– – N18/3/ECONO/HP3/ENG/TZ0/XX/M

Notes for examiners:

1. Whenever relevant, carry over marks must be awarded. If a candidate makes an error in
calculation, but then uses the incorrect figure appropriately and accurately in later question
parts, then the candidate may be fully rewarded. This is the “own-figure rule” and you should
put OFR on the script where you are rewarding this.

2. Alternative approaches may be taken in responses to the [4] questions that use A02 command
terms. If this is the case and the alternative approaches are valid, then full credit should be
given.

1. (a) (i) Calculate Firm A’s average fixed costs when it is producing 125 cartons
of coffee per month. [2]

500
125

Identification of FC at $500 or any valid working is sufficient for [1].

 $4

An answer of $4 or 4 (without working) is sufficient for [1].

(ii) Calculate Firm A’s average variable costs when it is producing 125 cartons
of coffee per month. [2]

1500
125

Identification of VC at $1 500 or any valid working is sufficient for [1].

 $12

An answer of $12 or 12 (without working) is sufficient for [1].

(b) (i) Using Figure 2, calculate the average fixed costs when 80 cans per month
are produced. [1]

(25  20)
 $5

An answer of $5 is sufficient for [1].

 – – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(ii) Using Figure 2, calculate the total costs when 55 cans per month
are produced. [2]

30  55

Identification of ATC at $30 or any valid working is sufficient for [1].

 $1650

An answer of $1650 or 1650 (without working) is sufficient for [1].

NB If the candidate identifies ATC as $29 or $31, (with a final answer of

$1595 or $1705) this should be fully rewarded.

(iii) Explain why in the short run, as output increases, marginal costs typically
decrease and then increase. [4]

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 The written response is limited. 1–2
For a limited explanation that marginal product initially tends to
increase but then because of a fixed input (factor), diminishing
returns cause MP to fall.

OR

MP falls because of a fixed input, which increases the additional

costs of one more unit, and so MC increases.

Allow [1] mark only if “productivity” used instead of MP or if fixed

input not mentioned.

An algebraic response (see below) without any reference to The

Law of Diminishing Marginal Returns may be awarded a
maximum of [2] marks.
2 The written response is accurate. 3–4
For explaining that marginal product initially tends to increase,
due to specialization, but then because of a fixed input (factor)
that has to be shared, diminishing returns cause MP to fall.

AND EITHER

as MP falls, the additional costs of one more unit of output will

begin to increase and so MC increases.

OR

VC (wL) L 
MC    w   1 
  w  MP 
Q Q  Q   
so, if MP increases, then MC will decrease and, when MP
decreases (as a result of the LoDMRs), then MC will increase.
 – – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(c) (i) Using this information, draw and label the average revenue curve on Figure 2. [1]

A correctly labelled AR (or P/MR/D) line is sufficient for [1].

(ii) Using Figure 2, identify the quantity of cans per month Firm B must produce
in order to maximize profits. [1]

Where marginal revenue equals marginal cost.

An answer of 105 is sufficient for [1].

If the candidate identifies the quantity as 104 or 106 this should be fully
rewarded.

OFR may apply.

(iii) Calculate the economic profit when Firm B is producing at the output level
identified in part (c)(ii). [2]

105 (21  23)

Any valid working is sufficient for [1].

 $210 or a loss of $210

An answer of $210 or a loss of $210 (without working) is sufficient for [1].

OFR may apply — eg $208 if 104 cans identified in (c)(ii) OR $212 if 106
cans identified in (c)(ii).
 – – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(d) Sometimes a firm continues to produce in the short run, even when it is making
an economic loss. Explain why the firm might choose to do this. [2]

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 There is limited understanding. 1
For a response that the price is above the shut-down price
(minimum AVC) OR the firm is covering its variable costs.
2 There is clear understanding. 2
For a response that in the short run, the firm should continue to
produce provided price covers (average) variable costs, since it
is making a contribution to fixed costs OR the firm’s losses are
less than its fixed costs, so its losses would be greater if it shut
down.

(e) Outline why a perfectly competitive firm is a “price taker”. [2]

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 There is limited understanding. 1
For a response that it does not have market power and so must
accept the market price.
2 There is clear understanding. 2
If the firm raises the price both its quantity sold and revenue will
drop to zero (there is also no benefit from lowering its price,
since it can sell any amount at the market price).

