total utility.

100 Subject CT7, October 2015, Question 6

Adverse selection refers to a situation where:

A having insurance makes an individual less careful.

B having insurance makes an individual more careful.
C the individuals who take out insurance are those who pose the highest
risk.
D the individuals who take out insurance are those who have the highest
risk aversion.

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101 Subject CT7, April 2016, Question 1

Which of the following statements explains how price, demand and supply
for a good respond to an increase in the price of a substitute good?

A price rises, quantity demanded falls and quantity supplied rises

B price rises, quantity demanded falls and quantity supplied falls
C price falls, quantity demanded rises and quantity supplied falls
D price rises, quantity demanded rises and quantity supplied rises

102 Subject CT7, April 2016, Question 2

If the demand for Good X increases (due to a rise in income of consumers)

and the supply of Good X increases (due to increased worker productivity)
then the equilibrium price of Good X:

A will fall and the equilibrium quantity may rise or fall.

B will fall and the equilibrium quantity will rise.
C may rise or fall or remain the same and the equilibrium quantity will fall.
D may rise or fall or remain the same and the equilibrium quantity will rise.

103 Subject CT7, April 2016, Question 3

If an 8% rise in the price of Good X results in a 4% fall in the quantity of

Good X demanded then the approximate price elasticity of demand for Good
X is:

A 12
B 0.5
C 2
D 4

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104 Subject CT7, April 2016, Question 5

Which one of the following statements concerning advertising is FALSE?

A Advertising is intended to shift the demand curve for a firm’s product

upwards to the right.
B Advertising is intended to make the demand for a firm’s product more
price-elastic.
C A potential feature of a successful advertising campaign is that it
increases a firm’s total revenue by more than it increases the firm’s total
costs.
D Advertising can enable a firm to gain economies of scale.

105 Subject CT7, September 2016, Question 1

The solution to the economic problem of deciding which goods to produce

requires:

A the establishment of freedom of entry and exit.

B the establishment of a system of market prices.
C a choice between the production of consumer goods and the sacrifice of
alternatives.
D a decision to be made on the degree to which capital will be used in the
production process rather than labour.

106 Subject CT7, September 2016, Question 2

Opportunity cost is always:

A constant.
B equal to a firm’s supernormal profits.
C equal to total revenue minus total variable cost.
D the cost in terms of the best foregone alternative.

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107 Subject CT7, September 2016, Question 3

Which of the following statements explains how price, demand and supply
respond to a surplus?

A Price rises, quantity demanded falls and quantity supplied rises.

B Price rises, quantity demanded falls and quantity supplied falls.
C Price falls, quantity demanded rises and quantity supplied falls.
D Price falls, quantity demanded rises and quantity supplied rises.

108 Subject CT7, September 2016, Question 4

Despite an increase in the price of admission from £15.00 to £18.00, a

football club finds that attendance at matches increased by 20%. Which of
the following could most effectively explain this situation?

A The prices of alternative attractions have fallen.

B Demand to watch football has a high price elasticity.
C Demand to watch football has a low price elasticity.
D Consumer preference has changed in favour of watching football.

109 Subject CT7, September 2016, Question 5

Diminishing marginal utility of income implies that individuals are:

A risk-lovers.
B risk-averse.
C risk-neutral.
D risk-diversifiers.

110 Subject CT7, September 2016, Question 6

Consumer A has a higher income than Consumer B but they have identical
preferences and pay the same prices for the goods which they consume. If
they both maximise utility then the marginal utility from each good consumed
will be:

A higher for A than for B and A will have a higher total utility.
B higher for A than for B and A will have a lower total utility.
C lower for A than for B and A will have a higher total utility.
D lower for A than for B and A will have a lower total utility.

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111 Subject CT7, April 2017, Question 1

The problem of scarcity in economics:

A exists only in economies which rely on the market mechanism.

B could be eliminated if prices are forced to fall.
C means that there are shortages of some goods.
D exists because there are insufficient resources to satisfy human wants.

112 Subject CT7, April 2017, Question 2

If the government chooses to use resources to build a hospital instead of a

school, this illustrates the concept of:

A a market system.
B macroeconomics.
C competition.
D opportunity cost.

113 Subject CT7, April 2017, Question 4

In relation to insurance, moral hazard describes the fact that:

A people who know that they are a particularly high risk are more inclined
to take out insurance.
B a policyholder may act in a way which makes the insured event more
likely to occur.
C people who know that they are a particularly high risk are less inclined
to take out insurance.
D an insurance company will face false insurance claims.

114 Subject CT7, April 2017, Question 5

A firm’s decision to reduce its expenditure on advertising is most likely to

have the following impact on its demand curve:

A The curve will shift to the left and become less elastic.
B The curve will shift to the right and become less elastic.
C The curve will shift to the left and become more elastic.
D The curve will shift to the right and become more elastic.

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115 Subject CT7, October 2017, Question 1

Which of the following statements defines adverse selection in relation to

insurance?

A Adverse selection describes the fact that people who know that they are
a particularly bad risk are more inclined to take out insurance.
B Adverse selection describes the fact that a policyholder may act in a
way which makes the insured event more likely to occur.
C Adverse selection describes the fact that people who know that they are
a particularly bad risk are less inclined to take out insurance.
D Adverse selection describes the risk that an insurance company will
face false insurance claims.

116 Subject CT7, October 2017, Question 4

Good X has a cross elasticity of demand with respect to Good Y which is

equal to minus unity (ie –1). Good X is which of the following with respect
to Good Y?

A a perfect substitute
B an imperfect substitute
C a perfect complement
D an imperfect complement

117 Subject CT7, October 2017, Question 5

Which of the following is NOT a characteristic of an inferior good?

A The income elasticity of demand is negative.

B The income elasticity of demand is between zero and one.
C The demand for the good increases as income falls.
D The demand will rise if its price falls.

118 Subject CT7, October 2017, Question 6

If the government chooses to use resources to build a hospital instead of a

school, this illustrates the concept of:

A a market system.
B macroeconomics.
C competition.
D opportunity cost.

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119 Subject CT7, October 2017, Question 7

Which of the following is NOT a motive for advertising by an existing firm in

an industry?

A to make the demand for the product more price-elastic

B to shift the demand for the firm’s product to the right
C to increase barriers to entry
D to increase sales and so help the firm exploit economies of scale

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Short-answer questions

1 Subject CT7, April 2008, Question 27

Outline the three categories that may be used to classify different types of
economies. [3]

2 Subject CT7, April 2008, Question 28

From information in the table, calculate the following elasticities:

Point 1 Point 2
Quantity demanded of Good X 250 300
Quantity supplied of Good Y 100 110
Price of Good X 50 45
Price of Good Y 60 65
Income of Individual A 250 260

(i) income elasticity of demand of Good X [1]

(ii) price elasticity of supply of Good Y [1]

(iii) price elasticity of demand of Good X [1]

(iv) cross-price elasticity of Good X with respect to the price of Good Y. [1]
[Total 4]

3 Subject CT7, April 2008, Question 30

Use and appropriately label a diagram to:

(i) Show the production possibilities of producing two Goods X and Y.

Indicate on the diagram a point where the production of goods is
inefficient. [2]

(ii) Explain how the opportunity cost of Good X is related to the production
of Good Y. [2]
[Total 4]

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4 Subject CT7, April 2008, Question 34

(i) Two normal goods, A and B, are available for a consumer to purchase.
Using an appropriate diagram illustrate how an increase in the price of
Good A can be explained using income and substitution effects. [5]

(ii) State how the relationship between the income and substitution effects
will differ where one good is an inferior good. [1]
[Total 6]

5 Subject CT7, September 2008, Question 27

A consumer has £1 of income. Good X and Good Y cost 20 pence each.

The relevant marginal utilities for the consumer are:

Consumption Marginal utility Consumption Marginal utility

of Good X of Good X of Good Y of Good Y

1 100 1 200
2 80 2 160
3 60 3 120
4 40 4 100
5 20 5 80

(i) What quantities of Good X and Good Y will the utility-maximising

consumer buy? [1]

(ii) What will be the total utility of the consumer when satisfaction is
maximised? [1]

(iii) If the consumer’s income is raised to £1.80 and the price of Good Y is
raised from 20 pence to 40 pence, what will be the new
utility-maximising quantities of Goods X and Y purchased? [2]
[Total 4]

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6 Subject CT7, April 2009, Question 29

In 2008, with a given quantity of resources and technology, Country X is

capable of producing combinations of consumer goods and capital goods as
set out below.

Consumer Goods (C) 120 100 80 50 0

Capital Goods (K) 0 30 60 80 100

(i) Using the data in the table, sketch a production possibility frontier. [3]

(ii) Which of the following combinations can Country X produce?

A 100(C) 50(K)
B 90(C) 40(K)
C 30(C) 100(K)
D 10(C) 130(K) [1]

(iii) Country X is making full use of its resources and producing 80 units of
consumer goods. Calculate the opportunity cost to Country X, in terms
of capital goods, of producing 20 more units of consumer goods. [2]
[Total 6]

7 Subject CT7, September 2009, Question 29

Draw a separate diagram for each of the following events to illustrate the
impact of the change on the quantity of Good X demanded and supplied.

Good X is an inferior good. Before the introduction of the change, label the
demand curve D1, the supply curve S1 and price and quantity P1 and Q1
respectively. Label any new demand and supply curves D2 and S2
respectively and the new price and quantity P2 and Q2.

