JC Economics Factor Immobility & Income Inequality Essay Model Answers
How many of you know that you are guaranteed one Market Failure topic question in your Cambridge “A” Levels for H2 Economics? Thus, we at Adam Smith Economics Tuition, we over-prepare you for this topic, so that, regardless of the difficulty level of the question, you are able to answer it. Be it on the topic of market imperfections such as imperfect information, or on market dominance, or even obscure externalities, you will be able to conquer it and secure your Level 3 answer.
After all, you need to answer at least one Micro Econs question in Section A of your eventual Cambridge A-Level Economics exams.
(a) Explain why immobility of factors of and income inequality may lead to market failure. 
(b) Examine the policies used by the Singapore government to correct the above-mentioned types of market failure. (15)
JC Economics Essay – Market Imperfections: Immobility of Factors
Market Failure occurs when the market mechanism fails to allocate resources efficiently and equitably.
Allocative Efficiency: Right amount of the right good being produced. Occurs where P=MC
Productive Efficiency: Bundle of goods produced using the least cost method of production. Occurs at min. LRAC
Allocation of resources that is considered to be fair and just
SCOPE 1: Explain why immobility of factors of production leads to market failure
Definition-Factors of production are immobile when factors of production cannot be transferred easily from one location or sector to another. It consists of geographical or occupational immobility.
Definition of the 2 terms
Explain how the market fails→ When factors of production are immobile the market will fail to achieve 1) productive efficiency ii) allocative efficiency
Case 1: Allocative Inefficiency
1) Given an increase in demand for a product, firms may not be able to increase production since supply is dependent on the availability of factors of production. If factors of production are immobile, firms will not be able to increase production and thereby leading to allocative inefficiency as the right amount of the right good is not produced.
(sketch a diagram, though optional)
Case 2: Productive Inefficiency
1) When there is occupational immobility some workers will not be able to move expanding sector where jobs are in demand due to reasons such as lack of skills, trade union restrictions etc.
2) In the case of geographical immobility some workers will be unwilling to move from high unemployment areas to low unemployment areas due to social ties, family commitments, or significant differences in cost of living.
Productive inefficiency will thus occur as the expanding industry or the region experiencing rapid economic growth cannot utilize the existing FOP in the most optimal combination as part of the available FOP is still engaged in the “sunset” industry. Firms are unable to employ the best FOP for their production and therefore will not be producing using the least cost. The economy will thus be producing inside its PPC.
JC Economics Essay – Income Inequality
SCOPE 2: Explain how income inequality leads to market failure Inequity may arise from income inequality which will lead to an unfair distribution of resources and goods and services in the society. Income inequality could be caused by differences in earned income and also differences in wealth.
Explain the possible causes of income inequality briefly
(1) Caused by differences in earned income
The income that people received for their labour services depend on the demand and supply of labour. As in Fig 1, a combination of high demand (DH) and low supply (SL) lead to high income (OWHE1N). The converse holds true. The demand for labour is determined by labour productivity which is influenced by the worker’s education, skills & health. The supply of labour is influenced by factors such as the level of education, skills and population size. For example, in Singapore, a relatively higher demand and lower supply of engineers (more skilled/educated) leads to a higher income earned as compared to general cleaners (relatively high supply and low demand) who earns OWL E1N.
(ii) Caused by differences in wealth
Quality and quantity of assets owned contribute to differences in income. The more assets one owns, the more income he gets. The better the quality of the asset, the greater the price it fetches in the market. For example, if a person owns more assets in the form of property, they will be able to collect more rent from the property. Also if the quality of asset is better, it will fetch a greater market price.
(note: diagram is optional)
As a result of income inequality, the rich would be able to cast more money votes and drive the market to produce goods and services biased towards their taste and preference while the poor, with a lower income and wealth would have a lower ability to cost money votes and hence resulting in certain goods and service being under-produced. Hence, in a market economy, luxury goods would be over-produced while necessities may be under-produced, resulting in inequitable distribution of goods and services, leading to market failure. Without government intervention, the poor / lower income would face inaccessibility to certain basic necessities, worsening their standard of living.
Factor immobility and income inequality violate the conditions for the free market to function efficiently and equitably and therefore cause the market to fail.
