Transcript IB Economics Section 1.4 Market Failure Section 2.4 Equity
IB ECONOMICS SECTION 1.4 MARKET FAILURE SECTION 2.4 EQUITY IN THE DISTRIBUTION OF INCOME
1. Define community surplus, social efficiency, and Pareto optimality
Explain that the best allocation of resources from society’s point of view is at competitive market equilibrium, where
social (community) surplus
(consumer surplus and producer surplus) is maximized (marginal benefit = marginal cost).
Total surplus = Community Surplus
1. Define community surplus, social efficiency, and Pareto optimality
When a market is in equilibrium, with no external influences and with no external effects, it is said to be in a state of
Pareto optimality
. Pareto optimality exist
when it is impossible to make someone better off without making someone else worse off.
It dose not, however, mean that everyone is equal. If a market is
Pareto optimal
, then it is said to be socially efficient.
Social efficiency
exists when
community surplus
is maximized. Community surplus is the welfare of society and it is made up of a
consumer surplus
plus a
producer surplus.
1. Define community surplus, social efficiency, and Pareto optimality
Allocative efficiency
refers to the efficiency with which markets are allocating resources. A market will be
allocatively efficient
if it is producing the right goods for the right people at the right price. An
allocatively efficient
market is therefore one which has no imperfections.
(No Deadweight Loss)
2. Examine the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over allocation of resources (overprovision of a good) or an under-allocation of resources (under-provision of a good)
Market failure
is a concept within economic theory describing when the allocation of goods and services by a free market is
not efficient
. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off. (The outcome is not Pareto optimal.)
Market failures
can be viewed as scenarios where individuals' pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point-of-view.
2. Examine the concept of market failure as a failure of the market to achieve allocative efficiency, resulting in an over allocation of resources (overprovision of a good) or an under-allocation of resources (under-provision of a good)
Markets can fail for lots of reasons:
Negative externalities
(e.g. the effects of environmental pollution) causing the social cost of production to exceed the private cost
Positive externalities
(e.g. the provision of education and health care) causing the social benefit of consumption to exceed the private benefit
Imperfect information
or
asymmetric information
responsibility for their action with creates a means that one party in a transaction has more information than the other or they neglect to take full
moral hazard.
The private sector in a free-markets cannot profitably supply to consumers
pure public goods
and
common access to resources
and threat to
sustainability
. Market dominance by be damaged
monopolies
lead to under-production and higher prices than would exist under conditions of competition, causing consumer welfare to
Factor immobility
causes unemployment and a loss of productive efficiency Equity (fairness) issues. Markets can generate an ‘unacceptable’
distribution of income
and consequent social exclusion which the government may choose to change
3. Explain the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
Marginal private cost (MPC):
The cost incurred by just the firm in producing each extra unit of a good.
Marginal social cost (MSC):
unit of a good.
The cost incurred by both the firm and society in producing each extra
Marginal private benefit (MPB):
The increase in private benefit resulting from the consumption of one more unit or the production of one more unit.
Marginal social benefit (MSB):
The increase in private benefit and society from the consumption of one more unit or the production of one more unit.
3. Explain the concepts of marginal private benefits (MPB), marginal social benefits (MSB), marginal private costs (MPC) and marginal social costs (MSC).
Private Costs and Social Costs
The existence of externalities creates a divergence between
private and social costs
of production and the private and social benefits of consumption.
Where there are externalities: Social Cost
= Private Cost + External Cost Social Benefit = Private Benefit + External Benefit
Where no externalities exist: Social benefits = private benefits Social costs = private costs
4. Describe the meaning of
externalities
as the failure of the market to achieve a social optimum where
MSB = MSC.
Externalities
are
third party effects
arising from production and consumption of goods and services for which no appropriate compensation is paid.
Externalities occur outside of the market
i.e. they affect people not directly involved in the production and/or consumption of a good or service. They are also known as spill-over effects.
Economic activity creates spill over benefits and spill
over costs
Externalities (MSB ≠ MSC)
4. Describe the meaning of
externalities
as the failure of the market to achieve a social optimum where
MSB = MSC.
The cost of an externality is a
negative externality
, or external cost, while the benefit of an externality is a
positive externality
, or
external benefit
.
In the case of both
negative and positive externalities
or benefits of producing or consuming a product or the costs nor reap all of the benefits of the economic activity, and too much or too little of the goods will be produced or consumed in terms of overall costs and benefits to society.
, prices in a competitive market do not reflect the full costs service. Producers and consumers may neither bear all of
4. Describe the meaning of
externalities
as the failure of the market to achieve a social optimum where
MSB = MSC.
Externalities of both types can in the course of the production or consumption of a good or service.
Negative externality of consumption
(
Demand
) = use of a product creates spillover cost to others
Negative externality of production
(
Supply
) = making of a product creates spillover cost to others
Positive externality of consumption
(
Demand
) = use of a product creates spillover benefits to others
Positive externality of production
(
Supply
) = making of a product creates spillover benefits to others
5. Explain, using diagrams and examples, the concepts of consumption of a good or service.
negative externalities
of production and consumption, and the welfare loss associated with the production or
Negative externalities
Negative externalities occur when production and/or consumption impose
external costs on third parties
outside of the market for which no appropriate compensation is paid. When
negative production externalities
exist,
social costs exceed private cost.
This leads to
over production
if producers do not take into account the externalities.
5. Explain, using diagrams and examples, the concepts of
negative externalities
of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
External costs from production
Production externalities
are generated and received in supplying goods and services - examples include noise and atmospheric pollution from factories.