(i) A rise in the price of a substitute Good Y. [1]

(ii) A government subsidy on the production of Good X. [1]

(iii) A fall in consumers' incomes. [1]

(iv) A fall in input costs in the industry that produces Good X. [1]
[Total 4]

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8 Subject CT7, September 2009, Question 30

(i) Describe the problem of adverse selection and how it might be dealt
with by insurance companies. [2]

(ii) Explain the problem of moral hazard and how it affects the price of
insurance. [2]
[Total 4]

9 Subject CT7, September 2009, Question 31

Read parts (i) to (iii) before answering. Use only one diagram to answer all
three parts of the question.

A consumer has an income of £600 which he can spend on Good X or

Good Y or some combination of the two goods. Good X costs £20 per unit
and Good Y costs £40 per unit.

(i) Draw a budget line for the consumer, labelling the quantities of Good X
and Good Y at the points where the budget line meets the quantity of
Good X and Good Y axes. [1]

(ii) On the diagram for (i), draw an indifference curve for Good X and
Good Y labelled IC1, part of which shows a number of different
combinations of quantities of Good X and Good Y which the consumer
could afford to buy. Mark with a Z all the points on the curve where the
consumer is spending all his income. [2]

(iii) On the same diagram, draw a second indifference curve for Good X and
Good Y labelled IC2 which represents an unobtainable level of utility for
the consumer. [1]
[Total 4]

10 Subject CT7, April 2010, Question 27

(a) Describe THREE factors which could cause an upward shift in the
supply curve for a product.

(b) Provide an example in each case. [4]

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11 Subject CT7, April 2010, Question 28

The demand for Good X is 300 units when its price is £4. Assume that as a
result of a price fall, the demand for the good increases to 400 units and the
sales revenue falls by £400.

(i) (a) Calculate the price of Good X after the fall.

(b) Calculate the price elasticity of demand with respect to the fall in its
price. [2]

(ii) State whether elasticity will change with a downward movement along a
linear demand curve. [1]

Assume that the cross-price elasticity of demand for Good Y, which is a

complement to Good X, is 1.5.

(iii) Calculate the proportionate change in the demand for Good Y as a

result of the fall in the price of Good X. [1]
[Total 4]

12 Subject CT7, April 2010, Question 29

A company producing a health drink called Boost has plans to carry out a
new advertising campaign to publicise Boost’s properties of bringing vitality
and health to the consumer.

(i) Describe, with reference to an appropriate diagram, the effects of

advertising on the demand for Boost. [4]

(ii) Explain how advertising can achieve these effects. [2]

[Total 6]

13 Subject CT7, September 2010, Question 29

(i) Explain how the concept of moral hazard can be applied in the context
of a government’s measures to rescue banks in a financial crisis. [2]

(ii) List two ways in which insurance companies attempt to mitigate the
additional risk arising from moral hazard. [2]

(iii) Explain the adverse selection problems facing banks and why these
may mean that raising interest rates may lower rather than raise bank
profits. [3]
[Total 7]

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14 Subject CT7, September 2010, Question 32

(i) Draw a diagram showing the demand D and supply S curves for a good.
Show the equilibrium price by P1 and the equilibrium level of sales by
Q1 . [1]

(ii) On your diagram draw the line S  T to show the new supply curve after
an excise tax of T is imposed on the good. Denote the new equilibrium
price and quantity by P2 and Q2 . [2]

(iii) Show clearly on your diagram consumer and producer surplus before
and after the tax, the government revenue and the excess burden
(ie net welfare loss) from the tax. [3]
[Total 6]

15 Subject CT7, April 2011, Question 27

Explain, using appropriate diagrams, why price elasticity of supply might be

important to:

(i) a government deciding whether to introduce a new sales tax. [3]

(ii) a business expecting a significant increase in demand for its product. [3]
[Total 6]

16 Subject CT7, September 2011, Question 28

Draw the following curves on four separate diagrams, with price on the
vertical axis and quantity on the horizontal axis:

(i) a demand curve with price elasticity of 1 throughout its entire length [1]

(ii) a demand curve with price elasticity of zero throughout its entire length
[1]

(iii) a demand curve for a good with no substitutes [1]

(iv) a demand curve with infinite price elasticity throughout its entire length.
[1]
[Total 4]

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17 Subject CT7, April 2012, Question 27

(i) Explain with the use of an appropriate formula the term cross-price
elasticity of Good X and Good Y. [2]

(ii) The demand for Good X is 260 units per year when price is £2.50 per
unit.

(a) If the price of Good X falls to £2.00 per unit and demand for Good X
increases to 300 units per year, calculate the own-price elasticity of
demand for Good X. [2]

(b) If consumer income increases from £23,000 to £26,000 per year

and demand for Good X rises to 320 units per year, calculate the
income elasticity of demand for Good X. [1]
[Total 5]

18 Subject CT7, April 2012, Question 31

Explain with the use of examples the following terms:

(a) risk-neutral
(b) risk-loving
(c) risk-averse. [3]

19 Subject CT7, October 2012, Question 30

Outline with the use of a diagram why essentials, such as water, have such
low prices, whilst luxuries, such as diamonds, have relatively high prices. [4]

20 Subject CT7, October 2012, Question 31

The market demand curve ( QD ) and supply curve ( QS ) of Good X are given
by the following equations:

QD = 120 - 2P
QS = 2P

where P is the price in pounds.

(i) Calculate the market equilibrium price and quantity. [2]

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(ii) Calculate the market equilibrium price and quantity if a sales tax of £10
per unit is imposed on Good X. [2]

(iii) Calculate the total tax revenue raised by the sales tax. [1]
[Total 5]

21 Subject CT7, April 2013, Question 32

(i) Explain the problem of adverse selection and how it might be dealt with
by insurance companies. [2]

(ii) Explain the problem of moral hazard and how it affects the price of
insurance. [2]
[Total 4]

22 Subject CT7, September 2013, Question 32

(i) Discuss, with the use of examples, two factors that influence the price
elasticity of demand for a good. [2]

(ii) Demonstrate, with the use of two separate diagrams, the effect of an
increase in labour productivity on the price and quantity traded when
demand is:
(a) elastic
(b) inelastic. [2]
[Total 4]

23 Subject CT7, September 2014, Question 27

(a) Define what economists mean by the term rational choice.

(b) Explain the concept of rational choice with reference to consumers. [3]

24 Subject CT7, September 2014, Question 28

Explain how changes in income and consumer expectations of future laptop

prices affect the demand for laptops and the price and quantity of laptops
traded. [3]

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25 Subject CT7, September 2014, Question 35

The table below shows the marginal utility a person derives from consuming
different quantities of Good X in terms of £s. Assume that Good X sells for
£10.

Quantity consumed 0 1 2 3 4 5 6
Marginal utility 25 20 16 12 8 4

(a) State the person’s total utility from consuming 3 units.

(b) State the person’s total expenditure from consuming 5 units.
(c) State the person’s marginal consumer surplus from consuming a 4th
unit.
(d) State the person’s total consumer surplus from consuming 2 units.
(e) State the level of consumption at which total consumer surplus is
maximised.
(f) State the general rule for maximising total consumer surplus. [5]

26 Subject CT7, April 2015, Question 27

Outline the factors that affect the demand for shares. [5]

27 Subject CT7, April 2015, Question 28

Explain three factors that would cause the market demand curve for sports
cars to shift to the right. [3]

28 Subject CT7, April 2015, Question 29

Outline the factors that affect the supply of oil. [3]

29 Subject CT7, October 2015, Question 27

Define the two branches of economics: macroeconomics and

microeconomics. [2]

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30 Subject CT7, October 2015, Question 28

Explain why firms would prefer consumer demand to be inelastic, rather than
elastic, following an increase in price. [4]

31 Subject CT7, April 2016, Question 27

Supply and demand for Good X are initially in equilibrium resulting in an

equilibrium price and quantity.

Explain how the introduction of each of the following controls will affect the
price, quantity supplied and quantity demanded, and whether the outcome
will be a surplus or a shortage of Good X.

(a) A maximum price set below the free market price. [2]

(b) A guaranteed minimum price set above the free market price. [2]
[Total 4]

32 Subject CT7, September 2016, Question 27

(i) Describe the difference between uncertainty and risk. [1]

(ii) Describe, with the use of an example, how firms might seek to reduce
uncertainty. [3]
[Total 4]

33 Subject CT7, April 2017, Question 27

State how the market demand curve for a normal good shifts (left shift, right
shift, no shift) in response to the following cases, assuming that in each case
all other factors affecting the demand remain the same:
(a) The price of a substitute good falls.
(b) The price of a complementary good falls.
(c) The good becomes more expensive.
(d) Consumers’ real incomes rise. [4]

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34 Subject CT7, October 2017, Question 27

(a) State the factors of production that exist within an economy.

(b) Describe how scarcity arises in the context of these factors. [3]

35 Subject CT7, October 2017, Question 28

Explain the factors that are likely to influence house prices. [5]

36 Subject CT7, October 2017, Question 29

(i) Explain why a government favours placing a sales tax on goods that
have a relatively price-inelastic demand. [1]

(ii) Show on a diagram, the producers’ and consumers’ share of the tax
burden. [3]
[Total 4]

37 Subject CT7, October 2017, Question 30

Explain the reasons why the utility you gain from a refrigerator is uncertain.
[4]

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Long-answer questions

1 Subject CT7, September 2016, Question 36

Discuss, with the use of supply and demand diagrams, how each of the
following scenarios may influence the price and equilibrium quantity of
housing within the market. Each scenario should be discussed separately.

