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

What is market failure? Market failure is defined as the situation where the free market fails to achieve allocative efficiency – the market fails to achieve an outcome that maximizes society’s welfare. Government intervention during market failure may in certain cases be justified, but in other cases unjustified. This essay intends to discuss if government intervention in markets that fail is justified and effective, by addressing and focusing on the economic problem of externalities, demerit goods, and the lack of provision of public goods. 

Governments can utilise various methods to address externalities and demerit goods. Externalities are third party spillover effects, and can be both positive and negative, and can come from consumption or production sides. Demerit goods are goods that either cause negative externalities, or are goods that governments deem unacceptable for their citizens, for instance smoking and gambling. In the case of negative externalities and demerit goods, when goods are over-consumed as their marginal social costs exceed the marginal social benefit, the government may adapt the use of an output tax to prevent the over-consumption of the good. 

[Insert a diagram on output tax showing how this policy cures the problem]

Imposing a tax per unit that is equal to the MEC shifts the MPC to the left. The new private equilibrium now coincides with the new social equilibrium Qs where MSB = MSC. Allocative efficiency is achieved as the output has been reduced to the social optimal level and therefore government intervention is justified.

Alternatively, the government may also impose an output quota which is defined as the limit for the quantity that the industry can legally produce, therefore effectively reducing the over-consumption of the good generating either negative externalities or demerit goods.

[Insert a diagram for output quota showing how this policy cures the problem]

The original equilibrium is determined by the intersection of MSC and MSB. When the government imposes a quota, the new equilibrium price increased while output falls. Therefore, the quota effectively increases the equilibrium price and decreases the equilibrium quantity of the good.

In the case of positive externalities and merit goods, the government may choose to adopt the policy of subsidies to effectively reduce the extent of under-consumption of the good, to raise the consumption or production of a good to bring about a more socially desirable outcome.

[Insert diagram on subsidies showing how this policy cures the problem]

Giving producers a per unit subsidy that is equal to MEB lowers their production costs and shifts the MPC to the right. The initial social equilibrium of Qs where MSB = MSC now coincides with the new private equilibrium. Allocative efficiency is now achieved as output is now raised to the socially optimal level.

Alternatively, the government may also provide for the good completely free to the society, so as to reduce the extent of under-consumption of the good that brings about positive externalities or merit goods. Also, in the case of public goods, there is a missing market and usually governments have to provide the good for society. Public goods are goods that are non rival and non excludable, which means that they cannot be "used up" when someone consumes them, such that there is less of the good for others, and which means that no one can be excluded from the consumption of the good, respectively. For instance, defence and street lighting are both public goods because they are non rival and non excludable goods. These two conditions of non-rivalry and non-excludability imply that the good has MC = 0, and also that there will be free riders, and therefore profit oriented companies simply will not produce the good as they are assumed to be profit driven. 

[Insert diagram on free provision of goods showing how this policy cures the problems (plural)]

For free provision, the social outcome where output is at Qs, is when MSB = MSC. When the output is subsidized, MSC shifts to the right, where the socially optimal output of Qs is achieved. Therefore the effective price of the good is now zero and the entire cost of the good generating positive externalities or merit goods is now absolutely borne by the government.

However, although government intervention in the market may seemingly be beneficial in helping to shift prices and output to the socially desirable outcomes, they may not always be justified, as there are limitations to it as well. In the case of demerit goods and externalities, high implementation, enforcement and mentoring costs may be incurred by the government in fulfilling its role as an interventionist and thus the total administrative costs may exceed the benefits from implementing such measures, leading to an overall decline in society’s welfare. Taxing the public may also be politically unpopular and therefore hinder governments from implementing such measures by placing political interest over economic ones. 

Moreover, in the case of merit goods and positive externalities, using subsidies to resolve the problems posed may be economically costly and full provision may lead to over-production and over-consumption beyond the socially optimal level and therefore lead to allocative inefficiency as well, therefore proving that government intervention is not justifies and not effective to a large extent. 

Hence, in the final analysis, whilst government intervention in the case, where market failure arises, may be beneficial to a limited extent in helping society to maximize its welfare, in the long term, the costs of government intervention may far exceed the short term benefits enjoyed by society as seen in the limitation of using subsidies, quotas, taxes and free provision. Therefore, markets should be rid of government intervention to a maximal extent, because it is only effective in the short run and to minimal extents and therefore is unjustified as a whole.

JC Economics Essays - H1, H2 A level Economics - tutor's comments on the essay: This economics paper is clear cut, direct, and to the point, and tries its best to answer the question. There are of course a few improvements which can be made to it - try to think about what the improvements are. However, more importantly, as this is a 15 mark examination question, it is the part (b) from another part (a) question, and therefore linked to it in a particular way. Economics exam questions on market failure at H1 and H2 levels often ask for explanation in part (a) of the question, followed by deeper analysis and more evaluative comments on the same topic in the second part of the essay. This is an important thing to note - explanation will not get the highest marks here, but analysis and deeper thinking. Perhaps you could focus on the essay's well-written conclusion, which evaluates market failure and the impact of government intervention. This makes this economics essay come to a well-reasoned, nuanced, balanced, evaluative conclusion, which greatly helps the essay get higher examination marks. Thanks for reading and cheers. Special thanks to AG, who will surely be an outstanding undergraduate candidate at Nanyang Technological University, and the other students who made this essay possible: SH, JC, NT, M, and SS. Thanks for reading and cheers. 

Explain, with relevant examples, the situations when prices determined by the intersection of demand and supply do not correctly reflect the costs and benefits, and how these situations lead to market failure in the free market.

The topic addressed in this economics paper is market failure in competitive markets. Prices do not always accurately reflect the costs and benefits of the market, thus leading to market failure in the case of positive and negative externalities, merit and demerit goods. This essay aims to identify the circumstances when prices do not correctly reflect the costs and benefits of the market and explain how markets fail as a result.

Firstly, negative externalities are defined as the adverse spillover effects on third parties arising from the production or consumption of a good. Third parties refer to people who are not directly involved in the transaction of a good. An example of negative externalities would be evident in the case of production, where plants may discharge industrial waste into the environment and therefore cause health and environmental risks to nearby residents. In addition, in the case of consumption, the existence of alcoholics may pose as a threat to the peace and security of law abiding people and society at large. Therefore, negative externalities result in the marginal social costs exceeding the marginal private costs in society, causing deadweight loss.

[Insert diagram for negative externality in production]

Without government intervention, the private equilibrium occurs where MPB = MPC, but the social equilibrium occurs where MSB = MSC. Between Qs and Qp, since MSC > MSB, the triangle pointing towards Qs represents the negative welfare generated and therefore the good is over-produced in the case of negative externalities, leading to market failure. 

Positive externalities, on the other hand, refer to the benefits enjoyed by third parties from the production and consumption of the good. In the case of production, for example, receiving a complete education up till or beyond the tertiary level will not only benefit the student himself but also the society collectively as a whole due to his contribution to the society through application of his knowledge. Likewise, in the case of consumption, for example, vaccination not only reduces the risk of contracting a disease in the vaccinated person, but also reduces the risk of diseases for third parties coming into contact with him. Thus there are greater marginal social benefits than costs but the good may be under-consumed by the society.