(f) Firm B and all the other firms in the tea market begin to sell their tea in distinctive
packages and many differentiate their product with organic tea or fruit flavours.
Explain how the demand curve faced by Firm B will change as a result. [2]

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 There is limited understanding. 1
For a response that the demand curve will now slope down.
2 There is clear understanding. 2
For a response that the demand curve will slope down because
the firm now has the market/monopoly power (or the ability to be
a price maker) OR that the demand curve will slope down
because it is now a monopolistic competitor OR the firm’s
demand curve is no longer perfectly elastic because it now has
the market power to change its price.
 – – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(g) Firm B conducted a market survey and found out that the price elasticity of demand for
its brand of tea is 0.8 among urban customers, whereas it is 1.2 among customers
in rural areas. The sales director said “This information could help Firm B to raise its
revenue, by trying to separate the two markets, provided that certain conditions are
satisfied”. Explain this statement. [4]

Firm B could:
 price discriminate in two separate markets (charge different prices in
different/separate markets)
 charge a higher price to urban customers (or a lower price to rural)
 when demand is inelastic a higher price yields more revenue (or when elastic demand a
lower price yields more revenue)
 Firm B needs to separate the two markets so no opportunity for resale (or Firm B needs to
have some monopoly/price-setting power).

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 There is limited understanding. 1–2
Award [1] for one of the points above.
Award [2] for two of the points above.
2 There is clear understanding. 3–4
Award [3] for three of the points above.
Award [4] for all of the four points above.
 – – N18/3/ECONO/HP3/ENG/TZ0/XX/M

2. (a) (i) Define the term social (community) surplus. [2]

Level Marks
0 The work does not meet a standard described by the 0
descriptors below.
1 Vague definition 1
The surplus that consumers and producers receive / enjoy.
2 Accurate definition 2
The sum of the consumer surplus and producer surplus
received / enjoyed.

(ii) Calculate social (community) surplus in the market for cotton. [2]

consumer surplus
(10  50)
 1000  250 000
2

producer surplus
(6  50)
 1000  150 000
2

social surplus
250 000  150 000

Any valid working is sufficient for [1].

 $400 000

OR

(16  50)
 1000
2

Any valid working is sufficient for [1].

 $400 000

An answer of $400 000 or 400 000 (without working) is sufficient for [1].
 –9– N18/3/ECONO/HP3/ENG/TZ0/XX/M

(b) (i) Draw and label the new supply curve following the granting of the subsidy
to domestic cotton producers on Figure 3. [2]

Drawing a new supply curve parallel and below / to the right of the original
supply curve is sufficient for [1].

(ii) Calculate the cost to the government of San Marcus of providing this subsidy
to domestic cotton producers. [2]

8  75 ( 1000)

Any valid working is sufficient for [1].

 $600 000

An answer of 600 000 or $600 000 (without working) is sufficient for [1].

OFR may apply.

 –1 – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(iii) Calculate the resulting change in producer surplus following the introduction
of the subsidy to cotton producers in San Marcus. [2]

(50  75)
 (13  10)  1000
2

OR

(0.5  75  9)  (0.5  50  6)  337.5  150

Valid working may include:

 correct workings for initial PS (0.5  50  6)
 correct workings for final PS (0.5  75  9)
(50  75)
 correct workings for the trapezium  (13  10)  1000
2

Any valid working is sufficient for [1].

 $187 500

An answer of 187 500 or $187 500 (without working) is sufficient for [1].

OFR may apply.

(iv) Calculate the change in the consumer surplus resulting from the subsidy. [2]

(50  75)
 (10  5)  1000
2

OR

(0.5  75  15)  (0.5  50  10)  562.5  250

Any valid working is sufficient for [1].

Valid working may be:

 correct workings for initial CS (0.5  50  10)
 correct workings for final CS (0.5  75  15)
(50  75)
 correct workings for the trapezium  (10  5)  1000
2

 $312 500

An answer of 312 500 or $312 500 (without working) is sufficient for [1].

OFR may apply.

 – 11 – N18/3/ECONO/HP3/ENG/TZ0/XX/M

(c) Explain two reasons why the government of San Marcus may have decided
to grant a subsidy to its cotton producers. [4]

Level Marks
0 The work does not meet a standard described by the descriptors 0
below.
1 The written response is limited. 1–2
For a limited explanation of one reason, award a maximum of
[1].

For an accurate explanation of one reason or a limited

explanation of two reasons, award a maximum of [2].

Reasons may include:

 to assist buyers of cotton
 to assist producers (farmers) of cotton
 to assist the textile industry
 to increase employment (lower unemployment)
 to decrease urbanization
 to promote exports/reduce imports.

Any other valid response.

2 The written response is accurate. 3–4
For providing an accurate explanation of one reason and a
limited explanation of a second reason, award a maximum of
[3].

For providing two accurate reasons, award a maximum of [4].

Accurate explanations may include:

 to assist buyers of cotton the cotton subsidy will decrease
production costs, increase supply and thus decrease price
 to assist producers (farmers) of cotton as the price per unit
earned following the subsidy as well as the amount produced
and sold will be greater leading to higher revenues
 to assist the textile industry as cotton is (as stated) an input
and thus costs of production will decrease making textiles
cheaper and increasing profitability
 to increase employment (lower unemployment) as more
output in the cotton and textile markets will require more
workers
 to increase exports and/or reduce imports by making the
cotton produced in San Marcus more competitive in the
international market.

Any valid response.