2013_MI_H1_Econs_Essay Mark Scheme

3 (a) Using appropriate examples, explain why the existence of negative externalities and public good causes market failure. [10] (b) Discuss the various policies which the Singapore government adopts in correcting the market failures above. [15] Suggested answer: Part (A) Intro 1. Define market failure  Less than desirable outcome where resources are not used in the most efficient way. Hence, there is allocative and productive inefficiencies.  Partial market failure: where there is over or under production/consumption which leads to inefficient allocation of scarce resources. This arises when there are externalities.  Define externalities 1. 3 rd party effects on someone not directly involved in the production &/or consumption of a gd. 2. may be negative( external cost or 3 rd party cost) or positive ( ext. benefit or 3rd party benefit) Body 1. State that traffic congestion is a form of partial market failure where there is negative externality  Define negative externalities (by making reference to any e.g.: road congestion, smoking): external cost to 3rd parties who are not directly involved in the production and/or consumption of the good. For example, road congestion generates noise and air pollution that affect the quality of living for residents living near the congested roads or road congestion leads to a delay in arrival time for work for other road users such as passengers on public buses. This could lead to a fall in the revenue for firms when the workers report late for work./ Smoking generates second hand smokers which can cause other non-smokers to have health problems like breathing difficulties.  Because of the presence of negative externa lities, there is a divergence between private costs and social costs by the extent of the external costs. 2. Explain how road congestion/second hand smoke results in negative externalities and hence, market failure.  Diagram showing socially optimal level of consumption (MSC=MSB) and the equilibrium level of consumption without government intervention (MPC=MPB).  Show that there is overconsumption of cars/smoking and hence, welfare loss to society. D E MPC MSC Quantit y C Cost, benefit 0 MPB=MSB Qs Q m

  Assuming that there is no external benefit, marginal private benefit (MPB) is equal to marginal social benefit (MSB). In this case, marginal private cost could include cost of petrol and the depreciation cost of the car for the additional trip, and the time lost when the driver is caught in traffic congestion/ cost of cigarettes, personal health problems. Marginal private benefit could be in terms of the convenience one gets from driving a car/satisfaction from smoking. The private equili brium occurs at MPC equals to MPB, i.e. 0Qm level of traffic flow/smoking in a not crowded place. The social equilibrium occurs at MSC, which is the summation of marginal private cost and marginal external cost, equals to