The Role of Markets in Allocating Resources: 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 a private market system certain goods and services would not be available unless the government intervened. What does this identify in a private market?
Answer: C.
If a market will not supply something people need unless a government steps in, then the market on its own is not allocating resources to where society values them, and that is exactly what market failure means. The usual reason is that the good is a public good, non-excludable so that nobody can be made to pay and everybody can free-ride, or a merit good that people under-consume because they undervalue its long-term benefit. Either way the intervention is the response and the failure is what is being identified. Market structure describes how competitive an industry is, whether one firm dominates or many compete, so it is a description of the market rather than a judgement about the outcome. Market equilibrium is the position where quantity supplied equals quantity demanded, and a market can be in perfect equilibrium while still failing society. Market distribution concerns who ends up with the goods, which is a question of equity rather than of whether the good is supplied at all.
Question 2
What is the function of the price mechanism in a market economy?
Answer: A.
Prices carry information and incentives: they signal what consumers want, ration scarce goods, and direct resources towards the uses people value most. Allocating resources and guiding choice is therefore the price mechanism's function. Fairness is not part of it, markets allocate to those willing and able to pay, and price stability is a government objective rather than something the mechanism delivers.
Question 3
What is an essential feature of a market economy?
Answer: D.
In a market economy the price mechanism does the allocating: prices signal what is scarce and what is wanted, and producers and consumers respond. Central planning describes a COMMAND economy, and equality of distribution is not something markets aim at. Note that market prices reflect private costs only, leaving out external costs is precisely why market failure occurs.
Question 4
To help reduce the price of oil, new supplies are needed. However, objectors oppose exploration of new sites because of the environmental damage it may cause. Why is this statement an example of the basic economic problem?
Answer: A.
The correct answer is A: oil is a limited resource.
The basic economic problem is scarcity: limited resources against unlimited wants, and the passage illustrates it directly. The world wants more oil than is currently available, which is why the price is high and new supplies are sought. Because the resource is limited, society faces a choice it cannot avoid: extract more oil and accept environmental damage, or protect the environment and accept less oil. Both are wanted; both cannot be had in full.
Why the other options are wrong:
The basic economic problem is scarcity: limited resources against unlimited wants, and the passage illustrates it directly. The world wants more oil than is currently available, which is why the price is high and new supplies are sought. Because the resource is limited, society faces a choice it cannot avoid: extract more oil and accept environmental damage, or protect the environment and accept less oil. Both are wanted; both cannot be had in full.
Why the other options are wrong:
- D, external costs in production, is a genuine feature of the scenario, the environmental damage falls on people outside the transaction. But an externality is a market failure, a separate concept from the basic economic problem, and it explains why the market may get the quantity wrong rather than why a choice must be made at all.
- C, involving demand and supply, describes the mechanism through which the market responds to scarcity, not the problem itself.
- B, oil being expensive, is a symptom. The price is high because the resource is scarce, so this states the consequence rather than the cause.
Question 5
In a free market, market failure causes a misallocation of resources. What is not an example of market failure?
Answer: B.
Market failure means the market mechanism itself allocates resources wrongly for SOCIETY, so the test is whether the price signal misses something that matters to people outside the transaction. A, C and D all pass that test: external costs of production fall on third parties who never chose to bear them, demerit goods are over-consumed because buyers undervalue the harm, and merit goods are under-consumed because buyers undervalue benefits that arrive years later. Internal diseconomies of scale are a different kind of problem entirely, because they arise inside ONE firm that has grown too large to coordinate, so its average costs rise. That is a management failure that hurts the firm and its shareholders, and the market corrects it by leaving room for smaller rivals, so no misallocation of society's resources follows.
What this practice covers
These questions are drawn from past Cambridge IGCSE papers. 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 the role of markets in allocating resources, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Saying a market must be a physical place.
- Giving only one or two functions of price when the question asks about its role.
- Confusing signalling with incentive. Signalling gives information; incentive gives a reason to act.
- Saying the market allocates to those who need goods. It allocates to those who can pay.
- Describing the price change without explaining the functions.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: The Role of Markets in Allocating Resources revision notes.