Edexcel IAL Economics: Government intervention and government failure in markets (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 cover section 1.3.6 Government intervention in markets, items 1 and 2, of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018. This is Unit 1 content, labelled IAS and also part of the full IAL. All figures are invented; currency units are “cu”.

Links: study guide, revision notes, Edexcel economics hub, printable checklist and free 10-minute diagnostics.

Questions

1. A government considers two taxes on a good whose pre-tax price is 80 cu: a specific tax of 10 cu per unit, or an ad valorem tax of 15%. Calculate the ad valorem tax per unit at 80 cu and at 120 cu, and explain how the two taxes differ when the price rises. [3]

2. A specific tax of 3 cu per unit raises the market price from 20 to 22 cu and cuts quantity from 500 to 420 units. Calculate the tax revenue and the part of it paid by consumers and by producers. [5]

3. Country B subsidises evening classes by 6 cu per place. The price paid by students falls from 30 to 26 cu and places rise from 200 to 260. Calculate the cost of the subsidy, the gain per place to students and to providers, and the cost per extra place. State one factor that decides whether the subsidy is worthwhile. [5]

4. In Country C the household heating fuel market has demand Qd = 1,500 - 15P and supply Qs = 20P - 250, with equilibrium at 50 cu and 750 units. The government sets a maximum price of 44 cu. (a) Calculate the shortage. [3] (b) Calculate the welfare loss, using the price buyers would pay for the last unit supplied. [3]

5. In Country D, grain has demand Qd = 800 - 10P and supply Qs = 15P - 200, with equilibrium at 40 cu and 400 tonnes. The government sets a guaranteed price of 48 cu and buys any surplus. (a) Calculate the surplus. [3] (b) Calculate the cost to the government, the change in farmers’ revenue, and state one limitation of the policy. [3]

6. Firms X and Y each emit 60 tonnes of waste. A cap of 80 tonnes in total is set, with 40 tradeable permits each. Abatement costs 12 cu per tonne for X and 30 cu per tonne for Y. (a) Calculate the total abatement cost if trading is not allowed. [2] (b) Calculate the total cost if trading is allowed, and the saving. [2] (c) State the range within which the permit price must lie for a trade to occur. [1]

7. (a) Explain how giving a fishing cooperative legal ownership of a lake could reduce overfishing. [3] (b) Explain how a clear label on sugary snacks could reduce consumption. [3]

8. A rural bus route in Country E has weekly operating costs of 900 cu and fare revenue of 400 cu. Officials estimate the external benefits at 700 cu a week. No private firm will run it. (a) Calculate the weekly private loss and the net social benefit. [2] (b) Evaluate state provision of the route. [6]

9. In Country A a good has demand Qd = 100 - 5P and supply Qs = 5P - 20 (thousand units). Its true external cost is 2 cu per unit. Officials wrongly estimate it at 5 cu and impose a specific tax of 5 cu. (a) Find the equilibrium without intervention and the social optimum. [2] (b) Find the price and quantity after the tax. [2] (c) Calculate the welfare loss without the tax and with it, and the net effect of the tax. [3] (d) Explain why this is government failure and name its cause. [1]

10. Country G’s government pays farmers the full value of flood losses. Payouts are 4,000 cu and inspecting claims costs 1,200 cu. (a) Explain how moral hazard might arise. [3] (b) Calculate the administrative cost per cu delivered to farmers and the total cost per cu delivered, and explain why this lowers welfare. [3]

11. Country H wants to cut emissions from its factories. Assess whether tradeable permits or a tax per unit of emissions would be the better method. [10]

Answers

1. At 80 cu: 15% x 80 = 12 cu [1]. At 120 cu: 15% x 120 = 18 cu [1]. The specific tax stays at 10 cu per unit, but the ad valorem tax per unit rises with the price, so it is a constant share of the price but a growing amount per unit as price rises [1]. [3] Examiner insight: Giving both tax amounts and then stating the contrast in words usually reads more complete than numbers alone.

2. Revenue = 420 x 3 = 1,260 cu [1]. Consumers pay 22 - 20 = 2 cu more per unit [1]. Producers receive 22 - 3 = 19 cu, down 1 cu [1]. Consumers pay 2 x 420 = 840 cu [1] and producers 1 x 420 = 420 cu, so 66.7% and 33.3% of the revenue [1]. [5] Examiner insight: Use the new quantity (420), not the old one; a revenue figure on 500 units is an easy slip.

3. Cost = 260 x 6 = 1,560 cu [1]. Students gain 30 - 26 = 4 cu per place [1] and providers receive 26 + 6 = 32, up 2 cu [1]. Extra places = 60, so cost per extra place = 1,560/60 = 26 cu [1]. It is worthwhile only if the external benefit per extra place is at least as large as this cost (or if the funds have no better use) [1]. [5] Examiner insight: A final comment that compares the cost with a benefit gives the figure a purpose.

4. (a) Qd = 1,500 - 15 x 44 = 840 [1]. Qs = 20 x 44 - 250 = 630 [1]. Shortage = 840 - 630 = 210 units [1]. [3] (b) Buyers would pay (1,500 - 630)/15 = 58 cu for the 630th unit [1]. Suppliers need 44 cu [1]. Welfare loss = 0.5 x (750 - 630) x (58 - 44) = 840 cu [1]. [3] Examiner insight: A cap below equilibrium creates both the shortage and the welfare loss; it helps to say which is which.