External costs from consumption
Consumption externalities
played in built-up areas.
are generated and received in consumption - examples include pollution from driving cars and motorbikes and externalities created by smoking and alcohol abuse and also the noise pollution created by loud music being
Negative consumption externalities
benefit.
lead to a situation where the social benefit of consumption is less than the private
5. Explain, using diagrams and examples, the concepts of
negative externalities
of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
Deadweight loss
Deadweight loss
(also known as excess burden or allocative inefficiency) is a loss of economic efficiency that can occur when equilibrium for a good or service is not
Pareto optimal
. In other words, either people who would have more marginal benefit than marginal cost are not buying the product, or people who have more marginal cost than marginal benefit are buying the product.
Causes of
deadweight loss
can include
monopoly pricing
(in the case of artificial scarcity),
externalities
,
taxes
or
binding price ceilings
or
floors subsidies
(including minimum wages). , and The term
deadweight loss
may also be referred to as the "excess burden" of monopoly or taxation.
Deadweight loss
6. Explain that
demerit goods
are goods whose consumption creates external costs.
A
demerit good
is a good or service whose consumption is considered unhealthy, degrading, or otherwise socially undesirable due to the perceived negative effects on the
consumers themselves
. It is over-consumed if left to market forces.
Examples
of demerit goods include tobacco, alcoholic beverages, recreational drugs, gambling, junk food and prostitution. Because of the nature of these goods, governments often levy taxes on these goods (specifically,
sin taxes
), in some cases
regulating
or
banning
consumption or
advertisement
of these goods.
6. Explain that
demerit goods
are goods whose consumption creates external costs.
There is an important conceptual distinction between a
demerit good
and a
negative externality
. A
negative externality
occurs when the consumption of a good has measurable negative consequences on
others
who do not consume the good themselves. Pollution (due, for example, to automobile use) is the canonical example of a negative externality. Another example is cigarettes. It not only affects you, but the people around you (second hand smoking). By contrast, a effects upon the consumer.
demerit good
is viewed as undesirable because its consumption has negative
6. Explain that
demerit goods
are goods whose consumption creates external costs.
7. Internalizing the externality
Internalizing the externality
:
Altering incentives so that people take account of the external effects of their actions.
When either private negotiations or government action lead the price to the party to fully reflect the external costs or benefits of that party’s actions.
7. Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation and tradable permits), and government regulations, to the problem of negative externalities of production and consumption
Public Policies Toward Externalities
Two approaches
Command-and-control policies
regulate behavior directly. Examples: limits on quantity of pollution emitted requirements that firms adopt a particular technology to reduce emissions
EX: Laws & regulations & direct provision
Market-based policies
provide incentives so that private decision-makers will choose to solve the problem on their own.
EX: Taxes, Subsidies, Price Controls & Advertising
7. Evaluate, using diagrams, the use of policy responses, including market-based policies (taxation and tradable permits), and government regulations, to the problem of negative externalities of production and consumption
Command and control instruments (CAC) Command and control instruments,
standards
or
regulations
also referred to as , are the most common forms of environmental policies in both the advanced and developing countries. As the name implies, the CAC approach consists of a
'command',
which sets a
standard
- the maximum level of permissible pollution, and a
'control'
, which monitors and enforces the
standard
.
Advantages of Standards
• • • The main
advantage of standards
is that they are a more widely understood form of environmental policy.
Although
standards
are considered to be inefficient, they are a pragmatic approach when there is uncertainty about the effects of pollution on the environment.
Political costs of market based instruments such as taxes and subsidies as setting
standards standards
are lower compared to does not incur direct budgetary implications.
Disadvantages of Standards
• • • An
'optimum' standard
is one which is not only set at a socially acceptable level, but also is economically efficient or cost effective. In order to set an economically efficient standard, the government needs to know the demand curve for clean air (or water) as well as the supply curve for pollution abatement.
However, clean air (or water) is not a marketable good and therefore the demand curve is not directly observable .
especially when there are numerous polluting firms.
The government also lacks information about the supply curve,
Under a
CAC
approach,
firms have no incentives to reduce pollution beyond the standard
, since it tends to discourage the development of technologies that might otherwise result in greater levels of (pollution) control
Penalties for violating standards tend to be too low and enforcement tends to be weak.
Market-Based Instruments (MBIs) Market-based instruments (MBIs) are policy instruments that use markets, price, and other economic variables to provide incentives for polluters to reduce or eliminate negative environmental externalities.
MBIs
seek to address the market failure of externalities (such as pollution) by incorporating the external cost of production or consumption activities through
taxes
or
charges
on processes or products, or by creating
property rights
and facilitating the establishment of a proxy market for the use of environmental services.
Market-Based Instruments (MBIs)
Examples include
environmentally-related taxes, charges and subsidies, emissions trading and other tradable permit systems, deposit-refund systems, environmental labeling laws, licenses, and economic property rights.
Market-based instruments
do not prescribe that firms use specific technologies, or that all firms reduce their emissions by the same amount, which allows firms greater flexibility in their approaches to pollution management.
Market-Based Instruments (MBIs)
Intervention Type
Excise Tax Subsidies to producers
Effect on Domestic Quantity traded
Falls Rises Maximum Price Ceiling for Producers Falls; Excess Demand Minimum Price Floor for Producers Falls; Excess Supply
Effect on Domestic Consumer Surplus
Falls Rises Rise or Fall Falls
Effect on Domestic Producer surplus
Falls Rises Falls Rise or Falls Zero
Effect on Government Budget
Positive Negative Zero
Tradable permits
Tradable permits
are a cost-efficient, market-driven approach to reducing greenhouse gas emissions. A government must start by deciding how many tons of a particular gas may be emitted each year. It then divides this quantity up into a number of
tradable emissions entitlements
- measured, perhaps, in CO2-equivalent tons - and allocates them to individual firms. This gives each firm a cheaply may find it profitable to do so and to
quota
of greenhouse gases that it can emit over a specified interval of time. Then the market takes over. Those polluters that can reduce their emissions relatively opportunities had been exhausted.
sell their emissions permits
to buy extra permits. Trading would continue until all profitable trading to other firms. Those that find it expensive to cut emissions may find it attractive
Tradable permits
will result in firms to lower the quantity of goods produced.
