IB DP Economics: Externalities and common pool resources – 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 – the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

This set follows the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. It covers sub-topic 2.8, Market failure: externalities and common pool or common access resources, for SL and HL. Parts marked HL only use the welfare loss calculation. All figures are invented. The bracketed 1 marks in the answers are only a revision aid. Learn the ideas in the study guide and the revision notes.

Questions

1. Define a negative externality of production. [2]

2. State two characteristics of a common pool resource and name the problem that results from them. [3]

3. Make clear how a merit good differs from a demerit good, with a real-world illustration of each. [4]

4. (calculator-free) In the fictional country Veltria the market for tanned leather has demand (MPB) P = 60 − 2Q and supply (MPC) P = 12 + 2Q, where Q is in thousand sheets and P in crowns. Tanning pollutes a river, a marginal external cost of 8 crowns per sheet.

(a) Find the market equilibrium output and price. [2] (b) Find the socially optimum output. [2] (c) Find the indirect tax per sheet that achieves the optimum, and the revenue it raises. [2] (d) (HL only) Calculate the welfare loss at the market output. [2]

5. On the shared pasture of the fictional village of Dunmere, the total milk (in litres a day) from different herd sizes is: 1 cow 30, 2 cows 56, 3 cows 78, 4 cows 96, 5 cows 110, 6 cows 120, 7 cows 126, 8 cows 128. Each cow costs 16 litres a day to keep, and herders can add cows freely.

(a) Find the herd size under open access. [2] (b) Find the herd size that maximises the village’s net gain, and that gain. [3] (c) Explain why individual herders push the herd beyond the best size. [3]

6. (calculator-free) Two fictional firms, P and R, each emit 50 units of a pollutant. The cap is 70 units in total. Cutting one unit costs P 4 crowns and R 10 crowns.

(a) Find the total cost of meeting the cap if each firm cuts the same amount. [2] (b) Find the total cost if the firms trade permits so that the cap is met at least cost. [2] (c) State the range in which the permit price per unit would settle. [1] (d) Explain one limitation of a tradable permit scheme. [2]

7. Explain, using a diagram, why a market produces too little of a good with a positive externality of production, and how a subsidy could correct this. [6]

8. (calculator allowed) In the fictional steel industry of Orland, demand (MPB) is P = 80 − Q and supply (MPC) is P = 20 + Q, with Q in million tonnes and P in crowns a tonne. Carbon emissions impose a marginal external cost of 10 crowns a tonne.

(a) Find the market output and price. [2] (b) The government introduces a carbon tax of 10 crowns a tonne. Find the new output and the price paid by buyers. [3] (c) Find the price producers keep after tax and the tax revenue. [2] (d) (HL only) Calculate the welfare loss before the tax. [2] (e) Explain one effect of the carbon tax on a stakeholder other than buyers and the government. [3]

9. Evaluate the use of legislation and regulation compared with tradable permits to reduce industrial pollution. [10]

10. Explain why international cooperation is needed to deal with a global pollutant, and why it is hard to achieve. [6]

11. Explain two challenges in measuring externalities and how they affect policy. [4]

12. (calculator-free) In the fictional country Norland the market for booster vaccination appointments has demand (MPB) P = 50 − Q and supply (MPC) P = 14 + Q, with Q in thousand appointments and P in marks. Each appointment gives other people a marginal external benefit of 6 marks.

(a) Find the market equilibrium output and price. [2] (b) Find the socially optimum output. [2] (c) Find the subsidy per appointment that achieves it, and its total cost. [2] (d) (HL only) Calculate the welfare loss at the market output. [2]

Answers

1. A cost [1] imposed on a third party by the production of a good, which is not paid for by the producer or reflected in the market price [1]. [2] Examiner insight: A definition needs both a third party and no compensation; “pollution” alone is an example.

2. The resource is rivalrous (one person’s use reduces what is left for others) [1] and non-excludable (people cannot easily be kept out) [1]. The result is overuse, called the tragedy of the commons [1]. [3] Examiner insight: “State” asks for names, not explanation; “shared” alone does not name a characteristic.

3. A merit good is one people consume too little of, because they undervalue its benefits or because it creates external benefits [1]; education [1]. A demerit good is one people consume too much of, because they underestimate the harm or because it harms others [1]; tobacco [1]. [4] Examiner insight: “Distinguish” needs the difference made clear; an example helps only if it fits your definition.

4. (a) 60 − 2Q = 12 + 2Q, so 4Q = 48, Q = 12 [1]; P = 60 − 24 = 36 crowns [1]. [2] (b) MSC = 12 + 2Q + 8 = 20 + 2Q [1]; 60 − 2Q = 20 + 2Q gives Q = 10 [1]. [2] (c) Tax = marginal external cost = 8 crowns [1]; revenue = 8 × 10 = 80 thousand crowns [1]. [2] (d) At Q = 12, MSC = 20 + 24 = 44 and MSB = 36, gap 8 [1]. Area = ½ × (12 − 10) × 8 = 8 thousand crowns [1]. [2] Examiner insight: Set demand equal to the social curve for the optimum; keep units.

