“The Central Problem of Economics (CPE) is about scarcity and choice.” Is this statement true? [25 marks]

This paper examines the central problem of economics (CPE). 

One fundamental assumption of economics is that man’s wants are unlimited but the world’s resources are limited. 

In economics, resources refer to the factors of production of land, labour, capital, and entrepreneurship. 

Land refers to natural resources, such as oil, gas, minerals, and water. 

Labour refers to human effort and skill. 

Capital refers to goods that produce other goods, like any machine or equipment that can produce other things. It does not solely refer to financial capital or money or finance. 

Entrepreneurship is the ability to take risks, organise, and plan production effectively, and coordinate the other factors of production in the pursuit of profits. 

All countries have a finite amount of these factors of production of land, labour, capital, and entrepreneurship. 

Based on these assumptions, it is clear that it is not possible to produce all that we want, given that the factors of production are limited while man's wants are unlimited. Some goods will have to be sacrificed to obtain more of other goods. 

Put another way, this situation is one of scarcity, and scarcity necessitates choice. 

This means that a rational choice has to be made of what to produce, how to produce, and for whom to produce. 

Since something has to be forgone, there is a "cost" involved. In a world of scarcity, there is a cost of sacrifice involved in satisfying a particular want. 

This cost is called opportunity cost, and is defined cost of the next best alternative foregone to satisfy the particular want.

The way in which a free market mechanism with minimal government intervention solves the CPE is through the price mechanism.  

The intersection of demand and supply determines the market equilibrium (or market clearing) price and output, which will resolve the issues of what to produce (by signalling the price or value of the good), how to produce (producers will ensure they find cost-effective methods of production), and for whom to produce (those who can afford it). 

In conclusion, the statement “The Central Problem of Economics (CPE) is about scarcity and choice” is true to a large extent, because this is the main problem that all demand and supply models are intended to address, and which all economics students are putting under the microscope. 

I think that although this issue is generally quite simplified as a heuristic, the CPE is indeed about scarcity necessitating rational, logical choices and that is what economics is all about.  

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JC ECONOMICS ESSAYS Tutor's Comments: Well written, interesting and insightful. Brilliant effort! Do please think of how you would draw and label the PPC/PPF properly? Do also think about other alternative ways of approaching this JC economics question. Other than this economic approach, how else could this economics essay have been answered? Thank you for reading this sample essay, and cheers. 

According to economic theory, the price mechanism in a free market will always allocate scarce resources efficiently for all goods and services. Evaluate the validity of this statement. [25]

This essay question was adapted from an actual H2 A level economics examination question

This economics essay evaluates whether the price mechanism in a market economy will always allocate scarce resources efficiently for all goods and services. This essay argues that, on the one hand, the price mechanism working in a free market economy will indeed allocate scarce resources efficiently, according to standard economic theory, because of the price mechanism can achieve productive and allocative efficiency. On the other hand, the allocation of scarce resources may not always be efficient, especially when there are market failures and resources are not allocated efficiently, leading to a situation of allocative inefficiency, which distort the workings of the free market.

First, we need to deal with the central problem of economics. Human wants are unlimited, while the earth's factors of production of land, labour, capital, and entrepreneurship are limited. Land refers to gifts of nature such as physical land, natural resources, and oil and gas, among other examples. Labour refers to human ingenuity, effort, time, and talent in the form of “human capital”. Capital in economics often refers to goods that are used to produce yet other goods. And entrepreneurship is the risk-taking, decision-making element that coordinates the other factors of production in an economy. This situation of limited factors of production that could potentially be allocated to different outputs, and the context of unlimited human wants, results in a situation of scarcity. It is important to note that economic scarcity necessitates choice, usually made between competing uses. 

Tutor’s Question: What economics diagram do you think should be drawn here? And how would this diagram back up your arguments?

The price mechanism, through the intersection of demand and supply, determines the optimal price and output and it is from the rational choices of millions of suppliers, producers, and firms meeting the requirements of millions of consumers, individuals, and households that eventually leads to the free market determining what to produce, how to produce, and for whom to produce. Demand is defined as the willingness and ability to purchase a good or service, ceteris paribus, while supply is defined as the willingness and ability to produce a good or service, also ceteris paribus. Oftentimes, one major assumption for this economic theory to work is the situation of perfect competition, where there are many buyers and sellers in a market, selling a homogeneous and non-differentiated good or service, and there are no (or very low) barriers to entry into the market.

Under the market price, consumers seek to maximise utility, and will therefore only consume if they are able to have a positive net benefit from the consumption of these goods and services. Those who are willing and able to pay will obtain the good and service. And the resources used to produce these goods and services will also be efficiently allocated, as producers maximise their profits. As a result, there is productive efficiency, since goods will be produced at the lowest cost combination to ensure profits are maximised, and price will be equal to marginal cost. On the whole, there is also allocative efficiency, since society’s welfare is maximised, and the Pareto efficient situation is reached, where we can only make some people better off by making others worse off in such an economic situation.

