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GCE A/L Economics study materials
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GCE A/L Economics practice questions

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Question 1Basic economic ideas and resource allocation

In economics, what is meant by the opportunity cost of a decision?

  1. the value of the next best alternative forgone when a choice is made Correct answer.
  2. the sum of all alternatives available to a consumer
  3. the total money spent on producing a good
  4. the cost of a good measured in units of money

Explanation

Opportunity cost arises because resources are scarce and choices must be made. It measures the value of the next best alternative that is given up, not the total of every alternative nor simply the money paid.

Question 2Basic economic ideas and resource allocation

Which item is classified as capital as a factor of production?

  1. a worker's annual wage
  2. a government unemployment benefit
  3. a delivery van owned by a firm Correct answer.
  4. a natural forest

Explanation

Capital consists of man-made producer goods that are used to produce other goods and services. A delivery van is a produced asset used by a firm in its operations, so it is capital.

Question 3Basic economic ideas and resource allocation

Which statement is a normative statement?

  1. The government ought to spend more on public transport. Correct answer.
  2. Average household income increased by 3% in real terms.
  3. The unemployment rate in the country rose from 4% to 5% last year.
  4. A fall in the price of a good usually raises the quantity demanded.

Explanation

A normative statement makes a value judgement about what should or ought to be done, so it cannot be tested solely by evidence. The word “ought” signals a recommendation rather than a factual claim.

Question 4Basic economic ideas and resource allocation

A movement along an economy's production possibility frontier from one point to another represents

  1. a reallocation of resources with an opportunity cost Correct answer.
  2. a reduction in the economy's total output
  3. the existence of unemployed resources
  4. an increase in the economy's productive capacity

Explanation

Along a production possibility frontier, all resources are assumed to be fully and efficiently employed. Moving between points changes the mix of output, so producing more of one good requires sacrificing some of the other.

Question 5Basic economic ideas and resource allocation

Which change is most likely to shift an economy's production possibility frontier outward over time?

  1. a fall in the population's willingness to work
  2. a sustained improvement in technology that can be used in all industries Correct answer.
  3. a movement from unemployed resources to full employment
  4. a transfer of resources from capital goods to consumer goods

Explanation

An outward shift of the production possibility frontier requires an increase in the economy's productive potential. Improved technology raises the output obtainable from given resources across industries, so it expands that potential.

Question 6Basic economic ideas and resource allocation

Which is most likely to result from increased division of labour in a factory?

  1. The factory needs fewer co-ordinating activities.
  2. Each worker completes the whole product from start to finish.
  3. Workers become less dependent on machinery.
  4. Output per worker rises because tasks are specialised. Correct answer.

Explanation

Division of labour breaks production into separate tasks performed by different workers. Specialisation allows workers to become more proficient and to avoid time lost switching tasks, raising output per worker.

Question 7Basic economic ideas and resource allocation

In a free market, a shortage of a good is most likely to lead to

  1. a reduction in the quantity supplied
  2. a fall in the good's price
  3. a rise in the good's price until quantity demanded equals quantity supplied Correct answer.
  4. government rationing of the good

Explanation

A shortage means quantity demanded exceeds quantity supplied at the current price. In a free market, buyers bid the price up, which reduces quantity demanded and encourages producers to supply more until the shortage is removed.

Question 8Basic economic ideas and resource allocation

When an economist says that a price rise will, ceteris paribus, reduce quantity demanded, the phrase ceteris paribus means that

  1. the relationship is a value judgement
  2. all consumers have identical incomes
  3. all other relevant influences are held constant Correct answer.
  4. the good is always a normal good

Explanation

Ceteris paribus is the assumption that other things remain equal. It allows economists to isolate the effect of a change in one variable, such as price, without other influences changing at the same time.

Question 9Basic economic ideas and resource allocation

Why is a production possibility frontier usually drawn concave to the origin?

