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. 

The price mechanism will always allocate scarce resources efficiently for all goods and services in a market economy. Assess the validity of this statement made by an economist. [15]

This economics paper assesses whether the price mechanism will always allocate scarce resources efficiently for all goods and services in a market economy. 

On the one hand, it will indeed allocate scarce resources efficiently in economic theory, because of the workings of the price mechanism to 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, which distort the workings of the free market.

On the one hand, the price mechanism allocates scarce resources efficiently in the market economy for goods and services through its signalling, rationing, allocating, and incentive functions. The signaling function is one where the price of a good allows for a re-calibration of the quantity demanded and quantity supplied, allowing goods to be efficiently allocated. 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. Those who are willing and able to pay will obtain the good. Correspondingly, the resources used to produce these goods will also be efficiently allocated, as producers maximise their profits by producing only if the cost of production is less than or equal to the prevailing market price. As a result, there is productive efficiency, since goods will be produced at the lowest cost combination to ensure profits are maximised. On the whole, there is also allocative efficiency, since society’s welfare is maximised, where only those who are able to consume and produce do so. 

Question: What economics diagram do you think should be drawn here? How would this diagram back up your arguments? 

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

Here, we focus on 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 the merit good. Externalities are defined as the spillover effects to third parties who are not involved in the production or consumption of the good. Vaccinations provided for example by the National Health Service (NHS) are examples of merit goods. However, an individual consumer only considers his private benefit from getting vaccinated, and does not consider the positive externalities his vaccination confers on society. This results in an under-consumption of the merit good of vaccination, and there is therefore dead-weight loss, as society’s welfare has yet to be maximized due to this under-consumption.

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?

In conclusion, while the price mechanism allocates scarce resources efficiently in theory, this may not be the case in reality, as there are market failures that challenge the assumptions upon which the efficiency of the price mechanism is predicated. In the real world, with market failures, there is the need for government intervention in the free market to reduce or eliminate market failures so that the free market can produce the optimal outcomes the economists promise. 

Economics Tutor's Comment - This is a rather strong economics essay which covers quite a few important points and arguments, but it could do so much more. The candidate's use of economic theory is quite strong in this economics essay. Could more examples have been used, or could the example of the NHS have been even better utilised to make the point? Perhaps another market failure - the lack of provision of national defence - would have also been brought in to buttress the arguments. 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 site helps economics students with the A-Levels Economics (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. This blog provides a range of useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom, and also in countries such as Malaysia and Singapore, can use to excel in their studies and examinations.

This model essay was contributed by WT, our resident expert who helps students understand the beauty of Economics and provides content on economic issues. WT has a wide-ranging interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. And as always, S. S., the editor of JC Economics Essays, edited this economics essay. He also provided comments for this essay. 

Consumers and producers are generally assumed to be motivated by self-interest. Explain how the pursuit of self-interest can help to address the central economic problem of limited resources and unlimited wants. [10]

Adapted from an actual economics essay examination

This economics paper explains that the pursuit of self-interest results in an efficient allocation of resources through the price mechanism, which addresses the problem of scarcity. 

Human wants are unlimited, while earth's resources of land, labour, capital, and entrepreneurship are limited. This results in scarcity. What is scarcity? It refers to the situation where resources that are limited are not able to meet the requirement of unlimited wants. However, there is a solution to meeting these two different imperatives - and that is the free market, with its price mechanism, which as Adam Smith said, acts like "an invisible hand". 

The price mechanism means that it is the intersection of demand and supply that determines the price and the quantity eventually produced. It is the rational choice of millions of suppliers, producers, and firms meeting the requirements of millions of consumers, individuals, and households. 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. 

The price mechanism addresses the central problem of economics, coordinating resources to their best uses, and solving the problem of what to produce, how to produce, and for whom to produce, because it serves the important four functions of signaling, rationing, allocating, and incentivising. The signaling function is one where the price of a good allows for a re-calibration of the quantity demanded and quantity supplied. As the price of a good increases, indicating a more pronounced situation of scarcity, the quantity demanded of a good falls, while the quantity supplied rises, ceteris paribus. The converse is also true, where the fall in the price of a good, which indicates an amelioration of scarcity, results in an increase in the quantity demanded and a fall in the quantity supplied.