5. (a) Average output per cow is 128 ÷ 8 = 16 at 8 cows, equal to the cost of 16 [1]; so herders keep adding cows until 8 and net gain is zero 8 cows [1]. [2] (b) Extra milk from each cow: 30, 26, 22, 18, 14, … [1]. The fifth cow adds 14, less than the cost of 16, so stop at 4 cows [1]. Net gain = 96 − 4 × 16 = 32 litres [1]. [3] (c) A herder compares the average share of milk with the cost of a cow [1]. Each extra cow reduces the milk from all the others, a cost the herder does not bear [1]. So cows are added until the average equals the cost, beyond the point where the extra milk equals it [1]. [3] Examiner insight: Use the extra (marginal) return for the best level and the average return for open access; mixing them gives a wrong herd size.

6. (a) Cuts needed = 100 − 70 = 30, so each cuts 15 [1]. Cost = 15 × 4 + 15 × 10 = 60 + 150 = 210 crowns [1]. [2] (b) The cheaper firm P makes all 30 cuts [1]: cost = 30 × 4 = 120 crowns [1]. [2] (c) Between 4 and 10 crowns a unit [1]. [1] (d) For example, the cap may be set too high or too low because the regulator lacks information [1]; so pollution may stay above the level that is best for society, or cost firms more than necessary [1]. [2] Examiner insight: A limitation gains more when you say what it does to the outcome.

7. A positive externality of production means the activity benefits third parties [1]. The firm ignores this, so MSC lies below MPC [1]. The market output is where MPC meets demand (MPB = MSB), which is lower than the social optimum where MSC meets demand [1]. The triangle between the two outputs is welfare loss [1]. A subsidy to producers equal to the marginal external benefit shifts MPC down to MSC [1]. Output rises to the optimum and the welfare loss is removed [1]. [6] Examiner insight: A labelled diagram with MPC, MSC, both outputs and the shaded triangle supports the written points; label which curve moves.

8. (a) 80 − Q = 20 + Q gives Q = 30 [1], P = 50 crowns [1]. [2] (b) MSC = 30 + Q [1]; 80 − Q = 30 + Q gives Q = 25 [1]. Buyers pay P = 80 − 25 = 55 crowns [1]. [3] (c) Producers keep 55 − 10 = 45 crowns [1]. Revenue = 10 × 25 = 250 million crowns [1]. [2] (d) At Q = 30, MSC = 60 and MSB = 50, gap 10 [1]. Area = ½ × 5 × 10 = 25 million crowns [1]. [2] (e) For example, steelworkers [1]: if output falls from 30 to 25, firms may employ fewer people [1], so some face job losses [1]. [3] Examiner insight: Link the stakeholder effect to the figures; a group named without a reason and a direction of change is thin.

9. Indicative points: legislation sets a clear, certain limit [1] that is simple to apply [1], but gives firms no reason to cut below it [1] and treats firms alike even when their costs differ [1]. It needs monitoring and penalties [1]. Permits cap the total and let the cheapest cuts happen first [1], with a continuing reason to cut further [1]; but the cap may be set wrongly, since the external cost is hard to measure [1], and the first allocation may be unfair [1]. A judgement that depends on the pollutant, the number of firms and the ability to monitor [1]. [10] Examiner insight: Weigh the two policies against each other and end with a supported judgement.

10. The pollutant crosses borders, so one country cannot control the harm [1]. A country that cuts bears the cost while others share the benefit, which tempts them to free ride [1]. Countries differ in income and harm suffered, so they disagree on who pays [1]. Agreements need accurate monitoring of emissions [1]; they need enforcement against countries that break them [1], which is hard because states are sovereign [1]. [6] Examiner insight: Cover both parts, why cooperation is needed and why it is hard; an answer on one alone is incomplete.

11. The external cost has no market price [1], so it must be estimated, for example by valuing health damage or lost habitat [1]. Estimates are uncertain [1], so a tax or subsidy set from them may be too high or too low, leaving some welfare loss or burdening firms and consumers needlessly [1]. [4] Examiner insight: Tie each challenge to a consequence for policy; naming “hard to measure” twice adds nothing.

12. (a) 50 − Q = 14 + Q gives Q = 18 [1]; P = 32 marks [1]. [2] (b) MSB = 56 − Q [1]; 56 − Q = 14 + Q gives Q = 21 [1]. [2] (c) Subsidy = marginal external benefit = 6 marks [1]; cost = 6 × 21 = 126 thousand marks [1]. [2] (d) At Q = 18, MSB = 38 and MPC = 32, gap 6 [1]. Area = ½ × 3 × 6 = 9 thousand marks [1]. [2] Examiner insight: For a positive externality of consumption add the benefit to demand; the wrong curve gives the wrong optimum in every later part.

Where marks are usually lost

• Setting the optimum where the market curves cross instead of where MSB meets MSC.
• Adding an external benefit to supply or an external cost to demand.
• Using the price, not the gap between MSB and MSC at the market output, as the triangle height.
• Mixing average and marginal return in common pool questions.
• Naming a policy without saying which curve it moves.
• Calling a common pool resource a public good.

Next steps

• Re-read the study guide for any weak part.
• Condense it with the revision notes.
• Tick off the printable checklist and visit the course hub.
• Take one of the free 10-minute diagnostics to find weak topics.
• Book a free trial class if you want a teacher to go through your answers.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published February 2020, International Baccalaureate Organization. This page covers sub-topic 2.8 (Unit 2: Microeconomics).