EJC Econs N2019 H2 Paper 1 Suggested Ans and Mark Scheme

Suggested Answers for H2 N2019 CSQ1: Market Failures in the Vietnamese energy market (a) With reference to Extract 1, identify a demand factor and explain how it has affected demand for coal in the US. [2] • Demand factor: Cheaper substitute such as cleaner gas produced using fracking. • A fall in the price of cleaner gas which is a substitute for coal as an alternative source of energy, will cause profit-driven US firms to increase the quantity demanded for cleaner gas and switch away from coal. Thus, the demand for coal falls. [1] (b) Using the evidence in Extract 1, explain whether the cross elasticity of demand in China between coal and renewable energy is positive or negative. [3] • As coal and renewable energy are substitutes in demand (to produce energy). [1], the cross elasticity of demand (XED) between coal and renewable energy is positive. [1] • Evidence: From Extract 1, an enormous investment in renewable energy would lead to a large increase in the supply of renewable energy which would cause a fall in the price of renewable energy. Hence a fall in price of renewable energy would lead to a fall in demand for coal in China. [1] (c) Using a diagram and Extract 1, explain how the UK government’s change in the minimum price of coal in 2016 is likely to have affected the UK market for coal. [3] • Imposing a minimum price at P min1 would result in a surplus of Q dd1Qss1 in the market for coal.

• When there is an increase in the minimum price of coal in 2016 from Pmin1 to Pmin2 , it would increase the size of the surplus, where the larger surplus resulted from Qdd1Qss1 to Qdd2Qss2 in the market for coal [1] • Higher price of coal from Pmin1 to Pmin2 • Assuming |PED|>1 for coal (availability of substitutes), there will be more than proportionate fall in transacted quantity of coal from Q dd1 to Qdd2. Overall, TR falls as seen by a great er fall in revenue of Area A as opposed to gain in revenue in Area B. [1] • Diagram [1] (d) With the help of a diagram, explain how a rise in the demand for coal in Vietnam is likely to affect its social welfare. [4] • Coal consumption g enerates negative externalities which exists when there are costs borne by third parties due to the consumption of a good or service. [1] • MEC to 3rd parties: Higher healthcare cost to local residents and fishing industry workers from waste generated from coal power plants (Extract 3) are not compensated for the damage done to their health [1] • There is an over -consumption of coal by Q p1Qs. For every trip beyond Qs till Qm, each additional coal consumed adds more to social cost than to social benefits since MSC is greater than MSB. This forgone societal welfare is the deadweight loss (area EsAEp1), leading to allocative inefficiency. • Further increase in demand will shift MPB to the right from MPB1 to MPB2, worsening allocative inefficiency and forgone societal welfare with greater deadweight loss of area BEsC. [1] • Diagram [1]

(e) Discuss whether the Vietnamese government’s plan to ban motorbikes and switch travel to public transport is likely to be better than a policy of road pricing in improving air quality in Hanoi. [8] Command words: Discuss whether Two-sided perspective: P1: Banning motorbike and switching to public transport is a better policy in improving air quality in Hanoi. P2: Road pricing is a better policy in improving air quality in Hanoi. Context words: • Air Quality in Hanoi, • Motorbike Ban • Public Transport • Road Pricing (Taxes) Content words: • Negative Externality • Ban (HAL) • Taxes (HAL) End Point Ban + Switch to public transport or Road Pricing is a better policy in reducing allocative inefficiency Suggested Response: Introduction The transportation market in Vietnam is facing a market failure, where resources are allocated inefficiently to the consumption of motorbikes which spews gas into the air . This is primarily due to the presence of negative externalities, such as severe air pollution, resulting in breathing difficulty for pedestrians which may incur healthcare expenses. To tackle this issue, the Vietnamese government has decided to intervene by proposing policies such as a ban on motorbikes in conjunction with implementing publi c transportation as well as introducing road pricing, which will be discussed in detail whether which is best in resolving the market failure. P1: Explaining the market failure of negative externality The consumption of motorbikes result in negative externalities. The marginal private cost (MPC) of a motorcycle rider would include the cost of fuel. However, gas spewed from the five million motorbikes will result in severe

air pollution, where third parties such as pedestrians would face breathing difficulties. In turn this may cause them to incur higher medical expenses, resulting in an external cost. This leads to a divergence between MPC and MSC as seen in F igure 1 below. Assuming no positive externality, the marginal social benefit (MSB) is equal to the marginal private benefit (MPB), which consists of the utility and convenience of a rider travelling via motorbikes. If riders are driven by their private costs and benefits, the market equilibrium is derived from the intersection between MPC and MPB, where the output is Qp. However, the socially optimal output level is given by the intersection between MSB and MSC, at Qs. Hence the overconsumption of motorbikes results in a deadweight loss of area ABC and hence allocative inefficiency. P2: How + Advantage of a ban An effective ban on motorbike would result in the usage of motorbikes to fall to 0, eliminating the deadweight loss ABC entirely. This would effectively remove the air pollution caused by the motorbikes in Hanoi, improving the air quality significantly. However, this would also mean Hanoi would forgo all the potential improvement to society’s welfare from the usage of motorbikes, such as the benefits of convenience in travelling from one place to another. With a ban in place, it me ans that society is forgoing area C DE in Fig 1, sacrificing any improvement to welfare between 0 and Q s of motorbike usage. Assuming that the MEC is extremely high, area ABC exceeds area CDE significantly, therefore a ban is justified and should be implemented to improve air quality. The advantage of a ban is that as a blanket policy, it is simple to implement and identify transgressors, for example motorbike users who continue riding even after the ban. P3: Limitations of a ban

However, a ban may result i n government failure. If the MEC is overestimated, the area CDE may actually be larger than area ABC, hence a ban would result in an overall loss to society’s welfare when consumption of motorbikes is at 0. Also, maintaining a ban could be an uphill task for the government as they would need to devote substantial resources to monitor and enforce the ban, such as hiring enforcement officers, which could lead to greater inefficiency too. P4: How + Advantage of road pricing The policy of road pricing works by charging riders a fee every time they use their motorbikes on specified roads by setting up toll booths. The Vietnamese government can charge a fee on riders equal to the size of the marginal external cost (MEC), effectively increasing MPC to MPCt in Fig 3. This would allow riders to internalise the spillover costs, removing the divergence between MSC and MPC. Hence at this new equilibrium, motorbike riders will consider their MPCt and MPB and consume at the new output which coincides with the socially optimal output, Qs, eliminating the deadweight loss of ABC effectively and the market for motorbikes achieves allocative efficiency as air quality is improved. P5: Limitation of road pricing However, it is not feasi