Explain how production that causes pollution leads to market failure.

Discuss whether government regulation is the most effective way to deal with negative externalities of consumption.

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

Answers may include:

• definition of market failure, negative production externalities
• diagram to show an over-allocation of resources where MSC is greater than MPC
• explanation that pollution causes a negative externality of production and over-production
• examples of where pollution leads to market failure.

NB Where a diagram showing negative externalities of consumption is used, a maximum of level 2 should be awarded.

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

Answers may include:

• definition of government regulation, negative externalities of consumption
• diagram to show how government regulation reduces the problem of negative consumption externalities
• explanation that government regulation can reduce the demand for the product, shifting the MPB curve closer towards the MSB curve and the socially optimum output or decrease in supply if a government regulation leads to a fall in output
• examples of where government regulations have been used to control negative externalities of consumption
• synthesis or evaluation (discuss).

Discussion may include: the effectiveness of government regulation including the policing of regulation, consideration of alternative policies like taxation, where the tax revenue raised can be used to pay for some of the of the consequences of the negative externality.

NB To reach level 4, students need to consider an alternative approach to regulation.

This question was generally well answered with clear definitions of negative externalities and market failure and an effective explanation of how pollution leads to market failure. Most students supported their answers with an effective cost/benefit diagram that illustrated the market failure caused by negative externalities. The best answers included real world examples to illustrate the theory they used. A common error amongst weaker answers were poorly labelled diagrams.

Students produced accurate explanations of the market failure associated with the negative externalities of consumption using demerit goods such as cigarettes and alcohol and illustrated this with an effective diagram. The use of regulation as a policy option to deal with the negative externality was often poorly developed. Many answers confused taxation and advertising to reduce consumption as methods of regulation. This lost candidates marks because they failed to clearly answer the question. The best answers considered regulations on cigarettes and alcohol such as age restrictions, bans on consumption in public places and limits on promotion and evaluated these methods effectively. Top level answers used relevant real-world examples to support their answers.