EJC H2Econs Topic5

1 © Eunoia Junior College Economics Department Topic 5: Government’s Microeconomic Objectives Theme 2.3 Microeconomic Objectives and Policies How to use this set of lecture notes? 1) BEFORE LECTURES – UNDERSTANDING CONTENT - Reference your notes against your H2 syllabus. Mark out the key concepts so that you know what you MUST know - Read your notes ahead so that you can focus on listening and capturing additional notes during lectures 2) During lectures – APPLYING CONTENT - Bring your hard copy notes along, and use your PLDs to refer to the lecture slides concurrently - Capture additional notes, especially the real -world examples where you can note down how concepts are applied and how economic analysis are developed in varying contexts - You should make use of a notetaking/consolidation tool to take notes during lessons and to consolidate your learning at timely junctures. Examples are MIRO, Notion, Goodnotes, Notability, Microsoft One Note, KAMI, etc. The choice is yours! 3) After Lectures – TUTORIAL PREPARATION to use content flexibly to show application, analysis and evaluation skills - Revise concepts relevant for the case study and essay questions - Refer to the notes and use it flexibly to prepare your answers to meet question requirements. Pure memorisation will not work as it does not involve deep understanding. - Do share your notes with your friends to multiply learning!

2 © Eunoia Junior College Economics Department Essential Questions: 1. Under what circumstances would price s fail to s erve as signals between producers and consumers in the allocation of resources? 2. How may each cause of market failure lead to inefficiency in allocation of resources in a free market economy? 3. Why might government need to intervene when there is inefficiency in resource allocation? 4. How does the government intervene to correct inefficient resource allocation? 5. Why does government intervention not always bring about allocative efficiency and equity? Introduction 1. Price Mechanism and Efficient Allocation of Resources 2. Governments’ Microeconomic Objectives 3. Market Failure and its Causes and Government Intervention 3.1 Public goods 3.2 Externalities 3.3 Information failure 1: Perceived vs. Actual cost/benefit 3.4 Information failure 2: Asymmetric information 3.5 Factor immobility 3.6 Market dominance 4. Inequity and Government Intervention 4.1 Income inequality 4.2 Market dominance 5. Government Failure (as an assessment of effectiveness of government intervention) Annex CONTENTS

3 © Eunoia Junior College Economics Department Introduction Have you ever questioned whether there are too many cars on Singapore’s roads, or if cigarette consumption is excessively high? If so, you may be suggesting that there is an optimal number of cars the roads can support, and an ideal level of cigarette consumption for society. But how can we determine what that optimal level is? Can economic tools help us make sense of these issues? Our study of economics begins with the fundamental problem of scarcity. In the topic of demand and supply, we examined how the price mechanism acts as a key economic tool, helping free markets allocate limited resources to satisfy unlimited wants. The price mechanism functions through signalling, incentivising, and rationing to guide resource allocation. However, we must also ask: does the quantity of goods and services determined by the price mechanism truly reflect what society desires? In other words, does it achieve allocative efficiency? Proponents of the free market often argue that the free-market mechanism is the best way to achieve allocative efficiency and equity in resource allocation. However, markets do not always deliver these outcomes. Through government intervention, different stakeholders intervene to work towards achieving allocative efficiency and equity in the market. Even so, the government might not know how much intervention to carry out as they do not necessarily know the exact amount the society desires. Could government action unintentionally worsen the situation? If so, should we advocate for government intervention? And if we don’t, would that compromise society’s overall welfare? By the end of this topic, you will be able to justify if the free market is always efficient and equitable in the allocation of resources. If the free market is unable to do so, is there a role for the government ? If so, to what extent should the government intervene? 1. Price Mechanism and Efficient Allocation of Resources With scarcity, all economies are faced with the basic questions of resource allocation and governments are concerned with how well the economy/society utilises and allocates these resources. In a free market, the price mechanism determines how much resources are allocated to producing each good or service based on the equilibrium.

4 © Eunoia Junior College Economics Department In Topics 2 to 4 , we assumed a perfectly competitive market , which is characterised by: a. Many buyers and sellers b. Identical/homogeneous product c. No barriers to entry and exit d. Perfect knowledge or information e. Perfect factor mobility f. Absence of externalities Under the above assumptions, the perfectly competiti ve market is able to achieve an efficient and equitable allocation of resources. The demand curve indicates the value [marginal private benefit (MPB)] that each buyer places on the last unit of the good that he consumes which is based on the utility derived from the consumption of that unit of good. In the absence of any external benefits to third parties, the MPB to each buyer (which is indicated by the price) is equal to the marginal social benefit (MSB). The supply curve indicates the additional cost to a firm of producing the last unit of the good. In the absence of any external cost to third parties, the marginal private cost (MPC) incurred by firms is equal to the marginal socia l cost (MSC). The (opportunity) cost to society refers to other goods that could have been produced by the resources used to produce this additional unit of output. Note: MPB = MSB and MPC = MSC only when there are no externalities. Case 1: Under-production/consumption at Q1 (MSB > MSC) At output Q 1 which is below the socially optimal output Qs, an additional production/consumption of the good towards Qs will lead to a positive marginal net benefit (since MSB > MSC). Society’s welfare could be better improved by increasing production/consumption till the socially optimal amount Qs. Only then, will the total net benefit to society be maximised. For example, if the output level of the good is only Q1, potential welfare can be gained by producing/consuming up till Qs. This is because if the output level of the good is at Q1 instead of Q s, between Q 1 and Qs, the additional benefit (Q 1CEQs) is greater than the additional cost (Q 1DEQs). This under-production/consumption of the good results in a deadweight loss represented by area CDE. Therefore, by increasing the output of the good to Qs, where MSB = MSC, society welfare will be maximised. C D P B QS MSB = MPB (= DD) MSC = MPC (= SS) Cost/benefit Quantity E A Q1 Q2 F G Figure 1: Social optimum MSB=MSC 0

5 © Eunoia Junior College Economics Department Figure 1 shows that for every additional unit produced /consumed beyond Q1 up to QS, MSB is still greater than MSC. Hence, to increase and maximise society’s welfare, production/consumption of the good should be increased. Case 2: Over-production/consumption at Q2 (MSC > MSB) Conversely, if the output produced/consumed is