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9708 · 1.4

Resource allocation in different economic systems — practice questions

Practice and worked examples for 9708 Resource allocation in different economic systems. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Compare how a market economy and a planned economy would respond to rising demand for electric vehicles.

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Market economy: Higher consumer demand shifts demand right → price rises → profit incentive attracts firms → supply expands; resources (labour, capital) reallocate via price signals. Firms that fail to adapt lose market share.

Planned economy: Central planners may set EV production quotas, allocate steel and battery inputs, and direct state factories. Response may be slower if planners lack local information; quality and variety may be limited.

Evaluation: Markets adjust quickly but may ignore pollution externalities (→ 3.1). Planners can prioritise long-term goals but risk inefficiency and lack of consumer sovereignty.

Worked example 2

A factory in a mixed economy produces 1,000 tonnes of steel per month. The private cost of production is $400 per tonne. The pollution from the factory imposes an external cost on the community (e.g., healthcare costs, environmental damage) estimated at $100 per tonne. The market price for steel is $450 per tonne.

(a) Calculate the total social cost of producing 1,000 tonnes of steel. (b) Explain why this represents a misallocation of resources. (c) How might a government in a mixed economy intervene?

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(a) Calculation of Total Social Cost

  • Step 1: Calculate Total Private Cost (TPC) TPC = Private Cost per tonne × Quantity TPC = $400 × 1,000 tonnes = $400,000

  • Step 2: Calculate Total External Cost (TEC) TEC = External Cost per tonne × Quantity TEC = $100 × 1,000 tonnes = $100,000

  • Step 3: Calculate Total Social Cost (TSC) TSC = Total Private Cost + Total External Cost TSC = 400,000+400,000 + 100,000 = **500,000∗∗500,000**

(b) Explanation of Resource Misallocation

The market allocates resources based on private costs and benefits. The firm is willing to produce steel because the market price ($450) exceeds its private cost ($400). However, the true cost to society (social cost) is $500 per tonne ($400 private + $100 external). Since the marginal social cost ($500) is greater than the marginal social benefit (represented by the price of $450), resources are misallocated. Society is losing $50 of welfare on the last tonne produced. This leads to over-production and an over-allocation of resources to steel manufacturing.

(c) Government Intervention

In a mixed economy, the government can intervene to correct this market failure. A common solution is to impose a Pigouvian tax equal to the external cost. By imposing a tax of $100 per tonne, the government forces the firm to internalise the externality. The firm's private cost would rise to $500 per tonne. This would reduce production to a more socially optimal level where the new marginal private cost equals the marginal social benefit.

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