[Insert diagram on positive externality in production]

When there is no government intervention, the private equilibrium is where MPB = MPC. The social equilibrium however is at MSB = MSC. Between Qp and Qs, as MSB > MSC, the loss in potential welfare of the society is represented by the triangle pointing towards Qs. Therefore the good is under-produced in the case of positive externalities, leading to market failure.

Furthermore, merit goods refer to goods 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. For example, a student may decide to leave school early to work as he perceive the short term benefits of working to be greater than the long term benefits of receiving a complete education, therefore unknowingly undermining the marginal private benefits he has brought to himself.

[Insert diagram on merit good]

For merit good, the private outcome is Qp where MPB = MPC, whereas the social outcome is Qs where MSC = MSB. Between Qp and Qs, since MSB > MSC, there is a loss in potential welfare represented by the triangle pointing towards Qs, and the good is under-consumed, thereby leading to market failure. 

Demerit goods are goods that the state believes will be over-consumed if left to the free market forces because some individuals are unable to factor in the dull private costs of consumption. For example, goods like alcohol and cigarettes may result in severe health and financial problems when excessively consumed and since there are people that still consume them thinking that the marginal private costs do not exceed the marginal private benefits, when it is in reality, thus results in market failure. 

[Insert diagram on demerit good]

For demerit good, the private outcome is when MPC = MPB at Qp, while the social outcome is at Qs when MSC = MSB. Between Qp and Qs, since MSC > MSB, this results in a deadweight loss represented by the triangle pointing towards Qs, where the good is over-consumed in the case of demerit goods. 

In conclusion, prices do not always accurately reflect their costs and benefits of the market. As seen in the cases of merit goods and positive externalities, the goods are under-consumed by the society although the marginal social benefits outweigh the marginal social costs, and in the case of negative externalities and demerit goods, the marginal social costs outweigh the marginal social benefits and the goods are over-consumed. Therefore, the deadweight loss – the loss in potential welfare of the society due to the over-consumption and under-consumption of goods leads to market failure.

JC Economics Essays - H1, H2, H3 sample essays - tutor's comments: Market failure and the operation of the free market under conditions of perfect competition are important economics topics for both Economics at A levels and introductory undergraduate economics courses, and as such this might be a useful topic to prepare for examinations. It might be a good idea to get a firm understanding of how markets operate and how market failure distorts the workings of the price mechanism as it allocates resources. In this section on comments on the above economics paper, instead of providing general feedback or pointing out what went well and went not so well with it, I will ask questions instead: using Bloom's taxonomy as an intellectual framework to address this economics essay, has the student identified the topic properly, defined and explained key terms, drawn the right diagrams, explained the economic theory with real world examples, explained the diagrams drawn, and come to a reasoned, fair, nuanced conclusion? What has the essay writer done well, and what has the essay writer got to improve on and make better? Are there economics materials that you would have added, and why are these additional concepts, ideas, and arguments important and relevant? Think through these issues. I should give a hint for an important enduring understanding: structure is important to good essay writing, and this economics paper is well structured and well laid out. Always remember to improve on your writing skills, and craft well-thought-out, clear economics essays. Special thanks to S S and A G once again for their useful, relevant, and interesting contributions. Thanks for reading and cheers. 

Explain with relevant examples why imperfect information and the immobility of the economic factors of production lead to market failure.

Market failure refers to the situation where the free market fails to achieve an outcome that maximizes society’s welfare, of which imperfect information and the immobility of the factors of production, which refers to the inability of resources to move perfectly from one market to another in response to changing market conditions, would lead to market failure as well. In my essay, I explain how the above two factors cause market failure.

Imperfect information is the situation where people engage in economic transactions without having perfect information of what they are buying, due to a discrepancy between the perceived benefit or cost and the actual benefit or cost. Due to the lack of perfect information, consumers end up buying something that is not what they really want or need. This is because consumers are often swayed by persuasive advertising and sales staff pushing products based on commission. As a lot of time and effort is required for one to acquire all the necessary information as they lacked the time and expertise to learn about the many products in the market, this principal-agent problem is likely to persist. Hence, when a consumer buys a good that is not what they really want or is less suitable, his welfare is below the socially optimum level and this gives rise to market failure. 

Imperfect information also contributes to market failure that arises from negative externalities and the presence of demerit goods. This is because adverse effects are imposed on third parties when these goods are produced or consumed. Externalities are defined as third party spillover effects, where third parties are affected when goods are produced or consumed, and demerit goods are goods which the government deems undesirable in the light of consumers lack of information or due to the negative externalities imposed on third parties.

In this case of demerit goods, individuals are unaware of the social cost incurred during their consumption of the good. Both negative externalities of production as seen in the figures below. Without government intervention, MPB = MPC and output is at Qp. The social equilibrium Qs is at MSB = MSC. Since MSC > MSB, a deadweight loss is generated. Since Qp > Qs, the good is over-produced. 

[Insert diagrams on negative externalities from production and consumption]

As for demerit goods, when MPB = MPC, the output is at Qp. However, the social outcome Qs is where MSB = MSC. Between Qp and Qs there is a loss of potential welfare (deadweight loss). Since Qp > Qs, the good is said to be over-consumed. 

As for factor immobility, there are two major types – occupational and geographical immobility. Occupational immobility of labour arises because workers lack the required education or skills to take on new jobs in another industry. For instance, people working in fields with low technology will find it hard to work in Silicon Valley due to their lack of knowledge, thus making them occupationally immobile. On the other hand, geographical labour immobility exists in large countries when there are barriers to people moving from one region to another in search of jobs. This barriers include family and social ties and cost involved in moving to another area to settle down. Large countries like the USA and the UK will face these sorts of geographical immobility problems and issues. 

Market failure arises as resources are unemployed due to factor immobility and hence the economy is producing inside its PPC. Hence, the outcome is productive inefficient and also allocatively inefficient.

[Insert a diagram on production possibilities curve]

The diagram shows that there are unexploited resources untapped, and therefore there is productive inefficiency. Also, there could be market failure due to allocative inefficiency. This is because resources are unable to flow from contracting to expanding markets. Hence, society’s welfare is not fully maximized and it can be argued that market failure results. 

In conclusion, imperfect information is often present in market dominant firms such as oligopolistic and monopolistic firms as they are price setters with large market power, often arising from possession of asymmetric information. Imperfect information prevents consumers from knowing all the prices and the product production processes also. Therefore, it is difficult to remove the presence of imperfect information as it is so prevalent. Factor immobility is also another common cause of market and it is difficult to be eradicated. Hence, market failure would tend to persist.

