Policies to Correct 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 2020, the governor of California issued an order to ban the sale of new vehicles from 2035 that are powered by petrol or diesel fuel. Which type of government policy is this?
Answer: D.
The correct answer is D) regulation.
Explanation:
A nudge is a concept in behavioural economics where positive reinforcement and indirect suggestions are used to influence people's behaviour and decision-making.
A permit to pollute is a concept that allows a company or entity to pollute within set limits or standards in exchange for obtaining a permit.
Nationalisation is the process of a government taking control and ownership of private industry or assets.
In this scenario, the governor of California issues an order to ban the sale of new vehicles powered by petrol or diesel fuel. This action is a form of regulation as it imposes a rule or restriction on the type of vehicles that can be sold in the state. Regulations are government policies that establish rules and standards to guide and control behaviour in specific areas such as environmental protection, public health, or safety.
Therefore, the correct answer is D) regulation, as the ban on the sale of petrol or diesel-powered vehicles is a regulatory action aimed at promoting the use of cleaner, more sustainable transportation options in California.
Explanation:
A nudge is a concept in behavioural economics where positive reinforcement and indirect suggestions are used to influence people's behaviour and decision-making.
A permit to pollute is a concept that allows a company or entity to pollute within set limits or standards in exchange for obtaining a permit.
Nationalisation is the process of a government taking control and ownership of private industry or assets.
In this scenario, the governor of California issues an order to ban the sale of new vehicles powered by petrol or diesel fuel. This action is a form of regulation as it imposes a rule or restriction on the type of vehicles that can be sold in the state. Regulations are government policies that establish rules and standards to guide and control behaviour in specific areas such as environmental protection, public health, or safety.
Therefore, the correct answer is D) regulation, as the ban on the sale of petrol or diesel-powered vehicles is a regulatory action aimed at promoting the use of cleaner, more sustainable transportation options in California.
Question 2
A cost-benefit analysis is carried out on the construction of a hydroelectric power station.
Which combination of circumstances would be most likely to lead to the scheme being approved?
Answer: B.
Cost-benefit analysis exists precisely because a private calculation misses the effects a project has on everyone else, so it works with SOCIAL totals: private costs plus external costs on one side, private benefits plus external benefits on the other. A hydroelectric scheme is approved when social benefits exceed social costs, which is the condition that the project makes society as a whole better off. A is the firm's own commercial test rather than society's, and a scheme can pass it while imposing large external costs on people downstream. C compares a social figure with a total cost figure that is not defined on the same basis, so the two sides are not measuring the same thing. D compares costs with revenue rather than with benefits, and revenue captures only what people pay rather than the value they receive.
Question 3
Assuming there are no externalities, where would a nationalised firm set output to maximise social welfare?
Answer: B.
Maximising social welfare means producing right up to the point where the value society places on the last unit equals what that unit costs to produce, in other words price equals marginal cost. Since average revenue IS price, that condition is written AR = MC, which is B. C is the profit-maximising rule, and a nationalised firm pursuing social welfare is precisely not doing that; because marginal revenue lies below average revenue for a downward-sloping demand curve, MR = MC gives a smaller output and a higher price than society would want. D would maximise total revenue, which is a different objective again. A is the break-even condition, where the firm covers its costs and makes normal profit, but there is no reason why that output should be the socially optimal one.
Question 4
Which government policy would not be classified as regulation?
Answer: D.
Regulation works by RULE: it bans, requires or licenses a particular behaviour, and ignoring it carries a legal penalty rather than a price. A, B and C are all of that kind, since a ban on heroin and cocaine forbids consumption outright, compulsory seatbelts require an action, and licences for water extraction permit an activity only to those who hold one. Taxing cigarettes and tobacco does none of these things, because it leaves the choice entirely with the smoker and simply makes one option dearer. That makes it a market-based instrument, which works through the price mechanism and lets individuals decide how much to change their behaviour, and it is the standard alternative to regulation rather than an example of it.
Question 5
What is a key difference between the use of cost-benefit analysis in public-sector investment projects compared with its use in private-sector investment projects?
Answer: D.
Cost-benefit analysis differs from private appraisal because it counts EXTERNAL effects, noise, congestion, landscape, health, and most of those are never traded, so no market price exists for them. Valuing them requires estimation, which is where the uncertainty comes from. Both sectors face risk and both have benefits arriving in the future, so those cannot be the distinguishing feature.
What this practice covers
These questions are drawn from past CIE 9708 papers and filtered to policies to correct 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 policies to correct market failure, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Treating tax revenue as the measure of success rather than the change in quantity.
- Applying a tax to a positive externality, or a subsidy to a negative one.
- Setting the correction equal to the externality at the free market output rather than at the optimum.
- Asserting that a policy "will solve" the failure with no conditions attached.
- Confusing efficiency arguments with equity arguments.
- Describing a diagram without stating what happens to price, quantity and welfare loss.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Policies to Correct Market Failure revision notes.