Download - 2467f_n Lecture (Mkt Failure Nov 08 Essay)
GCE ‘A’ Levels Nov 2008
(a) Explain why imperfect information and immobility of factors of production may lead to market failure. (10)
b) Evaluate the policies currently used by the Singapore govt to correct these causes of market failure. (15)
(a) Explain why imperfect information and immobility of factors of production may lead to market failure. (10)
Intro• Define mkt failure
–Mkt failure arises when the free market fails to achieve an efficient allocation of resources and when social goals are not met.
imperfect info market failure
Imperfect info
Individuals do not fully know private benefits/costs of consuming certain goods
Individuals are not aware of external benefits/costs of consuming certain goods
Personal Well-being Externalities
imperfect info market failure
Demerit goods (eg cigarettes)• Define demerit goods: gds that govt perceivesas bad for the individual consuming them
• Individuals may not be fully aware of the ill‐effects on their health underestimate their private costs when consuming cigarettes (OR overestimate private benefit) Incorrect valuation of private benefit (MPB/DD)
Price
Qty of cigarettes0
SS
Dd (with Perfect info)
Q Q’
A
B
Dd’ (with Imperfect info)
Qty of cigarettes consumed with full info on health effects
With imperfect info, too many cigarettes consumed.
Free mktover-consumption Mkt failure too many resources allocated to producing demerit gds under free mkt
imperfect info market failure
Merit good (healthcare such as vaccination, breast cancer screening)
• Define merit goods
• Eg: individuals not fully aware of long‐term private benefits of consuming vaccinationunderestimate their private benefits
Price
Qty of vaccination0
SS
DD’ (with imperfect info)
Q’ Q
B
A
DD (with perfect info)
Qty of vaccinations consumed with full info
on benefits
With imperfect info, too few consuming
vaccination.
Free market: under-consumption. Mkt failure: Not enough resources allocated to providing merit good
Imperfect infomarket fails
Negative Externalities• Consumers of demerit goods (eg smokers) may not be aware of costs borne by 3rdpartiesWill not take into account MECDivergence btw MPC and MSC Consumes where MPB=MPC over‐consumptionmkt failure
Price
Qty of cigarettes0
MSC = MPC + MEC
MPC
MPB = MSBQs Qp
Imperfect infomarket fails
Positive Externalities• Consumers of merit goods (eg flu vaccination) may not be aware of benefits received by 3rd partiesWill not take into account MEBExplain how this leads to mkt failure
Price
Qty of flu vaccination0
MPC = MSC
MPB
Qp Qs
A
C
B
MSB
Asymmetric information: whereby one party has better info than the other
• Eg: Healthcare – Patients rely heavily on doctors’ advice– Unscrupulous doctors may advise more medical tests or treatments than necessary DD for these tests or treatments higher than socially optimal
Imperfect infomarket fails
Price
Qty of medical
treatment
0
SS
DD (if consumers are fully informed)
Q Q’
A
B
DD’ (with asymmetric info)
Qty consumed with asymmetric info
Qty consumed with consumers having full
info
Free market: over-consumption Mkt failure: too many resources allocated to …
Factor immobility mkt failsPresence of strong BTE• Eg: A firm gaining control over majority of key resources
• FOPs immobile: not easily made available to potential rivals difficult for potential rivals to enter industry or to compete
Greater monopoly power for incumbent firm Fewer substitutes :DD becomes more inelastic
Greater ability to increase P above MC Greater allocative inefficiencyDiagram?
MC
Q1
P1
AR = DdMR
Costs/Rev/Price ($)
O Q
Left to free mkt, at profit max eqb, firm will produce at Q1.
At Q1, P1>MC
Not AE (explain!)
Not enough resources allocated to producing the gd
Factor immobility
FOPs may be slow to respond to changes in DD or SS
Occupational immobility
Geographical immobility
Occupational immobility• Eg: workers retrenched from electronics industry unable to gain re‐employment in growing industries
• Mismatch between skills offered by the workers and skills required by new industries
• (Structural) Unemployment results resources not fully utilized Mkt failure
Factor immobility mkt fails
Factor immobility mkt fails
Geographical immobility• Eg: Labour may face difficulty in moving from one place to another to find work(eg family ties, difference in cost of living)
• Unable to channel labour resources to areas where there are shortages of labour unemployment
• Note: This may not be applicable to Singapore. More applicable for large countries with huge regional disparity
Factor immobility (due to imperfect info)mkt fails
• Some people may be uninformed of what jobs are available unable to move on to new jobs ‘job search’ unemployment or frictional unemployment
Immobility of FOPs economy operates at point A inside the PPC•Suggests that resources are not fully utilized to achieve max level of output Indication of spare capacity (Inefficient use of resources!) PE not attained
Good X
Good Y
0
A
PE
•Achieving as much o/p as possible from given amt of resources.