5. (a) Qd = 800 - 10 x 48 = 320 [1]. Qs = 15 x 48 - 200 = 520 [1]. Surplus = 200 tonnes [1]. [3] (b) Cost = 200 x 48 = 9,600 cu [1]. Farmers’ revenue: 520 x 48 = 24,960 against 400 x 40 = 16,000, a rise of 8,960 cu [1]. Limitation: the government must store or dispose of the surplus, which uses taxpayers’ money that has other uses [1]. [3] Examiner insight: A limitation tied to the numbers (a surplus of 200 tonnes) is usually stronger than a generic one.

6. (a) Each must cut 20 tonnes. X: 20 x 12 = 240 cu; Y: 20 x 30 = 600 cu [1]. Total = 840 cu [1]. [2] (b) The total cut needed is 40 tonnes. X cuts all 40: 40 x 12 = 480 cu [1]. Saving = 840 - 480 = 360 cu [1]. [2] (c) Between 12 and 30 cu per permit [1]. [1] Examiner insight: Stating that total emissions are unchanged by trading shows why the saving is not a loss in environmental benefit.

7. (a) The cooperative becomes the owner and gains from the future stock [1]. It bears the cost of overfishing through lower future catches [1]. It therefore limits catches, or charges members, so overuse falls [1]. [3] (b) Information gaps mean buyers underestimate the health cost [1]. A label raises the perceived cost, so demand shifts left [1]. Quantity falls towards the social optimum [1]. [3] Examiner insight: Linking each tool to the failure it targets (no owner, imperfect information) keeps the chain tight.

8. (a) Private loss = 400 - 900 = -500, a loss of 500 cu [1]. Net social benefit = 400 + 700 - 900 = 200 cu [1]. [2] (b) Private firms will not supply because of the 500 loss [1]. State provision, funded by tax, can secure a service with positive net social benefit [1]. But the 700 is an estimate, so information gaps may mean the benefit is overstated [1]. A state provider may lack the incentive to control costs [1]. The funds have an opportunity cost in other uses [1]. Judgement: provision is justified if the estimate is reliable and costs are controlled, as the margin of 200 is small relative to the 700 estimated [1]. [6] Examiner insight: Weighing a stated number, such as the small net margin, tends to make evaluation more specific.

9. (a) Without intervention: 100 - 5P = 5P - 20, so P = 12 and Q = 40 [1]. Optimum: Qs = 5(P - 2) - 20, so 130 = 10P, P = 13 and Q = 35 [1]. [2] (b) Qs = 5(P - 5) - 20 = 5P - 45, so 145 = 10P, P = 14.5 [1] and Q = 27.5 [1]. [2] (c) Without the tax: height at Q = 40 is 14 - 12 = 2, so 0.5 x 5 x 2 = 5 [1]. With the tax: demand price 14.5, marginal social cost 9.5 + 2 = 11.5, height 3, so 0.5 x 7.5 x 3 = 11.25 [1]. Net effect = 11.25 - 5 = 6.25 thousand cu worse [1]. [3] (d) Welfare is lower than before, so intervention caused a net welfare loss; the cause is an information gap [1]. [1] Examiner insight: Comparing welfare with and without the policy is the test; stating only the new welfare loss leaves the comparison undone.

10. (a) Moral hazard is taking more risk because someone else bears the cost [1]. Farmers may plant on flood-prone land or skip protection [1]. Claims and government cost rise [1]. [3] (b) Administrative cost = 1,200/4,000 = 0.30 cu per cu delivered [1]. Total cost = 1.30 cu per cu delivered [1]. The 0.30 uses resources that could produce other things, so net benefit falls [1]. [3] Examiner insight: Naming the cause and showing how it works in the scenario helps; the label alone adds little.

11. Permits cap total emissions, so the quantity is known [1]. Trading lets low-cost firms cut more, which cuts the total cost of abatement [1]. A tax fixes the price per unit, but the resulting quantity cut is uncertain [1]. A tax raises revenue that can be reused [1]. Both need the government to know enough: a cap set too loose, or a tax set too low, fails [1]. If damage rises steeply past a threshold, a firm cap is safer [1]. Permits need monitoring and a working market; taxes need measurement of emissions [1]. Small firms may struggle to trade, and permits handed out free may favour incumbents [1]. Either may be unpopular if costs are passed on to households [1]. Judgement: permits suit a firm limit on emissions; a tax suits a case where damage per unit is steady and a fixed price is wanted [1]. [10] Examiner insight: Ending with a conditional judgement (“depends on whether the damage has a threshold”) usually reads stronger than a bare choice.

Where marks are usually lost

• Basing tax revenue or subsidy cost on the pre-intervention quantity.
• Mixing up price paid and price received.
• Drawing a tax as a demand shift.
• Using the wrong base for a welfare triangle.
• Treating a transfer, such as tax revenue, as a welfare gain.
• Applying a price cap above equilibrium.
• Naming a cause of government failure without applying it.
• Giving one-sided evaluation with no final judgement.

Next steps

• Review the revision notes and the study guide.
• Check your coverage on the printable checklist and the Edexcel economics hub.
• Take one of the free 10-minute diagnostics.
• Ready for a class? Book a free trial class.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics (YEC11), Specification, Issue 2, June 2018, Pearson Education Limited. These questions cover section 1.3.6 items 1 and 2 of Unit 1.