JC Economics Essay - H1, H2, H3 economics essays - tutor's comments: There are a lot of small problems with this economics paper that can be easily remedied, and therefore the question is: what are the areas that need to be worked on for this essay? Having said that, there are many salient strengths to this economics essay answer as well: think, what are the strengths and good points of the material presented in this economics essay? While fairly strong in economic theory, and covering most of the relevant ground to address the question posed, and having lots of interesting angles and possible areas of discussion, this economics essay answer could have more relevant examples and be more vivid, clearer, and better by giving specific real world examples for each model, theory, or economics concept mentioned. This economics essay could have pushed the envelope, but did not go too far nor did not stretch the point to emphasise, highlight, showcase certain good economics material, which would have vastly improved it. What other areas of improvement do you see and notice, and how would you have approached this essay question? Think about how to improve on this economics essay - how you can value add to this suggested, possible answer. Special thanks to A G and S S for their contribution. 

Explain, with relevant examples, the economic circumstances when prices do not accurately or correctly reflect actual benefits and costs, and explain how free markets fail as a result. [10]

The general theme of this economics essay is on market failure. The circumstances when prices do not correctly reflect costs and benefits include the presence of externalities, both positive and negative, merit and demerit goods, as well as imperfect pricing information. Therefore, this essay aims to explain how the above mentioned circumstances will lead to market failure.

What are externalities? Externalities refer to the spillover effects on third parties arising from the production or consumption of a good. They can then be sub-divided into positive externalities, referring to benefits imposed on third parties, and negative externalities, referring to adverse effects imposed on third parties.

Prices are usually set at the intersection point of the market demand and supply curves. However, in the case of positive externalities, prices do not reflect the actual costs and benefits since the market demand and supply curves fail to take into account the marginal external benefits brought about by the consumption and production of the good.

[Insert diagrams on positive externalities from consumption and production]

Marginal external benefits (MEB) is defined as the additional benefit enjoyed by third parties from the production or consumption of a good. For positive externalities in consumption, assuming no externalities on the production side, positive externalities results in MSB exceeding MPB by the amount equal to MEB. Without government intervention, the private equilibrium is at Qp, where MPB = MPC. However, the socially optimum equilibrium is at Qs where MSB = MSC. Since Qp < Qs, the good is under-consumed, resulting in allocative inefficiency and hence the market fails. An example would be the consumption of vaccination, where the risk of disease is reduced for both the vaccinated person and third parties he comes into contact with.

Similarly, for positive externalities in production, assuming no externalities on the consumption side, there is a divergence between MPC and MSC due to MEB. The private equilibrium is at Qp where MPC = MPB, while the socially optimal equilibrium is at Qs, where MSC = MSB. Since Qp < Qs, the good is under-produced, resulting in allocative inefficiency and hence market failure. An example would be the production of honey which bees would pollinate the nearby fruit orchards.

In the case of negative externalities, prices do not reflect the actual costs and benefits as the market demand and supply curves do not take into account the marginal external costs bought by the consumption or production of the good.

[Insert diagrams on negative externalities from consumption and production]

Marginal external costs (MEC) id defined as the additional costs imposed on third parties from the production or consumption of a good. For negative externalities from consumption, assuming no externalities on the production side, there exist a divergence between MSB and MPB due to MEC. This results in the over-consumption of the good as seen from how the private outcome Qp exceeds the socially optimal outcome of Qs. The outcome is allocative inefficient and thus the market fails. An example would be smoking, where third parties incur costs such as the inhalation and breathing in of second hand smoke.

For negative externalities from production, assuming no externalities from consumption, there exist a divergence between MPC and MSC due to MEC. This results in the over-production of the good, seen from how Qp exceeds Qs, resulting in allocative inefficiency and hence the failure of the market. An example would be the disposal of industrial waste into rivers, causing water pollution which poisons the catches of fishermen whom are third parties.

Next, prices also do not reflect the actual costs and benefits in the case of merit and demerit goods. Merit goods refer to goods 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. 

[Insert diagram on merit good]

For merit good, between Qp and Qs, MSB > MSC, thus the triangle pointing towards Qs represents the area of deadweight loss arising from allocative inefficiency, since the good is under-consumed. Hence the price will not be accurate in reflecting the benefits instead it is at MPB. An example would be the consumption of education where a person may leave school early because he is too young to understand education can improve his future. 

On the other hand, demerit goods are goods which the government believes will be over-consumed if left to the free market because some individuals are unable to factor in the full private costs of consumption.

[Insert diagram on demerit good]

For demerit good, between Qs and Qp, MSC > MSB and Qp > Qs, thus the triangle pointing towards Qs represents the area of deadweight loss arising from the over-consumption of the good, resulting in allocative inefficiency and thus market failure. Hence the price of the good will not be accurate in reflecting the costs since the demand of the good is at MPB, while it should have been at MSB. Examples of demerit goods include alcohol, where excessive consumption results in serious health and financial problems.

Lastly, where there is information asymmetry with regards to pricing, prices will not reflect the actual costs of production as sellers will be able to charge prices that are higher than marginal costs. This is due to the fact that buyers find difficulty acquiring pricing information from different sellers, thus gives seller pricing power and enable them to charge prices that are higher than marginal costs. Therefore, deadweight loss is generated and market failure occurs.

In conclusion, there are various instances where prices do not reflect the actual costs and benefits and in most of the cases, the resulting market failure arises due to the presence of allocative inefficiency.

JC Economics Essays - H1, H2, H3 economics essays - tutor's comments: This economics essay paper is very well done, by directly addressing the question requirements, and providing clear, simple to understand, direct examples that target the requirements of the economics exam question. Always remember to answer your economics exam question as it stands, and not as you imagine it to be. The student also has a very sound understanding of economic theory, and knows how to properly structure the memorised economics material and essay answer to make this paper a model essay. This model paper was done under timed conditions, which makes it even more remarkable. Thanks to S for editing work done, and thanks to A G and S H for their kind and invaluable contributions. Usual question applies - how can you apply this to your essay writing, and how could you write a better economics paper? Always seek to improve and better your standards. 

Economics Question on the "Fat Tax": “Unhealthy foods should be taxed.” Discuss. [25]

“Unhealthy foods should be taxed.” Discuss. [25]

This paper discusses if a “fat tax” should be imposed. What is a fat tax? Generally, a fat tax is a tax on the producer of unhealthy foods, for instance fast food or fatty food producers, and in particular a fat tax is an indirect tax that aims to reduce the supply of unhealthy food. A fat tax is considered by and levied by the government. This Economics paper argues that a tax on unhealthy food will raise equilibrium prices and lower the equilibrium quantity transacted, and hence will save lives by both saving private individual lives and also by addressing the societal market failure of negative externalities; yet on the other hand, there are certain other economic and non-economic perspectives that governments should also consider before implementing such a tax.

