These are original Marlbridge practice questions, not past exam questions. The mark points are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. All markets and data are fictional. A four-function calculator is enough.
Question 1 (multiple choice · foundation)
Which of the following is an example of a positive consumption externality?
- (A) A homeowner repaints the front of her house, making the whole street more pleasant for her neighbours.
- (B) A bakery’s ovens warm the flat above it, cutting the tenant’s heating bills.
- (C) Exhaust fumes from commuters’ cars harm the health of people walking nearby.
- (D) Many homeowners buy paint at once, so the price of paint rises for everyone.
Answer and explanation
Answer: (A). The homeowner is consuming (using) the paint, and the benefit to neighbours is not paid for. MSB is above MPB.
- (B) is a positive externality, but it comes from production (the bakery making bread), not consumption.
- (C) is a negative consumption externality: a cost on third parties.
- (D) is a price change passed through the market. Price changes are not externalities, because the market records them.
Question 2 (multiple choice · core)
A competitive market has a negative production externality and no government action. Compared with the socially optimal outcome, the market
- (A) produces too much and charges too low a price.
- (B) produces too much and charges too high a price.
- (C) produces too little and charges too high a price.
- (D) produces the optimal quantity, but third parties are harmed.
Answer and explanation
Answer: (A). Sellers ignore the external cost, so supply (MPC) lies below MSC. The market meets demand at a larger quantity and a lower price than where MSC meets demand.
- (B) gets the quantity right but the price wrong. A lower cost curve meets the downward-sloping demand curve at a lower price.
- (C) describes a monopoly (or a positive production externality), not a negative externality in a competitive market.
- (D) Harm alone does not make a quantity optimal or not. The market quantity is too large because units with MSC > MSB are produced.
Question 3 (multiple choice · core)
Tanneries in Varn, a fictional region, form a competitive market. Demand is P = 45 − Q and MPC = 5 + Q, where Q is thousands of hides per month and P is dollars per hide. Waste from tanning causes a constant marginal external cost of $8 per hide. Which policy reaches the socially optimal quantity, and what happens to output?
- (A) A per-unit tax of $8; output falls from 20 to 16 thousand hides.
- (B) A per-unit tax of $8; output falls from 20 to 12 thousand hides.
- (C) A per-unit tax of $16; output falls from 20 to 16 thousand hides.
- (D) A per-unit subsidy of $8; output rises from 20 to 24 thousand hides.
Answer and explanation
Answer: (A). Market: 45 − Q = 5 + Q gives Q = 20. MSC = 13 + Q, so the optimum is 45 − Q = 13 + Q, giving Q = 16. A tax equal to the MEC ($8) makes sellers’ cost line equal to MSC, so output falls to 16.
- (B) has the right tax but the wrong quantity: 12 would need a tax of $16.
- (C) A $16 tax is twice the MEC. It would cut output to 12, below the optimum.
- (D) A subsidy increases output, which makes overproduction worse.
Question 4 (calculation · core)
In Dunhallow, a fictional town, fireworks are sold in a competitive market. Q is thousands of boxes per year; P is dollars per box.
MPB = 90 − 2Q MPC = MSC = 10 + 2Q
The noise and litter from each box used impose a constant cost of $12 on neighbours.
(a) Find the market quantity and price. (b) Find the socially optimal quantity. (c) Calculate the deadweight loss. (d) The town charges buyers a tax of $12 per box. Find the new quantity, the price sellers receive, the price buyers pay including the tax, and the tax revenue.
Worked solution
(a) 90 − 2Q = 10 + 2Q gives 4Q = 80: Qm = 20 thousand boxes at $50.
(b) This is a negative consumption externality, so MSB = MPB − 12 = 78 − 2Q. Setting 78 − 2Q = 10 + 2Q gives 4Q = 68: Qs = 17 thousand boxes.
(c) At Qm = 20: MSC = 10 + 40 = $50 and MSB = 78 − 40 = $38. DWL = ½ × (20 − 17) × (50 − 38) = ½ × 3 × 12 = $18 thousand per year.
(d) The tax lowers what buyers will pay sellers by $12, so 78 − 2Q = 10 + 2Q again: Q = 17 thousand. Sellers receive $44; buyers pay 44 + 12 = $56 per box in total. Revenue = 12 × 17 = $204 thousand.
Suggested mark points (4): 1 for Qm = 20 and P = $50; 1 for MSB = 78 − 2Q and Qs = 17; 1 for DWL = $18 thousand; 1 for Q = 17, $44, $56 and $204 thousand.
Common error: adding the $12 to MPC. The cost falls on neighbours because of how buyers use fireworks, so it lowers the benefit curve, not the cost curve. In this case the quantities come out the same, but the graph must show MSB below MPB.
Question 5 (graph · core)
Beekeepers in a fictional valley sell honey in a competitive market. Their bees also pollinate nearby fruit orchards, which raises the orchards’ output. The orchards pay the beekeepers nothing.
(a) Draw a correctly labelled graph of the honey market showing the market quantity Qm, the socially optimal quantity Qs and the deadweight loss. (b) Identify a per-unit policy that would move the market to Qs, and show its effect on your graph. (c) Explain why the beekeepers produce Qm rather than Qs.
Model answer and suggested Marlbridge rubric
(a) Axes: “Price, benefit or cost ($ per jar)” and “Quantity of honey (jars per year)”. A downward-sloping D = MPB = MSB. An upward-sloping S = MPC. MSC lies below MPC by the marginal external benefit, because each jar also brings a benefit to orchards. Qm is where D meets MPC; Qs, to the right, is where D meets MSC. Shade the triangle between D (MSB) and MSC from Qm to Qs, pointing to where they cross.
