1.3.4 Price Mechanism — Practice Questions

Seven original multiple-choice questions on the price mechanism: what prices signal, how firms respond to a change in demand, niche and mass markets, and market growth.

7 questions Edexcel B A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 1.3.4 Price Mechanism revision notes.

1. 1. A skip-hire firm sees that local skip-hire prices have risen by 30% in a year. Its owner concludes that local building work has picked up. In reaching that conclusion, the owner is using the price rise as

   Definition in context

   Select one answer

   A An incentive, as each hire now earns the firm more.

   B A rationing device, as fewer people can afford skips.

   C A signal, as it shows demand is outrunning supply.

   D A signal, as it shows supply is outrunning demand.
   Show model answer

   Answer: C (A signal, as it shows demand is outrunning supply.). The owner is reading information from the price: a rising price shows that demand is outrunning supply. That is the signalling function. The signal is the information; the incentive would be the reason to act on it.

   Why the other options are wrong

   • A — The higher price does make each hire more profitable, which is the incentive to supply more. But the owner is drawing a conclusion about the market, not deciding to act.
   • B — The price rise may ration skips, but that is about who gets one. The owner is using the price as information.
   • D — This reverses the signal. A falling price shows supply outrunning demand. A rising price shows the opposite.

2. 2. During a two-week heatwave, a garden centre's sales of paddling pools treble and its stock starts to run short. Forecasters expect normal weather to return next week. The garden centre's most sensible response is to

   Applied reasoning

   Select one answer

   A Build a second warehouse to hold more pools.

   B Hire extra permanent staff to sell more pools.

   C Raise the price of the pools it has left.

   D Sign a three-year deal to buy twice as many pools.
   Show model answer

   Answer: C (Raise the price of the pools it has left.). How a firm responds to a rise in demand depends on whether the rise will last. This one ends next week, so building capacity makes no sense. With stock running short, the firm can raise its price: the higher price rations the pools it has left and earns more profit on each sale.

   Why the other options are wrong

   • A — A new warehouse is an investment in capacity. No firm builds capacity for a one-off spike in demand.
   • B — Permanent staff would still be on the payroll long after the heatwave has ended.
   • D — This commits the firm to twice the stock for three years, on the strength of two weeks of hot weather.

3. 3. Table 1 describes four firms that all see a rise in demand for their products.
   Using Table 1, the firm most likely to respond mainly by raising its price is

   Data interpretation

   Table 1: Four firms facing a rise in demand

   	Capacity in use	What rivals are doing	How long the rise is expected to last
   Firm 1	60%	Holding their prices	Several years
   Firm 2	100%	Raising their prices	A few weeks
   Firm 3	70%	Holding their prices	A few weeks
   Firm 4	85%	Cutting their prices	Several years

   Select one answer

   A Firm 1.

   B Firm 2.

   C Firm 3.

   D Firm 4.
   Show model answer

   Answer: B (Firm 2.). Three things decide a firm's response: spare capacity, whether the rise will last, and what rivals do. Firm 2 has no spare capacity, so it cannot produce more quickly. The rise is short, so investing in new capacity is not worth it. And its rivals are raising prices too, so a price rise will not drive customers away. Raising its price is the obvious response.

   Why the other options are wrong

   • A — Firm 1 has plenty of spare capacity and expects the rise to last. It can produce more now and may invest, and rivals holding their prices make a price rise risky.
   • C — Firm 3 has spare capacity, so it can meet a short rise by producing more with what it has. Its rivals are holding their prices, which makes a price rise risky.
   • D — Firm 4's rivals are cutting their prices, so raising its own would lose customers. With the rise expected to last, it is more likely to expand.

4. 4. A market report for one region shows that spending on dog grooming was £2.4m in Year 1, £3.0m in Year 2 and £3.3m in Year 3. The market's growth between Year 2 and Year 3 was

   Calculation

   Select one answer

   A 10%

   B 12.5%

   C 25%

   D 37.5%
   Show model answer

   Answer: A (10%). Market growth (%) = change in market size ÷ original market size × 100.
   Change between Year 2 and Year 3: £3.3m − £3.0m = £0.3m.
   Growth: £0.3m ÷ £3.0m × 100 = 10%.
   The market is still growing, but more slowly than the year before.

   Why the other options are wrong

   • B — This divides the £0.3m change by the Year 1 figure, £2.4m. The original value for this period is Year 2's £3.0m.
   • C — This is the growth between Year 1 and Year 2: £0.6m ÷ £2.4m × 100.
   • D — This is the growth over both years together: £0.9m ÷ £2.4m × 100.

5. 5. A small firm makes hiking boots for people with very wide feet. It has few rivals and earns a high profit on each pair. If this niche grows quickly, the most likely result over time is that

   Applied reasoning

   Select one answer

   A Bigger firms are drawn in, and prices fall.

   B Bigger firms stay out, as the market is too small.

   C Prices rise, as the firm still faces few rivals.

   D Prices stay high, as customers will pay more.
   Show model answer

   Answer: A (Bigger firms are drawn in, and prices fall.). A niche market has few competitors and high profit on each unit. Those high profits are a signal and an incentive to other firms. As the niche grows it becomes worth entering, so bigger firms are drawn in, supply increases, and prices fall.

   Why the other options are wrong

   • B — Small size is what keeps big firms out of a niche. The stem says this one is growing quickly, which removes that barrier.
   • C — The firm has few rivals now, but high profits in a growing market attract new ones.
   • D — Customers in a niche will often pay more, but once new firms enter they have more choice, and competition pushes prices down.

6. 6. Table 1 gives figures for four firms.
   Using Table 1, the firm whose figures best fit a niche market is

   Data interpretation

   Table 1: Four firms' sales, profit and rivals

   	Units sold a year	Profit on each unit	Rivals
   Firm 1	4,000,000	£0.05	Many, including several large firms
   Firm 2	800	£0.40	Many
   Firm 3	600,000	£0.30	A few large firms
   Firm 4	2,500	£45.00	Two

   Select one answer

   A Firm 1.

   B Firm 2.

   C Firm 3.

   D Firm 4.
   Show model answer

   Answer: D (Firm 4.). A niche market is a small, specialised part of a larger market. It has few competitors, customers will pay more for something that suits them, so profit on each unit is high, and sales are small. Firm 4 fits all three: 2,500 units, £45 profit on each, and only two rivals.

   Why the other options are wrong

   • A — Huge sales, a tiny profit on each unit and many large rivals are the marks of a mass market, where firms rely on high volumes.
   • B — Firm 2's sales are small, but its profit per unit is low and it has many rivals. It looks like a small firm in a crowded market, not a niche.
   • C — Large sales, low profit per unit and large rivals point to a mass market, not a niche.

7. 7. A firm is deciding whether to start installing home electric-car chargers. The evidence that best suggests the market has room to grow is that

   Applied reasoning

   Select one answer

   A Existing installers are cutting prices to clear stock.

   B Installers' prices and profits are rising across the market.

   C Several installers have left the market this year.

   D Total sales are flat, so firms grow by winning rivals' customers.
   Show model answer

   Answer: B (Installers' prices and profits are rising across the market.). Rising prices and profits across a market are a signal that demand is outrunning supply. That is one of the clearest signs a market has room to grow, and the profits are also the incentive for a new firm to enter.

   Why the other options are wrong

   • A — Cutting prices to clear stock is a sign of excess supply: sellers have more than buyers want.
   • C — Firms leaving a market usually means profits are falling, the reverse of a growing market.
   • D — This describes a flat market, where a new firm could only grow by taking customers from rivals.