Explain why demerit goods are an example of market failure.

Evaluate the effectiveness of using indirect taxation to correct market failure.

Answers may include:

• definitions of demerit goods, market failure, externalities, negative externalities
• diagram(s) to show market failure with negative externalities in consumption
• explanation of how negative externalities of consumption of demerit goods lead to an over-allocation of resources
• examples of demerit goods.

Marks should be allocated according to the Paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of indirect taxation and market failure
• diagram(s) to show the application of indirect taxation to correct market failure
• explanation of how indirect taxation may correct market failure where output is reduced towards the socially efficient output
• examples of where indirect taxation has been used to address market failure
• synthesis or evaluation.

Evaluation may include: the impact on different stakeholders in terms of price, consumption, production, employment, welfare and the wider economy; the problems of determining the level of tax to achieve the socially efficient output.

Marks should be allocated according to the Paper 1 markbands for May 2013 forward, part B.