Market failure

How are social costs worked out?

Feb/March 2016

Agriculture made up 17% of India’s Gross Domestic Product (GDP) of US$1890 billion in 2013. GDP had risen from US$1769 billion in the previous year. The country’s population went up from 1.22 billion in 2012 to 1.26 billion in 2013. In 2013, India and the US were both among the world’s top ten wheat producers. India came third with output of 95 million tonnes, whereas the US was fourth with output of 62 million tonnes. In 2013, just 1.6% of the US labour force worked in agriculture, compared with 45% in India. Agricultural subsidies have fallen in the US, but they are still high in India. The Indian Government believes support for farmers matters for national security and that food subsidies help to cut poverty. From 2010 to 2013, the Indian Government spent US$15 billion subsidising fertilisers to improve soil fertility. Fertiliser subsidies have raised wheat output, but they have also polluted rivers. The Indian Government believes that, over time, its agricultural sector will become more efficient and that subsidies will be needed less. It expects workers to become better educated and the quantity of capital equipment used in agriculture to increase. Some US economists have challenged this optimism. They note that the state-owned Food Corporation of India had to purchase 30% of the country’s yearly wheat harvest and that India had a huge stockpile of unsold wheat in 2014. Trade between India and the US is growing. US citizens are purchasing a larger amount of goods and services from India. For example, because life expectancy in the US, which had already reached 79 years in 2014, is rising, imports of Indian medicines into the US are increasing. Several factors will shape the pattern of trade between the two countries. These include the exchange rate between the US dollar and the Indian rupee. The value of the US dollar is set by market forces, so the long-term trend may fluctuate.

Feb/March 2016

Give one example of market failure.

Feb/March 2017

Governments try to cut market failure in several ways, one of which is to put regulation in place. They also make some goods and services themselves by employing people in the public sector.

Feb/March 2017

A government thinks that consuming a particular good will benefit society. Which policy is most likely to persuade producers to raise the output of that good?

Feb/March 2018

What does the term external cost mean in relation to mining coal?

Feb/March 2018

A private sector firm is awarded a contract by the government to provide a country’s water supply. Which government directive would minimise the risk of market failure?

Feb/March 2019

Botswana runs a range of conservation projects. These are believed to bring social benefits to nearby communities. Botswana operates a mixed economic system, and tax revenue as a share of GDP was 27% in 2017. Some Botswanan economists argue that the country ought to shift towards a market economic system, while taking care to avoid market failure.

Feb/March 2019

Study the source material carefully before you answer Question 1. Source material: Air pollution in India As India expands output, pollution rises. The government supports economic growth by encouraging investment and free trade. It is thinking about reducing taxes, increasing spending on education, cutting import tariffs and abolishing some import quotas. The Indian government intervenes in the economy for several reasons, including reducing pollution. Pollution is caused by vehicles and by factories in the private and public sectors that release harmful gases. Because the cost of making cars has fallen and incomes are rising, more cars are now being produced and bought in India. Producers and car users make choices using only their private costs and benefits. After harvesting, some farmers burn their fields to improve the growth of the next crop, even though this creates pollution. Also, some mine owners do not take enough care to stop minerals and metals from leaking into local water supplies. In addition to its effect on pollution, the relative size of the primary sector can also affect average income, as shown in Table 1. To cut pollution, the Indian government subsidises bus travel. It also insists that buses operate on natural gas instead of the more polluting diesel and petrol. Lower pollution may attract more foreign tourists. Foreign tourism and movements in the foreign exchange rate influence a country’s current account in the balance of payments. It has been forecast that India’s foreign exchange rate is likely to increase in the future.

Feb/March 2020

What features of a product can lead to market failure?

Feb/March 2021

In a mixed economy, the government supplies some goods that markets are unable to provide. What is the term for these goods?

Feb/March 2024

What is an external cost associated with smoking cigarettes?

Feb/March 2024

A government plans to construct a new road through a forest. What would count as an external cost of this?

Feb/March 2025

The table gives the harmful carbon dioxide emissions for a country in selected years, measured in millions of tonnes. Which action would probably have the biggest impact on cutting carbon dioxide emissions?