On the other hand, there are market failures in the real world, which may impede the efficient allocation of scarce resources. Market failure is the situation where the free market fails to allocate resources efficiently, and there is allocative inefficiency and deadweight loss to society. There are many types of market failure, such as the lack of provision of non-rival and non-excludable public goods, under-consumption of merit goods but over-consumption of demerit goods, externalities both positive and negative and also in consumption and production, imperfect competition leading to excessive market power in a market, imperfect information, factor immobility, and income and wealth inequality in a free market.

One major example is the under-consumption of merit goods. Because rational consumers seek to maximise their own welfare, they do not account for the positive externalities associated with the consumption of their good or service, which could be a merit good. There are many definitions of a merit good, but one definition is that a merit good is a good defined by society or the government to be beneficial to society, often because they bestow positive externalities on society when they are consumed. Externalities are defined as spillover effects to third parties not involved in the production or consumption of the good. Vaccinations provided by the National Health Service (NHS) are examples of merit goods, because they confer positive externalities on society, as when people who are vaccinated help by not infecting others and by making UK society healthier as a whole. However, an individual consumer only considers his marginal private benefit from getting vaccinated, and does not consider the positive externalities his vaccination confers on society – he would not take the positive externalities into account when making his economic decision. This decision results in an under-consumption of the merit good of vaccination, if the decision is left to the workings of the free market, and there is therefore dead-weight loss, as society’s welfare has yet to be maximised due to this under-consumption.

Tutor’s Question: What economics diagram do you think should be drawn here to support the merit good argument, which shows that markets do not always work efficiently?

Another example is the failure of the free market to produce public goods if there is no government intervention. A public good is one that is non-rival and non-excludable. Non-rival in consumption means that one person’s consumption of the good will not result in less of the good being available to others – or the consumption of the good does nothing to reduce the quality or quantity of the good for others, such as public lighting in the streets, where the amount of light cannot be “used up”. As a result, the marginal cost of the next user is theoretically zero, and if allocative efficiency means to produce where price equals to the marginal cost, and the marginal cost of producing the good is zero, then it follows that no private firm would produce the good only to  charge zero dollars (at the allocative efficiency level). And non-excludable means that non-payers cannot be excluded from consuming the good, for example national defence – it defends everyone in the country, including those who have not paid for it, such as foreigners or travellers, such as tourists. Therefore a rational firm would not produce this good because of the problem of free riders, where one who has not paid for the good has the ability to consume it. The government is the only decision-making body that has the willingness and ability to produce a public good, like street lighting and defence, as it has the mandate to do so for the welfare of its citizens (and therefore the willingness) and can raise the revenues to do so from compulsory taxes (and therefore the ability to do so).

In conclusion, while the price mechanism allocates scarce resources efficiently according to economic theory, this may not always be the case in reality, as there are market failures that challenge the assumptions upon which the efficiency of the price mechanism is predicated. Some government intervention is required in the free market to make it genuinely “free”, and to let the price mechanism work as it should. In the real world, with market failures such as the failure of the free market to produce public goods or the underconsumption of merit goods, or imperfect competition in the market, there is a strong need for government intervention in the free market to reduce or eliminate market failures so that the free market can go a long way to produce the optimal outcomes that the free market economists promise.

Economics Tutor's Comment - This is a top-quality, excellently-argued, and very strong economics essay which covers quite a few important points and arguments. The candidate's use of economic theory for market failure is quite strong in this economics essay and the anti-thesis arguments have been well-explained. Could more real-life examples have been used to demonstrate the arguments or the strength of the points? What else would make this economics essay even better than it is currently? Thank you for reading, and cheers! 

JC Economics Essays - This economics essays blog helps economics students with the A-Levels Economics examinations (Cambridge, A1/S, A2, H1/H2 A levels), and the international AS level economics examinations. IB students can also benefit from the economics materials and content in JC Economics Essays. This economics blog provides a range of useful and relevant economics essays, learning materials, study tips and techniques, and model economics essays that students in the United Kingdom, Malaysia, and Singapore, as well as worldwide, can use to excel in their studies and economics examinations.

This model economics essay was contributed by WT, our resident expert who helps students understand the beauty of Economics. She has wide-ranging academic interests in Econometrics, Economic History, International Trade, and Game Theory. And as always, SS, the editor of JC Economics Essays, edited this economics essay and also provided comments and pointers. Several editions and versions of this economics essay have been very popular, but do not accept them at face value and always think about how you would approach this economics question instead. Thank you for reading and cheers. 

View: What's Wrong With Obamacare?

