OCR A Level Economics: Economic efficiency and the nature of market failure (H460) – 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 Productive and allocative efficiency, Market failure and Externalities in Component 1, Microeconomics, of the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. Teaching is in the study guide and the revision notes. Related pages: the OCR Economics hub and the checklist. Every context and figure below is invented.

Questions

1. Distinguish between productive efficiency and allocative efficiency. [4]

2. Distinguish between static efficiency and dynamic efficiency, using an example. [4]

3. A small bakery in Country L (illustrative) has total cost TC = 72 + 8Q + 2Q², where Q is thousands of loaves and TC is in £ thousand. Marginal cost is MC = 8 + 4Q.

(a) Calculate average cost at 3, 6 and 9 thousand loaves. [3] (b) State the productively efficient output and use MC to explain it. [2] (c) The market price is £44. Find the output where P = MC, and the profit there. [3] (d) Explain whether the bakery is productively and allocatively efficient at that output. [2]

4. A sheltered firm in Country M (illustrative) has unit cost £15. A comparable firm in a competitive market has unit cost £12. The sheltered firm makes 80,000 units a year.

(a) Calculate the extra annual cost compared with the competitive firm. [2] (b) Express the excess as a percentage of the competitive firm’s unit cost. [1] (c) Explain two reasons why x-inefficiency may occur in the sheltered firm. [2]

5. A monopolist in Country N (illustrative) faces demand P = 66 − 2Q, so MR = 66 − 4Q. Marginal cost is constant at £30. Q is in thousands and P is in £.

(a) Find the allocatively efficient output and price. [2] (b) Find the output and price that maximise the monopolist’s profit. [3] (c) Calculate the welfare loss. [2] (d) Explain one reason why the monopolist may still be dynamically efficient. [2]

6. State whether each is a positive or negative externality, and of consumption or production.

(a) Late-night customers of a bar keep nearby residents awake. (b) A stone quarry spreads dust over neighbouring farms. (c) A person is vaccinated and so passes on less infection. (d) A firm trains staff, some of whom later join rival firms. [4] (e) For (b), state whether market output is above or below the social optimum. [1]

7. A quarry in Country P (illustrative) faces MPB = 62 − 2Q and MPC = 2 + 2Q. Each unit imposes an external cost of £16 on farmers. Q is in thousands and prices in £.

(a) State MSC. [1] (b) Find the market output and price. [2] (c) Find the socially optimal output and price. [2] (d) Calculate the welfare loss at the market output. [2]

8. A health screening service in Country R (illustrative) has MPB = 75 − 5Q and MPC = MSC = 15 + Q. Each screening gives an external benefit of £18. Q is in thousands and prices in £.

(a) Find the market output and price. [2] (b) State MSB, then find the socially optimal output and price. [3] (c) Calculate the welfare gain from reaching the optimum. [2]

9. Using a diagram that you describe in words, explain why a negative externality of consumption causes market failure. [6]

10. Evaluate whether a monopoly is always less efficient than a perfectly competitive market. [10]

11. Evaluate how externalities affect the markets for education and health. [10]

Answers

1. Productive efficiency means output is made at the minimum average cost [1], the lowest point of the AC curve where MC = AC [1]. Allocative efficiency is using resources to produce what consumers value most [1], where price equals marginal cost [1]. [4] Examiner insight: Give a definition and its condition for each type. A statement that one is “about cost” and the other “about price” alone is thin.

2. Static efficiency is efficiency at a point in time [1], given resources and technology [1]. Dynamic efficiency is efficiency over time [1], for example a firm investing in new machinery that lowers its costs in later years [1]. [4] Examiner insight: A named, developed example earns the last point. An example with no link to time or cost change does not show dynamic efficiency.

3. (a) AC = TC ÷ Q [1]. At 3: (72 + 24 + 18) ÷ 3 = 114 ÷ 3 = £38; at 6: 192 ÷ 6 = £32 [1]; at 9: 306 ÷ 9 = £34 [1]. (b) 6 thousand loaves, the lowest AC [1]; MC = 8 + 24 = £32, equal to AC [1]. (c) P = MC: 44 = 8 + 4Q [1], so Q = 9 [1]. AC = £34, so profit = (44 − 34) × 9 = £90 thousand [1]. (d) Allocatively efficient, because P = MC [1]. Not productively efficient, because AC at 9 is £34, above the £32 minimum at 6 [1]. [10] Examiner insight: Show the working for each AC figure. In part (d), compare the actual AC with the lowest AC and quote both.

4. (a) Extra cost per unit = 15 − 12 = £3 [1]; 3 × 80,000 = £240,000 [1]. (b) 3 ÷ 12 × 100 = 25% [1]. (c) Little competition means no pressure to cut costs [1]. Managers may pursue goals other than lowest cost, or effort and monitoring may be slack [1]. [5] Examiner insight: Each reason needs a link to why cost is above the efficient level. Simply writing “it is a monopoly” does not explain the cause.