(i) an increase in interest rates [4]

(ii) an expected rise in future house prices [3]

(iii) an increase in the rate of taxation for house builders [3]

[Total 10]

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SOLUTIONS TO PAST EXAM QUESTIONS

Multiple-choice questions

1 C 11 D 21 D 31 D 41 A
2 C 12 C 22 C 32 B 42 D
3 B 13 D 23 C 33 A 43 B
4 B 14 D 24 A 34 D 44 A
5 C 15 B 25 A 35 B 45 B
6 A 16 D 26 B 36 B 46 C
7 A 17 C 27 C 37 D 47 C
8 B 18 B 28 B 38 C 48 B
9 C 19 B 29 B 39 B 49 B
10 D 20 B 30 C 40 B 50 D

51 A 61 A 71 D 81 C 91 C
52 B 62 D 72 A 82 B or D 92 A
53 D 63 B 73 A 83 D 93 B
54 C 64 A 74 C 84 D 94 D
55 B 65 B 75 A 85 D 95 B
56 C 66 C 76 C 86 A 96 D
57 D 67 C 77 C 87 A 97 C
58 B 68 C 78 C 88 C 98 C
59 C 69 A 79 B 89 C 99 C
60 C 70 A 80 D 90 D 100 C

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101 D 111 D
102 D 112 D
103 B 113 B
104 B 114 C
105 C 115 A
106 D 116 C or D
107 C 117 B
108 D 118 D
109 B 119 A
110 C

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Short-answer questions

1 Subject CT7, April 2008, Question 27

Centrally planned or command economy – In a centrally planned economy,

central authorities decide what is to be produced, how it is to be produced,
and for whom it is produced. In practice, some local control may exist over
the method of production and consumers typically retain some choice as to
which goods they consume.

Free market economy – In a free market economy all economic decisions

are taken by individual households and firms, with no government
intervention. The interaction of supply and demand, driven by individuals
and firms acting in their own self interest, solves all the allocation questions.

Mixed economy – Mixed economies fall between the two extremes of

centrally controlled and free market economies. Some economic decisions
are made by the free market, some by the government, and some by
markets in which the government intervenes to a limited extent.

2 Subject CT7, April 2008, Question 28

(i) Income elasticity of demand of Good X

(300 - 250) / 250 50 / 250

= = +5
(260 - 250) / 250 10 / 250

(ii) Price elasticity of supply of Good Y

(110 - 100) / 100 10 / 100

= = +1.2
(65 - 60) / 60 5 / 60

(iii) Price elasticity of demand of Good X

(300 - 250) / 250 50 / 250

= = -2
(45 - 50) / 50 -5 / 50

(iv) Cross-price elasticity of Good X with respect to price of Good Y

(300 - 250) / 250 50 / 250

= = +2.4
(65 - 60) / 60 5 / 60

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3 Subject CT7, April 2008, Question 30

(i) Production possibilities

Good Y
(units)
40 A
B
30
C
20

10 Inefficient
D
10 20 30 40 50 Good X
(units)

(ii) Opportunity cost

At all points on the frontier curve, producing fewer units of one good is
necessary to produce more units of the other good.

So, the opportunity cost of producing 1 more unit of Good X is the number of
units of Good Y which must be given up.

As the quantity of Good X increases, the opportunity cost of producing

Good X (in terms of Good Y) increases. This is why the production
possibility frontier is bowed outwards.

If the economy is currently inefficient, then the opportunity cost of producing

more of Good X is zero, ie none of Good Y must be given up.

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4 Subject CT7, April 2008, Question 34

(i) Income and substitution effects

H
Quantity of
Good B
X

IC1
IC2

BL2 H BL1
Q2 Q3 Q1 Quantity of Good A

The consumer’s budget is represented by the budget line BL1. The

consumer will choose a combination of goods that maximises utility. This
will be a point on the indifference curve IC1 that is tangential to BL1. So, the
consumer will consume Q1 of Good A.

If the price of Good A increases, the consumer will be able to buy less
Good A with the available income, so the budget line pivots to BL2. Since it
is a normal good, the quantity of Good A consumed will fall to Q2.

We can split the change in demand from Q1 to Q2 into the substitution and
income effects by drawing in a hypothetical budget line, labelled HH in the
diagram, which has the same slope as BL2 (thus reflecting new relative
prices) but is tangential to IC1 (thus reflecting the original level of real
income).

The substitution effect is the decrease in demand from Q1 to Q3  this is

the decrease in demand due purely to the change in relative prices. The
substitution effect of the price change is therefore negative.

The income effect shows the change in demand due to the change in real
income resulting from the price change. Since the price of Good A has
increased, the consumer’s real income has fallen. This is illustrated by the
move from IC1 to a lower level of utility on IC2.

A normal good is one that has positive income elasticity of demand. Thus
for a normal good, the change in demand resulting purely from this fall in
real income will cause a decrease in demand. The income effect therefore
decreases consumption further from Q3 to Q2. The income effect of the
price change is therefore negative.

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(ii) Inferior goods

For a normal good, both the income and substitution effects are negative,
ie an increase in price will lead to a fall in the quantity demanded.

For an inferior good, the substitution and income effects will have opposite
effects on quantity demanded. The substitution effect will still be negative,
whilst the income effect will be positive, ie for the income effect, an increase
in price will lead to an increase in quantity demanded.

5 Subject CT7, September 2008, Question 27

(i) Quantities of Goods X & Y bought by utility-maximising consumer

Using first principles

pX and pY are both 20p, so, given an income of £1, we need to find the
consumption bundle consisting of a total of five units of Goods X and/or Y
that gives the greatest total utility.

The first unit of X yields a utility of 100, and all subsequent units less than
100, while the four units of Y all yield a utility of 100 or more. So, given that
the consumer can buy a total of five units of X and Y, the utility-maximising
bundle must consist of one unit of X and four units of Y.

Using the condition for utility maximisation

In a situation with two goods, utility is maximised where:

marginal utility of X p X
=
marginal utility of Y pY

As pX and pY are the same, the marginal utilities for each good must also
be the same. This occurs with both:
 1X  4Y
 2X  5Y

However, the latter bundle costs more than £1 and so is unattainable,

whereas the former costs exactly £1, is therefore attainable, and hence is
the utility-maximising consumption bundle.

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(ii) Total utility of the consumer when satisfaction is maximised

The utility-maximising bundle consisting of one unit of X and four units of Y

yields a utility of:

100 + 200 + 160 + 120 + 100 = 680

(iii) New utility-maximising quantities of Goods X and Y

Utility is maximised where:

marginal utility of X p X

marginal utility of Y pY

marginal utility of X 20 1
ie  
marginal utility of Y 40 2

Utility maximisation requires that the marginal utility from Good Y is twice the
marginal utility of Good X. This occurs with:
 1X  1Y (costs £0.60)
 2 X  2Y (costs £1.20)
 3 X  3Y (costs £1.80)

 4 X  5Y (costs £2.80)

Thus, as all income is spent and the utility-maximising condition is satisfied,

three units of each good must be the utility-maximising bundle.

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6 Subject CT7, April 2009, Question 29

(i) Production possibility frontier

consumer
goods
120

100

80

50

0 30 60 80 100 capital
goods

(ii) Combinations Country X can produce

A no
B yes
C no
D no

(iii) Opportunity cost of producing 20 more units of consumer goods

The opportunity cost of 20 more units of consumer goods is 30 units of

capital goods.

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7 Subject CT7, September 2009, Question 29

(i) A rise in the price of a substitute Good Y

P S1

P2
P1 D2
D1

Q1 Q2 Q

(ii) A government subsidy on the production of Good X

S1 S2
P

P1

P2 D1

Q1 Q2 Q

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(iii) A fall in consumers’ incomes

P
S1

P2

P1
D2

D1

Q1 Q2 Q

(iv) A fall in input costs in the industry that produces Good X

P S1 S2

P1

P2 D1

Q1 Q2 Q

8 Subject CT7, September 2009, Question 30

(i) Adverse selection

Adverse selection describes the fact that people who know that they are
particularly bad risks are more inclined to take out insurance than those who
know that they are good risks.

Insurance companies try and reduce the problems of adverse selection by

finding out lots of information about potential policyholders, who can then be
put in small, reasonably homogeneous pools and charged appropriate
premiums.

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(ii) Moral hazard

Moral hazard describes the fact that a policyholder may, because they have
insurance, act in a way that makes the insured event more likely.

Moral hazard makes insurance more expensive. It may even push the price
of insurance above the maximum premium that a person is prepared to pay.

9 Subject CT7, September 2009, Question 31

Good Y

15
Z

IC2
Z
IC1
BL
30 Good X

10 Subject CT7, April 2010, Question 27

Any three from the following:

 an increase in the costs of production, eg if raw material prices rise
 an increase in the profitability of alternative products (substitutes in
supply), eg the supply of carrots falls if the price of potatoes rises
 a fall in the profitability of goods in joint supply, eg the supply of diesel
falls if the price of petrol falls
 adverse natural events, eg bad weather reducing the supply of
agricultural produce
 expectations of future price changes, eg the supply of oil is reduced now
if the price of oil expected to rise in the near future
 a fall in the number of suppliers, eg if pension providers leave the
industry due to new regulatory requirements.

