IB Economics Section 1.4 Market Failure Section 2.4 Equity in ...

IB Economics Section 1.4 Market Failure Section 2.4 Equity in ...

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 societys 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 underallocation 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 betteroff 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 means that one party in a transaction has more information than the other or they neglect to take full responsibility for their action which creates a 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 monopolies lead to under-production and higher prices than would exist under conditions of competition, causing consumer welfare to be damaged 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): The cost incurred by both the firm and society in producing each extra unit of a good. 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, prices in a competitive market do not reflect the full costs or benefits of producing or consuming a product or service. Producers and consumers may neither bear all of 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. 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 negative externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service. 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 overproduction 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 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 played in built-up areas. Negative consumption externalities lead to a situation

where the social benefit of consumption is less than the private benefit. 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 subsidies, and binding price ceilings or floors (including minimum wages). 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). 6. Explain that demerit goods are goods whose consumption creates external costs. 7. Evaluate, using diagrams, the use of policy responses, including marketbased policies (taxation and tradable permits), and government regulations, to the problem of negative externalities of production and consumption 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 partys 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 marketbased 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, also referred to as standards or regulations, 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 standards are lower compared to market based instruments such as taxes and subsidies as setting standards 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 . The government also lacks

information about the supply curve, especially when there are numerous polluting firms. 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 environmentallyrelated 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 Market-Based Instruments (MBIs) Interventi on Type Effect on Domestic Quantity traded Effect on

Domestic Consumer Surplus Effect on Domestic Producer surplus Effect on Governme nt Budget Excise Tax Falls

Falls Falls Positive Subsidies to producers Rises Rises Rises Negative

Maximum Falls; Excess Rise or Fall Price Ceiling Demand for Producers Falls Zero Minimum Price Floor for Producers Rise or Falls

Zero Falls; Excess Falls Supply 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 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 cheaply may find it profitable to do so and to sell their emissions permits to

other firms. Those that find it expensive to cut emissions may find it attractive to buy extra permits. Trading would continue until all profitable trading opportunities had been exhausted. Tradable Pollution Permits Tradable Pollution Permits 8. Explain using diagrams and examples, the concepts of positive externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service. There are many occasions when the production and/or consumption of a good or a service creates external benefits which boost social welfare.

Where positive externalities exist, the good or service may be under-consumed or under-provided since the free market may fail to value them correctly or take them into account when pricing the product. 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 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 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 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 subsidize 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 MSB curve, and would thus increase welfare. The problem here is that there may be a high cost 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-run benefits may be minimal. The government could pass laws (Legislation) insisting that citizens have vaccinations against certain diseases, or have regular health checks, but this will only be successful if the government 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 cant. 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 persons use diminishes other peoples use. non-rivalry: This means that one persons 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 (nonrivalries and non-excludable) and private goods (rivalries and excludable).

Private goods: A good that's easy to keep nonpayers from consuming (called excludability), and use of the good by one person prevents use by others (termed rival consumption). They are privately owned and can be sold to others for a price. Public goods: A goods or services which are nonexcludable by the producers and 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, government must provide them. 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 public goods means they cannot be exchanged through markets. The only efficient way to provide public goods is through governments. The prime example of a 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 ACTIVE LEARNING 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 its a toll road or not. Consider the different cases. 49 ACTIVE LEARNING 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: monopoly congested non-toll road:

natural common 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 nonpayers 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

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: A resource, or good,

whose characteristics make it costly to exclude potential consumers from its usage, and which is vulnerable to congestion and overuse. Examples include natural resources over which there is no established private ownership. They are owned by no one, thus available to anyone to use. Their existence gives rise to the 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. government: 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 persons 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 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 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 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 global 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. 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 over-exploitation of land for agriculture. 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 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 fossil fuel supplies diminish, prices rise. However, since the producers and consumers of fossil fuels do not have to account to later generations for their overexploitation of resources, fossil fuels are over-produced, and over-consumed despite their increase in price. The over-production and overuse 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 greenhouse gasses (GHGs), such as Carbon Dioxide (CO2 ) contributing to the process of global warming. Although there is much argument about the extent to which the human activity contributes to climate change, 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 overexploitation 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 CO2 pollution using a number of mechanisms designed to reduce emissions of global greenhouse gasses and promote sustainability. These include:

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 cap and trade schemes for carbon trading funding for cleaner technologies Taxation and financial penalties increase the market price of carbon. This provides strong incentives to reduce carbon emissions by sending signals: 1. to consumers about what goods and services produce high carbon emissions

and which should be used more sparingly. 2. to producers about which inputs emit more carbon, and which emit less, so encouraging them to move to lower-carbon technologies. 3. to inventors and innovators to develop and introduce lower-carbon products and processes. 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 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', for example, may consist of hundreds of wind turbines and are frequently criticized by some local communities for their 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 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 other party. An example of moral hazard 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 renew the insurance. The adverse selection 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 major costs. An example 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 constraints. 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 and to control externalities. These include taxes, education programs and production regulation

intended to increase the flow of information to consumers. Remedies for information failure: Clearly, government has a considerable role in trying to ensure that some of these information failures are reduced or eliminated. 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. 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 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 A Richer

World BBC 25. Explain the difference between equity in the distribution of income and equality in the distribution of income. Equity is a normative concept and concerns the fairness with 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. Some people argue for much great equality in the post-tax distribution of income and wealth achieved by making the tax and benefit system much more progressive. They believe that a lack of 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 of goods and services. 25. Explain the difference between equity in the distribution of income and equality 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 resource allocation may overlook the 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 26. Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income. 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 for it. Hence the 'free' market, given the degree of inequality which typically exists, is likely to be one in which many people are severely disadvantaged in terms of their market power. 27. Analyze data on relative income shares of given percentages of the population, including deciles and quintiles. A quintile is a 20% portion of a countrys population; we can divide a population into five quintiles,

ranging from 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. 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 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. Perfect equality would be, for example, where 60% of the population gain 60% of national income. In the above Lorenz curve, 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 or index is a mathematical device used to compare income distributions over time and between economies. The 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 450 line to the right hand and 'x' axis. In terms of the 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 The state of earning an income that puts one in the lowest income level within his or her own country. Unlike 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, 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 keep them poor. 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 32. Explain possible consequences of poverty, including low living standards, and lack of access to health care and education. What Is Kuznets Curve?

The Kuznets curve is a hypothetical curve that graphs economic inequality against income per capita over the course of economic development. This curve is meant to illustrate the behavior and relationship of these two variables as an economy develops from a primarily rural agricultural society to an industrialized urban economy. The graph shows income inequality following the curve, 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. An indirect tax is a tax collected by an intermediary i.e. seller, from the person who bears the ultimate economic burden of the tax i.e. consumer. 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 (Goods and service tax) VAT (Value added tax) Consumers are charged a percentage of tax while purchasing a good/service and then the seller pays the tax collected to the Government.

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 incomeIncome tax Tax on wealth wealth Tax Tax on firms profits.- corporate tax 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. 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 nations 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. 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.

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