Please enable JavaScript.
Coggle requires JavaScript to display documents.
Microeconomic Objectives and Policies - Coggle Diagram
Microeconomic Objectives and Policies
MARKET FAILURE
exists when the free market fails to allocate resources in an efficient manner (i.e allocative efficiency is not achieved).
main sources of market failure
Public goods
Externalities
Information failure (Imperfect information on costs and benefits)
PUBLIC GOODS
are goods or services that have the features of non- rivalry and non-excludability and as a result would not be provided by the free market.
CHARACTERISTICS
i. Non-excludability
It is not possible to provide the good or service to only one person without it thereby being available for others to enjoy.
ii. Non-rivalry
The consumption of the good or service by an individual does not deplete the benefits available to others to enjoy.
REASONS FOR MARKET FAILURE IN THE PROVISION OF PUBLIC GOODS
CHARACTERISTIC OF NON-EXCLUDABILITY:
means that it is technically impossible or economically unfeasible to exclude anyone from the benefits of the good once it is provided. This is because the good is collectively consumed once it is provided ie. everyone benefits from it regardless of whether they pay for it or not. As non-paying users usually cannot be excluded from enjoying a public good, suppliers of such goods will find it difficult or impossible to collect fees for the benefits they provide.
eg: street lighting. Once the street lamp has been provided, it would be extremely costly, it’s also impossible to switch the street light on whenever a payer walks under the lamp & switch it off when a non-payer walks underneath it. Once the street light is provided, it will benefit everyone who walks under it, irrespective of whether the person has paid for it or not. Since non-payers would be able to enjoy the benefit of street lighting, this would deter people from deciding to pay for it in the first place. It is known as the 'free rider' problem. A free rider is a person who enjoys the benefit of the good without paying for it. Hence, this would lead to people not paying for street lighting even though it would benefit the society as a whole. Street lighting would thus not be provided by private producers.
Free-rider problem is a situation in which an individual is able to enjoy benefits from the consumption of a good or service without having to pay for the consumption of the good or service.
CHARACTERISTIC OF NON-RIVALRY:
means that the consumption of the good by one person does not reduce the benefit of the good available to others.
In the case of street lighting, when one person walks under the street lamp, the level of brightness will be the same as when two or three people were to walk under it. Ie, the level of brightness of the street lighting does not decrease with increasing number of people walking under it. This means that an additional user does not deplete the supply of a public good and the marginal cost (MC) of providing for an additional user is zero. With zero marginal cost (MC=0), the basic principle of optimal allocation (i.e. P = MC) calls for provision of public goods and services at no charge. However, there would be no private firms that are willing to produce street lighting at price = 0 because it means that they have to provide the street lighting for free. Alternatively, if the good were to be provided by private producers, they would have to charge a price above zero, and hence P > MC and allocative efficiency cannot be achieved.
MICROECONOMIC POLICIES: PUBLIC GOODS AND COST BENEFIT ANALYSIS
as part of decision making process, the gov makes use of cost-benefit analysis (CBA) to decide which projects to undertake.
LIMITATIONS:
gov may have difficulties determining the actual benefits and costs of provision without the price mechanism. This may lead to the government over-providing for the good/service, which would lead to inefficiency.
PRESENCE OF EXTERNALITIES
externality occurs when some of the costs or benefits associated with the production or consumption of a good 'spills over' onto third parties, that is, to parties other than the immediate seller or buyer, for which no compensation is paid.
eg:
Negative externalities from production – This occurs when costs are imposed on third parties (external costs are imposed on the society) from the production of a good or service by private firms (producers), e.g. air pollution by factories, water pollution from the dumping of toxic industrial waste or agricultural waste that may destroy marine ecological system (for example. fishes are destroyed or become unfit for consumption thereby depriving fishermen of their catch).
Positive externalities from production - This occurs when benefits accrued to third parties (external benefits are accrued to the society) from the production of a good or service by private firms (producers), e.g. research & development, where the knowledge gained from it can be used by other firms for improvements in their products or production processes.
