3.6.1 Government Intervention — Practice Questions

Nine original multiple-choice questions on how governments intervene in markets, written to the style and difficulty of Edexcel Paper 1 Section A.

9 questions Edexcel A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 3.6.1 Government Intervention revision notes.

1. 1. A water regulator caps prices under an RPI-X rule, with X set at 2 percentage points. In a year when RPI inflation is 5%, the largest price rise the company may make is

   Calculation

   Select one answer

   A 2%

   B 3%

   C 5%

   D 7%
   Show model answer

   Answer: B (3%). The RPI-X rule lets a regulated monopoly raise its prices by RPI minus X, where RPI is the rate of inflation and X is an efficiency factor the regulator sets.
   Permitted rise = 5% − 2% = 3%.
   The point of X is that prices must fall in real terms each year, so the firm has to find efficiency savings simply to hold its margin. If it beats X it keeps the difference until the cap is next reset, and that is what gives it a reason to cut costs rather than let them drift.

   Why the other options are wrong

   • A — 2% is the efficiency factor X itself — the amount by which the permitted rise falls short of inflation, not the rise.
   • C — 5% is RPI on its own, which is what the firm could charge if there were no efficiency factor at all.
   • D — 7% adds X to RPI instead of subtracting it. That would let prices rise faster than inflation and remove the pressure to become more efficient.

2. 2. A regulator caps a monopoly's profit at a fixed percentage of its revenue, intending to force prices down. Instead the firm's costs rise and its prices stay where they were. The most likely explanation is that the cap

   Applied reasoning

   Select one answer

   A Increased the firm's incentive to innovate.

   B Made the firm's demand curve more elastic.

   C Removed any reason to control its costs.

   D Removed the firm's legal barriers to entry.
   Show model answer

   Answer: C (Removed any reason to control its costs.). A profit cap defined against revenue can be met two ways. The firm can cut its price, which is what the regulator wants — or it can let its costs rise until profit falls to the permitted level, which costs the firm nothing it could have kept anyway. Edexcel gives exactly this as the evaluation of profit regulation: rather than lowering prices, firms may allow costs to inflate in order to reduce their margins, so consumers see no benefit at all. It is the mirror image of RPI-X, which rewards cost-cutting instead of penalising it.

   Why the other options are wrong

   • A — A profit cap weakens the incentive to innovate, since the returns from doing so cannot be kept.
   • B — The elasticity of demand depends on the substitutes available to buyers, which regulating profit does not change.
   • D — Nothing about a profit cap removes barriers to entry. That would be deregulation, which is a different tool with a different purpose.

3. 3. A rail regulator sets a demanding punctuality target backed by large fines. The operator meets it, but by cutting services on lightly used routes. This illustrates that quality standards can

   Applied reasoning

   Select one answer

   A Be met in ways that harm some consumers.

   B Guarantee lower prices for every passenger.

   C Never be enforced against a private firm.

   D Remove the operator's monopoly power entirely.
   Show model answer

   Answer: A (Be met in ways that harm some consumers.). Performance targets work by making one measurable outcome expensive to miss, and firms optimise against exactly what is measured. Withdrawing the services most likely to run late raises the punctuality percentage without improving anything for passengers — and takes the service away from those who depended on it. Edexcel gives precisely this as the evaluation of quality standards: unintended consequences, with the burden often falling on the very consumers the standard was meant to protect.

   Why the other options are wrong

   • B — The standard concerns punctuality, not fares. Complying with it may well raise costs and so prices.
   • C — The fines in the stem are being enforced. That is why the operator responded at all.
   • D — Meeting a punctuality target changes nothing about the operator's position in the market or its franchise.

4. 4. A council that has always run its own refuse collection invites private firms to bid against each other for a five-year contract to do it instead. This is

   Definition in context

   Select one answer

   A Competitive tendering.

   B Deregulation.

   C Nationalisation.

   D Regulatory capture.
   Show model answer

   Answer: A (Competitive tendering.). Competitive tendering puts a publicly funded service out to open bidding, so firms compete for the right to provide it. The competition happens for the market rather than in it — there is still only one refuse collector at any time, but the prospect of losing the contract at the next round disciplines both price and quality. Edexcel lists it among the ways governments promote competition and contestability.

   Why the other options are wrong

   • B — Deregulation means removing legal barriers and restrictions from a market. No rule is being removed here.
   • C — Nationalisation is the transfer of an enterprise into state ownership. This runs the other way, and the council keeps responsibility for the service either way.
   • D — Regulatory capture is a regulator coming to serve the firms it oversees. There is no regulator in the stem.

5. 5. A government is concerned that dominant supermarkets are forcing dairy farmers to accept prices below their costs. Of the following, the intervention aimed most directly at that problem is

   Applied reasoning

   Select one answer

   A A maximum price for milk in the shops.

   B Deregulating entry into food retailing.

   C Removing the tariff on imported dairy.

   D Setting a legal floor under milk prices.
   Show model answer

   Answer: D (Setting a legal floor under milk prices.). The problem here is monopsony power — a dominant buyer pushing the price it pays below what its suppliers need to survive. A price floor addresses that directly, by making it unlawful to pay less than a stated amount. Edexcel lists minimum prices first among the ways of protecting suppliers, alongside supporting cooperatives and using merger control to stop buying power concentrating further.

