NYJC_H2_ECON_ESSAY_QN_3

Question 3 a. Explain how the presence of negative ex ternalities and market dominance can lead to market failure. [10] b. Discuss what policies a government might adopt to achieve a more efficient allocation of resources where market dominance exists. [15] Suggested Answers a. Explain how the presence of negative ex ternalities and market dominance can lead to market failure. [10] Synopsis: Negative externalities & market dominance are sources of market failure and students are required to elaborate on how each of the above factors can cause market mechanism to fail. Using examples would aid in the analysis of the question. 1. Define market failure (highlighting the essential components): a. Workings of free market leads to undesirable outcomes from a societal viewpoint leads to: - Deadweight losses - Total (ie. consumers’ plus producers’) surpluses or societal welfare is not maximized – because of quantities (restricted) or price set - Inefficient allocation of resources b. Hence a market does not fail when the workings of the free market leads to - No deadweight losses - Total (ie. consumers’ plus producers’) surpluses or societal welfare are maximized - efficient allocation of resources 2. Explain how negative externalities cause market failure a. Choose a context of a particular market activity to illustrate a negative externality in production or consumption (application) – eg. negative externality arising from production using example (Power production) b. Define negative externality in context – the actions of producing electricity by parties directly involved (1 st parties) imposes an external cost (EC) on other members of society (3rd parties). c. The free market perspective - Identify objective of the 1st party - to maximize net private benefits where the revenue that they would gain from the level of power production is more than the costs incurred in using/buying resources to produce that level of power (ie. TPB – TPC = max.) - Choosing to produce at output level where MPB=MPC, i.e. Qp. (Pte equilibrium). - When the 1st party produces electricity, they generate negative externality (eg. air pollution & greenhouse gases all of which results in global warming) that imposes external costs for other members of society (3 rd parties). - This external costs (EC) comes in terms of possible harsh weather as a result of global warming and through the harsh weather results in possible poor harvest or ill health which translates into financial or monetary losses for 3 rd parties.

- 3rd parties here refer to the people living in the vicinity of the power station who are not directly involved in the activity of power production by the power stations. - The EC will cause a divergence betwe