Edexcel IAL Economics: Externalities and public goods as sources of market failure (YEC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions are aligned to the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018, section 1.3.5 Market failure, items 1 to 3, in Unit 1: Markets in action (International AS content, also part of the full IAL). All countries, firms and figures are invented. Use the study guide if a topic is new. Useful links: the Edexcel economics hub, the printable checklist and the free 10-minute diagnostics.

Questions

1. Distinguish between private cost and social cost. [3]

2. For each of the following, state whether it is a public good or a private good, and give a reason using rivalry and excludability.

(a) A seat in a cinema. [1] (b) A flood-warning siren heard across a whole town. [1] (c) A loaf of bread. [1] (d) A free-to-air radio signal that anyone with a receiver can pick up. [1]

3. A paper mill in Country A sells paper to printers. All figures are in currency units per tonne. Demand (MPB, equal to MSB) is 120 - 4Q. The mill’s private cost (MPC) is 30 + 2Q. Smoke adds an external cost (MEC) of 18 per tonne.

(a) Find the market output and price. [2] (b) Find the socially optimal output and the price consumers would pay at that output. [2] (c) Calculate the welfare loss. [2] (d) Explain why the welfare loss differs from the total external cost at the market output. [2]

4. A dental scheme in Country G offers check-ups. Per check-up: MPB = 96 - 4Q and MC = 16 + Q. Healthier mouths reduce the spread of some infections to others, giving MEB = 10 per check-up.

(a) Find the market output and price. [2] (b) Find the socially optimal output. [2] (c) Calculate the welfare gain from reaching the social optimum. [2] (d) Explain one reason why the welfare gain might be uncertain. [2]

5. Six harbour-side households in Country H share a fog signal that costs 90 to install. The households’ maximum willingness to pay is 30, 25, 20, 15, 12 and 8.

(a) Show that installing the fog signal would be worthwhile for the households as a whole. [2] (b) Explain why a private firm is unlikely to provide it. [3]

6. A bridge in Country J carries n trips per hour. Demand (MPB) is 45 - 0.05n. The average private cost per trip is 15 + 0.05n, so each extra driver slows everyone else and marginal social cost is MSC = 15 + 0.1n.

(a) Find the number of trips in a free market and the external cost per trip at that level. [2] (b) Find the socially optimal number of trips. [3] (c) Calculate the welfare loss at the market level. [2]

7. State whether each of the following is an external cost of production, an external cost of consumption, an external benefit of production or an external benefit of consumption, and give a reason.

(a) Train passengers talk loudly on their phones. [1] (b) A research hospital develops a technique that other hospitals copy free. [1] (c) Night-time freight lorries from a depot wake people living nearby. [1] (d) A household keeps its front garden attractive and the whole street gains. [1]

8. Explain how the failure of one lender could impose external costs on households and firms with no dealings with it. [6]

9. A firm in Country K produces a good. The table shows the marginal private benefit (MPB) and marginal private cost (MPC) of each unit. Each unit also imposes an external cost of 8.

Unit	1	2	3	4	5	6
MPB	50	44	38	32	26	20
MPC	14	20	26	32	38	44

(a) State the quantity produced in a free market. [2] (b) State the socially optimal quantity. [2] (c) Calculate the total external cost at each of these two quantities. [2] (d) Calculate the welfare loss from the market outcome and explain why it arises. [2]

10. A beach in Country L has free open access and is busy in summer. Explain whether it meets the specification’s definition of a public good. [4]

11. Evaluate the view that the market provides too little education because of externalities. [12]

Answers

1. Private cost is the cost paid by the consumer or producer directly involved [1]. Social cost is private cost plus external cost [1]. External cost falls on third parties who are not compensated, so social cost exceeds private cost whenever one exists [1]. [3] Examiner insight: State the relationship (social = private + external) and name who bears the external part.

2. (a) Private good: rival (one viewer takes the seat) and excludable (no ticket, no entry) [1]. (b) Public good: non-rival (one household hearing it does not reduce another’s warning) and non-excludable [1]. (c) Private good: rival and excludable [1]. (d) Public good: non-rival and non-excludable [1]. [4] Examiner insight: A bare label with no reason is hard to reward. Name both properties.

3. (a) Set MPB = MPC: 120 - 4Q = 30 + 2Q, so 6Q = 90 and Q = 15 tonnes [1]. Price = 120 - 60 = 60 [1]. (b) MSC = 30 + 2Q + 18 = 48 + 2Q. Set MSB = MSC: 120 - 4Q = 48 + 2Q, so 6Q = 72 and Q = 12 tonnes [1]. Price = 120 - 48 = 72 [1]. (c) At Q = 15, MSC = 48 + 30 = 78 and MSB = 60, a gap of 18 [1]. Area = 0.5 x (15 - 12) x 18 = 27 [1]. (d) Total external cost = 18 x 15 = 270 [1]. The welfare loss counts only the net loss on tonnes 13 to 15, so it is far smaller [1]. [8] Examiner insight: Show the equation you set equal and the line MSC = MPC + MEC.

