Economics · Oct / Nov 2016 · Paper 23 · Question 3

Identify two external costs of smoking. [2]

1 mark for each of two external costs identified:

Explain how perfectly inelastic demand differs from inelastic demand. [4]

Perfectly inelastic demand occurs when a change in price has no effect on demand (1)

represented by a vertical demand curve/PED = 0 (1)

example (1). Inelastic demand occurs when a change in price results in a smaller percentage change in demand (1)

represented by a relatively steep downward sloping demand curve/PED <1 (1)

example (1). Accept correctly drawn diagrams for one mark each.

Analyse two ways, apart from imposing an indirect tax, a government could discourage smoking. [6]

Regulation (1)

a ban could be imposed on smoking (1)

e.g. in public areas or raise age limit (1)

this could be backed up by law (1)

fines would be imposed on those who smoke (1). Provision of information (1)

a health campaign could be undertaken (1)

informing people of the harmful effects of smoking (1)

may include pictures of effects of smoking (1)

reducing demand for cigarettes/ consumption of cigarettes (1). Government subsidy of alternatives/ substitutes (1)

e.g. nicotine patches (1)

will help reduce consumption (1). Quota on imports may be imposed (1)

to restrict the supply of cigarettes (1). N.B. a maximum of 4 marks for the analysis of one way.

Discuss whether a merger between two large firms in the same industry will increase the price of the product. [8]

Up to 5 marks for why it might: Increase in size firm / reduction in competition (1)

the firms may be able to raise price as consumers may have no alternative / dominate the market (1). The firm may become a monopoly (1)

becoming a price maker (1). Firm becomes too large (1)

may experience diseconomies of scale (1)

example (1)

increases average cost of production (1)

and passes on higher costs in higher prices (1). Firms may produce higher quality products (1)

as a result of increased spending on research and development/new technology (1)

so demand for the products may be higher (1). Up to 5 marks for why it might not: The firm may experience economies of scale (1)

example (1)

lowering average cost of production (1)

example (1)

and lowers prices without affecting profits (1). The firm may still face considerable competition in the industry (1)

other mergers may have taken place/may still be a high number of firms in the industry (1). The firm may not be seeking to maximise profits (1)

may be trying to increase the share of the market (1)

may do this by keeping price relatively low (1). Government may intervene (1)

and limit price increases (1).