Video Lesson by Richard Pettinger on Market Failure: An Introduction

This is Richard Pettinger, a lecturer from Lady Margaret Hall and a former examiner of Edexcel. He is a dedicated writer/ economist and check out more of his postings at

www. economicshelp.org

This video is good for those who are still wondering what Market Failure is all about. Somehow, to those who never experience video learning, this maybe a bit difficult. So try to get used to it from now. It is never too late. Also I find it more effective since it is simulating and interactive. This is how I learn economics- making everything interesting to me, by substituting away from those thick and boring textbooks

Data Response Unit 1: Competitive Markets (Air Pollution)

This post is the continuation of the previous one. The second possible scenario to be tested is air pollution. The extract may have something to do with airports, congestion and rapid industrialisation

Types of question that could be tested are like:
(Bear in mind that the examples given have to be modified accordingly to information provided. Here I’m just assuming it has something to do with flights)

1. By giving examples, explain the potential private costs and external costs due to higher number of flights (expect 6m)

Private costs refer to costs that fall directly onto the producers or consumers when they engage in an economic activity. Examples of private cost due to flights are like wages to pilots and costs of leasing the planes

External costs (negative externalities) refer to costs that fall onto a third party which is not part of an economic transaction. Some of the examples are like air pollution and fall in the value of houses nearby the airport since it may create excessive noise during sleeping hours

2. Using the cost-benefit diagram, illustrate the concept of negative externalities (expect 4m)

In a free market without any government intervention, flights will be demanded until Q1 where MPB = MPC. But from society point of view, the desired level of flights should be at Q2 where MSB = MSC. Over flights by airline companies hence lead to welfare loss

3. Examine any two methods to overcome pollution (expect up to 10m)

First the UK government can propose higher environmental tax such as carbon tax onto airline firms. This is meant to increase the operating costs of airline firms. As such the MPC (or PMC) curve will shift backward towards the social efficiency point. As such the area of welfare loss will shrink. However, there are some problems. Airline firms can easily pass on the increase in costs to passengers in higher fares. Also it is worth to note that it is extremely difficult to quantity pollution. In other word, the tax paid may not reflect the true value of damage inflicted onto the environment

Next, the government could also propose carbon emission permits to airline firms. These are actually market-based solution to negative externalities of production. These permits are issued by government and airline firms are granted the permit to pollute up to certain amount of carbons. More efficient ones can sell excess permits to less efficient airline operators, so that they can pollute more. To government, it does not matter which firms pollute more or less, as long as the targeted overall emissions is not breached. However, such measures will not reduce overall emissions as there will always be inefficient firms that buy these permits from efficient ones. Secondly, it is difficult to set an acceptable level of pollutants. If set too high, pollution will not be reduced. If set too low, it may be harmful to the airline industry since tight restriction on number of flights can cause major loss to certain operators

Last tips:

In tackling data response questions, always look out for the followings:

a. Do I need to make reference from the Extract?
b. Can diagram help?
c. Do I need to define?
d. Do I need to evaluate?

Again, bear in mind that these questions may or may not appear in actual exam. It is to your best interest if you revise everything thoroughly. All the best.

Possible Case Studies and Nature of Data Response Question for Unit 1: Markets: How They Work and Why They Fail? (coming soon)

This post is meant for all those international students who will be sitting for the Edexcel Economics Unit 1: Competitive Markets this coming Friday. Bear in mind that the contents serve as a GUIDE, and again I strictly mean GUIDE rather than leaking out any actual examination questions. There are two reasons for me to put this up. First, is due to the overwhelming request from my fellow students. Secondly, Unit 1 is rather easy and to some extent the examination questions are really predictable

Why do I say so?

(1) MCQs
I have compiled all those MCQs in a booklet according to topics and I found that almost all topics are tested again and again in similar ways. For instance the concept of PPF and rising opportunity costs as well as PPF shifting inward or outward. Others are like diagram of taxation (subsidies) and students are required to identify incidence of tax onto consumers and producers (subsidies enjoyed by producers and consumers) and in many cases, involve calculation. In most cases, a table involving several items will be provided and students have to identify which are normal goods and which is inferior good. This is just a non-exhaustive list

(2) Data response
There are certain ‘fixed questions’ for each type of case studies. For instance, do expect:

Commodities:

(a) Demand and supply diagram, showing an increase/ fall in price + explanations

(b) Whether a good is elastic/ inelastic in demand: Define PED + mention if it’s inelastic and why + evaluations

(c) Whether another good is the substitute/ complementary for the mentioned good in extract: Define XED + mention that it is substitute/ complement + have positive/ negative XED + explain how relationship works + evaluation

(d) Is the good elastic/ inelastic in supply: Define PES + inelastic in short run/ elastic in long run and why + evaluation

