4.1.8.2 The meaning of market failure Quiz: AQA Economics, Unit 1

The 20 questions

1. Market failure occurs whenever a market:

   • Sets a price that is equal to marginal cost, so that every firm earns only normal profit in the long run.
   • Produces the same quantity of output as the government would have chosen for the same good in the economy.
   • Contains more than ten firms, so that competition is too strong for producers to earn any profit at all.
   • Leads to a misallocation of resources, so that the outcome is not the one that maximises social welfare.

2. What is a complete market failure?

   • A situation where a market is perfectly competitive, so that every firm earns exactly normal profit in the long run.
   • A situation where a market does not exist at all, so a good that society values is not provided by the market.
   • A situation where the government sets the price of a good, so that consumers pay less than the market equilibrium.
   • A situation where a market exists but contributes to a misallocation of resources in some respect while still operating.

3. What is partial market failure?

   • A situation where a market exists but still contributes to a misallocation of resources, such as through externalities.
   • A situation where the market price is exactly equal to the social optimum, so that no resource is misallocated at all.
   • A situation where the government fully replaces the market with direct provision of the good in every area of the economy.
   • A situation where a market does not exist, so that the good concerned is never supplied to any household at any price.

4. Which of the following can lead to market failure?

   • Perfect competition with many firms, each selling an identical product at the market price set by supply and demand.
   • Monopoly power, where a single firm can restrict output and raise prices above the level that would prevail in competition.
   • Complete mobility of factors of production, so that labour and capital can move freely between industries in the economy.
   • Full information for every buyer and seller, so that all transactions are made on the basis of accurate knowledge at the time in question.

5. Which market outcome would indicate a misallocation of resources?

   • Output of a good with positive externalities is equal to the socially efficient level of production in the market.
   • Output of a good is equal to the level where marginal social benefit equals marginal social cost in the market over the period concerned.
   • Output of a good with negative externalities is higher than the socially efficient level, because private costs are below social costs.
   • Price is equal to marginal cost in a competitive market where all firms earn only normal profit in the long run.

6. Which factor contributes to market failure through imperfect information?

   • Asymmetric information, where one party knows more than the other, so that buyers or sellers make decisions on a poor basis.
   • Symmetric information, where both buyers and sellers have full knowledge, so that every transaction is fully informed.
   • Free entry into a market, so that new firms can enter and compete with existing firms on price and quality.
   • A stable exchange rate, which keeps the prices of imported goods constant over the course of each year under the conditions described.

7. Which statement best explains why inequality can lead to market failure?

   • Inequality ensures that all households buy the same quantity of each good, so that demand is perfectly matched to supply.
   • Inequality increases the number of competing firms in each market, so that prices always fall to the level of marginal cost.
   • Some households cannot pay for goods or services they need, so markets fail to supply them and resources are misallocated.
   • Inequality removes all externalities from production, because wealthy households pay for the full social cost of their consumption.

8. Why is immobility of factors of production a source of market failure?

   • It causes all wages to be equal across regions, so workers have no reason to move between areas in search of work in the case described.
   • It ensures that every factor is always employed in its best use, so resources are never misallocated in the economy.
   • It prevents resources moving to where they are most productive, so unemployment or shortages can persist in some markets.
   • It lowers the price of all factors of production, so firms have no incentive to hire additional workers in any sector.

9. Which is an example of a market failure caused by a missing market?

   • A lower price for mobile phones, which results from increased competition between firms in a fully functioning market.
   • A lack of private provision of national defence, because the good cannot be sold to individual households in the usual way.
   • A rise in the price of petrol, which results from an increase in demand for transport in a competitive market over the period concerned.
   • A fall in the number of cinemas in a town, which results from a decline in local demand for leisure activities.

10. Which evaluation point suggests that not every apparent market failure requires government intervention?

    • Market failure always corrects itself over time, so government intervention is never required in any market at all.
    • Government intervention can itself misallocate resources, so the costs of intervention must be weighed against the benefits.
    • Market failure occurs only in monopolies, so intervention is required only in those markets and nowhere else in the economy.
    • Government intervention always produces a more efficient outcome than the market, so intervention should always be used.

