Market failure and government intervention practice questions (A-Level Economics)

Sample questions

All 4 free A-Level Economics questions on this topic, from the free A-Level Economics Practice Paper and the free A-Level Economics Multiple Choice Questions with Answers. Each answer is behind its own toggle; the whole paper, its PDF and the full answer key are on the exam page.

1. Question 11 mark · Market failure: information gaps
   Consumers systematically underestimate the long-term health damage caused by regularly consuming energy drinks. In a free market, this information gap means energy drinks are most likely to be:
   • A.
     under-consumed, because they are a merit good
   • B.
     under-provided, because non-payers cannot be excluded from consuming them
   • C.
     consumed at the socially optimal level, provided no third parties are affected
   • D.
     over-consumed, because perceived marginal private benefit exceeds the true marginal private benefit
   Show answerFrom the free A-Level Economics Practice Paper →
2. Question 21 mark · Market failure: public goods
   Street lighting is usually provided by local government rather than by private firms because it is:
   • A.
     a merit good whose benefits consumers underestimate
   • B.
     non-rival but excludable, like a toll road
   • C.
     non-excludable and non-rival, so free riders would prevent a private firm from covering its costs
   • D.
     a good with high fixed costs, which makes it a natural monopoly
   Show answerFrom the free A-Level Economics Multiple Choice Questions with Answers →
3. Question 31 mark · Government intervention: maximum prices
   The weekly market for a vaccine has demand $Q_d = 100 - 2P$ and supply $Q_s = 20 + 2P$, where $P$ is the price in pounds per dose and $Q$ is thousands of doses. The government imposes a maximum price of 15 pounds per dose. The result is:
   • A.
     a surplus of 20,000 doses per week
   • B.
     a shortage of 10,000 doses per week
   • C.
     no shortage, because 15 pounds is below the equilibrium price and so the maximum price is not binding
   • D.
     a shortage of 20,000 doses per week
   Show answerFrom the free A-Level Economics Multiple Choice Questions with Answers →
4. Question 41 mark · Government intervention: indirect taxes
   A specific tax of 6 pounds per unit is imposed on a good. As a result, the equilibrium price paid by consumers rises from 20 pounds to 24 pounds. The incidence of the tax is:
   • A.
     6 pounds per unit on consumers and nothing on producers
   • B.
     4 pounds per unit on consumers and 2 pounds on producers, because demand is less price elastic than supply
   • C.
     2 pounds per unit on consumers and 4 pounds on producers
   • D.
     4 pounds per unit on consumers and 6 pounds on producers
   Show answerFrom the free A-Level Economics Multiple Choice Questions with Answers →

Key terms

The definitions and formulas A-Level Economics expects for market failure and government intervention, typeset as they appear on the paper.

Market failure

When the free market allocates resources inefficiently, producing too much or too little of a good. Types: externalities, under-provision of public goods, information gaps, and (on some specifications) monopoly and factor immobility.

Externalities and welfare loss

Costs or benefits to third parties outside the price. A negative production externality puts marginal social cost above marginal private cost; the market quantity exceeds the social optimum and the welfare loss triangle lies between the two curves.

$$MSC = MPC + \text{external cost}, \qquad \text{optimum where } MSB = MSC$$

Public goods

Non-excludable and non-rival goods such as street lighting and flood defences. Because consumers can free ride, no one pays, so the market under-provides or fails to provide them (the missing market).

Information gaps

Consumers or producers lack the information to make rational decisions, as with the long-term effects of smoking or the quality of a used car (asymmetric information). It leads to over-consumption of demerit goods and under-consumption of merit goods.

Methods of government intervention

Indirect taxes and subsidies, maximum and minimum prices, tradable pollution permits, state provision, provision of information, and regulation. For each, know the diagram and the effect on price, quantity and welfare.

Maximum and minimum prices

A maximum price below equilibrium (rent controls) creates excess demand and may lead to black markets; a minimum price above equilibrium (minimum wage, agricultural prices) creates excess supply the government may have to buy.

Government failure

When intervention leads to a net welfare loss: distortion of price signals, unintended consequences, excessive administrative costs and the government's own information gaps. Essays expect it as the main counter-argument.

Frequently asked questions

Other A-Level Economics topics

• Nature of economics and economic methodology
• How markets work: demand, supply, elasticity
• Measures of economic performance
• Aggregate demand and aggregate supply
• National income, growth and the multiplier
• Macroeconomic objectives and policies
• Business growth, market structures and the labour market
• Globalisation, trade and exchange rates
• Poverty, inequality and development
• The financial sector

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