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Topic 5 Government intervention in the market

1 An example of a market functioning inefficiently is the international airline industry. International air flights do not pay fuel duty but they emit carbon dioxide emissions, which are negative externalities, into the atmosphere. This is a market failure because the airlines do not pay the full costs of production. This is inefficient because the market price does not reflect the true costs of air travel. As a result the free market price is too low, too many people travel by air and resource misallocation occurs.
(5 marks)

2 Fuel taxation could be used to raise the price of air travel. The revenues raised could be used to correct the damage caused by the negative externalities. The higher price will discourage consumption.
(2 marks)

3 The word ‘equitable’ means ‘fair’ or ‘just’ and the word ‘inequitable’ means ‘unfair’ or ‘unjust’. Many, though not all, economists believe that a highly unequal distribution of income should be deemed a market failure, on the ground of inequity. However, inequity and equity are normative words, so not all economists agree. Make sure that you do not confuse inequity with inequality (a positive word). Some say the market for bank workers is inequitable as the pay of top bankers is hundreds per cent higher than the pay of bank cashiers. (6 marks)

4 Progressive taxation could make the market for bank workers function more equitably. An income tax is progressive if a progressively larger proportion of income is paid in tax as income increases.
(2 marks)

The diagram above is nearly identical to the diagram drawn in the answer to part 04 of the data response question on tobacco as a demerit good in Topic 4 (see page 31). In this case, however, the demand curve has been drawn elastic, showing a more than proportionate fall in demand following the increase in price that results from the imposition of the indirect tax. Given this assumption about the elasticity of demand (which may be unrealistic), the indirect tax successfully reduces demand for alcoholic drink from Q1 to Q2. (8 marks)

6 Imposing a price ceiling on the fees universities can charge for higher education would keep the price down, but it could leave to excess demand and too few higher education places being made available by the universities. This means, to be successful, the price ceiling would need to be supported by another policy such as granting subsidies to universities. (4 marks)


7 A tradable market in permits to pollute in the electricity market works in the following way. Coal-burning power stations able to reduce pollution by more than the law requires sell their ‘spare’ permits to other power stations which, for technical or other reasons, decide not to, or cannot, reduce pollution below the maximum limit. The latter still comply with the law, even when exceeding the maximum emission limit, because they buy the ‘spare’ permits sold by the former group of power stations. In the long run, even power stations that find it difficult to comply with the law, have an incentive to reduce pollution, so as to avoid the extra cost of production created by the need to buy pollution permits. (8 marks)



8 The issue here is ‘fairer for whom’? Government provision of healthcare is certainly fairer for poor people who could not afford to buy market-provided healthcare but who now receive free state-provided healthcare. But is it fairer for somebody who in the current system lives in a part of the UK where local NHS hospitals are poor. Is it fairer for people whose health deteriorates while languishing on NHS waiting lists, or who suffer from a ‘postcode lottery’ in which similarly ill people living 50 miles away are prescribed expensive drugs denied to them.

Neither the current NHS provision nor market provision is fair, though arguably state provision is fairer. Hospital care could be provided through a state-guaranteed private insurance system. Healthy people never know whether they will be ill in the future and will require expensive hospital treatment many years ahead. But while an individual seldom knows whether a future operation will be required, insurers can predict, using the ‘law of large numbers’, how many people in an age group are likely to suffer a serious disease in the future. Private but state-backed health insurance, which forces everybody to pay insurance premiums and insurance companies to accept contributions from everybody, is the way forward. (10 marks)

9 The passage mentions three forms of rationing healthcare other than rationing through prices. These are: quantity rationing, which results in queues and waiting lists; rationing by lottery; and rationing through the notion of blame. This answer is going to evaluate the first of these, quantity rationing. Rationing by queues and by waiting lists occurs when the price of a good is set below the market-clearing price, which creates excess demand and a shortage. This can happen if the government introduces a maximum price law, or, in the case of events such as football matches, rock concerts and art exhibitions when the promoter of the event sets admission prices that are too low. Rationing by queues and waiting lists leads to black markets. Some economists believe that black markets perform a useful economic function, bringing together buyers and sellers, with the black market price clearing the market. Others argue that black markets lead to criminal behaviour and racketeering.

In the health service, quantity rationing has the adverse effect of patients dying while they wait several weeks or even months for treatment. It also leads to queue jumping when patients who can afford to choose private treatment instead, often in NHS hospitals. However, defenders of the system argue that this frees scarce resources within the NHS, which can be used to treat patients who cannot afford to queue jump. (10 marks)

10 Market failure occurs when markets function badly or unsatisfactorily. Market failure occurs when banks function inequitably or inefficiently, and in the latter case, when one of the three functions prices perform in a market breaks down. In an extreme case, when all three functions (signalling, incentive and rationing) break down, a market ceases to function at all. In this situation, there is a ‘missing market’.

Government failure, by contrast, occurs when government intervention in the economy, sometimes to correct market failure, is ineffective. In extreme cases, government intervention may create new problems worse than those the intervention was supposed to cure. For example, government intervention through high taxation to make incomes more equal may reduce incentives to work hard and this may harm economic growth. (10 marks)

Answers to exam-style questions (data response)

01 Imperfect information is when either a supplier or a buyer lacks sufficient information about a transaction to make an informed efficient choice. In everyday markets economic agents frequently make decisions based on imperfect information but as information becomes more limited the probability of a poor decision increases. (5 out of 5 marks)

This is a correct answer. The question does not require an example but it is often useful to include one as it will pick up a mark (provided it is correct) if the definition is a little imprecise or fuzzy.