•Occurs at any point ON the PPC
In conclusion…
• Mkt failure: Inefficient allocation of resources: can be manifested as–under/over allocation of scarce resources to certain goods
–resources not being fully utilized(wastage of scarce resources)
3b) Evaluate the policies currentlyused by the Singapore Governmentto correct these causes of marketfailure. [15]
Imperfect Info
Factor Immobility
• In view of the over‐consumption of cigarettes caused by imperfect information among private individuals, the Singapore govt has implemented policies such as:
Education & Campaigns• Anti‐smoking campaigns carried out by Health Promotion Board (HPB) eg. Anti‐smoking advertisements through various forms of media, anti‐smoking road‐shows, anti‐smoking telephone help‐lines
imperfect info market failureDemerit goods (eg. cigarettes)
Legislation• Health warnings on the damaging effects ofsmoking are to be conspicuously indicatedon cigarette packs.Eg.– ‘SMOKING CAUSES HEART DISEASE’– ‘SMOKING HARMS YOUR FAMILY’– Gory images
• Misleading labeling on tobacco productssuch as “light”, “mild” and “ultra‐light” is notpermitted.
Legislation–Cigarette companies are banned from sponsoring public events and arts programs
–Govt sets a minimum legal age (18) to purchase and smoke cigarettes
–Revoke licenses of retailers who sell tobacco products to buyers in school uniform (with 1st offence)
Explain how measures work?• Actions undertaken attempt to solve the root cause of over‐consumption of cigarettes on the part of private individuals i.e. Imperfect info DD for cigarettes corrects the market failure problem
Price
Qty of cigarettes0
SS
Dd1 (with Perfect info)
Q1 Q0
A
Dd0 (with Imperfect info)
B
Qty of cigarettes consumed with full info on health effects
With imperfect info, too many cigarettes consumed.
Explain how policy works?
EvaluationHowever, these policies may also have their limitations:Govt has to incur additional monitoring and enforcement costs to ensure compliance to legislation education & campaigns are costly to
implement effects of education & campaigns are uncertain and can only materialize in the longer term
imperfect info market failure Merit good (preventive healthcare such as breast cancer screening, vaccination)
• In view of the under-consumption of healthcare services caused by imperfect information, the Singapore govt has implemented policies such as:
• Education & Campaigns:E.g. Promotion of pre-emptive measures such asbreast cancer screening etc through variousforms of media, cancer screening road-shows,mobile screening vans
Evaluation:• Actions undertaken attempt to solve the root cause of under‐consumption of healthcare svcs on the part of private individuals ie. Imperfect info; thereby raising the Dd for healthcare svcs, thus solving the market failure problem.
Price
Qty of vaccination0
SS
DD0 (with imperfect info)
Q0 Q1
BDD1 (with perfect info)
A
Qty of vaccinations consumed with full info
on benefits
With imperfect info, too few consuming
vaccination.
Explain how policy works?
Evaluation (limitations)‐‐ education & campaigns are costly‐‐ effects of education & campaignsmaterialize only in the longer term
Asymmetric information: whereby one party has better info than the other
• Eg: Healthcare – Patients rely heavily on doctors’ advice– Unscrupulous doctors may advise more medical tests or treatments than necessaryDD for these tests or treatments higher than socially optimal
SOLUTION??
Imperfect infomarket fails
LegislationMedical practitioners are strongly encouraged to display prices of their services clearly so that patients are given full knowledge of costs of their medical treatment.
Factor immobility (due to imperfect info)mkt fails
• Some people may be uninformed of what jobs are available unable to move on to new jobs ‘job search’ unemployment or frictional unemployment
SOLUTION??
Career fairs Career guidance programs in schools Setting up of job agencies such as
Jobstreet.com etc.
Factor immobility Mkt fails
Explain how measures work?Measures attempt to…
– facilitate the flow of information between potential employers & employees
– reduce the time taken for the job search process reduce frictional unemployment
Good X
Good Y
0
A
B
Explain how measures work?• Attempts to help the economy move from a point within the PPC to a point on the PPC.
Good X
Good Y
0
A
B
Structural Unemployment: SOLUTION?Education & Skills training (CET Masterplan)• Workforce Skills Qualifications (WSQ) system: Offer several skills training programs
• Skills Program for Upgrading and Resilience (SPUR): financial support scheme to encourage declining businesses to send workers for up‐skilling
• Funded in part by the Skills Development Fund set up by the Workforce Development Agency (WDA)
Factor immobility Mkt failsOccupational immobility
Explain how measures work?• Equip the structurally unemployed with therelevant skills that enable them to be employedin the new jobs created Solves problem ofthe skills mismatch
• Effect on PPC?
Good X
Good Y
0
A
B
Evaluation (limitations)• Positive effects of retraining programs will only materialize in the long term.
• Besides, effectiveness of the skills programs also depends on the –motivational levels of the workers involved– the willingness of firms to employ older workers
– firms’ willingness to conduct training programs
Geographical immobility• Geographical immobility is not really valid in Singapore’s context.
• In any case, Singapore government has invested in improving the transportation facilities, in terms of efficiency as well as accessibility
Factor immobility Mkt fails
Presence of strong BTE• Monopoly power that is created as a result of firms gaining control over key FOPs is not a significant problem in Singapore due to the existence of the Competition Commission of Singapore (CCS) and the implementation of the Competition Law.
Factor immobility Mkt fails
Conclusion• As each policy has its pros & cons, govt needs to carry out its CBA before deciding on set of policies to implement.
Conclusion• Perhaps better to adopt a multi‐pronged approach by using a combination of policies –eg. Use of taxation together with legislation & education/campaigns for demerit gds
• Govt also needs to be aware of govt failure!