  1. Resources are not equally suited to producing both goods, so opportunity cost rises as production shifts. Correct answer.
  2. Resources are perfectly substitutable between the two goods.
  3. Opportunity cost is constant as production changes between the two goods.
  4. The economy always has unemployed resources.

Explanation

A concave frontier reflects increasing opportunity cost. As more resources are transferred to one good, factors less suited to that use must be employed, so increasing amounts of the other good are sacrificed.

Question 10Basic economic ideas and resource allocation

In a mixed economy, which best describes the role of the price mechanism compared with a command economy?

  1. The price mechanism guides allocation in the private sector while government provides some goods and regulates activity. Correct answer.
  2. The price mechanism is absent because all resources are state-owned.
  3. The price mechanism is used only to set wages in the public sector.
  4. The price mechanism determines all production decisions, as in a pure market economy.

Explanation

A mixed economy combines market allocation with government intervention. Prices guide many private-sector decisions, while the government supplies certain goods and services and regulates parts of the economy.

Question 11Basic economic ideas and resource allocation

Which of the following is the best example of a free good in economics?

  1. A public park maintained by a local council
  2. Bottled mineral water sold in a shop
  3. Fish caught from a managed lake
  4. Sunlight used to dry clothes outdoors Correct answer.

Explanation

A free good is not scarce: it is available in unlimited quantities at zero price and its use involves no opportunity cost. Sunlight used outdoors fits this because using it does not require sacrificing another good. A maintained park, bottled water and managed fish all use scarce resources.

Question 12Basic economic ideas and resource allocation

Which factor of production organises land, labour and capital and bears the risk of production?

  1. Entrepreneurship Correct answer.
  2. Land
  3. Capital
  4. Labour

Explanation

Entrepreneurship is the factor that combines land, labour and capital and takes the risk of production. The entrepreneur decides what to produce and bears losses if the venture fails. Land, labour and capital are inputs but do not perform this organising role.

Question 13Basic economic ideas and resource allocation

The basic economic problem of scarcity exists because

  1. prices rise faster than wages in many markets
  2. some countries have very low average incomes
  3. governments impose taxes on goods and services
  4. human wants are unlimited while resources are limited Correct answer.

Explanation

Scarcity is a universal problem because wants are effectively unlimited while the resources available to satisfy them are limited. It is not caused by low incomes, taxes or price changes, although these can affect how scarcity is experienced. Even wealthy countries face scarcity.

Question 14Basic economic ideas and resource allocation

An economy is producing at a point inside its production possibility frontier. What does this most likely indicate?

  1. Some resources are unemployed or inefficiently used Correct answer.
  2. The combination is impossible to produce
  3. All resources are fully employed
  4. The economy has achieved allocative efficiency

Explanation

A point inside the production possibility frontier means the economy is not using all its resources fully or is using them inefficiently. It could produce more of one good without giving up any of the other by improving efficiency. Points on the frontier represent full and efficient use.

Question 15Basic economic ideas and resource allocation

The extent to which division of labour can be used in production is limited mainly by

  1. the rate of income tax on households
  2. the amount of capital owned by the government
  3. the level of wages paid to workers
  4. the size of the market for the product Correct answer.

Explanation

Division of labour is limited mainly by the size of the market because specialisation requires enough demand to absorb the output of each specialised worker or task. A large market allows more tasks to be separated and more output to be sold. Wage rates, taxes and government capital ownership do not set this basic limit.

Question 16Basic economic ideas and resource allocation

In a centrally planned economy, the main method of allocating resources is

  1. price signals generated by supply and demand
  2. decisions made by government planning bodies Correct answer.
  3. competition between private firms
  4. consumer spending in free markets

Explanation

In a centrally planned economy, planning bodies decide what to produce, how to produce it and for whom. Prices may exist, but they are not the main signal guiding resource allocation. Consumer spending and private competition play a limited role.

Question 17Basic economic ideas and resource allocation

Consumer sovereignty describes a situation in which

  1. the government decides what goods are produced
  2. firms set prices without regard to demand
  3. consumers own the means of production
  4. consumer spending determines what firms produce Correct answer.

