Explain how the price mechanism reallocates resources when there is a decrease in the supply of a good.

Evaluate the view that the threat to sustainability, caused by economic activity requiring the use of fossil fuels, is best addressed through the use of carbon taxes.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of price mechanism, resources, supply 
• diagram to show how a decrease in supply leads to a reallocation of resources 
• explanation of how a decrease in supply shifts the supply curve left, creates excess demand at the original price, incentivizes producers to increase price, provides signals and incentives to consumers to change their consumption patterns, switches demand to less expensive goods and causes a reallocation of resources
• examples of goods where a decrease in supply has affected the allocation of resources.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of sustainability, carbon taxes
• diagram to illustrate the use of carbon taxes, showing a shift of the supply curve to the left, reflecting the value of the negative externality (or any other relevant diagram)
• explanation that the use of fossil fuels generates negative externalities in production and/or consumption and therefore poses a threat to sustainability, and that this can be addressed through carbon taxes, which make the polluter pay
• examples of the use of carbon taxes and fossil fuels
• synthesis or evaluation.

Evaluation may include: possible advantages and disadvantages of the use of carbon taxes, consideration of other available policy options such as cap and trade schemes and funding for clean technologies, assessment of “best”.

A maximum of [12] should be awarded if there is not at least some reference to other policies.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Generally, this question was not answered well by a majority of the candidates. While many candidates were able to explain the mechanics of a decrease in supply in terms of the leftward shift of the supply curve, the subsequent increase in price and decrease in quantity demanded, few were able to extend this analysis further by relating it to the signalling and incentive functions of price and the impact on resource reallocation. In addition, definitions of supply, price mechanism and resources were often absent and good developed examples were rarely provided. 

Again, good definitions were often lacking and the terms "sustainability" and "carbon tax" were not usually defined well by the candidates, if at all. On the plus side, candidates often demonstrated an understanding that taxes reduce supply and thus the quantity of fossil fuels produced but were often unable to explain the emission of carbon as a negative externality. If the term negative externality was mentioned at all, it was often not diagrammed well. The best responses were also able to discuss alternative policies to carbon taxes and to reach a considered judgment about "best".