State which method you use. The average (midpoint) method divides each change by the average of the old and new values, so it gives the same answer in both directions.
Wayfarer Cover sells single-trip travel insurance online. When it cut its price from £40 to £32 a policy, monthly sales rose from 5,000 to 6,000 policies. Assume nothing else affecting demand changed.
(i)
Calculate the price elasticity of demand using the original price and quantity as the base, to 2 decimal places.
2 marks
(ii)
Calculate the price elasticity of demand using average (midpoint) values, to 2 decimal places.
2 marks
(iii)
Calculate the change in Wayfarer's monthly premium income, in £.
2 marks
(iv)
Explain why the two methods give different answers, and comment on which result is consistent with the change in premium income.
2 marks
How the price mechanism allocates resources
Markets · Straightforward · 7 marks
Suppose that consumers in a free-market economy switch their spending from petrol scooters to electric bicycles because they have become more concerned about air quality.
(i)
Describe the signalling, incentive and rationing functions of prices.
3 marks
(ii)
Explain how the price mechanism would reallocate resources between the two industries in response to this change.
4 marks
Shifts in the motor insurance market
Markets · Straightforward · 8 marks
Consider the market for private motor insurance in a country where cover is compulsory for all car drivers. The price is the annual premium for a standard policy and the quantity is the number of policies sold.
(i)
List four factors, other than the premium itself, that affect the demand for motor insurance.
2 marks
(ii)
For each of the following events, state whether the demand curve or the supply curve for motor insurance shifts, and in which direction.
(a) The cost of repairing cars rises sharply because parts become more expensive. (b) Many more people buy cars as their incomes rise. (c) Fuel prices rise steeply, so fewer people choose to own a car. (d) Insurers adopt new software that cuts the administrative cost of each policy.
4 marks
(iii)
Explain the difference between a movement along the demand curve and a shift of the demand curve, using the motor insurance market as an example.
2 marks
Short-run and long-run elasticity of supply
Markets · Straightforward · 7 marks
On a fictional island, the price of a half-day fishing-boat charter rises from £150 to £180. Within a month the number of charters offered rises from 400 to 440 a month. Two years later, with the price still £180, 560 charters a month are offered.
(i)
Calculate the short-run price elasticity of supply using original values, to 2 decimal places.
1 mark
(ii)
Calculate the long-run price elasticity of supply using average values, to 2 decimal places.
2 marks
(iii)
Explain why the supply of charters is more elastic in the long run than in the short run.
2 marks
(iv)
Explain two other factors that determine the price elasticity of supply.
2 marks
Income elasticity in a growing economy
Markets · Standard · 7 marks
In the fictional economy of Westmark, average household disposable income rose from £38,000 to £42,000 a year. Over the same period, with all prices unchanged:
the number of private medical insurance policies held rose from 120,000 to 138,000;
weekly sales of a supermarket's value-range ready meals fell from 50,000 to 48,000 packs.
(i)
Calculate the income elasticity of demand for private medical insurance using average values, to 2 decimal places.
2 marks
(ii)
Calculate the income elasticity of demand for the value-range ready meals using average values, to 2 decimal places.
2 marks
(iii)
Classify each good using your results, and comment on what they imply for a medical insurer if Westmark enters a recession.
3 marks
Reaching equilibrium in a fish market
Markets · Standard · 8 marks
The daily market for fresh haddock in the fictional port of Strathmoor is described by
Qd=480−4P and Qs=2P−60,
where P is the price in £ per box and Q is the number of boxes.
(i)
Calculate the equilibrium price, in £ per box.
2 marks
(ii)
Calculate the equilibrium quantity, in boxes.
1 mark
(iii)
The market opens with traders asking £80 per box. Calculate the excess demand at this price, in boxes.
2 marks
(iv)
Explain how the market moves from a price of £80 to equilibrium, describing the diagram you would draw.
3 marks
Simultaneous shifts in demand and supply
Markets · Standard · 7 marks
The monthly market for bicycle servicing in the fictional town of Ellerby is initially described by
Demand: Q=300−5P; Supply: Q=20+2P,
where P is the price of a standard service in £ and Q is the number of services. Two things then happen at once: rising local incomes increase demand to Q=335−5P, and higher wages for mechanics reduce supply to Q=6+2P.