02 First, the percentage of obese and overweight men and women increased steadily throughout the period. In 1994 14% of men and 18% of women were obese yet by 2008 levels of obesity for both men and women had reached 25%. Likewise, in 1994 49% of women and 58% of men were overweight. By 2008 these figures had risen to 57% and 66% respectively.

Second, the gap between overweight men and women remained relatively stable over the 12-year period. In both 1994 and 2008 approximately 9% more men are overweight than women. By contrast, the gap between obese men and obese women closes over the period. In 1994 there is a gap of about 4% but by 2008 both genders have levels of obesity at roughly 25%. (8 out of 8 marks)

This answer meets all the requirements of part 02 or 06 questions and earns full marks. There is sufficient comparison across the different data series, all the comparative points are significant, and accurate statistical back-up is provided.

03 The central problem in this situation is that consumers are not being provided with sufficient information to make an informed choice. The food packets that customers are buying do not provide sufficient information about the number of calories contained. As a result individuals are making choices based on imperfect information, which leads to overeating and raised levels of obesity. As can be seen from the trends in Extract A, overeating and obesity have been steadily increasing in the last 20 years in the UK.

This is a market failure because consumers cannot make an informed choice and therefore behave in a manner that does not maximise their welfare. The figure above includes two curves, each showing the marginal benefits enjoyed by a person as a result of eating food. The inner curve is labelled marginal benefits (with full information). Full or perfect information includes information about the adverse health consequences of overeating, and/or eating the wrong kinds of foods. Given full information, the person chooses to eat Q2 food. But in real life, the problem is that many people ignore or downplay the long-term adverse consequences of overeating and/or consuming the wrong kinds of foods. The level of food consumption of a person whose eating habits are shown in the figure are determined where the curve labelled marginal benefits (with imperfect information) intersects the MPC curve. Q1 food is eaten, and overeating is shown by Q1 minus Q2. (12 out of 12 marks)

Pay special attention to the ‘appropriate diagram’ in this answer. Exam questions that focus on perfect and imperfect information are increasingly appearing in the ECON1 exam, but not all exam candidates seem to be familiar with the meanings of, and the difference between, the two concepts.

04 The debate about the role of government in an economic system is central to the study of economics. At present the UK has a mixed economy which is tilted in favour of markets. The dominant view among policy makers since 1979 is that markets are more efficient at allocating scarce resources than governments. Nevertheless, in 2012 the British state still accounts for 44% of GDP and large command structures, such as the NHS, still allocate billions of pounds of resources every year.

In terms of food markets, most economists believe food should be provided by markets because the profit incentive drives farmers to produce higher crop yields. However, the balance of market power between producers (farmers) and buyers (large supermarket firms) is tilted very much on the side of the supermarkets. Arguably, supermarkets use the market power that their size gives them to force farmers, who individually possess very little market power, to accept very low prices for the foods they are selling. At the moment, the UK government does very little, apart from trying to persuade the supermarkets to be fairer in their dealings with farmers, to alter this asymmetry in market power. Some people believe that the government should intervene in food markets in other ways to correct this market failure, for example by introducing and then enforcing minimum legal prices, or price floors, for agricultural produce. Others disagree, arguing that such intervention will lead to government failure, for example by creating excess supply which in a free market is corrected automatically by a fall in market prices. However, price floors would allow farmers to make sufficient profit to invest in new production techniques that might increase domestic supply of foods in the long run.

When it comes to the issue of food labelling rather than replacing the market mechanism for setting prices, economists are more divided. As Extract B explains, a government agency, the FSA, believes that food labels provide consumers with too little information about additives in processed foods. The FSA would like to correct the problem by introducing better food labels which will properly inform consumers about the qualities of the food that they buy. However, if food labels better inform customers about the food that they buy then demand for certain types of processed food will decrease because consumers will better understand the consequences of eating high fat and high salt foods. However, many free-market economists reject the call for further regulation on food labelling, arguing that it is unnecessary regulation that will increase food costs. In their view, self-regulation by the food industry is preferable to external regulation. On balance, the case for further external regulation is stronger, for the simple reason that self-regulation has simply not provided consumers with sufficient accurate information about the foods they buy. (21 out of 25 marks)

Very often, the preamble to a part 04 or 08 question is: Making use of the data and your economic knowledge … This answer makes use of both, but misses the opportunity to draw on characteristics of food markets, other than those set out in the Extracts, which might call for intervention by governments. While it is not vital to do this, these could include the health and safety aspects of food markets, and the monopoly power that food processing companies and large supermarket chains my exercise at the expense of small farmers (and/or consumers).


This answer has been placed at the top of Level 4, though a lack of formal analysis and use of diagrams, may mean the answer has been over-marked. Either way, the answer does not reach Level 5, for which the grade descriptor is:

AS LEVELS OF RESPONSE AO1 KNOWLEDGE and UNDERSTANDING of theories, concepts and terminology AO2 APPLICATION of theories, concepts and terminology AO3 ANALYSIS of economic problems and issues AO4 EVALUATION of economic arguments and evidence, making informed judgements
Level 5 22–25 marks (mid-point 24) Good analysis and good evaluation Good throughout the answer with few errors and weaknesses Good application to issues Good use of data to support answer Relevant and precise with a clear and logical chain of reasoning Good with a clear final judgement

 


Date: 2015-02-03; view: 921


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