PMT

SPECIMEN MATERIAL

A-level
ECONOMICS
7136/1
Paper 1 Markets and market failure

Specimen 2014 Morning Time allowed: 2 hours

Materials
For this paper you must have:
 an answer book
 a calculator.

Instructions
 Use black ink or black ball-point pen. Pencil should only be used for drawing.
 Write the information required on the front of your answer book. The Examining Body for this paper
is AQA. The Paper Reference is 7136/1.
 In Section A, answer EITHER Context 1 OR Context 2.
 In Section B, answer one essay.

Information
 There are 80 marks available on this paper.
 The marks for questions are shown in brackets.

7136/1
Section A

Answer EITHER Context 1 OR Context 2.

EITHER

Context 1 Total for this context: 40 marks.

The UK energy market

Study Extracts A, B and C and then answer all parts of Context 1 which follow.

Extract A: Average household dual fuel bills August 2009–2013 (£)

2009 2010 2011 2012 2013

Household bills 1145 1105 1250 1310 1420

Wholesale energy costs per bill 615 485 585 625 635

Profit per bill 10 55 45 50 95

Source: Contains public sector information licensed under the Open Government Licence v. 1.0

Extract B: Are energy firms exploiting their market power?

The UK energy market was privatised in the early 1990s and is dominated by six firms, British 1
Gas, EDF Energy, [Link], Npower, Scottish Power and SSE. These firms supply, produce and
own energy reserves. Gas is the main source of fuel used by electricity generators.
The increase in household fuel bills has been a cause of rising inflation in recent years. In
autumn 2013, prices were increasing at three times the rate of inflation. Energy prices have 5
risen faster than average earnings and 6.5 million households were spending over 10% of their
incomes on energy and so experiencing ‘fuel poverty’.
Are the oligopolistic energy utilities exploiting their monopoly power? Firms raise prices quickly
when their wholesale costs increase, but are slow to reduce them when market conditions
change. The energy regulator, OFGEM, doesn’t regulate prices or profits, but aims to promote 10
greater competition in the market. OFGEM has found no evidence of collusion between
energy suppliers to date.
Wholesale energy costs are responsible for around half the final domestic bill. Suppliers buy
energy on the wholesale market from energy producers. Contracts are complex and firms buy
energy to cover their future needs. A generator may sell energy to a supplier within the same 15
company before it is sold on to the consumer. The determination of wholesale prices and their
link to retail prices aren’t clear.
UK households faced over 1756 different price plans in early 2013. This makes it difficult for
consumers to compare rates and few consumers switch supplier. In 2013 OFGEM intervened
to fix the maximum number of price plans to four per firm; this should bring greater price 20
transparency.
Source: News reports, October 2013
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Extract C: Are price rises inevitable?

Do UK consumers pay too much for energy? Department of Energy & Climate Change 1
research shows domestic electricity prices were fourth lowest and gas prices second lowest in
a survey of 15 EU countries. Firms claim profits, averaging a return of 5% in 2012, are not
excessive and are used to fund much-needed investment in both infrastructure and future
energy supplies. 5
Will Morris, Group Managing Director of SSE, claims many factors are responsible for driving
up prices: “Buying wholesale energy in global markets, delivering it to customers, and
government-imposed levies collected through bills all cost more than last year.”
Ed Miliband, Leader of the Opposition in the UK, promised that a future Labour government
would impose “a price freeze for twenty months because the market is not working”, and that 10
the regulator would make the market more competitive.
In the longer term, the UK needs to become less dependent on imported energy and use
‘greener’ sources such as wind, solar and nuclear. One in five UK power stations will be
obsolete by 2023 and there is a risk of power shortages in coming years. The Government
guarantees high prices to firms producing energy from renewable and nuclear sources but 15
these costs are then passed on to consumers.
The Government claims that high guaranteed prices for power generators makes good long-
term sense. Gas prices are expected to rise over the longer term, despite the discovery of
shale gas in the UK. Could more be done to encourage households to reduce their demand
for energy? Energy conservation could result in lower bills but few households are making 20
use of the ‘Green Deal’ scheme to make homes more energy efficient.
Source: News reports, October 2013

0 1 Using the data in Extract A, calculate, to two decimal places, the overall percentage
change in household bills from 2009 to 2013.
[2 marks]

1145-1420/1145 x 100= 24.02 %

0 2 Explain how the data in Extract A show that energy companies have exploited their
market power.
[4 marks]
Energy has inelastic demand; if companies charge premium/higher
prices, consumers have no choice but to pay. There aren’t many
energy companies available = oligopoly/monopoly power leaving
consumers no choice and firms being able to exploit their market
power. Firms have generated higher profit in 2013 in comparison to
2009 (extract A), evidently presenting how energy companies have
exploited their market power to charge premium prices.