INFORMATION FAILURE
IMPERFECT INFORMATION ON THE COSTS OF CONSUMPTION OF A GOOD
eg, Goods like cigarettes can be over-consumed because consumers are not fully aware of the longer-term health implications of their consumption decisions. When smokers decide to smoke for thrill purposes or under peer pressure, they do not have full information about their actual MPC or may underestimate the chances of being affected by smoking- related illnesses, medical problems and possibly death.
-As shown in Figure 8, because consumers may be unaware of the actual costs of consuming these goods, the quantity consumed for cigarette is at 0Qp, where MPB=MPCperceived. However, had consumers been better informed, the quantity of cigarette to be consumed will be at 0Qa, MPB=MPCactual. The gap between 0Qa and 0Qp represent the over-consumption (of cigarettes) due to imperfect information.
The additional cost to the society for overconsuming the good is QaE1AQp, while the additional benefit is QaE1E0Qp. The welfare loss due to the overconsumption is represented by area E1AE0 in the figure above. Due to imperfect information, there is allocative inefficiency resulting in a deadweight loss to society.
IMPERFECT INFORMATION ON THE BENEFITS OF CONSUMPTION OF A GOOD
eg, Due to imperfect information, goods such as immunisation shots can be underconsumed because consumers are not fully aware of the longer- term health implications of their consumption decisions. Consumers may undervalue the MPB (benefits) of receiving immunisation shots such as overall better health and improved productivity at work rather than just a temporary improvement in immunity system, or the perceive that they will never be infected.
As shown in Figure 9, when consumers undervalue the benefits of receiving immunisation shots, the equilibrium will be at 0Qp where MPC=MPB perceived.
but, if consumers can appreciate the actual benefit of going for immunisation shots, the quantity will be at Qa where MPC=MPBactual. The gap between Qa and Qp represents the under-consumption due to imperfect information.
There is welfare loss to the society as the potential gain of area QpAE1Qa due to increased consumption with perfect information outweighs the additional cost of area QpE0E1Qa to the society with the underconsumption of QpQa. The welfare loss due to the underconsumption (of immunisation shots) is represented by area E1AE0 in the figure above. This results in allocative inefficiency causing a deadweight loss to society.
MICROECONOMIC POLICIES FOR IMPERFECT INFORMATION ON BENEFITS AND COSTS OF CONSUMING A GOOD
1) Public education
In using public education, the government reduces imperfect information by providing consumers with information about the “true” marginal private cost/benefit of consuming an extra unit of a good for themselves and encourages them to consume more/less of it, thereby improving their individual decision-making. The government provides information through public education via national campaigns, and/or radio and TV broadcasting and social media platforms.
Application of public education to inform consumers the actual benefit of a good and to increase its consumption
For example, in Singapore, the Health Promotion Board organises regular health education in schools and conduct national campaigns to inform public about the benefits of health checks and going for immunisation shots before travelling or during viral flu periods.
Application of public education to inform consumers the actual cost of a good and to reduce its consumption
In Singapore, The Ministry of Health and the Health Promotion Board aim to help Singaporeans increase their quality and years of healthy life through organising regular health education in schools and conduct community health screening, national campaigns to inform public about the harmful effects of smoking cigarettes.
Advantages of using public education
Addresses the root cause of imperfect information
Less distortion to price signals
LIMITATIONS
Difficult to change or influence peoples' mind sets and habits
2) Regulation (Command and control measure)
When the government perceives consumers as poor judges of their own welfare, the government could directly influence their consumption pattern by making consumption of the certain goods compulsory by law and/or making it illegal to sell or consume the certain goods. The government may also impose restrictions on the consumption of the good such as banning smoking in public places in order to reduce its consumption because it is more inconvenient to smoke (higher opportunity cost to smoke). This is backed by fines or other forms of punishments when the law is violated.
eg, Compulsory text and pictures in health warning messages to be displayed on all tobacco product packaging and labelling highlighting the negative health effects of smoking.
LIMITATIONS
Administrative and enforcement costs
Over-correction