Market failure – externalities and common pool -Paper 1

IBDP Economics  SL – Microeconomics – Market failure – externalities and common pool -Paper 1  Exam Style Practice Questions

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Market failure – externalities and common pool -Paper 1

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Exam Style Question for Market failure - externalities and common pool -Paper 1

Question

Explain why the exploitation of common access resources, such as uncontrolled fishing, might pose a threat to sustainability.

▶️Answer/Explanation

Answers may include:

  • definitions of common access resources and sustainability
  • diagram to show the negative externality associated with common access resources and/or demand and supply diagram
  • explanation of why the exploitation of common access resources, such as uncontrolled fishing, might pose a threat to sustainability
  • examples of the over-exploitation of common access resources.

Question

Evaluate whether the use of carbon taxes is the most effective way for the government to deal with the threat to sustainability posed by the use of fossil fuels.

▶️Answer/Explanation

Answers may include:

  • definitions of carbon taxes, sustainability, negative externalities
  • diagrams to show the effect of carbon taxes on the market for fossil fuels and how market failure is eliminated
  • explanation of how carbon taxes will increase costs of production and increase the price of fossil fuels, leading to a decrease in their consumption
  • examples of government responses to the threat to sustainability arising from the use of fossil fuels
  • synthesis or evaluation.

Question

To what extent is advertising the most effective way of increasing the consumption of merit goods?

▶️Answer/Explanation

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).

Question

Explain why public transport, such as buses and trains, might be under-provided in a market economy.

▶️Answer/Explanation

Answers may include:

  • definition of under-provision, market economy
  • diagram to show a positive externality of consumption
  • explanation of how the use of public transport results in marginal social benefit exceeding marginal private benefit
  • examples of under-provision of public transport.

Question

Discuss the view that imposing an indirect tax on gasoline (petrol) is the most effective way of reducing the market failure caused by cars.

▶️Answer/Explanation

Answers may include:

  • definition of indirect tax, market failure
  • diagram to illustrate the imposition of an indirect tax
  • explanation of how taxation can be used to reduce the demand for gasoline/cars
  • examples of where a government has applied such taxes
  • synthesis or evaluation (discuss).

Question

Explain how production that causes pollution leads to market failure.

▶️Answer/Explanation

Answers may include:

  • definition of market failure, negative production externalities
  • diagram to show an over-allocation of resources where MSC is greater than MPC
  • explanation that pollution causes a negative externality of production and over-production
  • examples of where pollution leads to market failure.

Question

Discuss whether government regulation is the most effective way to deal with negative externalities of consumption.

▶️Answer/Explanation

Answers may include:

  • definition of government regulation, negative externalities of consumption
  • diagram to show how government regulation reduces the problem of negative consumption externalities
  • explanation that government regulation can reduce the demand for the product, shifting the MPB curve closer towards the MSB curve and the socially optimum output or decrease in supply if a government regulation leads to a fall in output
  • examples of where government regulations have been used to control negative externalities of consumption
  • synthesis or evaluation (discuss).

Question

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.

▶️Answer/Explanation

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.

Question

Explain the concept of positive externalities of consumption.

▶️Answer/Explanation

Answers may include:

  • definitions of externalities, positive externalities of consumption
  • diagram to illustrate positive externalities of consumption
  • explanation of positive externalities of consumption in terms of MSB being greater than MPB
  • examples of positive externalities of consumption in practice

Question

Discuss the view that tradable permits are more effective than taxes in reducing pollution.

▶️Answer/Explanation

Answers may include:

  • definitions of tradable permits, taxes
  • supply and demand diagram(s) to show the use of tradable permits, and/or supply shifting left due to taxes, to tackle pollution
  • explanation that both methods represent market-based policies, tradable permits working via set allowances to pollute with implications for profits for over- or under-shooting, and taxes working via the effect on supply, price and quantity
  • examples of the use of taxes and/or tradable permits in practice
  • synthesis or evaluation (discuss).

Question

Discuss the significance of income elasticity of demand for producers of primary products and producers of manufactured goods when incomes are rising.

▶️Answer/Explanation

Answers may include:

  • definitions of primary products, manufactured goods, income elasticity of demand
  • diagrams to show how the demand for primary products and for manufactured goods is affected by a rise in incomes
  • explanation of the impact on producers of how primary products tend to have a low YED because they are necessities (with few or no substitutes) for their buyers and demand for them changes less than proportionally when incomes change; explanation of the impact on producers of how manufactured goods tend to have a high YED because they can be luxury goods and demand for them increases more than proportionally when incomes increase
  • examples of primary products with a low YED and manufactured goods with a high YED
  • synthesis or evaluation (discuss).

Question

Discuss the view that competitive markets will always achieve allocative efficiency.

▶️Answer/Explanation

Answers may include:

  • definitions of allocative efficiency, competitive market
  • diagram to illustrate the principle of allocative efficiency, eg demand = supply, marginal benefit= marginal cost
  • explanation that allocative efficiency occurs where market equilibrium occurs, where social (community) surplus is maximized with respect to producer and consumer surplus; marginal benefit equals marginal cost
  • example(s) of competitive markets or markets where there is market failure
  • synthesis or evaluation (discuss).

Question

Examine the view that the best allocation of resources, from society’s point of view, occurs where the marginal private benefit equals the marginal private cost.

▶️Answer/Explanation

Answers may include:

  • definition of marginal private benefit (MPB), marginal private cost (MPC), allocation of resources
  • diagram to show marginal private benefit in equilibrium with marginal private cost and community surplus being maximized
  • explanation of why MPB = MPC (demand = supply) represents an optimal allocation of resources
  • examples of marginal private benefits and costs or externalities
  • synthesis and evaluation (examine).

Question

Explain two types of government intervention that could be used to correct the market failure arising from the consumption of demerit goods.

▶️Answer/Explanation

Answers may include:

  • Terminology: market failure, demerit goods.
  • Explanation: of any two types of government intervention such as indirect taxes, legislation and regulation, education/awareness creation/negative advertising.
  • Diagram could show market failure of demerit goods and/or demand and supply diagram showing the consequence of the policy explained.

Question

Using real-world examples, discuss whether the provision of subsidies is the best way to increase the consumption of merit goods.

▶️Answer/Explanation

Answers may include:

  • Terminology: merit good, subsidy.
  • Explanation: of the impact of subsidies in terms of lowering production costs, increasing supply, lowering price and increasing the quantity demanded.
  • Diagram: demand and supply diagram showing the impact of a subsidy, or use of an MSC/MSB diagram.
  • Synthesis (discuss): the strengths and weaknesses of the use of subsidies, the strengths and weaknesses of other measures such as, direct government provision, legislation and regulation, awareness creation through education/advertising, consideration of “best”.
  • Examples: use of real-world examples to show instances of the consumption merit goods being increased through the use of subsidies or through the use of other means.

Question

Explain why, in the case of healthcare and education, positive externalities might cause market failure.

▶️Answer/Explanation

Answers may include:

  • Terminology: positive externalities, market failure.
  • Explanation: of healthcare and education as merit goods which generate external benefits, as well as private benefits, and whose consumption is therefore likely to be less than the socially optimal level if left to the free market to provide; explanation of positive externalities in the case of healthcare, eg control the spread of contagious diseases and healthy workers being more productive; and an explanation of the positive externalities in the case of education, eg the positive relationship between education, productivity, employment, innovation and economic growth.
  • Diagram: positive externalities of consumption diagram showing MSB above MPB, MSB not equalling MSC and welfare loss.
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