Explanation

Consumer sovereignty means that the pattern of consumer spending signals to firms what should be produced. Firms that ignore consumer demand lose sales and profits. It does not mean consumers own firms or that government sets output.

Question 18Basic economic ideas and resource allocation

A firm owns a machine that can produce either 500 units of good X, earning a profit of $10,000, or 300 units of good Y, earning a profit of $6,000. What is the opportunity cost of using the machine to produce good X?

  1. $10,000 of profit
  2. 500 units of good X
  3. $6,000 of profit Correct answer.
  4. $4,000 of profit

Explanation

The opportunity cost is the value of the next best alternative forgone. Choosing X means the firm gives up the $6,000 profit it could have earned from Y. The $10,000 is the return from X itself, not the cost of choosing it.

Question 19Basic economic ideas and resource allocation

A fully employed economy moves resources from producing consumer goods to producing more capital goods. What is the most likely long-run result?

  1. Its production possibility frontier shifts outward faster Correct answer.
  2. The opportunity cost of capital goods becomes zero
  3. Consumer goods output rises in the short run
  4. The economy moves inside its production possibility frontier

Explanation

More capital goods today increase the economy's future productive capacity, so its production possibility frontier can shift outward faster. The immediate effect is that fewer consumer goods are available because resources are reallocated. Opportunity cost is not eliminated, and a fully employed economy stays on its frontier.

Question 20Basic economic ideas and resource allocation

A production possibility frontier is drawn as a straight line. What does this indicate about opportunity cost?

  1. Opportunity cost is zero for both goods
  2. Opportunity cost is constant as output changes Correct answer.
  3. Opportunity cost decreases as more of a good is produced
  4. Opportunity cost increases as more of a good is produced

Explanation

A straight-line production possibility frontier shows that the opportunity cost of producing more of one good stays the same as output changes. Each unit of the good requires giving up a constant amount of the other good. A concave curve, by contrast, shows increasing opportunity cost.

Question 21Basic economic ideas and resource allocation

Which factor of production is rewarded by interest?

  1. Labour
  2. Enterprise
  3. Capital Correct answer.
  4. Land

Explanation

Capital consists of man-made resources such as machinery, tools and buildings that are used to produce other goods and services. The reward for supplying capital is interest, while land earns rent, labour earns wages and enterprise earns profit.

Question 22Basic economic ideas and resource allocation

A rise in the market price of coffee leads a farmer to plant more coffee bushes and fewer tea bushes. Which function of the price mechanism does this best illustrate?

  1. Rationing
  2. Signalling
  3. Equilibrium
  4. Incentive Correct answer.

Explanation

A higher price raises the potential profit from coffee, giving the farmer an incentive to reallocate land towards coffee production. Rationing would involve price allocating a fixed supply among competing consumers, while signalling conveys information rather than describing the farmer's response.

Question 23Basic economic ideas and resource allocation

A government decides to devote more resources to building new roads and fewer resources to maintaining public parks. Which fundamental economic question is being answered directly by this decision?

  1. For whom to produce?
  2. How to produce?
  3. What to produce? Correct answer.
  4. When to produce?

Explanation

The decision concerns the composition of output: which goods and services society chooses to produce with its scarce resources. The 'how' question concerns production methods, and the 'for whom' question concerns how output is distributed among people.

Question 24Basic economic ideas and resource allocation

Why may a free-market price mechanism allocate resources inefficiently when production creates pollution?

  1. Consumers are unable to respond to changes in price.
  2. Government intervention always sets prices below equilibrium.
  3. Firms in a free market cannot alter their output in response to profit.
  4. Market prices do not reflect the full social cost of production. Correct answer.

Explanation

Pollution is a negative externality, so the private cost facing producers is lower than the social cost of production. The market price therefore understates the true cost, and too many resources are allocated to the polluting activity.

