Market failure and the role of government practice questions (AP Microeconomics)

Sample questions

All 3 free AP Microeconomics questions on this unit, from the free AP Microeconomics Practice Exam. Each answer is behind its own toggle; the whole paper, its PDF and the full answer key are on the exam page.

1. Question 12 marks · Negative externalities
   The production of paper pollutes a river, imposing costs on downstream users that the paper mill does not pay. Relative to the socially optimal outcome, the unregulated market for paper produces:
   • A.
     too little paper at too high a price
   • B.
     too little paper, because the externality raises production costs
   • C.
     the efficient quantity, because pollution is a fixed cost
   • D.
     too much paper, because demand overstates marginal social benefit
   • E.
     too much paper, because marginal social cost exceeds marginal private cost
   Show answerFrom the free AP Microeconomics Practice Exam →
2. Question 22 marks · Public goods
   A public good is underprovided by private markets primarily because it is:
   • A.
     rival and excludable, so firms overcharge for it
   • B.
     non-rival and non-excludable, so consumers can free-ride
   • C.
     always produced by natural monopolies
   • D.
     subject to diminishing marginal returns
   • E.
     non-rival but excludable, like a toll road
   Show answerFrom the free AP Microeconomics Practice Exam →
3. Question 36 marks · Negative externalities
   Externality. The market demand for a chemical is $P = 16 - Q$ and the industry's marginal private cost is $MPC = 4 + Q$ ($P$ in dollars, $Q$ in tons). Production releases fumes that impose a constant marginal external cost of 2 dollars per ton on nearby residents.
   $P = 16 - Q, \qquad MPC = 4 + Q, \qquad MEC = 2$
   (a)

   Calculate the unregulated market equilibrium quantity and price.

   [2]
   (b)

   Calculate the socially optimal quantity. Show your work.

   [2]
   (c)

   The government imposes a per-unit tax on producers to correct the externality. State the efficient tax and the new equilibrium price paid by consumers.

   [2]
   Show answerFrom the free AP Microeconomics Practice Exam →

Key terms

The definitions and formulas AP Microeconomics expects for market failure and the role of government, typeset as they appear on the paper.

Externality

A cost or benefit that falls on a third party. A negative externality (pollution) makes marginal social cost exceed marginal private cost, so the market overproduces; a positive externality (vaccination) makes marginal social benefit exceed marginal private benefit, so it underproduces.

$$MSC = MPC + MEC, \qquad MSB = MPB + MEB$$

Socially optimal quantity

The output where marginal social benefit equals marginal social cost. Deadweight loss is the triangle between the market quantity and this quantity.

$$MSB = MSC$$

Per-unit tax and subsidy as remedies

A per-unit tax equal to the marginal external cost shifts the private cost curve up to the social cost curve; a per-unit subsidy equal to the marginal external benefit does the reverse for positive externalities.

Public goods and the free-rider problem

Goods that are non-rival (one person's use does not reduce another's) and non-excludable (non-payers cannot be kept out). Because people can free ride, private markets underprovide them and government usually supplies them.

Lorenz curve and Gini coefficient

The Lorenz curve plots the cumulative share of income against the cumulative share of households; the diagonal is perfect equality. The Gini coefficient is the area between the curve and the diagonal as a share of the whole triangle, from 0 (equal) to 1 (one household has everything).

$$G = \frac{A}{A + B}$$

Progressive, regressive and proportional taxes

A tax is progressive when the average rate rises with income, regressive when it falls, and proportional when it is constant. Income taxes with rising brackets are progressive; a sales tax is regressive.

Antitrust policy

Laws and regulation that limit market power: blocking mergers that would create a monopoly, breaking up cartels, and regulating natural monopolies' prices.

Frequently asked questions

Other AP Microeconomics topics

• Basic economic concepts
• Supply and demand
• Production, cost and perfect competition
• Imperfect competition
• Factor markets

All AP Microeconomics topics · AP Microeconomics exam guide · All free practice exams