TMJC 2022 A Level H2 EQ3

© TAMPINES MERIDIAN JUNIOR COLLEGE 2022 A Level H2 Economics, Paper 2 EQ3 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 for 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] Suggested answer (a) Introduction • Market failure describes the circumstances in which distortions in the markets prevent the price mechanism from allocating resources efficiently, resulting in welfare loss. • In the case of street lighting, it is generally not provided, i.e. public good, or considered to be overprovided in the free market due to the presence of negative externalities. Development Requirement 1: Public good • Street lighting is both non-rivalrous and non-excludable. • Non-rivalrous: Consumption of the good by one person does not diminish the quantity available for consumption by another person. The property of non -rivalry means that once the good is provided, the additional cost to provide for another person to benefit from consumin g the good is zero. In this context, the brightness of street lighting available to the next user will not reduce when one consumes/ passes by. Hence, the marginal cost of providing street light to one more person is zero. If the marginal cost is zero, the efficient price to charge should be zero (P = MC). If a price w as charged, there would be a welfare loss to society. But no private firms who are assumed to be profit-motivated would be willing to supply street light if the price is zero, resulting in zero supply of street lights. • Non-excludable: It is impossible, or prohibitively costly (not feasible) to exclude anyone from using the good once it is produced. The property of non -excludability gives rise to the free rider problem. Individual can free-ride on street lighting and utilize the lighting once it is installed without having to pay for it. The desire to be a free rider weakens the incentive for consumers to offer to pay for street light. Hence, no rational consumer will demand for street light, resulting in no expression of demand. Since there is no expression of demand, it is not possible to charge a market price for street light if the public good itself is left to the private firms.

© TAMPINES MERIDIAN JUNIOR COLLEGE • As a result, if street lightings are left to the market, they would not be provided at all. There is hence a missing market for street lighting, thus leading to complete market failure. The market has failed because no resources will be allocated to their production. Requirement 2: Good that exhibits negative externalities • Negative externalities arise from the generation of electricity used for street lighting. • Steps to explain negative externalities as a source of market failure: 1. Private (or Market) output (MPB=MPC) In a free market, the price mechanism will only consider private costs (costs of production for electricity) and benefits (revenue from electricity generation) , ignoring externalities. The individual producer will produce up to the output level, Q where MPB intersects MPC. Private welfare is maximised. 2. Divergence between MSC and MPC: Explain MEC in context Individual decision makers are not internalising all the costs that society is bearing. External costs of production (or consumption) are imposed on some third party adversely for which no compensation is being provided for. For example, the medical costs incurred by non -users who are affected by air pollution due to harmful gases emitted during the generation of electricity for the street lighting. Alternative: These lights disrupt nocturnal activity, interfering with reproduction and reducing populations of wildlife, which may lead to wildlife researchers having to incur additional costs to create conducive environment for them to thrive and reproduce. The presence of the marginal external cost (MEC) that arises from the existence of the negative externality causes the divergence between MP C and MS C where MSC>MPC. It is assumed that there are no positive externalities and thus MPB = MSB. Figure 1: Divergence between MSC and MPC due to negative externalities

© TAMPINES MERIDIAN JUNIOR COLLEGE 3. Socially optimal output (MSB=MSC) The socially optimal output will be at Q* where MSB intersects MSC where society’s welfare is maximised. 4. Allocative inefficiency: Over-production or over-consumption At Q, the MSC is greater than the MSB. This means that the last unit of output adds more to society’s costs than it will to society’s benefits. Hence, the price mechanism over-allocates resources to the production of the good, leading to an by Q*Q units. 5. Deadweight loss to society With reference to Figure 1 above, the deadweight loss is indicated by area ABC and is the difference between total social costs (area Q*CAQ) and total social benefits (Q*CBQ) of the additional Q*Q units being overproduced. The market fails because allocative efficiency has not been achieved at Q as resources can be re-allocated to increase society’s welfare. Thus, by decreasing production to output Q*, society can avoid the welfare loss. Conclusion • Since market fails in the provision of street lightings, there may be a need for government to intervene to ensure an optimal amount is being provided. Level Knowledge, Application/Understanding and Analysis Marks L3 • For a well-developed analysis on two reasons for market failure, with the use of well-labelled and well-explained diagrams where appropriate. 8 – 10 L2 • Relevant answer but theory may be incompletely explained. • Attempts to apply market failure concepts but lacks analyasis. • Explains only one possible reason for the market failure. 5 – 7 L1 For an undeveloped answer that • is descriptive, lacking in application of economic theory, and/or • contains serious and pervasive conceptual errors, and/or • is largely irrelevant. 1 – 4

© TAMPINES MERIDIAN JUNIOR COLLEGE (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] Suggested answer (b) Introduction • As seen in part (a), the market for street lighting failed to allocate resources efficiently as there could be problem of no street lighting produced at all as it is a public good and there is presence of negative externalities related to electricity generation and impact on wildlife. • All governments aim to achieve the microeconomic objective of efficiency in resource allocation to maximise society’s welfare – in this case, maximise the benefits of street lighting while minimizing the negative impacts. Hence government’s objective is to ensure the provision of street lighting at the socially efficient level, and it can do so by using a combination of policies , such as direct provision and legislation . This essay seeks to discuss the extent to which government should intervene in the market for street lighting. Development Requirement 1: A government should intervene in the market via free direct provision to ensure that the benefits of street lighting can be obtained • Having well -lit streets can allow society to move around safely and minimize the possibility of crimes happening. Therefore, street lighting is integral to the well -being of society. • Given the extensive benefits of street lighting to the society, free direct provision by the government is needed to obtain the benefits since no resources will be allocated to