2022 JC2 H2 Prelim Essay Q3 (Suggested Answers)

3 To ensurethesuccessofvaccinationasatoolinCOVID-19pandemicpreventionandcontrol,ahighvaccinationrateinacountryisrequired.However, despitethevaccinesbeingprovidedfreeofcharge,vaccinehesitancyisstillprevalentinsomecountries due to the spread of misinformation. (a) ExplainhowconsumersactrationallytodecidewhethertotaketheCOVID-19vaccineandthelikelyimpactoftheirdecisionsonresourceallocationintheCOVID-19 vaccine market. [10] (b) Discusshowgovernmentinterventioninthemarketforvaccinescouldleadtosocialwelfarebeingmaximisedandconsiderhowlikelysuchinterventionwillachieve this aim. [15] Suggested AnswerPart (a)IntroductionA rationalconsumerseeksto maximisehissatisfactionornetbenefit.In decidingwhetherto consumea good,theconsumerwillapplythemarginalistprincipleandconsiderthe marginalprivatebenefit(MPB)andmarginalprivatecost(MPC)ofconsumingthegood.TheMPBreflectsconsumers’additionalbenefit(i.e.satisfactionor utility)fromconsumingthelastunitof thegood/ service.TheMPCreflectsconsumers’ additional cost to consume the last unit of good / service. How consumers act rationally to decide whether to take vaccineTheconsumerwilltakehisMPBandMPCintoaccountin decidingwhethertotakeCOVID-19vaccine.TheMPBofconsumingthevaccineistheprotectionandsavingsonmedicalcostsheenjoysduetoloweredchancesoffallingillafterbeinginfectedwiththevirusandminimizingtheriskofspreadingthevirustohishousehold.TheMPCisthecostof vaccinationincurred.Otherthantheexplicitcost,i.e.thepriceof thevaccine,italsoincludestheopportunitycost,thenextbestalternativeforgoneintermsof othergoods,e.g.food,hecouldhavepurchasedwiththatamountofmoney. Hecouldalsohavespentthetimeallottedfor thevaccinationonotheractivitieslikewatching a movie instead. Withreferenceto Figure1, if hisMPBhigherthanMPC,at Q1 , theconsumerwillproceedtotakethevaccination.However, ifhisMPBislessthanhisMPC,atQ2 , theconsumerwilldecidenottotakethevaccination.Hence,theconsumerwillconsumeuptothepointwhereMPB= MPCatQp.Atthispoint,theconsumermaximiseshisnetbenefit as seen by the area abc.

How positive externalities can lead to under-allocation of resourcesHowever, consumptionof thevaccinationgeneratespositiveexternalities,whichthirdpartycanenjoy(externalbenefit)aswell.Vaccinationshelppreventthespreadofvirusesto thecommunityat large.Thoseinthecommunityarenowlesslikelytobeinfectedasthereis onelesspersonwhohasthepotentialtotransmitthevirus.Thecommunitywillbenefitfromsavedmedicalexpenses,andtheeconomybenefitssincelessman-hoursislosttoworkersbeingill.Thisexternalbenefitisnottakenintoaccountbytheconsumersin theirdecisionmakingastheyonlyconsidertheirMPB.Theexistenceofmarginalexternalbenefit(MEB)resultsinadivergencebetweenMPBandthemarginalsocialbenefitMSBasseenin thediagramabove,wheretheMSBliesabovetheMPB,withtheverticaldistancebetweenMPBandMSBrepresentingMEB.Thesociallyoptimaloutput,0Qs,iswhereMSC=MSB.Between0Qpand0Qs,MSB>MSC.Assuch,atoutput0Qp,societyvaluesanadditionalunitofvaccinationmorethanwhatit wouldcostsociety. Societydesiresmoreconsumptionof vaccination,hence,whenthedecisionislefttothemarket,thereisunder-consumptionofvaccinationbyQpQsamountorthereisanunder-allocationofresources.BysummingtheexcessofMSBoverMSCfortheunitsQpQs,wearriveata monetarymeasureofwelfareloss(also known as deadweight loss) of area ABC to the society. Figure 2: Presence of positive externalities How under-valuation of MPB can lead to under-allocation of resourcesIn addition,dueto imperfectinformation,consumersmightnothavean accuratevaluationoftheirMPBastheyarenotfullyawareofthebenefits(tohimself)ofgettingvaccinatedastheygetto avoidthepotentialcomplicationscausedbytheviruses.Therefore,consumersmay under-estimatethe actualmarginalprivatebenefit(MPBactual)of gettingvaccinated,resultingin a perceivedmarginalprivatebenefit(MPBperceived)thatis lowerthanMPBactual.Withaccuratevaluationof theMPB,quantityof vaccinationconsumedwouldbe at 0Qa.However, consumersareconsumingat outputlevel0Qp. Hence,thereisanunderconsumptionofvaccinationduetoimperfectinformationandthereisunder-allocationofresourcesinthemarketforvaccines. (Note:

