Question 1
A coastal town has a lighthouse that guides ships safely into the harbour. No shipping company can be prevented from using the light, and one ship navigating by the beam does not reduce its availability to any other vessel. Which classification best describes this lighthouse?No clue? Show me the answer
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Method #1Classification by Economic CharacteristicsStep 1: Identify the two key criteria for classification
To classify any good, ask two questions: (1) Can non-payers be excluded from consuming it? (2) Does one person's use reduce availability to others? Both answers determine the category.
Step 2: Apply the criteria to the lighthouse
The question states that no shipping company can be prevented from using the light — so the good is non-excludable. It also states that one ship using the beam does not reduce its availability to other ships — so it is non-rivalrous.
Step 3: Match both characteristics to the correct category
A good that is simultaneously non-excludable and non-rivalrous satisfies the definition of a pure public good. Both conditions must hold together — not just one.
Step 4: Select the correct answer
The lighthouse is a pure public good. This also explains why private firms would struggle to supply it profitably: because ships cannot be excluded, every shipping company has an incentive to free ride rather than pay, making private provision economically unviable.
Method #2Process of EliminationStep 1: Identify what the question is asking
The question asks for the correct economic classification of the lighthouse, based on its described characteristics — non-excludable and non-rivalrous.
Step 2: Eliminate 'quasi-public good'
A quasi-public good is excludable (a provider can charge for access) but non-rivalrous up to a point of congestion. The lighthouse cannot exclude non-payers, so this option is incorrect.
Step 3: Eliminate 'merit good'
Merit goods are goods consumers undervalue due to imperfect information, leading to underconsumption. The lighthouse question involves no information failure or underconsumption — it is about excludability and rivalry, so this classification is wrong.
Step 4: Eliminate 'common pool resource'
A common pool resource is non-excludable but rivalrous — one user's consumption reduces availability to others (e.g. fish stocks). The lighthouse beam is explicitly described as non-rivalrous, ruling out this category.
Step 5: Select the correct answer
By elimination, and confirmed by the two criteria (non-excludable and non-rivalrous), the lighthouse is a pure public good.
Question 2
In a free market for cigarettes, the marginal private cost of production equals the marginal private benefit at a quantity of 80 million packs per month. However, the marginal social cost — accounting for secondhand smoke and public healthcare burdens — intersects the marginal social benefit curve at 55 million packs per month. What type of market failure is illustrated, and what is the direction of the misallocation?No clue? Show me the answer
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Method #1Externality and Misallocation AnalysisStep 1: Identify the key features of the scenario
The free market quantity (80 million packs) exceeds the socially optimal quantity (55 million packs). This means the market is producing and consuming more than what maximises social welfare — an over-allocation of resources.
Step 2: Link the external cost to the type of externality
The external costs mentioned — secondhand smoke affecting bystanders and higher public healthcare costs — arise from the act of consuming cigarettes, not from the production process. This identifies the externality as a negative externality of consumption: the marginal social benefit (MSB) lies below the marginal private benefit (MPB) at every quantity.
Step 3: Confirm the direction of market failure
Because MSB < MPB, the free market settles at a higher quantity than the social optimum (). Each unit consumed between 55 and 80 million costs society more (via MSC) than it benefits society (via MSB), generating a welfare loss. This is over-allocation.
Step 4: Select the correct answer
The scenario describes a negative externality of consumption causing over-allocation of resources — cigarettes are overconsumed relative to the social optimum. This matches the first option exactly.
Method #2Process of EliminationStep 1: Identify what the question is asking
The question asks for both the type of externality and the direction of misallocation — over-allocation or under-allocation.
Step 2: Eliminate 'positive externality of production'
A positive externality of production causes underproduction (the free market quantity is too low), and it involves benefits flowing to third parties from the supply side. Here, the market quantity is too high and the harm comes from consumption — not production. This option is wrong on both counts.
Step 3: Eliminate 'merit good causing underconsumption'
Merit goods are under-consumed because consumers underestimate private benefits. Here, the market quantity (80 million) exceeds the social optimum (55 million), indicating overconsumption, not underconsumption. This option contradicts the data in the question.
Step 4: Eliminate 'public good and free-rider problem'
Cigarettes are excludable (a seller can withhold them) and rivalrous (one pack cannot be consumed twice), so they are not public goods. Free-riding causes under-provision, not over-provision. This option does not apply.
Step 5: Select the correct answer
The remaining option — a negative externality of consumption causing over-allocation — correctly identifies both the source of the external cost (consumption by smokers imposing harm on third parties) and the direction of misallocation (too much output relative to the social optimum).