1.3.1 Types of market failure Quiz: Pearson Edexcel Economics A, Unit 1

The 20 questions

1. What is market failure?

   • A situation where consumers buy less of a good because its price has risen in the market.
   • A situation where the free market allocates resources in a way that does not lead to the socially optimal outcome.
   • A situation where the free market allocates resources perfectly, so the government has no need to intervene.
   • A situation where a firm is forced to close because it cannot make enough profit to cover its costs.

2. Which of these is one of the types of market failure identified in the specification?

   • Externalities, where costs or benefits fall on third parties not involved in the transaction.
   • Unemployment, where workers are unable to find jobs at the going wage in the labour market.
   • Exchange rate volatility, where the value of a currency changes against other currencies over time.
   • High inflation, where the general price level rises persistently across the whole economy.

3. Which of these is a type of market failure linked to information?

   • Public goods, where goods are non-rival and non-excludable so that the private sector does not supply them.
   • Externalities, where the production of a good creates pollution that harms people outside the market.
   • Information gaps, where one party has more or better information than the other, leading to misallocation.
   • Demand shifts, where changes in income or tastes move the demand curve to a new position.

4. Which is the best description of under-provision of public goods as a type of market failure?

   • The government supplies more of a private good than consumers want, so the market is over-provided by the state.
   • The private sector supplies too much of a good that people do not want, so resources are wasted in the market.
   • The private sector does not supply enough of a good that is non-rival and non-excludable, so the market provides too little of it.
   • The price of a good is set too high by producers, so consumers buy less than they would at a fair price.

5. Which of the following illustrates market failure caused by externalities?

   • A factory emits pollution into a river, imposing costs on fishers and residents who are not part of the transaction.
   • A firm sells a product at a price that covers its costs and earns a normal profit in a competitive market.
   • A government lowers interest rates to encourage borrowing and spending in the economy as a whole.
   • A consumer chooses to buy a cheaper brand of a product because its price has fallen compared with others.

6. Why is market failure a reason for government intervention?

   • Because the market outcome is socially inefficient, so intervention can aim to improve resource allocation and welfare.
   • Because market outcomes are always efficient, so governments should intervene to make prices fairer for consumers.
   • Because market failure only affects government revenues, so it does not matter for the wider economy.
   • Because governments are always more efficient than markets, so intervention always improves outcomes in every market.

7. Which of these is the best evaluation of whether market failure always requires government intervention?

   • No, since market failure never exists in any real market, so intervention is never needed in practice.
   • Yes, since government intervention always removes market failure without any cost to the economy.
   • Not necessarily, since intervention can itself fail, so the benefit of correcting a market failure must be weighed against its costs.
   • Yes, since market failure always requires intervention, and no other response can improve social welfare.

8. Which of these markets is most likely to suffer from information gaps?

   • The market for petrol, where prices are posted publicly and buyers can compare them easily at all times.
   • The market for second-hand cars, where sellers may know more about a vehicle's condition than buyers do.
   • The market for fresh fruit, where quality is always inspected by a government officer before sale.
   • The market for bread, where all buyers and sellers know the prices and quality of each loaf they buy.

9. Which of these is most likely to be a public good?

   • A pair of shoes, which one buyer takes away and which can be excluded from others who do not pay.
   • A bar of chocolate, which is consumed by one person and cannot be used by anyone else at the same time.
   • National defence, which is non-rival in consumption and non-excludable once it is provided.
   • A cinema ticket, which gives access to one seat and can be refused to anyone without a ticket.

10. Which statement about market failure is correct?

    • Market failure means that prices are always too high in every market, so governments should set lower prices.
    • Market failure arises only in countries with command economies, since free markets always allocate efficiently.
    • Market failure arises only when firms make losses, since losses show that resources are being wasted in the market.
    • Market failure can arise from externalities, under-provision of public goods or information gaps, each causing misallocation.