   Why the other options are wrong

   • A — A maximum price protects buyers from high prices. Applied here it would squeeze the farmers harder still, since supermarkets would pass the pressure back down the chain.
   • B — Easier entry into retailing might eventually dilute the supermarkets' buyer power, but it is indirect and slow, and new entrants would start small.
   • C — Cheaper imports add to the supply competing with domestic farmers, pushing the price they receive down rather than up.

6. 6. Two hundred small growers form a single organisation that negotiates on behalf of all of them with the supermarket chains. The economic effect of doing so is to

   Applied reasoning

   Select one answer

   A Convert the growers into a monopsony.

   B Counter the buyers' power with seller power.

   C Remove the need for any competition policy.

   D Turn the growers into price takers.
   Show model answer

   Answer: B (Counter the buyers' power with seller power.). Individually each grower is a tiny seller facing a handful of enormous buyers, with no realistic choice but to accept what is offered. Acting together they become a single large seller, and a supermarket must now deal with all of them or none of them. Edexcel lists supporting cooperatives among the ways governments protect suppliers from monopsony power: it works by aggregating supply so that bargaining strength on the two sides is more evenly matched.

   Why the other options are wrong

   • A — A monopsony is a dominant buyer. The growers sell, so combining moves them towards being a monopolist instead.
   • C — Competition authorities take a close interest in arrangements like this, and permit them precisely because they offset existing buyer power rather than creating a new problem.
   • D — Price takers must accept whatever price is offered — which is exactly what the growers were before they combined.

7. 7. A government offers start-up grants, tax relief in the first two years of trading, and free business advice to new firms. In terms of market structure, the aim is to

   Applied reasoning

   Select one answer

   A Protect established firms from competition.

   B Raise the concentration ratio in each market.

   C Reduce the number of firms in each market.

   D Widen the threat of entry into each market.
   Show model answer

   Answer: D (Widen the threat of entry into each market.). All three measures reduce what it costs to begin trading, which lowers barriers to entry and makes markets more contestable. Edexcel's point is that this disciplines the firms already there even before anybody actually enters: incumbents cannot exploit their position if visible supernormal profit will bring newcomers in. It sits alongside deregulation, competitive tendering and privatisation among the measures aimed at promoting competition.

   Why the other options are wrong

   • A — The measures are aimed at newcomers, not incumbents — and easier entry is precisely what established firms would rather avoid.
   • B — More firms entering lowers concentration rather than raising it.
   • C — The whole purpose is to raise the number of firms, or at least the credible threat of more of them.

8. 8. Two state industries are privatised in the same year. One faces many competitors within twelve months; the other remains the only supplier in its market. Consumers are most likely to gain from

   Applied reasoning

   Select one answer

   A Both equally, since the profit motive applies to each.

   B Neither, since privatisation always raises prices.

   C The first, since competition disciplines the new owner.

   D The second, since one firm captures economies of scale.
   Show model answer

   Answer: C (The first, since competition disciplines the new owner.). The argument for privatisation is that shareholders want profit, and profit requires costs to be cut and customers to be kept. The second half of that only bites where customers have somewhere else to go. Edexcel makes the level of competition and contestability the deciding factor: a privatised parcel service faces rivals, and consumers gain lower prices and better service; a privatised water company faces none, and consumers can face higher prices and lower quality instead. Privatisation transfers ownership — it does not by itself create competition.

   Why the other options are wrong

   • A — The profit motive does apply to both, and that is the difficulty with the second. Where there is no competition, profit is most easily raised by charging more.
   • B — Privatisation into a competitive market has often lowered prices. The claim is too strong to be the best answer.
   • D — Economies of scale are a genuine argument for a single supplier, but they do not ensure the saving reaches consumers rather than shareholders.

9. 9. Table 1 describes four interventions in one industry.
   From Table 1, the one aimed at protecting suppliers rather than consumers is

   Data interpretation

   Table 1: Four interventions in one industry

   	Intervention
   Intervention 1	A cap limiting price rises to inflation minus 2%
   Intervention 2	A grant scheme for firms starting up in the market
   Intervention 3	A minimum price paid to the industry's suppliers
   Intervention 4	A minimum standard for service response times

   Select one answer

   A Intervention 1.

   B Intervention 2.

   C Intervention 3.

   D Intervention 4.
   Show model answer

   Answer: C (Intervention 3.). Three of the four work on what buyers of the industry's output receive — the price they pay, the choice available to them, and the standard of service they get. Only the minimum price paid to suppliers operates on the other side of the industry, protecting the firms selling into it from a dominant buyer's power. Edexcel separates the two purposes explicitly: controlling monopoly power and promoting competition on one hand, protecting suppliers and employees on the other.

   Why the other options are wrong

   • A — An RPI-X cap limits what consumers can be charged, so it is aimed at them.
   • B — Start-up grants lower barriers to entry, which raises contestability and reaches consumers through more competition.
   • D — A minimum service standard is a quality guarantee for customers.