May/June 2015

Developers are seeking to enlarge a significant shopping district in a city. It is believed that the plan would generate hundreds of jobs, make profits for the retailers, but lead to severe traffic congestion. Which economic concepts are directly involved in this statement?

May/June 2016

Developers are planning to expand a large retail shopping district in a city. It is believed that this proposal would generate hundreds of jobs, bring profits for the shops, but also lead to serious traffic congestion. What economic concepts are directly involved in this statement?

May/June 2016

Which sort of government policy would be most suitable for reducing external costs of production?

May/June 2016

It has been proposed that every nation producing arms should forbid the export of weapons and reduce production in order to lower the risk of war. What would be the outcome if this were to happen?

May/June 2016

Developers plan to enlarge a major city retail shopping district. It is believed that the scheme would generate hundreds of jobs, be profitable for the shops, but lead to severe traffic congestion. Which economic concepts are directly involved in this statement?

May/June 2016

In January and February 2014, there were demands for the UK Government to construct more flood defences. Floods damaged homes, factories and other resources, and some were destroyed. It was said that government intervention was necessary in this situation because there was evidence of market failure.

May/June 2016

In 2013, the Mexican Government was weighing up the introduction of a sales tax of one peso per litre on fizzy drinks. The Government aimed to reduce excessive fizzy drink consumption - 40% more fizzy drinks per person are consumed than in the United States of America. Several multinational fizzy drinks companies warned that they would exit the country if taxes were raised.

May/June 2016

Plans were drawn up in Australia for a project to construct one of the world’s largest coal mines. The estimated cost of the project was $US12.5 million. It would generate employment, but it would also put endangered species at risk because large coal ships would harm the Great Barrier Reef. What effects would this project have on the following costs and benefits?

May/June 2017

A bee-keeper keeps hives of bees in order to make honey. The bees may pollinate neighbours’ fruit trees, but they can also inflict a painful sting on gardeners. If both of these events happen, what effect will this have on costs and benefits?

May/June 2017

Sales of bottled water in China were twice as high in 2015 as they had been in 2010. In 2013 China moved ahead of the USA to become the largest market for water by volume, though not by value because a bottle cost more in the USA. The rise in worldwide bottled-water consumption has increased the size of firms producing bottled water, but it has also raised pollution.

May/June 2017

Coal is burned directly to heat homes all over the world, and it generates more than 40% of the world’s electricity. Even so, the coal industry faces several difficulties. These include rising concerns about the environmental impact of coal use and greater competition from other fuels. Mining coal and using it to generate electricity creates air pollution. Coal-fired power stations release carbon dioxide, which has a damaging effect on people’s health. Wildlife habitats are harmed when new mines are opened and when coal waste is tipped on landfill sites. Even so, demand for coal has fallen recently. As a result, the price of a tonne of coal dropped from US$300 in 2010 to US$150 in 2015. In 2015, even China, the world’s biggest consumer of coal, bought less. Some high-cost deep mines were closed in the USA. In the same year, Europe’s largest producer, Poland, sold coal at a loss of US$37 a tonne. The decline in demand for coal is partly due to competition from renewable energy. For example, advances in technology are lowering the cost of generating energy from wind power. Fig. 1 shows how the wind power market changed in 2015. Fig. 1 The market for wind power in 2015 shows a vertical axis labelled “price of wind power” and a horizontal axis labelled “quantity of wind power”. The initial equilibrium price is labelled $P_1$ and the new equilibrium price is labelled $P_2$. The initial equilibrium quantity is labelled $Q_1$ and the new equilibrium quantity is labelled $Q_2$. A downward sloping demand curve is labelled $D_1$. Two upward sloping supply curves are shown, labelled $S_1$ (on the left) and $S_2$ (on the right).

May/June 2017

A government gave approval for a new railway line linking major cities to be built. A private company would construct it, while part of the cost would be met through taxation. The scheme would provide many jobs. People living along the route were concerned about damage to their environment. Which concepts are directly involved in this statement?

May/June 2018

The table presents government estimates for the private and external benefits and costs involved in constructing a new dam. What is the difference between the social benefits and social costs of building the dam?

