May 2015 - Paper 1
1a) Explain how prices work to reallocate resources in a market.
Signalling, incentivising and rationing mechanisms.
If prices rise, firms are signalled to enter the market, as the rising price reflects rising demand which they
can capitalise on. These firms will often leave other markets behind, to enter the more profitable market,
which represents their reallocation of resources. Moreover, rising prices incentivise existing firms to
produce a higher quantity of goods as they have the potential to reach higher profits. As such, more
factors of production will be reallocated to produce this higher quantity of goods. Either way, goods are
reallocated.
Similarly, if prices fall, firms are signalled to exit the market, so resources are allocated away. Firms that
do not exit the market will at least be incentivised to produce less to avoid making a loss, and so they
utilise less resources in their production.
It can be seen therefore, that changes in price cause resource allocation to or from a market.
1b) Discuss the view that overuse of common access resources is best addressed by the
government.
Common access resources are resources that are rivalrous but at the same time non-excludable. A
typical example is a public pasture. If multiple shepherds all act in self-interest and graze their sheep in
the pasture, the pasture will eventually be degraded, becoming muddy and losing its grass. Common
access resources become degraded by individuals using it, hence the government should take action
preserve it to enable future sustainability of the common access resource. Other stakeholders, such as
the shepherds who graze their sheep on the pasture, are not incentivised to invest in the preservation of
the common access resource, as their investment will be enjoyed by other free-riders.
The government could take action such as a payment to use the common access resource. Since the
common access resource is no longer free, there would no longer exist “infinite” demand for the
resource. This is common on common access resources such as roads, where individuals who use the
roads are forced to pay tolls. This prevents overuse of the road (which would cause traffic congestion)
and permits money to be re-invested into the road to maintain its quality. As such, this prevents the
degradation of the resource caused by everyone acting in self-interest.
Equally, governments could put a general tax on its public, the revenue from which they can then direct
towards sustaining the quality of common access resources. However, this does not reduce the demand
for the good, so can be seen as inferior to a toll tax.
Similarly, governments could simply put a cap on the usage of the common access resource, such as
limitations on fishing in the sea, to preserve the number of fish. This ensures long term sustainability and
attempts to avoid the overcrowding of the good.
A key limitation of governmental policy is that, often, policy makers overlook long term negative effects,
in favour of seeking shorter term political effects. For example, a policy maker may abolish toll roads in
an attempt to win favour with the users of the roads in the lead up to an election. As such, the political
agendas of members of the government may disrupt the government’s ability to prevent overuse of
common access resources.
1a) Explain how prices work to reallocate resources in a market.
Signalling, incentivising and rationing mechanisms.
If prices rise, firms are signalled to enter the market, as the rising price reflects rising demand which they
can capitalise on. These firms will often leave other markets behind, to enter the more profitable market,
which represents their reallocation of resources. Moreover, rising prices incentivise existing firms to
produce a higher quantity of goods as they have the potential to reach higher profits. As such, more
factors of production will be reallocated to produce this higher quantity of goods. Either way, goods are
reallocated.
Similarly, if prices fall, firms are signalled to exit the market, so resources are allocated away. Firms that
do not exit the market will at least be incentivised to produce less to avoid making a loss, and so they
utilise less resources in their production.
It can be seen therefore, that changes in price cause resource allocation to or from a market.
1b) Discuss the view that overuse of common access resources is best addressed by the
government.
Common access resources are resources that are rivalrous but at the same time non-excludable. A
typical example is a public pasture. If multiple shepherds all act in self-interest and graze their sheep in
the pasture, the pasture will eventually be degraded, becoming muddy and losing its grass. Common
access resources become degraded by individuals using it, hence the government should take action
preserve it to enable future sustainability of the common access resource. Other stakeholders, such as
the shepherds who graze their sheep on the pasture, are not incentivised to invest in the preservation of
the common access resource, as their investment will be enjoyed by other free-riders.
The government could take action such as a payment to use the common access resource. Since the
common access resource is no longer free, there would no longer exist “infinite” demand for the
resource. This is common on common access resources such as roads, where individuals who use the
roads are forced to pay tolls. This prevents overuse of the road (which would cause traffic congestion)
and permits money to be re-invested into the road to maintain its quality. As such, this prevents the
degradation of the resource caused by everyone acting in self-interest.
Equally, governments could put a general tax on its public, the revenue from which they can then direct
towards sustaining the quality of common access resources. However, this does not reduce the demand
for the good, so can be seen as inferior to a toll tax.
Similarly, governments could simply put a cap on the usage of the common access resource, such as
limitations on fishing in the sea, to preserve the number of fish. This ensures long term sustainability and
attempts to avoid the overcrowding of the good.
A key limitation of governmental policy is that, often, policy makers overlook long term negative effects,
in favour of seeking shorter term political effects. For example, a policy maker may abolish toll roads in
an attempt to win favour with the users of the roads in the lead up to an election. As such, the political
agendas of members of the government may disrupt the government’s ability to prevent overuse of
common access resources.