Question 25The price system: demand, supply, elasticity and market equilibrium

A government health campaign reduces consumers' preference for sugary drinks. In the market for sugary drinks, this change is best represented as:

  1. a leftward shift of the demand curve Correct answer.
  2. a rightward shift of the demand curve
  3. a leftward shift of the supply curve
  4. a movement down along the demand curve

Explanation

A change in tastes or preferences alters the quantity consumers wish to buy at every price, so the whole demand curve shifts; an adverse health campaign reduces demand, shifting it left. A movement along the curve would result only from a change in the good's own price. The campaign does not alter production conditions, so supply is unaffected.

Question 26The price system: demand, supply, elasticity and market equilibrium

Which of the following will cause the supply curve for wheat to shift to the right?

  1. A fall in the price of fertiliser used in wheat production Correct answer.
  2. An increase in the wages paid to farm workers
  3. An increase in the market price of wheat
  4. A rise in household incomes

Explanation

Fertiliser is an input, so a fall in its price lowers production costs and makes it profitable to supply more wheat at every price, shifting the supply curve right. A change in wheat's own price causes a movement along the supply curve, not a shift.

Question 27The price system: demand, supply, elasticity and market equilibrium

When the price of a good rises from $10 to $12, quantity demanded falls from 500 to 400 units. Using proportional changes, the price elasticity of demand (absolute value) is:

  1. 2.0
  2. 1.0 Correct answer.
  3. 0.5
  4. 0.2

Explanation

The proportional fall in quantity is 100/500 = 20 per cent, and the proportional rise in price is 2/10 = 20 per cent. Dividing the quantity change by the price change gives an elasticity of 1 in absolute value, so demand is unit elastic over this range.

Question 28The price system: demand, supply, elasticity and market equilibrium

The cross price elasticity of demand between coffee and tea is +1.4. This value indicates that:

  1. the demand for coffee is price inelastic
  2. coffee and tea are complements, and a rise in the price of tea reduces coffee demand
  3. coffee is a normal good and tea is an inferior good
  4. coffee and tea are substitutes, and a rise in the price of tea raises coffee demand Correct answer.

Explanation

Cross elasticity measures the responsiveness of demand for one good to a change in the price of another. A positive value means the goods are substitutes: when tea becomes dearer, consumers switch toward coffee, raising coffee demand.

Question 29The price system: demand, supply, elasticity and market equilibrium

A good has an income elasticity of demand of -0.6. Which statement is consistent with this value?

  1. As consumer incomes rise, the quantity demanded of the good falls, and it is an inferior good. Correct answer.
  2. The good is a luxury whose demand rises faster than income.
  3. A rise in the good's own price reduces quantity demanded proportionally more than the price rise.
  4. As consumer incomes rise, the quantity demanded of the good rises, and it is a normal good.

Explanation

Income elasticity is the percentage change in quantity demanded divided by the percentage change in income. A negative value means quantity demanded falls as income rises, which defines an inferior good; the size 0.6 indicates the fall is proportionally smaller than the income rise.

Question 30The price system: demand, supply, elasticity and market equilibrium

Why is the price elasticity of supply of fresh flowers likely to be lower in the short run than in the long run?

  1. Because growers cannot quickly expand glasshouse capacity and planting, though they can build more capacity over time Correct answer.
  2. Because the demand for flowers is price inelastic in the short run
  3. Because flower prices are fixed by government in the short run
  4. Because consumers cannot change their spending habits quickly

Explanation

Price elasticity of supply depends on how easily firms can adjust inputs. Flower growers cannot instantly add glasshouses, land or planting cycles, so quantity supplied responds little to price in the short run; over years, capacity can be expanded, making supply more responsive.

Question 31The price system: demand, supply, elasticity and market equilibrium

A government sets a maximum price for bread below the free-market equilibrium price. Which outcome is expected?

  1. A surplus, because quantity supplied exceeds quantity demanded
  2. A shortage, because quantity demanded exceeds quantity supplied, often with queues or rationing Correct answer.
  3. No change, because the ceiling equals the equilibrium price
  4. A shortage, because the supply curve shifts to the left

Explanation

A binding maximum price below equilibrium makes the legal price lower than the market-clearing price. At that price quantity demanded exceeds quantity supplied, creating a shortage that typically produces queues, rationing or black markets. The ceiling does not shift either curve; it causes movements along them.

