2023 ACJC H2 Market Failure Tutorial Answers (Case Study and Essays)

©ACJC Econs Dept/2023/Market Failure & Government Intervention Tutorial Worksheet 1 H2 Market Failure Tutorial 2023: Suggested Answers Question 4: Policies for health improvement (Adapted from H2 A Level 2018) (a)(i) Using the information in Extract 1, calculate the value of the price elasticity of demand for sugar-sweetened beverages (SSBs). [2] Question approach & marks scheme:  Apply the formula of PED to calculate the PED value of SSBs.  1m: formula of PED  1m: value Suggested answer:  Price Elasticity of Demand measures the degree of responsiveness of consumers to a change in the price of the good, ceteris paribus. It can be calculated using the formula: % change in quantity demanded / % change in price of the good.  Using Extract 1, PED value of SSBs = | (-24%) / (+20%) | = 1.2 (a)(ii) Explain one possible factor that could lead to this value. [2] Question approach:  Using Extract 1, identify one possible factor and explain how it causes PED value > 1. Suggested answer:  There is a large number of substitutes for SSBs such as fruit juice and healthier beverages.  Therefore, the demand for SSBs is price elastic as consumers would readily switch to consuming these substitutes when the price of SSBs increase. Note: Other acceptable answers include the high proportion of spending on SSBs by low - income and younger consumers OR SSBs not being considered as a necessity by consumers. (b)(i) State the economic concept you would use to measure the relationship between the change in the price of SSBs as sales taxes are imposed and the resulting change in the demand for bottled water. [1] Suggested answer:  Cross Elasticity of Demand (XED). (b)(ii) Explain the value you would expect to get from this measurement. [3] Question approach and mark scheme:  1m: positive sign of XED  1m: magnitude of XED  1m: explain why the sign and magnitude

©ACJC Econs Dept/2023/Market Failure & Government Intervention Tutorial Worksheet 2 Suggested answer:  Sign of XED value: The XED value obtained will be positive because bottled water and SSBs are substitutes. As price of SSBs to increase  quantity demanded of SSBs decreases  increase in demand for bottled water when SSBs consumers switch over.  Magnitude of XED value: The greater the magnitude of the value, the stronger the relationship between the two products in terms of their substitutability.  In this case, bottled water and SSBs cannot be considered as close substitutes as one contains sugar but bottled water does not. Hence, even though they are both beverages, they give different level of satisfactions to the consumers. This will result in only a small proportion of consumers switching over to bottled water when price of SSBs increase. Hence, XED value between bottled water and SSBs is likely to be less than 1 in magnitude. (c) Discuss whether consumers would ever make rational decisions regarding their consumption of SSBs. [8] Question analysis: Command word Discuss: - Provide a balanced argument - Evaluate Concepts to use Perceived vs actual MPB and MPC Context Market for SSBs Introduction  Unpack what it means by making rational decisions. In the case of consumers, they aim to maximize their total net utility / satisfaction. This requires consumers to consume at a consumption level where marginal private benefit = marginal private cost.  In their consumption of SSBs, the presence of imperfect information arises as consumers do not have perfect information on the true costs and benefits of their consumption decisions. This prevents them from maximizing their total net utility / satisfaction. Requirement 1: Explain how consumers make rational decisions  In the case of consumers, they aim to maximize their total net utility / satisfaction. This requires consumers to consume at a consumption level where marginal private benefit = marginal private cost.  If MPB > MPC for the additional unit consumed, consumers would increase consumption as it would increase their total utility.  If MPB < MPC for the additional unit consumed, consumers would not consume more, as it would decrease their total utility.  Thus, self -interested and rational consumers would consume at MPB = MPC provided they have estimated MPB and MPC accurately. Requirement 2: Explain how imperfect information has prevented consumers from making rational decisions

©ACJC Econs Dept/2023/Market Failure & Government Intervention Tutorial Worksheet 3  Explaining perceived < act ual cost: In the consumption of SSBs, consumers may at times be affected by misleading marketing and product differentiation efforts (Extract 2: marketing and advertising products are very powerful influences on consumer demand“), hence causing either perceived cost to be lower than actual cost or perceived benefit to be higher than actual benefit. For instance, soda producers may choose to conceal the high sugar content of soda in their attempts to make soda a seemingly - healthier alternative.  Explaining Q m > Q s: Consumers therefore perceive their marginal private cost to be lower than the actual marginal private cost, hence causing market equilibrium output level to be at Qm where MPCperceived = MPB, while the allocatively efficient consumption level for the society is at Qs where MPC actual = MPB. As Q m is higher than Q s, SSBs have been overconsumed by Q m - Qs units, suggesting that too much resources have been allocated to the market for SSBs.  Explaining welfare / deadweight loss: Consumers a welfare / deadweight loss due to the overconsumption of SSBs. This can come in the form of medical costs for diabetes treatment caused by overconsumption of SSBs (Extract 1: “increased obesity amongst populations and a consequent rise in diseases such as diabetes and heart disease”). As shown in the figure below, welfare / deadweight loss is shown by the area ABC. Thus, the consumers fail to make a rational decision. Balanced Argument / Synthesis: Whether they can ever make rational decisions depends on the presence of external nudges in the form of government intervention such as sugar tax or subsidies on alternatives.  Government interventions that can change the perceived cost s and benefits of consuming SSBs include advertising regulations for producers to prevent misinformation, or advertising the “no-sugar options available” (Extract 3) or using fiscal policies to “influence consumers to make healthier choice and reduce consumption of SSBs through making sodas more expensive than bottled water” (Extract 2) via sugar tax.  With a more expensive SSBs, the marginal private cost to the consumers will likely increase and hence, closing the gap between the perceived and the actual private cost.  If left on their own without external nudges, the imperfect information will persist in the market, leading to the consumers overconsuming SSBs, resulting in the welfare loss to the society. Quantity of SSBs Quantity of SSBs

©ACJC Econs Dept/2023/Market Failure & Government Intervention Tutorial Worksheet 4  Hence, if the governments want the consumers to behave r ationally, they need to intervene in the form of tax or subsidies or both. Even so, it is not guaranteed that all consumers will change their perceived costs and benefits towards SSBs, especially the more addicted consumers. (d) Discuss whether fiscal intervention is the best government policy to deal with the problems caused by over-consumption of SSBs. [10] Question analysis: Command word Discuss: - Provide a balanced argument: fiscal intervention vs other policies - Evaluate which is the best policy Concepts to use Cost/benefit diagram and framework Fiscal intervention: taxes/subsidies Context Market for SSBs Introduction:  Government intervention typically takes place in case