This economics perspectives essay is contributed by a loyal reader (MSc Economics)

I would like to share some simple views and perspectives about the debates about Obamacare, and its possible repeal by Donald Trump and the Republicans (afternote: President Trump after 20th Jan 2017). This economics essay is an opinion piece, and just takes a fluid and flowing approach, expressing my views and explaining issues as they arise, rather than making solid or theoretical economic arguments, since after all this is an emotive issue for many US citizens and for both Hilary/Obama supporters and Donald Trump supporters alike. 

First and foremost, what is Obamacare? Some people say it is "universal healthcare", and others say that it is "compulsory insurance mandate", and some don't even know it is. 

Here are some basics. 

Basically, Obamacare is an informal term for a law in the USA intended to improve access to health insurance for US citizens. And the official name of the law is the Affordable Care Act or the Patient Protection and Affordable Care Act in full. Basically, it requires that all US citizens purchase a Private Health Care plan, get an exemption, or pay a tax penalty on their federal income taxes. US citizens who cannot afford health insurance will either qualify for Medicare, Medicaid, CHIP (the Children’s Health Insurance Programme) or get social assistance in tax credits or economic assistance with up-front costs through their state’s Health Insurance Exchanges. If health insurance is still not affordable after financial assistance, or if it costs more than 8% of a family’s income for self-only coverage, an individual can be exempted from getting individual insurance.

And the Affordable Care Act does lots of important things, including offering US citizens a number of benefits, rights, and protections: for example, setting up an online Health Insurance Marketplace where Americans can purchase federally regulated and subsidised Health Insurance; expanding Medicaid to all US citizens in many states; improving Medicare for seniors and those with long-term disabilities; expanding employer coverage to millions of employees; and requiring most people to have coverage each month in order to get an exemption, or pay a fee. 

In my view, some of its provisions are simple common sense healthcare reforms. For example, in the past, there was no uniform system for showing benefits included in insurance plans, but under the Act, a simple, standardised document makes comparing insurance options easy. Reducing information asymmetry reduces market failure - a commonsense economic argument. And a common sense one too. I think there can be little serious debate against some of these clearly useful healthcare reforms. 

Some interesting provisions are that, among other provisions, the law eliminates lifetime and unreasonable annual limits on benefits completely by 2014; prevents individuals from being dropped from coverage for any reason, aside from fraud, which means that insurers are stopped from dropping patients when the cost of care gets too great; and provides assistance for those who are uninsured because of a pre-existing condition. Under this law, no one can be charged more or dropped from coverage due to having a pre-existing condition and cannot be charged more due to health status either. This wonderful idea only works when there is compulsory insurance, which is what Obamacare basically is. 

To return the question posed at the start - What's wrong with Obamacare? I think there's nothing wrong with Obamacare, from the perspective of those who are insured by it. (There are of course some problems with Obamacare, such as tax issues, which we can deal with later in a future discussion.)

In response, this is what Donald Trump has to say – most notably in what some have termed “a post truth world”, an age of misinformation, mistruths, rumours, and misrepresentation – “Obamacare collapses under its own weight if we don't repeal”. Any other points?

“One thing we have to do: Repeal and replace the disaster known as Obamacare. It's destroying our country. It's destroying our businesses. You take a look at the kind of numbers that that will cost us in the year '17, it is a disaster. It's probably going to die of its own weight. But Obamacare has to go. The premiums are going up 60 , 70 , 80 percent. Bad health care at the most expensive price. We have to repeal and replace Obamacare.”

Putting aside the questions of sanity and rationality, can Trump really do it? While rolling back Obamacare, as Donald Trump has promised to do in his first few days in the White House, could be accomplished easily, enacting the legislation necessary to replace the law while protecting millions of US citizens who depend on Obamacare may prove challenging. Such a major step to roll back benefits, a step unprecedented in modern US history, would destroy state healthcare markets in the US. 

The Republicans could roll back Obamacare… as they have done before. Using Senate rules that exempt some budget-related laws from filibuster, the Republicans have passed a bill before that eliminated hundreds of billions of dollars provided by the health law to expand Medicaid coverage for poor US citizens and subsidise health insurance for low and moderate income US citizens on marketplaces created by the law. The bill, which also scrapped the unpopular insurance mandate (which essentially penalises US citizens who do not have health insurance, because effectively the only way to pay for Obamacare is to ensure universal insurance), envisioned a phasing out of the current law, giving Republicans time to develop an alternative policy proposal.

