Market Failure and the Role of Government Exam Questions
Five practice questions are below. Answer on the page: each one is marked the moment you pick, the correct option is shown whether or not you found it, and the full explanation opens either way.
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Market Failure and the Role of Government: five questions to try now
Real questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Cross-board concept practice · originally a IGCSE Economics question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 1
A private sector firm is given a contract by the government to supply a country’s water. Which government directive will minimise the risk of market failure?
Answer: B.
The correct answer is B: ensure the firm's supply includes all areas which are expensive to service.
Water is a merit good with strong positive externalities: clean water improves public health, reduces disease and raises productivity, and those benefits reach far beyond the individual customer. A profit-seeking supplier would serve only the areas where revenue exceeds the cost of connection, abandoning remote or poor districts where pipes are expensive to lay. Requiring universal supply prevents that under-provision, which is precisely the market failure the government is guarding against.
Why the other options would cause market failure:
D, providing water only to those who can pay, is the outcome to be prevented. It leaves the poorest without a basic necessity and allows disease to spread, a negative externality affecting everyone.
A, allowing the firm to ration water rather than meet demand, hands a monopolist the power to restrict supply, which is exactly how monopoly power harms consumers.
C, insisting the firm maximises profits, is the sharpest trap. A private water supplier is a natural monopoly with no competition to discipline it, so profit maximisation means restricting output and charging above cost. Profit maximisation produces efficient outcomes only in competitive markets.
C is worth dwelling on: the profit motive works well where competition exists, and badly where a single firm controls an essential service. That is why water and energy monopolies are regulated rather than left alone.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 2
A reason for government intervention in the workings of the economy is to attempt to correct for market failure. Sometimes, though, government failure may occur. What is not a possible reason for government failure?
Answer: B.
Government failure means intervention leaving the outcome worse than it found it, or at least failing to improve it, so a genuine cause has to be a reason the intervention goes wrong. Decisions made on out-of-date information are one, because a policy calibrated to conditions that have already passed can push the economy in the wrong direction. Difficulty in judging the extent of a market failure is another, since a tax or subsidy set at the wrong size overcorrects or undercorrects and creates a new distortion. Being unable to respond quickly when circumstances change is a third, and it is why policy is often said to arrive with a lag that can make a cycle worse. Making decisions that reduce negative externalities is not a cause of anything going wrong; it is the intervention doing precisely what it was designed to do, which makes it government success. The word not in the stem is the whole question, and the single positive statement among four problems is the one to pick.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 3
What will result from a government’s decision to allow health care to be provided entirely by market forces?
Answer: D.
Handing a market entirely to market forces guarantees one thing and one thing only: price will adjust until the quantity people want to buy equals the quantity suppliers want to sell. An equilibrium will be reached. That is D, and notice how modest a claim it is, an equilibrium is not the same as a good outcome. A is wrong because health care is not a public good: one person's operation uses up a surgeon's time, so it is rival, and people who do not pay can be excluded, so it is excludable. B fails because a market allocates by willingness AND ability to pay, so those who cannot afford treatment get less of it, not more. C has it backwards: health care in a free market suffers from imperfect information and large external benefits such as vaccination, so removing the government makes market failure worse rather than eliminating it.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 4
Which statement is the most valid reason for government intervention in a free market economy?
Answer: B.
Intervention is justified where the free market fails to reach the socially efficient outcome, and health and education are the classic merit goods: individuals undervalue the benefit to themselves and take no account of the external benefits a healthier, better educated population confers on everyone else, so the market quantity falls short of the social optimum. Under-provision of exactly these two services is therefore the market failure among the four statements. Consumers being well informed is a condition for markets to work properly rather than a fault in them, and thin producer profits are not in themselves a failure of resource allocation. Profit maximisation is the motive that drives supply towards what consumers want, so treating it as the problem mistakes the mechanism for the malfunction. Many competitive firms and few sole suppliers describes the market structure economists want, since the case for intervention arises from monopoly power, not from its absence.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not AP Economics past-paper material.
Question 5
Why might governments provide free education for children aged 4 to 16 years old?
Answer: A.
Free schooling is the classic response to a merit good, and the defining feature of a merit good is that people undervalue it because they do not fully appreciate what it does for them. A child of four cannot judge the lifetime returns to literacy, and parents may underestimate them too, so left alone the market would deliver less education than is good for either the individual or society. That information failure is A. B has the direction wrong: the problem is UNDER-consumption, not over-consumption. C misapplies the term public good, education is excludable, because a school can turn pupils away, and rival, because a place taken is a place unavailable, so free riding is not the issue. D also inverts the economics: the private benefits of education comfortably exceed the private costs, which is precisely why people are willing to pay for it at all.
These questions are drawn from past Cambridge papers, mapped across to this topic because the concept is the same. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
These are the errors that cost marks on market failure and the role of government, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
Shifting the wrong curve. Check whether the externality arises in production or consumption.
Marking only one quantity. Both the market quantity and the socially optimal quantity must appear.
Recommending "a tax" without stating that it equals the marginal external cost at the optimum.
Putting the deadweight loss triangle on the wrong side of the market quantity in a positive-externality question.
Calling a common resource a public good. Common resources are rival.
Saying the market under-provides a public good when it provides none.
Assuming a price ceiling is always harmful, in a monopoly it can raise output.
Letting a lump-sum tax change the firm's output. It shifts ATC, not MC.