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11 Subject CT7, April 2010, Question 28

(i)(a) Price of Good X

Before the price fall:

P = 4, Q = 300, TR = 1200

After the price fall:

Q = 400, TR = 1200 - 400 = 800

So:

800
P= =2
400

(i)(b) Price elasticity of demand

100 300 2
e = =-
-2 4 3

(ii) Value of elasticity along the demand curve

Yes, the absolute value of elasticity will fall with a downward movement
along a linear demand curve.

(iii) Proportionate change in demand for Good Y

Given that the price of Good X falls from £4 to £2, ie by 50%, the demand for
Good Y must rise by:

-1.5 ¥ -50% = +75%

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12 Subject CT7, April 2010, Question 29

(i) The effects of advertising on the demand for Boost

The two main aims of advertising Boost are:

1. to shift the demand curve for Boost to the right
2. to make the demand curve for Boost more inelastic.

price
of
Boost

P2
Demand with advertising
P1

Demand without advertising

quantity demanded
Q1 Q2 Q*
of Boost

The diagram shows that the shift of the demand curve to the right as a result
of the advertising campaign would increase the quantity demanded at the
original price P1 from Q1 to Q * . However, as the advertising has also
reduced the elasticity of demand, the firm can increase its price to P2 and
still increase sales to Q2 . By doing this, it will increase its revenue from
P1  Q1 to P2  Q2 . The more successful the campaign, the greater the shift
in the demand curve to the right and the greater the reduction in the price
elasticity of demand.

(ii) How advertising achieves these effects

The increase in demand for Boost (and hence the shift of its demand curve
to the right) is achieved by firstly providing information about the health drink
to increase awareness of the product.

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Secondly, the advertisements will persuade customers to buy the drink by

creating interest in and a desire for the product. The advertisements will
promote the positive effects on health and vitality and try to encourage
consumers to switch to Boost from other drinks.

If the advertising campaign convinces consumers that Boost is better for

them than any other drink on the market, the demand curve for Boost will
become more inelastic. This gives the company greater power to increase
the price of Boost. An increase in price will lead to a less than proportionate
fall in quantity demanded because consumers have been persuaded of the
merits of Boost and will largely remain loyal to the brand.

13 Subject CT7, September 2010, Question 29

(i) Moral hazard and banks

Moral hazard is the change in behaviour of a party to a deal, once a deal has
been struck, to the detriment of the other party.

If the government helps out the banks in a financial crisis, there is a danger
that the banks will expect such support in the future and will change their
behaviour as a result of such ‘insurance’. Confident that the government will
come to their rescue if they were to collapse in the future, the banks might
feel protected from the adverse consequences of ‘bad’ decisions and
therefore might undertake riskier activities than they otherwise would,
eg lending to uncreditworthy borrowers or investing in sub-prime debt.

(ii) Ways that insurance companies can mitigate the risk from moral
hazard

Any two from:

 the policyholder pays an excess, eg the first £50 of any claim
 no claims discount, so the policyholder has a reward in the form of lower
premiums for careful behaviour
 conditions attached to the policy, eg the insurance company will meet
the claim for a stolen bicycle only if the bicycle is fitted with a D-lock
 the disclosure of pertinent facts, eg the insurance might invalidate travel
insurance claims for skiing injuries if the policyholder did not disclose
the fact that the holiday was in fact a skiing holiday.

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(iii) Adverse selection problems facing banks

The problem of adverse selection is that, when information is imperfect,

high-risk groups are more attracted to profitable opportunities, to the
disadvantage of the average person.

The problem for banks is that if they lack sufficient information to be able to
distinguish high from low default risks, then they are likely to charge an
‘average’ interest rate that will attract high-risk customers and deter low-risk
customers. The ‘average’ rate of interest will then be too low to cover the
defaults of the predominantly high-risk customer base, and the banks will
make a loss.

If the banks try to increase profitability by increasing interest rates, they

might not succeed. As interest rates increase, low-risk customers are driven
away further because they think the rates increasingly unreasonable, so the
banks are left with an increasing proportion of high-risk customers, who are
more likely to default. So, increasing interest rates may ultimately lead to a
higher proportion of defaults and lower profit.

14 Subject CT7, September 2010, Question 32

(i), (ii), (iii) The diagram

price

S+T

a
S
P2
b
c d
P1
e g
f
P2 - T
h
D

Q2 Q1 quantity

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Prior to the introduction of the tax:

 the consumer surplus = a  b  c  d

 the producer surplus = e  f  g  h

After the imposition of the tax:

 the consumer surplus = a

 the producer surplus = h

 government revenue = b  c  e  f

 excess burden of tax = d  g

15 Subject CT7, April 2011, Question 27

(i) Importance of price elasticity of supply to a government

introducing a sales tax

In each of the diagrams below, a sales tax will increase the price of the good
from p1 to p2 and reduce the quantity from Q1 to Q2. The total tax revenue is
the area Q2 ¥ ( p2 - pp ) , of which consumers will pay Q2 ¥ ( p2 - p1) and
producers will pay Q2 ¥ ( p1 - pp ) .

Elastic supply

price
tax
revenue S'

sales
p2
tax S
p1
pp

Q2 Q1 quantity

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Inelastic supply

S'
S
price tax
revenue sales
tax

p2
p1

pp
D

Q 2 Q1 quantity

Price elasticity of supply is important because it affects:

 the quantity of the good that is produced.
– If the government is imposing the tax in order to reduce the quantity
produced, then there will be a bigger effect if supply is elastic.
– If there are no externalities, a sales tax will result in a greater
divergence from the socially optimal output if supply is elastic.

 the tax revenue raised – if the government is imposing the tax in order
to raise tax revenues, then it would prefer supply to be inelastic.

The elasticity of supply also affects the distribution of the burden of the tax
between consumers and producers. The more elastic the supply, the
greater the burden on consumers and the lower the burden on producers.

(ii) Importance of price elasticity of supply to a business expecting a

significant increase in demand

In each of the diagrams below, an increase in demand will increase the price
of the good from p1 to p2 and increase the quantity from Q1 to Q2 .

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Elastic supply
increase in
demand
price
S
p2
p1

D'
D

Q1 Q2 quantity

Inelastic supply
S
increase in
price demand

p2

p1

D'
D

Q1 Q2 quantity

Price elasticity of supply is important because it affects:

 the quantity of the good that is produced – the more elastic the supply of
the good, the bigger the impact on the quantity produced
 the price at which the good is sold – the more inelastic the supply of the
good, the bigger the impact on the price.

The product of the quantity sold and the price at which each unit is sold will
determine the total revenue (and hence the profits) made by the producer.
In either scenario, total revenue (and hence probably profit) will increase.

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16 Subject CT7, September 2011, Question 28

(i) Price elasticity of –1 throughout its entire length

price

quantity

(ii) Price elasticity of zero throughout its entire length

price D

quantity

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(iii) Price elasticity for a good with no substitutes

price

quantity

(iv) Infinite price elasticity throughout its entire length

price

quantity

17 Subject CT7, April 2012, Question 27

(i) Cross-price elasticity of demand

The cross-price elasticity of demand (eC ) measures the sensitivity of the

quantity demanded of one good to a change in the price of another good.

The cross-price elasticity of demand of Good X with respect to the price of

Good Y is defined as:

% change in quantity demanded of Good X

eC =
% change in price of Good Y

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As complementary goods are jointly consumed, they tend to have negative

cross-price elasticity of demand. As substitute goods are alternatives to
each other, they tend to have positive cross-price elasticity of demand.

(ii)(a) Calculation of own-price elasticity of demand

Using the original method:

% change in quantity demanded DQD / original QD

e= =
% change in price DP / original P
(300 - 260) / 260
=
(2.00 - 2.50) / 2.50
= -0.769

Using the average method:

% change in quantity demanded DQD / average QD

e= =
% change in price DP / average P

(300 - 260) / 280

=
(2.00 - 2.50) / 2.25
= -0.643

(ii)(b) Calculation of income elasticity of demand

Using the original method:

% change in quantity demanded DQD / original QD

eY = =
% change in income DY / original Y
(320 - 260) / 260
=
(26,000 - 23,000) / 23,000
= +1.769

Using the average method:

% change in quantity demanded DQD / average QD

e= =
% change in income DY / average Y
(320 - 260) / 290
=
(26,000 - 23,000) / 24,500
= +1.690

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18 Subject CT7, April 2012, Question 31

(a) Risk-neutral

A risk-neutral person is indifferent to risk and hence between accepting or

rejecting a fair gamble with no expected gain, eg tossing a fair coin and
winning £1 if it lands heads up and losing £1 if it lands tails up. Risk-neutral
individuals will accept a gamble with favourable odds and reject a gamble
with unfavourable odds.

(b) Risk-loving

A risk-loving person likes risk and will always accept a fair gamble.
Risk-loving individuals may also be willing to accept a gamble, even when
the odds are unfavourable. The more risk-loving the person is, the worse the
odds they are willing to accept.

Risk-loving individuals are more likely to spend time gambling.

(c) Risk-averse

A risk-averse person dislikes risk and will always reject a fair gamble.
Risk-averse individuals may be unwilling to accept a gamble, even when the
odds are favourable. The more risk-averse the person is, the better the
odds need to be to entice the person to accept the gamble.

Risk-averse individuals are most likely to take out insurance in order to

remove (or reduce) risk.

19 Subject CT7, October 2012, Question 30

The total utility derived from water is very high but, for most of us, the marginal
utility of water is very low. This is because water is plentiful, ie there is high
supply, and so we can consume nearly as much water as we want.

In contrast, diamonds are much scarcer, ie there is a very low supply. So

even if the demand for diamonds is lower than the demand for water, the price
of diamonds could still be higher.