The Republican plan would transform Medicaid, the government health programme for the poor, by eliminating federal rules that establish who should be covered, such as poor children and pregnant women, and which benefits should be offered, leaving those decisions to states. It should be pointed out that currently Medicaid and its related CHIP provide coverage to more than 70 million Americans. Another Republican approach may be that US citizens who don’t get coverage through an employer or through Medicare or Medicaid would qualify for a tax subsidy they could use to help offset the cost of a commercial insurance plan, similar to the system set up by the Affordable Care Act. Republicans argue these health plans would be more affordable than current plans available through Obamacare marketplaces because they would not be subject to as many federal regulations.

To conclude, while it looks like Donald Trump will get his way, we should think of this final point: before Obamacare was passed, an American citizen could be denied coverage or treatment because they had a pre-existing condition, be charged more because of their gender, or be dropped mid-treatment for making a simple mistake on his or her insurance application. Under Obamacare, all US citizens have access to a large number of unprecedented new benefits, rights, and protections. Think about losing that – and hopefully loss aversion will stop the US from repealing this law. 

JC Economics Essays. An economics blog with opinions. Special thanks to SS for his personal contribution to this economics blog. The opinions and views expressed are the author’s own views and are all made in his own private capacity. And his economic research came from articles written about Obamacare and the US healthcare system. Thank you for reading and cheers. 

Should governments always intervene when free markets fail to allocate resources efficiently? [15]

It should be recognized that free markets often fail due to allocative inefficiency, and there are various ways where governments can intervene to improve the outcome of resource allocation. However, governments should not always intervene as there are instances where intervention results in a less desirable outcome. This essay thus aims to analyse the pros and cons of the various ways of government intervention, and instances of government failure.

Yes, governments should intervene to improve the efficiency of free markets. Firstly, government policies to bring down the output level to the socially optimal output level can be divided into two categories, one market-based and another of direct control. A per unit output tax of the good raises production cost, thus reducing the output to the socially optimal outcome when there are negative externalities or demerit goods.

[Insert diagram for tax]

By imposing a per unit tax equivalent to MEC, MPC shifts to the left, thus bringing the output level down to Qs, coinciding with socially optimal output level. Hence, there should be intervention as it allows allocative efficiency to be achieved. 

On the flipside, an output subsidy would lower production costs, thus raising production to an output level coincidental to the socially optimal outcome, bettering the situation where there are positive externalities or merit goods.

[Insert diagram for subsidy]

By giving an output subsidy equivalent to MEB, MPC is shifted to the right, thus bringing the output level forward to Qs, the socially optimal level. Thus, allocative efficiency is similarly achieved.

While controlling output directly is a faster and more straightforward method, some may argue for the use of emission charges in the case of negative externalities as it advocates specific actions to cut down on the externalities which seem to some as a more long term solution. For example, in the case of pollution, emission charges induce firms to directly reduce pollution by the addition of a filter or the switch to less polluting production methods. However, there are limitations to such a policy as it gives high administrative costs due to the difficulty faced in monitoring emissions as compared to output.

When market-based policies fail to work, it may be sensible for the government to intervene with direct controls. An output ban could be used to forcefully bring down the output level to the socially optimal one. 

[Insert diagram on total ban]

An output ban will be advisable in the case where MEC is so large that the socially optimal output occurs at Qs = 0. In this case, a ban will be allocatively efficient. However, it should be noted that in a case where the MEC is relatively small, government intervention is not advisable as the outcome is even more allocative inefficient. As seen in the diagram above, when the government does not intervene, the area of welfare loss is smaller than when the government chooses to impose a total ban where quantity will be brought to zero. Hence, output bans are very extreme and thus governments should only intervene with a ban if MEC is large.

Another form of direct control would be direct free provision by the government to bring the output level to one that is socially optimal.

[Insert diagram on free provision]

For free provision, the MEB is so large that the socially optimal outcome occurs at Qs. Thus output has to be subsidized to such a large extent that the price of the good effectively becomes zero.

However, just like an output ban, free provision is very extreme and should only be used when the extent of MEB is very large. 

Where MEB is relatively small, MPC needs to be shifted to the right in order for socially optimal outcome to be achieved. Therefore, if the good was to be provided for free, the good will be over-consumed, resulting in a deadweight loss, implying that the outcome is worse than before intervention. Hence government should not intervene. 

In conclusion, despite substantial pros brought about by government intervention, the government should not always intervene as there will bound to be cases of government failure when the extent of intervention required is wrongly judged as seen from the examples above. Furthermore, the extent of administrative costs of some of the methods of intervention outweighs their benefits, translating to the view that the government should not always intervene.

JC Economics Essays - H1, H2, H3 Economics Essays - tutor's comments: While there is a lot of good economics material in this generally well written essay, the main problem is that it could have addressed the examination question more directly and targeted the answer better to the economics question specifically. Having said that, there are some saving graces to this economics essay. There is great use of varied economics diagrams, a lot of explanation, solid economic reasoning, and generally good application of economic principles and ideas, concepts, and logic. These save the essay quite a lot. However, better use of essay technique and more direct answering of the question would be great and would raise the grade achieved - also, lots of economics examples should also have been used. What other ways could be used to improve this essay? Think of how you could make this economics paper even better than it already is. 