4. (a) Set MPB = MC: 96 - 4Q = 16 + Q, so 5Q = 80 and Q = 16 [1]. Price = 16 + 16 = 32 [1]. (b) MSB = 96 + 10 - 4Q = 106 - 4Q. Set equal to MC: 106 - 4Q = 16 + Q, so 5Q = 90 and Q = 18 [1]. MC at 18 is 34 [1]. (c) At Q = 16, MSB = 106 - 64 = 42 and MC = 32, a gap of 10 [1]. Area = 0.5 x (18 - 16) x 10 = 10 [1]. (d) The external benefit of 10 is an estimate, because lower infection spread is hard to value in money [1]. A smaller value would shrink the triangle [1]. [8] Examiner insight: In part (d), link the uncertainty to the diagram, the gap between MSB and MPB.

5. (a) Total willingness to pay = 30 + 25 + 20 + 15 + 12 + 8 = 110 [1], which exceeds 90, so net benefit = 20 [1]. (b) The highest single willingness to pay is 30, below 90, so no household buys alone [1]. The signal is non-excludable, so households can free ride [1]. With an equal share of 15, the households valuing it at 12 and 8 would refuse, so only 60 is raised, short of 90 [1]. [5] Examiner insight: Tie free riding to its consequence, non-provision of a good with positive net benefit.

6. (a) Set MPB = private cost: 45 - 0.05n = 15 + 0.05n, so n = 300 [1]. External cost per trip = 0.1 x 300 - 0.05 x 300 = 15 [1]. (b) Set MSB = MSC: 45 - 0.05n = 15 + 0.1n [1], so n = 200 [1]. At n = 200, MSB = MSC = 35 [1]. (c) At n = 300, MSC = 15 + 30 = 45 and MSB = 45 - 15 = 30, a gap of 15 [1]. Area = 0.5 x (300 - 200) x 15 = 750 [1]. [7] Examiner insight: Do not mix average private cost and marginal social cost.

7. (a) External cost of consumption: the noise arises in use and affects other passengers [1]. (b) External benefit of production: others copy the hospital’s technique free [1]. (c) External cost of production: the harm arises as the depot operates [1]. (d) External benefit of consumption: the gain arises from the household’s use of its garden [1]. [4] Examiner insight: Decide making or using, then cost or benefit, and give the reason.

8. Depositors and creditors of the failed lender lose money [1]. Other banks holding its debts suffer losses [1]. Customers of sound banks lose confidence and withdraw savings [1]. Banks lend less, so firms cannot borrow [1]. Output and jobs fall, hurting households with no link to the lender [1]. The lender ignored these costs when taking risks, so social cost exceeds private cost and too much risk is taken [1]. [6] Examiner insight: Follow the chain from lender to named third party to consequence.

9. (a) The market produces while MPB is at least MPC. At unit 4, MPB = MPC = 32 [1], and unit 5 has MPB 26 below MPC 38, so the market quantity is 4 units [1]. (b) MSC = MPC + 8: 22, 28, 34, 40, 46, 52 [1]. Unit 3 has MPB 38 above MSC 34, but unit 4 has MPB 32 below MSC 40, so the optimum is 3 units [1]. (c) Total external cost = 8 x 4 = 32 at the market quantity and 8 x 3 = 24 at the social quantity [1], a difference of 8 [1]. (d) The fourth unit costs society 40 but is worth only 32, so the welfare loss is 8 [1]. The producer ignores the external cost of 8 per unit and produces until private benefit equals private cost [1]. [8] Examiner insight: With discrete data, compare unit by unit and say why you stop where you do.

10. A public good must be non-rival and non-excludable. It is non-excludable if anyone can walk on [1], and non-rival when quiet [1]. In summer, extra visitors reduce others’ space, so it becomes rival [1]. So it is a mixed case rather than a pure public good, and crowding is itself a negative externality [1]. [4] Examiner insight: Test each property separately; a good can pass one test and fail the other.

11. Analysis. An external benefit is a gain to a third party who does not pay [1]. A learner values education for personal gain such as higher pay [1]. Third parties also gain: employers, colleagues and communities with less crime [1]. So MSB lies above MPB [1]. The market quantity is below the social optimum [1]. The welfare gain is the triangle between MSB and MC from the market to the social quantity [1]. Evaluation. The external benefit varies by level and quality of course, so the gap between MSB and MPB may be small [1]. External benefits are hard to measure, so the welfare area is an estimate [1]. Private benefits are often large already, so many people may buy close to the optimum [1]. Some courses create few external benefits [1]. More education has an opportunity cost [1]. A final judgement that education is probably underprovided, by an amount that depends on the evidence, completes the answer [1]. [12] Examiner insight: Build a clear chain first, then weigh it against measurement, size and cost, and end with a judgement that follows.

Where marks are usually lost

• Not showing the equation that is set equal, so an arithmetic slip cannot be traced.
• Using the whole area under the curves instead of the triangle between Qs and Qm.
• Treating total external cost as the welfare loss.
• Calling a good public because the state provides it, or testing only one of rivalry and excludability.
• Describing free riding with no link to non-provision, or ending an evaluation without a judgement.

Next steps

• Revise with the revision notes and study guide.
• Use the hub and checklist.
• Take the free 10-minute diagnostics.
• Book a free trial class.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics, Specification, Issue 2, June 2018 (first teaching September 2018), Pearson Education Limited. Section 1.3.5 Market failure, items 1 to 3.