May/June 2018

A private company is among only a small number of electricity suppliers in an economy. The government penalises it for pollution caused by its coal-fired power stations, which harms the health of people living close by. What does this situation involve?

May/June 2018

In Swaziland, a small African country, six in ten people live in poverty and most firms are small, using very little capital equipment. A new airport was opened in October 2015. Some economists argue that constructing the airport had a high opportunity cost and brought several external costs. Building the airport is one element of the government’s programme to transform the country from developing into developed.

May/June 2018

In 2015, the World Economic Forum named the water crisis as the largest global risk. In many Asian and African countries, water supplies were down at critically low levels and could not satisfy the growing demand. This demand has increased because cities have expanded and population numbers have risen, creating a much larger need for agricultural output. Water scarcity affects many developing countries, where life expectancy is low. It is estimated that one third of all healthcare facilities in these countries do not have access to safe water or basic sanitation. Shortages of water damage public health - 80% of all illnesses in developing countries are caused by poor water and sanitation conditions. Water shortages also limit the level of food production. Table 1 presents the risk of water shortage (with the highest risk being 5) and Gross Domestic Product (GDP) per head in US$. Because of water shortages, a number of countries and regions have tried privatising supply. However, since water is a necessity, private provision has in some cases caused consumers to face major price rises. It is estimated that a 10% rise in the price of water leads to only a 0.7% fall in quantity demanded. This suggests that governments need to regulate water markets in order to safeguard consumers. Some economists believe that water has been consistently undervalued, which has caused it to be used inefficiently. The reason is that prices do not take into account the long-term effects of failing to conserve this valuable resource. As climate change leaves much of the world facing a hotter and drier future, water is likely to become even scarcer. More than 663 million people are estimated to be living without access to clean water. The World Bank provides finance for a range of projects aimed at dealing with this and, in doing so, lowering absolute poverty. Better access to natural resources is regarded as vital for encouraging economic development in some of the world’s poorest countries.

May/June 2018

Oil production is capital-intensive. Because it creates pollution, it is one cause of environmental market failure. In Nigeria, an oil monopoly is beginning to make more environmentally friendly liquefied petroleum gas (LPG) instead of kerosene in order to cut pollution. The Nigerian government plans to break the monopoly firm into separate companies to raise efficiency.

May/June 2018

What leads to market failure?

May/June 2019

By using larger aircraft, an airline enhances its services. The airline says that this will cut catering waste and decrease carbon ($\text{CO}_2$) emissions for each passenger journey, although fares could increase. What is a private cost and an external benefit of this decision?

May/June 2019

China has constructed a new railway in Kenya linking the capital city, Nairobi, with the port of Mombasa. Kenya has to pay back the railway’s cost to China. Travel time has fallen a great deal, but ticket prices have risen and farmers have lost farmland beside the new route. Who carries the external costs of this scheme?

May/June 2019

Non-renewable energy (e.g. coal) is believed to create a larger social cost than renewable energy (e.g. solar or wind power). Excessive demand for non-renewable energy leads to a failure of the market economic system. By contrast, producers of renewable energy, some of which specialise in one form of energy, are starting to produce on a larger scale.

May/June 2019

What is one example of an external benefit gained when a person cycles, instead of driving, to work?

May/June 2021

Which problem would be reduced by a government subsidy to a firm?

May/June 2021

How is market failure defined?

May/June 2021

An expanse of litter in the Pacific Ocean, known as the Great Pacific Garbage Patch, covers an area three times the size of France. It contains waste such as old fishing nets, although most of it is plastic waste. By 2050, it is predicted that there will be more plastic than fish in the Pacific Ocean. Several islands in the Pacific Ocean depend on fishing. More pollution will raise the social cost of the fishing industry.

May/June 2021

For certain illnesses, wearing a face mask is beneficial because it may stop people from becoming infected. However, not everyone is prepared to wear face masks. Using the statement above, why would the free market lead to an inefficient allocation of face masks?

May/June 2023

What is the most probable reason for raising government subsidies?