How is price determination related to the different roles of prices in a competitive free market? [10]

In a competitive free market, the equilibrium market price is determined by the intersection of the market demand and supply curves. Prices play four different and important roles in the market, namely signaling, allocating, rationing and providing incentives. After establishing how price is determined and identifying the different roles of prices, this essay seeks to first explain a perfectly competitive market before explaining in detail how the equilibrium price is determined with the aid of a diagram. Thereafter, the different roles of prices will be further elaborated before analyzing the relationship between that and price determination.

How are prices determined? To begin with, a perfectly competitive market is one where there are low barriers to entry, a homogeneous product being transacted between many buyers and sellers and perfect information regarding product prices. The key outcome of such a market is that neither individual buyers or sellers have the ability to influence prices, thus both parties are price takers. The equilibrium market price (PE), which buyers and sellers are equally satisfied with, is thus determined by the intersection of the market demand and supply curves.

[Insert diagram on equilibrium market price and quantity]

As depicted in the diagram, if the price is above PE at $10, the quantity supplied is 100 units while the quantity demanded is 50 units. There is a surplus of 50 units and to clear the excess supply, producers will lower their prices. As the price falls, the quantity demanded rises while the quantity supplied falls, reducing the surplus. The surplus is totally eliminated when the price falls to PE. Likewise, if the price is below PE at $5, the quantity supplied is 50 units while the quantity demanded is 100 units. There is a shortage of 50 units and producers will raise their prices. As the price rises, the quantity demanded falls while the quantity supplied increases. The shortage is totally removed when the price rises to PE.

Moving to the different roles of prices, the first is a signaling function. With a change in consumers’ tastes and preferences, an increase in demand for a good would increase the price of it. Producers would follow these price signals to produce accordingly, with more when the demand of the good is rising and with less when the demand of the good is falling. 

The second is the allocative function of prices. Following an increase in demand and subsequent increase in price for a good is an increase in profit. Hence, producers would channel scarce resources from less profitable to more profitable industries. 

The third is a rationing function of prices. When there are shortages, consumers would bid up the price of the good. Consumers with higher effective demand would get to purchase the good, in turn allowing goods in shortage to be rationed. 

Finally, prices function as incentives for consumers and producers to maximize welfare. For the consumers, when prices fall, they have the incentive to buy more to increase welfare. For the producers, when prices rise, they would have the incentive to sell more to increase profits and welfare. 

Looking at the relationship between price determination and different roles of prices, the signaling role is a movement along the supply curve whereas the rationing role is a movement along the demand curve. The incentivizing role is a movement along both the supply and demand curves while the allocative role needs diagrams of two different markets in order to be illustrated.

JC Economics Essays - H1 H2 H3 A Levels Economics, adapted question (part (a)): economics tutor's comments: Students sometimes do not do enough revision for the role of prices in a free market because they take it for granted, but a moment's reflection should inform students about the complexities of studying economics. What are the roles of prices? How are these related to the supply and demand diagram? (Remember that diagrams are very important in Economics.) Supply and demand economics questions are not limited to just factors affecting demand and supply, and elasticities. In this particular economics essay, there does not seem to be an essay conclusion, but having said that the essay's introduction was fairly well written - what makes for a good conclusion, and what makes for a good essay introduction? Special thanks to contributions by some motivated, hardworking, and generous students who share their skills, services, and materials. Just for interest: Milton Friedman's "pencil" concept on the free market can be found on YouTube. Do watch it just for interest about understanding the intuition behind the economics concept of the free, competitive, unfettered market.

H2 Explain the likely demand and supply factors affecting the oil (petroleum) market. [10]

Note: An "A" level Economics standard type of examination question.

This paper explains the likely demand and supply factors affecting the oil market. Demand refers to the willingness and ability to purchase a good, while supply refers to the willingness and ability to provide the good. The market price of a good is determined by the intersection of the demand and supply curves. The equilibrium output occurs when the quantity demanded is equal to the quantity supplied. 

There are various factors affecting the demand and supply of the oil market. 

First, let me deal with the demand side. For the demand aspect, the factors affecting it include derived demand, availability of substitutes and complements, population changes, expectations and increasing incomes. 

Derived demand refers to demand for goods which are not demanded for its own sake but it is used to facilitate the consumption/production of another. In the oil market, oil is demanded to facilitate the production processes in factories and for transportation. That is, the demand for oil is derived from the demand for transport as well as for production and manufacturing processes to spur the economy of a country. 

