Practice 2.10 Market Failure - asymmetric information (HL only) with authentic IB Economics exam questions for both SL and HL students. This question bank mirrors Paper 1, 2, 3 structure, covering key topics like microeconomics, macroeconomics, and international trade. Get instant solutions, detailed explanations, and build exam confidence with questions in the style of IB examiners.
Explain how moral hazard can create inefficiencies in the market.
Explain how adverse selection can lead to underproduction or underconsumption of a good.
Explain how government regulation can address the market failure caused by the moral hazard.
Explain how government provision of information can address the market failure caused by adverse selection in situations where the seller knows more.
Explain how signalling and screening are used by individuals in response to asymmetric information.
Explain how adverse selection and moral hazard result in market failure.
"Asymmetric information is inevitable in most markets, but its impact can be minimized through appropriate interventions." Using real-world examples, discuss this statement.
Health insurance markets often face issues related to asymmetric information, which can lead to market failures such as adverse selection and moral hazard. The government of Country X has implemented policies to address these issues by subsidizing insurance premiums and mandating universal coverage.
The government subsidizes 30% of the insurance premium for high-risk individuals. The annual insurance premium is $500 per person, and 1,000 high-risk individuals enroll in the program. Additionally, the government collects tax revenue from the general population to fund healthcare expenditures.
In 2023, the GDP of Country X was $1.5 trillion, with a population of 50 million people. The government’s total healthcare expenditure was $120 billion, of which 40% was financed through tax revenue. The country’s unemployment rate was 6%, and the Gini coefficient, which measures income inequality, was 0.38.
In response to trade liberalization policies, Country X signed a free trade agreement (FTA) with Country Y. This agreement reduced tariffs on pharmaceutical imports from 10% to 5%, leading to an increase in imported medicines by 20%. The price elasticity of demand (PED) for these medicines is estimated to be -0.8.
Table 1: Key Economic Indicators of Country X (2023)
| Indicator | Value |
|---|---|
| GDP | $1.5 trillion |
| Population | 50 million |
| Unemployment Rate | 6% |
| Gini Coefficient | 0.38 |
| Total Healthcare Spending | $120 billion |
| Tax Revenue for Healthcare | 40% of spending |
Table 2: Trade and Healthcare Market Data
| Variable | Value |
|---|---|
| Insurance Premium (Annual) | $500 |
| Government Subsidy (Per Person) | 30% |
| Number of High-Risk Individuals | 1,000 |
| Initial Tariff on Medicines | 10% |
| New Tariff on Medicines | 5% |
| Increase in Medicine Imports | 20% |
| Price Elasticity of Demand (PED) | -0.8 |
Using information from Table 2, calculate the total government subsidy cost for high-risk individuals.
Explain why moral hazard occurs in the health insurance market.
Using information from Table 1, calculate the per capita GDP of Country X.
Using information from Table 1, calculate the total tax revenue allocated for healthcare spending.
Define the term "price elasticity of demand (PED)."
Using information from Table 2, calculate the percentage decrease in the price of imported medicines after the tariff reduction.
Draw a demand and supply diagram to illustrate the effect of tariff reduction on imported medicines.
Using information from Table 2, explain how the change in tariffs is likely to affect the quantity of imported medicines based on PED.
Using the text/data provided and your knowledge of economics, recommend a policy that Country X could implement to reduce income inequality while maintaining economic efficiency.
Text A: The Coffee Market in Country Z
Country Z is a major producer of coffee beans, contributing significantly to its export revenues. However, due to a global oversupply of coffee, prices have fallen dramatically, impacting the incomes of local farmers. To support farmers, the government introduced a price floor above the equilibrium price. While this has stabilized farmer incomes, it has resulted in surplus production and increased government spending on storing unsold coffee.
In response to environmental concerns, Country Z has also introduced subsidies for farmers who adopt sustainable farming methods. Critics argue that while these measures aim to support farmers, they distort market efficiency and divert resources from other sectors of the economy.
Table 1: Coffee Production and Government Intervention
| Year | Market Price (US$ per kg) | Price Floor (US$ per kg) | Surplus Production (tonnes) |
|---|---|---|---|
| 2020 | 3.5 | - | - |
| 2021 | 3.2 | 4.0 | 10,000 |
| 2022 | 3.0 | 4.0 | 15,500 |
| 2023 | 2.8 | 4.0 | 20,000 |
Text B: Regional Economic Cooperation in Country Y
Country Y recently joined a regional trade bloc that promotes free trade and economic integration. This has resulted in the removal of tariffs on agricultural and industrial goods traded within the bloc. The government hopes the trade bloc will help diversify the economy, currently reliant on exports of low-value-added agricultural products.
However, small-scale farmers in Country Y have struggled to compete with larger, more efficient producers from neighboring countries. To address this, the government is providing subsidies to small-scale farmers to improve productivity. Critics warn that the focus on agricultural subsidies may hinder the country’s transition to a more industrialized economy.
Table 2: Trade Performance in Country Y
| Year | Exports (US$ billion) | Imports (US$ billion) | Trade Balance (US$ billion) | GDP Growth Rate (%) |
|---|---|---|---|---|
| 2019 | 15.0 | 18.5 | -3.5 | 2.8 |
| 2020 | 16.2 | 20.1 | -3.9 | 3.1 |
| 2021 | 17.5 | 21.3 | -3.8 | 3.5 |
| 2022 | 19.8 | 23.6 | -3.8 | 4.2 |
Define the term price floor.
List two ways in which subsidies can impact market efficiency.
Using information from Table 1, calculate the increase in surplus production from 2021 to 2023.
Using a supply and demand diagram, illustrate the effect of the price floor on the coffee market in Country Z.
Using a market failure diagram, explain how the subsidy for sustainable farming in Country Z may lead to inefficiencies.
Using a market diagram, explain the impact of tariff removal on small-scale farmers in Country Y.
Using a comparative advantage diagram, explain how joining the trade bloc might help Country Y diversify its economy.
Using an AD-AS diagram, explain how the trade bloc membership could affect Country Y’s GDP growth.
Using information from the text/data and your knowledge of economics, evaluate the impact of agricultural subsidies on economic growth and/or development in Country Y.
Explain why allocative efficiency is achieved under free market equilibrium conditions.
Using real-world examples, evaluate the impact of a minimum wage on the unemployment rate.