WJEC A Level Economics Market Failure Exam Questions

About WJEC A Level Economics Market Failure

Market failure is the main AS microeconomics evaluation topic in WJEC Economics. You first define efficiency as maximising consumer and producer surplus at the free market equilibrium, then explain the sources of market failure: public goods, merit and demerit goods, externalities, monopoly power, information asymmetries and gaps, the absence of private property rights, income inequality and volatile prices. You must draw externality diagrams, derive the socially efficient output and identify the welfare loss. You then analyse why and how governments intervene and the effects of that intervention, including government failure. It is examined in AS Units 1 and 2 and returns in A2 Unit 4 microeconomics essays.

What you need to know

• Efficiency and market failure A market is efficient when total consumer and producer surplus is maximised. Market failure occurs when the free market does not reach this outcome, so resources are misallocated.
• Public goods Public goods are non-rival and non-excludable, so free riders cannot be charged and private firms will not supply them. Examples include flood defences and lighthouses.
• Externalities and welfare loss Negative externalities mean marginal social cost exceeds marginal private cost, leading to overproduction; positive externalities mean marginal social benefit exceeds marginal private benefit, leading to underconsumption. The socially efficient output is where MSC = MSB, and the welfare loss is the triangle between the two outputs.
• Merit and demerit goods Merit goods such as education are underconsumed and demerit goods such as cigarettes overconsumed in a free market, often because consumers lack full information about their true benefits and costs.
• Other sources Information asymmetry (e.g. second hand cars), monopoly power, no property rights over shared resources, income inequality and volatile prices for agricultural goods.
• Government intervention Policies include indirect taxes, subsidies, maximum and minimum prices, regulation and legislation, tradable permits, state provision and information campaigns.
• Effects of intervention Intervention can correct market failure but may cause government failure: poor information, black markets, high administration costs, unintended consequences and distortion of incentives.

Common mistakes in Market Failure

• Shading the welfare loss in the wrong place. It is the triangle between MSC and MSB from the efficient output to the market output.
• Writing that a public good is anything provided by the state. Public goods are defined by non-rivalry and non-excludability.
• Calling all externalities pollution. Positive externalities, such as vaccination, also cause market failure.
• Stating that a maximum price always helps consumers. It creates a shortage, so some consumers cannot buy the good.
• Evaluating a policy without considering government failure. Strong answers explain how a policy could fail in practice.

Try three Market Failure exam-style questions