The total utility derived from diamonds is much lower than that derived from
water because we consume so few of them. However, the marginal utility of
diamonds is much higher than the marginal utility of water.

It is marginal utility, not total utility, that determines the price. The higher
marginal utility of diamonds is then associated with the higher price of
diamonds.

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The supply and demand for water and diamonds is illustrated in the following
diagram.

Sdiamonds

MU, P
Swater

Pdiamonds

Pwater MUwater
MUdiamonds
Qdiamonds Qwater Quantity

20 Subject CT7, October 2012, Question 31

(i) Equilibrium price and quantity

Equating QD and QS gives:

120 - 2P = 2P
4P = 120
P = 30

Substituting this back into either equation gives:

QD = 120 - 2P QS = 2P
= 120 - 2 ¥ 30 or = 2 ¥ 30
= 60 = 60

Therefore the market equilibrium price is £30 and the market equilibrium
quantity is 60.

(ii) New equilibrium price and quantity if a sales tax is imposed on

Good X

The new supply curve equation is:

P = 0.5QS + 10

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which rearranges to be:

QS = 2(P - 10)

Equating the original demand curve equation with the new supply curve
equation gives:

120 - 2P = 2(P - 10)

4P = 140
P = 35

Substituting this back into either equation gives:

QD = 120 - 2P QS = 2(P - 10)

= 120 - 2 ¥ 35 or = 2 ¥ (35 - 10)
= 50 = 50

Therefore the new market equilibrium price is £35 and the new market
equilibrium quantity is 50.

(iii) Total tax revenue

Total tax revenue is equal to £10 ¥ 50 = £500 .

21 Subject CT7, April 2013, Question 32

See solution to Past Exam Question 8.

22 Subject CT7, September 2013, Question 32

(i) Factors influencing price elasticity of demand

The greater the number of substitutes and the closer the substitutes, the
greater the change in demand following a price change as people can easily
switch between alternatives and therefore the more elastic the demand will
be. For example, the demand for a particular brand of butter is likely to be
more elastic than the demand for a specialist magazine.

Generally, the higher the proportion of income spent on the product the
higher the elasticity of demand. For example, the elasticity of demand for
luxury holidays might be higher than the elasticity of demand for matches.

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The narrower the product definition, the more elastic the demand, since it is
easier to find an alternative. For example, the elasticity of demand for a
particular brand of coffee is likely to be higher than the elasticity of demand
for coffee in general.

The lower the degree of brand loyalty or addiction to a product, the more
elastic the demand, since consumers will consider alternatives. For
example, the elasticity of demand for a well-branded item of sportswear is
likely to be lower than for an unbranded pair of shorts. Similarly the elasticity
of demand will tend to be lower for cigarettes than for crisps.

The more luxurious a product, the more elastic the demand, as consumers
can do without it if the price increases. For example, the demand for foreign
holidays is likely to be more elastic than the demand for milk.

The longer the time period following the price change, the higher the
elasticity of demand, since it is easier to find substitutes in time. For
example, the elasticity of demand for potatoes is likely to be higher in the
longer term as people switch to pasta and rice as alternatives.

(ii) Effect of an increase in labour productivity

Relatively elastic demand

price S1
S2

p1
p2 D1

Q1 Q2 quantity

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Relatively inelastic demand

S1
price S2

p1

p2

D1

Q 1 Q2 quantity

23 Subject CT7, September 2014, Question 27

(a) Definition of rational choice

A rational choice is one that involves weighing up the benefit of an activity

against its opportunity cost, so the decision maker successfully maximises
their objective, ie happiness or profits.

(b) Rational choice with reference to consumers

Rational choice (or rational decision making) involves weighing up the

marginal benefit of an activity and the marginal cost. For consumers
deciding what to buy, it involves choosing those goods that provide the best
value for money from those available. A particular good may be preferred by
a consumer, but it may also be the most expensive.

Specifically, if the marginal benefit derived from consuming a particular good

exceeds the marginal cost of purchasing the good, then the rational choice is
to purchase (and consume) the good.

Alternative answer (based on one-commodity model)

Marginal consumer surplus is the excess utility gained over and above the
price paid for an additional unit of a good.

Total consumer surplus is the total utility gained from the goods consumed,
less the total expenditure on them, ie the excess of what the person would
have paid over what they actually paid for the goods.

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Rational consumer choice attempts to maximise total consumer surplus.

24 Subject CT7, September 2014, Question 28

Laptops are normal goods. This means that as income increases, demand
will also increase. In other words, the demand curve will shift to the right.
This will lead to an increase in the price of laptops and an increase in the
quantity traded.

Consumers may believe that the price of laptops will fall in the future. In this
case, the demand for laptops will be lower now as consumers delay their
purchases. The demand curve will shift to the left, leading to a fall in the
price of laptops and a decrease in the quantity traded.

Conversely, consumers may believe that the price of laptops will rise in the
future. In this case, the demand for laptops will be higher now as consumers
buy them now rather than in the future. The demand curve will shift to the
right, leading to a rise in the price of laptops and an increase in the quantity
traded.

25 Subject CT7, September 2014, Question 35

(a) Total utility from consuming three units

25 + 20 + 16 = £61

(b) Total expenditure from consuming five units

5  10 = £50

(c) Marginal consumer surplus from consuming a fourth unit

12 – 10 = £2

(d) Total consumer surplus from consuming two units

25 + 20 – 2  10 = £25

(e) Level of consumption at which total consumer surplus is

maximised

The level of consumption at which total consumer surplus is maximised is 4

units (see part (f) below).

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(f) General rule for maximising total consumer surplus

Total consumer surplus is maximised when price equals marginal utility.

Note: Here consumer surplus is maximised at 4 units which is the last unit
for which marginal utility exceeds price. Marginal utility falls below price at 5
units, which will lead to a reduction in total consumer surplus.

26 Subject CT7, April 2015, Question 27

Factors affecting the demand for shares include any five from the following:

 the long-term expected return offered by shares, which reflects factors

such as the current price, expectations of long-term future dividend
income and capital growth.

In addition, investors who require income will generally demand shares

with high dividend yields, whereas others may prefer shares that offer
the prospect of higher capital growth.

 the perceived riskiness of shares in general / individual shares, both in

absolute terms and as compared to other individual shares and asset
classes, eg bonds and cash.

 the expected return offered by alternative investments. For shares in

general, these include bonds, savings accounts, etc. For individual
shares, they also include other shares, both in the same industrial
sector and in other sectors.

 investor tastes, which reflect regulation, investors’ appetite for risk,

investment objectives and liabilities etc. In addition, certain asset
classes and individual shares (eg Apple) tend to come in and out of
fashion.

 taxes and transaction costs, which affect the cost of buying and selling
shares. Likewise, the tax treatment of different assets (eg shares
versus bonds), and of income versus capital gains, will influence the
demand for shares.

 investors’ incomes and/or wealth. In general, a higher level of income

and/or accumulated wealth means that people have more funds
available to invest across all asset classes, some of which will be used
to buy shares.

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 expectations of future share price changes. For example, if share prices

are expected to fall in the short term, then some investors will tend to
sell their shares and hold cash and bonds instead. The same point
applies equally with regard to individual shares.

27 Subject CT7, April 2015, Question 28

Factors that shift the demand curve for sports cars to the right include any
three of the following:

 an increase in consumer incomes. The demand for expensive luxury

items is likely to have a high income elasticity of demand as people
switch from buying cheaper, run-of-the-mill cars to more expensive
sports cars.

 expectations of future price changes. For example, if sports car prices

are expected to rise shortly then demand might increase, as people buy
them prior to the price rise. In addition, the demand for certain makes of
rare sports cars, which are viewed as investments, might rise if their
prices are expected to rise over the long term.

 a change in consumer tastes, away from more everyday cars and

towards faster, sportier cars, eg due to advertising or a reduction in
concerns about car emissions

 a fall in the price of complementary goods, such as petrol, insurance

and/or vehicle excise duty, which will reduce the effective cost of
running sports cars.

 an increase in the availability of credit and/or a fall in interest rates / the

cost of borrowing will increase demand by reducing the cost of
purchases involving credit.

 a rise in the price of substitute goods, such as yachts or motor homes,

will result in sports cars being relatively less expensive and so increase
the demand for them.

28 Subject CT7, April 2015, Question 29

Factors that affect the supply of oil include any three of the following:

 the price of oil – for example, at high prices it will be profitable to extract
oil from deeper wells and to invest in finding and developing new oil
fields

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 the costs of extraction, production and distribution – which reflect factors

such as wage costs, technological developments and transportation
costs

 the profitability of substitutes in supply, such as gas or renewable

energy, which oil companies produce instead of oil if they become more
profitable to supply than oil

 the profitability of goods in joint supply, such as diesel and other by-
products. For example, the supply of oil is likely to increase if the by-
products become more profitable.

 random shocks and other unpredictable events, eg earthquakes,

industrial action, or wars in the countries where oil is extracted.

 the aims of producers, which might be to maximise sales rather than

profits. Conversely, cartels such as OPEC might aim to restrict supply
in order to raise the oil price.

 expectations of future price changes. For example, suppliers might hold

back supply to the market at the moment if they expect the oil price to
be higher in a few weeks’ time.

 the number of suppliers. For example, the increase in suppliers over

recent years has eroded OPEC’s ability to influence the total supply and
price of oil.

