Embed Size (px)
DESCRIPTION
-
Citation preview
Question 1: TYS 2005 Q4 (a) Explain why pollution and congestion caused by cars are likely to cause market failure. [10] (b) Discuss whether the Singapore government currently adopts appropriate policies to
overcome this market failure. [15]
(a) Explain why pollution and congestion caused by cars are likely to cause market failure.
[10]
1st Simple Schematic Plan (Cost-Benefit Approach – Use this for car trips only (Special Case to gel better with the ERP Intervention))
INTRODUCTION – Use KIA
Key word: Market Failure.
Issue: Identify driving will result in negative externality – pollution and congestion.
Approach: This essay aims to….
BODY – Use SEED
Define negative externality.
Define and give examples of PMC, PMB and EMC of driving.
Explain how market fails and leads to over-usage of road/driving with the help of a diagram.
CONCLUSION
INTRODUCTION
Key words Market failure occurs when free markets, operating without any government intervention, fail to deliver an efficient allocation of resources to produce goods and services.
Issue Due to the negative external cost incurred by pollution and congestion, markets do not capture the full cost associated with car-driving and thus cause market failure.
Approach This essay aims to explain why pollution and congestion caused by cars are likely to cause market failure.
BODY Negative Externality (Consumption of cars - driving) In a free market, drivers only weigh the private or individual costs and benefits of driving a car and do not take into account the negative externality they create to other road users. The Private Marginal Cost (PMC) of driving measures the additional cost to the driver from the additional journey/trip made. In this case, it is the cost, such as petrol and toll fee. The Private Marginal Benefit (PMB) of driving measures the additional value that the driver places on the additional journey/trip made. The benefit is the value placed by drivers for the convenience and comfort of commuting from place to place by car. However, when the roads get too congested it creates negative externality or External Marginal Cost (EMC) to third parties. Third-parties are those who are not directly involved either as consumers or producers. In this instance, the air pollution as a result of the emission of harmful substances from car exhaust pipes damage health. Besides, other road users such as office-
workers and even ambulances which are caught in traffic jams would result in delay and this is costly to society in terms of loss of productivity and lives. The price mechanism fails to bring about a socially efficient allocation of resources in this case. This is because the cost to other parties created is unpriced by the price mechanism and therefore is not included in the private costs of consumers. Hence we can say that there is a divergence between the Social Marginal Cost (SMC) and the PMC, and as a result SMC lies above that of PMC. I.e. SMC = PMC + EMC. What consumers pay is not the same (i.e. divergence) as what society has to pay.
Figure 1: External Cost from Car Journeys/Trips
In the diagram above, the market equilibrium quantity of car journeys/trips occurs at Qm when drivers account only for their private benefit and cost i.e. PMB=PMC. However, due to the presence of negative externalities (EMC which is measured by distance AB) of congestion and inconvenience to other road users, the social cost of car usage is higher than the private cost. Hence, the social equilibrium occurs when society takes into account of the negative externalities when SMB=SMC at QS (assuming no positive externalities present, PMB=SMB) There is an overconsumption of cars on the road by Qm-QS. The overconsumption created an increase in social cost of BCQSQm, while the social benefit is only ACQSQm resulting in a deadweight welfare loss of ABC. CONCLUSION Hence, pollution and congestion caused by cars are negative externality which is a form of market failure.
2nd Simple Schematic Plan (Market Based Approach – FYI)
INTRODUCTION – Use KIA
Key word: Market Failure.
Issue: Identify driving will result in negative externality – pollution and congestion.
Approach: This essay aims to….
BODY – Use SEED
Define negative externality.
Define and give examples of PMC, PMB and EMC of driving.
Explain how market fails and leads to over-usage of road/driving with the help of a diagram.
Cost/Benefit
Quantity
PMB=SMB (assuming EMB = 0)
SMC B
C
QS Qm
PMC
A
SMC = PMC + negative externality at QE
(EMC = distance AB)
CONCLUSION
INTRODUCTION
Key words Market failure occurs when free markets, operating without any government intervention, fail to deliver an efficient allocation of resources to produce goods and services.
Issue Due to the negative external cost incurred by pollution and congestion, markets do not capture the full cost associated with car-driving and thus cause market failure.
Approach This essay aims to explain why pollution and congestion caused by cars are likely to cause market failure.
NO EXTERNALITIES
The Private Marginal Cost (PMC) measures the cost to producers from an additional unit of car produced such as the cost of raw materials like steel and wages of workers. The costs measured include all opportunity costs and hence PMC represents the opportunity costs of using society’s scarce resources to produce cars, on the assumption that there are no externalities.
The Private Marginal Benefit (PMB) measures the benefit or value to consumers from an additional unit of car purchased. The benefit includes the convenience and comfort of driving instead of taking public transport PMB represents the benefit to society of using the limited resources to produce cars, on the assumption that there are no externalities.
If there are no externalities, the free market price is able to allocate resources efficiently by equating PMC=PMB. At this output level, society welfare or net total benefit of using the limited resources to produce cars is maximised.
EXTERNALITIES
However the use of cars or driving generates external costs to third parties who are not part of the production or consumption process.
The usage of cars generates at least 2 form of negative CONSUMPTION externality viz. pollution and road congestion. It is a consumption externality because it is generated from the use rather than production of cars.
The usage of cars generates pollutants such as carbon monoxide are emitted and breathed in by passers-by who will have a higher risk of developing pollution-related diseases. If they do fall sick, the car drivers do not bear their medical expenses. Furthermore, each additional car driver adds on to the congestion on the road, increasing the commuting times for other road users which may result in loss of productivity such as workers reporting late for work, business meetings cancelled leading to loss of contracts, or even loss of lives as ambulances cannot ferry the injured to hospital on time.
