(a) Explain why imperfect information and immobility of factors of production may lead to market failure. [10]

Transcription

1 1 H2 Economics Nov 2008 Market Failure (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 government to correct these causes of market failure. [15] Part (a) Step1: causes: imperfect information & immobile FOPs / effect: market failure Step 2: explain imperfect info; immobile FOPs Step 3: explain MF Step 4: explain how imperfect info leads to MF & explain how immobile FOPs leads to MF Suggested Answer Market failure refers to the inability of markets to achieve an efficient allocation of resource to maximise social welfare, when they are unregulated by governments. Market imperfections such as imperfect information and immobile FOPs, prevent the price mechanism from working efficiently to allocate resources. Remarks This is to explain effects Step 3 Allocative efficiency of resources is achieved when all markets produce the most preferred combination of goods that maximises welfare. Imperfect information occurs when consumers or producers have limited, incomplete, inaccurate or misunderstood data and information set. Thus, they face the risk of making sub-optimal choices that lead them to enjoying lower satisfaction or profits respectively. Hence, societal welfare is not maximised due to imperfect info. For example, consumers often under-consume merit goods, say healthcare because they do not have the full info on the full benefits derived from the consumption of such goods. Specifically, consumers of education are unable to value fully the benefits of consulting a doctor when they fall ill. They may fell that they are not ill enough to justify the doctor s consultation fees, and hence curtails his visits Step 2 explain causes ANALYSIS Step 4 An explicit link to imperfect information is needed.

2 2 to the doctor. This leads to under-consumption of healthcare that generates positive externalities and market failure results. Also, consumers often over-consume demerit goods, for eg, cigarettes, because on their own, they lack knowledge on the harms on their health and on non-smokers when they smoke. Similarly, producers also have imperfect information when they engage in production of goods. For eg, firms lack info on the damage they do to the environment and ozone layer when they produce aerosols and CFCs. They also lack complete info on the damage to ocean life when they discharge chemical wastes into the waters and seas, or due to the release of pollutants into the air. Step 4, now imperfect info for producers This leads to over-production of goods that generate negative externalities, i.e. pollution and market failure results. Factor immobility, for eg, labour immobility occurs when FOPs are unable to react to changes in market demand and supply, such that there is an underproduction of certain labour services. Labour immobility occurs due to either geographical or occupational immobility. In the case of geographical immobility, consider a teacher who lives in New York (east coast of USA). If there is a rise in the demand for teachers in California (west coast of USA), the price (wages) for teachers will rise, to signal to labour units to move to the west coast to take up teaching jobs. Step 2 Step 4 for geo immobility However, teachers in NY will refrain from relocation to California as there is relocation costs involved, for eg, costs of moving house and whole family, search for new schools for children, etc. The higher wages are insufficient to entice NY teachers to move, thus there is an under-production of teacher services on the west coast. As for occupational immobility, consider a worker, for eg, an electrical technician in relatively low-skilled industry who lost his job. If there is a rise in the demand for high skilled work, for eg, an water technology engineer, such as high value added manufacturing, the price (wages) for engineers will rise, to signal to labour units to switch industries, to take up engineering jobs. Step 4 for occup immobility

3 3 However, the switch will not be easy because the water tech engineer job requires very specific skills, such understanding of water chemistry, use of specialised computer programmes to monitor water processing, etc. The electrical technician possesses only general skills only, for eg, handling of manual tools, reading of simple programmes, etc. Thus, there exists structural unemployment, whereby there is a skills mismatch b/w the skill demanded (required) and the skills supplied (on offer). Hence, there is an under-production of water tech engineers. Thus, both geographical and occupational immobility lead to underproduction of labour when there are changes in market demand and supply, and market failure occurs. Notes: 1. Imperfect info and immobile FOPs are not context or egs. So, to make your life easier, you must aim to intro context ASAP! (Similarly for income equality.) 2. I intro egs very often along the way. When in doubt, use egs to rescue yourself! 3. Other poss approaches/answers: i) Imperfect info in imperfect markets, for eg, advertising distorts real and perceived benefits of consuming a goods or service. ii) Occupational immobility leads to productive inefficiency, for eg, labour used in ways that s not productively efficient (disguised unemployment, under-employment) or more time needed to match jobs and workers well. iii) Explain using capital instead of labour. Understand that CAMBRIDGE will accept a variety of approaches, not just one and only one. 4. Unsuitable approaches: i) Government lacks imperfect info, for eg, unable to value the cost of externalities ii) Consumers lack knowledge of prices or of products produced by monopolists (confused imperfect knowledge with imperfect markets.)