Tradable Pollution Permits
Tradable Pollution Permits
8. Explain using diagrams and examples, the concepts of consumption of a good or service.
positive externalities
of production and consumption, and the welfare loss associated with the production or There are many occasions when the production and/or consumption of a good or a service creates external benefit s which boost social welfare. Where positive externalities exist, the good or service may be
under-consumed
or
under-provided
account when pricing the product. since the free market may fail to value them correctly or take them into With
positive externalities
the benefit to society is greater than your personal benefit.
Therefore with a
positive externality
the
Social Benefit > Private Benefit
Remember
Social Benefit = private benefit + external benefit.
Positive externalities
Impacts on 'outsiders' that are advantageous to them and for which they do not have to pay. In the case of
positive externalities
the external effects are benefits on other people. These are also known as
external benefits
. There may be external benefits from both
production
and
consumption
. If these are added to the private benefits we get the total social benefits.
For example:
When you consume education you get a private benefit. But there are also benefits to the rest of society. E.g you are able to educate other people and therefore they benefit as a result of your education.
A farmer who grows apple trees provides a benefit to a beekeeper. The beekeeper gets a good source of nectar to help make more honey.
If you walk to work, it will reduce congestion and pollution, benefiting everyone else in the city.
Positive Externalities
9. Explain that
merit goods
are goods whose consumption creates external benefits.
Merit Goods
A product, which consumers may undervalue but which the government believes is 'good' for consumers. It would be under-provided in a pure free-market economy. This is because they have external benefits that people would not take into account when they made their decisions about how much to consume.
With
merit goods
the state is concerned with maximizing the consumption of certain goods which it deems to be desirable; goods and services where the
social benefits exceed the private benefits
, e.g.
education and healthcare
are assumed to generate positive externalities.
9. Explain that
merit goods
are goods whose consumption creates external benefits.
Higher government spending on these welfare.
merit goods
should yield a positive social rate of return which leads to an improvement in total economic There is a case for some form of government intervention to encourage increased consumption of
merit goods
. This might take the form of an
explicit government subsidy
to reduce the private marginal costs of consumption and cause an expansion of demand or provide it themselves.
9. Explain that
merit goods
are goods whose consumption creates external benefits.
SUBSIDY
Payments to producers or consumers designed to encourage an increase in output.
Potential Welfare Gain from Positive Externalities
10. Evaluate, using diagrams, the use of government responses, including
subsidies
, legislation, advertising to influence behavior, and direct provision of goods and services.
The government could
subsidize
the supply of health care. A
subsidy subsidize
would shift the
MSC
curve outward and, in this way, the socially efficient level of consumption could be reached, Indeed" it may be that the government deems the importance of health care to be so great that it will it to the point where it is free to the consumer, or the state will supply it at no direct cost to the consumer.
The main problem with such a solution is cost.
While this provision is possible in many developed countries, developing countries are not able to fund such schemes and so do not fully benefit from the positive externalities that are to be gained from the consumption of health care.
10. Evaluate, using diagrams, the use of government responses, including subsidies,
legislation
,
advertising
to influence behavior, and direct provision of goods and services.
The government could use positive
advertising
to encourage people to consume more health care. This would shift the
MPB
curve to the right, towards the increase welfare.
MSB
curve, and would thus
The problem here is that there may be a high cost
run benefits may be minimal.
to providing the advertising and, although the effect may be beneficial in the long run, it takes a long time to have an effect and so the short The government could government
pass laws (Legislation)
insisting that citizens have vaccinations against certain diseases, or have regular health checks, but this will only be successful if the
provides this free of charge.
Also, people often
resent laws
of this sort being imposed by the government. They see it as an
infringement
of their civil liberties. Laws can be difficult and costly to enforce.
10. Evaluate, using diagrams, the use of government responses, including subsidies, legislation, advertising to influence behavior, and
direct provision of goods and services.
Direct provision of goods and services
like health care could lead to shortages and rationing of these goods and services if they are provided free or without price. Items that are free to the users have no price and thus the market can not ration the good or service.
Public goods
are examples of
direct provision
by governments because markets can’t.
Society may deem certain goods and services worthy for everyone to have access because of the social benefit even thou they are provided my the private markets. Examples are
merit goods
like
healthcare
and
education
.
11. Using the concepts of rivalry and excludability, and providing examples, distinguish between public goods (non-rivalries and non-excludable) and private goods (rivalries and excludable).
excludability:
The ability to keep people who don't pay for a good from consuming the good.
non-excludability:
This means that when the public good is provided to one person, it is not possible to prevent others from enjoying its consumption.
rivalry in consumption:
The property of a good whereby one person’s use diminishes other people’s use.
non-rivalry: This means that one person’s use of the public good does not deprive any other person of such use or does not diminish the amount available to others.
11. Using the concepts of rivalry and excludability, and providing examples, distinguish between public goods (non-rivalries and non excludable) and private goods (rivalries and excludable).