Given the prevailing market prices, buyers who seek to maximise their utility will demand the good. Under this demand function, those are willing and able to pay for the good are able to obtain it, while those who are not willing or able to pay will go without the good. Meanwhile, producers who are willing and able to produce the good at a cost below or equivalent to the prevailing market price will produce it, as they are incentivised to maximise profits, while those who produce at a cost above the market price will not. This also determines the allocation of resources that go into producing this good.

In conclusion, the pursuit of self-interest utilises the price mechanism to address the problem of scarcity, achieving an efficient allocation of resources.

Economics Tutor's Comment - This is a very strong effort for the A levels and covers quite a few important points and arguments. The candidate's use of economic theory is quite strong in this economics essay. However, one should not and cannot rest on one's laurels. What would make this economics essay even better? Thank you for reading. Cheers!  

JC Economics Essays - This economics essays site helps students with the A-Levels (Cambridge, A1/S, A2, H1/H2 levels), and the international AS level economics examinations. This blog provides a range of useful economics content, materials, tips and techniques, and model economics essays that students in the United Kingdom, and all around the world, can use to excel in their studies and examinations.

This model essay with sample comments was contributed by WT, our resident Economics expert who helps students understand the beauty of Economics and its applications in real life. WT has a strong interest in Econometrics, Economic History, International Trade, and Game Theory, especially applications to real life. This economics post was edited by S. S., the editor of JC Economics Essays.

View: Are The Water Price Hikes in Singapore Announced in 2017 Justified?

This economics view post is contributed by the editor of JC Economics Essays

The Budget and Committee of Supply Debates 2017 in Singapore had many economic policies announced. However, one major announcement stood out and generated a lot of debate, including many negative views – yes, the water price hikes, especially the figure of 30%.

In summary, the issue here is that the price of water in Singapore is set to increase by 30 per cent in two phases, from 1 July 2017 onwards.

This economics view post argues that while some may say the hikes are not justified, the reality is that the water price hikes are based on sound economics and are needed, necessary, and important for Singapore’s survival.

Before we delve into economic terms like "LRMC" and "pricing" and "infrastructure", there are of course, non-economic arguments based upon reasoning about Singapore’s strategic imperatives and our fundamental vulnerabilities.

Singapore’s Deputy Prime Minister Teo Chee Hean said, rather clearly, that water is critical to Singapore's survival, and Singapore has adopted a strategic approach in planning for its water supply. It may not be a very well-known fact that water is tied rather closely to Singapore’s sovereignty, a significant reflection that water is critical to Singapore’s survival. According to the National Library Board, the Separation Agreement signed between the governments of Singapore and Malaysia on 9 August 1965 guaranteed the 1961 and 1962 water agreements.

As DPM Teo went on to say, "Our struggle to make sure our people have water, is the struggle for Singapore's survival and independence… To make sure that we could survive, preserve our independence and thrive, we have taken a strategic approach to planning for water supply.” 

This strategic argument reflecting the importance of water has actually led to concrete steps taken to reduce Singapore's dependence on imported water and raise Singapore's water security. 

To reduce Singapore's dependence on imported water from Malaysia, the government has increased the size of the local water catchment area (in other words, reservoir water) and to build up water supply from non-conventional sources, namely NEWater (in other words, reclaimed water or less glamorously, “sai chui” in Singapore local parlance) and desalinated water (in other words, treated seawater), by setting up water treatment plants in various parts of Singapore. In total, these form the four national taps of Singapore.

The real success of the four national taps came in 2011. When the 1961 water agreement with Malaysia expired, Singaporeans did not face a disruption in water supply, and the event passed almost unnoticed.

DPM Teo went on to argue that, in the same vein, Singapore must prepare now for 2061 when the second water agreement with Malaysia, which currently meets half of Singapore’s water needs, expires. Besides preparing for the future, DPM Teo also warned of a more immediate worry (at least in the near term). Johor's Linggiu Reservoir is only one-third full and there is a danger of it failing in prolonged dry weather – and the water is needed by both Malaysia and Singapore. 

Other than the fact that the water source is under stress, while bilateral ties are sound today, where in recent years Singapore and Malaysia have shared a good relationship, what would happen if climate change and increasing water scarcity makes it challenging and difficult politically for Malaysia to export water to Singapore?

However, let us turn to the economics and look at the issue from an economics perspective. 

