Market Failure

Worksheet Marking Scheme

Multiple Choice Questions (MCQs)

Question Answer Explanation
1. D Concept.
Net social benefit implies MSB – MSC. The benefit to
society or social welfare includes consumer and
producer welfare. Therefore, at output OQ, this is
2. B
captured by area X. The negative externality is
captured by area Y and the net benefit to society is
area X – area Y. B is the answer.
3. A Concept.
Rules and laws are included the in regulations form
4. D
of government intervention.
5. – –
Reduction of externalities is not a form or reason of
government failure it would man that government
6. B
failure is effective as the cost to society is less than
before an intervention was made.
An example of a moral hazard is when because of
one party’s desire to engage in more risky behaviour
7. A there is a cost to society through the misallocation of
resources or inefficient allocation of resources. This
is possible due to imperfect information.
8. C Concept.
When both parties have to share a loss that is
incurred, less risky behaviour or actions will be
9. B
made. A more efficient allocation of resources can
be achieved as a result.
Due to the firm wishing to have a smoother and more
efficient production process, there is a benefit to the
10. C
society through the construction of the local road
that all residents in the town are able to use.
11. – –
12. – –
Students should remember that maximum price is
13. C
placed below the equilibrium price.
14. D Concept.
Net social benefit implies MSB – MSC. The benefit to
society or social welfare includes consumer and
producer welfare. Therefore, at output OQ, this is
15. B
captured by area X. The negative externality is
captured by area Y and the net benefit to society is
area X – area Y. B is the answer.
16. A Concept.
Rules and laws are included the in regulations form
17. D
of government intervention.
18. – –
Since the firm is the largest in the industry, it would
have considerable market power – therefore, the
market is imperfect.

Vaccines have a positive consumption externality as

19. B when they are consumed they benefit the individual
by protecting them from contracting the illness and
also benefit society as other individuals have a lower
risk of contracting an illness.

B is the answer.
20. – –
21. – –
Subsidising public transport will make it cheaper and
increase the quantity demanded of the good. Since
22. D
public transport is a substitute of car travel, there will
be a fall in the demand for cars.
The market equilibrium is at point X or where MPC =
23. B MSC.
 Since there is a negative production externality, the
MPC + (negative externality) = MSC. The social cost
curve will be to the left of the private cost curve.

As there is a positive consumption externality, MPB +

(positive externality) = MSB. The social benefit curve
will be to the right of the private benefit curve.

B is the answer.
The provision of information will result in the
reduction of demand. Information will be a mindful
24. C
nudge for consumers as they realise the negative
impacts that air travel has on the environment.
Students should note that the question has asked for
the marginal external cost or the size of the social
external cost and not the net cost to society.
25. A
Therefore, students have to consider the cost to
society given the level of production in society at
MPC=MPB. The marginal social cost to society or
marginal external cost at MPC=MPS is EG.
If benefit>costs, societies welfare will increase.
26. D
Therefore, D is the answer.
27. – –
28. – –
Only option that shows the correct mix of cost to
29. B society (external cost) and benefit to society
(external benefit).
The socially efficient output level is where MSC=MSB
at Q2. What is currently being produced is at where
30. C
MPC=MPB. Therefore, Q2 to Q3 is the overproduction
of the good. C is the answer.
Government failure is in terms of the harm to the
31. B environment caused by the encouraging of
production of the fruits and vegetables.
32. C Concept.
 The situation is such that the free market will most
definitely provide the good to be able to reap the
33. B
profits that can result from that as the cost of
producing is also low.
34. – –
Selling the permits results in gaining the amount at
which the permit is sold (firms cannot producer more
as they need the permit to producer more and earn
more profit).

Buyers of the permit will lose the amount by which

the permit is bought for (they can produce more as a
35. B
result of having the permit. Since the question
mentions that other revenues stay the same – we will
assume that the firm is only losing money by buying
the permit.

