2013 HCI H1 Econs Essay Q3

HWA CHONG INSTITUTION Year Two H1 Economics 2013 3 (a) Explain why government intervention is advocated in the markets both for public goods and merit goods. [10] (b) There is free wireless connectivity in public areas through Wireless@SG in Singapore. Discuss whether wireless connectivity should be provided free by the government. [15] ---------------------------------------------------------------------------------------------------------------------------------------------- Suggested Outline: part (a) (i) Explain public goods resultin g in complete market failure A pure public good is a good or a se rvice that has the characteristics of non-excludability and non-rivalry. As such, they will not be provided by the market. Non-excludable (Free-rider problem) It is impossible or prohibitively expensive to exclude non-payers from using it. For instance, once street lighting is provided, there is no inexpensive or practical way to restrict the availability of the service to people who pay. Non Rivalry (MC=0) Consumption of the good by additional individuals will not prevent others from enjoying the same good, or reduce the quantity and quality consumed by existing consumers. Marginal cost of providing the good to the additional user is zero. For instance, the use of the street lighting by a pedestrian will not reduce the amount of light available to others. Missing market/ Complete market failure As a result of the character istics of non-excludability, the provisi on of public goods suffers from the “free- rider” problem. Since it is not possible to exclude those who do not pay from consuming the good, no self- interest, rational co nsumer will reveal his effective demand an d hence has no incentive to pay what the good really is worth to them. Since anyone can enjoy all the benefits of a pure public good once it is produced without paying for it, there will be an absence of price signal and producers will not supply this good. Hence, despite the fact that a pure public good yields valuable benefits to society, the “free rider” problem means that the market will not provide such a good. As a result of the c haracteristics of non-rivalry, no self-interest, a rational firm will not be willing to produce the good or service. Therefore government intervenes to provide what is socially optimal. (ii) Explain merit goods resulting in under consumption/ production MERIT GOODS are goods or services that have been deemed by the government as socially desirable and under-consumed/produced and their desirability is usually due to external benefits spilled over to the society.

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HWA CHONG INSTITUTION Year Two H1 Economics 2013 (b) There is free wireless connectivity in public areas through Wireless@SG in Singapore. Discuss whether wireless connectivity should be provided free by the government. [15] Thesis: Yes, it should be provided free 1. MC = 0 Established earlier in part (a) that public good should be provided by the government due to missing market. Now, consider whether wireless connectivity is a public good and hence whether it should be provided by the government. Wireless@SG can be made excludable to non-payers. Only registered users can enjoy the free access. If charges need to be imposed, non-payers can be easily excluded. Wireless@SG seems to be non-rivlarous as access to the network by one user does not mean that an additional user will be excluded in the consumption, i.e. it can support multiple users. Since supply of wireless connectivity is not depleted by an additional user, the MC of serving an additional user is zero. Therefore, the government should provide for it free and not charge a price so as to achieve allocative efficiency (P=MC=0). However, as more additional users access the network it does slow down the speed of access which means the quality of service is not the same as before. Thus additional user can lead to rivalry in consumption in terms of speed access. 2. Wireless connectivity is a meri t good with huge positive externality The Private Marginal Cost (PMC) - The private cost of providing an additional user the wireless service by service providers such as M1 and SingTel is the additional cost in providing the service such as wages for hiring more employees to explain to walk-in customers or those who call up and to process paperwork. The Private Marginal Benefit (PMB) The private benefits of providing the service to an additional user is the additional revenue to the company. Social Benefits (private and external benefits) In the provision of wireless network, it creates positive externality or External Marginal Benefits (EMB) to society at large. This positive third party spillover effects include the benefits of increasing efficiency for people to access information and leading to higher productivity. A more technological advanced environment will benefit the employers and the economy. The price mechanism fails to bring about a socially efficient allocation of resources in this case. This is because the benefit to other parties created is unpriced by the price mechanism and therefore is not included in the private benefits of providing wireless network. Hence we can say that there is a divergence between the Social Marginal Benefit (SMB) and the PMB, and as a result SMB lies above that of PMB. I.e. SMB = PMB + EMB.

HWA CHONG INSTITUTION Year Two H1 Economics 2013 Illustrate with the aid of a diagram . From Figure 1, the market equilibrium occurs at Q E where PMB=PMC since service providers only take into account their own benefits and costs . However, due to the presence of positive externalities (EMB), the social benefit of providing the service is higher than the private benefit. The socially efficient allocation occurs when society takes into account of the positive externalities when SMB=SMC at Q SE (assuming no negative externalities present, PMC=SM C). This divergence between private and social benefits causes a