Eduqas A Level Economics Market Failure Exam Questions

About Eduqas A Level Economics Market Failure

Market failure is the final area of Eduqas microeconomics and one of the most common essay areas in Component 3. You need to understand why free markets may fail to allocate resources efficiently, through public goods, externalities, merit and demerit goods, information gaps, monopoly power, missing property rights, inequality and volatile prices. You then look at why and how governments intervene, using indirect taxes, subsidies, maximum and minimum prices, regulation, tradable permits and state provision, and at the effects of that intervention, including government failure. Examiners expect correct externality diagrams showing the welfare loss and evaluation of which policy works best in a given context.

What you need to know

• Understanding market failure Market failure occurs when the free market leads to a misallocation of resources, so output is not at the socially optimal level where marginal social cost equals marginal social benefit.
• Public goods Public goods are non-rival and non-excludable, so the free rider problem means the market under provides or fails to provide them, e.g. street lighting and national defence. Private goods are rival and excludable.
• Externalities An external cost or benefit falls on a third party. With negative production externalities, MSC is above MPC so the market overproduces; with positive consumption externalities, MSB is above MPB so the market underconsumes. Shade the welfare loss triangle between the market and socially optimal output.
• Merit and demerit goods Merit goods (education, healthcare) are under consumed in a free market, often because of information gaps and positive externalities. Demerit goods (tobacco, alcohol) are over consumed because consumers underestimate the harm.
• Other causes Information asymmetry, monopoly power, the absence of property rights (e.g. over fish stocks or the atmosphere), inequality of income and wealth, and volatile commodity prices can all lead to market failure.
• Government intervention Tools include indirect taxes, subsidies, maximum and minimum prices, buffer stocks, regulation, tradable pollution permits, state provision and providing information. Each aims to move output towards the social optimum.
• Government failure Intervention may make things worse because of information problems, unintended consequences (e.g. black markets), administrative costs, regulatory capture or political short-termism.

Common mistakes in Market Failure

• Shading the wrong area for welfare loss. The welfare loss triangle lies between MSC and MSB from the socially optimal output to the market output.
• Defining a public good as one provided by the government. It is defined by non-rivalry and non-excludability, not by who supplies it.
• Saying merit goods have no private benefit. They have private benefits, but consumers underestimate them, so the free market leads to under consumption.
• Recommending a tax without considering elasticity. If demand is price inelastic, as for cigarettes, a tax raises revenue but cuts consumption only a little.
• Ignoring government failure in evaluation. Strong essays explain why a policy might fail in practice, such as setting the tax at the wrong level.

Try three Market Failure exam-style questions