(e) Impact of increase in production costs for firms

(f) What happen if the good is subsidise by government: Define subsidies + diagram + explain the diagram and impact onto producers + evaluation

(g) Effectiveness of buffer stock: Define buffer stock + diagram +explanation of diagram + evaluations

(h) Government failure: Negative impact of government interventions + evaluations of why it is not that bad with government intervention

Cigarettes/ Alcohol/ Education/ Healthcare:

(a) Definition of private cost + external cost + examples for each type of cost

(b) Definition of private benefit + external benefit + examples for each type of benefit

(c) Diagram showing existence of external costs/ external benefits

Congestion/ Pollution

(a) Definition of private cost + external cost + examples for each type of cost

(b) Diagram showing that negative externalities exist

(c) Methods to overcome congestion + evaluation of each method

(d) Methods to overcome pollution + evaluation of each method

(3) In real examination, questions are likely to contain both the elements of How They Work and Why They Fail? Depending on nature of case studies, certain case studies like congestion or pollution are likely to carry more questions on Why They Fail. Extracts like rice, rubber, cocoa and oil are likely to carry more questions on How They Work. It is highly unlikely for question like ‘What are the private/ external benefits of consuming cocoa?” or questions like income elasticity on demand to appear in an extract of pollution

(4) The Examination Board will have to think of a case study where questions from both How They Work and Why They Fail can fit into. As such, those ‘weird’ case studies such as Financing BBC (2007), Wind Power Farms and many more are unlikely to be tested

What will probably turn out in this round for Unit 1?

National Health Service (NHS) is in my top list. It is one of the most popular case studies which are yet to be tested thus far. So this round, it has the possibility of 90% to appear in your exam. The nature of the questions maybe somewhat similar to the questions tested in Education (Jan 09)

They are:

(1) How does an increase in government spending onto NHS represent an opportunity cost?
Opportunity cost is defined as the next best alternative foregone. If the UK government does not spend this amount of money onto NHS, the equal amount of money could have been used elsewhere, such as improving the standard of education, betterment of public infrastructures and others

(2) Examine the likely impact on the PPF due to the increase in government investment on NHS. Illustrate your answer with PPF

Production possibility frontier is a curve that shows the combination of two goods than can be produced in an economy if all resources are fully and efficiently utilised

Public expenditure onto NHS will have the impact of increasing the productive capacity of UK’s economy. Healthier workforce on average will have higher productivity and as such higher output per person is expected. This will increase the potential growth as shown by the outward shift of PPF

However the increase in NHS spending is likely to result in austerity measures in other public sectors, for instance education. This is related to the concept of opportunity cost. As such the PPF growth may not be as impressive or it seems. To some extent it could be entirely muted

(3) Explain two other external benefits of higher spending onto NHS (most possibly there will be an external benefit diagram)
External benefits refer to benefits gained by a third party, which is not directly part of an economic transaction

First, healthier workers can contribute productively to an organization. Higher output will result in fall of production costs. Firms can operate more profitably

Secondly, a more productive workforce will be a great attraction to FDI. Foreign firms will be highly interested to set up operations in a country where production costs are low. It will also increase the competitiveness of UK economy. On top of that, government can also collect more tax revenue

(4) Other than external benefits, explain three reasons for state intervention in NHS
UK has an increasing number of old populations just like Italy, Japan and US. As such, demand for healthcare is great

Secondly, healthcare is a normal good. During the period of rising income, increasing number of people will increase their spending onto seeking treatments for instance more regular body check up and other necessary treatments

Merit good like healthcare is often under-consumed due to the presence of asymmetric information. As such government needs to intervene to increase the free market level of consumption to the socially optimal level

Others are like increasing number of new diseases/ rising population

Stay tune for next forecast question: Air pollution

Handy Definitions/ Glossary For Unit 4 (Edexcel Economics): Global Economy

Finally, the long awaited list of definitions for those international students who will be sitting for Edexcel A-Levels Economics, Unit 4: Global Economy in late June 2010

1. Absolute advantage: Is when a country can produce more of a good using similar resource as in another country

2. Balance of payment: An account that summarises the financial transaction between one country and the rest of the world

3. Budget deficit: Where government expenditure exceeds tax revenue

4. Budget surplus: Where government tax revenue exceeds public spending

5. Comparative advantage: Is when a country can produce a good with lesser opportunity costs than the other and hence should specialise in the production of that good

6. Current account: An account that measures the flow of money in and out of a country resulting from the visible and invisible trade

7. Capital account: An account that measures the flow of capital in and out of the country

8. Dumping: An act by manufacturer in one country exporting a good to another country at a price below what it charges in home market or even below production costs

9. EMU (Economics and Monetary Union): Refers to the currency union of EU members who have adopted euro as their sole legal tender