While housing, healthcare, and education are subsidised in Singapore, because they are essentially merit goods, it was argued in Parliament that water has to be priced fully because consumers must feel the price of water to realise its value. It is a sound economic principle that the ones using the water should be the ones to pay for it. In other words, the Minister of the Ministry of Environment and Water Resources, Masagos, is essentially right in terms of economic reasoning – water is not a merit good and should not be subsidised, whereas there are foregone positive externalities to society or there would be under-consumption of goods such as housing, healthcare, and education if they were not to be subsidised by the government. 

Now for the pricing itself, beyond the economic principles. 

Minister Masagos said in Parliament that even with the impending 30 per cent hike in water prices, the price of water here will fall short of the Long Run Marginal Cost (LRMC) — which is the increase in cost of producing an additional unit of water, over the long run, arising from increasing production. 

In other words, he argued that the increased price of water will bring up the pricing to nearer the true LRMC of water. 

With the 30 per cent increase, the price will be close to, though slightly lower than, the price of the next drop of water or LRMC. This is the best way to emphasise the scarcity value of water, because the price will fundamentally reflect the long run cost of the next drop of water – and this is based on economic reasoning. If the price is equal to the LRMC, production would be allocative efficient - a concept familiar to economics students, where the price reflects the additional (i.e., marginal) cost of production. 

In Parliament, it was revealed that the LRMC of water comes from the costs of NEWater and desalination. And between the two, Singapore will have to depend more on desalination – which is more expensive than NEWater – to meet increasing water demands, as there is a limit to recycling used water in the NEWater plants. For example, three more desalination plants will be built by 2020. 

And why are the relatively cheaper NEWater plants not being used instead? The answer is that as the proportion of water being reclaimed for NEWater increases, waste water becomes more concentrated, thus becoming difficult and even more costly to treat. 

In addition, it also costs the government more to build new and replacement pipes to deliver water - thus adding to the LRMC.

In the final analysis, while there are actually solid strategic reasons for raising the price of water to build critical infrastructure to ensure Singapore’s future, the price hikes are based on sound economics.

JC Economics Essays – This is an economics blog with views, opinions, and perspectives on a wide range of socio-economic issues. It also has a wide range of A level economics essays answers. 

Since 2007, this useful and popular economics blog has assisted students with economics essays, in particular the A level Economics examinations at H1, H2, and H3 levels, and the International Baccalaureate (IB) Economics too.

And there are many economics essays on this site that economics students can access, read, and reflect on for improving their essays and learn how to answer examination questions. Thank you for reading and cheers! 

Explain how benefits to the UK economy can arise from exchanges, arising from specialisation, to address the central problem of economics. [10]

This paper explains the benefits to the UK (United Kingdom) economy of exchanges arising from the price mechanism, arising from specialisation, that addresses the central problem of economics.

First and foremost, the central problem of economics, according to Lord Lionel Robbins of the London School of Economics, is basically about humans having unlimited wants, but because of limited resources of the factors of production of land, labour, capital, and entrepreneurship, people cannot have everything that they want. This is the situation of scarcity necessitating rational choice, given finite resources on earth to meet unlimited wants. 

There are a few keywords and core concepts that we need to address before we start on our essay. Exchanges refer to the movement of goods and services in exchange for money, in a free market economy. Specialisation refers to the division of labour that occurs in a free market economy that uses the price mechanism. Specialisation means that individuals or firms produce one good, and can thus reap economies of scale from it, where economies of scale refer to falling long run average costs (LRAC) a the scale of output increases. The central problem of economics can basically be addressed through the price mechanism in a free market economy, which refers to the intersection of demand and supply, where, as Adam Smith famously said, prices act as an “invisible hand” coordinating the factors of production to allocate goods in the economy, solving the problems of "what" to produce, "how" to produce, and "for whom" to produce those very goods. This paper now explains the benefits to the UK economy of exchanges arising from specialisation.

First and foremost, the price mechanism and the concomitant specialisation that arises from it lead to efficiency in the UK market. There are many kinds of efficiency, but according to economic theory the price mechanism in a competitive market would be productive and allocative efficient, ceteris paribus. Productive efficiency means that the market produces at the lowest possible average price, while allocative efficiency means that the market produces also where P = MC, where MC means marginal costs. Alternatively, allocative efficiency can also be defined as where the market allocation is the socially optimal level for society, under conditions of no market failure. For example, if UK farmers specialised in the production of various crops  and then exchanged to get what they need for their daily needs, then the agricultural produce market would achieve productive and allocative efficiency, because UK farmers would produce at the bottom of their LRAC and thus achieve the Minimum Efficient Scale (MES), the lowest point of the LRAC. This would ultimately benefit UK consumers because of lower prices and greater output, the greatest benefits of productive and allocative efficiency.