Alternatively, it isalsopossibletoanalysethatinefficientallocationofresourcesarisesfrom MPCperceived being higher than MPCactual .) Figure 3: Presence of imperfect information ConclusionArationalconsumerwouldweighhisMPBagainstMPCindecidingwhethertotakethevaccineashisaimistomaximisehisownnetbenefit.However, suchaprocessmightnotgenerateanoutcomethatis sociallyoptimalastheconsumers’valuationof hisprivatebenefitmightnotbeaccurateordoesnottakeintotheexternalbenefit,resultingin theMPBbeinglowerthantheMSB.Asa result,thereisunder-consumptionandunder-allocation of resources in the market. Suggested Mark SchemeLevel Knowledge, Application, Understanding and Analysis Mark L3 Forananswerthatdemonstratesdevelopedexplanationonhowa rationalconsumerdecideswhethertoconsumevaccineusingthemarginalistprincipleandresourceallocationin thevaccinemarketisinefficientduetothepresenceofpositiveexternalitiesorimperfect information. 8 - 10 L2 Forananswerthatdemonstratesunderdevelopedexplanationonhowa rationalconsumerdecideswhetherto consumevaccineusingthe marginalistprincipleandresourceallocationin thevaccinemarketis inefficientdueto thepresenceof positiveexternalities or imperfect information. Max 5 marks:A one-sidedanswerthatexplainshowa rationalconsumerdecideswhetherto consumevaccineusingthe marginalistprinciple. Or 5 - 7

Aone-sidedanswerthatexplainshowtheallocationofvaccineisinefficientdue to the presenceof positiveexternalitiesorimperfect information.L1 Forananswerthatshowslimitedknowledgeofrationaldecisionmakingandmarketfailureandcontainsmajorconcepterrorsinunderstanding and shows lack of coherence. 1 - 4 Part (b)IntroductionAsthereisunder-allocationofresourcesinthevaccinemarket,governmentinterventionisrequiredinthemarkettoensurethatthereisefficientallocationofresourcessothatwelfare to society can be maximized. How subsidies work to achieve efficient allocation of resourcesSubsidies is a policy which could be used to tackle market failure in the vaccine market. With referencetoFigure4,thegovernmentcanprovideaper-unitsubsidythatisequaltotheMEBatthesociallyoptimallevelofoutput,0QS.Theamountofper-unitsubsidyisequaltotheverticaldistanceof MEB(DistancebetweenMSBandMPBactual ) at0QS . Thesubsidyprovidedhasthesameeffectasdecreasingtheunitcostofconsumingthevaccine.Thus,thesubsidyshiftstheconsumer’sMPCverticallydownwardsbythefullamountofthesubsidytocoincidewithMSC.ThisisillustratedbyMPC- subsidy. IfthesubsidyiscalculatedtoaccuratelyreflecttheMEBat0Qs,consumerswillconsiderthetruesocialbenefitofconsumingthevaccineandincreaseconsumptiontothesociallyoptimallevel0QS . Thus, allocative efficiency is attained. How effective is subsidySubsidiesaim to tacklethe root cause,presenceof positiveexternalitiesofunder-consumption.Thisis becausethroughrationaldecisionmakingin thefreemarket,producersandconsumersignoreexternalbenefitsandonlyaccountfortheirself-interestsbyconsideringprivatebenefitsandcosts.Asubsidyiseffectivesinceittargets this root cause as these external benefits are internalised.

If amountofsubsidyimposediscorrectlyestimatedtoreflectmonetaryvalueofMEBgenerated,theamountofvaccinesconsumedorproducedinmarketwillcoincidewiththesociallyoptimallevel.However, thisrequiresanaccurateestimationoftheMEB.Under-valuationofMEBimpliesthatalthoughconsumptionofthevaccinesisincreasedbythegivensubsidies,itisnotsufficienttobringoutputtothesociallyoptimalleveltomaximisesociety’swelfare.Anover-valuationoftheMEBimpliesthatalthoughoutputisincreased,it will resultin over-consumptionandwelfareis againnotmaximised.However, thisdoesnotseemtobetheconcernofsomegovernmentsastheirpurposeistoencourageallthosewhoareeligibletoconsumebygivingfullsubsidizationofthevaccine. (Note:Alternatively, itispossibletoarguethatMEBinthiscaseissolargethatitjustifiesafullsubsidization by the government.) How public education works to achieve efficient allocation of resourcesHowever