Private goods:
A good that's easy to keep nonpayers from consuming (called to others for a price.
excludability
), and use of the good by one person prevents use by others (termed
rival
consumption). They are privately owned and can be sold
Public goods:
A goods or services which are
non excludable
by the producers and government must provide them.
non-rivalry
in consumption. Because of these characteristics, private sector firms have little or no incentive to produce them, since they would be impossible to sell. Therefore,
11. Using the concepts of rivalry and excludability, and providing examples, distinguish between
public goods
(non-rivalries and non excludable) and
private goods
(rivalries and excludable).
Public Goods
do not have well-defined property rights meaning they are, in essence, owned by everyone.
But such "
public
" ownership is okay because every member of the public can benefit from simultaneously consuming the goods. This public or joint ownership of governments. The prime example of a
public goods
means they cannot be exchanged through markets. The only efficient way to provide public goods is through
public good
is
national defense
. Every member of society benefits when the country is protected from foreign attack and nonpayers can not be excluded from this protection.
11. Using the concepts of rivalry and excludability, and providing examples, distinguish between
public goods
(non-rivalries and non excludable) and
private goods
(rivalries and excludable).
The Different Kinds of Goods
Private goods
: excludable, rival in consumption example: food
Public goods
: not excludable, not rival example: national defense
Common resources
: rival but not excludable example: fish in the ocean
Natural monopolies
: excludable but not rival example: cable TV
A C T I V E L E A R N I N G 1 :
Categorizing roads
A road is which of the four kinds of goods?
Hint: The answer depends on whether the road is congested or not, and whether it’s a toll road or not. Consider the different cases.
49
A C T I V E L E A R N I N G 1 :
Answers
Rival in consumption? Only if congested. Excludable? Only if a toll road. Four possibilities uncongested non-toll road: public good uncongested toll road: natural monopoly congested non-toll road: common resource congested toll road: private good 50
12. Explain, with reference to the
free rider problem
, how the lack of public goods indicates market failure.
Public goods
are difficult for private markets to provide because of the
free-rider problem. Free rider:
a person who receives the benefit of a good but avoids paying for it If good is not excludable, people have incentive to be free riders, because firms cannot prevent non-payers from consuming the good. Result: The good is not produced, even if buyers collectively value the good higher than the cost of providing it.
12. Explain, with reference to the
free rider problem
, how the lack of public goods indicates market failure.
If the benefit of a
public good
exceeds the cost of providing it, government should provide the good and pay for it with a tax on people who benefit.
Problem
: Measuring the benefit is usually difficult. Cost-benefit analysis: a study that compares the costs and benefits of providing a
public good
Cost-benefit analyses
are imprecise, so the efficient provision of
public goods
is more difficult than that of private goods.
13. Discuss the implications of the direct provision of public goods by government.
Public goods
are invariably provided by government because there's no way a private business can profitably produce them. Private businesses can't sell public goods in markets, because they can't charge a
price
and keep nonpaying people away. Moreover, businesses shouldn't charge a
price
, because there's no opportunity cost for extra consumers.
For efficiency, government needs to pay for public goods through taxes.
14. Explain, using examples, common access resources.
Common access resource:
congestion and overuse. A resource, or good, whose characteristics make it costly to exclude potential consumers from its usage, and which is vulnerable to
Examples
include gives rise to the
natural resources
over which there is no established private ownership. They are owned by no one, thus available to anyone to use. Their existence
tragedy of the commons.
Tragedy of the Commons:
a parable that illustrates why common resources get used more than is desirable from the standpoint of society as a whole
14. Explain, using examples, common access resources.
Common Resources
Like public goods,
common resources
are
not excludable.
cannot prevent free riders from using little incentive for firms to provide role for government: seeing that they are provided Additional problem with
common resources
:
rival
in consumption each person’s use reduces others’ ability to use role for government: ensuring they are not overused
Policy Options to Prevent Overconsumption of Common Resources
regulate
use of the resource impose a
corrective tax
to internalize the externality example: hunting & fishing licenses, entrance fees for congested national parks auction off
permits
allowing use of the resource example: spectrum auctions by the U.S. Federal Communications Commission if the resource is land,
convert to a private good
by dividing and selling parcels to individuals Assign
property rights
15. Apply the concept of sustainability to the problem of common access resources.
It is argued that the lack of a price mechanism for
common access resources
results in their overuse, depletion and degradation. The consequence of the actions of producers and consumers, who do not pay for the resources they use, creates a threat to
sustainability
and, therefore, the availability of
common access resources
for future generations.
Sustainability
Sustainability
is the capacity to endure. For humans, sustainability is the long-term maintenance of responsibility, which has environmental, economic, and social dimensions, and encompasses the concept of stewardship, the responsible management of resource use. "
Sustainable development
is development that meets the needs of the present without compromising the ability of future generations to meet their own needs."
16. Examine the consequences of the lack of a pricing mechanism for
common access resources
means that these goods may be overused/depleted/ degraded as a result of activities of producers and consumers who do not pay for the resources that they use, and that this poses a threat to sustainability.
The threat to global
sustainability
comes from the unplanned and often unfettered exploitation of the world's natural resources. The increase in globalization, the drive for economic growth, population growth and developments in technology has made the need for management of
common access resources
more acute, whether this is by governments or by local communities. Clearly, there are already many examples of threats to sustainability from the depletion and destruction of common access resources, such as
deforestation, soil erosion and the overfishing of oceans.
over-exploitation of land for agriculture.
These are compounded by the pursuit of economic growth by newly developing countries, and in less economically developed countries where high levels of poverty and poor regulation creates negative externalities through The depletion of natural resources, such as fossil fuels and fishing resources, creates individual hardship and political instability and potentially threatens world peace. Resource depletion is accelerating and the economic growth of countries that ignore this trend will be eroded by higher commodity prices.