Question 32The price system: demand, supply, elasticity and market equilibrium

A specific tax is imposed on producers of a good with price-inelastic demand and relatively elastic supply. Who bears the larger share of the tax?

  1. Producers, because the tax is collected from them
  2. Consumers, because they cannot easily reduce quantity demanded Correct answer.
  3. Consumers and producers equally, because the tax creates a wedge between prices
  4. Producers, because supply is elastic

Explanation

The burden of a tax falls more heavily on the side of the market that is less responsive to price. With inelastic demand, consumers reduce quantity only slightly when price rises, so producers can pass most of the tax forward in higher prices; elastic supply means producers can divert resources elsewhere instead of absorbing the tax.

Question 33The price system: demand, supply, elasticity and market equilibrium

In the market for a normal good, consumer incomes rise at the same time as a new technology lowers production costs. Which prediction is certain?

  1. Both equilibrium price and equilibrium quantity rise.
  2. Equilibrium quantity rises, but the effect on equilibrium price is indeterminate. Correct answer.
  3. Both equilibrium price and equilibrium quantity fall.
  4. Equilibrium price rises, but the effect on quantity is indeterminate.

Explanation

Rising incomes shift demand right, raising both price and quantity; cheaper technology shifts supply right, lowering price and raising quantity. Quantity therefore rises under both changes, but price is pulled up by one shift and down by the other, so the net price change cannot be determined without knowing the relative sizes of the shifts.

Question 34The price system: demand, supply, elasticity and market equilibrium

A firm faces price-elastic demand (PED = 2.0) at current prices. If it raises its price by 5 per cent, total revenue will:

  1. rise by about 10 per cent
  2. fall, because quantity demanded falls proportionally more than the price rise Correct answer.
  3. rise, because each unit now sells at a higher price
  4. remain unchanged, because the elasticity is exactly 2

Explanation

With a PED of 2, a 5 per cent price rise reduces quantity demanded by about 10 per cent. Revenue is price multiplied by quantity, so the 5 per cent gain per unit is outweighed by the 10 per cent fall in units sold, and total revenue falls by roughly 5 per cent.

Question 35The price system: demand, supply, elasticity and market equilibrium

Which change is represented by a movement downward along an existing demand curve for oranges?

  1. A rise in household incomes
  2. A report that oranges improve health
  3. A fall in the price of oranges Correct answer.
  4. A fall in the price of a close substitute

Explanation

A movement along a demand curve is caused only by a change in the good's own price. A lower price for oranges raises the quantity demanded while the demand curve itself stays in the same position. Changes in income, substitute prices or preferences shift the whole demand curve.

Question 36The price system: demand, supply, elasticity and market equilibrium

If the market price of a good is above the equilibrium price and there is no government intervention, which adjustment is expected?

  1. A shortage, so the price rises further
  2. A surplus, so the price falls toward equilibrium Correct answer.
  3. The demand curve shifts right to restore equilibrium
  4. The supply curve shifts left to restore equilibrium

Explanation

At a price above equilibrium, quantity supplied exceeds quantity demanded, creating a surplus. Sellers respond by cutting prices, which increases quantity demanded and reduces quantity supplied until the market clears. This is a movement along the existing curves, not a shift of either curve.

Question 37The price system: demand, supply, elasticity and market equilibrium

Which characteristic of a product is most likely to make its price elasticity of demand relatively high?

  1. It has many close substitutes available Correct answer.
  2. It takes a very small share of consumers' budgets
  3. It is bought infrequently but has no alternative uses
  4. It is a necessity with few substitutes

Explanation

Price elasticity of demand measures how responsive quantity demanded is to a change in price. When many close substitutes exist, consumers can switch away easily, so demand tends to be elastic. Necessities, goods with a small budget share and goods with no alternatives tend to have inelastic demand.