At the same time, beyond microeconomics, this question also asks about the UK economy. For the larger economy, specialisation would lead to an economy that could exchange goods internationally. International trade is defined as the exchange of goods and services across international boundaries. If the UK specialises, for example, in the production of capital intensive goods, such as cars and technological products, and then trades with another country, say China which specialises in the production of labour intensive goods, such as clothing, then trade can take place, which could increase UK’s actual growth, as AD  = C + I + G + (X-M). This is basically the benefit of specialisation and exchange on the international stage, called comparative advantage, where one country specialises and produces a good it has a lower opportunity cost of producing, and then exchanges it for a good in which it has a comparative disadvantage in, which leads to a higher consumption possibilities. 

In conclusion, it can be argued that exchange and specialisation to solve the central problem of economics can benefit the UK economy in terms of promoting productive, allocative efficiencies, as well as international trade because of comparative advantage for the benefit of the UK's economic growth. 

JC Economics Essays - This excellent economics essay, written under examination conditions, was kindly contributed by S. S., who achieved an grade A for H2 Economics at the A level examinations and also a Merit for H3 Economics. He achieved a university place at the London School of Economics and received good recommendations and testimonials from his economics and civics tutors. Special thanks for the kind and useful contribution. What can we learn about writing good economics essays from this sharing? Thank you for reading, and cheers. 

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. 

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. 

The terrorist attack on New York City, USA, on September 11, 2001 precipitated a worldwide recession and an increased fear of air travel, which massively affected the demand for travel by air. This led to the closure of some major airlines in the world. Explain how the worldwide recession and the closure of some of the major airlines affected the market for air travel. [10]

Due to the terrorist attack of 9/11, there were many economic effects - recession and an increased fear of flying would lead to a decrease in demand whereas the subsequent closure of some of the major airlines of the world would lead to a decrease in supply. Recession refers to negative economic growth that affects consumption since economic growth is the key determinant of changes in average household income. Hence, this essay aims to discuss how recession and closure of major airlines affect the demand and supply and thus the equilibrium price and output of the market for air travel. 

Negative economic growth or economic decline causes a decrease in demand as it influences the average household income causing a decrease in level of income and wealth. Income refers to the earnings per time period. A fall in income due to economic decline leads to falling ability to purchase goods, in this case air travel ticket or packages. Decreasing income also leads to fall in disposable income for travelling. Thus, demand falls as a result. 

Economic decline also leads to a decrease in economic activities and hence business activities. With decreasing business activities, the need for business travels fall, contributing to the decrease in demand for air travel, shifting demand curve leftwards.

In addition, in the times of poor economic outlook or situation, the ease of acquiring credit may fall due to the need to maintain the financial stability. Hence, consumer may find it harder to borrow to finance expensive items, including holidays. Thus, demand for air travel may decrease significantly as well. Stringent financing rules that discourage borrowing also contribute to the fall.

On the other hand, closure of some of the major airlines would have a significant impact on the supply for air travel, especially when major firms are usually responsible for a significant proportion of the supply. Closure of major airlines decreases the number of firms in the industry, shifts the supply curve leftwards, decreasing supply. This can also be caused by a decrease in size of existing firms as it decrease the total capacity of the airline industry.

Terrorist attacks causing major closures and financial crisis can be considered as supply shocks, disrupting and reducing the supply of air travel, shifting supply curve leftwards. 

However, the extent of decrease in demand and supply may differ, resulting in differing price and output equilibriums. 

[Insert diagrams of market of air travel to show the difference in the fall of supply and demand causes price and output equilibriums to shift differently]

If the supply decreases to a greater extent since it involves the closure of major airlines, the price increases as supply curve shifts leftward to a larger extent than the demand curve falling. However, if the decrease in demand is a larger extent compared to the decrease in supply fuelled by fear of flying, the price decreases instead.

In conclusion, the extent of shift of demand and supply curves eventually determines the equilibrium price and output. In the long run, a new equilibrium may be reached as the economy recovers and consumers regain their confidence. Hence, this change in price is a short run outcome for the market for air travel.