17. Discuss, using negative externalities diagrams, that economic activity requiring the use of
fossil fuels
to satisfy demand poses a threat to
sustainability
.
Fossil fuels fossil fuels
are non-renewable resources as they take millions of years to form and accelerating overuse is leading to their rapid depletion. The principles of supply and demand mean that as overexploitation of resources,
fossil fuels
over-consumed despite their increase in price.
fossil fuel
supplies diminish, prices rise. However, since the producers and consumers of do not have to account to later generations for their are over-produced, and The over-production and overuse of
greenhouse gasses
contributing to the process of
fossil fuels
raises environmental as well as economic concerns, since coal, petroleum, and natural gas contain high percentages of carbon; the burning of which generates
climate change
(GHGs), such as Carbon Dioxide (CO2 )
global warming
. Although there is much argument about the extent to which the human activity contributes to , the effects of climate change are undisputed, leading to increases in average temperature, altered habitats, extreme weather conditions, sea-level changes and flooding.
18. Discuss the view that the existence of
poverty
in economically less developed countries creates negative externalities through
over-exploitation of land
for agriculture, and that this poses a threat to
sustainability
.
Population increases are both a consequence, and cause, of increasing poverty and low standards of living around the world, especially in Asia and Africa. As populations increase the demand on
common access resources
intensifies resulting in extensive
negative externalities
which threatens sustainability.
For the 70% of the world's poor who live in rural areas, agriculture is the main source of income and employment. The depletion and degradation of natural resources poses serious challenges to producing enough food and other agricultural products to sustain local livelihoods, but also to meet the needs of urban populations which rely on this supply.
18. Discuss the view that the existence of
poverty
in economically less developed countries creates negative externalities through
over-exploitation of land
for agriculture, and that this poses a threat to
sustainability
.
Where low-income rural populations rely on subsistence agriculture, the likelihood is that
common access resources
will become depleted, unless there is some form of community collaboration.
Sustainability
of resources may be lost if poor communities are forced to sell land and resources, such as forests, to external private corporations who do not have the interests of the local community as a priority, but need to satisfy their shareholders. Logging companies,
for example
, will wish to maximize their utilization of timber resources taking only their private costs into consideration, ignoring the external costs to the local population. As a consequence, there will be overexploitation of timber and deforestation creating
negative externalities
such soil erosion, landslides, flooding and loss of bio-diversity.
19. Evaluate, using diagrams, possible government responses to threats to sustainability, including
legislation
,
carbon taxes
, cap and trade schemes, and funding for clean technologies.
Governments can respond to
negative externalities
of production and to resource depletion and CO 2 to reduce emissions of global greenhouse gasses and promote sustainability. These include: pollution using a number of mechanisms designed • • • • environmental
taxation
, such as carbon taxes, to recover the external costs of pollution
legislation
setting environmental standards and banning firms which fail to meet these standards adoption of
funding cap and trade schemes
for cleaner technologies for carbon trading Taxation and financial penalties increase the market price of carbon. This provides strong incentives to reduce carbon emissions by sending signals: 1.
2.
3.
to
consumers
about what goods and services produce high carbon emissions and which should be used more sparingly. to
producers
about which inputs emit more carbon, and which emit less, so encouraging them to move to lower-carbon technologies. to
inventors and innovators
processes. to develop and introduce lower-carbon products and
19. Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation,
carbon taxes
,
cap and trade schemes
, and funding for clean technologies.
A
cap and trade scheme
is a
market-based approach
to reduce carbon emissions via financial incentives that allows corporations or national governments to trade emissions allowances under an overall cap, or limit, on those emissions. Fines are imposed for producers exceeding those limits, while producers operating below their carbon limits can sell or "trade" their offsets to companies that are operating above the limits.
Taxation
has the advantage that it can be implemented by individual governments without international agreement, but, environmental taxes have
dead-weight losses
in addition to their beneficial effects in addressing externalities. It is also argued that establishing a price for GHGs through
cap and trade schemes
has the advantage of providing some certainty about reductions in quantities of emissions and creates a market to achieve the climate change mitigation target at the lowest cost.
19. Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and funding for
clean technologies
.
Clean technologies
are designed to minimize pollution and the emissions of
greenhouse gasses
, by creating electricity and fuels with a smaller environmental and carbon footprint. These technologies include recycling, renewable energies (wind and solar power, biomass and biofuels and hydropower), green transportation, waste water recycling and energy efficient lighting, homes, buildings, electric motors and commercial and domestic appliances.
19. Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and
funding
for clean technologies.
If government
subsidies
are particularly focused on the generation of electricity using renewable energy sources, such as wind and solar power, then firms generating electricity using cleaner technologies will face lower costs of production. This will encourage energy producers to produce more wind and solar power, shifting the supply curve to the right and lowering prices for consumers.
19. Evaluate, using diagrams, possible government responses to threats to sustainability, including legislation, carbon taxes, cap and trade schemes, and
funding
for clean technologies.
Cleaner technologies
are not always welcomed by local and national communities.
'Wind farms
local communities for their ', for example, may consist of hundreds of wind turbines and are frequently criticized by some
negative environmental impacts
. They are often seen as a 'blot on the landscape' as well as posing a danger for birds and bats, whose migratory and flight paths may take them into collision with wind turbines and towers. Other alternative energy sources have created similar controversies. The production of
biofuels
has resulted in
food price inflation
worldwide, with land previously used for growing food for human consumption being transferred to the production of crops used to produce biofuels
20. Explain, using examples, that government response to threats to sustainability are limited by the global nature of the problems and the lack of ownership of common access resources, and that effective responses require international cooperation.
