YIJC 2024 H1 Market Failure Booklet Student (Final)

©YIJC ECONOMICS 2024 YISHUN INNOVA JUNIOR COLLEGE 2024 JC1 H1 ECONOMICS Lecture Notes Topic 3: Market Failure and Government Intervention

Contents SUGGESTED READINGS ................................ ................................ ................................ ......... 2 LEARNING OBJECTIVES ................................ ................................ ................................ ......... 2 TOPIC CONCEPT MAP ................................ ................................ ................................ ............. 0 1 INTRODUCTION ................................ ................................ ................................ ................ 4 2 PRIVATE & SOCIAL OPTIMUM OUTPUT ................................ ................................ .......... 5 2.1 Private Optimum Output (Qp) ................................ ................................ ....................... 5 3 SOURCES OF MARKET FAILURE................................ ................................ ..................... 8 3.1 Non-Provision of Public Goods ................................ ................................ .................... 8 3.1.2 Policy Intervention for Non-Provision of Public Goods ................................ .............11 3.1.3 Practice Question on Policy Intervention (Public Goods) ................................ ...........14 3.2 Presence of Externalities ................................ ................................ ............................15 3.2.1 Positive Externalities ................................ ................................ ............................... 15 3.2.1.1 Positive Externalities in Consumption ................................ ................................ ........16 3.2.1.2 Positive Externalities in Production ................................ ................................ ............17 3.2.1.3 Practice Questions on Positive Externalities (Causes & Consequences)................19 3.2.1.5 Practice Questions on Policy Intervention (Positive Externality) ...........................26 3.2.2 Negative Externalities ................................ ................................ .............................. 28 3.2.2.1 Negative Externalities in Consumption ................................ ................................ .......28 3.2.2.2 Negative Externalities in Production ................................ ................................ ..........30 3.2.2.3. Practice Questions on Negative Externalities (Causes & Consequences) .............32 ................................ ................................ ................................ ................................ ..............32 3.2.2.5 Practice Questions on Policy Intervention (Negative Externalities) .......................41 4 INFORMATION FAILURE / IMPERFECT INFORMATION ................................ .................42 4.1 Under-estimation of Private Benefits ................................ ................................ ...........42 4.4. Practice questions on Information Failure (Causes & Consequences) ........................51 5 INADEQUACY OF RESOURCE ALLOCATION VIA PRICE MECHANISM ........................52 5.1 Inequitable Distribution of Economic Welfare ................................ ................................ ...52 5.2 Policy Intervention to Improve Equity ................................ ................................ ...............52 6 CONCLUSIONS ................................ ................................ ................................ .................58 7 Practice Questions: Full Case Studies ................................ ................................ ...............59

SUGGESTED READINGS 1. Sloman, J., Garratt, D., & Guest, J. (2018). Economics (10th Edition), Chapter 10 & 11, Pearson Education. 2. Mankiw, G, Quah, E & Wilson P (2021). Principles of Economics, An Asian Edition (3rd Edition), Chapters 10 & 11, Cengage Learning Asia Pte Ltd. 3. O’Sullivan, A., Sheffrin, S. M., Lim, K. L., Seevaratnam. V (2007). Principles of Economics. Pearson Education. Chapter 8. 4. Sexton, Robert L. (2010). Exploring Economics 5th Edition, Cengage Learning. Chapter 8 & 9. 5. Thaler, R. H. (2015). Misbehaving: The Making of Behavioural Economics , Chapter 8. Penguin Random House UK. LEARNING OBJECTIVES At the end of the topic, students will be able to  1. State and describe government’s microeconomic objectives concerning resource allocation in the market. 2. State the conditions that is required for decisions made by firms and consumers in the free market to bring about desirable market outcomes (i.e. allocative efficiency and/or equitable distribution of resources). 3. Explain the causes of market failure and how market outcomes can be inequitable. 4. Explain how decisions made by firms and consumers in the free market can lead to undesirable market outcomes (e.g. allocative inefficiency and/or inequitable distribution of resources) 5. Explain the concept of deadweight loss in relation to market failure. 6. Explain the policy decisions undertaken by governments to achieve microeconomic objectives in relation to efficiency and equity. 7a. Explain with examples and diagrams, how policy measures including taxes, subsidies, quotas and tradeable permit s work to achieve government’s microeconomic objectives (e.g. Reduce allocative inefficiency and inequity). 7b. Explain with examples and diagrams, how policy measures including joint and direct provision, rules & regulations, public education and improving quality and access to information work to achieve government’s microeconomic objectives (e.g. Reduce allocative inefficiency and inequity). 8. Apply the DM framework to explain and evaluate the effectiveness, feasibility, and appropriateness of government policies.

TOPIC CONCEPT MAP

©YIJC ECONOMICS 2024 Page | 4 1 INTRODUCTION In the previous topic, we examined how the free market addresses the central economic problem - Scarcity. More specifically, we explored how price mechanism, through free market forces of demand and supply, operate to achieve allocative efficiency. Allocative efficiency is achieved when resources are allocated to produce the combination of goods and services that maximises society’s welfare (i.e. when consumers and producers collectively maximise their gains/welfare.) We can therefore say that there is a social optimum outcome when allocative efficiency is achieved in the free market. However, the efficient market outcome will only occur under the following strict conditions: • Absence of public goods (i.e. All goods are private goods) • Absence of externalities (i.e. Market accounts for all the benefits and costs) • There is perfect information (i.e. Economic agents have perfect information) • There is perfect competition (i.e. Market is perfectly competitive) • There is perfect factor mobility (i.e. Factors of production are perfectly mobile) When these conditions do not hold in the real, we describe the situation as market failure. In this topic, we will explore the various causes and consequences of market failure. We will see that it provides a major argument for government intervention in the free market. Thereafter, we will examine how governments may correct these market failure and improve resource allocation through public policy measures while recognising the costs, limitations, unintended consequences and possible trade-offs of the intervention. Before that, let us gain an understanding of the concepts of private (market) optimum and social optimum. This will help us better grasp the concept of market failure. Market failure is a n economic situation in which the free market fails to allocate resources efficiently towards the production / consumption of the combination of goods & services, wh