May/June 2023

What could be one external benefit if the number of university graduates in an economy rises?

May/June 2023

A government thinks that people consume too much sugar but too little fruit. Which set of policies would the government put in place?

May/June 2023

The diagram illustrates the market for petrol (gasoline). $S_p$ represents the supply of petrol based on the private cost of petrol production and $S_s$ represents the supply of petrol based on the social cost of production. Which distance represents the market failure caused by the production of petrol?

May/June 2023

New Zealand is a fairly small economy and it aims to become carbon-neutral by 2050. Carbon-neutrality means that a country removes from the atmosphere the same amount of carbon dioxide that it gives off, or cuts carbon dioxide emissions to zero entirely. A range of policies is now in place to cut external costs in industries such as milk production and the car industry. Both industries are major causes of air pollution, and milk production also damages the surroundings in which many wild animals live. The government plans to end imports of petrol-powered cars by 2032 and also restrict the number of cows that each farmer can keep. Even so, suitable alternatives will need to be found if these goals are to be achieved. Consumers will want a cheaper replacement for petrol-powered cars, while farmers will need another source of income instead of cows. Whether the government’s plans succeed will be important for New Zealand’s macroeconomic performance. New Zealand exporters depend on a clean and green image, and this can support economic growth and cut the deficit on the current account of the balance of payments. However, not every firm will gain from government action to achieve carbon-neutrality and inflation rates may also rise. A shift to a carbon-neutral economy could also increase unemployment because of major job losses in the coal, oil and gas industries. This may raise poverty in some communities and create large losses for the firms that supply these communities. However, these changes may be short-lived and an economy with high mobility of factors of production could avoid these problems. The good news is that New Zealand already has a low level of carbon dioxide emissions. Even so, not all countries can take the path New Zealand plans to follow. For selected countries, Table 1.1 shows their share of world GDP (%) and their share of world carbon dioxide emissions (%) in 2018.

May/June 2023

The food processing, tourism and education industries each make an important contribution to the government budget of the US state of Wisconsin. The education industry contributes more than the other industries because wages in education are higher. It also helps to increase the state’s population. This generates not only private benefits but external benefits as well.

May/June 2023

Which definition correctly describes a demerit good?

May/June 2024

The government wants to cut the damaging emissions produced by road transport. Which measure would be effective in helping to achieve this aim?

May/June 2024

Since 2020, revenue in the video gaming industry has been greater than revenue in the film industry. The most rapidly expanding section of the video gaming industry is mobile gaming, which substitutes for console gaming. Young people are spending many hours on video games and some governments worry that this could harm their health and educational progress. For that reason, regulations have been introduced to cut the amount of time young people spend playing these games.

May/June 2024

What is one feature of a demerit good?

May/June 2025

What is the most likely explanation for placing a tax on oil?

May/June 2025

Study the source material thoroughly before you answer Question 1. Source material: The future of the economy of St. Kitts and Nevis St. Kitts and Nevis is a small Caribbean nation made up of two islands. The country’s three key industries are tourism, financial services and agriculture. Visitors are drawn by the country’s beaches, coral reefs, forts, rainforests and shipwrecks. However, if rainforests keep being cleared and soil erosion keeps contaminating the coral reefs, causing marine life to die, tourism may be put off. The St. Kitts and Nevis Government is also worried that the social costs of tourism are greater than the private costs. St. Kitts and Nevis’s financial services include a growing banking sector. Among the country’s commercial banks are a few foreign multinational companies (MNCs). These MNCs are attracted by the country’s relatively high incomes, the absence of personal income tax and a relatively high literacy rate. Some of the country’s main agricultural products are carrots, onions, peanuts and sweet potatoes. In 2017, the St. Kitts and Nevis Government introduced a training scheme to raise the productivity of onion farmers. Other important industries in St Kitts and Nevis include healthcare and fishing. Table 1.1 shows healthcare spending as a percentage of GDP and life expectancy in six selected countries in 2022. The small scale of St. Kitts and Nevis’s fishing industry means that it imports large quantities of fish. The country’s fishing boats are small and some lack up-to-date equipment. A larger fishing industry, with bigger boats, may bring a number of benefits to the country. Changes in the structure and performance of industries in St. Kitts and Nevis may alter the country’s price level. Between 2018 and 2020, the country experienced deflation. This affected people’s purchasing power, saving and debts. It also affected the country’s exports and firms’ investment decisions. Answer all parts of Question 1. Refer to the source material in your answers.

