Unit 1 - Introduction to markets and market failure
Institution
PEARSON (PEARSON)
This document consists of 26 pages of Paper 1 Essay plans (Microeconomics). Each essay plan includes top facts, analysis, knowledge and evaluation to get you an A* in your Economics A-level. Each plan is tailored to the top scoring 25 marker structure of the Edexcel Board. However, they can be used...
Unit 1 - Introduction to markets and market failure
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Paper 1 Essay Plans
Negative Externalities Essays:
Evaluate two policies a government could impose to reduce effects of a negative
externality in Production. Use an industry of your choice in your essay.
Intro: Beef cattle production is a booming industry in America - $66 billion in added value to
the U.S. However, huge negative externality in production –> pollution.
P1: Indirect Tax
Point: An indirect tax can be used to reduce the negative externality.
Cause of externality:
Cows produce more CO2 then the emissions from 22 million cars a year -> Negative
externality is a cost to a third party -> Respiratory illnesses + Global warming ->
health risk -> Market failure -> inefficient allocation of resources.
Research showed that taxes of 40% on beef would be suitable to account for the
damage of production via climate change onto people
How to reduce it:
In free market good is overconsumed and overproduced -> high Social cost ->
welfare loss -> Role of the government to eliminate this -> indirect tax:
Causes cost to suppliers to increase -> Shifts MPC by the size of the tax -> new
equilibrium is formed at Q1,P1 (socially optimum level) -> dead weight loss no longer
cost to society -> if the size of the tax is correct -> completely internalise the
externality -> also a source of revenue for government. Tax diagram.
Example: Australia carbon tax in 2012 -> Greenhouse gases emission decreased 9.6%
Evaluation:
Depends on elasticity of supply curve -> if inelastic -> not much output change ->
won’t reach optimum level. Burden on Consumers/producers
Shift supply to other countries -> decline in industry -> decrease in tax revenue.
Government may have sufficient knowledge/info to set appropriate tax -> difficulty
of quantifying it.
With $60 billion of beef being retailed in the USA, taxing beef production could be
economically unviable as it would harm many agricultural firms and those firms
which they supply.
P2: Tradable pollution permits:
Point: Tradable Pollution permits can be used to reduce pollution.
Cause:
They are rights to sell and buy actual and potential pollution in artificially created
markets. They are issued by the government to firms to allow them to pollute up to
a certain limit.
Consequence:
, Any pollution above this limit -> fines -> key function is that it works through market
system -> people can sell and buy permits -> incentive to become green -> therefore
can sell permit -> make profit -> reduce pollution.
According the to the European Commission, the scheme has been responsible for
an 8% decline in emissions from big emitters in Europe from 2005-10.
Evaluation:
There is still pollution occurring just less than before.
Large efficient firms may buy up permits -> increased pollution -> ineffective way of
dealing with pollution.
Short-run -> works, long run -> another solution is needed.
According to a UBS research team, emissions could have been reduced by 40% if
the funds that were invested into the EU Emissions Trading Scheme were invested
into other emission cutting methods.
Assess the policies that might be most effective in reducing the scale of plastic
pollution in the UK and other countries of your choice.
P1: Government policy of taxation in order to internalise the externality:
Ø Production of plastic leads to significant pollution both in terms of the air pollution
created by the factories as well as the fact that it takes a long time to decompose. Thus,
there is a negative externality of production. (Draw Diagram)
Ø Government can enforce a tax on plastic pollution, Phillip Hammond announced March
2018 he intends for UK government to introduce a tax on single-use plastics (i.e. specific tax
on each unit produced)
Ø The tax (seen as vertical distance between P3 and P1) would shift MPC to the left,
increasing the price (P1- P2) and decreasing the quantity produced (Q1-Q2) towards the
socially optimal level (Q2 P2). Thus, the government tax has effectively internalised the
externality and the scale of plastic production has been reduced to a level that benefits
society.
Evaluation:
Ø However, due to the fact that the price elasticity of demand for Plastic is very inelastic
due to it being a necessity good, the government would need to impose a very large tax in
order to significantly reduce the quantity of plastic produced. (Draw diagram with very
inelastic demand).
Ø As plastic is used in so many of the products that we use every day, consumers will not
change the quantity of plastic products that they consume despite a change of price. Thus,
the government tax, increasing the price form P1 to P2 would only decrease quantity by Q1-
Q2 and so the policy may not be that effective.
, P2- Provide subsidies for alternative clean products.
Ø The government could subsidise alternatives to plastic, such as biodegradable
thermoplastics. Currently, producing ordinary plastic is far cheaper than the production of
biodegradable thermoplastic, and thus ordinary plastic can be sold for much less, and thus a
far greater quantity of ordinary plastic is demanded and thus there is significant plastic
pollution. (Draw Subsidy diagram). A large government subsidy for such alternatives would
shift the supply curve (S1-S1+subsidy) and this would allow production of such plastics to
increase (Q1-Q2) whilst price fell significantly (P1-P2). Thus, Biodegradable thermoplastics
would become more affordable for consumers, and thus it could be argued that the
government policy would mean that, if price is reduced enough, consumers would switch
their spending from polluting ordinary plastics to environmentally friendly biodegradable
thermoplastics, essentially reducing the scale of plastic pollution.
Evaluation:
Ø However, due to information gaps and habitual behaviour, the cross elasticity of demand
for plastics may be very low and thus consumers may not switch consumption. Many
consumers unaware of the existence of new plastic alternatives, and due to the influence of
habitual behaviour, many consumers, even if they do know about the existence of
alternatives may never switch consumption and continue to demand the same ordinary
plastic products. Thus, it is likely that plastic and environmentally plastic alternatives would
be weak substitutes will have a low cross elasticity of demand (around -0.5). Thus, despite
the government subsidy to reduce the price of plastic alternatives, many consumers may
not switch their spending and thus the scale of plastic production and thus pollution will
continue.
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