Tuesday, May 25, 2010

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.

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