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Market Failure: Government Intervention (strategies only) (To address…
Market Failure: Government Intervention (strategies only)
To address positive externalities:
Subsidies on Consumption:
good is under-consumed by society if left to the free market.
govt. would want to increase good's consumption
govt. provides a per unit subsidy that is equal to the MEB at 0Qs, which will shift the MPB curve by __ to coincide with the MSB curve.
the lowered price of good would thus be an incentive for consumers to consume more of the good.
consumers have internalised the value of external benefits.
consumers will now consume at consumption level that is deemed to be socially optimal, 0Qs, where MPB'=MPC. (Note: this would only apply for diagrams where MPC=MSC)
consumers will consume at the same consumption level where MSB=MSC.
deadweight loss of ___ is eliminated.
resources would be efficiently allocated.
society's welfare is maximised. market failure is addressed.
Subsidies on Production:
govt. wants to increase consumption of food because it is under-consumed by society
govt. provides subsidies to producers
leads to fall in cost of production.
cost savings is passed on to the consumers.
reduces the MPC of the consumers as they will now pay less for the good.
under-allocation of resources-> under-consumption of good-> govt. provides subsidy
subsidy will allow cost savings to be passed on to the consumer to be equal to the MEB at 0Qs, which is the socially optimal output.
govt. subsidy will shift the MPC curve by __ to MPC'.
market equilibrium is achieved where the socially optimal level of output is 0Qs.
resources efficiently allocated-> societal welfare maximised -> deadweight loss of ___ is eliminated.
Advantages of subsidies:
raises consumption level from ( ) to ( ).
deadweight loss is completely eliminated.
easy to implement as the govt. will provide subsidies directly to the consumers or producers.
Limitations of Subsidies:
difficult to estimate the amount of subsdy to be provided.
difficult to accurately measure MEB.
difficult to identify who these third parties are.
impractical to impute a monetary value to such benefits for the purpose of computing the correct amount of subsidies to be given.
consumers or producers might overvalue the goods or services if they were heavily subsidised. over-consumption/production may occur, which may result in over-allocation of scarce resources-> a failed attempt to achieve allocative efficiency.
take a toll on the govt. budget as subsidy given to producers and consumers could be channelled to other uses.
To address positive externalities:
Government Provision/
Government Financing and Production:
thought process:
when positive externalities exist, govt. would want to increase consumption of good to be at/closer to socially optimal level (0Qs) if positive externalities exist.
e.g. building additional production facilities, offering free or subsidised vaccines in government clinics.
Advantages:
consumption level will be increased to be at/closer to the socially optimum level, 0Qs, if the govt. manages to estimate the amount to provide accurately.
better quality of goods & services as the govt. is able to closely monitor the service and good production standards.
Limitations:
take a toll on the govt. budget and divert govt. resources away from other projects such as infrastructure devt. or educational programmes. this may affect the economic progress of the country.
public provision: govt. has to directly provide the optimal amt. of good. this may result in inefficiency as govt. may be subject to govt. failures too. this happens when the govt., in its bid to intervene and correct the situation in markets, end up making the situation worse and may create greater inefficiency.
To address positive externalities:
Legislation:
Government's act of formulating rules and regulations to increase the consumption of goods with positive externalities.
e.g. Recognising MEB of education as an enabler in skills acquisition, the Compulsory Education Act in Singapore came into effect on 1st Jan 2003. It enforces compulsory education for all Singaporeans up to Primary 6. This is targeted at bringing the consumption of education up till primary 6 to the socially optimal level for the general population in Singapore.
Advantages:
direct and fast approach to achieve socially optimum outcome.
consumers are compelled by laws to act appropriately.
Limitations:
high administration costs to ensure compliance by consumers due to:
more manpower employed to conduct checks
manpower needed to report and collate data
formulation of rules and regulations are time-consuming:
requires substantial research and deliberation by govt. officials.
needs constant review, which will incur higher costs in the years to come.
To address positive externalities:
Public Education:
Through the govt. publicising the benefits of consuming goods or services that generate positive externalities through public education such as campaigns.
