Economic Systems and Market Failure: Economics 0455 (Cambridge O Level / IGCSE)

In a market economic system, how are the answers to the "what, how and for whom to produce" questions mainly determined?

The coastal fishing industry of Velmora, a small island nation, operates almost entirely through free-market allocation. Fishing crews decide independently what species to catch, how much to land each day and what price to charge, based on the prices buyers are willing to pay at the dockside auction. There is very little government regulation of the industry.

(a) Define a market economic system. [2]

(b) Explain one advantage of allocating resources in Velmora's fishing industry through a market economic system. [2]

(c) Explain one disadvantage of allocating resources in Velmora's fishing industry through a market economic system. [2]

Four proposals for a small river-delta town are described below.

Which one is an example of a public good, as distinct from a merit good, a demerit good, or a good with an external cost?

Two independent activities take place near the town of Ashcombe.

• Every summer, an open-air music festival is held just outside the town. The organiser pays for staging, artists and security, but the amplified sound and late-night traffic disturb nearby residents, who receive no compensation.
• Separately, a small logistics firm based in Ashcombe pays for its delivery drivers to take an advanced vehicle-safety and fuel-efficient driving course, well beyond what their licences legally require. The extra skills make the drivers safer and more careful, but some drivers later move to jobs at other local delivery firms, who then benefit from this training without paying anything towards its cost.

(a) Define a private cost and a social cost. [2]

(b) Using the music festival, explain how the social cost of holding the festival differs from its private cost. [3]

(c) Using the logistics firm's driver training, explain why the firm might provide less training than would be best for society as a whole, if it bases its decision only on its own private costs and benefits. [3]

The government of Kelmara wants to increase consumption of reusable water-filter cartridges, a merit good that reduces households' reliance on single-use bottled water. It introduces a subsidy of $0.75 per cartridge sold to manufacturers.

Before the subsidy, 40 000 cartridges were sold across Kelmara each month. After the subsidy takes effect, monthly sales rise to 55 000 cartridges.

(a) Define a subsidy. [2]

(b) Calculate the total monthly cost of the subsidy to the Kelmaran government once it is in effect. [2]

(c) Explain one advantage and one disadvantage of using a subsidy, rather than direct government provision, to increase consumption of this merit good. [4]

In the nation of Vantrell, a central planning ministry decides each year how much wheat, steel and cloth every state-owned factory and farm will produce, sets the wages paid to workers in each industry, and distributes the goods produced through state-run shops at prices the ministry itself fixes in advance.

Which type of economic system does Vantrell operate?

The government of Bellara, a mixed economy, wants to protect cassava farmers from low prices by introducing a minimum price in the domestic cassava market. Before any government intervention, the table below shows the quantity of cassava (in thousand sacks per month) that would be demanded and supplied at each price.

(a) Define a mixed economic system, referring briefly to Bellara's cassava market. [2]

(b) Using the table, state the free-market equilibrium price and quantity that would occur in Bellara's cassava market without any government intervention. [2]

(c) The government sets a minimum price of $35 per sack. Calculate the size of the resulting surplus of cassava per month. [2]

(d) Explain one consequence of this surplus for the Bellaran government, and describe one method the government could use to deal with it. [3]

The government of Draymoor is concerned that disposable vaping devices are a demerit good: their price to consumers does not reflect the wider costs they create for the public health system and for the environment.

Before any tax, disposable vaping devices sell for $12.00 each, and 80 000 devices are sold across Draymoor each month.

The government introduces a specific tax of $3.50 on every device sold, which manufacturers pass on in full to consumers. Once the tax takes effect, monthly sales fall to 70 000 devices.

(a) Define a demerit good. [2]

(b) Explain why disposable vaping devices are considered a demerit good, referring to private cost and external cost. [3]

(c) Calculate the new price consumers pay for a device once the tax is in effect, and calculate the monthly tax revenue collected by the Draymoor government at the new quantity sold. [3]

(d) Explain one disadvantage of using this tax, rather than a regulation such as banning sales to under-18s, to reduce consumption of disposable vaping devices. [2]

The council of Calderwell is deciding whether to leave street lighting on the town's roads to a private company, or to provide it directly itself.

(a) State and explain the two properties that define a public good, using street lighting as your example. [4]

(b) Explain what is meant by the "free-rider problem" in relation to street lighting, and why this means a private firm is unlikely to provide it profitably. [3]

(c) Explain why street lighting is normally provided directly by the government or local council and funded through taxation, rather than sold to individual residents at a market price. [2]

Frayle Water Co. is the only supplier of piped water across the region of Ostgate, because building a rival network of pipes would be prohibitively expensive for any competitor (a natural monopoly). Left completely unregulated, Frayle Water Co. could restrict the quantity of water it supplies and charge a higher price than would prevail if the market were competitive.

Which government intervention addresses this cause of market failure by giving the state formal ownership and direct control over Frayle Water Co.'s pricing and output decisions, rather than merely constraining a privately owned firm's behaviour from outside?