Answer Exercise 3.

1
1 (a) Role of commercial banks:
accept deposits
lend to customers
enable customers to make payments
travellers cheques/foreign currency
deposit important documents
source of financial advice.
(b) Functions of money:
means of exchange
unit of account/measure of value
standard for deferred payments
store of value.
2 (a) PED measures the sensitivity of demand to a change in price (1).
Precise formula: percentage change in quantity demanded of a product divided by
percentage change in price of a product (2).
it is usually negative, it can range from perfectly inelastic to perfectly elastic (1).
(b) Comment on the ability to predict what would happen to demand and therefore to income
and to profits.
Might use knowledge of elasticity of different products to decide which to expand.
Might use knowledge of elasticity to help form pricing policy.
Link between elasticity/price changes/total revenue.
Supply elasticity not required but could allow this.
[6]
(c) Smokers derive a private benefit (they might smoke to release stress) , but may also incur a
private cost in buying cigarettes and in health terms if they fall sick due to consequence of
smoking . Non-smokers incur an external cost because they have to breathe in second hand
smoke.
Candidates could contrast the net private benefit with the overall net social benefit/cost.
After the ban, there will be a reduction in external costs, therefore, social costs is reduced too.
[6]
(d) Manufacturers might decide that the low elasticity will mean that demand will be unchanged
and only a small percentage quantity of cigarette changes.
They may decide that if more people will be persuaded not to smoke, so may need to diversify
the products. They may reduce costs by closing some production units,
or try to find other markets where smoking is not prohibited because ppl could still smoke at
private area like the house. [4]

3(a) (i) Correctly labelled diagram (price, quantity, demand) (1).

Shift of demand curve to the right (1). [2]
(ii) Possible causes:
rise in income
greater availability of credit to finance borrowing
fall in interest rate on loans
price of substitute has gone up
price of complement has gone down
effect of advertising campaign
growth in population
change in tastes and preferences of consumers in favour of a product.
(b) If PED is elastic, the business should reduce price (1) to benefit from an increase in revenue
(1)
If PED is inelastic, the business should increase price (1) to benefit from an increase in
revenue (1). [4]
(c) - Firms may come to dominate and have monopoly power, leading to higher prices and lower
levels of output.
- There may be significant differences in income and wealth, which gives some consumers much
more power than others.
- Merit goods, which are socially desirable, may be under-provided and under-consumed.
- Demerit goods, which are socially undesirable, may be over-provided and over-consumed.
- Public goods, which cannot be easily provided through a market system, may not be provided
at all.
- Resources cannot always easily move from one use to another, e.g. labour may not have the
necessary skills and/or information.
- Externalities may not be taken into account in consumption and production decisions.
A general understanding of what is meant by market failure can gain up to 2 marks.
A narrow focus on one particular area of market failure, that is done well, can gain a
maximum of 5 marks.

Exercise 3.1
1. Commercial banks perform an important role in most economies. Money helps in the
exchange of goods and services and, in the form of wages, is an influence on the choice of
occupation for many individuals.
(a) Explain the role of commercial banks. [4]
(b) Describe the various functions that money performs in an economy. [4]
(c) Describe the likely changes in income for individuals over their lifetime. [4]

2. A company produces cigarettes which it believes have a low price elasticity of demand.
(a) Explain what is meant by price elasticity of demand. [4]
(b) How might knowledge of price elasticity be of use to a producer? [6]
(c) Some countries have now prohibited smoking in public areas in buildings. Use the concepts
of private and social costs and benefits to explain this policy. [6]
(d) Discuss what effect the policy of prohibiting smoking in public areas might have on the
manufacturers of cigarettes. [4]

3 (a) (i) Using a demand diagram, show an increase in demand for a product. [2]
(ii) Identify two causes of such an increase in demand. [2]
(b) Why is the concept of price elasticity of demand potentially very useful to a business? [4]
(c) Discuss why market failure could occur in an economy. [8]