IB

ECONOMICS
Question Bank

Market Failure

Book Number: 6053

Name:……………………………….

School:………………………………

Date:………………………………...
 QUESTIONS

1. To what extent is advertising the most effective way of increasing the consumption of merit goods? [15]

2. Discuss the consequences of the direct provision of public goods by the government. [15]

3. Evaluate the view that the market failure caused by the consumption of demerit goods is best dealt with
through the use of taxation. [15]

4. Discuss two possible government responses to threats to sustainability. [15]

5. Explain how the overuse of common access resources can lead to negative externalities. [10]

6. Discuss the view that the best way to reduce the threat to sustainability, arising from the burning of fossil
fuels, is for the government to provide subsidies to firms that produce energy through renewable sources.
[15]

7. Market failure can occur when there is asymmetric information, abuse of monopoly power and positive
externalities. Explain why any two of these represent market failure. [10]- HL

8. Evaluate the view that regulations are the most effective government response to the market failure of
negative externalities. [15]

9. Explain how direct provision of a public good by the state (government) can correct the problem of market
failure. [10]

10. a) Analyse the private and external benefits associated with the consumption of university education. [10]

b) Evaluate the policies a government might use to increase the consumption of university education. [15]

11. Carefully distinguish between merit goods, demerit goods and public goods. [10]

12. Explain how the use of expenditure/indirect taxation might be an appropriate response to the problem of
negative externalities. [10]

13. Use a diagram to explain why the under provision of merit goods is considered to be an example of market
failure. [10]

14. Why is pollution an example of market failure? Use a diagram to illustrate you answer. [10]
 MARKSCHEME

1. Answers may include:

 definition of merit good
 diagram showing positive externalities to illustrate how advertising can be used to deal with the market
failure associated with merit goods
 explanation of the positive externalities associated with merit goods and how advertising can increase the
demand and consumption of merit goods
 examples of the advertising of merit goods to increase consumption
 synthesis or evaluation (to what extent).

Evaluation may include: the cost of advertising, the effectiveness of advertising and reference to alternative
ways to increase the consumption of merit goods.

2. Answers may include:

 definition of public goods
 PPF diagram to show the trade-off between public good and private goods. Candidates should not be
expected to use a diagram for this part of the question
 explanation of the relationship between the characteristics of public goods, the free rider problem and
market failure
 examples of public goods and/or consequences of their direct provision
 synthesis or evaluation (discuss).

Discussion may include: the extent to which public goods exist, the opportunity cost of providing public
goods, the extent to which the government understands what is best in terms of allocating resources and moral
hazard.

3. Answers may include:

 definitions of demerit goods, market failure and indirect taxation
 diagram(s) to show market failure and use of indirect taxation
 explanations of the market failure caused by the consumption of demerit goods (negative consumption
externalities); taxation policy to reduce consumption of demerit goods; other market-based policies, i.e.
tradable permits and non market-based policies, e.g. regulation and negative advertising
 examples of demerit goods and examples of where such responses have occurred, or might occur
 synthesis or evaluation.
 Evaluation may include: consideration of the positive and negative consequences of the policies used.

4. Answers may include:

 definition of sustainability
 an explanation of two possible policies such as legislation, carbon taxes, cap and trade schemes and
funding for clean technology. A consideration of the limitations / strengths of government responses
generally
 diagrams to show the application of the policies selected
 examples of the application of policies
 synthesis or evaluation (discuss).

Discussion may include: consideration of the advantages and disadvantages of the selected policies, impacts
on stakeholders, short-term and long-term consequences.

5. Answers may include:

 definitions of common access resources and negative externalities
 diagram to show negative externalities arising from overconsumption (depletion of common access
resources) or production (environmental degradation as a by-product of production activities)
 explanation that overuse of common access resources can lead to environmental damage or resource
depletion, which are forms of market failure, leading to negative externalities of production or
consumption
 examples of how overuse of common access resources leads to negative externalities such as over-fishing,
open-cast mining and deforestation.

6. Answers may include:

 definition of subsidies and sustainability
 diagram(s) to show the impact of subsidies on the market for renewable energy and the market for fossil
fuels
 explanation that subsidies reduce the costs of production for renewable energy firms and the price of
renewable energy to consumers, which reduces the demand for energy produced by burning fossil fuels.
This creates greater sustainability in the energy market
 examples of subsidies on the market for renewable energy such as solar power and wind farms
 synthesis or evaluation (discuss).
 Discussion may include: alternative policies that could be used instead of subsidies, consideration of the impact
of subsidies on different stakeholder groups, negative effects on the fossil industry. It could also consider the
short-term costs of subsidies and the long-term benefits on sustainability.