5. (a) P = MC: 66 − 2Q = 30 [1], so Q = 18 thousand and P = £30 [1]. (b) MR = MC: 66 − 4Q = 30 [1], so Q = 9 thousand [1], and P = 66 − 18 = £48 [1]. (c) Triangle with base 18 − 9 = 9 and height 48 − 30 = 18 [1]; area = ½ × 9 × 18 = £81 thousand [1]. (d) Supernormal profit can be used to fund research and new equipment [1], lowering costs or creating better products over time [1]. [9] Examiner insight: Part (d) needs the route from profit to investment to lower cost. Part (c) uses the gap between price and MC at the monopoly output, not at the efficient one.

6. (a) Negative externality of consumption [1]. (b) Negative externality of production [1]. (c) Positive externality of consumption [1]. (d) Positive externality of production [1]. (e) Above the social optimum, because MSC exceeds MPC [1]. [5] Examiner insight: Name both parts of each answer, the sign and the activity. “Negative externality” alone does not say whether it arises from consumption or production.

7. (a) MSC = MPC + MEC = 18 + 2Q [1]. (b) 62 − 2Q = 2 + 2Q [1], so Q = 15 thousand and P = £32 [1]. (c) 62 − 2Q = 18 + 2Q [1], so Q = 11 thousand and P = £40 [1]. (d) At Q = 15: MSC = 48 and MSB = 32, a gap of 16 [1]. Welfare loss = ½ × (15 − 11) × 16 = £32 thousand [1]. [7] Examiner insight: Use the MSC curve, not MPC, to find the social optimum. A common slip is to take the gap at the wrong output.

8. (a) 75 − 5Q = 15 + Q [1], so Q = 10 thousand and P = £25 [1]. (b) MSB = 75 − 5Q + 18 = 93 − 5Q [1]. 93 − 5Q = 15 + Q gives Q = 13 thousand [1] and P = 15 + 13 = £28 [1]. (c) At Q = 10: MSB = 43 and MSC = 25, a gap of 18 [1]. Gain = ½ × 3 × 18 = £27 thousand [1]. [7] Examiner insight: Add the external benefit to MPB, not to MPC. State the direction of the shift so the working can be followed.

9. The market sets output where MPB equals MPC [1]. Consuming each unit imposes an external cost on third parties, such as noise or congestion [1]. So MSB lies below MPB [1]. Consumers ignore the external cost and consume at the market output, where MPB = MPC [1]. The social optimum is at the lower output where MSB = MSC [1]. Between the two outputs MSC exceeds MSB, so resources are over-allocated to the good and there is a welfare loss [1]. [6] Examiner insight: Name each curve and the two output levels. A chain from private decision to ignored cost to over-consumption gains more than a statement that “externalities cause market failure”.

10. A monopoly sets price above MC, so it is allocatively inefficient [1], and it restricts output below the competitive level [1]. A perfectly competitive firm sets P = MC [1], and in the long run reaches the lowest AC [1]. However, perfect competition earns only normal profit in the long run, leaving little for research [1], while monopoly profit can fund innovation [1]. A monopoly protected from rivals may be x-inefficient [1]. A large firm may have economies of scale giving lower AC than many small ones [1]. Perfect competition is a benchmark rather than a description of most markets [1]. Overall a monopoly is not always less efficient: the outcome depends on the size of the price gap, the scale economies and how the profit is used [1]. [10] Examiner insight: A one-sided answer that says “monopoly is inefficient” does not evaluate. Use arguments both ways and give a reasoned judgement.

11. Education has a positive externality of consumption, because skills benefit employers and society [1]. Individuals count only private benefit, so MSB exceeds MPB and education is under-consumed [1]. Vaccination has a positive externality because it lowers infection risk for others [1], whereas smoking has a negative one because it harms others, causing over-consumption [1]. The result is a welfare loss [1]. However, external benefits are hard to measure, so the right level of provision is uncertain [1]. Education benefits appear over many years [1]. Under-consumption may also arise from low income or poor information, not only externalities [1]. A small externality may cost more to correct than the gain [1]. Overall externalities are significant in both markets, but the extent is uncertain and judged by size and measurement [1]. [10] Examiner insight: Link each market to a specific externality. A final judgement that compares the markets or weighs size earns credit that a list does not.

Where marks are usually lost

• Using P = MC for allocative efficiency in a market with an externality, where MSB = MSC applies.
• Reading the welfare loss triangle from the wrong output or using MPC instead of MSC.
• Giving productive efficiency as “low cost” with no mention of the lowest point of AC.
• Not stating which of the four externality cases applies, or the direction of market output.
• Adding the external cost to the wrong curve.
• Evaluation that lists points but never weighs size, timing or measurement.
• Treating monopoly as always worse without considering scale economies or dynamic gains.
• Leaving out units, such as thousands of units and £ thousand.

Next steps

• Review the revision notes and the study guide
• Course hub: OCR A Level Economics and the checklist
• Take all free 10-minute diagnostics
• Ready for a lesson? Book a free trial class

Official syllabus

OCR, A Level Economics (H460), Version 3.0 (June 2026), for first assessment in 2021. Component 1 Microeconomics: Productive and allocative efficiency, Market failure and Externalities.