Arguments for a Tax on Unhealthy Foods: Personal Cost of Obesity – A Fat Tax Saves Lives

First and foremost, eating unhealthy foods increases the likelihood of obesity, early death, depression and a whole range of health problems. A fat tax will raise the price of such foods. Higher prices caused by such a tax would discourage people from consuming unhealthy foods. It may not stop people eating fatty foods completely, but this is not the primary aim. Reducing consumption of fatty and salty foods would have a significant benefit in improving health and personal wellbeing. Currently, many people from all around the world die from heart attacks and strokes each year. As well as saving lives, reducing obesity will also improve consumers’ quality of life. According to the diagram below, a tax will shift the supply curve to the left, and thus raise the price of the good and lower the quantity transacted. This translates into less unhealthy foods consumed.

Arguments for a Tax on Unhealthy Foods: Externalities of Unhealthy Foods

Unhealthy eating has an impact, not just on consumers, but also on the rest of society. An externality is a third party spill-over effect, and can be classified as negative or positive. Fatty foods, by harming consumers, have massive external costs to society and as such produce negative externalities. For instance, there are medical costs for treating obesity, and worse still these explicit costs also come with opportunity cost, the cost of the next best alternative forgone, which means that other patients could potentially receive less attention and other more pressing diseases receive less funding. Also, there would be lost productivity at work not just due to obesity but also to illness, premature death, and a whole host of health-related problems that affect society negatively and have to be paid for. Therefore, the government should collect sufficient taxes from the producers of unhealthy foods to pay for the external costs that they create. It is the same principle as to why cigarettes are taxed, because cigarettes cause pollution, and harm or kill consumers and third parties alike.

While it can be argued that the external cost of unhealthy foods is not easy to calculate, due to imperfect information, this is not a reason to avoid having a fat tax. The idea is that at the moment society is effectively subsidising the consumption of unhealthy foods, and ultimately it is the taxpayer who has to pay for this in terms of healthcare, workplace, and productivity costs to society.

Arguments against a Fat Tax: A Tax on the Poor

On the other hand, a fax tax could be seen as politically unacceptable, because it could be perceived as just another scheme to raise government revenue. Thus, a tax on unhealthy foods should be revenue neutral and not about raising total tax revenue, but about switching the tax burden. The revenue raised from the fat tax could be used to subsidise healthy foods, pay for healthcare services, or reduce other types of taxes.

Also, a fat tax can be seen as a tax against the poor, who tend to eat fast food or are unable to afford more expensive healthier food. The argument is that those on low incomes are more likely to consume unhealthy foods and therefore this tax will increase inequality as it targets the poor. However, it can be argued that if a tax on fatty foods saves lives, we should not avoid implementing it because, in fact, it is the poor who will mostly benefit because their lives will be saved. If the government is concerned about the impact of a fat tax on equality, the revenue can be targeted to the poor by redistribution, for example by transfer payments. Thus, an increase in inequality need not occur from a fat tax.

Arguments against a Fat Tax: Paternalism

Some people argue that a fat tax smacks of paternalism (what is sometimes known as the “nanny state”). Who is the government to tell people what to eat? It would seem that on the surface the government is telling people what to do. However, the whole point is that consumers are still free to consume as much salty and fatty foods as they like. It is just that now consumers have to pay a fairer reflection of the true cost to society, which means that they have to internalise the negative externality, the negative harm to society which results from their health problems caused by such foods. Thus, society has a right to make consumers pay for the economic cost of unhealthy food. Also due to imperfect information, consumers may not know the full damage done by unhealthy food. Hence, paternalism might actually be good for them. As an additional benefit, consumers will probably live longer, and healthier, and also feel happier.

Arguments against a Fat Tax: Inelastic Demand

Some detractors could argue that the demand for fatty foods could be inelastic, and as such a tax would not reduce the quantity demanded by a lot. This is because, ceteris paribus, a relatively inelastic demand curve means that a huge increase in price would lead to a small fall in quantity demanded. However, while demand may be inelastic for fatty foods, they will still reduce consumption by a certain amount, and this is the intended effect. For example, a huge tax on a fast food meal may reduce consumption by say 30%. Instead of eating ten burgers a week, some consumers may only consume seven burgers a week after the tax is imposed. This reduction of 30% will have a big impact on improving the consumers’ health. The aim is not to stop consumers eating unhealthy foods, but reduce excessive consumption, because in moderation fatty and salty foods do not cause a fundamental health problem.

Conclusion

In conclusion, a fat tax should be imposed to save individual lives, and, above all, to reduce the massive negative externalities of illness and lowered productivity imposed upon society. The fat tax will force consumers to internalise the negative externalities whilst allowing them to enjoy, in moderation, fast food, and therefore in the final analysis unhealthy foods should indeed be taxed. 

JC Economics Essays: Tutor's Comments - This Economics paper is about an interesting and current topic that many countries worldwide have discussed: should they implement a fat tax, or a tax on unhealthy foods? How should this fat tax be implemented? This essay makes interesting and easy reading, and covers a lot about inequality and other related issues, that you should definitely study and write about during an Economics examination on this topic of the fat tax. However, my usual tutor's comment applies: other than a diagram or two, how would you make this paper better? What would you write differently here? What other Economics materials and points could you add in to make this Economics paper better? Remember to give it a good, critical viewpoint as well. As an Economics tutor, one major improvement would be that the conclusion could be a little bit more evaluative and considered - which means that the student should have an opinion (or two) and a justification that weighs up arguments, and is nuanced, balanced, and perhaps even "personalised". Thanks for reading, and do give this serious thought!

(b) Evaluate the idea that a government should use tradable permits to correct the market failure resulting from the existence of a negative externality. [15]

(b) Evaluate the idea that a government, for instance Singapore’s government, should use tradable permits to correct the market failure resulting from the existence of a negative externality. [15]

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

This paper discusses whether a government such as that of Singapore should use a policy of tradable permits to try to correct market failure resulting from the existence of a negative externality. An externality is a third-party spill-over effect affecting the welfare of a third-party in production/consumption of a good, but he neither receives nor pays compensation for that effect. In pursuit of their self-interest, producers and consumers only consider their own private costs and benefits and not account for their third-party effects, hence creating a divergence between private and social costs and benefits. However this paper discusses only negative externalities in production. One example of a negative externality in production is pollution.

Under the assumptions of perfect competition, the Marginal Private Cost curve is the same as the Marginal Social Cost Curve and that the quantity of pollution rises with output; the demand-supply diagram of a negative externality in production reflects this situation.

Diagram.

The free market equilibrium is at Em with output Qe units, since firms equate their MPC to price (MPC=P). Since the production of the good generates negative externalities, otherwise known as Marginal External Cost (MEC), the Marginal Social Costs arising from individual’s consumption of the good (MSB) is higher than Marginal Private Cost (MPC) by amount of the MEC, creating a divergence between MSC and MPC. However, the socially desired output level is Qs units (where MSB=MSC).  From society’s point of view, there is over-consumption of the good by QsQe units, and too many resources are channelled to its production. This is a situation of allocative inefficiency. The money value of benefits from output QsQe =Area QsEsRQe, and the money value of resources from output QsQe =Area QsEsEmQe. Hence the deadweight loss in not producing output QsQe = Area EsREm, showing that there is a market failure.