Question 38The price system: demand, supply, elasticity and market equilibrium

A per-unit subsidy is paid to the producers of a good. In a competitive market with a downward-sloping demand curve and an upward-sloping supply curve, what is the immediate effect?

  1. Supply shifts down, consumer price falls, quantity rises Correct answer.
  2. The supply curve shifts to the right, so both price and quantity rise
  3. The demand curve shifts to the right, so both price and quantity rise
  4. The supply curve shifts to the left, so price rises and quantity falls

Explanation

A subsidy lowers producers' effective costs, so the supply curve shifts downward by the amount of the subsidy, which is equivalent to a rightward shift. The new equilibrium has a lower price paid by consumers and a larger quantity traded. The demand curve is not directly affected by a subsidy paid to producers.

Question 39The price system: demand, supply, elasticity and market equilibrium

A statutory minimum wage is set above the equilibrium wage in a competitive labour market. What is the predicted effect?

  1. A shortage of labour, as firms compete for workers
  2. The equilibrium wage to fall to clear the market
  3. A surplus of labour, often called unemployment Correct answer.
  4. The demand for labour to shift right

Explanation

A minimum wage above equilibrium acts as a price floor in the labour market. At that wage, the quantity of labour supplied exceeds the quantity demanded, creating a surplus of labour that appears as unemployment. The wage cannot fall to the equilibrium level because of the legal minimum.

Question 40The price system: demand, supply, elasticity and market equilibrium

The cross price elasticity of demand for printers with respect to the price of ink cartridges is -0.8. What does this value indicate?

  1. Printers and ink cartridges are substitutes
  2. The demand for printers is price inelastic
  3. Printers are an inferior good
  4. Printers and ink cartridges are complements Correct answer.

Explanation

Cross price elasticity measures the responsiveness of demand for one good to a change in the price of another. A negative value means that a rise in the price of ink cartridges reduces demand for printers, which is the relationship between complementary goods. The magnitude 0.8 does not by itself show income elasticity or own-price elasticity.

Question 41The price system: demand, supply, elasticity and market equilibrium

When the market price of a good falls, with all else unchanged, what happens to consumer surplus?

  1. It increases because consumers pay less for each unit bought Correct answer.
  2. It becomes zero because the market clears
  3. It stays the same because demand has not shifted
  4. It decreases because consumers buy less

Explanation

Consumer surplus is the difference between what consumers are willing to pay and what they actually pay. A lower market price increases surplus on units that were already being bought and also adds surplus from additional units purchased. A price change causes a movement along the demand curve, so consumer surplus changes even without a shift in demand.

Question 42The price system: demand, supply, elasticity and market equilibrium

Along a downward-sloping straight-line demand curve, which statement about price elasticity of demand is correct?

  1. Demand is unit elastic at every point where price equals average revenue
  2. Elasticity is the same at every point because the slope is constant
  3. Demand is elastic at high prices and inelastic at low prices Correct answer.
  4. Demand is inelastic at high prices and elastic at low prices

Explanation

For a straight-line demand curve, elasticity equals price divided by quantity multiplied by the reciprocal of the constant slope. At high prices and low quantities the price-to-quantity ratio is large, so demand is elastic; as price falls and quantity rises, the ratio falls and demand becomes inelastic. Elasticity is therefore not constant even though the slope is constant.

Question 43The price system: demand, supply, elasticity and market equilibrium

In a competitive market with no externalities, allocative efficiency occurs at the output where:

  1. The price of the good equals average total cost of production
  2. Total revenue received by sellers is at its maximum
  3. Marginal social benefit equals marginal social cost Correct answer.
  4. Marginal cost of production has fallen to zero

Explanation

Allocative efficiency requires that the marginal benefit to society of the last unit equals the marginal cost of producing it. In a competitive market with no externalities, the demand curve reflects marginal social benefit and the supply curve reflects marginal social cost, so their intersection is the efficient output. Producing beyond or below that point creates a deadweight loss.