10. EU: Is an economic and political union of 27 member countries located primarily in Europe

11. Eurozone: A collective group of countries which use euro as their common currency

12. Economies of scale: Fall in the long the run average costs associated with an increase in output

13. Fiscal policy: Manipulation of government spending and level of taxation to influence movement of AD and overall economic activities

14. Fixed exchange rate: Is when a currency of a country has a set rate against the currency from another country and there will be no fluctuation

15. Floating exchange rate: Is when the exchange rate of a country against another is determined through the forces of demand and supply

15. FDI (Foreign Direct Investment): Refers to investment of foreign assets into domestic structures, equipments or organizations

16. Golden Rule: A guideline for the operation of fiscal policy set by Chancellor Gordon Brown, which mentions that over the economic cycle, government borrowing is only justified if it is meant for investment and not to fund current spending (payment onto pensions, benefits etc)

17. Globalisation: Refers to the freer movement of human, capital, goods and information

18. Hot money: Extremely volatile short term capital that moves on short notice to any countries that provide better return and is usually associated with investment onto stock market in another country

19. Import quotas: Limit onto the amount of goods that can be brought into a country

20. J-curve: The tendency for the fall in value of currency to worsen the balance of trade before improving it

21. Laffer curve: A curve that shows that for any economy, there will be an optimal income tax rate which will help the government to maximize tax revenue

22. Monetary policy: Manipulation of interest rates to influence the movement of AD and overall level of economic activities

23. National debt: Total amount of money a government owes to private sectors and the purchasers of bonds

24. Progressive taxation: Tax rate that increases as the taxable base amount increases and as such is felt more by the rich

25. Protectionism: Steps taken by government to protect local industry from harmful foreign competition

26. Terms of trade: Refers to the average price of exports to the average price of imports and is a measurement of competitiveness

27. Regressive taxation: Tax burden that falls more heavily onto those people with low income such as sales tax and value added tax (VAT) since it tends to take up a bigger percentage of the budget of a person with low income

28. Sustainable investment rule: A rule which requires debt to be kept at prudent level, which is below 40% of GDP in UK

29. Supply side policy: Policies to influence the movement of AS by increasing the productive capacity of an economy

30. Trade creation: Increased trade between member countries of trading bloc usually resulting from economies of scale due to enlargement of market or common external tariff

31. Trade diversion: Decreased in trade with the more efficient non-member countries which is replaced by the increased in trade with less efficient member due to formation of trading bloc

32. Trading bloc: A regional group of economies cooperating together by liberalising trade between one another

33. Tariffs: Taxes onto goods that are brought into a country

34. WTO: An international agency set up to promote freer trade between member countries, administer global trade agreements and resolving trade dispute if they arise

35. Absolute poverty: A level of poverty where only minimum level of food, clothing and shelter can be met

36. Bilateral aid: Aid given by one country directly to another

37. Debt relief: Refers to the partial or total forgiveness of debt or the slowing down of debt growth

38. Development: The process of improving the quality of life within a country

39. Dependency ratio: A measure which shows the number of dependents (those aged 0-14 and above 65) to the number of economically active people (those who are in working age 15-64)
40. Gini coefficient: A measurement of income inequality ranging from 0 (absolute equality) to 1 (absolute inequality)

41. Growth: A sustained increase in real GDP/ increase in potential GDP

42. HDI (Human Development Index): A measurement of development which include real GDP per capita (PPP), life expectancy at birth and combined gross enrolment ratio in primary, secondary and tertiary education

43. HIPCs (Highly Indebted Poor Countries): Countries with extreme poverty and debt overhang which are eligible for special assistance from IMF and World Bank

44. Import-substitution effect: A policy to replace foreign goods with domestically produced one

45. IMF (International Monetary Fund): An organization set up in 1944 to lower trade barriers between countries, to stabilize currencies by monitoring the foreign exchange systems of member countries and lending money to developing nations

46. LDCs (Less Developed Countries): Countries which exhibit the very low HDI rating of all countries in the world

47. MDCs (More Developed Countries): Countries which exhibit very high HDI rating of all countries in the world and are usually referred to the Western economies

48. Multilateral aid: Aid is given to countries through an intermediary organization such as the World Bank, which pools donations from several countries’ government before distributing to recipients

49. MNC (multinational company): A company which has operations in more than one country

50. NICs (Newly Industrialised Countries): Refer to countries whose economies yet to reach the First World status, but have in macroeconomic sense outpaced many other developing counterparts and is usually referring to countries like Brazil, China, India, Malaysia, Thailand and several others

51. Lorenz curve: A graph showing the difference between the country’s actual income distribution and perfect equality of income distribution

52. Relative poverty: Is when income is less than the average income of a nation by certain percentage

53. SAPs (Structural Adjustment Programs): A series of economic policies designed to promote free market and to reduce government intervention

54. World Bank: An international agency set up to assist countries with the process of development by providing loans, research and advice and was founded in 1940s to initially assist Western economies with capital after World War II