To correct a negative externality in production, a government such as Singapore’s can help adopt a policy such as using tradable permits. In the case of pollution, the government can use tradable carbon permits. A tradable permit is a government set quota to limit the production of a good that is a negative externality, hence limiting the amount of production of negative externalities by firms. Based on a cap and trade principle, the firms purchase permits to pay for every unit of negative externality they generate, and the cap set by the government is the socially optimal level of production of the good associated. At the same time, firms who find it more incentivising and cheaper to internalise the externality than holding on to the permits, via means such as research and technological development, will do so. This causes the external costs to society, and hence the divergence between the MSC and MPB to fall, as these producers now internalize these externalities. At the same time, they sell their permits to other firms who do not have the ability or willpower to do so. Society as a whole hence produces less of this good, and the market produces the socially optimal output of the good generating negative externalities. Hence the market failure is successfully and fully corrected. Even though the government intervenes, this market based solution does not require excessive monitoring freeing up the government’s resources for other uses. More importantly, it allows the market to use the most efficient and efficient means to abate the amount of good produced, internalising the externalities.

However, using the tradable permits scheme has its disadvantages as well. On one hand, geographical areas which have the presence of firms that can internalise the negative externalities reduce the external costs to third parties. However, this increases or concentrates the externalities in other geographical areas where firms which do not find it cheap to internalise them but produce more via purchasing more permits. This is counter-intuitive to the aims of the policy, which is to reduce or eliminate the negative externality. Even though society as whole reduces the externality, there is merely a redistribution of the externalities between those who can and cannot afford to reduce it, which could be inequitable.

At the same time, the government can introduce an indirect (Pigouvian) tax on producers to reduce the negative externality, equal to the marginal external costs to third-parties. This is shown in the diagram below.

Diagram.

Using this tax causes the producers and consumers to internalise the costs as well, because it is a market-based solution. Such a tax allows markets to continue operating along market forces to a large extent. Although prices have been inflated by taxes, consumption and production decisions are made while firms and household pursue their own self-interest. Apart from taxes providing revenue for governments to finance social and community development projects, most importantly, society as a whole reduces the externality by internalising its costs without concentrating it or reducing it only in specific geographical areas, unlike tradable permits.

Conclusions

In conclusion, governments like the Singapore government can not only use tradable permits, but also other policies such as taxation to reduce negative externalities. This is because each of these policies has their distinct advantages and disadvantages. Despite its disadvantages, I believe that governments should employ the tradable permits scheme. In a technologically-advanced country like Singapore, a majority of firms can readily seek solutions to internalise the externality, since they have the advantage of technology and financial power. At the same time, taxes might not be so effective, especially if the demand for that good or service is price inelastic. This is because a very high tax has to be imposed before any effect on production or consumption can be achieved. This also reduces the government’s popularity, as people view the government as trying to gain from the people, what more if a high tax is imposed. Despite being effective, the government’s vote pool might be reduced, which is not what it wants –maximise votes from the people. Hence, a regime of tradable permits is more effective to implement in countries like Singapore.

JC Economics Essays: Tutor's Comments - This is the second part to an Economics answer based on an actual "A" level Economics examination, but amended to fit this post to demonstrate the answering technique and approach. This Economics essay is about tradeable permits, a very hot topic - and one major suggestion that I would give is that students should find out about Ronald Coase, and his paper on Social Cost (where he came up with what is eponymously known today as Coase Theorem or Coase's Theorem). By the way, whilst Coase might seem to have nothing to do with this paper in the eyes of some new Economics students, because they might not have taught this in schools, the inclusion of his ideas into this paper would be a very good idea because Coase's ideas fit into this whole approach of tradeable permits, with the ideas of transaction costs, trading and bargaining, and internalisation of externalities. In fact, it can be argued that tradeable permits are an application of Coase's ideas. Those are relevant Economics materials that can be included into this paper. Having said that, this is a well written answer that is to the point and analyses the diagrams (they were drawn in the actual answer); yet, my usual tutor's question applies: how would you improve this Economics answer? Thanks for reading and cheers. 

Discuss the advantages and disadvantages of Electronic Road Pricing in the United Kingdom. [25]

Discuss the advantages and disadvantages of Electronic Road Pricing in the United Kingdom. [25]

Tutor's Note: My site will start having more and more Economics materials and interesting Economics topics from around the world, rather than just purely having material from Singapore or from pure Economic theory only. See here, as an illustration, for an example of an Economics essay on China's economy on JC Economics Essays. 

Introduction

This paper discusses the economic advantages and disadvantages of Electronic Road Pricing (ERP) in the United Kingdom (the UK). First, a few definitions are in order: what is ERP? ERP is the idea of congestion charges, where a charge is imposed on cars that drive within a restricted zone during certain times of the day. This paper discusses the economic advantages and disadvantages of ERP in the United Kingdom’s context.

Advantages of Electronic Road Pricing in the UK

First, ERP raises revenue for the UK government effectively, because the demand for road trips is relatively inelastic, especially during peak hours during the day. According to economic theory, relatively inelastic demand suggests that when prices are raised, revenue will increase, ceteris paribus. If the UK government gets more tax revenue, other taxes can be decreased, the government can spend more on public transport, or the budget deficit in the UK can be reduced. Hence, this method of raising revenue can be considered a major advantage.

Second, ERP can increase social efficiency. In a free market, the consumption of car trips is heavily over-consumed. This is because when people are driving, they ignore the negative externalities of congestion and pollution, and only consider their own marginal private costs and benefits. Externalities are third party spill-over effects, and can be negative or positive. In the case of cars, they produce many negative externalities to other people who are not involved in the use of private cars. The marginal social cost of driving is thus much greater than the marginal private cost of driving. 

In fact, empirically, congestion costs the UK economy billions every single year in lost output and wasted time. Pollution from cars is also a significant contributor to carbon dioxide emissions in the UK. Road charging should encourage people to look for other forms of transport which do not pollute as much. Therefore it makes sense for the government to charge a much higher price of driving in congested areas because this will make drivers internalise the externality.

Disadvantages of Electronic Road Pricing in the UK

On the other hand, there are of course certain disadvantages of ERP in the UK. First, it seems to be an intrusion on liberty. To drive one will need countless documents or be monitored by technology. The driver’s movements on the roads and whereabouts might be tracked, which could affect his freedom.

However, this point does not seem rather strong because most times when consumers use electricity or Internet access, their movements and usage are tracked as well, and hence this cannot be considered an infringement of liberty.

Secondly, the government seems to be just using ERP to raise money, which may not be politically acceptable. There could be the perception that this idea does not tackle negative externalities, but is instead a new method of raising revenue from the people.

However, that is indeed one of the reasons for the existence of income tax, Value Added Tax, and every other type of tax. Raising money from a new tax enables other taxes to be lowered or spending to be increased, and therefore this need not necessarily be negative.

Thirdly, ERP increases inequality in the UK. This is true to an extent. This is because a road pricing charge is a higher percentage of a tax for those with low incomes, relative to those with higher incomes, and as such impacts the poor more than the rich who can easily afford to drive, even with congestion charges.