11. A market produces a good whose costs fall on people outside the market. Which concept is most relevant to explaining the resulting outcome?

    • Price elasticity of supply, since it measures how responsive producers are to changes in the price of the good.
    • Externalities, since the private costs and benefits differ from the total social costs and benefits of the good.
    • Consumer surplus, since it measures the benefit consumers receive from buying the good at the market price.
    • Opportunity cost, since it measures the value of the next best alternative to producing the good in the market.

12. Why might a free market under-provide a public good such as a lighthouse?

    • Because people can enjoy the good without paying for it, so private firms have little incentive to supply it.
    • Because public goods are never demanded by consumers, so no firm has a reason to supply them.
    • Because private firms always supply public goods in excess, so the market provides too much of them.
    • Because public goods are always expensive, so consumers are unwilling to buy them even at a low price.

13. Which of these is the best evaluation of information gaps as a cause of market failure?

    • They never cause market failure, since all buyers and sellers always have perfect information in every real market.
    • They only affect government budgets, so they are not relevant to how resources are allocated in markets.
    • They always cause the market to close, since information gaps make it impossible for firms to sell any product.
    • They can lead to misallocation, since buyers or sellers may decide without the information needed to judge quality or risk.

14. A market for a good has 40 units traded at a price where private marginal benefit equals private marginal cost, but external costs are not reflected in the price. What is the best description of the outcome?

    • The market quantity cannot be determined, since external costs make all price and output levels equally inefficient.
    • The market quantity is too low relative to the social optimum, since social costs exceed private costs and under-production results.
    • The market quantity is too high relative to the social optimum, since social costs exceed private costs and the good is over-produced.
    • The market quantity equals the social optimum, since private marginal benefit equals private marginal cost in the market.

15. Which of these best describes the difference between a private good and a public good?

    • A private good is non-rival and non-excludable, while a public good is rival and excludable in consumption.
    • A private good is always provided by government, while a public good is always provided by the private sector.
    • A private good is always cheap, while a public good is always expensive in every market.
    • A private good is rival and excludable, while a public good is non-rival and non-excludable in consumption.

16. Explain why market failure is more likely when a good has large external benefits.

    • Large external benefits raise prices in the market, so consumers buy less of the good than they would otherwise.
    • External benefits reduce social welfare, so the market produces more of the good than society desires.
    • Private consumers ignore the external benefits they create for others, so the private demand is lower than the socially desirable level.
    • Private consumers take account of all external benefits, so the market always provides the socially optimal quantity.

17. Which of these is the most accurate statement about social welfare and market failure?

    • Market failure occurs when the market outcome maximises the profits of every firm in the economy at once.
    • Market failure occurs when the government raises taxes, since taxes always reduce social welfare by definition.
    • Market failure occurs only when consumers are unhappy with the quality of the goods they buy in the market.
    • Market failure occurs when the market outcome does not maximise social welfare, given the costs and benefits to all parties.

18. Which of the following is an example of a public good provided by government?

    • A street lighting system that lights roads for every passer-by, whether or not they have paid for it.
    • A loaf of bread bought by one household that cannot be shared with other households at the same time.
    • A concert ticket that gives access only to the buyer and is refused to anyone who has not paid.
    • A mobile phone used by one person, whose use by the owner prevents anyone else from using it.

19. Which of these outcomes is a sign of market failure?

    • A market where consumers buy a good at the equilibrium price set by supply and demand.
    • A market where firms enter and leave as profits change over time in the economy.
    • A market where the price of a good falls because demand has decreased in the economy.
    • A market where the quantity of pollution produced is far greater than what would be socially optimal.

20. Which of these is a type of market failure linked to public goods?

    • Over-provision, since private firms always produce public goods in excess of what consumers want.
    • Under-provision, since the private sector may not supply goods that are non-rival and non-excludable.
    • Exchange rate movements, since public goods are always priced in a foreign currency in the market.
    • Price ceilings, since government price controls always prevent public goods from being produced.

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