BA1: Microeconomics

Answer: B. The conventional primary objective of a profit-seeking company is to maximise shareholder wealth, usually expressed through the long-run value of the business. Maximising employment is not a financial objective and may conflict with efficiency. Minimising tax is a constraint or sub-goal, not the primary aim. Maximising revenue regardless of cost ignores profitability — high revenue with higher costs can reduce wealth.

Answer: A. The principal-agent problem arises from the separation of ownership and control: shareholders (principals) delegate decision-making to directors and managers (agents), whose personal objectives may diverge from maximising shareholder wealth. The other options describe taxation, price regulation and employment law respectively — real issues for businesses, but unrelated to the agency relationship between owners and managers.

Answer: D. Above the equilibrium price, the quantity supplied exceeds the quantity demanded, creating a surplus (excess supply). To clear the surplus, sellers reduce prices, moving the market back toward equilibrium. A shortage pushing prices up is what happens below equilibrium, not above it. Demand and supply do not both simply increase, and the equilibrium price is set by supply and demand rather than rising to meet the prevailing price.

Answer: A. Price elasticity of demand = percentage change in quantity demanded ÷ percentage change in price. The quantity change is (900 − 1,000) ÷ 1,000 = −10%. The price change is (£12 − £10) ÷ £10 = +20%. PED = −10% ÷ 20% = −0.5, or 0.5 ignoring sign. As this is below 1, demand is price-inelastic. The 2.0 answer inverts the ratio. The 0.1 answer misuses the figures. The 1.0 answer would indicate unitary elasticity.

Answer: C. Demand is price-inelastic when quantity demanded changes little in response to a price change. A life-saving medicine with no substitutes is a necessity for which consumers have little choice, so demand barely changes when price rises — highly inelastic. Luxuries, branded goods with substitutes and non-essential items all tend to have elastic demand, because buyers can readily switch, delay or do without when prices rise.

Answer: A. Original total revenue = 500 × £20 = £10,000. New total revenue = 600 × £18 = £10,800. The change is an increase of £800. Because the price cut raised revenue, demand over this range is price-elastic — the proportionate rise in quantity outweighed the proportionate fall in price. The £1,000 decrease is the price cut (£2) applied to the original 500 units, ignoring the volume gain, while the £1,800 increase counts the extra units' revenue but ignores the revenue lost on existing units.

Answer: A. Internal economies of scale arise from the growth of the individual firm itself — here, purchasing economies from buying in bulk. The other three are external economies (or, for the subsidy, simply an external factor): they arise from the growth of the industry or environment and benefit all firms, not from the size of one firm. Distinguishing internal from external economies is a frequently tested point.

Answer: C. A negative externality is a cost imposed on third parties not involved in a transaction, such as pollution affecting a community. It is a source of market failure because the producer does not bear the full social cost. A positive externality confers an uncompensated benefit on others. An internal economy of scale concerns a firm's own cost savings, and a maximum price control is a government intervention — neither describes the situation.

Answer: C. A not-for-profit organisation exists to serve its beneficiaries or mission, so its primary aim is to use its resources effectively to meet their needs — often framed as value for money (economy, efficiency and effectiveness). It has no owners seeking wealth and does not distribute dividends. Competing for market share is a commercial objective. The absence of a profit motive is precisely what distinguishes these organisations.

Answer: C. Shareholder wealth is reflected in the market value of their investment — the share price multiplied by the number of shares held, plus dividends received. The number of shares issued says nothing about their value. Directors' salaries are a cost, not a measure of owners' wealth. Sales revenue ignores costs and so does not measure the return to shareholders. Maximising this market value is the conventional financial objective.

Answer: B. Advertising is a non-price determinant of demand. Because it raises the quantity demanded at every price, the whole demand curve shifts to the right. Movements along a demand curve are caused only by a change in the product's own price, not by advertising. A shift in the supply curve concerns producers, not consumer demand. Distinguishing shifts of a curve from movements along it is a core skill.