JC Economics Essays (H2 'A' Level Economics Essay): economics tutor's comments - There are many economics examination questions that make reference to contemporary world events, and 9/11 is one of the major events in the world that students should know about. The focus of this essay question is, however, about the market for air travel, and in particular the economics concepts of demand and supply. How are the factors of demand and supply related to the scenario described? Fundamentally, economics students should be able to link the theoretical model of demand and supply to economics questions during examinations. This ability to link real world examples and context to economic theory is a real skill that should be developed. The usual questions apply - how would you improve this essay to make it more developed? How would you further the arguments? Think of how you would write your economics essay in response to the question. If you are able to recall the factors affecting demand and supply, how would you link those to the concepts? What revision do you need to make this essay excellent, or better? Special thanks to student contributors for this sample essay. 

Explain how the pricing decision between a monopoly firm and a perfectly competitive firm differs because of differences in the levels of barriers to entry. [10]

A monopoly refers to a market where there is only one seller of one product that has no close substitutes. In perfect competition, there are many sellers and buyers selling one homogeneous product. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly is a price setter while firms in perfect competition are price takers. A monopoly exists because barriers to entry are very high, whereas a perfectly competitive firm exists because barriers to entry are very low or even non existent. In this Economics essay, I will explain the reasons for high and low barriers to entry for a monopoly and firms in perfect competition respectively, and how the price decision will thus differ between the two market structures.

A monopoly exists because barriers to entry are so high such that new firms are totally deterred from entering the market, and therefore there is only one dominant or major firm in the market. There are two types of barriers to entry: natural barriers and artificial barriers to entry. Natural barriers refer to inherent characteristics of the market which deter the entry of firms into a market. For example, the monopoly of diamond market, De Beers controlled more than 98% of the diamond resources last time and was able to deter any other firms from entering the market. Localised monopoly also has very high barriers to entry due to the fact that limited population does not demand so many firms for one good or service. Hence, in a small town, one firm is enough to fulfill the demand. For example, hairdressing shops can be considered localised monopolies.

Artificial barriers refer to deliberate actions taken by governments of firms to deter entry into a market. Governments may sell licenses to firms which want to enter a market in very high prices. For example, setting up one casino is very hard in most of the countries because governments will consider the negative externalities of opening a casino. Existing firms will set their prices lower than entering prices to deter new firms from entering the market. 

In perfect competition, barriers to entry are low so it is relatively easy for new firms to enter the market to produce. Therefore, so many small firms with each having an insignificant market share are present in perfect competition. Each firm’s market share is negligible due to the low barriers to entry and exit. Changes in a single firm’s output will not have effect on the market’s total supply and hence the market price.

Hence, as price takers, firms in perfect competition will take the price attained from intersection of demand and supply of the whole market. 

[Insert diagram for the Industry (Market)]

[Insert diagram for the Firm]

As shown in the diagrams above, the price decision in a perfect competition is taken by all the small firms at P0. P0 is the same as PE which is the intersection equilibrium price of demand curve D and supply curve S in the industry. 

If the industry has only one firm which is monopoly, it can decide the price as it wants due to the fact that there is no other firm to hinder its great market power. 

[Insert diagram on monopoly]

As shown in the diagram above, the price is determined when maximum profits can be generated. i.e. at the point where MC = MR. 

In conclusion, a monopoly firm and a perfectly competitive firm differs in terms of pricing because the barriers to entry confer market power (or the lack thereof), which leads to price setting ability or a price taking result. 

JC Economics Essays (H2 'A' Level Standard Economics Essay, part (a)): Economics tutor's comments - There are many important essay writing lessons that students can learn from this economics essay on monopoly, perfect competition, and profit maximisation. What is good, and what is bad, about the essay introduction? Was the introduction clear, addressing the topic, and defining key terms and concepts needed? What is good about the economic analysis in this particular paper, in the body of the essay? Did the analysis address the requirements of the economics question? What is good or less good about the writing style and approach taken in this economics essay? Is the essay well written? To a large extent, this is an excellently crafted essay, well written and clear, but there are some ways in which it could have been further developed and made even better - what are those ways? How would you do essay editing for this paper, if you were the economics tutor? How would you apply more of the economics knowledge, insights and analysis to make this paper more developed? Also, how would you mark this economics essay, if you were the examiner? Thanks for reading and cheers. Special thanks to contributions from students. 