Question 44The price system: demand, supply, elasticity and market equilibrium

A government sets a maximum price for a good at a level above the free-market equilibrium price. What is the expected outcome?

  1. A persistent shortage of the good
  2. The demand curve shifts to the right
  3. A surplus that the government must buy
  4. No binding effect on price or quantity Correct answer.

Explanation

A maximum price is only binding if it is set below the equilibrium price. When the ceiling is above equilibrium, the market price can still settle at equilibrium, so the ceiling does not create a shortage or surplus. The price control is therefore non-binding in this case.

Question 45The price system: demand, supply, elasticity and market equilibrium

A fall in the price of a complementary good, such as a games console, will, in the market for video games, cause:

  1. a movement up along the supply curve
  2. the demand curve to shift to the right Correct answer.
  3. the supply curve to shift to the left
  4. a movement down along the demand curve

Explanation

Complementary goods are consumed together, so a lower price for the console raises the quantity of video games consumers want at every price. This is a non-price determinant of demand, so the demand curve for video games shifts to the right. A movement along a curve would require a change in the good's own price.

Question 46The price system: demand, supply, elasticity and market equilibrium

In a competitive market, demand increases at the same time as supply decreases. What happens to the equilibrium price and quantity?

  1. Price is indeterminate and quantity rises
  2. Price falls and quantity definitely falls
  3. Price rises and quantity change is indeterminate Correct answer.
  4. Price rises and quantity definitely rises

Explanation

An increase in demand raises both equilibrium price and quantity, while a decrease in supply raises price but lowers quantity. Both shifts push price upward, so price definitely rises. Their effects on quantity work in opposite directions, making the quantity change indeterminate.

Question 47The price system: demand, supply, elasticity and market equilibrium

The cross price elasticity of demand between two goods is zero. This indicates that the goods are:

  1. complements
  2. unrelated in consumption Correct answer.
  3. inferior goods
  4. substitutes

Explanation

Cross price elasticity measures the responsiveness of demand for one good to a change in the price of another. A value of zero means the price of one good has no effect on demand for the other, so the goods are unrelated. Complements have negative values and substitutes have positive values.

Question 48The price system: demand, supply, elasticity and market equilibrium

A good has an income elasticity of demand of +2.5. Which description is most consistent with this value?

  1. a luxury good whose demand rises faster than income Correct answer.
  2. a necessity whose demand rises less than income
  3. an inferior good whose demand falls when consumer income rises
  4. a normal good whose demand rises less than income

Explanation

A positive income elasticity means the good is normal, and a value greater than one means demand rises proportionally faster than income. Such goods are classified as luxuries. A value between zero and one would indicate a necessity, while a negative value would indicate an inferior good.

Question 49The price system: demand, supply, elasticity and market equilibrium

A per-unit tax is imposed on a good whose demand is perfectly price-inelastic while supply is upward sloping. Who bears the tax?

  1. Consumers bear the whole tax because quantity demanded is fixed Correct answer.
  2. Producers bear the whole tax because supply is upward sloping
  3. The tax is shared equally between consumers and producers
  4. Neither bears the tax because the market cannot adjust

Explanation

With perfectly inelastic demand, buyers do not reduce quantity when the price rises, so producers can pass the entire tax forward. The price paid by consumers rises by the full amount of the tax, while the net price received by producers is unchanged. Tax incidence depends on relative elasticities, not on who formally pays the tax.

Question 50The price system: demand, supply, elasticity and market equilibrium

Which characteristic of a product is most likely to make its price elasticity of supply relatively high in the short run?

  1. The product is highly perishable and cannot be stored
  2. The production process takes several years to complete
  3. Production requires specialised labour that is difficult to hire
  4. Firms hold large stocks that can be released quickly Correct answer.

Explanation

Elasticity of supply is higher when firms can increase output quickly in response to a price rise. Large existing stocks allow firms to release goods onto the market without a long production delay. Perishability, specialised labour shortages and long production periods all make supply less responsive.