2023 ACJC H2 Market Failure Lecture Notes

©ACJC Econs Dept/2023/H2 Market Failure 1 ANGLO-CHINESE JUNIOR COLLEGE JC1 Economics H2 MARKET FAILURE AND GOVERNMENT INTERVENTION Section Content Page 1 Efficiency in Markets 4 2 Sources of Market Failure and Government Intervention 7 2.1 Public Goods 8 2.2 Externalities 11 2.2.1 Overview to Externalities 12 2.2.2 - 2.2.3 Negative Externalities 15 2.2.4 - 2.2.5 Positive Externalities 26 2.3 Information Failure 35 2.3.1 – 2.3.2 Insufficient and Inaccurate Information 35 2.3.3 Asymmetric Information 41 2.4 Factor Immobility 48 2.5 Market Dominance 53 3 Equity in Relation to Markets 57 3.1 Understanding the concept of Equity 57 3.2 Government Intervention to address Inequity 58 4 Decision Making by the Government 60 4.1 Summary of Government Policies 60 4.2 Government Failure 61 Learning Reflection and Annex 63

©ACJC Econs Dept/2023/H2 Market Failure 2 WHAT IS THIS TOPIC ABOUT?  Due to the central economic problem of scarcity, resources need to be allocated in ways that bring about the most efficient outcome.  In the free market, the price mechanism is the primary means by which resources are allocated and this would bring about efficiency in resource allocation.  However, these conditions must be present for price mechanism to bring about efficiency: o There are price signals to ‘direct’ resource allocation. o No third-party effects (externalities) in consumption or production o The market is perfectly competitive. o Perfect information in the market. o Perfect factor mobility.  When any of these conditions is not met, resource allocation becomes inefficient (market failure). Examples of the market failure: o Missing market for public goods. o Under or over-consumption/production due to externalities. o Underproduction due to market dominance (H2 only). o Collapse of market or under/over consumption/production due to information failure. o Inefficiencies due to factor immobility.  Due to these market failures, the government has to step in to correct them in order to achieve an efficient and equitable allocatio n of resources.  However, due to several constraints and factors, the government might fail. Its interventions may cause even greater inefficiency in resource allocation than under the workings of free market forces. LEARNING OUTCOMES Enduring Understanding (students can explain and apply to real world):  Price mechanism can fail to allocate resources efficiently and equitably. NOTE: Inequity is a distributional issue and not considered a source of market failure.  Government has to make decisions on how to intervene in markets to correct market failure in order to achieve efficient and equitable allocation of resources.  However, even with government intervention, the intended outcomes may not be achievable due to constraints in policy implementation, uncertainty of policy effects, and unintended consequences. Overarching essential question: To what extent should governments intervene in the free market?

©ACJC Econs Dept/2023/H2 Market Failure 3 Let’s Think! The Personal Mobility Devices (PMD) footpath ban In November 2019, former Senior Minister of State for Transport Lam Pin Min said that the Ministry of Transport (MOT) announced that t he use of e-scooters on footpaths would be banned, almost three years after their use on footpaths was made legal under the Active Mobility Act. This came amid an increasing number of accidents involving such PMDs. Then-Transport Minister Khaw Boon Wan noted at the time that about 300 people were treated in hospital for PMD-related accidents in 2018, based on figures from the National Trauma Registry. In April 2020, the footpath ban was extended to other motorised PMDs, such as hoverboards and electric unicycles. Although they are banned from footpaths, all such devices can still be used on cycling paths and Park Connector Networks. PMD advocate Denis Koh described the footpath ban as “appropriate but abrupt”, noting the disruption caused to responsible users as well as those who depended on such devices for work. Singapore University of Social Sciences (SUSS) lecturer Cecilia Rojas, whose research has focused on active mobility, said a longer notice time might have allowed those who used PMDs for work, such as delivery riders, more time to cope with the changes. “Education, education, education,” said Mr Koh, when asked what else could have been done to address the issue of safety on public paths. “Ultimately everyone keeps blaming the device instead of the errant rider,” said the former member of the Active Mobility Advisory Panel, which proposes regulations on the safe use of bicycles and PMDs in public places here. “Remove the PMDs (and) these errant riders will use bicycles, then we will go back to all the complaints about cyclists we had six to eight years ago.” Source: Channel News Asia, 31 Oct 2020 Questions: 1. Why do you think the Singapore government decided to impose these new regulations on personal mobility devices? (Hint: consider the concepts you have learnt in previous topics) 2. How might these regulations affect the following economic agents? a) Consumers (in terms of welfare and consumer surplus) b) Firms (In terms of revenue, profit, and producer surplus)

©ACJC Econs Dept/2023/H2 Market Failure 4 1. EFFICIENCY IN MARKETS Governments mainly want to achieve resource allocation which meets the following microeconomic objectives: 1) EFFICIENT and 2) EQUITABLE allocation of resources (to be discussed in section 3) Understanding the concept of ‘efficiency’: There are 3 types of efficiency you will learn in economics: i. Productive efficiency This refers to a situation where goods are produced at the minimum average cost possible for the given output size, based on current technology. ii. Dynamic efficiency This refers to when firms invest in technology so that productivity and product quality will improve over time. iii. Allocative efficiency This refers to the situation where the current combination of goods produced and sold maximises society’s welfare. For this topic, we will be focusing on allocative efficiency. In free market s, resource allocation takes place with the following characteristics:  The economic agents (individuals and firms) base their decisions on the pursuit of self-interest (satisfaction, profits).  Prices of goods and services (price signals) will direct the movement of resources and goods and services between markets.  No government intervention in markets. Resource allocation through price si gnals can bring about allocative efficiency in markets. Figure 1: Diagrammatic representation of Allocative Efficiency  In Figure 1 above, allocative efficiency is at market equilibrium point E. At this point, Triangle AEC is the total welfare to society (i.e. the sum of consumer and producer surplus). Social welfare is maximised. We will revisit these efficiency concepts when we learn about firms and decisions in topic 4. SLS Lesson: “Efficiency”

©ACJC Econs Dept/2023/H2 Market Failure 5  The supply curve is determined by the marginal costs of production and, since this is the marginal cost to society, we refer to it as the marginal social cost (MSC).  The demand curve is determined by marginal utility and, since this is the marginal benefit to the whole community, it is known as marginal social benefit (MSB).  At Q1 (or any quantity below Q0): o MSB is greater than M SC, so there will be net benefit added to society’s welfare if one more unit of the good is produced/consumed. o There is a loss of potential welfare when society consumes at Q1. This loss of potential welfare is represented by the area of triangle BDE.  At Q2 (or any quantity above Q0): o MSC is greater than MSB, so the