Market failure: Practice Questions

Which of the following is most likely to cause market failure in the allocation of resources?

A factory produces chemicals and discharges waste into a local lake, causing fish stocks to decline. This decline in fish stocks affects the income of local fishermen.

In this scenario, the loss of income for the fishermen is an example of:

Which characteristic distinguishes a public good from a merit good in the context of market failure?

Which of the following is the most accurate definition of market failure?

In a specific market, the consumption of a product generates benefits for third parties who are not involved in the transaction. This situation results in market failure because:

Define the term social cost and state its relationship with private and external costs.

A factory emits smoke that damages the health of nearby residents, but the factory owner only considers the cost of raw materials and wages.

Explain why this situation leads to market failure in terms of resource allocation.

Market failure can occur when there are external benefits (positive externalities).
Explain why the free market tends to under-provide merit goods, such as healthcare, relative to the socially optimum level.

(a) Define social cost.

(b) Identify two examples of demerit goods.

(c) Explain why the existence of monopoly power in a market can lead to market failure.

(a) Define public goods.
(b) Explain the difference between non-excludability and non-rivalry as characteristics of public goods that lead to market failure.