Market Failure: three 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
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:
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.
Question 2
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 3
Which characteristics of a product will cause market failure?
Answer: C.
The correct answer is C: the product is non-rival and non-excludable.
Those two properties define a public good, and they cause complete market failure. Non-excludability means a supplier cannot prevent a non-payer from consuming, so everyone has an incentive to free-ride and wait for someone else to pay. With no revenue obtainable, a profit-seeking firm supplies nothing at all: provision falls to zero rather than merely being too low. Non-rivalry means one person's consumption leaves as much available for everyone else, so charging would be inefficient even if it were possible.
Why the other options describe conditions where markets work well:
Those two properties define a public good, and they cause complete market failure. Non-excludability means a supplier cannot prevent a non-payer from consuming, so everyone has an incentive to free-ride and wait for someone else to pay. With no revenue obtainable, a profit-seeking firm supplies nothing at all: provision falls to zero rather than merely being too low. Non-rivalry means one person's consumption leaves as much available for everyone else, so charging would be inefficient even if it were possible.
Why the other options describe conditions where markets work well:
- A, information known equally by consumers and producers, is symmetric information. Information failure causes market failure; its absence does not.
- B, consumption having no external benefits, means there are no positive externalities to be under-priced, so private and social benefit coincide.
- D, production having no external costs, means there are no negative externalities, so private and social cost coincide.
What this practice covers
These questions are drawn from past Cambridge IGCSE papers and filtered to 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 market failure, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Saying market failure means the market "stopped working". It means resources are allocated badly.
- Giving only one feature of a public good. Both non-excludable and non-rival are needed.
- Confusing merit goods with public goods. Merit goods are rival and excludable.
- Saying the market produces too little of a demerit good, it produces too much.
- Forgetting that externalities affect third parties, not the buyer or seller.
- Listing government policies without saying a drawback of any of them.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Market Failure revision notes.