Hwa Chong Institution Year One H2 Economics 2015 Chapter #9: Microeconomics II Market Failure & Government Intervention

Transcription

1 8 Why is the gap between PM and SM converging? an the gap diverge? The decreasing divergence is due to the decreasing EM as the number of people who consume vaccines increases. For example, if there are 5 people, the first person who consumes vaccines benefit the remaining four people. The second person who consumers vaccines benefits only the remaining three people who are vaccinated. Eventually, the last person who vaccinates only benefits himself/herself but no other third parties and hence the EM reduces to 0. The gap can diverge for other goods such as R&D as if more R&D output is produced, the possibilities of cross-pollination of technologies increases, increasing the EM of each additional amount of R&D. 9 Explain and illustrate with a diagram how imperfect information can cause market failure in smoking. (HINT: Imperfect information on costs.) Smokers think that costs of smoking will be the price of cigarettes only and are ignorant to the fact that such habit can result in sickness and more medical bills. So actual costs of smoking are actually higher than what the smokers perceived. ost/enefit Figure 1: Imperfect information on actual PM of smoking PM actual PM perceived PM Qm Qm OR: It is possible to explain imperfect information from divergence in benefits for smoking they key difference is in the exemplification. E.g. Smokers think that smoking means being cool and will enable them to have more friends. However in actual fact, smoking is deemed to be unacceptable and result in lesser friends. In this case, the diagram should be as follow:

2 ost/enefit Figure 2: Imperfect information on actual PM of smoking PM PM actual = Demand (perfect info) Qm Qm 10 an you think of other situations in which one s perceived benefits are higher/lower than actual benefits? ancer Screening Perceived PM < ctual PM Drinking lcohol, Gambling Perceived PM > ctual PM 11 Do you think all goods with positive externalities are merit goods and those with negative externalities are demerit goods? Explain No! To qualify as Merit or Demerit goods, goods have to be deemed by the government to be socially desirable or undesirable leading to under or over consumption/production respectively. Not all goods which has spill over effects are deemed by the government as over/under consumed/produced.

3 ONUS QUESTIONS FOR TUTORS TO ONSIDER ONUS QUESTION Using a diagram, explain the outcome(s) of a 100% subsidy on healthcare products such as vaccines FREE vaccines or 100% subsidy will be given only when the positive externalities generated is sufficiently high and is illustrated below. SS = PM=SM (since EM=0) P S P m Subsidy = EM at Q S PM = PM subsidy P S s PM Q M D Q S SM = PM + EM Hence, the new market equilibrium quantity where PM = PM subsidy, now coincides with the socially efficient quantity Q S, where SM = SM. If the subsidy accurately reflects the external marginal benefit, students are now in effect being compensated for the external benefit they bring to third parties as the price they are paying is now lower at P S s, compared to P m before the subsidy. The externality has then been internalised. Students should note that there are other possible outcomes such as overconsumption of healthcare if subsidy>em.

4 ONUS QUESTION Using a diagram, analyse the resulting deadweight welfare loss if the government over or under subsidies. i.e. per unit subsidy > or < EM. SS = PM=SM (since EM=0) P S PM = PM subsidy P m P S s Subsidy = EM at Q S PM SM = PM + EM Q M Q S Diagram 1: Per Unit Subsidy = EM at Qs. Without subsidy, deadweight welfare loss = With per unit subsidy (= EM at QS), level of consumption/production is increased from QM to QS No deadweight welfare loss Diagram 2: Per Unit Subsidy < EM at Qs. Without subsidy, deadweight welfare loss = With per unit subsidy (< EM at QS), level of consumption/production is increased from QM to QM Since QM < QS, the level of consumption/production is still less than the socially efficient level, resulting in a deadweight welfare loss represented by triangle DE. However this deadweight welfare loss is less than the deadweight welfare loss without subsidy, represented by triangle

5 SS = PM=SM (since EM=0) P S E D PM = PM subsidy PM (Subsidy > EM at Q S) P m P S s Subsidy = EM at Q S SM = PM + EM PM Q M Q S Q M Diagram 3: Per Unit Subsidy > EM at Qs. Without subsidy, deadweight welfare loss = With per unit subsidy (> EM at QS), level of consumption/production is increased from QM to Q M Since Q M > Q S, the level of consumption/production is more than the socially efficient level, resulting in a deadweight welfare loss represented by triangle DE. However this deadweight welfare loss is less than the deadweight welfare loss without subsidy, represented by triangle. If the subsidy is too much, the deadweight welfare loss due to over consumption/production may exceed the deadweight welfare loss of triangle without government intervention. You may want to try drawing the diagram to convince yourself.

6 externalities. ONUS QUESTION Provide some good examples of positive production POSITIVE EXTERNLITIES - Technology spillover (production of new R&D techniques) Figure 7: External benefit from production of R&D technologies Positive Externality PM=SM where EM=0 Y Z X PM SM = PM + EM Q E Q SE Market for R&D technologies Define and give examples of PM, PM & EM. PM: The satisfaction derived by the consumer from consuming additional unit of the new technology product. PM: The cost of developing the technology i.e. cost of production for additional unit of the new technology product. Typically, this will be a large amount. EM: Other firms (3 rd parties) will benefit from the additional unit of the new technologies developed Exemplification: NS space technologies, which was primarily developed to aid in achieving their competencies in space exploration, have been used in other non-space sectors by other industries. For over 50 years, NS has created new technologies with direct benefit to the public sector, supporting global competition and the economy. The resulting commercialization has contributed to products and services in the fields of health and medicine, transportation, public safety, consumer goods, energy and environment, information technology, and industrial productivity. Since 1976, NS has featured over 1,800 technologies in its Spinoff publication. Source: Explain the diagram clearly the equilibrium output, social optimum output and how the deadweight loss is derived. In the diagram above, the market equilibrium occurs when private firms account for their private

7 benefit and cost, when PM=PM at QE. Due to the presence of positive externalities (EM) of benefits to economy, the social benefit of producing R&D technologies is higher than the private benefit. Hence, the social equilibrium occurs when society takes into account of the positive externalities when SM=SM at QSE (assuming no negative externalities present, PM=SM) There is an underproduction of R&D technologies by QSE QE. This underproduction created a loss to society in the form of total social benefit foregone of YZQSEQE, while only having total social cost savings of only XZQSEQE. This creates a welfare loss or deadweight loss of XYZ. Other possible examples External benefits from improved training and education External benefits from restoration and use of historic buildings External benefits from development of renewable energy sources