However, buying a car and paying for petrol also affects inequality in the UK. If concern about the equality of income distribution is an issue, the government can alter other taxes and benefits, by taxing differently and redistributing the proceeds. A tax which increases efficiency – in this case solving the market failure of negative externalities – need not be stopped on equity grounds. It is always possible to compensate the effects to others by different redistributions of income, which is outside this paper’s arguments.

Conclusions

In conclusion, ERP clearly has both advantages and disadvantages for the UK government. First, ERP raises revenue for the UK government effectively, because the demand for road trips is relatively inelastic, especially during peak hours during the day. Second, ERP can increase social efficiency and force drivers to internalise their externalities, thus solving a market failure. On the other hand, there are of course certain disadvantages of ERP in the UK. First, it seems to be an intrusion on liberty. Secondly, there could be the perception that this idea does not tackle negative externalities, but is instead a new method of raising revenue from the people. Thirdly, ERP increases inequality in the UK by impacting the poor more than the rich.

In the final analysis, however, given that the core economic issue here seems to be the market failure of negative externalities affecting the socially efficient level of output, then ERP is indeed a good method of solving a particular market failure in the UK, and all other considerations seem to be secondary rather than primary to the core issue. 

JC Economics Essays: Tutor's Commentary - As promised, this site offers more than just topics of interest to Singapore, but also other countries and international events, situations, and much more material. Hopefully this will help you in your Economics revision, and at any rate you can get to learn more about other countries and their economies, or their economic situation, and see how general Economics concepts can be applied to different countries' contexts, and the international context as well. Observe that from a student's viewpoint (as well as an Economics tutor's viewpoint), solving congestion utilises general economic principles that apply not just to Singapore, but to other countries' contexts as well. In other words, always think of how you can APPLY Economics to DIFFERENT contexts, topics, and subjects. As usual, the usual tutor's comments apply: think of what the relevant diagrams should be; how would you improve on this answer, and how can you approach this Economics question other than using this approach? Thanks for reading, and cheers! (Acknowledgement: This Economics essay was written by a student who worked with me.) 

Evaluate the policies used by the Singapore government to correct imperfect information and the lack of mobility of the FOP? [15]

Evaluate the policies used by the Singapore government to correct these causes (imperfect information and lack of mobility of the factors of production/ resources) of market failure. [15]

Tutor's Quick Note: This is a continuation, part (b), of the previous question on this economics site.

There are many policies that the Singapore government can implement to correct market failure due to imperfect information and due to immobility of resources. This paper evaluates the Singapore government’s policies in correcting imperfect information and lack of resource mobility, and the evaluation here is whether these policies solve the underlying cause, causing the market failure, directly.

First, we examine subsidies for merit goods like subsidized healthcare, to compensate for consumers’ undervaluation of them and suppliers’ underproduction of them. Secondly, we also examine state intervention in the form of taxes to solve negative externalities. These two examinations address positive and negative externalities which are unknown or unconsidered by private consumers and producers and thus cause market failure.

Insert Economics diagram. Think: which diagram is relevant here? How would you explain it?

The economic answer is clear: increasing subsidies solves the problem of positive externalities being unacknowledged, while increasing taxes solves negative externalities. For instance, there are portions of the budget set aside for subsidized healthcare for senior citizens. Provision of food stamps and rations for low-income families, a wide umbrella of social services to provide free counseling for problem cases such as troubled teenagers, marital and family problems, and other services which private markets tend to fail in. These subsidies cost money, and perhaps that might be a problem, due to opportunity cost, which is the cost of the next best alternatives foregone. Yet, it is still possible to argue that using a cost benefit analysis the costs of the subsidies are worth it.

Furthermore, smoking, which is a demerit good, which has negative externalities, is heavily taxed in Singapore. These show that the Singapore government has done the right thing by removing distortions caused by people not taking externalities into account. The underlying causes indeed were taken into account.

Secondly, there can be the direct provision of information, for instance, with respect to smoking as well as insurance and unit trusts. The public often over-value demerit goods like cigarettes and tobacco, causing market failure as consumers overestimate the marginal benefits of it. The government thus runs a full series of anti-smoking campaigns trying to educate consumers such that they make informed decisions and are fully aware of health consequences in purchasing cigarettes. This does not fully correct market failure but mitigates it. Regarding cost-benefit analysis, this is viable due to the low costs of mass media campaigns but sustainable benefits of consumer knowledge. In Singapore, there is the Financial Advisers Act, under which independent advisory firms act as intermediaries between agents (insurance companies) and principals (consumers), acting to inform and educate consumers fully about insurance products from all insurance firms and providing proper product recommendation. This policy can correct market failure in the long run as many consumers are reliant on private insurance providers. However, it has its sustainable benefits as independent advisory advisers earn their remuneration from the portfolio growth of their clients, thus aligning their interests. Lack of information thus necessitates more information. Therefore, possibly the underlying causes were taken into account.

In Singapore, the most immobile form of capital is labour, which the government has targeted constantly. Capital flows are all flexible in Singapore, as from the beginning we have had a focus on external MNCs and foreign direct investment. We focus here on labour. Has the government done a good job here?

The government can solve the problem of immobility of factors of production: first, job matching and training schemes to link up supply and demand forces in the labour market. Colleges have job centers to facilitate the process in which graduates get their credentials matched to suitable jobs. Similar job matching centers under the National Trades Union Centre (NTUC) are widely available, all measures to improve structural rigidities, to reduce time-lags in factors of employment is responding to market demands. Perhaps the only criticism might be in terms of costs of training and opportunity costs. The underlying economic causes were taken into account. Increasing information and increasing training solve frictional unemployment and structural unemployment and hence reduce immobility of labour greatly.

Regarding trade union pressures, all agents representing workers’ benefits come under the NTUC, which tries to incorporate employee and firm interests, aligning them to national interests. Politicking at workplaces and lobbying are actively stopped by the Singapore government. This is a measure that only works for Singapore, in which political power is centralized and the state can intervene. Singapore’s uniqueness works in its favour here.

However, for other countries with many federal states, lobbying and union pressure is still abundant, which proactively try to manipulate prices and market systems for their own interests. Hence it might be only possible for Singapore to use the internationally famous tripartite method of solving immobility of labour.

In conclusion, Singapore has many heavy duty weapons in its arsenal for reducing imperfect information and immobility of labour. However, any policy used must be checked for its effectiveness in solving the underlying problems that cause the market failure.

JC ECONOMICS ESSAYS Tutor's Comments: This was written by a former Economics student of mine (from MJC) under examination conditions. I would not have approached this economics question this way; however this quite skilfully written economics paper is very good and very clear. Do, however, ask yourself a few questions. How would you have written it, to address the question? How would you have improved on it? There are many other ways to approach this question that would have also adequately addressed its specialised requirements. Do remember to think of how you can learn from this Economics essay. Thank you for reading and cheers. 

(b) Evaluate the possible policies a government might adopt to deal with the above market failure.

