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!