H2 WA2 (Full Answer with Examiners' Report)

The consumption of sugary beverages is linked to health issues like obesity, diabetes, and dental problems, impacting both individuals and society. Challenges in accessing accurate information about these risks exacerbate the problem. To address this, Singapore's Ministry of Health introduced Nutri-Grade labeling and advertising restrictions in December 2023. This system assigns grades from A to D, with D indicating the highest sugar content, aiming to reduce sugar intake and shape consumer behavior in the long term. (a) Explain two reasons why there may be an inefficient allocation of resources in the market for sugary beverages. [10] Part (a) Question interpretation Command word Explain two reasons Elaborate why Content required Inefficient allocation of resources which does not optimize society’s welfare Market failure Context Market for sugary beverages “impacting both individuals and society” - Negative externalities “Challenges in accessing accurate information about these risks exacerbate the problem” - Imperfect information Approach: • R1: Explain how negative externalities arising from the consumption of sugary beverages lead to market failure. • R2: Explain how imperfect information about the consumption of sugary beverages lead to market failure. Suggested answer Introduction Market failure is said to occur when free markets, operating without government intervention, fail to deliver a socially-efficient allocation of resources and hence economic welfare is not maximized. Consumption of sugary beverages may generate negative externalities, which leads to market failure. At the same time, individuals may also have imperfect information about the true benefits of consuming these goods, which also contributes to market failure. In this essay, I will explain why negative externalities from the consumption of sugary beverages and imperfect information about these beverages will result in an inefficient allocation of resources in this market. Define key terms Overview Body – R1: Negative externalities in consumption In the consumption of sugary beverages, consumers consider only their marginal private cost (MPC) and marginal private benefit (MPB). The MPC of consuming an additional unit of sugary beverage includes the cost of the drink itself as well as the increase in medical expenditure from the possible development of health issues in oneself, such as obesity, diabetes, and dental problems. The MPB of consuming an additional unit of sugary beverage is perhaps the increase in wages as a result of higher productivity in the workplace as a result of stress relief that such beverages may give. Rational Explain private equilibrium

and self-interested consumers will consume QP amount of sugary beverages where MPB = MPC, the private equilibrium level, to maximise their net benefit. But over and above this private cost, the consumption of sugary beverages places an additional cost on third parties who are not directly involved in the market transaction, i.e. it generates marginal external cost (MEC). Increased prevalence of obesity and diabetes, for example, leads to higher healthcare expenditures, not only for individuals but also for the government, who usually subsidizes healthcare in a country. The existence of the MEC raises the marginal social cost (MSC) above MPC. Considering the full cost of consuming sugary beverages to the society as a whole, the socially optimum output should only be QS, where MSB = MSC, to maximise societal welfare. But consumers, acting in pursuit of their self-interest, disregard the external cost and consequently consume at QP. Due to this over-consumption, society has to bear a cost (area QScaQP) that is in excess of the benefits (area QScbQP) derived from the additional units of sugary beverages consumed, giving rise to a welfare loss or deadweight loss of area abc. Contextualise negative externality Explain the divergence Explain socially optimal equilibrium Derive DWL Diagram Body – R2: Imperfect information At the same time, consumers may also have imperfect information about the actual benefits they receive from the consumption of sugary beverages. This is because there are challenges in accessing accurate information about the associated health risks from consuming too much sugary beverages. Consumers may not know what is the optimal amount of sugar they can and should consume a day, and they also may not know exactly how much sugar their beverage contains. They may hence over-estimate the MPB they derive from an additional unit of sugary beverage consumed. In the free market, consumers would consume at QP, where their MPC = perceived MPB. However, if they had perfect information about what their actual MPB was, they would have consumed at QS, where MPC = actual MPB to maximise their utility. As a result, there is overconsumption by the Contextualise the imperfect information Explain the divergence Explain the private and socially optimal equilibrium Quantity of sugary beverages MPC QS Qp MSC = MPC + MEC c a b $ MPB = MSB (assume MEB = 0)

amount QSQP, which causes society to bear an additional area of deadweight loss given by the area abc, moving even further away from the socially optimal point. Diagram Conclusion Since the consumption of sugary beverages generate negative externalities and consumers themselves may also have imperfect information about their actual private benefits received, this leads to market failure, where there is an inefficient allocation of resources in this market. As a result, there is a need for government intervention. Summary and link to part (b) Note: Students may also illustrate imperfect information as a divergence between actual and perceived MPC. L3 Answer is relevant and is able to explain briefly how negative externalities AND imperfect information lead to market failure. There is good use of examples and well-drawn diagrams in support of answer. Two reasons well explained (externalities + imperfect info) – L3 – 10m One reason well explained (externalities) + one cursorily developed (imperfect info) – L3 – 8 or 9m 8 – 10 L2 Answer is relevant and is able to explain briefly how negative externalities AND imperfect information lead to market failure. There is some errors present in explanation/use of diagram. There is some attempt to use examples in support of answer. One reason well explained (externalities) – L2 – 6m One reason well explained (externalities) + one other reason severely undeveloped (imperfect info) OR both reasons cursorily explained – max L2 – 7m 5 – 7 L1 Answer is irrelevant and/or there are gross conceptual errors in the explanation of how negative externalities and imperfect information lead to market failure. Answer 1 – 4

displays no awareness of context and there is little/no attempt to use a diagram. Examiners’ Comments Part (a) This part of the question is relatively well done, with majority of students providing responses that reflect a L3 standard. However, there are still two main areas for improvement: Firstly, since the negative externality is generated from the consumption of sugary beverages, the analysis of how the market for sugary beverages fails should be done from the perspective of consumers, not producers. Appropriate examples of the private costs, private benefits, and external costs/benefits should be provided. Weaker responses either had unclear examples of external costs (e.g., link to a third party was unclear or lacking), or had conceptually incorrect examples. The marginal analysis should be made explicit (i.e. students should highlight that MPB/MPC is the benefit/cost derived/incurred from ‘an additional unit of the good’ consumed’). Secondly, students should note that they need to go beyond merely identifying the areas of deadweight losses for society - they should be able to derive these areas, clearly analysing and explai