The first part of the question: (a) Explain why pollution and congestion caused by cars may cause market failure. [10]

(b) Evaluate the possible policies a government might adopt to deal with the above market failure. [15]

(in this case, externalities, as can be seen in the part (a) answer above) (15)

There are many policies that a government can utilize to overcome externalities in terms of congestion and pollution. This paper suggests policies and highlights their pros and cons. The government can impose congestion charges, such as the Electronic Road Pricing in Singapore (ERP), impose quotas or taxes to control the vehicle population, such as Certificates of Entitlement in Singapore (COE), improve the public transport system, build more roads, and other miscellaneous policies. All these will be explained and then evaluated in this paper.

First, would congestion charges work? They might work as the government is forcing drivers to internalize the externality. In this case, drivers will internalize the negative externality. What does this mean? Internalizing externalities means that the drivers are forced, by the use of the congestion charge, to factor this additional cost into their calculations, hence reducing the number of trips they take and raising the private cost of driving to the drivers. This suggests that congestion charges are an excellent government policy that would have a high chance of working precisely because they makes drivers consider social costs as private costs.

Insert economics diagram. What diagram goes here?

The diagram above demonstrates the core idea of congestion charges, which is to shift q1 to q2 and p1 to p2, which shifts the private cost curve to the social cost curve.

Yet, the problem is that the government may further distort the market instead of getting a desired outcome because of imperfect information. The government may want to know but it cannot. There is no way for the government to know exactly what and where the socially optimum level of driving is because in reality, such data is impossible to find. How much congestion charge should the government charge?

In addition, the government might find it hard to adjust congestion charges because of political reasons. Should the congestion charge be high, possibly solving congestion and pollution, but endangering political success at elections; or should the congestion charge be low, possibly not solving congestion and pollution, but being more acceptable? It seems that theoretically congestion charges tackle the core issue of the overconsumption of car journeys by making drivers internalize the externality, but in practice there are many unaddressed and difficult issues.

Controlling the population of vehicles is another possible solution, where governments target the supply of cars and not the demand for cars. The Singapore government, for instance, uses COEs to control the supply of cars, as whoever wants to drive needs this licence to own a car. The total number of cars can be thus controlled with this kind of quota, which limits the total number to a cap. In comparison with congestion charges, COE does not restrict the use of the car, but reduces car ownership, with the central idea being that there would be less congestion and less pollution with fewer cars around.

Yet controlling the population reduces the total amount of pollution, yet may not reduce congestion. The reason is that congestion depends primarily on usage, which can be thought of as how many cars are out on the road at any given time. During peak hours there would automatically be congestion, even if governments were to reduce the total number of cars. This is because the cars are on the road at the same time. Hence, controlling the vehicle population is a good idea but should be done in conjunction with reducing usage as well.

Improving the public transportation system is yet another solution. This would provide an alternative to using cars as a means of transport, or as we say in economics terms, a substitute. By subsidizing public buses and trains, and making them more affordable and convenient, the use of cars would be lessened, and congestion and pollution would be reduced. For instance, people who would drive will decide to take the bus, and there would be fewer cars on the road.

However, with the exception of trains, buses produce pollution as well, and while reducing congestion would not necessarily reduce pollution if more buses are put on the roads. Also, the cost of improving public transport might be prohibitive, where governments face the opportunity cost of the money forgone for other more pressing uses, and there might also be strong opposition from people who prefer their own cars. All considered, however, improving public transport would still prove to be a good method of reducing congestion and pollution.

Another solution by governments is usually to build more roads, as by building roads, there would be less congestion. However, the issue is that road building does not solve the underlying problem, which is the externality. There would still be many cars on the road, and the decisions made by private individuals would still conflict with the social good. Unlike the other methods discussed earlier, road building does not reduce the usage of cars, and does not reduce car ownership. Hence building roads helps win elections more than it does actually solve congestion or pollution, which are market failures by nature.

Moral suasion and other non economic methods could also be used, but they are short term and still do not address the underlying negative externality. For example, posters and public education are not that effective in reducing overall car usage in Singapore. Therefore, they are also not heavily used in most other countries as well as compared to the methods of reducing car usage and ownership.

In conclusion, a government has many ways of dealing with congestion and pollution, but each policy chosen has pros and cons which must be carefully evaluated. Controlling car usage by the use of congestion charges like ERP make consumers internalize the negative externality because they consider their private costs and not social costs, yet there are political repercussions and informational challenges. Reducing the total number of cars will bring about less congestion and pollution overall but does not solve the problem that car usage is concentrated at certain times. Improving transportation systems would be a good idea if the cost were not too oppressive, as there would be an opportunity cost in terms of other more pressing governmental projects. Building roads and moral suasion might not be sustainable. Therefore, all considered, a mixture of various policies should be used rather than a one size fits all policy that pretends to be a panacea but is not.

JC ECONOMICS ESSAYS Tutor's Comments: This Economics essay is very well written and addresses the question fully. How and why? Think about it. How would you improve this essay, or how could you approach this question slightly differently or alternatively? This Economics paper was also professionally written, jointly with part (a).

(a) Explain why pollution and congestion caused by cars may cause market failure [10]

(a) Explain why pollution and congestion caused by cars may cause market failure. [10]

Pollution and congestion may cause market failure because they are forms of negative externalities, which distort the socially optimal workings of the free market. Externalities are third party spillover effects, and can be categorized as positive and negative. Whether positive or negative, externalities cause market failure as they distort the socially optimum output to society because of a discrepancy between the social costs and benefits and private costs and benefits. Market failure can be defined as the failure of free markets to allocate resources in a socially efficient manner. This paper discusses why negative externalities cause market failure in the context of congestion and pollution, and demonstrates there is a deadweight loss to society when drivers consider only private costs and benefits and not social costs and benefits.

A negative externality occurs when motorists fail to consider the social costs of their journeys. The individual motorist only considers his private costs and benefits, and hence only his private marginal cost matters to him. For instance, fuel costs are part of his private costs and he factors them into his calculations. However, by driving on the roads, a motorist inflicts external costs on others, namely congestion and pollution. Congestion is a third party external cost because other drivers have their speeds reduced as a result and pollution is a third party external cost because pedestrians and motorcyclists suffer from irritation and perhaps even health problems. Hence, the motorist who considers only his private costs and benefits fails to take into account the external costs that he imposes on others.

These results can be seen in the following diagram…

Insert diagram

The diagram demonstrates that the socially optimum level of car journeys should be at q2 at a price of p2, yet the private market, which does not take externalities into account, produces q1 car trips at a cheaper price of p1. This means that the negative externality results in more car trips being taken at a lower price than what is socially efficient. Since the number of car journeys is underpriced and overprovided there results a deadweight loss to society. The socially optimum level should be at p2 and q2, not p1 and q1.

Therefore, pollution and congestion caused by cars are likely to cause market failure.