Answer: A. Price elasticity of supply = percentage change in quantity supplied ÷ percentage change in price. Quantity change = (575 − 500) ÷ 500 = +15%. Price change = (£24 − £20) ÷ £20 = +20%. PES = 15% ÷ 20% = 0.75. As this is below 1, supply is price-inelastic over this range. The 1.33 answer inverts the ratio. Options C and D fail to express the changes as percentages of the original figures.

Answer: A. Supply is more price-elastic when producers can respond quickly and easily to a price change. Spare production capacity lets a firm increase output rapidly, making supply elastic. The other factors all make supply more inelastic: long production lead times, difficulty storing stock and raw-material shortages all limit a producer's ability to expand output in response to higher prices.

Answer: C. External economies of scale arise from the growth of the industry or its environment and benefit all firms within it — such as a pool of skilled labour developing in a region. The other three are internal economies, arising from the growth of the individual firm: spreading fixed costs, financial economies from size, and managerial specialisation all stem from the firm's own expansion, not the industry's.

Answer: D. A minimum wage is a price floor. Set above equilibrium, it raises the quantity of labour supplied (more people want to work at the higher wage) while reducing the quantity demanded (employers hire fewer workers). The result is excess supply — unemployment in that market. A shortage of labour would arise from a price ceiling set below equilibrium, not a floor above it. Wages are not set solely by employers once a binding floor exists, and the wage cannot fall below equilibrium while the floor is in force.

Answer: C. Transaction costs are the costs of arranging, monitoring and enforcing dealings with outside parties. When these fall, using the market becomes relatively cheaper than performing activities internally, so a firm is more likely to outsource. This is the logic behind network organisations and shared service centres. Higher transaction costs push the other way — toward bringing activities in-house. The other options are unrelated to transaction-cost reasoning.

Answer: A. PED = percentage change in quantity demanded ÷ percentage change in price. Quantity change = (260 − 200) ÷ 200 = +30%. Price change = (£45 − £50) ÷ £50 = −10%. PED = 30% ÷ 10% = 3.0. As this exceeds 1, demand is price-elastic — quantity is highly responsive to price. The 0.3 answer inverts the ratio. The large response of quantity to a modest price cut is what makes demand elastic here. 6.0 uses the absolute rise of 60 units instead of the 30% proportionate change.

Answer: A. Original revenue = 1,000 × £8 = £8,000. New revenue = 900 × £10 = £9,000. Revenue increases by £1,000. Because raising the price increased revenue, demand is price-inelastic over this range — the proportionate fall in quantity (10%) was smaller than the proportionate rise in price (25%). A £1,000 decrease simply reverses the direction. When demand is inelastic, a price rise raises total revenue. A £2,000 increase applies the £2 price rise to the original 1,000 units and ignores the fall in volume. A £200 decrease multiplies the 100-unit fall by the £2 price change, which is not a revenue figure.

Answer: C. Equilibrium occurs where demand equals supply: 100 − 2Q = 20 + 2Q. Solving: 80 = 4Q, so Q = 20 units. Substituting back: P = 100 − (2 × 20) = £60 (and the supply equation confirms 20 + (2 × 20) = £60). The £40 answer and the others result from arithmetic slips in solving the equations. Setting the two functions equal and solving for Q first, then for P, is the reliable method.

Answer: D. Complementary goods are used together, so a rise in the price of one reduces demand for both. If printers become more expensive, fewer are bought, and demand for the ink cartridges used with them falls accordingly — a negative cross elasticity of demand. The 'demand will rise' answer describes substitutes, where a price rise in one good raises demand for the other. Suggesting the cartridge's own price would automatically rise confuses a shift in demand with a change in the cartridge's own price.

Answer: D. Cheaper access to finance because of size is a financial economy of scale — a type of internal economy. A technical economy arises from more efficient larger-scale production methods. An external economy benefits all firms in an industry rather than one firm because of its size. A diseconomy of scale is a rise in unit costs as a firm grows too large, which is the opposite of an economy.

Answer: C. Performance-linked share options give directors a personal financial stake in the share price, aligning their incentives with shareholders' goal of increasing the value of the company — a common response to the principal-agent problem. A fixed salary regardless of performance does nothing to align interests, and removing performance targets weakens alignment further. Corporation tax payments are unrelated to the agency relationship between owners and managers.

Answer: B. A positive externality is a benefit enjoyed by third parties who are not involved in the transaction — here, the reduced spread of disease benefiting society as a whole. Because the market tends to under-provide goods with positive externalities, governments often subsidise them. A negative externality is an uncompensated cost imposed on others. The remaining options describe a firm's cost savings and a price intervention, neither of which fits.

Answer: C. With unitary elasticity, the percentage change in quantity exactly offsets the percentage change in price, so total revenue is unchanged whichever way the price moves. Revenue rising when price rises would indicate inelastic demand, and revenue falling when price rises would indicate elastic demand; unitary elasticity is the dividing point where revenue is constant. Revenue does not fall to zero as a result of a unitary value.

Answer: A. Under perfect competition there are many small firms selling an identical product, so no single firm can influence the market price — each must accept the prevailing price and is therefore a price taker. Price-making power belongs to firms in less competitive structures. A monopolist is a single dominant seller, and high entry barriers are a feature of monopoly, not perfect competition, where entry and exit are free.

Answer: B. A monopoly exists where a single seller dominates the market and high barriers to entry prevent competitors from entering, giving the monopolist substantial power over price. Many firms selling identical products describes perfect competition; a few interdependent firms describes oligopoly; and many firms with differentiated products describes monopolistic competition. The single dominant seller and entry barriers define monopoly.

Answer: C. An oligopoly is a market dominated by a few large firms whose decisions are interdependent — each must consider how rivals will react to its pricing and output choices, which often leads to price stability or non-price competition. Perfect competition has many price-taking firms, a monopoly has one dominant seller, and monopolistic competition has many firms with differentiated products. Interdependence among a few firms is the hallmark of oligopoly.

Answer: D. A good whose demand falls as income rises is an inferior good, and it has a negative income elasticity of demand: the rise in income and the fall in quantity move in opposite directions. Normal goods have positive income elasticity, and a luxury has a high positive value. Zero elasticity would mean demand is unaffected by income. The negative sign is what identifies an inferior good.

Answer: D. Diseconomies of scale are rises in long-run average cost as a firm grows too large; poor communication and coordination across a sprawling organisation is a classic cause, alongside management difficulties and falling staff motivation. Bulk-buying discounts, employing specialists and spreading fixed costs are all economies of scale that reduce unit costs. Diseconomies set in when the firm becomes too big to manage efficiently.

Answer: B. Income elasticity of demand = percentage change in quantity demanded ÷ percentage change in income = 5% ÷ 10% = 0.5. The positive value shows a normal good, and being below 1 it is income-inelastic (demand rises less than proportionately with income). The value 2.0 inverts the ratio. A negative value would indicate an inferior good, which does not fit a rise in demand when income rises. 1.5 adds the two percentage changes and divides by 10 ((5 + 10) ÷ 10) instead of dividing one by the other.

Answer: C. Profit is maximised where marginal cost equals marginal revenue: up to that point each extra unit adds more to revenue than to cost, and beyond it each extra unit adds more to cost than to revenue. Maximum total revenue ignores costs, minimum average cost is about efficiency rather than profit, and the relationship between fixed and variable costs does not determine the profit-maximising output. MC = MR is the decision rule.

Answer: D. Monopolistic competition features many firms selling similar but differentiated products (through branding, quality or design), with relatively low barriers to entry — think of restaurants or hairdressers. A single seller is a monopoly, a few interdependent firms an oligopoly, and identical products sold by price takers describe perfect competition. Product differentiation among many easily-entering firms is what defines monopolistic competition.

Answer: A. Internal stakeholders are those within the organisation, such as employees (and managers and owners), who participate directly in its operations. Customers, the government and suppliers are external stakeholders — they have an interest in the company but are not part of it. Distinguishing internal from external (and connected) stakeholders helps in analysing their differing interests and influence.

