Edexcel IAL Economics notes, with no missing steps

1.3.5 · 1aWhat market failure means

Imora is a small town on the coast, and its cement market is busy. Builders buy cement every day at the market price. Yet the dust and noise from making cement fall on the households near the works, and those households are not part of any sale.

Imora's market for computer courses is busy too. A worker who takes a course also helps the people who work beside them, but none of those people pays towards the course.

Is either market making the right amount?

1aWhy market failure occurs: too much or too little produced and/or consumed

• Socially optimal output: where marginal social benefit = marginal social cost (MSB = MSC), the quantity that gives society the greatest net benefit.
• Why it happens: the price mechanism gives the wrong signals. Prices reflect only private costs and benefits (externalities), no price can be charged (public goods), buyers or sellers lack information (information gaps), a party is shielded from the cost of risk (moral hazard), or prices are driven by expected rises (bubbles).
• Result: a welfare loss: society could be better off if output were different.

• (2)Define the term 'market failure'.

  How to earn the marks

  Two marks means two separate things to say, and the second is not a rewording of the first. The specification defines this term by a quantity rather than by a description of a market in difficulty, so decide first what the quantity is being compared against, and make sure that comparison appears in your answer.

• (4)Explain how an external cost of production causes the social cost of a good to exceed its private cost.

  How to earn the marks

  An Explain of a reason needs a two-stage chain, so plan both links before you start writing. The first link is about who pays what; the second is about what that does to the relationship between two things the question names. Keep the two costs clearly separated throughout — using one word for both is what makes this answer collapse into one stage.

• (4)Draw a diagram, using marginal analysis, to show the welfare loss arising from an external cost of production.

  How to earn the marks

  Decide the shape of the diagram before you draw a single line: which pair of curves splits apart, and which one stays single. Then build it in order — the curves, then the two positions, then the area — because the area is bounded by both positions and cannot be shaded until both are on the page. Label the vertical axis for what a marginal diagram actually measures rather than for a price, and mark both quantities on the horizontal axis.

• (6)Analyse the external costs arising from the consumption of car journeys in a congested city.

  How to earn the marks

  An Analyse wants depth rather than breadth, so choose your ground: one or two external costs followed all the way to the quantity will do more than a list of every effect a car has. Decide first whether the externality arises from making the car or from using it, because that settles which curve moves and the whole chain hangs off it. Appendix 6 says a diagram is credited where appropriate, and here it is.

• (8)Examine the effects of imperfect market information on the allocation of resources in healthcare.

  How to earn the marks

  The question names one context, so stay in it: a general account of asymmetric information with healthcare mentioned at the end will not be answering what was asked. Work out first which side of the transaction holds the advantage here, because it is not the same side as in insurance and the consequences run differently. Appendix 6 says an Examine needs a brief assessment as well as a chain of reasoning, so leave yourself room at the end to weigh how serious the problem is and whether it can be reduced.

• (14)Discuss the impact of moral hazard in banking on consumers, producers, workers and governments.

  How to earn the marks

  Four groups are named and the marks are there for taking each of them somewhere, so plan the four before writing and give each its own paragraph. Two of the four never chose anything, and saying so is worth more than describing them: it is the point at which this becomes a market failure rather than a private arrangement. A Discuss also asks for different viewpoints and a critical assessment, so decide in advance what your counter-argument is — there is a real one here about whether the cover is worth having at all.

• (20)Evaluate the view that market bubbles in housing cause more damage than bubbles in stocks and shares.

  How to earn the marks

  This is a comparison and the marks follow the comparing, so do not write everything you know about one and then everything about the other. Pick the features that actually differ between the two markets and take each one through to a consequence, and keep asking damage to whom — the two markets do not hurt the same people. A judgement is required, so decide in advance what would have to be true for the view to hold and say so explicitly rather than concluding that it depends.