In conclusion, there are many types of market failure: imperfect markets, the failure of Adam Smith’s free market to produce public goods, and above all externalities. In the case of cars, causing congestion and pollution, the market failure in question is externalities – and in particular, negative externalities, where third parties suffer negative spillover effects such as congestion and pollution when others drive.

JC ECONOMICS ESSAYS Economics Tutor's Comments: This is a very well-written Economics answer. What can you learn from the way this economics essay is written? Why is it good? How would you have addressed the question? And what other comments would you have about it? Do think about how to write a proper economics essay every time you read one. This economics essay was professionally written.

(b) “The government should produce all public goods and all merit goods”. Is this statement accurate from an economist’s point of view? (15)

(b) “The government should produce all public goods and all merit goods”. Is this statement accurate from an economist’s point of view? [15]

Note: please read the economics tutor's comments at the back after reading this economics essay. 

The efficient allocation of resources is the use of a country’s limited resources in such a manner that maximises the total welfare of the people. A pure market economy will not be able to do this for three main reasons: the emergence of imperfect market structures, externalities and the lack of public goods. Therefore, government intervention is needed to deal with these market failures. In this paper, we shall look at the main features of the market economy, and then look at its limitations.

Firstly, in a market economy, there is private ownership of resources and finished goods. Individuals and firms can thus transfer ownership to any other party that they wish. Secondly, the allocation of resources is determined by a unique system known as the price mechanism of the market. The forces of demand representing consumers and the forces of supply that represent producers interact to determine the price of goods – thus leading to “the invisible hand” allocating resources to the best possible uses. The price mechanism is the channel by which consumers signal to producers of the goods they want and the respective quantity that they want.

The market mechanism is also very efficient because decision making is completely decentralised. Producers respond at the local market level immediately to consumer preferences. As freedom of choice and profit motive is allowed, producers will use scarce resources as efficiently to produce. Intense competition also forces producers to produce at the lowest cost and thus forces producers to produce at the lowest cost and thus forces them to innovate and invent new products in order to satisfy the wants of consumers. In the long run, it is the consumer who benefits in the form of new, better and cheaper products.

However, the market economy is not without its drawbacks and the most serious one is its inability to deal with externalities. Externalities are benefits (positive externality) and costs (negative externality) that fall on society due to economic activities which the price mechanism is unable to account for.

In the case of public goods, no producers would want to produce goods like street lighting or radio broadcasts because these are non-exclusive between payers and non-payers. And they are also inexhaustible. Thus, in a market economy, they would not be produced although the consumers would generally benefit from these goods. Thus, to maximise welfare, government should supply the good at zero market price. The government may either produce these goods itself or contract the production of these goods to the private sector. The government would hence, finance the production of these goods from tax revenue.

Even in the case of market goods, the market will not produce a quantity at the socially optimum level- private companies would only produce education for those who can pay although it is to society’s benefit in the long run to provide all children with education Thus, the government would intervene in the case of merit goods by providing subsidies.

Subsidies are transfers from the government to individuals and firms. In the case of merit goods, a subsidy can be provided directly to producers or consumers. Legislation, which is enacting laws and regulations to ensure optimum consumption of a good, can also, be implemented by the government. Thus, the fear of being penalised increases the demand for the goods, leading to greater consumption. The government may also provide the shortfall of merit goods or may contract private firms to supply the shortfall. The government can also educate the public through mass media and carry out campaigns to teach the citizens the importance of consuming the merit good. Thus, in the case of merit goods, the government would have to intervene as it has large revenue from taxes that is able to finance the provision of merit goods unlike private enterprises which do not have such a large capital base.

In the case of a negative externality, private consumers and businesses would generate the social costs of pollution, congestion and environment degradation in the process of seeking their own interest. As the market fails to place a market value on these costs, they get away with paying for them. Thus, the government also has to intervene in this case due to the negative externality generated that affects the third party. Thus, the government would have to impose taxes such that producers would be motivated to produce using greener technologies in order to reduce their probability of them having to pay taxes that add on t their production costs. The government may also introduce legislation in order to reduce emissions and negative externalities in production.

Figure 1: Marginal Social Costs, Benefits and Marginal Private Benefits, costs

Indeed for the efficient allocation of resources, form all points of view, production of any good should be where the MSC=MSB. As show in Figure 1, output 0Q0, is the ideal level of production from society’s point of view. However, the market will only consider MPC which is only part of MSC. Marginal Private Benefit is only part of MSB. Therefore, goods are either under produced or overproduced. Hence, government intervention is required to correct these market imperfections in order to achieve the socially optimum level of output.

The market mechanism may also undermine consumer’s welfare. As producers are profit motivated-they only produce for the rich-people who can afford to pay. Thus, food, housing, medical services and even ordinary goods will not be adequately produced and provided for the poor.

Another disadvantage is the market economy does not guarantee against the concentration of economic power in the hands of a few. This is called a monopoly or an oligopoly. One company would then be able to exploit consumers.

Finally, the market economy, as seen in history, causes a wide gap or disparity between groups of people in the country. Massive wealth is held by a few and this small group gets richer because one needs wealth to generate more wealth. Thus, the market economy may fail to maximise society’s welfare.

For the above reasons, it is best that some form of government supervision of economic activities may be present. A good example of this is Singapore. This country has prospered due to the spirit of free enterprise-private ownership and profit. However, the government has set up a number of authorities to ensure that resources are efficiently allocated while market forces prevail. The Urban Redevelopment Authority (URA) looks into the use of limited land space. The Land Transport Authority (LTA) supervises private and public transportation. The Port of Singapore Authority (PSA) looks into ports and shipping. In this way, Singapore benefits from the market system: without its bad effects.

JC ECONOMICS ESSAYS - Economics Tutor's Note: This is a very interesting approach. I think this Economics essay is interesting, well thought-out and reflective. In fact, it is rather good. However, it is not the standard way to deal with "A" level exam questions. In terms of an A level answer, this would not be the proper way to answer the economics question. The standard view should be something like:

Essay Introduction - Define public goods and merit goods, perhaps arguing that merit goods are underconsumed and underproduced because of either imperfect information or the presence of positive externalities. Introduce the main arguments. 

Essay Thesis - Yes, on the one hand, the government should produce public goods and merit goods (Diagram +egs + why)

Essay Anti-thesis - No, on the other hand, the government shouldn’t produce public goods and merit goods (Diagram + egs + why)

It can legislate, it can use free market, it can use the Coase theorem (perhaps tradeable permits or other methods), it can subsidise private producers. (Include limitations of the government also; government failure - thus it shouldn't, since it could be even worse.)

Essay Synthesis, for an evaluative conclusion that weighs the arguments and their merits - Govt produces public goods, govt taxes/subsidises. Demerit/merit goods should not be directly provided. Clever, pithy, evaluative opinion-based statement justified with Economics reasoning, concepts, and theories at the end.

Having said that, think of how you could approach this essay question and think about the answers that you would give. This student answered the question in a divergent way, but there are lots that we can learn from it. Perhaps, this economics essay could be even better if the student had focused on answering the question directly or in a more clear or obvious manner. Thanks for reading and cheers.