May/June 2025

A developer constructed some large houses in a rural area that poorer people were unable to afford. The houses ruined an area of natural beauty. What type of market failure was caused by the development?

Oct/Nov 2015

A company that supplies water spent $\$470\text{ million}$ on building a pipe network to make water distribution more efficient. It hired local people and helped the local economy grow. It also improved facilities for the tourist industry. What cannot be concluded from this information?

Oct/Nov 2015

A developer constructed several large houses in a rural location that poorer people were unable to afford. The houses damaged a place of natural beauty. What sort of market failure did this development cause?

Oct/Nov 2015

There has been growing concern about how large firms exploit the environment. What is the principal cause of this concern?

Oct/Nov 2015

Give one instance of a public good.

Oct/Nov 2015

A developer had some large houses constructed in a countryside location that poorer people could not buy. Building them damaged an area of natural beauty. What type of market failure was caused by this development?

Oct/Nov 2015

The United Nations’ World Tourism Organisation has estimated that, by 2020, only 7% of the world’s population will have visited another country. If international travel rises, it may generate jobs and affect incomes. However, it would also place strain on finite resources and produce external costs.

Oct/Nov 2015

The chart presents total world carbon emissions in 1995 and projected emissions for 2035. If the chart is accurate, what will have changed by 2035?

Oct/Nov 2016

What shows that external costs are present in an economy?

Oct/Nov 2016

A government decides to transfer the monopoly supply of gas to households to a private firm. How might the government safeguard the interests of households after selling a large company to the private sector?

Oct/Nov 2016

The chart displays total world carbon emissions in $1995$ and the emissions forecast for $2035$. If the chart is accurate, what will have occurred by $2035$?

Oct/Nov 2016

Cars being used in many cities lead to negative externalities. The diagram indicates the free market equilibrium $X_1$ and the socially efficient market equilibrium $X_2$. From the diagram, which statement is correct?

Oct/Nov 2016

A 2014 United Nations report advised governments to try to halve meat consumption. It was argued that cutting meat consumption would lessen the market failure created by pollution from chemical fertilisers and manure. If meat consumption fell, large areas of land would become available for growing vegetables, cereals and fruit to feed a growing population. The supply of a number of agricultural products is inelastic.

Oct/Nov 2016

In 2014 the United States’ second-largest cigarette producer submitted a bid to acquire the country’s third-largest cigarette producer. If the merger took place, cigarette prices were expected to rise. How quantity demanded would respond to a price rise would depend on the price elasticity of demand.

Oct/Nov 2016

A government has to decide how large a fine to impose on firms that create the external costs of air pollution in industrial areas. Which external cost would be hardest to put a money value on?

Oct/Nov 2017

State one example of market failure.

Oct/Nov 2017

A government permitted a building company to construct new houses, and this damaged an area that had been designated as one of natural beauty. Which concepts can be applied to this statement?

Oct/Nov 2017

Which effect of economic development counts as an external cost?

Oct/Nov 2017

What could be an external cost of consuming alcohol?

Oct/Nov 2017

A major highway was constructed for US$175 million linking Nairobi, Kenya, with its suburbs. It cuts journey times and improves safety, although it creates environmental difficulties for small enterprises located along the route. Who is affected by the external costs of this project?

Oct/Nov 2018

UK coal production has fallen in recent years. One explanation for this is that the social cost of coal production is too great. What best describes the social cost of coal production?

Oct/Nov 2018

The government supplies hospital services, with taxation used to pay for them. Long waiting lists mean that people are not always able to receive the treatment they need. What is this an example of?

Oct/Nov 2018

Mexico has recently had relatively low inflation, and the Mexican government wants to keep this price stability. Even so, its currency has lost value, so each Mexican peso now exchanges for less foreign currency. The government is also aiming to cut pollution across the country. One major source of pollution in Mexico is car travel. Driving involves both private and external costs.