These third party costs due to congestion and pollution generated from driving are not borne by the car drivers but by society at large.
Third parties are not compensated by car drivers for the external costs they imposed on others. Hence, the negative consumption externality from driving cars are unpriced or not internalised by the price mechanism. As such, the free market has “under-priced” the usage of cars which will lead to an inefficient allocation of resources and hence market
failure.
For each additional car, the social marginal cost (SMC) includes the private marginal cost (PMC) of the car plus the external marginal cost (EMC). Hence the actual cost borne by the society is represented by the SMC, which takes into account the full opportunity cost to society of an extra unit of car. SMC = PMC + EMC.
Social Marginal Cost (SMC) = Private Marginal Cost (PMC) + External Marginal Cost (EMC)
Figure 1: External Cost from the Usage of Cars
As seen in Figure 1, the presence of a Negative consumption externality causes a divergence between private and social costs of using cars. The SMC lies above the PMC. From society’s viewpoint, the SMC includes both the PMC and EMC (i.e. SMC =PMC + EMC)
Assume that driving cars yields no positive externality, EMB=0. Thus, PMB=SMB.
Assuming perfect competition, market equilibrium quantity of usage of cars which can be measured in terms of no of car trips or quantity of miles driven is Qm, where PMB = PMC.
However, this output does not represent the socially optimal level of consumption because it does not take into account the negative externality or third party costs imposed on society.
The socially efficient level of consumption or use of cars should be at QS where SMB=SMC, where the full costs and benefits and costs to society are included.
Qs is less than the market equilibrium level of consumption, Qm. where PMB = PMC. Thus there is overconsumption or use of cars by Qm – QS
Area QmQSBC is the total social cost incurred for the overconsumption Qm – QS.
Area QmQSBA is the total social benefit gained for the overconsumption Qm – QS.
Price
Quantity
PMB=SMB (since EMB=0)
SMC = PMC + EMC
C
B
QS Qm
PMC
A
EMC at Qm Ps
Pm
Since total social costs incurred exceeds the total social benefits gained for overconsumption Qm – QS, Area ABC represents the deadweight welfare loss due to overconsumption of QS – Qm.
CONCLUSION Hence, pollution and congestion caused by cars are negative externality which is a form of market failure.
(b) Discuss whether the Singapore government currently adopts appropriate policies to overcome this market failure. [15]
Simple Schematic Plan
INTRODUCTION
BODY
Policies that overcome congestion Policies that overcome pollution
ERP: Control car usage
COE: Control ownership
Others: Public transport for alternatives
Rules and regulations
Explain how the policies work and their possible limitations
Reach a synthesis comparing the policies
CONCLUSION
INTRODUCTION Currently the government has adopted various policies to reduce congestion and pollution by reducing car usage, ownership and provision of an efficient public transport system. The ultimate goal of implementing these policies is to effectively reduce the number of cars driving on the road per hour, to the socially optimal level.
BODY 1 – to reduce congestion predominantly Main Solution 1 (Electronic Road Pricing - ERP):
Figure 2: ERP to internalise EMC from car trips Referring to Figure 2, the government make car users to pay a fee (a congestion tax on each unit of output), the amount of the tax corresponding to the external marginal cost (i.e. third-party costs) at QS. This shifts the PMC upwards so that the new private marginal cost, PMC1, PMC1 = PMC + tax. The drivers will now drive to the point where PMC1 = PMB, causing him to internalize the externality. The imposition of the tax equals to the EMC resulting in a number of car journeys that corresponds to the socially efficient level of output, QS where SMB=SMC. The tax is seen as payment for the congestion or third-party costs designed to get drivers to "internalize the externality" by considering the external costs of driving and serves as incentives to reduce the usage of cars. For Singapore, the road congestion tax imposed is known as the Electronic Road Pricing (ERP) where gantries are placed on roads to deduct fees on motorists using the highways leading to the Central Business District. If ERP correctly priced in the negative externality, road users should be able to use roads which are congestion free. In practice, ERP rates are adjusted to take into account different road traffic conditions at different spots and at different times of the day. Rates are highest during peak periods on busy roads where road congestion is most likely to occur. The system allows different areas to have different rates depending on the level and time of congestion. Hence the method is more equitable because it deters those who do not need to enter the CBD during the hike of the peak period from entering. Hence, those who enter during the hike of the peak will pay the highest ERP charges as they will be the ones who are both willing and able to pay those charges. In this way, this method spreads out the volume of traffic across different hours of the day thus avoiding heavy concentration of traffic at peak or rush hours. Limitations (GOVERNMENT FAILURE) LACK OF INFORMATION: Is it easy to obtain information of the actual cost of reducing congestion along Orchard during peak hours to work out the ERP rate? The government may not possess all the information needed to be able to estimate the ‘correct’ amount of tax to impose. An overvalued ERP may reduce the optimal use of the road, while an undervalued ERP may not reduce traffic congestion by much.
Cost/Benefit
Quantity
PMB=SMB (since EMB=0)
SMC = PMC + EMC
C
B
QS Qm
PMC
A
= EMC at Qs ERP
D
Ps
Pm
PS - t
PMC + tax
Example: When weather conditions are hazardous, flooding or downpour, the EMC of driving is much higher, due to the higher probability of congestion/accidents. ERP is not able to account for this. ERP is a regressive tax: It takes up a higher proportion of the poor's income than the rich. "Unfair" to the poor. ERP will not be very effective in discouraging driving if the demand is relatively price inelastic, especially with COE added in. Main Solution 2 (Certificate of Entitlement - COE): In theory, this is a quota system to restrict car ownership used in Singapore. Officially called the VQS (vehicle quota system), it requires a car buyer to purchase a Certificate of Entitlement (COE) for the purchase of new vehicles. The supply of COE is strictly regulated/rationed by the government while the price of COE is subject to bidding, hence it is determined by market forces. Prices of COEs sometimes soared, whilst at other times it might plummet according to demand and supply of COE in the market over time. Thus, to effectively control car ownership, the government will be reducing the number of COE for bidding over time so as to increase the price of COEs in order to deter car ownership. Note: COE is not a form of marketable permits. Limitations (GOVERNMENT FAILURE)
LACK OF INFORMATION: Government may estimate the number of COEs wrongly. There were times that the price dropped to $1 when many cars were scrapped and the number of COEs in the open market increased tremendously.
BLUNT INSTRUMENT: it affects those who are not within the targeted group. Those who usually drive during off-peak which do not contribute to the congestion also end up paying high COEs.
NEGATIVE IMPLICATION: However, reducing COEs may have unintended consequences as it might leads to more intensive use of cars on the road. It makes car ownership more expensive thus creating the incentive for car owners to maximise the benefit from car ownership by using their cars more often. In other words curbing ownership has paradoxically cause more usage and road congestion. Furthermore, the high prices of COE can be a cause of rising living cost in Singapore since expenditure on transport is a main component in the Consumer Price Index.
Evaluation/Synthesis (Comparing ERP and COE): A few years back, our government tried to steer away from car ownership deterrence towards car usage as the objective should be to "punish" those who use their cars during peak periods or congested roads and not those who own cars. However, this has changed as the cost of car usage is deemed relatively much smaller compared to buying a car. I.e. Once a car is bought, it seems right to maximize the use to spread the fixed cost over more journeys and thus drivers are not deterred by ERP payment. So the government is curbing car ownership again. Be it deterring car ownership or discouraging driving during peak hours, perhaps a better solution is to provide an excellent and affordable public transport. Refer to ‘Solution 3’. Solution 3 (provide good substitutes to driving)
The use of substitutes such as public transport is widely encouraged to divert the private motorist away from using their cars. In Singapore, the affordable, extensive and efficient transport network such as existing and new MRT lines and buses would encourage some private motorists to give up driving cars. Limitation: Public transport is not so effective for many Singaporeans who are getting richer and more status-conscious. Cars are positional goods which people aspire to possess once they become successful. Thus, no matter how efficient public transport maybe, it cannot completely replaced/substitute for car ownership. This is an issue the government needs to carefully manage in an affluent country like Singapore. With the train breakdowns, and overcrowding of buses and trains, the cross price elasticity of demand between driving and public transport is getting smaller, making this policy less effective. Suggestion: Thus government has enacted certain regulations to ensure that public commuters do not get hindered by traffic congestion. This would include the use of bus only lanes during peak hour, restricting cars from using these dedicated lanes. By having these lanes, the issue of third party cost may be reduced when private motorist do not impede the public transport commuters from getting to work. However, bus only lanes are good if it is well policed. Some private motorists may breach the rule by entering the lanes. In addition, the cost of having dedicated lanes may be prohibitively high in land scarce Singapore.
BODY 2 – to reduce air pollution Mandatory installation of catalytic converter in cars; car scrapping and annual inspection: ensuring car exhaust emission from all vehicles in use meet the limits set by Ministry of Environment; banning of leaded petrol to reduce sulphur content diesel fuel; introducing tax incentives to narrow the price gap between electric/hybrid vehicles and conventional ones.
Conclusion/Synthesis (FINAL JUDGMENT) At present, the issue of traffic congestion is adequately managed by a combination of restrictions on car ownership and usage, matched with an efficient public transportation while pollution is kept under control by various regulations. However, in the long run, with Singapore’s population increasing and not matched by an increase in land space, it would be almost impossible to increase the number of private vehicles. Thus the only viable solution in the future would be to get most of Singapore households to rely on public transport. Towards this end the government has already stepped up construction of MRT lines to link up various parts of the island so to provide a comprehensive rail network to offer a good alternative to private car ownership.
Question 2: IJC 2012 (a) Explain whether expressways and traffic lights are examples of public goods. [10]
Learning Objectives: 1) Applying the characteristics of rivalry and excludability to a good to arrive at a proper
categorization. 2) Learning how to handle an ambiguous context, e.g. expressways are rival during peak-
hours and non-rival during non-peak hours, excludable with a toll booth and non-excludeable without a toll booth. The matrix table below can be used to guide discussion.
Part (a) Public goods are those goods or services that are non-rival and non-excludable in consumption.
A good is non-rival in consumption if one person’s consumption of the good does not reduce the quantity available to another person. Because of this, once a public good is provided, the marginal cost of providing the good to an additional user is zero. With zero marginal cost, the basic principle of optimal resource allocation calls for provision of public goods and services at zero price or no charge. However, if the price is zero, no firm would want to supply the good. This results in a missing market.
A good is non-excludable in consumption if it is difficult to exclude non-payers from enjoying the good. This gives rise to a free rider problem. Since non-payers can also enjoy the good, no one would be willing to pay for it. As a result, demand is concealed and difficult to estimate. With no price and marginal cost, this leads to zero production resulting in complete market failure.
A. EXPRESSWAYS Rivalry
A motorist’s use of the expressway will not reduce the quantity available to other motorists during off-peak hours. However, rivalry occurs when there is overcrowding during peak hours.
There is additional cost involved in allowing one additional motorist to be on the expressway during peak hours, such as the time loss due to traffic congestion. This means that there is a price that consumers would be willing to pay, hence producers will be willing to produce since it is possible for them to charge a price. Debatable
Excludability
Expressways can be treated in the same way as a public good. However, in reality, it is possible to exclude non-paying motorists from using the expressway. ERP charges can be collected for the use of expressway, i.e. non-excludability in consumption. This can be done either manually via toll booths where cars are barred from entering the expressway if they do not pay a fee or using the ERP gantry system.
There are administrative costs involved in collecting money for use of expressways e.g. labour costs or the high initial cost of building ERP gantry. Hence, government may choose not to build the gantry at some areas and as a result there is non-excludability in consumption.
B. TRAFFIC LIGHTS Rivalry
The use of the traffic light by pedestrian does not reduce the “quantity” available to another pedestrian. This will mean that the cost of providing service of traffic light to an additional pedestrian is zero. Since optimal resource allocation is attained where P = MC. Since the marginal cost of providing additional unit of traffic light is zero, it will efficient when the price of it is set at zero. Profit-maximizing producers are not willing to produce traffic light since they are unable to charge a price for the use of it.
Excludability
Once the traffic light is provided for a consumer, others who do not pay for the use gets to use the traffic light as well. There is no way to obtain payment from each consumer who is using the traffic lights. Hence, it is difficult to exclude non-payers from enjoying the service provided by traffic lights. This gives rise to the problem of free riders, and no one is willing to pay for the use of the service. As no one is willing to reveal his demand for public goods, this means that there is concealed demand. In this case, no profit maximizing producers will want to produce traffic lights.
Conclusion
Traffic light is an example of public good as it satisfies the two characteristics of non-rivalry and non-excludability. Expressways can be considered as a public good although the characteristic of non-rivalry may not hold true all the time.
For a good to be classified as a pure public good, it must satisfy the two characteristics of non-rivalry and non-excludability. Therefore, it can be concluded that traffic light is an example of public good, whereas expressway is not a pure public good.
Mark Scheme Level Descriptors Marks
L3
Well-developed explanation on the key characteristics of “public good” in terms on degree of rivalry, degree of non-excludability and extent of market failure. There is a clear stand on whether traffic light and expressways are examples of a public good.
7-10
L2 Under-developed explanation on concept of “public good”. Unable to make clear links between the characteristics of a public good and nature of the two goods.
5-6
L1 Descriptive answer with little economic analysis.
1-4
Question 3: Adapted from RJC 2011 and IJC 2012 (a) Distinguish between public and merit goods. [10] (b) Assess the economic case for free university education in Singapore. [15]
Schematic for Q3(a)
Intro
Define public goods
Define merit goods
Body
Distinguish based on rivalry, excludability and provision
Use examples
Conclusion
Tutor's notes: Emphasize on the command word "distinguish" which affects the structuring of the essay. It requires the two concepts of merit good and public good to be contrasted (no need for similarities!) throughout the answers. The contrast of concepts can be done by using the at least three key criteria identified. It should be understood that real-life examples should be cited to achieve Level 3 marks. The matrix below can be used for brainstorming/planning to "scaffold" the writing process. Introduction:
(Adopt KIA structure in Intro) Provide definitions of Merit good and Public good State approach of "distinguishing" the concepts using criteria: rivalry, excludability and
provision Body:
Distinguishing Criteria
Merit goods Public goods
Rivalrous in consumption - Definition: The
consumption of the good by one person diminishes the amount available for another person to consume.
Yes Explain the concept of rivalry using an example of one person’s consumption of healthcare service such as flu vaccination - when one person
consumes vaccination, there will be one less available for the others
No Explain the concept of non-rivalry using an example of street lighting - The consumption of street lighting by
one person does not diminish the quantity or quality available for the next person.
Excludable in consumption - Definition: Means that it
is technically possible or feasible to exclude anyone who has not paid for the good/svc from consuming it once it is produced.
Yes Explain the concept of excludability using an example of consumption of flu vaccination - the direct benefits from
the consumption of the flu vaccination is confined to those who
No Explain the concept of non-excludability using an example of street lighting No single person has to pay to enjoy the light provided by street lighting. i.e. it is technically impossible / prohibitively expensive to exclude anyone who walks on the street from benefiting from it even though he /she doesn’t pay for it directly.
pay for the vaccine
Provision Provision by private sector
Due to the rivalrous and excludable characteristics of the merit good, it can be provided by the private sector. Due to the characteristic of excludability
those who wish to enjoy the good must pay for them
Firms are therefore able to charge a price for the good since there is an expression of demand
Rational profit maximizing firms will hence be incentivized to supply the good for a profit
*Note: However, while the free market tends to produce merit goods, it tends to be under-produced and under-consumed due to problems of imperfect information and the existence of positive externalities. So, the provision of merit goods tends to create that of a partial market failure problem.
Provision by government Non-provision by private sector, can only be provided by the government (financed by taxation) Non-rivalry
cost of supplying the good to an additional consumer is zero i.e. MC=0
to achieve AE, P = MC = 0
not possible for private sector to supply the good if P = 0 since private firms are assumed to be profit-motivated
Since there will be zero allocation of resources to the provision of the public good, there is a misallocation of resources and AE is not achieved, leading to market failure, calling for the government intervention.