Substitutes are goods which are considered to be alternatives to each other while complements are goods that when consumed together, gives rise to a higher combined utility than if goods were consumed individually. There are no substitutes for oil as it is a necessity for the operations of machinery in production processes and for transportation. As a result, the demand for oil is very price inelastic due to lack of availability of other related goods to substitute oil. 

The rising incomes among the population affect the demand for oil too. With increasing household income, the purchasing power among consumers increases. They have the financial capability to buy private cars which offer more comfort than taking public transport. Rising income will see a rise in private car ownership as well. This will drive up the demand for oil in the private car market.

Expectations will affect the demand for oil. If the price of oil is expected to rise, buyers may want to purchase more of the oil now before the price rises, thus raising current demand. In this case, producers may intensify their production processes to take advantage of the cheaper oil price now. Conversely, if the price of oil is expected to fall, buyers may want to hold back their purchases thus reducing current demand. For instance, private car owners may switch to take public transport temporarily to save on costs. 

On the other hand, there are also various factors affecting the supply aspect in the oil market. 

This paper now deals with the supply side factors. These factors include costs of production, expectations on the part of producers, number of firms and government policies on the part of the OPEC producers. 

The entry of new firms into the oil market will shift the market supply curve rightwards. An increase in the size of existing firms raises the total capacity of the industry, thus shifting the market supply curve rightwards. In the oil market, the discoveries of new oil reserves will increase the number of producers, leading to the expansion of firms, thus, shifting the supply curve rightwards. On the other hand, when the oil reserves are used up and oil wells run dry, supply could shift to the left, reducing supply. 

Government policies on the part of OPEC influence the supply of oil too. Indirect subsidies will shift the supply curve downwards while indirect taxes shift the supply curve upwards. Increased taxes on oil will raise the cost of production of the oil barrels which reduces the supply. Alternatively, decreases in OPEC’s production will also shift supply to the left. 

Economics Diagram: Supply & Demand Interaction

[Tutor's note: This section here describes the diagram and explains the movements of the curves.] The initial equilibrium price and output is at P1 and Q1 respectively, as determined by the intersection of the S1 and D1 curves. Supply curve shifts from S1 to S2 while demand curve shift simultaneously from D1 to D2. The new equilibrium price and output is P2 and Q2, as determined by the intersection of the S2 and Q2 curves. 

In conclusion, the factors affecting demand and supply of oil will shift the curves respectively. When considering which factor is more responsible for the shifting of the curve, it is important to consider it on a case-by-case basis. 

JC Economics Essays: Economics Tutor's Comments - Demand and supply analysis is totally fundamental to "A" level Economics (for practically all the A level Economics papers, and is also important for first year introductory undergraduate Economics), and can be applied to many markets, ranging from the oil market to the car market, or from commodities to even the market for labour and other factors of production. Hence, knowing the Economics of demand and supply is crucial to scoring well at the examinations. This Economics paper is rather well written, simple, clear, and to the point. Once again, special thanks to S YQ who contributed this well written economics essay. The usual question applies: how can you make the essay better? It goes without saying that the diagram should be drawn accurately and well labelled. Other than that, what else could you do or would you have done? Note that for advanced A level students or even H2, H3 students taking the examinations, this paper could possibly have included oligopoly and perhaps even discussed elasticities, adding on to the analysis. Thanks for reading, and cheers. 

H2 Explain the difference between public goods and merit goods, using examples from the United Kingdom. [10m]

Market failure refers to a situation where the free market fails to achieve an outcome that maximises  society’s welfare. Such a society is said to be allocatively inefficient. This paper delves into detail regarding the difference between public goods and merit goods, using examples from the UK. 

A public good is defined as a good that is non-excludable and non-rival; non-excludable means that it is impossible to prevent someone who has not paid from consuming the good while non-rival means that the consumption of the good by one person does not diminish the amount or quality available to others. 

On the other hand, a merit good refers to a good in which the state believes will be under-consumed if left to the free market, because some individuals are unable to factor in the full private benefits of consumption. This means that the perceived marginal private benefit is less than the actual marginal private benefit and the good is under-consumed. 

Due to the non-excludable and non-rivalrous characteristics of public goods, consumers are unwilling to pay because they are able to enjoy the benefits as “free-riders”. Firms are unable to charge a price and so they find the good unprofitable to produce. Under a free market, production does not occur and total market failure arises. 

When this happens, the government must fully finance the production of the good in which the cost of financing such good is funded from general taxation. In the case of UK, the flood control defence is funded by the government. It is non-excludable as people in the country who did not pay for the flood control system will get to enjoy the same level of safety from floods. It is non-rivalrous too as such security against these natural hazards does not diminish even if the population increases. 