Answer: B. For a normal good, demand rises as incomes rise, shifting the whole demand curve to the right (more is demanded at every price). A fall in incomes would shift it left. Changes in the good's own price cause movements along the demand curve, not shifts of it, so the options about the good's own price describe a different effect. Only a non-price determinant such as income shifts the curve.

Answer: C. A rise in production costs makes supplying the good less profitable at every price, so producers offer less and the supply curve shifts left. Lower raw-material costs, improved technology and a producer subsidy all reduce costs or raise profitability, shifting supply to the right. Non-price determinants such as costs shift the supply curve, whereas a change in the good's own price moves the firm along it.

Answer: D. Cross elasticity of demand = percentage change in quantity demanded of B ÷ percentage change in the price of A = 10% ÷ 20% = +0.5. The positive sign shows the goods are substitutes: as A becomes dearer, buyers switch to B. The value 2.0 inverts the ratio, and the negative values would wrongly imply complements. A positive cross elasticity indicates substitutes; a negative one indicates complements.

Answer: A. As output expands in the long run, economies of scale reduce average cost, producing the downward-sloping part of the long-run average cost curve. Diseconomies of scale cause the later upward-sloping part as the firm grows too large. A rise in fixed costs would raise average cost rather than explain its fall, and the market price relates to revenue, not the cost curve. Falling unit costs with size means economies of scale.

Answer: B. Marginal cost is the addition to total cost from producing one more unit: £5,040 − £5,000 = £40. The figure £50.00 is the average cost of the first 100 units (£5,000 ÷ 100), and £49.90 is the average cost of 101 units — averages, not the marginal figure. £5,040 is the new total cost. Marginal cost looks only at the change in total cost for the extra unit.

Answer: C. A public sector body generally aims to deliver a service to the public as efficiently and effectively as possible — value for money — rather than to make a profit. It has no shareholders seeking profit or dividends, and competing for market share is a commercial goal not typically relevant to a state service. The absence of a profit motive, replaced by service and value-for-money objectives, characterises the public sector.

Answer: D. A vertical demand curve means the quantity demanded is the same whatever the price — quantity does not respond to price at all — which is perfectly inelastic demand (elasticity of zero). Perfectly elastic demand is a horizontal line. Unit elasticity and relative elasticity describe responsive demand with downward-sloping curves. The vertical line, showing no quantity response to price, is the perfectly inelastic case.

Answer: A. Spreading advertising and promotion costs over a large output lowers the cost per unit and is a marketing economy of scale — one of the internal economies a firm gains as it grows. A diseconomy of scale would raise unit costs, a negative externality is a cost imposed on third parties, and a price ceiling is a government control. The fall in unit marketing cost with size is the economy being described.

Answer: B. Consumer surplus is the benefit consumers gain when they pay less than the maximum they would have been willing to pay — the gap between willingness to pay and the actual price. A firm's total revenue and per-unit profit relate to the seller, not the buyer's surplus, and a tax is a separate charge. Consumer surplus measures the value buyers receive over and above what they hand over.

Answer: C. PED = percentage change in quantity ÷ percentage change in price. Quantity change = (50 − 40) ÷ 40 = +25%. Price change = (£20 − £25) ÷ £25 = −20%. PED = 25% ÷ 20% = 1.25. As this exceeds 1, demand is price-elastic over this range. The value 0.80 inverts the ratio. The quantity response being larger than the price change in proportionate terms is what makes demand elastic here. 0.25 is the 25% change in quantity on its own, without dividing by the change in price.

Answer: A. Where a monopoly harms consumers, governments can intervene by regulating prices, investigating the firm through a competition authority, or acting to promote competition. Granting further protection from competitors, encouraging higher prices, or removing consumer protection would all worsen the problem rather than address it. Curbing the abuse of monopoly power through regulation or competition policy is the standard remedy.

Answer: B. Agency costs arise from the need to align the interests of managers (agents) with those of owners (principals); the cost of monitoring directors — through audit, performance measurement and incentive schemes — is a clear example. Dividends are a return to shareholders, corporation tax is a charge by the state, and loan interest is a financing cost; none arises from the principal-agent relationship. Monitoring and incentive costs are the classic agency costs.