2024 SAJC JC1 H1 Microeconomic Objectives & Policies Lecture Notes (v2)

ST ANDREW’S JUNIOR COLLEGE JC1 H1 ECONOMICS 2024 Microeconomic Objectives and Policies In a market-based economy, the price mechanism is assumed to allocate resources efficiently. In such an ideal model of the economy, firms are assumed to have perfect information and there is perfect factor mobility. In this topic, we will explore how in the real world, markets may not work efficiently because the assumptions of an ideal economy do not hold true. This leads to the failure of the market to allocate resources efficiently. This is termed as ‘market failure’. Market failure provides the justific ation for government intervention in the free market. Learning about market failure will deepen our understanding of real-world complexities, equip us with the tools to analyze and predict the impact that decisions have on firms, industries and the nation. The knowledge, skills and values that we develop will help us to appreciate policies in Singapore to address market failure and encourage us to take an active interest in Singapore’s economy as contributing and concerned citizens. Important concepts and tools of analysis  Allocative Efficiency  Equity  Market Failure  Deadweight loss  Marginal private benefit and cost  Marginal external benefit and cost  Marginal social benefit and cost  Social versus private (market) optimum  Public goods – Non-excludability and non-rivalry  Information Failure Key questions to consider 1. What are the microeconomic objectives of the government? 2. What is market failure? 3. What are the sources of market failure? 4. How does the presence of externalities lead to market failure? 5. How does the presence of information failure lead to market failure? 6. How does the non-provision of public goods lead to market failure? 7. What can the government do to deal with market failure? 8. How does the lack of equity lead to a distributional issue? 9. What are the causes of inequity? 10. What can the government do to deal with inequity? 11. What causes government failure?

2 Contents 1. INTRODUCTION ..............................................................................................................................................................4 2. GOVERNMENTS’ MICROECONOMIC OBJECTIVES ................................................................................................5 2.1. Efficiency ..................................................................................................................................... 5 2.2. Equity .......................................................................................................................................... 8 3. MARKET FAILURE .......................................................................................................................................................... 10 3.1. Presence of Externalities and Government Intervention................................................................... 11 3.1.1. Negative Externalities in Consumption ..................................................................................................... 14 3.1.2. Negative Externalities in Production ......................................................................................................... 17 3.1.3. Government Intervention to Deal with Negative Externalities ............................................................ 19 3.1.4. Positive Externalities in Consumption ........................................................................................................ 30 3.1.5. Positive Externalities in Production ............................................................................................................ 33 3.1.6. Government Intervention to Deal with Positive Externalities ................................................................ 36 3.2. Presence of Information Failure and Government Intervention ......................................................... 44 3.2.1. Imperfect Information in Imperfect Competition ..................................................................................... 44 3.2.2. Imperfect Information due to Under-estimation of Costs ...................................................................... 46 3.2.3. Imperfect Information due to Under-estimation of Benefits ................................................................. 48 3.2.4. Government Intervention to Deal with Imperfect Information .............................................................. 53 3.3. Non-Provision of Public Goods and Government Intervention .......................................................... 59 3.3.1. Non-Provision of Public Goods .................................................................................................................. 59 3.3.2. Government Intervention to Deal with Non-Provision of Public Goods ............................................. 61 4. INEQUITY AND INCOME INEQUALITY .................................................................................................................... 62 4.1. Causes of Inequity ...................................................................................................................... 62 4.2. Government Intervention to Deal with Inequity............................................................................... 65 5. Government Failure ..................................................................................................................................................... 69 5.1. Reasons for Government Failure ................................................................................................... 69 6. Annex.............................................................................................................................................................................. 72 6.1. Introduction to Behavioural Economics .................................................. Error! Bookmark not defined. 6.2. Healthcare in Singapore .............................................................................................................. 72 6.3. Should Healthcare Provision be left to the Market? ........................................................................ 74 6.4. Dealing with Traffic Congestion in Singapore ................................................................................ 77 6.5. A Case of Negative Externalities- Environmental Degradation ........................................................ 79 6.6. Climate Change Conferences ....................................................................................................... 81 6.7. Gini Coefficient in Singapore over the years ................................................................................. 85

3 Concept Map

MICROECONOMIC OBJECTIVES AND POLICIES 4 1. INTRODUCTION Due to the problem of scarcity, all economies are faced with three basic questions of resource allocation: i. What to produce? ii. How to produce iii. For whom to produce? Recall “What to produce?” affects whether an optimal amount of a good/service is being produced/provided and hence the objective of allocative efficiency. “How to produce?” affects whether the most cost-efficient method of production is being used and hence the objective of productive efficiency. Lastly, “for whom to produce?” affects how the goods are being distributed and hence the objective of equitable distribution of income and wealth. The free market uses the price mechanism (which is the interaction of demand and supply) to achieve an efficient allocation of resources. Proponents of the free market often argue that the free market mechanism is the best way to allocate resources. However, there are times when it can fail to achieve the objectives of efficiency (both allocative and productive efficiency) due to different sources of market