Merit goods may also exhibit positive externalities, or alternatively, due to imperfect information, may be under-consumed as a result. Thus, society’s welfare is not maximised. To correct such market failure, the government must raise consumption through subsidies. In the case of the UK, the entry to national museums and art galleries is free and tickets to the opera are subsidised as the government recognizes the under consumption of art among the people. Individuals may fail to factor in the private benefits of consuming such a good such as providing an alternative form of escapism from the hectic life of city dwellers through the appreciation of art. To raise the consumption, the UK government subsidizes the entry tickets to art galleries to point of being free so as to raise the overall welfare of the society. 

Public goods defer from merit goods as the former exhibit non-excludability and non-rivalrous characteristics. On the other hand, the latter are private goods which exhibit excludability and rivalrous characteristics. Merit goods are provided by private producers as they are able to set a price on the good. There is no “free-riders” problem in the case of merit good whereas there exists such a problem in the case of public goods. As such, a public good is provided by the government directly whereas merit goods tend to be subsidised or partially provided. The argument on merit good focuses is more on individuals undervaluing private benefits while the “free-riders” problem plays a significant role in the argument on public good. 

JC Economics Essays - Economics Tutor's Comments: This is a simple, clear cut, and well presented Economics essay that is fairly accurate, direct, and to the point. This essay addresses the question posed directly. However, the usual question applies: how could you improve upon this Economics essay to make it better, or even more accurate or precise? How could you further develop the essay's paragraphs? Special thanks to S YQ for this excellent piece of economic writing. Thanks for reading and cheers. 

(a) Explain ‘public goods’ and ‘merit goods’, making clear how these cause markets to fail. [10] (Adapted from the A levels)

(a) Explain ‘public goods’ and ‘merit goods’, making clear how these cause markets to fail. [10]

Adapted from an actual Economics Examination: November 2008, H1, A-Level

A public good is a good that is not produced by the free market despite it being beneficial or desirable to society. This is because a public good is non-rivalrous or non-diminishable, meaning that its supply is not depleted by an additional user and consumption by one does not reduce the amount available to others. Also, it is non-excludable, meaning that it is impossible or costly to exclude non-payers from consuming the good.

By being non-rivalrous, it means that the marginal cost of allowing an additional consumer to share in the usage of such a good is zero, and so is the marginal cost of serving an additional user. Hence, since at the socially optimum level, P=MC, if MC=0, then the price of the public good is also equal to 0. Hence, none of the good will be supplied by profit-motivated private suppliers as they have no incentive to do so.

By being non-excludable, consumers do not have much incentive to pay for the good and suppliers will find it difficult or impossible to collect fees for the benefits they provide; this is the problem of free riders. When large numbers of people become free riders, there is virtually no incentive for consumers to offer to pay for the good. This non-expression of demand makes it impossible for profit-motivated private suppliers to charge a market price for the public good, leading to either none or not much of the public good being produced. This situation leads to a missing market for public goods. Hence, there is no provision of the public good in the free market, resulting in market failure as there is allocative inefficiency when resources are not allocated to producing public goods, which are essential or beneficial to society.

Figure 1 –Imperfect Information when Consuming Merit Goods

A merit good is a good or service that a paternalistic government perceives as beneficial for individuals consuming them because of the information failure causing them to under-estimate their private benefits in consuming them. An alternative view is that merit goods generate positive externalities in consumption. As consumers underestimate their private benefits when consuming merit goods, if left wholly to the private sector, it is likely they will be under-consumed because individuals do not understand or appreciate the good effects that can result from consumption. Examples of merit goods include healthcare and education. Because knowledge of these benefits is an ongoing process, individuals themselves will tend to underestimate the long term private gains from a proper education or proper healthcare. If the consumers were fully informed of the additional private benefits, the demand curve would be D (perfect info) and the equilibrium output Y as shown in figure 1, where the true and full information value of an extra unit of good equals to its Marginal Social Benefit. However, the free market equilibrium occurs at output Z since consumers cannot individually discover the benefits associated with the particular good, such as the fact that proper education allows consumers to have higher potential earnings over one’s working life and be employed. Hence, imperfect information incurs a welfare cost ABC when the uninformed consumers use the wrong marginal valuation of benefits of the good.

Figure 2 –Positive Externality in Consuming Merit Goods

At the same time, merit goods also create a positive externality in consumption, assuming perfect competition and that the Marginal Private Cost curve is the same as the Marginal Social Cost Curve, as shown in figure 2. Since the consumption of the good generates positive externalities, otherwise known as Marginal External Benefit (MEB), the Marginal Social Benefits arising from individual’s consumption of the good (MSB) is higher than Marginal Private Benefit (MPB) by the amount of the MEB, creating a divergence between MSB and MPB. The free market equilibrium is at Em with output Qe units; however, the socially desired output level is Qs units.  From society’s point of view, there is under-consumption of the good by QeQs units, and too little resources are channelled to its production. This is a situation of allocative inefficiency. The money value of benefits from output QeQs =Area QeREsQs, and the money value of resources from output QeQs =Area QeEmEsQs. Hence there is a deadweight loss in not producing output QeQs = equal to Area EmREs. This shows that there is market failure in consuming merit goods as they incur a positive externality.