Oct/Nov 2018

In a city, which good or service is least likely to be supplied by the private market system?

Oct/Nov 2019

What indicates that market failure exists?

Oct/Nov 2019

Under a private market system, some goods and services would not be provided unless the government stepped in. What does this indicate in a private market?

Oct/Nov 2019

Why may a market economy not achieve the most efficient use of scarce resources?

Oct/Nov 2020

Read the source material closely before you answer Question 1. Source material: The destruction of forests in Indonesia Indonesia is the biggest producer of palm oil in the world. The production costs of palm oil include land rent, fertiliser, palm oil seeds, upkeep of irrigation systems and casual labour. Forests are cleared by setting fires to create space for palm oil plantations. These fires destroy the habitats of many wildlife species and release harmful gases into the air. Since 2011, the Norwegian government has paid Indonesia to conserve its forests. Although Indonesia is the largest producer of palm oil, it ranks third for rice production. Indonesia exports 85% of its palm oil, but at times it must import rice to satisfy domestic demand. Its overseas trade in palm oil and rice is affected by movements in its foreign exchange rate. The value of the Indonesian currency, the rupiah, fell in 2017. Rice growing also adds to air pollution. After harvesting, rice farmers burn the stubble that remains to clear the fields and increase the fertility of the land so that they can grow more rice. Some environmentalists say that stubble burning ought to be banned. The Indonesian economy, together with the world economy, keeps expanding. Economic growth can create pollution. It can also influence a country’s GDP per head ranking and Human Development Index (HDI) ranking, as shown in Table 1.1. Indonesia has net emigration. Some Indonesians work overseas and remit money to their families at home. People also arrive from abroad to work in Indonesia, including some in comparatively well-paid jobs in the country’s growing tourism industry. Indonesia currently receives fewer tourists than its neighbours, Singapore and Malaysia. However, it has many natural tourist attractions and is presently price competitive.

Oct/Nov 2020

Hungary has the highest obesity rate in Europe. Hungarians consume fewer vegetables than most other Europeans and a larger quantity of foods that may be viewed as demerit goods. In 2017, the Hungarian government brought in a tax on unhealthy food called the chips tax. This tax has been partly successful in shifting demand towards healthier foods. Some economists argue that governments ought to use price controls, as well as taxes, to affect the food market.

Oct/Nov 2020

At what point is production certain to damage society?

Oct/Nov 2021

Which combination of features best describes a public good?

Oct/Nov 2021

Give one example of a public good.

Oct/Nov 2021

What kind of goods must be financed by a government?

Oct/Nov 2022

In a free market, market failure leads to a misallocation of resources. Which of these is not an example of market failure?

Oct/Nov 2022

To ease traffic congestion, a government chooses to construct a new road. A toll is charged for using the new road. What is the primary aim of this government intervention?

Oct/Nov 2022

What is the reason a government provides public goods?

Oct/Nov 2022

State one possible consequence of market failure.

Oct/Nov 2022

Digital money, for example cryptocurrencies, is being adopted more widely. Transactions using digital money are carried out on electronic devices such as computers and smartphones. However, market failure may arise because external costs are created by the heavy energy consumption of non-renewable sources. One way to lower external costs is to tax the product.

Oct/Nov 2023

In 2020, Paraguay’s Consumer Prices Index increased by 3% and its foreign exchange rate moved up and down. Every year Paraguay has net emigration. People depart from a country for several reasons. These include a low rate of economic growth and a high degree of market failure. The Paraguayan government does intervene in the economy in an effort to lessen market failure.

Oct/Nov 2023

A government plans to construct a new international airport in a region of outstanding natural beauty. What would be one external cost of this decision?

Oct/Nov 2024

What does the term external benefit mean?

Oct/Nov 2024

A bridge is constructed across a river, and this shortens journey times. The table sets out the costs and benefits of constructing the bridge. private benefit = $12000$, private cost = $10000$, external benefit = $8000$, external cost = $5000$. Which calculation shows social benefit?

Oct/Nov 2025