Turn over 
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0 3 Extract B (lines 11–12) states that there is ‘no evidence of collusion between energy
suppliers to date.’

With the help of a diagram, explain how collusion between energy suppliers could
affect the retail prices paid by consumers. (9 marks)

Oligopoly is an industry which is dominated by few firms, some barriers of entry

and high concentration ratios. Collusion is a possibility in an oligopoly market for
firms to be able to charge higher prices and exploit consumers

Through Collusion, oligopoly firms adapt monopolistic characteristics, allowing

them to be price setters and charge prices they wish to do so.
Through collusive pricing, output is restricted and goes from Q1 to Q2, see figure
1. Prices will
increase from P1 to
P2, see figure 1. By
colluding and acting
like monopolists,
firms can make
abnormal profits at
point abcd (shaded
area) where AR is
greater than AC, see
figure 1. As firms will
be acting as
monopolists, there
are no incentives to
reinvest abnormal
profits into research
and development.
Therefore, through
collusion, it is unfair to consumers as firms are able to charge higher prices to
consumers and would affect retail prices paid by consumers.

Figure 1

However, sometimes collusion can benefit a consumer and allow consumers to

have cheaper retail prices. This is often referred to as cooperation rather than
collusion. An example of this, is firms joining together to innovate a new
production process. These might benefit society as a whole as efficiency for the
Industry might improve. This will lead to lower production costs that can benefit
the consumer. This can be distinguished from collusive practices that impact
negatively on price for the consumer. Therefore, through cooperation, energy
companies can reduce their production cost and decrease their overall retail
prices for consumers.
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0 4 In Extract C, (lines 9–10) Ed Miliband is quoted as saying that a future Labour

government would impose “a price freeze for twenty months because the market is not
working”.

Using the data in the extracts and your economic knowledge, assess whether you
agree that fixing a maximum price for energy that is sold to households is the best way
of dealing with market failure in the UK energy industry?
[25 marks]

Turn over 
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6
Do not answer Context 2 if you have answered Context 1.
OR

CONTEXT 2 Total for this Context: 40 marks

Inequality

Study Extracts D, E and F and then answer all parts of Context 2 which follow.

Extract D: The effects of taxes and benefits in the UK on household income by quintile
groups, 2011–2012

Quintile group

Source: Office for National Statistics licensed under the Open Government Licence v. 1.0.

Extract E: In favour of inequality

The way in which society’s resources are distributed has long been of major concern to 1
economists, directly affecting as it does the level of social welfare. Changes in the size and
distribution of national output raise important questions of efficiency and also involve basic
issues of equality. However, what is equitable is a matter of considerable debate amongst
economists of different political persuasions. 5
It has been argued by the supporters of free-market capitalism that growing inequality would
create incentives, kick-start enterprise, boost growth and is good for us all. Free market
economists would argue that justice automatically arises from the interaction of demand and
supply and the existence of competitive markets. In such a scenario, each factor receives what
it is worth in terms of the value of its marginal revenue product. Disparities in income and 10
wealth are justified by such factors as greater levels of innate or acquired skills which enable
some factors to be more productive than others and earn a greater amount. Differences in the
distribution of income and wealth are therefore viewed as inevitable and also desirable in that
they provide the necessary incentives for individuals to study, train, supply their factor services
and set up new businesses. These differences help the smooth operation of the price system 15
and lead to an efficient resource allocation.
Moreover, an unequal distribution of income is seen as necessary to ensure economic efficiency
and a faster growth rate – by making the rich richer, the size of the national cake, that is real
GDP, will grow, and the benefits will trickle down to the less well off.
Source: News reports, November 2013
Extract F: Against inequality