29 Subject CT7, October 2015, Question 27

Macroeconomics is concerned with the economy as a whole and studies

economic aggregates, such as national income, unemployment and the
general level of prices. It considers:
 aggregate demand – the total level of spending in the economy, by
consumers, firms and the government
 aggregate supply – the total amount of output (ie goods and services)
produced in the economy.

Microeconomics is concerned with individual parts of the economy

(eg households, firms and industries) and the way they interact to determine
the pattern of production and distribution of goods and services.

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30 Subject CT7, October 2015, Question 28

Demand is said to be elastic / inelastic if a given percentage change in price

leads to a larger / smaller absolute percentage change in the quantity
demanded, ie the price elasticity of demand is greater / smaller than one in
absolute terms.

When firms are considering a price increase, they will try to estimate its
effect on total revenue, ie price × quantity.

If demand is elastic, a rise in price will lead to a larger percentage fall in

quantity demanded. This will result in an overall decrease in total revenue.

Conversely, if demand is inelastic, a rise in price will lead to a smaller

percentage fall in quantity demanded and hence an overall increase in total
revenue.

Therefore, a firm which is raising its prices will prefer demand to be inelastic.

31 Subject CT7, April 2016, Question 27

(a) Maximum price set below the free market price

A maximum price set below the free market equilibrium price will result in:
 a fall in price
 a decrease in the quantity supplied
 an increase in the quantity demanded
 a shortage.

(b) Minimum price set above the free market price

A minimum price set above the free market equilibrium price will result in:
 a rise in price
 an increase in the quantity supplied
 a decrease in the quantity demanded
 a surplus.

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32 Subject CT7, September 2016, Question 27

(i) Difference between uncertainty and risk

Risk refers to a situation in which the probabilities of the different possible

outcomes are known, but it is not known which outcome will occur.

Uncertainty refers to a situation in which the probabilities of the different

possible outcomes are not known.

(ii) How firms might reduce uncertainty

Any two of the following points are sufficient.

Firms could:
 hold stocks of goods and services that can be supplied to the market
when prices are favourable, eg when the oil price is low, oil companies
may retain some stocks of oil, which can subsequently be released into
the market when the price is higher
 purchase information, eg airlines may employ oil market analysts to help
them decide the most appropriate time to buy fuel
 use futures and forwards to hedge against unexpected price changes,
eg if an airline is worried that fuel prices are about to rise, it could use
forwards to fix the price at which it buys its fuel
 purchase insurance to protect themselves against unpredictable
adverse events, eg property insurance to protect them against losses
arising from flood, fire or burglary
 take over a supplier / retailer to reduce the uncertainty regarding the
availability and prices of raw materials / access to markets, eg a
manufacturer could take over a chain of shops to sell its goods
 form a strategic alliance in order to share risks, eg firms could work
together on a project and take a share in the returns generated.
 diversify, eg into different products and/or markets.

33 Subject CT7, April 2017, Question 27

(a) left shift

(b) right shift
(c) no shift
(d) right shift

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34 Subject CT7, October 2017, Question 27

(a) Factors of productions within an economy

These are:
 labour – all forms of human input (both mental and physical) into
production
 land and raw materials – all naturally occurring resources, eg oil, cotton
 capital – manufactured resources, eg factories, computers.

(b) How scarcity arises in the context of these factors

Scarcity refers to the excess of human wants over what can be produced to
fulfil those wants. It arises due to infinite wants and finite quantities of
resources available.

Labour is limited because there is only a limited number of people of working

age who are both willing and able to work at the available wage rates. In
addition, the productivity of labour is limited by the skills of the workforce and
the capital and the technology they are working with.

Land and raw materials are limited due to the finite amount of land available
on which to grow raw materials and also the finite quantities of, for example,
naturally occurring minerals and oil.

Capital equipment is limited because there is a limit to the quantity of

factories, machinery, computers and so on that can be produced using the
finite natural and human resources available. The productivity of this
equipment is limited by technology.

35 Subject CT7, October 2017, Question 28

House prices are influenced primarily by the demand for housing and the
supply of housing available to purchase.

Factors influencing the demand for housing

 the level of national income  as incomes increase, buying houses

becomes more affordable and so demand, and hence house prices, are
likely to increase
 the distribution of income  a redistribution from the rich to the poor
would increase the demand for private sector housing and hence house
prices

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 expectations of future price changes  if prices are expected to rise,

then buyers (including investors) might buy now ahead of the expected
price rises, whereas if they are expected to fall, then buyers might delay
purchasing in order to benefit from a lower price. These factors will tend
to magnify any existing movements in house prices.
 demographic changes, ie changes in the size and the composition of the
population, eg an ageing population leads to an increase in the demand
for, and the price of, retirement apartments
 tastes, eg the desire for home ownership compared to renting
 the number and price of substitute forms of accommodation, eg privately
rented accommodation
 the number and price of substitute forms of investment, eg shares,
bonds and cash
 the number and price of other complementary goods, eg home
insurance, the availability and cost of mortgages
 government policy, eg schemes to either encourage or discourage
home ownership or investment in residential property
 the costs associated with buying houses, eg taxes and legal fees
 the taxation of investment property returns, both income and capital
gains

Factors influencing the supply of housing

 the costs of building (materials, labour, new sites and planning

permission) will affect the supply of new homes. An increase in costs is
likely to result in a reduction in supply and hence a rise in house prices.
 expectations of future price changes, eg if house prices are expected to
rise, then housebuilders may commit to building more new homes,
whereas investors may delay the sale of existing properties. The
increase in new houses will be offset by the decrease in the supply of
existing houses. Consequently, the overall effect on supply and hence
house prices is uncertain.
 nature, random shocks and other unpredictable events, eg extreme
weather, flooding, earthquakes
 the aims of producers, eg maximising sales of new homes rather than
profits
 the costs associated with selling houses, eg taxes, legal fees

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36 Subject CT7, October 2017, Question 29

(i) Why a government favours a sales tax on goods with inelastic

demand

The effect of a sales tax is to increase the price of a good, resulting in a fall
in the quantity consumed.

This fall will be smaller the less sensitive demand is to price, ie the more
inelastic is demand.

Consequently, the total tax revenue raised by the government, which

depends on the number of units purchased, will be greater than if demand
was more elastic.
S2
S1
price
indirect tax per unit

Pc = P2
C tax revenue
P1
P
Pp D

Q2 Q1 quantity

On the diagram above:

 The market price paid by the consumer and the price received by the
producer after tax are denoted by c and p subscripts.
 C and P denote the shares of the tax burden borne by consumers and
producers respectively.

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37 Subject CT7, October 2017, Question 30

A refrigerator is a consumer durable, ie a product that lasts a period of time,

during which the consumer receives utility.

Like any product, the utility gained from consuming a fridge is likely to be
uncertain to some extent, but there is far greater uncertainty about the utility
that will be derived from a consumer durable than for a product that is
consumed instantaneously, eg an ice-cream.

At the time of purchase, consumers will have an expectation of how a fridge

is likely to perform subsequent to purchase, maybe based on advertising,
information gained from a brochure or a discussion with a sales person
and/or past experience of similar makes and models of fridge.

However, they will not possess perfect information about how a particular
fridge will subsequently perform and the extent to which it will meet their
needs.

Consequently, the future performance of the fridge with regard to durability

and reliability is uncertain. For example, consumers cannot predict exactly
the working lifetime of the fridge, nor the chance of it breaking down, and
hence needing costly and inconvenient repairs.

In addition, consumers cannot predict how their needs as regards keeping

food cold and fresh may change over a period of several years. For
example, if the family grows or switches to consuming more fresh food for
health reasons, then the fridge may no longer be large enough to meet its
needs.

Consumers tend to value present utility more highly than future utility and
therefore will tend to buy products that offer utility now rather than in the
future. Rational consumers should consider their degree of impatience and
use an appropriate discount factor to convert future utility into present
values.

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Long-answer questions

1 Subject CT7, September 2016, Question 36

(i) An increase in interest rates

An increase in interest rates would raise the cost of borrowing. This would
increase the effective cost of house purchases funded by mortgages,
leading to a reduction in the demand for house purchases.

In addition, current homeowners who are considering moving to more

expensive homes may find it more costly to do so, so may choose not to
move, reducing the supply of existing housing.

Furthermore, house builders who are borrowing to finance builds would find
that their overall costs increase, leading to a fall in the supply of new homes.

Finally, a large increase in interest rates could result in some existing

homeowners defaulting on their mortgage payments, resulting in forced
sales of existing properties and hence an increase in their supply.

If both the demand and supply curves shift to the left, there will be an overall
reduction in the equilibrium volume of properties traded in the market.
However, the equilibrium price could either rise or fall, depending on the
relative sizes of the shifts in demand and supply.

price S2
S1

P1
P2

D1
D2

Q2 Q1 quantity

(ii) An expected rise in house prices

An expected rise in future house prices might increase current demand for
house purchases (for both owner occupiers and investors). So, the demand
curve would shift to the right.

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At the same time, house builders, current homeowners and property

investors may limit the supply of housing onto the market with a view to
selling later at a higher price, thereby increasing their profits in future. So,
the current supply may be reduced.

As both curves move upwards, the overall effect would be to increase prices.
However, the effect on the quantity traded would be dependent on the
magnitude of the shifts in supply and demand.

price S2
S1
P2

P1

D2
D1

Q1 Q2 quantity

(iii) An increase in the rate of taxation for house builders

An increase in taxes for house builders would increase their costs. So, the
supply curve would shift vertically upwards by the amount of the tax levied.

