Efficiency and Market Failure: five questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
In the diagram, Q1 is the quantity produced of a good as the result of market forces. (private cost) S2 (social cost) Q1 D Which concept is present at output Q1?
Answer: B.
Two cost curves are drawn because private cost and social cost differ here. The social cost curve sits above the private one, so every unit imposes a cost on somebody outside the transaction, and that gap is a negative externality. Since the market settles where private cost meets demand, Q1 lies beyond the socially optimal quantity.
The other options would each look different on the diagram. A subsidy (A) or a positive externality (C) would put the social curve BELOW the private one. A specific tax (D) shifts the private supply curve itself rather than opening a gap between two separate curves.
The other options would each look different on the diagram. A subsidy (A) or a positive externality (C) would put the social curve BELOW the private one. A specific tax (D) shifts the private supply curve itself rather than opening a gap between two separate curves.
Question 2
The diagram shows the demand for and supply of a good and the marginal social costs (MSC) for that good. Assuming there are no external benefits, which area measures the net social benefit at output OQ?
Answer: B.
Net social benefit is the total benefit to society minus the total cost to society. Area x is the surplus measured against the private cost curve, so it captures only what the buyer and the seller gain between them. Marginal social cost lies above supply, which means production also imposes the external cost shown by y, and that has to be taken off.
Subtracting it once gives x minus y. A leaves the external cost out altogether, C adds it as though harm to third parties were a gain, and D takes off a further area on top, deducting more than the externality actually costs.
Subtracting it once gives x minus y. A leaves the external cost out altogether, C adds it as though harm to third parties were a gain, and D takes off a further area on top, deducting more than the externality actually costs.
Question 3
The diagram shows a production possibility curve (LM) for an economy producing agricultural goods and manufacturing goods. R T S L M manufacturing goods O agricultural goods What can be concluded from the diagram?
Answer: C.
Read off where each point sits. R and S both lie ON the curve, while T lies inside it. A point on the curve means every resource is fully and efficiently used, which is precisely productive efficiency, so C is correct for S. A overreaches: R is also on the curve and so is productively efficient, but ALLOCATIVE efficiency asks whether the particular mix of agricultural and manufactured goods is the one society actually wants, and no diagram of production possibilities can tell you that; it would need information about preferences. B fails because T lies inside the curve, so resources are idle and more of BOTH goods could be produced; you could make someone better off without making anyone worse off, which is the opposite of Pareto efficiency. D fails because the boundary is bowed outwards rather than straight, and that curvature is exactly what increasing opportunity cost looks like.
Question 4
Transport economists estimate the price elasticity of demand for private car use is very low.
What would be the most effective way of reducing road traffic congestion?
Answer: A.
A very low price elasticity of demand means drivers barely change their behaviour when the cost of driving changes, so any instrument working THROUGH PRICE will shift few journeys off the road. Road pricing in C raises the cost of driving, and with demand that inelastic most motorists simply pay the charge and carry on. Subsidising bicycles in B and public transport in D lowers the price of the alternatives, but a driver whose demand for car use is so unresponsive is not the sort of buyer who changes mode for a fare cut. What is left is direct regulation, and banning private cars and lorries from town centres removes the journeys by prohibition rather than by persuasion, which works whatever the elasticity, so A is the most effective. The general lesson is to match the instrument to the elasticity, because price-based policies need a responsive demand curve before they can bite.
Question 5
The production of a firm which operates in an imperfectly competitive market gives rise to external production costs. Which statement about this firm must be correct?
Answer: C.
Social cost is private cost plus external cost. If production generates an external cost then that component is positive, so the social cost of each unit has to exceed the private cost the firm itself pays. This follows from the definition and needs nothing further from the question.
The other options all claim more than the question supports. Nothing has been said about external BENEFITS, so A cannot be judged either way. B reverses the relationship, which would need a negative external cost. D compares social cost with social benefit, which is a claim about whether output is too high, and that depends on the size of the externality rather than on its existence.
The other options all claim more than the question supports. Nothing has been said about external BENEFITS, so A cannot be judged either way. B reverses the relationship, which would need a negative external cost. D compares social cost with social benefit, which is a claim about whether output is too high, and that depends on the size of the externality rather than on its existence.
What this practice covers
These questions are drawn from past CIE 9708 papers and filtered to efficiency and market failure. 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.
What examiners see students get wrong here
These are the errors that cost marks on efficiency and market failure, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- “All market equilibria are allocatively efficient”. Only if market demand and supply reflect all social benefits and costs and market power/information problems are absent.
- “P = MC always proves allocative efficiency”. The MC may be private rather than social, and price may not equal marginal social benefit.
- “On the PPC means allocatively efficient”. It proves productive efficiency for the stated constraints, not that society prefers that product mix.
- “Pareto optimal means fair”. The criterion is silent on equality and distribution.
- “Dynamic efficiency means only lower LRAC”. It also includes better quality, new products, cleaner processes and future capabilities.
- “Merit goods are public goods”. Merit goods are underconsumed because benefits are underestimated or information is imperfect. Pure public goods are non-rival and non-excludable.
- “Government provision proves market failure has been solved”. Intervention can itself be poorly designed. Government failure is examined in Topic 8.1.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Efficiency and Market Failure revision notes.