In addition, the govt. can educate the public through:
improved information flow to correct information failure.
therefore, consumers will internalise underestimated private benefits/costs-> his/her MPB raised closer to MSB-> consumption level is brought closer to the socially optimum level-> deadweight loss is reduced/eliminated.
Advantages:
problem of under-consumption by society may be reduced/eliminated
society will consume closer to/at the socially optimal level.
increases awareness of consumers
educates the public on the importance of consuming more merit good.
helps to tackle the root cause of the problem if imperfect information is the cause of under-consumption.
if campaign is vv. successful, minimal govt. efforts/funds will be needed in the future to solve the problem of under-consumption.
Limitations:
a long term policy: results can only be seen after a considerable period of time.
hard to change the habits or mindsets of the population.
people can be difficult to persuade.
To address negative externalities:
Tax Policy:
imposition of tax per unit equal to the MEC at 0Qs.
it has the same effect as an increase in the cost production.
MPC is raised to MPC'
producer is forced to internalise the external cost that he generates.
producer will respond by reducing the output level to 0Qs units as he seeks to equate MPC' (MPC+tax) which coincides with MSC and MPB (=MSB).
socially optimum level of output is achieved.
Advantages:
deadweight loss eliminated.
problem of over-consumption/production by the society is eliminated.
easy policy implementation, as not much monitoring is required.
tax revenue collected can be used to finance govt. projects such as public education programmes.
Limitations:
firms might not be motivated to reduce the amount of pollution esp. if the burden of tax can be passed on to the consumers.
external costs may only be reduced, not eliminated, esp. if the tax is not sufficiently high. however, the outcome is still better than that in the free market bc production level is closer to the socially optimal level.
the amount of tax imposed to achieve the socially optimal level of output is difficult to estimate, as it is difficult to estimate the amount of external costs imposed on the society.
To address negative externalities:
Direct Regulation:
output restricted to the socially optimal level.
standard-setting
examples:
automobile emission standards, installation of pollution abatement equipment by firms to reduce the amount of pollution.
policies:
use of COE
to tackle issue of car ownership to increase costs of purchasing a car.
ERP (electronic road pricing)
to tackle issue of excessive 'car usage' that cause traffic congestion in Singapore.
with these policies in place, MPC of driving is raised. thus consumption of car journeys (driving) is reduced, and ideally brought closer to the socially optimum level.
govt. can place a legal limit on the production of a certain good/service.
Advantages:
direct approach that ensures strict compliance by individuals.
once regulation is implemented, it is easy for the govt. to control the amount of traffic congestion that is deemed optimal by monitoring the situation and making changes according to the market/traffic conditions.
heavy penalties are imposed on firms/individuals who violate the regulation, which will deter others from doing the same.
Limitations:
negative externalities in production: there is no incentive for firms to reduce pollution beyond the legally required limit.
imposes high monitoring costs on the govt. as it is difficult and costly to ensure compliance.
negative externalities in consumption: it depends heavily on the driver's price elasticity of demand for car journeys to determine whether direct regulation will help the situation.
price inelastic: road pricing would not be very effective in reducing traffic congestion unless it is set at a prohibitively high level.
price elastic: road pricing would be effective.
COE may control car ownership, but not necessarily car usage (no. of car journeys)
To address Imperfect Information:
Public Education
Advantages:
Limitations:
To address negative externalities:
Total Ban
Advantages:
Limitations:
To address negative externalities:
Tradable Permits
Advantages:
Limitations:
To address negative externalities:
Public Education
Advantages:
Limitations:
To address Imperfect Information:
Direct Regulation
Advantages:
Limitations:
To address Inequalities in Distribution of Income and Wealth:
Progressive Tax System
Advantages:
Limitations:
To address Inequalities in Distribution of Income and Wealth:
Transfer payments/subsidies
Advantages:
Limitations:
To address Inequalities in Distribution of Income and Wealth:
Minimum Wage Legislation
Advantages:
Limitations: