Market Failure Diagrams: Which Version Should You Draw?

Topics: Microeconomics | Market Failure | Externalities

Level: JC A-Level Economics / IB Economics

One of the biggest sources of confusion for Economics students (and teachers!) is that there are multiple frameworks for drawing Market Failure diagrams.

• Should I draw Demand and Supply curves?

• Where is the divergence (externality)?

• Why does my school teach it differently from the textbook?

Here, we break down the 3 Main Versions used in Singapore JCs and IB schools, and give you the final verdict on which one you should use in the A-Level and IB exams.

Watch the video explanation together with accompanying pointers below:

Version 1: The “Classic” Market Framework (Common in IB)

This is the standard Demand & Supply framework found in most international textbooks. It links externalities strictly to their source.

• The Logic:

  • Consumption Externalities cause a divergence on the Demand side (Consumer behaviour).

  • Production Externalities cause a divergence on the Supply side (Producer behaviour).

• How to Draw It:

  • Negative Externality of Consumption: The Marginal Social Benefit (MSB) is lower than the Marginal Private Benefit (MPB).

    • Graph: The MSB curve lies below the Demand curve.

  • Negative Externality of Production: The Marginal Social Cost (MSC) is higher than the Marginal Private Cost (MPC).

    • Graph: The MSC curve lies above the Supply curve.

Version 2: The “Twisted” Framework (Specific Schools)

Note: Some schools (e.g., RI) have used a variation that “twists” the labelling of the positive and negative externalities on the diagram. In the video, we advise avoiding this version unless explicitly required by your school teachers, as it often causes unnecessary confusion.

Version 3: The “Single Party” Framework (Common in Singapore JCs)

This is the version most commonly taught in Singapore Junior Colleges. It simplifies the analysis by focusing on Rational Decision Making (RDM) for a single part – either the Consumer or Producer.

• The Logic:

  • We do not use “Demand” and “Supply” labels. Instead, we use Marginal Curves (MPB, MSB, MPC, MSC).

  • The diagram represents either the Consumer or the Producer—not both interacting in a market.

• The Rule:

  • Positive Externality (Any): MSB is above MPB. (Society benefits more than the individual).

  • Negative Externality (Any): MSC is above MPC. (Society pays more than the individual).

• Pros: It is very simple to memorize. There are only 2 diagrams compared to the earlier versions (4 diagrams).

Version 4: The “Hybrid” Framework (TET’s Recommendation)

This version combines the best of Version 1 and Version 3. It uses the familiar Demand/Supply curves but applies the simpler divergence rules.

• The Logic:

  • You draw standard Demand & Supply curves.

  • Positive Externality: Draw MSB above MPB/Dd regardless of whether in Consumption or Production

  • Negative Externality: Draw MSC above MPC. Same logic as above.

• Why is this the best version?

  1. Policy Analysis is Easier: Since you have Demand and Supply curves, you can easily illustrate Taxes, Subsidies, and Quotas (which you already learned in the Market Mechanism topic).

  2. SEAB Approved: The Singapore Examinations and Assessment Board (SEAB) endorses this simplified “2-diagram approach” where MSB is higher for positive externalities and MSC is higher for negative ones.

Summary: Which One Should You Use?

Examination Tip:

Regardless of which version you choose, you must correctly identify the Deadweight Loss (Welfare Loss) area.

Confused about where to shade the Deadweight Loss?

In our JC Economics Tuition A-Level and IB Economics Tuition classes, we teach a “fail-proof” method to identify the welfare loss area for every single diagram version.

(For more details on Market Failure policies like Taxes and Subsidies, check out our dedicated Market Failure Notes. For other topics, browse our full Economics Notes Library.)