Government responses to threats to
sustainability
are limited by the global nature of the problems and the lack of ownership of
common access resources
. Therefore, effective responses require international cooperation.
The United Nations Framework Convention on Climate Change (UNFCCC or FCCC)
The UNFCCC is an international environmental treaty resulting from the 1992 United Nations Conference on Environment and Development (the 'Earth Summit'), held in Rio de Janeiro. The objective of the treaty was to stabilize greenhouse gas concentrations in the atmosphere, although it was considered legally non-binding as it set no mandatory limits on greenhouse gas emissions for individual countries. However, the treaty provided for future 'protocols' or updates that would set these enforceable limits.
The 1997 Kyoto Protocol
The Kyoto Protocol established legally binding obligations for developed countries to reduce their greenhouse gas emissions. Industrialized countries agreed to reduce their combined emissions to 5.2% below 1990 levels during the five-year period 2008-2012. The protocol came into force in 2005.
21. Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more
information
than the other party.
For markets to work, there needs to be
symmetric information
i.e. consumers and producers have the same level of knowledge about the products, and they know everything there is to know about them.
Asymmetric information
occurs when somebody knows more than somebody else in the market. This can make it difficult for the two people to do business together. This is an example of
information failure
in a market.
21. Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more
information
than the other party.
The
moral hazard
other party. problem is the tendency of one party to a contract to alter their behavior after the contract is signed in ways which could be costly to the An
example
of
moral hazard
renew the insurance.
is when people are more likely to behave recklessly after becoming insured, either because the insurer cannot observe this behavior or cannot effectively retaliate against it, for example by failing to The
adverse selection
major costs. problem arises when information known by the first party to a contract is not known by the second and, as a result, the second party incurs An
example
constraints. of
adverse selection
is when people who are high risk are more likely to buy insurance, because the insurance company cannot effectively discriminate against them, usually due to lack of information about the particular individual's risk but also sometimes by force of law or other
21. Explain, using examples, that market failure may occur when one party in an economic transaction (either the buyer or the seller) possesses more
information
than the other party.
A common example of where the buyer pays more for a good than is socially efficient is where the seller knows much more about the characteristics of that good than the buyer.
For example where:
the seller of a product knows it is faulty commercial ideas with technical aspects are hard to describe contractually, but privately known by innovators labelling of food products use alternative terms for ingredients consumers would normally avoid, e.g. various names for sugars such as glucose, sucrose and fructose firms may have no incentive to provide consumers with information in markets with a public good aspect
22. Evaluate possible government responses, including legislation, regulation and provision of information.
The
government
has a number of policy tools at its disposal to correct
asymmetric information
externalities. These include taxes, education programs and production regulation intended to increase the flow of information to consumers. and to control
Remedies for information failure:
Clearly,
government
ensure that some of these information failures are reduced or eliminated. has a considerable role in trying to The two basic strategies are to increase both the supply of, and demand for, information.
22. Evaluate possible government responses, including legislation, regulation and provision of information.
Increasing the supply of information: Options to increase the supply of knowledge include:
Government may force producers to provide accurate information about products through
accurate labeling
.
Public broadcasts
to improve knowledge may also be made. A government can
subsidies
public service TV and radio broadcasting.
Laws
may be passed to force public limited companies to be more transparent, and publish their financial accounts, as well as have them audited to ensure accuracy. Government may also
regulate advertising standards
to make advertising more informative, and less persuasive.
22. Evaluate possible government responses, including legislation, regulation and provision of information.
Increasing the supply of information
Employers may be forced to request that job applicants disclose information about themselves, such as whether they have a criminal record.
Government may force car owners to have their vehicles regularly checked by test, which provides some basic information to potential buyers. In addition to direct intervention, government may establish organizations to act as
regulators
and
watchdogs
Increasing the demand for information
Market theory suggests that demand for knowledge will increase if it is provided freely, or at low cost, hence consumers should not have to pay for information.
Government may also promote the formation of
pressure groups
, which campaign for more knowledge to be made available by producers.
In addition, promoting literacy, numeracy, and IT skills may help increase the demand for information. Having the skills to acquire knowledge can create an increase in demand for knowledge, and a greater appreciation of the value of information in making rational choices.
23. Explain how
monopoly power
can create a welfare loss and is therefore a type of market failure.
Monopolists,
and other imperfect markets, restrict output in order to push up prices and maximize profits. Because of this, they are not producing at the socially efficient level of output. Any imperfect market will fail to equate marginal social cost (
MSC
) and marginal social benefit (
MSB
).
23. Explain how
monopoly power
can create a welfare loss and is therefore a type of market failure.
Market power
is the ability to affect the terms and conditions of exchange so that the price of a product is set by a single company (price is not imposed by the market as in perfect competition). Although a
monopoly's market power
is great it is still limited by the demand side of the market. A monopoly has a negatively sloped demand curve, not a perfectly inelastic curve. Consequently, any price increase will result in the loss of some customers.
24. Discuss possible government responses, including legislation, regulation, nationalization and trade liberalization.
Governments may try to reduce this market failure by intervening in a number of ways. They may use legal measures to make markets more competitive. They may pass laws that
do not permit mergers or takeovers
that give an individual firm more than a certain percentage of the market. In addition, they may pass laws that do not permit mergers or takeovers that enable a specified number of the largest firms in an oligopoly to control more than a certain percentage of the market.