As a result, the prices of new houses in particular, and houses in general,

would increase and the quantity of houses traded would fall.

price S2
S1

P2
P1

D1

Q2 Q1 quantity

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FINAL COMMENTS

Finally, we set out a checklist of the definitions, formulae and explanations

that we think you most need to know for this topic. We have based this upon
past exam papers in this subject and on what we feel are likely questions in
the future, bearing in mind the contents of the syllabus and Core Reading.

This list, however, cannot be considered exhaustive. In particular, you must

always remember that the examiners can ask a question on any part of the
Core Reading. So there is always a possibility that some ‘new’ area – ie one
that has not been examined before – might come up, particularly on the
topics that were first introduced to the Subject CB2 Syllabus in 2019.

There is a lot to learn for Subject CB2. One useful way of learning lists of
ideas is via acronyms and mnemonics, and the best ones are probably those
that you create yourself. Beware though that you don’t just write down what
you have learned without considering carefully the specific situation given in
the question. The examiners are keen to see that you can apply your
knowledge intelligently to the question. By intelligently, we mean that only
those points from the list that are relevant to the specific question being
asked should be included in your answer. It is by selection that you
demonstrate understanding to the examiner, rather than just the ability to
memorise lists of facts.

We also stress that learning definitions, formulae etc is not a substitute for
understanding. Many of the explanations we have described in this booklet
(and in the course) become ‘obvious’ once you have fully understood the
concepts involved. So, if you do not feel that the subject has become
‘obvious’ to you, then it may be that you need to take a step back and revisit
the Course Notes, or maybe do some more Q&A Bank questions.

Finally we stress again how useful and important it is to do some exam

questions, including preferably a complete past paper or Mock Exam, under
examination conditions. Only by completing questions successfully in the
time and conditions available in the exam room will you know if you are fully
prepared to sit the exam.

We hope that you have found this booklet to be a useful revision aid. If you
have any comments that might help us to improve this set of booklets then
please email your ideas to [email protected].

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CHECKLIST

This checklist can be used as a detailed set of learning objectives that you
need to have mastered for this part of the Subject CB2 exam. Note that the
objectives listed below correspond to those in the checklists in Modules 1, 3,
4 and 5 of the Course Notes.

You can use the boxes that follow each item to indicate when you have first
understood the objective (a), and when you have become fully fluent with it
(z) (ie you have reached exam speed – being able to perform the task
required under exam conditions and in the time available).

1 Define the following key terms:

 production (a): ______(z): ______
 consumption (a): ______(z): ______
 factors of production (or resources) (a): ______(z): ______
 labour (a): ______(z): ______
 land and raw materials (a): ______(z): ______
 capital (a): ______(z): ______
 scarcity (a): ______(z): ______
 macroeconomics (a): ______(z): ______
 microeconomics (a): ______(z): ______
 aggregate demand (a): ______(z): ______
 aggregate supply (a): ______(z): ______
 inflation (a): ______(z): ______
 balance of trade (a): ______(z): ______
 recession (a): ______(z): ______
 unemployment (a): ______(z): ______
 demand-side policy (a): ______(z): ______
 supply-side policy (a): ______(z): ______
 opportunity cost (a): ______(z): ______
 rational choices (a): ______(z): ______

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 marginal costs (a): ______(z): ______

 marginal benefits (a): ______(z): ______
 rational decision making (a): ______(z): ______
 economic efficiency (a): ______(z): ______
 productive efficiency (a): ______(z): ______
 allocative efficiency (a): ______(z): ______
 equity (a): ______(z): ______
 production possibility curve (a): ______(z): ______
 increasing opportunity costs of production (a): ______(z): ______
 investment (a): ______(z): ______
 barter economy (a): ______(z): ______
 market. (a): ______(z): ______

2 Describe the two main macroeconomic concerns, ie full employment of

resources and growth. (a): ______(z): ______

3 Describe the three main microeconomic choices that have to be made by an

economy because resources are scarce. (a): ______(z): ______

4 Draw a production possibility curve and explain why it is a curve rather than
a straight line. (a): ______(z): ______

5 Use a production possibility curve to demonstrate:

 choice and opportunity cost (a): ______(z): ______
 increasing opportunity cost as output of one product increases
(a): ______(z): ______
 output at less than the economy’s full potential (a): ______(z): ______
 growth in the economy’s potential output. (a): ______(z): ______

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6 Define the following key terms:

 centrally planned or command economy (a): ______(z): ______
 free market economy (a): ______(z): ______
 mixed economy (a): ______(z): ______
 informal sector (a): ______(z): ______
 subsistence production (a): ______(z): ______
 input-output analysis (a): ______(z): ______
 price mechanism (a): ______(z): ______
 equilibrium (a): ______(z): ______
 equilibrium price (a): ______(z): ______
 mixed market economy (a): ______(z): ______
 relative price. (a): ______(z): ______

7 Describe how the following economies allocate resources and distribute

output:
 command economy (a): ______(z): ______
 free market economy (a): ______(z): ______
 mixed economy. (a): ______(z): ______

8 Explain the interdependence of goods and factor markets.

(a): ______(z): ______

9 Discuss the advantages and disadvantages of a:

 command economy (a): ______(z): ______
 free market economy. (a): ______(z): ______

10 Define the following key terms:

 price taker (a): ______(z): ______
 the law of demand (a): ______(z): ______
 income effect (a): ______(z): ______
 substitution effect (a): ______(z): ______
 quantity demanded (a): ______(z): ______

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 demand curve (a): ______(z): ______

 substitute goods (a): ______(z): ______
 complementary goods (a): ______(z): ______
 normal goods (a): ______(z): ______
 inferior goods (a): ______(z): ______
 econometrics. (a): ______(z): ______

11 Explain why the quantity demanded falls when the price rises.
(a): ______(z): ______

12 Draw individual and market demand curves. (a): ______(z): ______

13 Explain how demand functions can be estimated using regression analysis.

(a): ______(z): ______

14 Describe six factors, other than price, that influence the demand for a good.
(a): ______(z): ______

15 Distinguish between a change in demand and a change in the quantity

demanded. (a): ______(z): ______

16 Define the following key terms:

 supply curve (a): ______(z): ______
 substitutes in supply (a): ______(z): ______
 goods in joint supply. (a): ______(z): ______

17 Give three reasons why quantity supplied increases with price.

(a): ______(z): ______

18 Draw market supply curves. (a): ______(z): ______

19 Describe seven factors, other than price, that influence the supply of a good.
(a): ______(z): ______

20 Distinguish between a change in supply and a change in the quantity

supplied. (a): ______(z): ______

21 Define the following key term:

 market clearing. (a): ______(z): ______

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22 Calculate the equilibrium price and quantity by equating demand and supply
functions. (a): ______(z): ______

23 Draw diagrams to show the market equilibrium and the effect on the
equilibrium price and quantity of:
 an increase in demand (a): ______(z): ______
 a decrease in demand (a): ______(z): ______
 an increase in supply (a): ______(z): ______
 a decrease in supply. (a): ______(z): ______

24 Give examples of:

 financial incentives (a): ______(z): ______
 non-financial incentives (a): ______(z): ______
 perverse incentives. (a): ______(z): ______

25 Explain the problem of identifying the demand and supply curves from
limited data, ie the identification problem. (a): ______(z): ______

26 Define the following key terms:

 price elasticity of demand (PED) (a): ______(z): ______
 elastic / inelastic demand (a): ______(z): ______
 unit elasticity of demand (a): ______(z): ______
 total consumer expenditure on a product (TE) (a): ______(z): ______
 total revenue (TR) (a): ______(z): ______
 arc elasticity (a): ______(z): ______
 point elasticity. (a): ______(z): ______

27 State the general formula (in terms of percentage changes) for PED and the
average (or ‘midpoint’) formula. (a): ______(z): ______

28 Interpret both the sign and value of PED figures. (a): ______(z): ______

29 Describe three determinants of the PED. (a): ______(z): ______

30 Explain the implication of different values of the PED for total revenue.
(a): ______(z): ______

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31 Draw graphs to illustrate three special cases of PED. (a): ______(z): ______

32 Calculate:
 arc elasticity using percentage changes and the general formula
(a): ______(z): ______
 arc elasticity using the original method (a): ______(z): ______
 arc elasticity using the average or mid-point method
(a): ______(z): ______
 point elasticity using price, quantity and gradient at a point.
(a): ______(z): ______

33 Explain the intended effect of advertising on the demand curve.

(a): ______(z): ______

34 Explain how PED varies along a straight-line demand curve.

(a): ______(z): ______

35 Define the following key terms:

 price elasticity of supply (PES) (a): ______(z): ______
 income elasticity of demand (IED) (a): ______(z): ______
 cross-price elasticity of demand (CPED) (a): ______(z): ______
 normal goods (a): ______(z): ______
 inferior goods. (a): ______(z): ______

36 State the factors that influence the values of PES, IED and CPED.
(a): ______(z): ______

37 Calculate (using the general formulae, arc and point methods) PES, IED and
CPED and interpret the results of these calculations. (a): ______(z): ______

38 Define the following key terms:

 speculation (a): ______(z): ______
 speculators (a): ______(z): ______
 self-fulfilling speculation (a): ______(z): ______
 stabilising / destabilising speculation (a): ______(z): ______
 risk (a): ______(z): ______
 uncertainty (a): ______(z): ______

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 futures or forward market (a): ______(z): ______

 short selling (or shorting) (a): ______(z): ______
 future price (a): ______(z): ______
 spot price. (a): ______(z): ______

