4.1.8.6 Market imperfections Quiz: AQA Economics, Unit 1

The 20 questions

1. Asymmetric information exists when:

   • Information about the market is available only after a transaction has been completed, so no party can plan in advance.
   • The government publishes all the information about a market, so no firm is able to hide any detail from consumers in the case described.
   • One party to a transaction has more or better information than the other party, so the two sides do not share the same knowledge.
   • Both buyers and sellers have exactly the same information about price, quality and availability of the good in the market.

2. Why can asymmetric information in the second-hand car market lead to market failure?

   • Sellers and buyers have identical information about each car, so the market always clears at a price that reflects its true quality.
   • Information is shared perfectly between buyers and sellers, so cars of poor quality are always priced below those of high quality.
   • Sellers know a car's quality better than buyers, so buyers may pay less than good cars are worth and good cars may leave the market.
   • Buyers know more about the quality of cars than sellers do, so sellers always set prices that exactly match each car's true condition.

3. Which is an example of moral hazard arising from asymmetric information?

   • A household reduces its consumption after paying the premium, because its disposable income has fallen during the year.
   • A person buys insurance only after learning they are a high-risk customer, so the insurer receives full information in advance.
   • An insured person takes fewer precautions against theft because the insurer bears the cost of any loss that occurs.
   • An insurer charges each customer the same premium regardless of risk, so high-risk customers have no reason to change behaviour.

4. How does monopoly power cause market failure?

   • A monopolist reduces its profit to zero, so consumers pay the same price as in a perfectly competitive market in every period.
   • A monopolist increases output beyond the competitive level, which lowers the price below marginal cost for all buyers in the market.
   • A monopolist restricts output and charges a higher price than in competition, reducing consumer surplus and creating deadweight loss.
   • A monopolist always produces the output at which price equals marginal cost, so no welfare loss arises in the market at all.

5. A monopolist sets a price of £14 where its marginal cost is £6. Which statement is correct?

   • Price is below marginal cost, so the monopolist makes a loss on each unit sold to the consumers in the market.
   • Price equals marginal cost, so the monopolist allocates resources efficiently in the same way as a competitive firm does.
   • Price exceeds marginal cost, so output is below the allocatively efficient level and welfare is lost to the market.
   • Price exceeds average cost but equals marginal revenue, so the monopolist produces the competitive level of output.

6. Why does immobility of labour cause market failure?

   • Workers cannot easily move between regions or occupations, so jobs go unfilled in some areas while unemployment persists elsewhere.
   • Immobile labour lowers the price of goods, so firms have no incentive to hire additional workers in any industry at all.
   • Workers move freely to wherever jobs are available, so regional unemployment is eliminated within a single year in the economy.
   • Immobile labour raises productivity in every industry, because workers remain in one job for their whole working career.

7. Which is an example of immobility of capital?

   • A manager who transfers between two plants owned by the same company, with no delay in starting the new job at the other site.
   • A factory building that cannot easily be converted to a different use when demand for its product falls in the market.
   • Shares that are sold on a stock exchange within seconds of the company announcing a change in its expected profit.
   • A firm that relocates its headquarters to a different country within a single month whenever tax rates change in that country.

8. Which is an example of a barrier to entry?

   • A large number of firms selling identical products at a price equal to marginal cost in the market over time.
   • High set-up costs or patents that prevent new firms from entering a market profitably and competing with existing producers.
   • Free access to a public database that any firm can use to develop a competing product at no cost to the firm in the case described.
   • Full information for all buyers and sellers about the price and quality of every product on sale in the market.

9. A patient cannot judge whether a surgeon's proposed treatment is necessary. What form of market imperfection is this?

   • Immobility of labour, because surgeons cannot easily move between hospitals in different regions of the country.
   • Under-provision of a public good, because the treatment benefits all patients in the population at no cost to them.
   • Asymmetric information, because the surgeon knows far more about the treatment than the patient does before deciding.
   • A barrier to entry, because only qualified surgeons are allowed to offer treatment in the market for medical services.

10. In a used-car market, buyers cannot tell good cars from poor ones, so they offer a low average price. What is the likely outcome?

    • Owners of poor-quality cars withdraw them, so the average quality of cars on sale rises above the market average.
    • Owners of good-quality cars withdraw them from the market, so the average quality of cars on sale falls further.
    • The average price rises to the full value of good cars, because buyers pay for the true value of each car in the market.
    • Owners of good-quality cars sell at the full value, because buyers accurately recognise quality at the point of sale.