JC Economics Essays: Tutor's Comments - This is an Economics answer based on an actual A level Economics examination, but it has been amended and changed to fit this blogpost as well as show the answering technique and approach. This is a very well written answer that is to the point and analyses the diagrams (they were drawn in the actual answer); yet, the usual tutor's question applies: how would you improve upon this Economics answer? Let me give you a hint from an Economics tutor's point of view - whilst this is an excellent theoretical answer, perhaps it lacks consistent application of real world examples...? Yes, you should include more real world examples such as national defence. By the way, this is the basic questioning approach that I take in this site: imagine you are an Economics tutor or examiner, and as a tutor or examiner - what would you like to see in the answer? Think about this question and think of the implications for how you would approach Economics essays. Also do note that there are many other public goods and merit goods essays in this site here, so do explore and compare and contrast various questions and the concomitant answers. Thanks for reading and cheers. 

Explain carefully why imperfect information and the immobility of the factors of production may lead to market failure. [10]

Explain carefully why imperfect information and the immobility of the factors of production may lead to market failure. [10]

Market failure can be defined as the failure of the free market mechanism to provide goods in a socially optimal and thus efficient manner, and is usually attributed to imperfect markets, the existence of externalities, the lack of provision of public goods, and inequity. Imperfect information and immobility of the factors of production also lead to market failure, because they directly contradict the assumptions of the free market system. The two main assumptions violated are firstly that all participants have perfect information, and secondly that the factors of production are mobile, such that they can respond to changing prices which function as a signal for producers to move resources into various areas of production. With those assumptions violated, Pareto optimality - when one person cannot be made better off without making someone else worse off - cannot be derived from perfect competition in a free market. This paper explains carefully why imperfect information and the immobility of the factors of production lead to market failure.

The free market system assumes that consumers have perfect knowledge of costs and benefits, thus the market-clearing equilibrium is able to be reached when individuals’ valuation of the good equal suppliers’ marginal cost of production; hence demand = supply. But in reality, consumers are often ignorant about the quality of the goods and durables they purchase. These are cases of imperfect information, which cause market failure as individuals are unable to fully obtain the marginal benefits of the good. As the market demand curve is derived by summing up all individual demand curves an optimal market equilibrium cannot be derived. On the supply side, firms are often ignorant of market opportunities, prices and costs, and may often make inaccurate estimations of market consumer demand or fail to respond promptly to demand changes due to errors in judgment. Thus market failure occurs.

Imperfect information is present when consumers and producers do not or are unable to consider society’s benefits and society’s costs, as reflected in the diagrams below.

Insert Economics diagrams here: HINT, draw externality diagrams. Why externality diagrams?

In the first diagram, there is an overproduction of a good distorting the market. Negative externalities, if unknown to producers, or if they merely consider their own private costs benefits and ignore society’s efficiency, also result in market failure, but this time in overproduction of a good.

In the second, there is an underproduction distorting the market. Consumers often have lower than optimal demand for desirable public goods, for example healthcare and education, as they only take into account current utilities, failing to judge the full extent of welfare and benefits the good delivers to society. This presence of unacknowledged positive negative externalities results in the underproduction of the good. Hence, the failure to acknowledge externalities is a lack of full or perfect information that distorts the market.

For private markets to function efficiently, factors such as labor and capital must be able to move freely. If factors are immobile, due to perhaps occupational rigidities and inefficient job seeking processes and bureaucratic issues, it affects the supply of these knowledge-based products. This immobility can lead to the wrong price signals and inefficient allocation of resources to these industries. For the socially optimal equilibrium to be reached, firms and labor must respond to market signals. When firms have trade unions as stakeholders, markets tend to fail as unions tend to aggressively seek minimum wage rates or protect their wage benefits or restrict entry of new labor, even in the face of declining market demand.

Hence, both imperfect information and lack of mobility of resources affect the workings of the price mechanism in the free market, and because perfect competition fails, then there is market failure, and the Pareto efficiency promised by perfect competition in the free market does not arise.

JC ECONOMICS ESSAYS - Tutor's Comments: This Economics essay is rather well written and addresses the issue of market failure well. There are many good aspects to learn about it. However, it was not written by an "A" level student but was written by a trainee teacher (trainee tutor) from education school. Perhaps, as improvement, the author should have also compared and contrasted asymmetric information with imperfect information. For more information on asymmetric information, see George Akerlof and Michael Spence (for further advanced Economics readings).