The main outcome of the post-1980 experiment in neo-liberal (market) economics has been an 1
economy that is much more divided and unhealthy, both of which are closely related. There are
three powerful reasons why the global financial crisis of 2008 and 2009 had its roots in excessive
concentrations of income and wealth.
First, above a certain limit of inequality, economies develop a natural tendency to deflation. In the 5
UK and US, by cutting the purchasing power to buy the extra output being produced, the
long wage squeeze has created consumer societies without enough consumers. The
solution has been to allow an unsustainable increase in private debt to fill the gap.
Second, concentrating income in fewer and fewer hands eventually leads to bubble economies
in which the prices of assets, such as houses and shares, rise continuously until the ‘bubbles’ 10
eventually burst. From the early 1990s, the growing inequality created a global mix of increasing
company profits, excessive bank lending and rapidly growing personal wealth, all of which
contributed to the bubbles in property and share prices. This eventually brought the global
economy to its knees.
Finally, excessive concentrations of wealth create dangerous concentrations of economic power. 15
Corporate lobby groups, which promote the interests of the financial sector, are able to promote
measures such as weak financial regulation by the state and lower taxes on the wealthy.

Source: Copyright Guardian News & Media Ltd 2011

0 5 Using the data in Extract D, calculate the difference between the mean original
income and the mean final income of the five quintile groups.
[2 marks]
Total Original income/ 5 = 35400
Final income/5= 35000
35400-35000= £400

0 6 Explain how the data in Extract D show that taxes and benefits have been successful
in reducing inequalities in household income in the UK.
[4 marks]
Through progressive taxation, high income earners final income is
reduced. Tax revenue is then redistributed through benefits to low
income earners. By doing so, distribution of income and inequalities
have been reduced in UK

0 7 Extract F (lines 9–10) states that ‘concentrating income in fewer and fewer hands
eventually leads to bubble economies in which the prices of assets, such as houses
and shares, rise continuously’.

With the help of a diagram, explain how growing inequality might lead to a persistent
rise in the price of houses.

[9 marks]
0 8 Extract E (lines 6–7) states that ‘growing inequality would create incentives,
kick-start enterprise, boost growth and is good for us all’.

Using the data in the extracts and your economic knowledge, assess the view that
inequality is ‘good for us all.’
[25 marks]
Section B

Answer one essay from this section.

Each essay carries 40 marks.

EITHER

Essay 1
Apple sells iPhones and iPads at considerably lower prices in the USA than in the
UK market, but sources the products from the same factories in the Far East.

0 9 Explain why firms, such as Apple, might be able to charge different prices for the same
product in different markets.
[15 marks]

1 0 Discuss the view that price discrimination only benefits suppliers, such as Apple.
[25 marks]
OR
Essay 2
Traditional economic theory assumes that consumers make rational decisions that
maximise their economic welfare, but behavioural economists disagree.

1 1 Using examples to illustrate your answer, explain how anchoring and loss aversion
can affect an individual’s choices when deciding how to spend or save their income.
[15 marks]

1 2 The Government would like to improve the well-being of the population by encouraging
people to adopt a healthy diet. Using your knowledge of both traditional economic
theory and behavioural economics, assess alternative policies that the Government
might adopt to try to achieve its objective
[25 marks]
OR
Essay 3
It is generally accepted that we need to adopt new ways of charging for the use of
our roads. This is partly because of worsening congestion, but is also due to the
reduction in revenue generated from taxes on fuels as a result of more fuel-efficient
vehicles.

1 3 Explain why, in the absence of government intervention, too many journeys are likely
to be made by road and too few by rail.
[15 marks]

1 4 Assess the view that a system of road-pricing is the best way to tackle the problem of
worsening traffic congestion in the UK.
[25 marks]

END OF QUESTIONS
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Acknowledgement of copyright holders and publishers

Permission to reproduce all copyright material has been applied for. In some cases, efforts to contact copyright-holders have been
unsuccessful and AQA will be happy to rectify any omissions of acknowledgements in future papers if notified.

Extract A © Source: Contains public sector information licensed under the Open Government Licence v. 1.0
Extract B © Source: News reports, October 2013
Extract C © Source: News reports, October 2013
Extract D © Source: Office for National Statistics licensed under the Open Government Licence v. 1.0.
Extract E © Source: News reports, November 2013
Extract F © Source: Copyright Guardian News & Media Ltd 2011

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