11. Which change would most reduce a monopolist's market power?

    • Protecting the monopolist from future competition, so that it can set prices without any entry by rivals in the market.
    • Lowering barriers to entry so that new firms can compete and push price closer to marginal cost over time.
    • Raising the minimum price the monopolist can set, so consumers pay more in every period under regulation in the market.
    • Granting the monopolist a subsidy for each unit it sells, which lowers its costs and increases its profit margin on sales.

12. Which evaluation best challenges the view that monopolies are always inefficient?

    • Monopolies never invest in research, because they face no competitors and so have no incentive to innovate in any market.
    • Monopolies may achieve economies of scale and invest in research, so the efficiency effect depends on the balance of these factors.
    • Monopolies are always inefficient, since they produce at a level of output where average costs are at their highest in every case.
    • Monopolies cannot achieve economies of scale, because output is always restricted by the monopolist's pricing policy in every market.

13. Structural unemployment is most likely to result from:

    • Workers voluntarily leaving jobs to search for better opportunities while vacancies remain open in other sectors of the economy.
    • Seasonal changes in the demand for labour in tourism industries that reverse each year without any retraining being needed.
    • A fall in aggregate demand that reduces the number of job vacancies across all sectors of the economy at the same time.
    • A mismatch between the skills workers have and those demanded by employers, combined with difficulty in retraining for new work.

14. Why can asymmetric information in the labour market lead to market failure?

    • Workers always know the productivity of employers, so they can avoid firms that pay below their true value to the business.
    • Employers cannot easily judge the productivity of applicants before hiring, so wages may not reflect the true productivity of workers.
    • Employers always know the productivity of applicants, so wages always reflect marginal revenue product in every job in the case described.
    • Information is symmetric in the labour market, so there is no problem of hiring under-qualified workers in any sector.

15. A monopolist produces 40 units at a price of £20. A competitive market would produce 60 units at £12. Which statement is correct?

    • The monopolist restricts output and raises price, so consumers buy fewer units at a higher price than under competition.
    • The monopolist raises output and lowers price, so consumers benefit from greater output than under competition in this market.
    • The monopolist's output and price are identical to the competitive outcome, so monopoly power has no effect on welfare at all.
    • The monopolist produces more than the competitive output but charges the same price, so there is no welfare loss in this market.

16. Which evaluation suggests that barriers to entry are not always harmful?

    • Patents can encourage research and development, so barriers may be justified if they fund innovation that benefits society overall.
    • Barriers always raise welfare, since they keep prices high and so fund investment in every market in the economy.
    • Barriers always lower prices, because firms with no entry threat compete more fiercely on price in every market in the case described.
    • Barriers never affect innovation, because firms always invest in research regardless of how easy it is to enter the market.

17. What is adverse selection?

    • A situation in which a government selects which firms may enter a market, based on their past profit records and size.
    • A situation in which insurers reduce premiums after a period with no claims, so that the most cautious customers pay less overall.
    • A situation in which private information leads higher-risk customers to buy insurance more often than lower-risk customers.
    • A situation in which a worker chooses the lowest-paying job, because they value leisure more highly than the income from work.

18. A monopolist charges a price of £20 against a marginal cost of £8. What is the mark-up on marginal cost?

    • 66.7 per cent, since the marginal cost of £8 divided by the gap of £12 gives the mark-up on the price charged.
    • 50 per cent, since the gap of £12 is half of the price of £20 charged to consumers in the market for the good.
    • 12 per cent, since the gap of £12 divided by £100 gives the mark-up on the price charged to consumers in the market.
    • 150 per cent, since the price-cost gap of £12 divided by the marginal cost of £8 gives 1.5.

19. Which is the most likely consequence of immobility of factors in a region with declining industries?

    • Lower house prices for workers, because housing becomes cheaper and so workers move there from other regions of the country.
    • Persistent unemployment and lower incomes in that region, as workers cannot easily move to growing areas or retrain for new jobs.
    • Falling unemployment, because workers in declining industries are always absorbed by the rest of the economy quickly.
    • Rising wages in the region, because the shortage of workers always pushes up the wage rate in declining industries in the case described.

20. Which combination of market imperfections best explains persistent market failure in a privatised utility?

    • Complete information, where consumers and producers know the cost of every unit supplied in the market at all times.
    • Mobile factors, where workers and capital move freely to the most profitable sectors of the economy each year in the case described.
    • A natural monopoly with high barriers to entry, where the firm can set prices above marginal cost with limited competition.
    • Perfect competition, where many firms supply identical products at a price equal to marginal cost in the market.

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