Non-excludability
free-rider problem no expression of demand/concealed demand
firms are unable to charge a market price for the good without information with regards to demand for the good.
unprofitable for private firms to supply the good
free market thus allocated zero resources to the provision of this good, leading to complete market failure.
government intervention required Due to the characteristics of non-rivalry and non-excludability, no resources will be allocated to the production of public goods when left to the private sector. The problem of a complete market failure calls for the government to intervene to provide for such goods that yield high positive externalities.
(b) Assess the economic case for free university education in Singapore. [15]
Tutor's notes: Given the contentious nature of the subject matter, this question is rather ideal as a motion for a classroom debate to elicit economic arguments and counter-arguments before constructing the essay. A ppt template for conducting debate can be obtained from the C1H2 sharing folder if the tutor is keen. Do approach members of the Market failure PLC for assistance if necessary.
Schemmatic for Q3(b)
INTRODUCTION
BODY
Thesis I: Merit Good Argument
Thesis II: Income Inequality
Anti-thesis I: EMB hard to determine; EMB varied across university courses and other counter-arguments
Anti-thesis II: Equity issue from free higher education and other counter-arguments
SYNTHESIS
CONCLUSION
Introduction
Market failure occurs when markets operating without government intervention, fail to deliver
an efficient or optimal allocation of resources.
Therefore, social welfare may not be maximised – leading to a loss of allocative and
productive efficiency (i.e. welfare losses for society).
The economic case for free university education can be examined mainly based on the
relevant sources of market failure in university education, namely merit good and equity
arguments.
Thesis I: Economic Case for Free University Education - Merit Good
The market for university education in Singapore can be an example of a merit good.
It has positive externalities and is deemed intrinsically desirable by the government.
Coupled with imperfect information, the good tends to be under-consumed when left to an
individual.
E.g. Many young people can be myopic when making university and degree course
decisions. Or they may be averse to taking on debts even though it might be in their long-
term financial interest to do so.
Thus, to correct market failure, government intervention is required to achieve a more efficient allocation of resources so as to ensure that society’s welfare is maximised.
The Private Marginal Benefit (PMB) to the students receiving university education refers to additional benefits from consuming an additional unit of higher education, like improvement in knowledge and ability to secure a higher paying career.
The Private Marginal Cost (PMC) measures the additional cost to universities from an additional unit of education produced, such as the wages of professors, utility bill.
The External Marginal Benefit (EMB) refers to benefits accrued to third parties who are not directly involved in the consumption or production of the university education.
For example, there is compelling evidence that human capital increases productivity and thereby increases an economy’s trend rate of growth and international competitiveness.
Education is found to yield additional indirect benefits to economic growth for example by stimulating capital investments and technological development and adoption across many different industries in Singapore, like biomedical and finance sectors.
However, the third parties in the society do not compensate students for the external benefits they reaped. Hence in this case of a positive consumption externality, the students are not concerned about the external benefits to third parties but their own private benefits
as the external benefits are "unpriced" by the price mechanism and not included in the private benefits.
As such, we can say that the free market has “over-priced” the consumption of university education which will lead to an inefficient allocation of resources and hence market failure.
For each additional unit of education, the social marginal benefit (SMB) includes the private marginal benefit (PMB) plus the external marginal benefit (EMB). Hence, the actual benefit reaped by the society is represented by the SMB, which takes into account the full benefits to society of an extra unit of education.
Figure 1: External benefit from consumption of university education
As seen in Figure 1, the presence of an external benefit causes a divergence between private and social benefits, with SMB above PMB as SMB = PMB + EMB.
Assume that consumption of education in this case yields no negative externality, EMC=0. Thus, PMC=SMC.
(Assuming perfect competition, market equilibrium quantity of education is Qm, where PMB = PMC, as consumers and producers of vaccines only consider their own benefits and costs.)
However the socially efficient quantity of education should be at QS where SMB=SMC,
where the full costs and benefits and costs to society are considered. Qm is less than the
market equilibrium quantity, QS. where PMB = PMC. Thus there is underconsumption of
education by the quantity QS – Qm.
The merit good argument hence forms the main economic case for free university education when the positive externailties generated is sufficiently high.
Theoretically, the government might provide a subsidy to producers corresponding to the external marginal benefit i.e. subsidy = EMC at QS (distance BD) on each unit of education. This shifts the PMC downwards so that the new PMC, which equals PMC – subsidy, coincides with the PMB at QS.
Figure 2: Subsidy to internalise EMB from university education
Price
Quantity
PMC=SMC (since EMC=0)
SMB = PMB + EMB
B
A
Qm QS
PMB
C
EMB at Qm PS
Pm
Subsidy
= EMB at QS
Price
Quantity
PMC=SMC (since EMC=0)
SMB = PMB + EMB
B
A
Qm Qs
PMB
C
D
PMC – subsidy PS
PS – s
Pm
Hence, the new market equilibrium quantity where PMB = PMC – subsidy, now coincides with the socially efficient quantity QS, where SMB = SMC.
If the subsidy accurately reflects the external marginal benefit, students are now in effect being compensated for the external benefit they bring to third parties as the price they are paying is now lower at PS – s, compared to Pm before the subsidy.
The externality has then been internalised. Anti-thesis / Evaluation :
Subsidies used to internalise a positive externality is a market-based approach.
This approach gives private individuals the freedom of choice in making rational decisions with regard to the best level of consumption that would maximise society’s welfare.
The government’s role is not to replace the market but to help markets price in the externality so that private individuals can take into account the full social benefits of consuming university education.