39 Explain and illustrate how markets adjust over time to changes in demand
and supply. (a): ______(z): ______

40 Distinguish between, and draw diagrams to illustrate, stabilising and

destabilising speculation. (a): ______(z): ______

41 Distinguish between risk and uncertainty. (a): ______(z): ______

42 Outline the advantages and disadvantages of short selling.

(a): ______(z): ______

43 Explain how the following can help firms to deal with uncertainty:
 holding stocks (a): ______(z): ______
 forwards or futures. (a): ______(z): ______

44 Explain how futures and forwards can be used by:

 firms and individuals to reduce uncertainty (a): ______(z): ______
 speculators to try to make profits. (a): ______(z): ______

45 Define the following key terms:

 minimum price (or ‘floor’) (a): ______(z): ______
 maximum price (or ‘ceiling’) (a): ______(z): ______
 rationing (a): ______(z): ______
 illegal or underground or shadow markets. (a): ______(z): ______

46 Draw diagrams to show the effect of price controls on quantity demanded

and quantity supplied. (a): ______(z): ______

47 Explain and illustrate how elasticity of supply / demand will affect the size of
any surplus or shortage arising as a result of price controls.
(a): ______(z): ______

48 Outline the possible reasons for imposing a minimum price.

(a): ______(z): ______

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49 Discuss the effects of imposing a minimum price and the ways that
government may address these effects. (a): ______(z): ______

50 Outline the possible reasons for imposing a maximum price.

(a): ______(z): ______

51 Discuss the effects of imposing a maximum price and the ways that
government may address these effects. (a): ______(z): ______

52 Define the following key terms:

 indirect tax (a): ______(z): ______
 specific tax (a): ______(z): ______
 ad valorem tax (a): ______(z): ______
 incidence of tax (a): ______(z): ______
 consumers’ share of a tax on a good (a): ______(z): ______
 producers’ share of a tax on a good. (a): ______(z): ______

53 Explain, with the aid of diagrams, the impact of specific and ad valorem
taxes / subsidies on the supply curve and the equilibrium quantity and price.
(a): ______(z): ______

54 Draw diagrams to illustrate how the burden (benefit) of indirect taxes

(subsidies) is shared between consumers and producers.
(a): ______(z): ______

55 Explain and illustrate how price elasticities of demand and supply affect tax
incidence and tax revenue. (a): ______(z): ______

56 Define the following key terms:

 rational consumer (a): ______(z): ______
 total utility (a): ______(z): ______
 marginal utility (a): ______(z): ______
 util (a): ______(z): ______
 principle of diminishing marginal utility (a): ______(z): ______
 consumer surplus (a): ______(z): ______
 marginal consumer surplus (a): ______(z): ______
 total consumer surplus (a): ______(z): ______

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 rational consumer behaviour (a): ______(z): ______

 equi-marginal principle (in consumption). (a): ______(z): ______

57 Explain and illustrate the relationship between total utility and marginal utility
curves. (a): ______(z): ______

58 Give a reason why a person’s marginal utility schedule might change.

(a): ______(z): ______

59 Describe and clarify the water-diamond paradox. (a): ______(z): ______

60 Explain the derivation of the demand curve according to the one-commodity

model. (a): ______(z): ______

61 Discuss the weaknesses of the one-commodity model.

(a): ______(z): ______

62 Explain why the optimum combination of goods consumed occurs where the
marginal utility per £ spent is equal for all goods. (a): ______(z): ______

63 Explain the derivation of the demand curve according to the multi-commodity

model. (a): ______(z): ______

64 Define the following key terms:

 exponential discounting (a): ______(z): ______
 present value (in consumption) (a): ______(z): ______
 discount factor. (a): ______(z): ______

65 Explain how a rational consumer can make optimal choices when the costs
and benefits of consumption occur over a period of time.
(a): ______(z): ______

66 Define the following key terms:

 indifference curve (a): ______(z): ______
 marginal rate of substitution (between two goods in consumption)
(a): ______(z): ______
 diminishing marginal rate of substitution (a): ______(z): ______
 indifference map (a): ______(z): ______
 budget line (a): ______(z): ______
 income-consumption curve (a): ______(z): ______

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 real income (a): ______(z): ______

 price-consumption curve (a): ______(z): ______
 income effect of a price change (a): ______(z): ______
 substitution effect of a price change (a): ______(z): ______
 Giffen good. (a): ______(z): ______

67 Describe the main benefit of indifference analysis over marginal utility theory.
(a): ______(z): ______

68 Explain why an indifference curve is convex to the origin.

(a): ______(z): ______

69 State the algebraic relationship between the marginal rate of substitution and
the marginal utilities of Good X and Good Y. (a): ______(z): ______

70 Construct budget lines when given income and prices of two goods.
(a): ______(z): ______

71 Express the slope of the budget line in terms of the prices of two goods.
(a): ______(z): ______

72 Illustrate the effect on the budget line of changes in income and prices.
(a): ______(z): ______

73 Draw a diagram to illustrate the optimum consumption point and explain why
this position maximises utility. (a): ______(z): ______

74 Illustrate the effect of a change in real income on the demand for two
commodities, one of which might be an inferior good. (a): ______(z): ______

75 Illustrate the effect of a change in the price of one commodity on the demand
for two commodities. (a): ______(z): ______

76 Illustrate and explain the way in which an individual’s demand curve may be
derived using indifference analysis. (a): ______(z): ______

77 Explain, using a diagram, the separation of the income and substitution

effects of a price change for a:
 normal good (a): ______(z): ______
 inferior but non-Giffen good (a): ______(z): ______
 Giffen good. (a): ______(z): ______

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78 Discuss the usefulness of indifference analysis. (a): ______(z): ______

79 Define the following key terms:

 consumer durable (a): ______(z): ______
 expected value (a): ______(z): ______
 certainty equivalent (a): ______(z): ______
 risk premium (a): ______(z): ______
 diminishing marginal utility of income (a): ______(z): ______
 spreading risks (for an insurance company) (a): ______(z): ______
 law of large numbers (a): ______(z): ______
 independent risks (a): ______(z): ______
 diversification (a): ______(z): ______
 asymmetric information (a): ______(z): ______
 adverse selection in the insurance market (a): ______(z): ______
 moral hazard. (a): ______(z): ______

80 Explain how the problem of imperfect information affects the purchase of

consumer durable goods and assets. (a): ______(z): ______

81 Describe a person’s attitude to a fair gamble (ie when the expected value of
the gamble is the same as the certain payoff of not taking the gamble) for:
 a risk-averse person (a): ______(z): ______
 a risk-neutral person (a): ______(z): ______
 a risk-loving person. (a): ______(z): ______

82 Explain the relationship between the expected value of a gamble, the

certainty equivalent of the gamble and the risk premium.
(a): ______(z): ______

83 Explain why diminishing marginal utility of income accords with risk-averse

behaviour. (a): ______(z): ______

84 Explain why insurance companies are able to make profits.

(a): ______(z): ______

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85 Explain why and how the problems of adverse selection (unobservable

characteristics) and moral hazard (unobservable actions) affect insurance
companies and how these problems can be dealt with.
(a): ______(z): ______

86 Define the following key terms:

 bounded rationality (a): ______(z): ______
 heuristic (a): ______(z): ______
 framing (a): ______(z): ______
 nudge theory (a): ______(z): ______
 reference-dependent loss aversion (a): ______(z): ______
 endowment effect (or divestiture aversion) (a): ______(z): ______
 time consistency (a): ______(z): ______
 present bias (a): ______(z): ______
 reciprocity (in economics). (a): ______(z): ______

87 Explain how behavioural economics differs from traditional economics.

(a): ______(z): ______

88 Discuss the validity of the assumption of rationality in economic theory.

(a): ______(z): ______

89 Explain why behavioural economics has grown in importance in recent

years. (a): ______(z): ______

90 Give examples of what has been learned from behavioural economics about
consumer choice in terms of:
 the number of choices on offer (a): ______(z): ______
 the time, effort and expense involved in obtaining more information
about potential options (a): ______(z): ______
 different strategies used by consumers in situations of bounded
rationality and the factors affecting consumer responses
(a): ______(z): ______
 the way in which choices are presented (or framed)
(a): ______(z): ______
 the biases or preconceptions people have (a): ______(z): ______

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 the reference points for decision making (eg own expectations,

decisions of others, current or past position, ownership/non-ownership)
(a): ______(z): ______
 consistency / inconsistency of preferences over time
(a): ______(z): ______
 the effect it will have on others (a): ______(z): ______
 the influence of others and possible herd behaviour.
(a): ______(z): ______

91 Describe the role of behavioural economics in designing economic policy.

(a): ______(z): ______

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EXAM PREPARATION CHECKLIST

Past Exam Questions

We recommend that you work through as many questions as possible under

exam conditions. By doing so, you’ll get used to the style of question asked,
the style of answers required and to working under time pressure. Keep a
note of which questions you have attempted and when. Watch your
multiple-choice score improve!

Multiple-choice questions (1½ marks per question)

Attempt Date Score (max 178½)

1
2
3

Short-answer (S) and long-answer (L) questions

Q Date Q Date Q Date

S1 S11 S21
S2 S12 S22
S3 S13 S23
S4 S14 S24
S5 S15 S25
S6 S16 S26
S7 S17 S27
S8 S18 S28
S9 S19 S29
S10 S20 S30

S31 S34 S37

S32 S35 L1
S33 S36

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