Remarks from JC Economics tutor:
1.For income inequality, there are more than 1 way to explain this MF. The above concept of Consumer Sovereignty is one. What other 2 ways can you explain income inequality between high- and low-income consumers?
JC Economics Essay – Policy Options To Reduce Inequity & Factor Immobility
The Singapore government has put in place policies to counter the problems above. The tent of government intervention is dependent on the severity of the problems as well as other government objectives such as economic growth.
Scope 1: Policies to address factor immobility in Singapore Owing to the small size of the country and the efforts by the government to improve the transport system, geographical immobility does not pose a problem. Hence government policies are tailored toward increasing occupational mobility.
Education & training
In Singapore, the government invests heavily in education and there are many programmes in place to encourage education, training and lifelong learning. The Skillsfuture Program, CET and Lifelong Learning Endowment Fund grants are set up by the government to subsidise firms in the training and upgrading of skills of workers. In the recent budget, a new program known as SPUR (skills program for upgrading and resilience) was introduced. This entails a subsidy on course fees for training as well as some compensation to companies for workers absence from full time work when they embark on training.
Education and training is the primary method to reduce occupational labour immobility. Governments may try to solve the problem through subsidies and tax rebates given to workers to encourage them to retrain and acquire the relevant skills to move between different jobs in the changing demand conditions. Redundant or retrenched workers in certain industries can be retrained for jobs in other industries. This increases their mobility between occupations. By increasing labour mobility, it allows improvement in allocative efficiency as the right amount of the right goods will be produced and increase in demand of a good will allow firms to gainfully employ factors of production to increase their output. Productive efficiency will also improve as firms are now able to employ the best labour for their production and employ the least cost method of production.
(this is essentially policy tackling structural unemployment.)
Through addressing labour immobility, Income inequality is also addressed. Workers who were previously unemployed due to occupational immobility will now gain employment and this will increase their income. Hence, this will also reduce income inequality.
Training and education can be costly as it involves government expenditure which are to be financed by taxes. Also, the outcome can be unpredictable as it depends on worker’s and firm’s receptivity. Workers may also be reluctant to be trained. Subsidies are mainly channeled through employers and firms. This means that existing unemployment workers may not receive the benefits until they find employment, which will prove to be difficult unless they have the requisite skills. Government intervention in Singapore is not based purely on theoretical considerations but also to fulfill pragmatic objectives such as growth and full employment. (Supply-side policy limitations)
Scope 2: Policies to address income inequality in Singapore
State objectives of Singapore government policies
1. Reduce unacceptable unequal distribution of income and wealth
2. Ensure equal access to basic products
3. Reduce or eliminate poverty (absolute, rather than relative)
Identify types of government policies to correct income inequality
Market based solution (Taxes & Subsidies)
Other policies (increasing labour productivity of lower skilled workers by encouraging education and training)-addressed above
(1) Taxes: compulsory payments made the government by people or firms. There can be direct taxes or indirect taxes. An example of direct taxes would be income tax and an example of indirect tax would include GST.
Progressive income tax
Singapore adopts a progressive income tax system where the rich is taxed more heavily than the poor (i.e. proportion of income paid as taxes increases as income rises). A progressive income tax is often used to redistribute resources from the higher income earners to lower income earners. The more progressive is the tax, the more equal will be the post-tax incomes of the population, thus addressing income inequality. The income tax rate in Singapore ranges from 0% to 20%; whereby workers earning less than $20000 annually need not pay income tax while those in the highest income bracket face an income tax of 20% of their annual income. As announced in Budget 2016, personal income tax is made more progressive for Singaporeans. Hence, the average rate of taxation rises as income increases and this reduces the income gap between the rich and the poor.
Tax Rebates (Update to Grow and Share Package 2011
The Grow and Share Package is a set of measures announced in Budget 2011 to share the fruit of nation’s growth with all Singaporeans, especially for the lower and middle income group in tax rebates are higher for lower income Singaporeans and it includes among other schemes, CPT Med Top ups additional U-save, Workfare Special Bonus and Services & Conservancy Charges (SCC) Such measure aims to provide greater assistance to the lower income in coping with the ring cost of living in recent years, with the higher tax rebates awarded to the lower income families therefore increasing their disposable income and reducing income inequality.