Therefore, the profit of sellers increases, and profit of

buyers decreases. B is the answer.
36. D This is an example of a mindless nudge.
Concept. The individuals living around the area are
37. D
not a part of the decision-making process.
Habit-forming or addictive goods tend to have a price
inelastic demand. Therefore, despite the government
38. C
interventions the quantity demanded can remain
high.
All other options for this question are reasons why
the policy can success or about the policy. Since cars
39. D
are owned significantly, there can be very little
availability of permits for individuals willing to buy.
Indirect taxes are part of a separate category of
40. B government intervention different from the
application of nudge theory.
41. B Indirect taxes are a regressive form of taxation.
42. C Concept.
The situation is such that the free market will most
43. B
definitely provide the good to be able to reap the
 profits that can result from that as the cost of
producing is also low.
44. – –
Selling the permits results in gaining the amount at
which the permit is sold (firms cannot producer more
as they need the permit to producer more and earn
more profit).

Buyers of the permit will lose the amount by which

the permit is bought for (they can produce more as a
45. B
result of having the permit. Since the question
mentions that other revenues stay the same – we will
assume that the firm is only losing money by buying
the permit.

Therefore, the profit of sellers increases, and profit of

buyers decreases. B is the answer.
46. D This is an example of a mindless nudge.
47. D Concept.
Subsidies to a substitute of coal will reduce the price
48. D of the good and lead to a reduction in the demand for
coal towards the socially efficient outcome.
49. D An example of a mindless nudge.
50. – –
51. D Concept.
Increases in mergers and takeovers can result in
52. B monopoly behaviour to be more likely which is a form
of market failure.
53. – –
Consumption of sugary drinks harms health so it is a
negative consumption externality, and it is a demerit
good so it is consumed more than should be.
54. C
Therefore, the indirect taxes are tackling the problem
of negative consumption externality and the over-
consumption of demerit goods.
 Reduction of competition can result in inefficiency
55. D as the producers do not have incentive to lower costs
and maximise efficiency.
The minimum wage will make the labour more
expensive for the firms. If the demand for the labour
is elastic, then the quantity demanded will change by
56. B
a greater proportion than a change in price.
Therefore, B is the answer as less workers will be
hired as a result of the minimum wage.
57. C Concept.
58. – –
The more efficient use of energy means using less
energy. If the government restricts the amount by
which price can rise, the amount of energy being
consumed will not fall as only when prices rise will
59. A
quantity demanded fall.

Therefore, A is the answer as restrictions on price will

least likely result in the efficient use of energy.
Pollution is taking place by the consumer in this
60. C case. Therefore, there is a negative consumption
externality.
The residents likely enjoy the facilities that were
designed for Olympic athletes which can be a world-
61. D
class experience due to the high-profile nature of the
event.
62. C Concept.
Pollution is taking place by the consumer in this
63. C case. Therefore, there is a negative consumption
externality.
The residents likely enjoy the facilities that were
designed for Olympic athletes which can be a world-
64. D
class experience due to the high-profile nature of the
event.
65. C Concept.
66. C Concept.
67. – –
 This is an example of a mindful nudge. By knowing
68. D the negative effects of littering, consumers will
pollute less.
69. – –
70. – –
71. A Concept.
Net welfare includes the area of producer and
72. B consumer surplus. This is captured by area v and w
which would be lost if supply was restricted to OQ.
73. C Pollution is a cost to society.
74. – –
75. – –
76. B Concept.
77. D Concept.
78. B Concept.
The subsidy amount equal to VW will result in the
79. B supply curve (MPC) to shift to the right to the output
level of OQ2.
80. B Concept.
Regulation involves rules and laws. Option A is the
81. A
only option that satisfies this condition.
82. A Concept.
83. – –
All other options are ways that market failure can be
84. D
corrected.
85. B Concept.
86. C Concept.
When there is a larger external benefit than private
87. C benefit, there is a reduced incentive for individuals to
consume a good.
Non-price competition involves developing a
producer to be more distinct or attractive or
advertising by a firm.
88. D
However, in this case the charity is encouraging
donations by letting people who are donating the
positive impact of their act. D is the answer.
89. – –
90. A Concept.
91. – –
All other options are ways that market failure can be
92. D
corrected.
93. B Concept.