Market Failure | Model Answer

A-level Economics

“With the help of an appropriate diagram and the information in the extract, explain why the negative externalities caused by the cutting down of trees may lead to market failure.”

Here is a question and answer from the markets and market failure section of the A-level Economics syllabus.

This question is an ‘explain’ question - the type of question where students have to showcase their knowledge. This question shows the examiner that ‘you know your stuff’.

You have to ensure you try very hard with these questions because answering without enough detail can lead to precious lost marks.

THE FREE ESSAY PLAN BELOW CAN BE USED AS A GUIDE TO HELP YOU WRITE YOUR RESPONSE.

The question asks you to explain why cutting down trees can lead to market failure. You will need to structure this properly, never forgetting to stick to the question be asked. Remember to insert your diagram!

Essay Plan

Possible Definitions

Market failure

Market failure occurs when the free market mechanism fails to allocate resources efficiently. In these circumstances, the government may choose to intervene in order to restore social welfare.

Negative externalities

Negative externalities in free markets lead to market failure, because costs to third parties are not being accounted for. This leads to a problem of overproduction/overconsumption causing deadweight losses to welfare.

Explanation: how can tree-cutting lead to market failure?

Draw a negative production externality diagram
Explain the concepts within the diagram
Relate your answer to the context of farmers/forestry companies
Relate the answer to market failure
Explain how it causes a deadweight loss
Can you show if there is overproduction - if so, by how many units?

Extract information

Flooding sometimes results from market failure. One example is the negative externality caused by farmers and forestry companies. They cut down trees in hills surrounding flood plains (the low-lying land next to rivers). This increases the risk of floods, which are suffered as negative externalities by some of the households living on flood plains. Trees help to intercept and absorb rainwater so, by cutting them down, the risk of flooding increases. The increased risk of flooding results partly from global warming, but other factors are also involved. One has been government. Successive governments have allowed construction companies to build houses on flood plains. If the houses had not been built, fewer people would have suffered the negative externality. Source: news reports, 2009