7. Answers may include:

 definitions of market failure, asymmetric information, monopoly power, positive externalities (depending
on which two are chosen)
 diagrams to show MSC/MSB in relation to asymmetric information and positive externalities and a
monopoly diagram to illustrate abuse of monopoly power
 an explanation of the link between asymmetric information and market failure; and/or abuse of monopoly
power and market failure; and/or positive externalities and market failure
 examples of instances to which this might be, or has been applied.

8. Answers may include:

 definitions of regulations, market failure and negative externalities
 diagram to show the impact of regulations on negative externalities, e.g. MSC/MSB
 an explanation of the different types of regulations that might be applied and their potential impact on
negative externalities of production and consumption
 examples of the use of regulations in practice
 synthesis and evaluation.

Evaluation may include: consideration of the effectiveness of regulations in terms of such factors as their direct
impact, the difficulty of ensuring enforcement, the cost of policing, the range of regulations, including outright
bans, the potential benefits of market-based measures such as taxation and tradable permits unintended
consequences of regulation(s).

9. Candidates may include any of the following:

 definition of a public good: a god whose consumption by one person does not reduce the amount available
to be consumed by another person (non-rivalry) and once provided nobody can be excluded from its
consumption (non-excludability)
 explanation of market failure: the inability of an unregulated market to achieve allocative efficiency in all
circumstances (marginal benefit does not equal marginal cost)
 example of a public good e.g. national defence with explanation of why it is a public good
  the under-provision of public goods by private markets due to the free rider problem
 explanation of the free rider problem
 recognition that the size of free rider problems is such that private markets will provide such goods on a
scale smaller than required to achieve allocative efficiency.
 Government is likely to provide public goods on a much larger scale and get closer to allocative efficiency.

10. a) Answers may include:

 definitions of private benefits and external benefits
 diagram to show the private and external benefits associated with the consumption of university education
 an explanation of the private benefits of university education in terms of employment prospects, the
enjoyment of the experience and the development of wider life skills; explanation of the external benefits
of university education in terms of: improvements in the quality of the workforce, lower unemployment,
higher growth rates
 examples of the private and external benefits of university education.

b) Answers may include:

 definition of a merit good
 diagram(s) to show the impact of the policies the government might use to increase in the consumption of
university education
 an explanation of the policies a government might use to increase the consumption of university education
as a merit good: subsidies to universities, financial support for students, promotion of university education
 example(s) of the policies the government might use to increase the consumption of university education
 synthesis or evaluation.

Evaluation may be in terms of the policies’ costs and effectiveness

11. Answers may include:

 definition and explanation of all three types of goods by referring to the following features:
o merit: MSB>MPB, positive externalities, underproduction/underconsumption, example
o demerit: MSC>MPC, negative externalities, overproduction/overconsumption, example
o public: non-excludability, non-rivalry, free riders, example
 distinguish between merit and demerit goods on the one hand and public goods on the other.
 indicate that all three can lead to market failure
 reward the drawing of an MSC/MPC diagram or any other relevant one.
12. Candidates might usefully begin by explaining what is meant by negative externalities; and that indirect
taxation might be an appropriate response to market failure caused by the generation of negative externalities,
where the problem is one of overproduction/consumption at the free market price. Good candidates will use
the standard MSC/MSB diagram, or equivalent, to show how taxation can shift the MPC curve to the left to
raise price, reduce output and achieve optimum social benefits.

13. Responses should include:

 definitions of both merit goods and market failure
 reference to the existence of positive externalities (external benefits) and examples which illustrate
external benefits
 a correctly labelled diagram to illustrate positive externalities
 an explanation of the diagram which refers to the socially efficient level of output and which shows that
the free market level of output would predict under provision of the good/service and therefore be an
example of market failure (socially inefficient allocation of resources).

14. Responses should include:

 definitions of market failure, negative externality and pollution
 reference to MSB/MPC as shown in the diagram below
 negative externality leading to MSC>MPC
 overallocation of resources, such that the good is under-priced and oversupplied.