However, in practice, it is difficult to determine the amount of subsidy accurately in order to attain the socially optimum level of education, as it is difficult to accurately measure the extent of EMB due to tangible and intangible benefits.
To argue that the EMB is sufficiently large to warrant a large subsidy such that P=0 is highly debatable. (Especially, when compared to primary and secondary levels of education, the EMB of tertiary education may be significantly lower, with PMB significantly higher.)
Therefore, if the main benefit of a degree is a higher salary to the student, it seems justifiable that the recipient of this benefit should pay for the personal benefit he/she receives. Thus associated to the subsidy is equity consideration (which is discussed below).
In addition, the levels of EMB also vary at different types of university education – the EMB may be higher for certain specialization, such as medicine and law, as opposed to Archeology. (This is again a highly "normative" issue, but given the context of Singapore, it is likely to be the case.)
If this is indeed the case, varied subsidy amount catering to different types of higher education may need to be imposed (according to the varied extent of EMB generated).
Last but not least, in the analysis, we assumed that PMC=SMC, hence the potential
negative externalities of higher education have been mainly ignored in the debate.
Thus, on balance, based on the merit goods argument, the ground for free university
education across the board seems shaky. A more calibrated approach of
"customized" subsidy according to EMB by university courses may be required.
Thesis II: Economic Case for Free University Education – Income Inequality
There is also a common argument that university education should be free to ensure
"equality of opportunity".
Markets can generate what is perceived to be an ‘unacceptable’ distribution of income and
too high a level of "social exclusion" where citizens of lower incomes are denied access to
essential goods and opportunities considered ‘normal’ by a society, like university education.
E.g. Public universities in Germany charge no or only marginal tuition fees, i.e. tuition fees
are mostly or completely covered by public funds. Should Singapore be like Germany?
In Singapore, the transition to a knowledge-based economy leads to more opportunities
being created in sectors requiring highly skilled labour, like in biomedical sector, while the
lower-skilled production is increasingly phased out. Those who are highly educated and
possess the relevant skills experience a faster increase in income as the demand for such
workers will increase while those who are low-skilled would have difficulty getting
employment with the fall in demand for such workers.
Thus, a re-distribution to the lower-income in the form of university subsidies can be used
to reduce income inequality in Singapore (which has been deteriorating in recent years). If
students from lower income group have to pay for university education, this may dissuade
them from pursuing it. In theory, students could take out loans or work part-time, but this
may be sufficient to discourage students from studying and instead may enter the job
market earlier.
Anti-thesis / Evaluation:
Is it equitable for students to make a financial contribution to their degree education?
They stand to gain financially from a degree – education is an investment and it is rational
for students to "borrow" at this stage of their life-cycle to finance such investment. It is
rational to forgo current earnings in return for higher future earnings
Furthermore, access to higher education to people from less privileged backgrounds can be
protected. Tuition fees can be "means-tested" to offset the danger that fees will hit lower
income students hardest.
Funding tuition from general taxation is an expensive and poorly targeted way of intervening
in the market, because graduates, who are predominantly found towards the top of the
income distribution, benefit at the expense of everyone else e.g. why should non-graduates
pay for the degrees of graduates?
The basis of promoting students to a higher level of education is solely on the basis of
achievement, merit and hard work, upheld by the principle of meritocracy. Meritocracy
recognises and rewards everyone who works hard and excels and it is the best means to
maximize the different capacities of a small country like Singapore. Thus, to provide free
university education may erode the incentive to work hard and excel which may be
detrimental to the enhancement of human capital of Singapore. Furthermore, the argument
that education should be provided free is much stronger for the case of primary and
secondary education than for higher education to achieve meritocracy aim as it benefits
more in the society.
Other Evaluations – Intervention Cost & Government Failure
Intervention cost of the government in the provision of education has to be carefully considered. The Singapore government spends approximately S$9.7 billion in its education budget. To increase such a hefty sum invested into education, there are high opportunity costs on government funds.
There may also be government failure as well in terms of bureaucracy, inefficiency and lack of public support for free university education.
Conclusion
The economic case for free higher education in Singapore is based on merit good argument
and income inequality considerations.
For merit good argument, even if positive externalities exist, it is unclear whether the extent
is sufficient to justify a high subsidization, given high intervention cost and potential for
government failure.
On the other hand, negative repercussions of free higher education on income inequality in
the long term can be significant.
For Singapore, as the intervention cost of heavy subsidy is high, less extreme forms and
multi-pronged approach in intervention in the market for higher education is required.
For instance, "mean-tested" subsidy, coupled with other bursary schemes to help the
students from less-privileged background can be used to tackle the equity issue.
Question 4: TYS 2008 Q3
(a) Explain why imperfect information and immobility of factors of production may lead to market failure. [10]
(b) Evaluate the policies currently used by the Singapore government to correct these causes of market failure. [15]
(a) Explain why imperfect information and immobility of factors of production may lead to market failure. [10]
Simple Schematic Plan
INTRODUCTION
BODY
How imperfect information leads to market failure
How immobility of factors of production leads to market failure
(1) Due to ignorance of the actual benefits to oneself - If perceived
benefits are less than the actual benefits, it will lead to under-consumption
- If perceived benefits are more than the actual benefits, it will lead to over-consumption
Only use ‘SEED’ for 1 perspective under time constraint.
(2) Due to ignorance of benefits/costs to others (EMB/EMC)
Only use ‘SEED’ for 1 perspective under time constraint. Note: In fact, if ‘SEED’ is already been used for (1), this part will be brief as there is still immobility of FOP to be covered.
