Microeconomics Prep – Externalities

Read:
Read and make notes on Year 1 textbook pages 98-103 AND 108-116

Think:

Please answer multiple choice in the pack and the written answer on lined paper

Q1.
Where there is partial market failure,
 
A a market exists but there is a misallocation of
resources.

B the product is both non-excludable and non-rival

in consumption.

C the market can only be competitive with

government support.

D there is excess demand in the market at the

current market price.
[1 mark]

Q2.
Which one of the following is a source of market failure?
 
A An increase in a firm’s profits resulting from
excess demand for its product

B Government intervention to correct a divergence

between private and social benefits

C Increasing diseconomies of scale as a firm

increases production

D Inequalities in the distribution of income and

wealth
[1 mark]
 Q3.
At current levels of output, the marginal social cost of making a good is greater than its
marginal private cost. Also, the marginal social benefit of the good is greater than its
marginal private benefit. As a result, there will probably be
 
A a misallocation of resources.

B positive externalities in production.

C negative externalities in consumption.

D diseconomies of scale in production.

[1 mark]

Q4.
The diagrams below show the marginal social cost and marginal private cost (MSC and
MPC) curves and marginal social benefit and marginal private benefit (MSB and MPB)
curves for different goods. Which diagram, A, B, C or D, is most likely to illustrate a
demerit good?

Answer _________________
[1 mark]
 Q5. The diagram below shows the marginal private benefit (MPB) and marginal social benefit
(MSB) curves and the marginal private cost (MPC) and marginal social cost (MSC) curves for a
merit good.

In the absence of government intervention in this market, a misallocation of resources is

likely to occur because
 
A the free market price is too low.

B there is over-production of the good, of HJ.

C the free market output is too high.

D there is under-consumption of the good, of HJ.

[1 mark]

Q6. The diagrams below show the marginal private benefit (MPB) and marginal social benefit
(MSB) curves and the marginal private cost (MPC) and marginal social cost (MSC) curves of the
consumption and production of a good.

Which one of the following diagrams, A, B, C or D, correctly shows negative externalities

in both the consumption and production of the good?

 
Answer _________________
 Q7.
The diagram below shows the marginal private benefit and marginal social benefit (MPB
and MSB) curves and the marginal private cost and marginal social cost (MPC and MSC)
curves for Good X.

From the diagram it can be inferred that Good X is a

 
A merit good.

B public good.

C demerit good.

D normal good.

[1 mark]

Q8.
Complete market failure always exists when
 
A there are negative externalities in production.

B the free market fails to provide sufficient merit

goods.

C the free market underprices demerit goods.

D there is a missing market in the provision of

public goods.
[1 mark]
 Q9.
The government is considering four possible capital investment projects. It has the
resources to implement only one of these projects. The table below shows the estimated
value of the private and external costs and benefits that each project is expected to yield.
 
New New New
New roads
  hospitals railways housing
(£ million)
(£ million) (£ million) (£ million)

Private benefits 600 500 1000 150

Private costs 450 500 2000            70

Positive
200 250 1000            40
externalities

Negative
           90            80 200 120
externalities

Which one of the projects should the government adopt if it wishes to maximise the
economic welfare of the whole community?
 
A New railways

B New hospitals

C New housing

D New roads

[1 mark]
 Q10.
The diagram below illustrates the market demand (D) and supply (S) curves for a good.
The production of the good creates a negative externality.

To reduce production and consumption of the good to OQ2, the government could impose
a
 
A price ceiling of OP3.

B tax of P2P3.

C minimum price of OP2.

D tax of P2P1.

[1 mark]

Q11.
Market failure arises whenever firms
 
A make a loss.

B replace machines with workers.

C create externalities.

D reduce expenditure on research and

development.
[1 mark]
 Q12.
‘The Scottish Government also intends to advertise widely the health consequences of
drinking’ (Markets for Alcoholic Drinks in Scotland Extract F, lines 10−11).

With the help of an appropriate diagram, explain why, if left to the market, too much
alcohol is consumed.
[10 marks]

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