Market failure: Practice Questions

A pure public good is characterised by which two properties?

A pure public good is defined by two specific characteristics. Which of the following identifies why the private sector often fails to provide such goods?

In the context of negative consumption externalities, such as smoking, the socially optimal level of output is achieved where:

In the context of the insurance market, which situation best illustrates the concept of moral hazard?

Define the term 'non-excludable' when classifying a good as a public good, and explain why this characteristic leads to the free-rider problem.

Explain the difference between the concepts of private marginal cost (PMC) and social marginal cost (SMC) in the context of negative production externalities.

A company offering vehicle insurance knows less about its customers' driving habits than the customers themselves. Explain how this information gap leads to the problem of moral hazard after a policy has been purchased.

Public goods are often not provided by the free market, leading to a specific type of market failure.

(a) Define the term non-rival in the context of consumption. (1)
(b) Explain why the free-rider problem leads to the non-provision of public goods by private firms. (2)

The production of synthetic rubber generates significant air pollution, leading to negative external costs on surrounding residents.

(a) Define negative externality of production and state why it results in market failure. (2)

(b) With the aid of a diagram showing marginal private cost (MPC), marginal social cost (MSC), and marginal social benefit (MSB), illustrate the welfare loss that results from the production of synthetic rubber. Clearly label the market output (\(Q_M\)) and the socially optimal output (\(Q_S\)). (4)

(c) Evaluate the effectiveness of introducing a specific indirect tax on synthetic rubber production as a solution to this market failure, compared to using legislation (e.g., pollution caps). (3)