(b) A per-unit subsidy to beekeepers equal to the marginal external benefit at Qs. It shifts the supply curve down to MSC, so the market quantity rises to Qs and the DWL disappears.
(c) Beekeepers are rational. They produce where the price equals their private marginal cost and do not count the benefit to the orchards, because they receive nothing for it. So for units between Qm and Qs, MSB is above MSC, but the beekeepers do not produce them.
| Point | What earns it |
|---|---|
| 1 | Correctly labelled axes, D, S = MPC and MSC below MPC |
| 1 | Qm < Qs, with DWL shaded between Qm and Qs |
| 1 | Per-unit subsidy that shifts supply down to MSC, giving Qs |
| 1 | Beekeepers respond to private cost and ignore the benefit to orchards |
Also accept a graph that shows the externality as MSB above demand, if it is clearly labelled and explained as the orchards’ benefit.
Question 6 (constructed response · core)
A fictional dye factory upstream releases waste into a river. It could install a filter that costs $40 thousand a year. The waste costs a fish farm downstream $25 thousand a year. They are the only two parties and can bargain at no cost.
(a) Is it efficient to install the filter? Explain. (b) The fish farm has the legal right to clean water. What happens? (c) The damage to the fish farm is now $60 thousand a year, and the factory has the legal right to release waste. What happens? (d) Explain why private bargaining is unlikely to work if the waste instead harms 500 small fishing households.
Model answer and suggested Marlbridge rubric
(a) No. The filter costs $40 thousand but prevents only $25 thousand of damage. Society would lose $15 thousand a year by installing it.
(b) The factory must either stop the damage or pay for it. Paying the fish farm $25 thousand (or more, up to $40 thousand, for permission to release waste) is cheaper than the $40 thousand filter. The factory pays and keeps releasing waste. No filter, which is efficient.
(c) Now the filter ($40 thousand) costs less than the damage ($60 thousand), so the efficient outcome is to install it. The fish farm can pay the factory between $40 thousand and $60 thousand to install the filter, and both gain. The filter is installed.
(d) Finding and organising 500 households costs time and money: transaction costs are high. Each household also gains from cleaner water whether or not it contributes, so each has an incentive to free ride. The bargain is unlikely to happen, so regulation or a per-unit tax on the waste may be needed.
| Point | What earns it |
|---|---|
| 1 | (a) Not efficient: $40 thousand cost > $25 thousand damage avoided |
| 1 | (b) Factory pays compensation (or buys permission), no filter |
| 1 | (c) Fish farm pays the factory between $40 thousand and $60 thousand; filter installed |
| 1 | States that bargaining reaches the efficient outcome in both (b) and (c); with low transaction costs, who holds the right only decides who pays whom |
| 1 | (d) High transaction costs and/or free riding prevent bargaining |
Question 7 (explanation · stretch)
Fertiliser plants in the fictional Calloway Basin form a competitive market. Q is thousands of tonnes per year; P is dollars per tonne.
MPB = MSB = 70 − Q MPC = 10 + Q
Run-off harms the basin’s lakes, and the harm per tonne rises as output rises: MEC = 0.5Q.
(a) Find the market and socially optimal quantities and prices. (b) Calculate the DWL at the market quantity. (c) Find the per-unit tax that achieves the optimal quantity, and show that it works. (d) A classmate proposes a tax of $15, the MEC at the market quantity. Find the quantity and the DWL that result, and explain the mistake.
Model answer and suggested Marlbridge rubric
(a) Market: 70 − Q = 10 + Q gives Qm = 30 thousand tonnes at $40. MSC = 10 + Q + 0.5Q = 10 + 1.5Q. Optimum: 70 − Q = 10 + 1.5Q gives 2.5Q = 60, so Qs = 24 thousand tonnes at $46.
(b) At 30: MSC = 10 + 45 = $55 and MSB = $40. DWL = ½ × (30 − 24) × (55 − 40) = ½ × 6 × 15 = $45 thousand per year.
(c) Tax = MEC at Qs = 0.5 × 24 = $12 per tonne. Sellers then face 22 + Q. Setting 70 − Q = 22 + Q gives Q = 24 ✓. Buyers pay $46, the same as MSB = MSC at the optimum.
(d) With a $15 tax, sellers face 25 + Q: 70 − Q = 25 + Q gives Q = 22.5 thousand tonnes, below the optimum. At 22.5, MSB = $47.50 and MSC = 10 + 33.75 = $43.75. DWL = ½ × (24 − 22.5) × (47.50 − 43.75) = ½ × 1.5 × 3.75 = $2.81 thousand (to 2 decimal places). The mistake: the MEC at the market quantity is larger than at the optimal quantity, because the harm per tonne rises with output. Taxing at $15 overcorrects, so now too little is produced.
| Point | What earns it |
|---|---|
| 1 | Qm = 30 at $40 |
| 1 | MSC = 10 + 1.5Q and Qs = 24 at $46 |
| 1 | DWL = $45 thousand |
| 1 | Tax = $12 (MEC at Qs), with a check that Q = 24 |
| 1 | $15 tax gives Q = 22.5 and a new DWL of about $2.81 thousand |
| 1 | Explains that the tax must equal MEC at Qs, not at Qm, when MEC rises with output |
Allow follow-through in (b) to (d) from an incorrect MSC line in (a).
How did you do?
- Q1 or Q2 wrong: re-read “What an externality is” and “Negative externalities on a graph” in the study guide.
- Q3, Q4 or Q7 wrong: re-read Worked examples 1 and 2 and the policy table. Check which curve moves and where you measure the MEC.
- Q5 graph marked down: compare with Figures 1 and 2, and label every curve, Qm, Qs and the DWL.
- Q6 incomplete: re-read Worked example 3.
Then tick off the topic checklist.