(i)
Calculate the initial equilibrium price, in £, and state the equilibrium quantity.
2 marks
(ii)
Calculate the new equilibrium price, in £, and state the new equilibrium quantity.
2 marks
(iii)
Describe, with the aid of a diagram described in words, the effect of the two changes, and explain why the effect on the equilibrium quantity could not be predicted without the numbers.
3 marks
Market and firm elasticity in motor insurance
Markets · Standard · 8 marks
In a country where motor insurance is compulsory for drivers, the price elasticity of demand for private motor insurance across the whole market is estimated at −0.3. Kestrel Insurance, one of many insurers selling through price comparison websites, estimates the price elasticity of demand for its own policies at −2.5. Kestrel is considering raising its premiums by 4% while its competitors keep theirs unchanged. Treat each elasticity as constant over the change considered, so that the percentage change in quantity equals the elasticity times the percentage change in price.
(i)
Calculate the percentage change in the number of policies Kestrel sells. Give your answer as a percentage.
1 mark
(ii)
Calculate the percentage change in Kestrel's premium income, to 1 decimal place.
2 marks
(iii)
Explain why demand for motor insurance is inelastic for the market as a whole but elastic for Kestrel.
3 marks
(iv)
Explain two other factors that affect the price elasticity of demand for a product.
2 marks
Hedging wheat costs with a forward contract
Markets · Standard · 10 marks
Mardle Bakeries, a fictional UK bakery chain, will need 2,000 tonnes of milling wheat in six months' time. The current spot price is £200 a tonne. A grain merchant offers a forward contract to deliver 2,000 tonnes in six months at £210 a tonne.
(i)
Calculate the total cost of the wheat, in £, if Mardle takes the forward contract.
1 mark
(ii)
Suppose Mardle does not hedge and the spot price in six months is £240 a tonne. Calculate how much more it pays than it would have paid under the forward contract, in £.
1 mark
(iii)
Suppose instead that Mardle takes the forward contract and the spot price in six months is £185 a tonne. Calculate how much more it pays than it would have paid without hedging, in £.
1 mark
(iv)
Explain why Mardle might choose to hedge even though the forward price is above today's spot price.
2 marks
(v)
Describe how a futures contract on wheat differs from the forward contract offered by the merchant.
3 marks
(vi)
Explain why an insurer will cover Mardle against a fire at one of its bakeries but will not insure it against a rise in the price of wheat.
2 marks
Short- and long-run supply of office space
Markets · Hard · 9 marks
In the fictional city of Kelbridge, the market for city-centre office space is described by the following, where Q is thousands of square metres let and P is the annual rent in £ per square metre.
Initial demand: Q=1200−2P
Short-run supply: Q=480+0.4P
Long-run supply: Q=2P
The market starts in equilibrium at a rent of £300, where both supply curves give 600 thousand square metres. A large technology firm then moves to the city and demand rises to Q=1320−2P.
(i)
Calculate the new equilibrium rent in the short run, before any new offices can be built, and the quantity let. Give the rent as your final answer, in £.
2 marks
(ii)
Calculate the new equilibrium rent in the long run, and the quantity let. Give the rent as your final answer, in £.
2 marks
(iii)
Calculate the price elasticity of supply over the move from the initial equilibrium to the new short-run equilibrium, using average values, to 2 decimal places.
2 marks
(iv)
Explain why the supply of office space is more elastic in the long run than in the short run, and comment on what this means for rents and for property investors in Kelbridge.
3 marks
Speculation and a house price bubble
Markets · Hard · 9 marks
In the fictional coastal town of Port Elden, the average house price rose from £180,000 to £270,000 over three years, while the average rent on a house stayed at £9,000 a year. Mortgage interest rates for buy-to-let investors were about 5% a year throughout. Local estate agents report that many buyers expect prices to keep rising at recent rates.
(i)
Calculate the average annual compound rate of growth of house prices over the three years, as a percentage to 2 decimal places.
2 marks
(ii)
Calculate the gross rental yield (annual rent divided by price) at the start and at the end of the period, as percentages to 2 decimal places. Give the end-of-period yield as your final answer.
2 marks
(iii)
Explain why investors might buy at a rental yield below their borrowing cost, and how this behaviour can produce a price bubble.