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.

Compare and contrast the various types of economic efficiencies. [10]

Compare and contrast the various types of economic efficiencies. [10]

The fundamental economic problem is a problem of scarcity, necessitating choice. This is because human wants are potentially unlimited, but resources are limited, and hence choices have to be made, “efficiently”, between competing uses for the same resources. The scarce resources, or factors of production, are land, labour, capital, and entrepreneurship. Land refers to resources, gifts of nature, and other natural factors. Labour refers to human effort and work. Capital refers to any good that can be used to produced another good. Entrepreneurship refers to risk-taking, organisation, and business acumen, among other things. It can be said that efficiency is concerned with the optimal production and distribution of society’s scarce resources. This economics essay compares and contrasts the various main types of economic efficiencies – productive efficiency, allocative efficiency, dynamic and static efficiency, X-inefficiency, social efficiency, and Pareto efficiency.

Productive Efficiency

First, productive efficiency occurs when the maximum number of goods and services are produced with a given amount of inputs. This will occur on the production possibilities curve or production possibilities frontier (PPC or PPF), meaning that any point along the PPC will be productively efficient. On the PPC, it is impossible to produce more goods without producing fewer services. Productive efficiency will also occur at the lowest point on individual firms’ average cost curves (AC curves). This is because productive efficiency can be thought of as the method of least cost production, which means that production costs are minimised. Productive efficiency is not the same as the other types of efficiencies.

Think: how would you draw the PPC?

Allocative Efficiency

Second, allocative efficiency occurs when goods and services are distributed according to society’s preferences or when they are allocated in accordance with maximising society’s welfare. An economy could be productively efficient but produce goods that people that do not need, and this would be allocatively inefficient. In other words, allocative efficiency is a subset of productive efficiency, where productive efficiency is a necessary condition of allocative efficiency. (A necessary condition is a condition for some state of affairs that must be satisfied before the state of affairs can be obtained.) It should be noted that allocative efficiency occurs when the price of the good produced by a firm equals the marginal costs of production.

Dynamic Efficiency

Third, dynamic efficiency refers to efficiency over time, whereas static efficiency refers to efficiency at a particular point in time. The first concept has the element of time taken into consideration whereas the other does not consider time. Dynamic efficiency involves the introduction of new technology and working practices to reduce costs over time, whereas static means “at a fixed point in time”. Basically, this concept of dynamic means that there are changes over time whereas static means that time is held, as it were, frozen.

X-inefficiency

Fourth, X-inefficiency occurs when firms do not have incentives to cut costs. This is usually associated with monopolies, which usually pursue rent-seeking behaviour rather than think of how to lower costs. For instance, a monopoly which makes supernormal profits may have little incentive to get rid of surplus labour. Therefore, a monopolistic firm’s average costs may be higher than necessary.

Social Efficiency

Social efficiency occurs when externalities are taken into consideration and occurs at an output where the social cost of production (SMC) = the social benefit (SMB), or alternatively, the marginal social costs (MSC) = the marginal social benefits (MSB). This is closely related to both the concepts of allocative and Pareto efficiency, also known as Pareto optimality. Pareto efficiency or optimality is defined as a situation where it is not possible to make one party better off without making another party worse off. Hence, Pareto efficiency is socially efficient and also allocatively efficient, at society’s level.

Conclusion

In conclusion, there are many efficiency concepts in Economics and it is important to understand economic efficiency. Many of the concepts are related and can be understood in relation to each other.

JC Economics Essays – Tutor’s Commentary: This is a good introduction to the various “efficiencies” that Economics has to offer, not just at ‘A’ levels, but also at O, AS levels and introductory undergraduate Economics as well. ‘A’ level Economics can be quite esoteric, it is true, and this Economics material might seem difficult. Think positively instead: how could you make this Economics essay comprehensible and easily understood by you? Let’s do some counterfactual experiments here. Put yourself in the role of the Economic tutor, the examiner, or the lecturer, and you were marking this essay paper. If you were an Economics tutor, how would you judge this essay? What were its strengths and weaknesses, and why do you think – as a professional Economics tutor – those parts of the Economics essay were strengths or weaknesses? Thanks for reading, all the best and good luck!

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). 

(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.