VCE-ECON-U12 5.1 📋 Practice Exam 2: Question Paper

Practice Exam 2

VCE Economics | Market Failure – Externalities, Public Goods and Information Failure

Question 1

Market failure occurs when:

A) Prices rise above equilibrium
B) The free market fails to allocate resources efficiently — producing outcomes where social welfare is not maximised
C) Government intervention distorts prices
D) A firm makes losses

Question 2

A negative externality arises when:

A) A third party benefits from a transaction without paying
B) A third party suffers costs from a transaction they were not part of
C) A firm earns monopoly profit
D) Government fails to tax polluters

Question 3

The Pigouvian tax on a negative externality aims to:

A) Raise government revenue only
B) Internalise the externality by making the polluter pay the social cost — raising the private cost to equal the social cost
C) Subsidise the victim of the externality
D) Eliminate the market entirely

Question 4

A positive externality in production occurs when:

A) The producer receives more than the social benefit
B) Third parties benefit from a firm’s production without contributing to costs
C) The good is undersupplied
D) Government subsidises production

Question 5

Public goods are characterised by:

A) Being provided only by the government
B) Non-excludability and non-rivalry in consumption
C) Being merit goods
D) Having positive externalities only

Question 6

The free rider problem with public goods occurs because:

A) Goods are provided for free by the government
B) People can enjoy public goods without paying for them — because they cannot be excluded — so the private market will underprovide them
C) Goods travel freely in international trade
D) Government sets price at zero

Question 7

The socially optimal level of output with a negative externality is:

A) Higher than the free market output
B) Lower than the free market output — the market overproduces relative to social optimum
C) Identical to the free market output
D) Where marginal private cost equals zero

Question 8

Which of the following is an example of a positive externality in consumption?

A) A factory producing smoke
B) A person getting vaccinated — protecting others from disease through herd immunity
C) A firm dumping waste in a river
D) A company monopolising a market

Question 9

Merit goods are goods that:

A) Are non-rival and non-excludable
B) Are consumed less than is socially desirable — people undervalue them due to imperfect information; government encourages consumption
C) Are always provided free by the state
D) Produce negative externalities

Question 10

The Coase theorem suggests that if property rights are clearly defined and transaction costs are zero, then:

A) Government must always intervene to correct externalities
B) The affected parties can negotiate a solution to an externality problem that achieves the socially efficient outcome
C) Externalities are always harmful
D) Markets always fail in the presence of externalities

Question 11

The social marginal cost (SMC) of a good with a negative externality equals:

A) The private marginal cost only
B) Private marginal cost plus the marginal external cost
C) The marginal external cost only
D) The market price

Question 12

Government subsidising education is justified on the grounds that:

A) Education is a public good
B) Education generates positive externalities — a more educated workforce benefits society beyond the individual student — and people undervalue long-term returns
C) Education markets have natural monopoly features
D) Education has negative externalities

Question 13

Information asymmetry refers to:

A) One party in a transaction having significantly more relevant information than the other
B) Government having more information than the private sector
C) Prices not conveying all information
D) Unequal distribution of income

Question 14

The problem of adverse selection arises when:

A) Markets produce socially suboptimal levels of output
B) Due to information asymmetry, lower-quality products or higher-risk individuals disproportionately participate in a market — driving out higher quality
C) Government intervention distorts prices
D) Firms collude to raise prices

Question 15

The market for ‘lemons’ (Akerlof) demonstrates that:

A) All markets are efficient
B) When buyers cannot assess quality (used cars), sellers of low-quality goods dominate; quality of goods in the market falls; eventually the market may collapse
C) Only government can provide used car markets
D) Price signals are always reliable

Question 16

A demerit good is one that:

A) Has positive externalities
B) Is overconsumed relative to the social optimum — due to imperfect information about harms; government discourages consumption
C) Is undersupplied by the market
D) Has inelastic demand only

Question 17

Carbon pricing is justified as a solution to climate change because:

A) It raises government revenue primarily
B) It internalises the negative externality of greenhouse gas emissions by making emitters pay the social cost of carbon
C) It is cheaper than regulation
D) It applies only to large emitters

Question 18

The concept of allocative efficiency means:

A) All resources are fully employed
B) Resources are allocated such that the marginal social benefit equals the marginal social cost — maximum net social welfare
C) Costs of production are minimised
D) All consumers are satisfied

Question 19

A private good is characterised by:

A) Being provided only by private firms
B) Excludability and rivalry — one person’s consumption prevents others from consuming the same unit
C) Having positive externalities
D) Being a merit good

Question 20

Environmental externalities are a form of market failure because:

A) Firms always pollute
B) The market price of goods does not reflect environmental costs — the market overproduces polluting goods and underproduces the clean environment
C) Government always fails to address pollution
D) Environmental goods have inelastic demand

Question 1 (4 marks)

Question 2 (4 marks)

Question 3 (4 marks)

Question 4 (4 marks)

Question 5 (4 marks)

Question 6 (4 marks)

Question 7 (4 marks)

Question 8 (4 marks)

Extended Response 1(a) (6 marks)

Extended Response 1(b) (3 marks)

Extended Response 2(a) (5 marks)

Extended Response 2(b) (3 marks)