Progressive taxes may act as a disincentive to work and effort for the higher income earners thereby reducing their disposable income and lowering the opportunity cost of leisure. The rich is likely to put a higher premium on leisure and may choose to work less hard if a large proportion of their income is taxed. A high progressive tax system will also deter foreign talent into S’pore which could have adverse impact on the size of labour force. The higher the tax rates, the more likely people are to try and escape paying some of their taxes.
Tax evasion lowers revenue collected by the government and can limit the use of expansionary fiscal policies. The greater the tax, the greater the disincentive to work and the more tax evasion and tax avoidance Tax rebates may help to offload the financial burden of the lower income but is not likely to be feasible in the long term as people may become reliant on such measures The tax rates on direct taxes (le. personal and corporate) have fallen is accompanied by an increasing GST (an indirect tax) system, shifting away from reliance on direct taxes towards indirect taxes in order to keep Singapore’s tax system internationally competitive. This shift in tax structure will make it more regressive hence penalizing the lower-income households and thus limit the effectiveness of Singapore’s tax structure to reduce income inequality..
Subsidies are transfers from government to people and firms. Subsidies will lessen inequality if they account for a larger proportion of a poor person’s income than a rich person’s. They can eliminate poverty by ensuring that all individuals are entitled to a minimum standard of living regardless of personal circumstances, and equal access for all to certain basic goods and services such as education and health. Hence, it reduces the problem of inequity resulting from income inequality. Subsidies can be given out in the form of means-tested benefits or universal benefits.
Universal benefits are given to everyone in the same category e.g. free dental care for school children or child benefit such as Edusave grant. Eg; subsidy provided in education. Government expenditure on education ensures that it remains affordable for the population at large. Currently for higher education, the Government subsidises up to 75% of the cost of university education, and 85% of the cost of Polytechnic Diploma courses. In addition, public healthcare is also heavily subsidized but not healthcare services provided by private hospitals. Such a policy ensures that basic necessities and essential goods are accessible to everyone. This reduces the problem of inequity resulting from income inequality.
(Source: Agency for Integrated Care or AIC)
Means tested subsidies are given to people who can prove that their income is below a certain level of, or different rates of subsidies are given, based on the level of income earned. Such subsidies are implemented in various markets to reduce the financial burden of the lower income and hence Improve income distribution. (IN other words, this is to avoid the issue of one size, fits all limitation of subsidies. A good point of evaluation.)
Furthermore, Medifund is designed to ensure that no Singaporean is denied good basic care because of a lack of ability to pay. Subsidies from Medifund, is given out on a means-tested method to ease the financial burden of high medical cost for the lower income. In 2010, subsidies for inpatient treatment at public hospitals are also given out at differing rates depending on the household income of the patient. Lower income household ill receive greater subsidy rate while those in the higher income bracket will receive less. This ensures that the lower income household would have access to good medical services and treatment by ensuring its affordability.
Eg: financial assistance to students in Singapore whose family earn less than $1800 per month to help cope with the finances of the lower income household to ensure that children from the lower income are not deprived of an essential good the education,
Lower income families buying a flat receive bigger subsidies via an additional CPF Housing Grant, more affordable housing options
Evaluation: Financing the subsidies may require high taxes which have disincentive effects on work and investment. This may have adverse effects on economic growth. Means-tested benefits are often expensive to administer and have low take-up rates due to bureaucracy and social stigma. Universal benefits are more straightforward to administer and do not have a stigma attached to them. But some of the benefits may go to people who do not need it.
S’pore government uses a policy mix of market-based systems, direct provision, and legislation to overcome the root causes of market failures resulting from factor immobility and income inequality. However, given Singapore’s rising Gini coefficient which will imply that inequality of income is on the rise, the government will require more targeted measures to deal with income inequality. Also, there could possibly be time lag in the measures being rolled out by the government and vested interests by the government with the elections looming. An example of this could be the government’s intent to raise the BTO income ceiling from $8,000 to $10,000 mentioned by the incumbent.
Econs tutor’s comment: For such MF essay question, you should be able to answer any type of failures, including imperfections, divergences, externalities, dominance, etc, as long as you have a step by step approach to it. Targeting at least 19 out of 25 marks for your H2 essays for questions on inequity and market imperfections? Join us for your accelerated success to Economics NOW!