Edexcel IGCSEEconomicsGeneral Applications15 Marks

A government might intervene in a market to correct market failure.

(a)Define the term *market failure*.[2]
(b)Explain how the consumption of merit goods can lead to market failure.[4]
(c)Discuss the effectiveness of indirect taxes as a method to reduce the consumption of demerit goods.[9]

Mark scheme

Marking points from the official mark scheme. The mark or mark type is shown in brackets.

*(a)* Award 1 mark for each valid point up to a maximum of 2 marks.
Market failure occurs when the free market (1) fails to allocate resources efficiently/optimally (1).
*(b)* Explanation should include identification of market failure (1) and development of how merit goods contribute (3).
Merit goods are under-consumed in a free market (1) because consumers underestimate their private benefits and/or there are positive externalities (1). This leads to a misallocation of resources (1) as social benefits are greater than private benefits, resulting in welfare loss (1). (4)
*(c)* (AO1 – 2 marks, AO2 – 2 marks, AO3 – 5 marks)
For a discussion of effectiveness of indirect taxes to reduce consumption of demerit goods. Max 9 marks.
**Arguments for effectiveness:**
Raises the price of demerit goods (1) leading to a decrease in quantity demanded (1) due to the law of demand (AO2).
Discourages consumption (1) especially if demand is elastic (AO3).
Generates tax revenue (1) which can be used to fund public services or subsidise alternatives (AO2).
**Arguments against effectiveness/Limitations:**
May be ineffective if demand for the demerit good is inelastic (1) (e.g., addictive goods like cigarettes) (AO3).
Could lead to a black market (1) if taxes are too high, reducing government revenue and control (AO3).
Regressive impact (1) as it disproportionately affects lower-income households (AO3).
Difficulty in setting the 'correct' tax level (1) to achieve optimal reduction without excessive side effects (AO3).
May not change consumer behaviour (1) if they are unaware of the negative externalities (AO2).
**Conclusion/Overall Judgement:** (AO3)
Requires a reasoned conclusion regarding the overall effectiveness, perhaps dependent on elasticity of demand, level of tax, complementary policies (e.g., education campaigns). (1 mark for reasoned judgement)