They may set up
regulatory bodies to investigate markets
where it is felt that monopoly power is being used against the public interest. For example most countries have some sort of "
Monopolies Commission
" or "
monopoly watchdog
". These bodies are then empowered to take action of some kind, or to recommend that the government should take action, if it can be shown that the public interest is being harmed.
2.3 Macroeconomic Objectives: Equity in the distribution of income
25. Explain the difference between
equity
income and
equality
in the distribution of in the distribution of income.
Equity
is a normative concept and concerns the
fairness
which scarce resources are allocated among competing ends. Inevitably there are huge disagreements between people as to what an equitable distribution of resources should be.
with Some people argue for much great distribution of income and wealth achieved by making the tax and benefit system much more
equality
in the post-tax
progressive
. They believe that a lack of of goods and services.
equity
leads to market failure because each one dollar of income equates to an economic vote. And since resources tend to flow to those markets where economics votes are highest, a high level of inequality can lead to what is perceived as being an unfair allocation
25. Explain the difference between
equity
income and
equality
in the distribution of in the distribution of income.
The opposite of equity is
inequality
, and this can arise in two main ways:
Inequality of outcome
Inequality of outcome from economic transactions occurs when some individuals gain much more than others from an economic transaction. For example, individuals who sell their labor to a single buyer, a monopsony's, may receive a much lower wage than those who sell their labor to a firm in a very competitive market.
Differences in income are an important type of inequality of outcome.
Inequality of opportunity
Inequality of opportunity occurs
when individuals are denied access to institutions or employment
, which limits their ability to benefit from living in a market economy. For example, children from poor homes may be denied access to high quality education, which limits their ability to achieve high levels of income in the future..
26. Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income.
Given the
unequal distribution of income
that exists in most capitalist economies, is unlikely to be one in which all have an equal say _ clearly economic voting power is directly related to income so that the rich would have many more votes, and thus a much greater pull on resources, than the poor. Consequently, the resulting pattern of pressing, often life and death needs of the poor, and reflect instead the more trivial wants of the rich. In the economics of the market place, human wants are those that are supported by
effective demand resource allocation
may overlook the i.e. demand backed by the ability and willingness to pay the market price for it. Hence the
. Human needs
, however, if unaccompanied by the wherewithal to pay, are simply ignored. This is the overriding reason for the existence of mal-nutrition and starvation in the world today: it is not that there is an overall shortage of food - there is more than enough in total terms to feed everyone; the problem, quite simply, is that those who need the food lack the money to pay
'free' market, given the degree of inequality
their market power. which typically exists, is likely to be one in which many people are severely disadvantaged in terms of
27. Analyze data on relative income shares of given percentages of the population, including deciles and quintiles.
A
quintile
is a
20%
can divide a population into the lowest quintile (the poorest 20% of the population) to the highest quintile (the richest 20%). If income were completely equally distributed, everyone would receive exactly the same income, in which case every quintile would receive 20% of income. However, in the real world this is a virtual impossibility. portion of a country’s population; we
five quintiles
, ranging from Income shares can also be shown by
deciles
, which are
10%
portions of the population (there are ten deciles) as well as
quartiles
, or
25%
portions of the populations (there are four quartiles).
28.
Draw a Lorenz curve and explain its significance.
The two main methods for measuring inequality are the Lorenz curve and the Gini index.
The Lorenz curve:
A
Lorenz curve
shows the % of income earned by a given % of the population. A
‘perfect’ income distribution
would be one where each % received the same % of income. above
Perfect equality Lorenz curve
would be, for example, where 60% of the population gain 60% of national income. In the , 60% of the population gain only 20% of the income, hence the curve diverges from the line of perfect equality of income. The further the
Lorenz curve
is from the 45 degree line, the less equal is the distribution of income. ‘
28. Draw a Lorenz curve and explain its significance.
29. Explain how the Gini coefficient is derived and interpreted.
The
Gini co-efficient
to compare income or between economies. The
index
is a mathematical device used distributions over time and
Gini co-efficient
can be used in conjunction with the
Lorenz curve.
It is calculated by comparing the area under the
Lorenz curve
and the area from the 45 hand and 'x' axis. In terms of the 0 line to the right
Gini index
, the closer the number is to 100 the greater the degree of inequality.
30. Distinguish between absolute poverty and relative poverty.
Absolute Poverty
The state of people who live on less than $1.25 per day (purchasing power parity), as defined by the World Bank. Generally, such individual are unable to afford the basic necessities of life: food, shelter, education, health, etc.
Relative Poverty
that puts one in the lowest income level within his or her own country. Unlike The state of earning an income
absolute poverty
, it exists everywhere, since within even the richest nations a proportion of the population earns relatively less than the top income earners.
30. Distinguish between absolute poverty and relative poverty.
poverty line
an absolute level of income set by the federal government for each family size below which a family is deemed to be in poverty
poverty rate
the percentage of the population whose family income falls below an absolute level called the poverty line
31. Explain possible
causes of poverty
, including low incomes, unemployment and lack of human capital.
Poverty has many causes
keep them poor. , some of them very basic. Some experts suggest, for instance, that the world has too many people, too few jobs, and not enough food. But such basic causes are quite intractable and not easily eradicated. In most cases, the causes and effects of poverty interact, so that what makes people poor also creates conditions that
Primary factors that may lead to poverty include
overpopulation, the unequal distribution of resources in the world economy, inability to meet high standards of living and costs of living, inadequate education and employment opportunities, environmental degradation, certain economic and demographic trends, and welfare incentives.
32. Explain possible
consequences of poverty
, including low living standards, and lack of access to health care and education.