4 4 Part (b) Step1: causes: policies / effect: correct market failure Step 2: explain policies Step 3: already done in part (a) Step 4: explain how chosen policies corrects MF Step 5: evaluate the policies, either in terms of effectiveness or limitations Suggested Answer One of the micro goals of the S pore Govt is to achieve social efficiency. Remarks S2 Hence, several policies are currently adopted to correct market failure due to imperfect information and immobile FOPs. The most apt choice of policies depends on the root of the problem. For eg, in order to reduce the root problem of imperfect info in the case of consumers unable to value the full benefits of doctor consultation or preventive healthcare, education measure is one main method to provide more info. For eg, Govt highlights the importance of health screening procedures on air, TV and in newspapers, so that consumers realise that regular health tests can detect and prevent major illnesses that may occur later, if left undetected. Or Govt can stress on the importance of consulting doctor, even if its merely fever, as the underlying causes of fever can be very serious or contagious, such as public health risks like H1N1, SARS, etc Consumers can then appreciate the need for such healthcare services, so as to be able to continue with a healthy lifestyle. More information on the importance can change the tastes and preferences in favour of preventive healthcare, and hence raises the demand for this merit good. However, education measures aimed at changing mindset of consumers mean success in the SR is limited. Education campaigns will take time to be effective, and thus more budget needs to be set aside by the Govt. Potentially, conflict such as market failure in other areas can arise due to funds rechanneling. - evaluate

5 5 Next, as for producers having imperfect info to be able to value the true cost of their production activities, a tax is another method to provide more info. A tax that equals to the MEC in the case of pollution due to production can provide more info to producers. With a tax imposed, producers can better understand the environmental damage that results from their production. They can more fully estimate the full cost to society. With this awareness, producers have an incentive to internalize the tax, and use this new info to reduce production levels that is socially efficient. However, not all firms release equal amounts of pollutants into the air, so ideally varying tax rates can be imposed. In order to do so, the Govt needs to have perfect info, which is unlikely too. A common tax rate is unfair, and potentially the market may experience Govt failure, in the event of the tax being too high. Legislation measures have been seen in the case of smoking, whereby it is compulsory for firms to display clearly health warnings on cigarettes packs. This continuous provision of info to smokers helps to raise knowledge of health risks. Demand for cigarettes may fall. However, the demand for cigarette smoking is highly price inelastic. Very few substitutes are avail. More success can be seen if the Govt reduces demand among youths and beginning smokers, whose demand is relatively price elastic, rather than tackle the problem among seasoned smokers. In the case of occupational labour immobility, the S pore Govt has implemented various manpower policies such as training and skills upgrading programmes to equip labour with new and essential skills to gain employment in the new growth, sunrise industries. For eg, Skills Programme for Upgrading and Resilience (SPUR) and Workforce Skills Qualification (WSQ) programmes aim to train local, low-skilled and retrenched workers to upgrade skills to land on the new jobs available. Such manpower programmes are heavily subsidised by the Govt, so that there is sufficient production of high skilled workers. Again, supply-side manpower policies need time to raise workers adaptability and skill flexibility. Their willingness and ability to undergo is another challenge because the concepts of lifelong learning and lifetime employability have to be instilled before success can be seen. Also, there is potentially govt failure here, as it is the former who predicts the

6 6 trends and need of the S pore economy in future. Any training that caters to a short-lived industry becomes obsolete very fast. Finally, geographical labour immobility in S pore is not serious because we re physically small. Plus the highly public transport and road networks, the issue is non-existent. In summary, the Spore Govt has implemented several policies to correct market failure due to imperfect info, geographical and occupational labour immobility. Currently, occupational labour immobility seems to be the most severe and the success of the policies depends on how quickly the mindsets of the labour force can be changed favourably. Notes: 1 As context is not chosen at all in the qn, you can vary your egs anytime you wish. In the above sample, I have demo with consistent egs in parts (a) and (b). You NEED NOT do so. This should prove to be easier for you to conquer this essay. 2 Other approaches/answers: i. Legislation in healthcare: display of prices of medicine and medical procedures and operations. ii. iii. iv. Legislation in education: compulsory education for P1 to P6 primary education. Education in lifestyle: food pyramid for healthy eating; regular preventive dental care Subsidies / funding to non-profit orgs or charitable orgs: encourage charity works to reduce income inequality v. Legislation in imperfect markets: disallow false info that can be released by firms that do advertising, to reflect true benefits derived from the consumption of the good. 3 Answers not suitable: a. Firms to advertise to inform consumers where to purchase the goods b. Price discrimination to let some consumers to gain from consumption that they couldn t afford when only a single price was set. Obviously, I added more points (analysis and evaluation) than needed to secure a level-3 answer in this sample. Cambridge marks more leniently than your tutors. However, they are still very strict on ANALYSIS. Remember, breakdown for more linkages, and use egs and/or diagrams to provide good analysis.