NYJC_H1_ECONS_Q3_suggested_answer

1 2017 JC2 H1 Econs Prelim Exam Suggested Answers for Question 3 3 (a) Explain how the existence of merit goods such as art galleries represent market failure. [10] (b) Discuss the view that subsidies to provide free entry to art galleries is the best way to achieve efficient allocation of resources. [15] a) Explain how the existence of merit goods such as art galleries represent market failure. [10] Command Word: Explain Context: Art Galleries Content: Market failure (Merit Goods) Intro: Merit goods are goods that the government feels that the people will under-consume due to poor economic decisions (imperfect information) that they make on their own behalf and that it give rise to positive externalities when consumed. 1: Imperfect Information Due to imperfect information, consumers may not rea lise that making visits to art galleries enhances the quality of life and helps th em to develop their critical thinking, to cultivate creative problem-solving and to commun icate and express themselves effectively. Therefore, they may not visit the art galleries at the socially optimal level. This can shown in the diagram below (Figure 1) wher e consumers perceived the marginal private benefit to be at MPB perceived which is lower than the actual MPB (MPB actual ). Hence, with no government intervention, consumer s will only be concerned about MPB perceived and MPC and visit art galleries at Qc which is belo w the socially optimal level, Qs (where MSC = MSB).

2 Hence, as a result of under-consumption of visits t o art galleries, it result in a deadweight loss of the shaded area as shown in Figu re 1 leading to inefficient allocation of resources and thus market failure. 2: Positive Externality In addition, when merit goods are consumed, it give s rise to positive externalities. When visiting art galleries, consumers are only concerned with the own private benefit (e.g. leisure) and private cost (e.g. entry fee). However, it gives rise to external benefit as well which are the economic benefits to the coun try. Art galleries provide job opportunities directly and indirectly due to touris ts visiting the art galleries and spending in other sectors during their stay in the country. If there is no government intervention, consumers w ill only consider their private benefit (MPB) and private cost (MPC) and consume at Qc (refer to Figure 2), ignoring the external benefit (MEB). The presence of externa l benefit result in the divergence of MSB and MPB and the socially optimal number of v isits to the museums is at Qs where MSB cuts MSC. This leads to an under-consumpt ion of visits to art galleries resulting in the presence of deadweight loss as sho wn by the shaded area shown in Figure 2. Thus, the market has failed as there is u nder-allocation of resources to the visits of art galleries. Figure 1 Qc

3 Conclusion: As the market has failed to allocate resou