Labour immobility - occupational - geographical
Capital Immobility
CONCLUSION
SUGGESTED ANSWERS
INTRODUCTION
Key words Market failure occurs when free markets, operating without any government intervention, fail to deliver an efficient allocation of resources to produce goods and services.
Issue & Approach
This essay aims to explain why imperfect information and immobility of factors of production may lead to market failure.
BODY (A) HOW IMPERFECT INFORMATION MIGHT LEAD TO MARKET FAILURE In an efficient market, both buyers and sellers have good knowledge of the product in order to make rational decisions that equate marginal benefits to marginal costs. When imperfect information exists, buyers and sellers are prevented from achieving the efficient outcome. The inefficient allocation of resources leads to welfare loss. The case of health care is a classic case whereby consumers (i.e. patients) may have very poor knowledge about their health conditions and rely on the doctors to give them the information. E.g. patients suffering from the early stages of a serious disease may not consult their doctor until the symptoms become acute, by which it may be too late. This is the problem of ignorance. Misallocation Such imperfect information will result in misallocation of resources in providing the service or drugs
for the patients. In the case of ignorance, consumers might end up under-consuming medical/health-care services
e.g. health-screening for major illnesses like cancer etc. They fail to go for regular check-up as their perceived benefits are lower than the actual benefits.
Yet, there could be cases where consumers buy products that leave them worse off. For example, smokers fail to realize the harm smoking brings about such as lung cancer to themselves and also people around them. Their perceived benefits are much higher than actual benefits as they only take into account of the enjoyment or satisfaction they gain from smoking and are unaware of the harm it does to their health. Also, if they are more aware of the harm they have done to passive smokers such as their family members, they might cut back on smoking. Such ignorance will lead to over-consumption and thus over-production.
Example of colorectal cancer screening Ignorance of benefits to oneself
Consumers may underestimate their true private marginal benefits from colorectal cancer screening due to imperfect information. For example, if consumers knew that colorectal cancer is now the most common cancer in Singapore affecting both males and females, they would realise that the benefit of such screenings is that it has a good chance of detecting the cancer early. Furthermore, the early stage of colorectal cancer is often localised to the bowel and hence early diagnosis can often lead to a complete cure.
Figure 1: Imperfect information on actual PMB of cancer screening
Assume that there are no positive or negative externalities.
As seen in Figure 9 above, with imperfect information, consumer demand for colorectal cancer screenings is lower at PMB perceived as they underestimate the actual benefit of such screenings.
As such, the market equilibrium quantity would be at Qm where PMB perceived = PMC.
However, the true private marginal benefit should be at PMB actual.
Hence, the socially efficient quantity should be higher at QS where PMB actual = PMC.
Hence the ignorance of the full benefits of colorectal cancer screenings causes an underconsumption QS – Qm of such screenings.
Area QSQmCB is the actual total private benefit gained for the underconsumption QS – Qm.
Area QSQmAB is the total private cost incurred for the underconsumption QS – Qm.
Since the actual total private benefits gained exceeds the total private costs incurred for underconsumption QS – Qm, area ABC represents the deadweight welfare loss due to underconsumption of QS – Qm.
(B) HOW IMMOBILITY OF FACTORS OF PRODUCTION MIGHT LEAD TO MARKET FAILURE Immobility of factors of production contributes to market failure as resources cannot respond to Market incentives to produce goods and services demanded by consumers or disincentives to stop or cut production. The greater the immobility of factors, the more difficult it is for markets to achieve socially efficient allocation of resources. The 2 most common context of factor mobility: (a) labour immobility (includes occupational immobility and geographical immobility) (b) Capital immobility. Explain how occupational immobility of labour leads to market failure (STRUCTURAL UNEMPLOYMENT)
Very often as an economy progress, there will be a shift of focus in the types of industries in the economy.
For instance, a developed economy may create more employment opportunities in the service sector whereas the manufacturing industries are facing a decline in their business due to a loss
Price
Quantity
PMC = SMC (assume EMC = 0)
PMB actual = DD (perfect info)
B
A
Qm QS
PMB perceived = DD (imperfect info)
C
in the comparative advantage.
Despite greater opportunities in the service industries, workers are not able to switch jobs immediately to work in the service sector due to occupational immobility. They lack the skills to work in this sector.
Thus, even though there may be abundant supply of workers in the economy, they will not be able to fill the job vacancies that are created in the service sector. These workers become structurally unemployed.
For example, a large number of unemployed factory operators with primary school education in Singapore may not be able to work in growing industries like pharmaceutical industries. This implies that there is a mismatch of skills between the unemployed and those required in expanding sunrise industries in Singapore.
Explain how geographical immobility of labour leads to market failure
Workers are not able to travel to another location to work even though there are job vacancies. Geographical immobility exists in large countries (e.g.UK, USA, China and India) when there are barriers to prevent people moving from one region to another in search of jobs.
These barriers include family and social ties, costs involved in moving home, regional variations in house prices and differences in the general cost of living between regions.
Thus market failure occurs because resources are not being reallocated from areas with few jobs opportunities & unemployed labour even though there is high demand for labour & plenty of job vacancies in another region/country or industry.
Explain how geographical immobility of capital leads to market failure
Certain capital goods are difficult to transfer from one use to another. E.g. A train once built is only useful as a train. It cannot be changed into a car or a plane. For other capital goods, it is difficult to transfer it from a geographical location to another. For example, a petrochemical plant built in China cannot be easily uprooted and transferred to the US.
