Externalities & Common Pool Resources: 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 CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 1
Assuming there are no externalities, where would a nationalised firm set output to maximise social welfare?
Answer: B.
The correct answer is B: where average revenue equals marginal cost.
Social welfare is maximised at the allocatively efficient output, where price equals marginal cost. Average revenue is price, total revenue divided by quantity, so the condition AR = MC is the same statement as P = MC. At that output, the value consumers place on the last unit exactly equals the resources used to produce it, so the combined consumer and producer surplus is at its maximum. With no externalities, as the question specifies, private and social costs coincide, so marginal cost is the correct social measure.
Why the other options are wrong:
Social welfare is maximised at the allocatively efficient output, where price equals marginal cost. Average revenue is price, total revenue divided by quantity, so the condition AR = MC is the same statement as P = MC. At that output, the value consumers place on the last unit exactly equals the resources used to produce it, so the combined consumer and producer surplus is at its maximum. With no externalities, as the question specifies, private and social costs coincide, so marginal cost is the correct social measure.
Why the other options are wrong:
- C, MR = MC, is the profit-maximising condition. For a firm facing a downward-sloping demand curve, MR lies below AR, so this output is lower and the price higher than the welfare-maximising level. It is what an unregulated monopoly would choose, and precisely what nationalisation is meant to avoid.
- D, MR = 0, is the revenue-maximising output. It gives more output than profit maximisation but still not the allocatively efficient quantity.
- A, AR = AC, is the break-even or normal-profit output. It ensures the firm covers its costs, and it is a common regulatory target because it avoids a subsidy, but with a downward-sloping average cost curve it does not equate price with marginal cost, so it is not welfare-maximising.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 2
A government makes it compulsory for motorbike riders to wear helmets.
What would represent a positive externality of consumption associated with this decision?
Answer: A.
The correct answer is A: decreased pressure on the provision of health care.
A positive externality of consumption is a benefit enjoyed by third parties as a result of someone else's consumption decision. When riders wear helmets, head injuries fall, so fewer hospital beds, surgeons and rehabilitation resources are absorbed by motorcycle casualties. Those resources become available for other patients, and taxpayers bear a smaller burden, benefits accruing to people who had no part in the decision to wear a helmet. That third-party gain is what makes it external.
Why the other options are wrong:
A positive externality of consumption is a benefit enjoyed by third parties as a result of someone else's consumption decision. When riders wear helmets, head injuries fall, so fewer hospital beds, surgeons and rehabilitation resources are absorbed by motorcycle casualties. Those resources become available for other patients, and taxpayers bear a smaller burden, benefits accruing to people who had no part in the decision to wear a helmet. That third-party gain is what makes it external.
Why the other options are wrong:
- B, surveillance expenses, is a cost of enforcing the policy, and a cost rather than a benefit in any case.
- C, increased life expectancy of the riders, is the sharpest distractor. It is a real and large benefit, but it accrues to the rider: the person doing the consuming, so it is a private benefit, not an external one. The whole reason the government has to make helmets compulsory is that riders underweight this private benefit; if it were external, the argument would be different.
- D, higher profits for helmet manufacturers, is a private benefit to the producers, arising from an ordinary market transaction rather than as a spillover.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 3
The table shows the marginal costs of production and marginal benefits of consumption. marginal private marginal social marginal private marginal social cost ($) cost ($) benefit ($) benefit ($) 100 150 150 200 What is demonstrated in these values?
Answer: D.
Read which side of the table each divergence sits on. Marginal social cost ($150) exceeds marginal private cost ($100), so production imposes costs on third parties, a negative production externality. Marginal social benefit ($200) exceeds marginal private benefit ($150), so consumption confers benefits on third parties, a positive consumption externality.
B is the trap, and half the candidates took it: the positive divergence is real, but it is on the BENEFIT side, and benefits are consumed rather than produced. A positive production externality would show marginal social cost BELOW marginal private cost, which is not what these values show. A fails for the mirror-image reason, a negative consumption externality would need marginal social benefit below marginal private benefit.
With a divergence on both sides the market quantity cannot be the social optimum, so resources are misallocated: D. Pareto optimality (C) would require private and social values to coincide.
B is the trap, and half the candidates took it: the positive divergence is real, but it is on the BENEFIT side, and benefits are consumed rather than produced. A positive production externality would show marginal social cost BELOW marginal private cost, which is not what these values show. A fails for the mirror-image reason, a negative consumption externality would need marginal social benefit below marginal private benefit.
With a divergence on both sides the market quantity cannot be the social optimum, so resources are misallocated: D. Pareto optimality (C) would require private and social values to coincide.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 4
A government removes a subsidy on a rural school bus service.
What is the effect of this on the market for this bus service?
Answer: B.
The correct answer is B: private marginal costs increase.
A subsidy lowers the cost the producer actually bears. Removing it means the bus operator must once again meet the full cost of running the service from its own resources, so private marginal cost rises back to the level of the true resource cost. Supply shifts left, fares rise and the quantity of bus travel falls.
Why the other options are wrong:
A subsidy lowers the cost the producer actually bears. Removing it means the bus operator must once again meet the full cost of running the service from its own resources, so private marginal cost rises back to the level of the true resource cost. Supply shifts left, fares rise and the quantity of bus travel falls.
Why the other options are wrong:
- A says deadweight loss decreases. A rural school bus service generates positive externalities: less car traffic, reduced congestion and emissions, and access to education for children who would otherwise struggle to attend. Social benefit therefore exceeds private benefit, and the service is already under-consumed in a free market. Removing the subsidy moves output further below the social optimum, so deadweight loss increases.
- C says private marginal benefit decreases. The benefit passengers derive from a bus journey is unchanged by the funding arrangement; what changes is the price they must pay for it.
- D says social marginal costs decrease. The real resources consumed by running the bus, fuel, driver's time, vehicle wear, are exactly the same whether or not a subsidy exists. A subsidy transfers who pays the cost; it does not alter the cost itself.
Cross-board concept practice · originally a CIE 9708 question, used here because the concept is the same. It is not IB Economics past-paper material.
Question 5
The table shows the marginal costs of production and marginal benefits of consumption. marginal private cost ($) marginal social cost ($) marginal private benefit ($) marginal social benefit ($) 100 150 150 200 What is demonstrated in these values?
Answer: D.
Marginal social cost ($150) exceeds marginal private cost ($100), so production imposes a cost on third parties, a negative production externality. Marginal social benefit ($200) also exceeds marginal private benefit ($150), so consumption confers a benefit on third parties, a positive consumption externality. Because both diverge, the private optimum where MPC = MPB is not the social optimum where MSC = MSB, and resources are misallocated. A and B each name the wrong type of externality, and C is ruled out precisely because the private and social values differ.
What this practice covers
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.
What examiners see students get wrong here
These are the errors that cost marks on externalities & common pool resources, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Mislabelling the MSC/MSB diagram, or shading the welfare-loss triangle on the wrong side of the social optimum.
- Confusing production with consumption externalities. Check whether the third-party effect arises from making the good or from using it.
- Saying "the market fails" without identifying which curve diverges and in which direction.
- Presenting one policy as a complete fix. Every policy question wants trade-offs.
- Describing a common pool resource as a public good. Public goods are non-rival; common pool resources are rival, which is exactly why they are depleted.
- Recommending a tax without saying how large it should be.
- Treating a tax on output as equivalent to a tax on emissions.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Externalities & Common Pool Resources revision notes.