CIE A Level Economics 7 The Price System and the Microeconomy Exam Questions

About CIE A Level Economics 7 The Price System and the Microeconomy

Topic 7 is the largest A Level section of the Cambridge 9708 syllabus and takes AS microeconomics much further. It begins with consumer theory (marginal utility, equi-marginal principle, indifference curves and budget lines, and income and substitution effects), then moves to productive, allocative and dynamic efficiency, market failure and externalities. The second half is the theory of the firm: short-run and long-run costs, revenue curves, profit, perfect competition, monopolistic competition, oligopoly and monopoly, contestable markets, growth and integration of firms, and objectives other than profit maximisation. Examiners expect accurate cost and revenue diagrams and comparisons of efficiency between market structures.

What you need to know

• 7.1 Utility Total and marginal utility; diminishing marginal utility explains a downward-sloping demand curve. The equi-marginal principle: consumers maximise utility where MU/P is equal for all goods. Know limitations of the model, including behavioural insights such as bounded rationality.
• 7.2 Indifference curves and budget lines An indifference curve joins combinations giving equal satisfaction; the budget line shows affordable combinations. The optimum is the tangency point. A price change can be split into income and substitution effects, which differ for normal, inferior and Giffen goods.
• 7.3 and 7.4 Efficiency and externalities Productive efficiency is output at minimum average cost; allocative efficiency is where P = MC; dynamic efficiency comes from innovation over time. Social cost = private cost + external cost. Negative externalities cause overproduction where marginal social cost exceeds marginal social benefit, with a deadweight welfare loss.
• 7.5 Costs, revenue and profit Short run: at least one fixed factor; the law of diminishing returns explains rising MC. Long run: economies and diseconomies of scale shape the LRAC curve. Normal profit is where AR = AC; supernormal profit is above it. Profit is maximised where MC = MR.
• 7.6 Market structures Perfect competition (many firms, homogeneous products, no barriers), monopolistic competition (differentiated products, low barriers), oligopoly (few interdependent firms, possible collusion, kinked demand curve), monopoly (single seller, high barriers). Contestable markets depend on ease of entry and exit, not number of firms.
• 7.7 and 7.8 Growth and objectives of firms Firms grow internally or by horizontal, vertical (forward or backward) or conglomerate integration; small firms survive in niche markets. Objectives include profit maximisation (MC = MR), revenue maximisation (MR = 0), sales maximisation (AR = AC) and satisficing, linked to the principal-agent problem. Know price discrimination conditions and effects.

Common mistakes in 7 The Price System and the Microeconomy

• Stating that a perfectly competitive firm is allocatively efficient but not productively efficient in the long run. In long-run equilibrium it is both, because P = MC = minimum AC.
• Drawing the MC curve cutting AC and AVC away from their minimum points. MC must cut both at their lowest points.
• Confusing the law of diminishing returns with diseconomies of scale. Diminishing returns is a short-run idea with a fixed factor; diseconomies of scale are long-run, when all factors vary.
• Labelling the monopolist's price at the point where MC = MR. Find output where MC = MR, then read price up to the AR (demand) curve.
• Assuming an oligopoly always means collusion. Firms may compete or collude; game theory and the kinked demand curve explain different outcomes.

Try three 7 The Price System and the Microeconomy exam-style questions