EJC Econs N2022 H2 EQ3

Suggested answer for 2022 A-Level Paper 2 Question 3 Street lighting is considered to be a public good. However, there are also negative externalities resulting from the generation of electricity for the lighting on the environment and the effect of bright street lights on wildlife. a) Explain two different reasons f or the market failure associated with the provision of street lighting [10] b) Discuss the extent to which a government should intervene in the market to ensure that the benefits of street lighting can be obtained while minimising the negative impacts. [15] Part (a) - Question Analysis Approach Command Word Explain Question Type Cause and effect Start point 1. Public good 2. Negative externalities End Point Market failure Content and Context Content • Market failure (allocative efficiency) • Public good (non-rivalrous, non-excludable in consumption) • Negative externalities Context Street lighting, electricity Introduction State essay approach: Street lighting is a public good as it non-excludable, non-rivalrous and non- rejectable in consumption. The free market would not provide public good as there is a lack of price signal, leading to a missing market where there is zero allocation of resources. Hence government need to intervene by directly providing the street lights to benefit society. Street lights consume electricity which generates negative externalities, leading to overallocation of resources. Body Point 1: One reason for the market failure associated with the provision of street lighting is lack of price signal • Street lighting is non-excludable in consumption. It is impossible or very costly to exclude non- payers from consuming street lighting once it is provided as non-payers could easily enjoy the benefits of street lighting by being near the stree t lighting. Since those who cannot pay will not be excluded, no one has the incentive to pay for the good. This leads to free-rider problem where everyone will wait for someone else to pay, in hopes of enjoying the marginal benefit from the street lighting without having to pay for it. Hence, there will be no effective demand for street lighting and profit-maximizing firms will make the rational decision not to even enter the market to supply the street lighting. Therefore, if street lighting was left the free market, there would be no resources allocated to its production, leading to a missing market and complete market failure. • Street lighting is also non-rivalrous in consumption. This means that the consumption by one person does not reduce the amount available to another. When one person stands under the streetlight, the same amount of light is still available to the next user. Therefore, supplying street lighting to an additional user does not require another streetlight to be built. This means

that the marginal cost of providing streetlighting for an additional user is zero. In an allocative efficient market, the price to charge is equal the marginal cost (P=MC), hence the price which consumers should pay is equal to the marginal cost which is zero. In a free market, profit - maximizing firms will not provide their goods at a price of zero. Therefore, no rational private firms would be willing to supply street lighting if the price is zero. If left to the free market, no street lighting will be produced, and there is complete market failure. Body Point 2: One reason for the market failure associated with the provision of street lighting is presence of external costs. • Negative externality in production exists when there are costs borne by third parties due to the production of a good or service, for which they are not compensated. • Electricity is needed for street lighting to provide lighting to the streets. When coal-fired power station produces electricity, its private benefits are the additional revenue from selling electricity. It also incurs private costs such as the costs of providing the electricity grid and wages paid to labor. However, producing electricity by burning coal leads to air pollution which worsen global warming/extreme weather conditions. The firm does not take into account the fact that farmers and fishermen (third parties) have to bear the external cost in terms of making losses due to falling crop yields, fishery stocks and wildlife that are caused by global warming and are not compensated for the financial losses that they suffer. • Due to the negative externality in production, the social costs of producing electricity are higher than the private cost (MSC>MPC). In Figure 1, the MSC lies above the MPC by a vertical distance equal to marginal external cost (MEC). Assuming no positive externalities, the marginal private benefits (MPB) is equal to marginal social benefits (MSB). In the pursuit of self-interest, the firm considers only its private benefits and private costs when producing coal-fired electricity. This leads to the market equilibrium output QP, where MPB=MPC. However, the socially optimal output is given by QS, determined by the intersection of the MSB with the MSC. Since Q P>QS, the firm over -produces coal-fired electricity, leading to an over-allocation of resources. Between QP and QS, marginal cost to society is greater than marginal benefit to society. This means that societal welfare could have been improved by reducing quantity of coal -fired electricity to the socially MEC C Figure 1: Negative externality in production of coal-fired electricity QS QP A MPC MSC Quantity B Cost/benefit MPB=MSB

optimal output of Q S. This forgone societal welfare is the deadweight loss (area ABC), leading to allocative inefficiency and hence market failure. Conclusion Therefore, there is a missing market for street lighting without government intervention as it is a public good. However, when government step in to provide street lighting, negative externalities would be generated from the generation of electricity, leading to ove r-allocation of resources in the market for coal-fired electricity. Therefore, a government should intervene in the market in a way that the benefits of street lighting can be obtained while minimising the negative impacts. Mark Scheme Level Knowledge, Understanding, Application, Analysis Marks L3 Full display of AO1, AO2 and AO3 skills: For an answer that shows well-developed explanation of two reasons why the market fails in the provision of street lighting • clear and accurate explanation of how street lighting leads to complete market failure due to non -excludable and non -rivalrous in consumption and how negative externalities in electricity generation leads to over - production • supported with appropriate diagrammatic analysis • supported with relevant examples 8-10 L2 Uneven display of AO1, AO2 and AO3 skills: For an answer that shows under-developed explanation of why the market fails in the provision of street lighting • lacks depth of analysis (i.e. , limited effective use of relevant economic analysis or gaps in diagrammatic analysis) • lacks scope in explaining either public good or negative externalities • lacks relevant examples 5-7 L1 Limited display of AO1 and AO2 skills: For an answer that shows limited knowledge of why the market fails in the provision of street lighting • listing of points, unexplained statements, or descriptive response • many conceptual errors (i.e., mix up non-rivalrous and non-excludable etc) • irrelevant response such as on positive externalities or imperfect information • smattering of points 1-4 0 B

b) Discuss the extent to which a government should intervene in the market to ensure that the bene