Direct costs:
Health care for the uninsured and the underinsured Shelters for the homeless Public housing and support for private housing Food for the hungry Direct costs to victims of higher crime rates High debt levels
Indirect costs:
Increased costs for police, the judicial system, correction facilities and security systems Reduced income taxes and other taxes “Loss of the multiplier effect of having people employed at living wages” Contributions to society lost because of an uneducated public
33. Distinguish between
direct
and examples of each, and explain that direct taxes may be used as a mechanism to redistribute income.
indirect taxes
, providing
An
indirect tax
the person who bears the ultimate economic burden of the tax i.e. consumer. is a tax collected by an intermediary i.e. seller, from
It is imposed on expenditure
. In simple terms, it is a tax which is imposed on goods and services sold. It is usually added to the cost of the good or service and charged from the ultimate consumer. The seller will then file a return to the government on all the taxes he has collected from the consumer.
Examples
GST VAT
(Goods and service tax) (Value added tax) Consumers are charged a the Government.
percentage of tax
while purchasing a good/service and then the seller pays the tax collected to
33. Distinguish between
direct
and
indirect taxes
, providing examples of each, and explain that direct taxes may be used as a mechanism to redistribute income.
Direct Taxes
It is a tax paid directly to the government by the persons on whom it is imposed.
Examples
Tax imposed on peoples’ income-
Income tax
Tax on wealth –
wealth Tax
Tax on firm’s profits.-
corporate tax
34. Distinguish between progressive, regressive and proportional taxation, providing examples of each.
Progressive Tax
A tax in which people with more income pay a larger percentage in taxes.
Example: Income tax (Direct Tax)
Regressive Tax
A tax in which people with more income pay a smaller percentage in taxes.
Example: Sales Tax (Indirect Tax)
Proportional Tax
same percentage of income in taxes regardless of their incomes.
A tax in which people pay the
Example: Flat Tax (Direct Tax)
Examples of the Three Tax Systems
income
regressive
tax % of income $50,000 $15,000 30%
proportional
tax % of income $12,500 25%
progressive
tax % of income $10,000 20% 100,000 25,000 25 200,000 40,000 20 25,000 25 50,000 25 25,000 25 60,000 30
35. Calculate the
marginal rate of tax
and the
average rate of tax
from a set of data.
An
average tax rate
is the ratio of the total amount of taxes paid to the total tax base (taxable income or spending), expressed as a percentage.
Let
T
be the total tax liability.
Let
B
be the total tax base.
Average tax rate = T / B
35. Calculate the
marginal rate of tax
and the
average rate of tax
from a set of data.
A
marginal tax rate
is sometimes defined as the tax rate that applies to the last (or next) unit of the tax base (taxable income or spending). In plain English, the
marginal tax rate
is the tax percentage on the highest dollar earned. For example, in the United States, the top
marginal tax rate
is 39.6%, but that rate applies only to earnings over $400,000 per year; earnings under $400,000 have a lower tax rate of 33% or less.
That formal definition only holds true to the equation following when the denominator equals one unit of the tax base. In practice most decisions require the denominator to be a larger amount. The as a percentage.
marginal tax rate
equals the change in taxes divided by the change in tax base, expressed Let
T
be the total tax liability.
Let
B
be the total tax base.
Marginal tax rate =
T / B
36. Explain that governments undertake expenditures to provide directly, or to subsidize, a variety of socially desirable goods and services (including health care services, education, and infrastructure that includes sanitation and clean water supplies), thereby making them available to those on low incomes.
Higher government spending on
merit goods
should yield a
positive social rate of return
which leads to an improvement in total economic welfare.
There is a case for some form of government intervention to encourage increased consumption of
merit goods
. This might take the form of an
explicit government subsidy
to reduce the private marginal costs of consumption and cause an expansion of demand.
The government often provides merit goods "
free at the point of use
" and then finances them through general taxation. Examples of merit goods that are largely state provided include primary health care and public schooling.
37. Explain the term allowances.
transfer payments
, and provide examples, including old age pensions, unemployment benefits and child A
transfer payment
is a payment from the government to an individual for which no good or service is exchanged. In order to be eligible to receive them, an individual has to fall below a certain income threshold or to be experiencing economic hardship.
Transfer payments
existing in most developed countries include: Unemployment benefits Social security benefits Nutritional subsidies Higher education grants and tuition subsidies Welfare benefits
38.
Evaluate
effects on government policies to promote
efficiency equity
(taxation, government expenditure and transfer payments) in terms of their potential positive or negative in the allocation of resources.
A
tax system
that punishes innovation, productivity and hard work is clearly undesirable and should therefore be avoided. However, a tax system including
progressive marginal income taxes
combined with
regressive indirect taxes
ensures that both the rich and the poor share a portion of the nation’s tax burden. Yet it also ensures that those with the greatest ability to pay bear the largest burden while those whose ability to pay the lowest benefit from the
public
and
transfer payments
that the government provides. This reduces the inequality of income distribution and corrects for the
market failures
that results in a
free market system
.
38.
Evaluate
effects on government policies to promote
efficiency equity
(taxation, government expenditure and transfer payments) in terms of their potential positive or negative in the allocation of resources.
Progressive Tax
A tax in which people with more income pay a larger percentage in taxes.
Regressive Tax
A tax in which people with more income pay a smaller percentage in taxes.
Proportional Tax
A tax in which people pay the same percentage of income in taxes regardless of their incomes.
in-kind transfers
transfers to the poor given in the form of goods and services rather than cash
38.
Evaluate
effects on government policies to promote
efficiency equity
(taxation, government expenditure and transfer payments) in terms of their potential positive or negative in the allocation of resources.