11. Which is the best description of a deadweight welfare loss?

    • The consumer surplus gained by households when the government sets a maximum price below the market equilibrium in the case described.
    • The value of trades that would have benefited both buyers and sellers but do not take place because of the market failure.
    • The total revenue earned by firms in a market that charges a price equal to marginal cost to every customer served.
    • The fall in profit that every firm experiences when the market price rises above its average total cost of production.

12. Which best describes the link between monopoly power and market failure?

    • A monopolist may restrict output and charge a higher price than under competition, which leads to a welfare loss for society.
    • A monopolist removes all barriers to entry, so new firms enter until the market reaches a perfectly competitive outcome.
    • A monopolist always produces the socially optimal output, because it has the power to set the level of output for all firms.
    • A monopolist cannot affect price or output, because it has no competitors and therefore no influence on market conditions.

13. Which of these is an example of a merit good that could be under-consumed without intervention?

    • Education for young people, because some of its benefits are not fully recognised by individuals making consumption decisions.
    • A ticket to a sports match, because it is always provided in full by the private market without any market failure.
    • A fashion item bought for personal enjoyment, because its benefits are fully recognised by the buyer at the point of sale.
    • A luxury car, because its consumption is always too low to affect the wider economy in any meaningful way during the period under review.

14. Which statement about market failure and government failure is correct?

    • Market failure and government failure are the same problem, because both always result from excessive regulation of firms.
    • Government failure occurs only when the market fails, so the two cannot exist separately in the same economy at any time.
    • Market failure is a reason for intervention, but intervention may create government failure if it misallocates resources.
    • Market failure can only be corrected by the market itself, so government intervention is never a valid response in any case.

15. A firm with a large share of a market raises its price and earns abnormal profit that is not competed away. Which failure is this?

    • Market failure from monopoly power, which allows the firm to restrict output and keep prices above competitive levels.
    • Government failure from conflicting objectives, because the government has set the firm's price at too high a level.
    • No failure, because abnormal profit is always a sign of an efficient outcome in every competitive market in the economy.
    • Market failure from public goods, because the firm is providing a good that every household can enjoy without paying for it.

16. Which of the following is a valid reason why a market may fail to provide information that buyers need?

    • Markets always supply information at the socially optimal level, so the question of information failure never arises at all.
    • Buyers always know more about the quality of goods than sellers, so no information gap exists in any market transaction.
    • Sellers know more about the quality of the good than buyers do, so buyers cannot judge quality properly before purchase.
    • Information is freely available to everyone at no cost, so no buyer or seller ever faces any uncertainty about a purchase.

17. Which of the following is a likely consequence of an external cost of production that is not included in the market price?

    • Overproduction of the good, because the price does not reflect the full social cost of making it.
    • A fall in the external cost, because the producer always chooses methods that reduce pollution without any intervention.
    • Underproduction of the good, because the price is too high for consumers to buy it in the market at all.
    • Efficient production of the good, because the firm internalises all of the costs of its production process automatically.

18. Which evaluation best explains why the same market can be efficient for one group and inefficient for another?

    • Efficiency is a fixed property of each market, so it cannot be affected by the distribution of costs and benefits among groups.
    • Efficiency is measured against social welfare, so a market outcome can benefit some groups while imposing costs on others.
    • Efficiency depends only on the price of the good, so a market is either efficient for everyone or inefficient for everyone.
    • Efficiency is determined by the number of firms in a market, so the same outcome is always judged the same for all groups.

19. Which is the best example of a market failure caused by external benefits?

    • Fashion clothing, because buyers gain status that is fully reflected in the price they pay at the point of sale.
    • Vaccination, because people who are immunised also protect others who do not pay for the vaccine.
    • Alcohol, because its consumers pay all of the social costs they create, through the prices charged in shops and bars.
    • Petrol for cars, because drivers bear all of the costs of their journeys, including the congestion they create on roads.

20. A firm's private cost is £5 per unit and its social cost is £8 per unit. Which statement is correct?

    • The market price reflects the social cost of £8 per unit, so output is already at the efficient level for society as a whole.
    • The external cost of £3 per unit is paid by the firm itself, so the market already internalises the full social cost of output.
    • The market price is set too high relative to social cost, so output is below the socially efficient level of production.
    • The market price is set too low relative to social cost, so output is higher than the socially efficient level of production.

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