In research and development there is a need to make capital more mobile in order to channel more funds to bring about the discovery of cutting edge technology or new cures for deadly flu virus
CONCLUSION
(b) Evaluate policies currently used by the Singapore government to correct these causes of market failure. [15]
Examiner’s Report:
(b) Answers to this part of the question tended to fall into two broad types of response: those that addressed the question and those that wrote in length about policies to resolve any and all forms of market failure in general terms. Many candidates wrote at length about policies designed to reduce monopoly power without any reference whatsoever to either imperfect information or immobility of factors. There were some very good answers but these were in a relatively small minority. These candidates examined a range of policies to overcome the problems caused by imperfect information – in the context of Singapore these included health warnings on cigarette packets, better product labeling to encourage healthy eating, compulsory education and the requirements for medical practitioners to clearly display prices so that patients are given full knowledge of the likely cost of their treatment.
Where lack of information about externalities was used to explain market failure, appropriate policies to correct for this failure in the Singapore context were given. A common example of evaluative judgement was the problems of government failure when setting taxes or subsidies to overcome market failure due to externalities. In terms of a lack of factor mobility, candidates often referred to government policy in terms of training and skill enhancement and in research and development needs to make capital more mobile. Good evaluative comment explained that the Singapore government had done much to improve transport facilities and that geographical mobility was less of an issue in Singapore than in many larger countries.
Simple Schematic Plan
INTRODUCTION
BODY
Policies that correct imperfect information Policies that correct immobility of factors of production
(1) Correct ignorance of benefits to oneself through education
(2) Correct ignorance of benefits to others (EMB) through subsidy and correction of ignorance of costs to others (EMC) through taxation
Correct labour immobility through supply-side policies such as training /education & better infrastructure
Correct capital Immobility through supply-side policies such as tax incentives and financial help
Explain how these policies work and possible limitations.
CONCLUSION
SUGGESTED ANSWERS
INTRODUCTION The Singapore government is current using various policies especially supply-side policies to correct these two causes of market failure. This essay will aim to explain how they work and possible limitations.
Solutions to correct imperfect information For ignorance of own benefits and positive externalities (benefits to third party), the Singapore government uses public education to encourage the consumption of healthcare products or services. The Health Promotion Board in Singapore often organizes health education program in schools and runs national campaign nationwide to inform the public about the benefits of healthcare. Residents will be more aware of the full social benefits of health to themselves as well as to society at large. With such awareness talks and campaigns, the more accurate assessment of PMB and thus moving PMBperceived nearer to or even reach the PMBactual. Referring to Figure 1, with perfect knowledge, consumers will be able to know the actual PMB of colorectal cancer screening and hence consume at the socially optimal level Qs where PMBactual = PMC, eliminating the welfare loss area ABC.
Limitations: Education is a long drawn process that involves changing mindsets. It is not merely the dissemination of information by the state. Its effectiveness depends on whether the information is treated as credible or merely state propaganda. For instance, the ill effects of smoking is sometimes derided as scare tactics used by the without proven scientific basis. Private tobacco companies have attempted also to provide evidence to debunk the link between smoking and cancer. It is often difficult to change the mindsets of people in adopting a healthier lifestyle or to go for immunization to prevent certain diseases. Individuals tend to make decisions based on private benefits and costs, ignoring the external benefits of consuming healthcare services sufficiently.
Solution to correct immobility of factors of production SUPPLY-SIDE POLICIES to overcome occupational immobility of labour (macro policy)
The Singapore government encourages the workers to attend courses to upgrade their skills to meet the changing demand of the economy. They provide retraining programmes to help workers obtain the requisite skills for the new economy. For example, in Singapore, the Workforce Development Agency (WDA) developed a Continuing Education and Training (CET) infrastructure, based on an established network of Industry Skills and Development Councils, to help it chart the future of manpower development in each economic sector. EDB, in conjunction with the WDA, also helps in the retraining of PMETs (Professionals, Managers, Executives and Technicians).
In 2008 the government introduces the Skills Program for Upgrading and Resilience (SPUR) where a subsidy is provided to workers who attend higher courses to upgrade their educational knowledge and skills.
This reduces market failure caused by occupational immobility as the policy allows the workforce in Singapore to acquire new skills to find a job in the sunrise industries such as the service sector.
Limitations: Success of training subsidies would depend on whether the age gap, attitude gap, aptitude gap & expectation gap with regards to training & job openings can be bridged. Policies to overcome geographical immobility of labour The Singapore government has also spent a lot of resources to improve the transport network system such as the extension of the MRT lines to more parts of the country and the building of more expressways to improve the accessibility and connectivity between parts of the island. This is to reduce geographical immobility so that workers are able to travel to different parts of the country to work. Evaluation: In small countries like Singapore, geographical mobility is less of an issue than in many larger countries especially after the government had done much to improve transport facilities. Policies to overcome geographical immobility of capital For capital immobility, governments can perhaps target certain sectors and encourage firms to purchase capital goods (that they view as important) by giving them preferential incentives (e.g., tax cuts, financial help).
CONCLUSION Hence, the Singapore government has implemented appropriate policies to correct market failures arising from imperfect information and immobility of factors of production. Even though these policies may not completely correct the market failures, government intervention in the form of subsidies & education to correct underconsumption and taxes & campaigns to correct overconsumption/production as well as the constant improvement to a world class transportation network in Singapore will definitely reduce the extent of market failure due to imperfect information & factor immobility respectively. Resources are hence allocated more efficiently and the equilibrium level of output will be moved closer to the socially efficient level.
