Explain why merit goods tend to be under-provided in a free market.

Evaluate the use of carbon taxes to reduce threats to sustainability.

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

Answers may include:

• definitions of market, merit goods
• diagram showing positive externalities in the consumption of a merit good
• an explanation that consumers do not take external benefits into account when deciding how much to demand, resulting in producers allocating insufficient resources to the production of merit goods in a free market
• examples of merit goods.

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

Answers may include:

• definitions of carbon taxes, sustainability
• diagram to show the application of a carbon tax
• an explanation of the impact of a carbon tax on the amount of fossil fuels produced and/or on different stakeholders
• examples of cases where carbon taxes have been applied
• synthesis or evaluation (evaluate).

Evaluation may include: consideration of the extent to which carbon taxes affect different stakeholders, the advantages and disadvantages of carbon taxes in comparison with alternative policies, the difficulties of measuring externalities / estimating the socially-optimal level of output.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

The better responses demonstrated clear understanding of merit goods, but some lower-achieving responses showed confusion of merit goods with public goods or with goods that have positive externalities of production. Some candidates correctly pointed out that merit goods are associated with positive externalities of consumption, but their answers could be improved by listing third-party benefits instead of only private benefits such as (in the case of education) higher starting salary or higher material standard of living.

The clarity of many candidates’ answers would be improved if they had fully labelled the diagram (e.g. using the much more informative Quantity of electricity and Price of electricity instead of the generic Q and P labels) and had used this labelling to clearly explain in their answers which market they were analysing with the help of the diagram and what exactly were the negative externalities in that market.

The candidates demonstrated good general understanding of indirect taxes, but some lower-achieving answers took this aspect of the question too far and focused on explaining and evaluating taxes on demerit goods, virtually ignoring the aspects of the question that referenced carbon and sustainability. Another weakness in some answers, which could possibly be avoided by more careful labelling of the diagram, was the explanation of carbon taxes as taxes on carbon as if the carbon is the main product of the firms being taxed with carbon taxes, not a side effect from the production of other goods (such as electricity).