The market's inability to achieve equity practice questions.

Which statement best captures the concept of equity as used in economics?

• All individuals receive identical incomes
• Resources are allocated to their most profitable use
• The distribution of income is judged fair or just
• All markets clear at their equilibrium prices

Answer: The distribution of income is judged fair or just

Equity refers to fairness or justice in distribution; it is a normative idea and must not be confused with equality, which means identical amounts for everyone.

Why may a free market fail to achieve equity even when it is allocatively efficient?

• Because the price mechanism allocates by willingness and ability to pay, not need
• Because free markets always produce at a point inside the production possibilities curve
• Because equilibrium prices are always set above marginal cost
• Because allocative efficiency automatically guarantees an equal distribution of income

Answer: Because the price mechanism allocates by willingness and ability to pay, not need

Efficiency concerns maximizing total surplus, not how it is shared: those without sufficient income are priced out of even essential goods, so an efficient outcome can still be judged unfair.

In a pure market economy, a household's income is primarily determined by:

• the government's assessment of the household's needs
• the value of the factors of production the household owns
• the average income earned across all households in the economy
• an equal share of the nation's total output

Answer: the value of the factors of production the household owns

Market incomes flow from selling labour, land, capital and entrepreneurship; because ownership of these factors and their prices are highly unequal, the resulting income distribution may be very unequal.

Which situation best illustrates the market's inability to achieve equity?

• A monopolist restricting output in order to raise the market price
• A factory emitting pollution that harms third parties
• A firm exiting an industry after sustained losses
• A life-saving medicine priced beyond the reach of low-income patients

Answer: A life-saving medicine priced beyond the reach of low-income patients

Rationing by price means access depends on ability to pay rather than need; essential goods being unaffordable to the poor is the classic equity failure. The other options illustrate market power and externalities.

Which of the following is a normative statement about income distribution?

• The richest 10% of households earn 30% of total income
• The Gini coefficient rose from 0.32 to 0.38 over the decade
• The government ought to redistribute income
• Average nominal wages increased by 4% last year

Answer: The government ought to redistribute income

Normative statements involve value judgements ('ought', 'should', 'fair') and cannot be tested against data; judgements about what is equitable are inherently normative.

The rationing function of the price mechanism means that scarce goods are allocated to:

• the consumers with the greatest need for the good
• those willing and able to pay the market price
• whoever arrives at the market first, regardless of income
• the producers with the lowest costs of production

Answer: those willing and able to pay the market price

Prices ration scarce goods by excluding those who cannot or will not pay; since ability to pay depends on income, need plays no direct role, which is why market outcomes may be inequitable.