JC Economics Essay Series #4 – Market Failure & Income Inequality

JC Economics Market Failure & Income Inequality Essay Model Answers 

For market failure topics tested in Cambridge GCE “A” Levels, this one is your best bet in the entire Section A of essay paper (Paper 2). Among the 3 questions of Market Mechanism, Market Failure and Market Structures, this is the easiest to score, and one topic whereby every JC Econs student will attempt.

And that’s why I over-prepare you for Market failure, for your H2 Economics exams (Syllabus Code: (757), so that no matter how difficult and obscure the question is for your eventual A-Level Econs exams, you can conquer it! Here is an example that’s fairly novel and unfamiliar:


(a) Explain why income inequality and congestion are examples of market failure. [10]

(b) Evaluate the policies currently used by the Singapore government to correct the above causes of market failure.


JC Economics Essay – Market Failure: Application & Analysis to Income Inequality Context

Suggested Answer Part (a): (Causes & Effects Question)

Market failure refers to the inability of markets to achieve an efficient allocation of resource to maximise social welfare, when they are unregulated by governments. Market imperfections such as income inequality and congestion, prevent the price mechanism from working. efficiently to allocate resources. Allocative efficiency of resources is achieved when all markets produce the most preferred combination of goods that maximises welfare.


Income inequality is due to the wealth of the economy is in a small number of consumers, i.e. the high income, whereas the rest, i.e. the low income account for a very low % of wealth of the economy. With income inequality, the market face the risk of making sub-optimal choices that lead them to enjoying lower satisfaction or profits respectively. Hence, societal welfare is not maximised.


(Sketch the relevant diagram and use it in your body of explanation)
For example, the high-income consumers only consume merit goods, say An explicit education up to the point whereby their own satisfaction is maximised. On the other hand, the low-income lack the ability to consume sufficient education, so effective demand is lower than socially desirable. Thus, for the market as a whole, this leads to under-consumption of education that generates positive externalities and market failure results.


Similarly, the high income also tend to over-consume demerit goods, for eg, cigarette smoking, gambling habit and drugs because such consumption leads to a new level of satisfaction not brought about by many other goods and services. Such goods are highly addictive, so it is very likely that the high-income overconsume them, if left on their own. Hence, for the market as a whole, this leads to over-consumption of demerit goods that generates negative externalities and market failure results.


(Congestion context:)
Externalities are costs or benefits arising from the production/consumption of a good or service that falls on a third party and is not taken into account by those who undertake the transaction (buyers and sellers themselves). This is sometimes referred to as “spillover”/”third party” costs or benefits. Such externalities could be positive externalities which accrue benefits on a third party or they could be negative externalities which impose costs on a third party. Both negative and positive externalities could occur in production or consumption of goods and services.


Explaining why congestion is a form of market failure: Due to land or road constraints in a small country, Singapore frequently faced the problem of traffic congestion in the city area and main road leading to it during morning and evening peak periods. Such traffic congestion problem is an example of negative externality in consumption, which results in over-consumption of the vehicles and road space. This in turn brings about inconveniences to third party and the society at large.


congestion negative externalities JC Econs tutor sg

With reference to the diagram 1 above, the amount of cars being ‘over-consumed’ is depicted by the distance Q₂Q₁. This is because the motorists, who look into their own self-interests, will only consider their own private benefits such as the satisfaction and benefit gained upon reaching their destinations and their private costs, such as the costs of petrol and depreciation of the cars, in order to decide their amount of car usage. This behaviour will hence result in a traffic flow of Q, where MPB (marginal private benefit) = MPC (marginal private costs).
[Note the horizontal axis: to secure more application marks, modify the label to fit the context. other egs are distance travelled, number of car trips, instead of ‘quantity of cars’.]


However, the socially optimum level of traffic flow, which is Q₂, occurs where MSC (marginal social cost) = MSB (marginal social benefit). The MSC is greater than MPC because there are marginal external costs (MEC), which is represented by the vertical distance AB on Diagram 1, that impose on the third party.


Examples of such MEC are the increase in the cost and journey time of other motorists (third party) as the additional motorist slow down the traffic while using the congested road. Other examples of MEC could include the reduction in the quality of environment to others (third party) due to contribution to global warming. The socially optimum level of traffic flow is lower than the actual traffic flow Q, because at Q₁, MSC is greater than MSB. When MSC > MS8, from the society point of view, the private motorists should have used less of cars for travelling on roads in Singapore. Due to excessive use of cars/roads in the city during peak hours, there will be a welfare loss (deadweight loss) of an area C imposed on the Singapore’s society.
(Note: strictly speaking, JC Econs pupils are better off to separate  between traffic jams and pollution from cars on the roads. one is congestion and one is pollution.)


Conclusion: As usual, highlight 2 things: i) which type of failure, ie overconsumption, underconsumption, overproduction, underproduction, and ii) deadweight loss on diagram.


Notes by JC Econs tutor:

1. Income inequality is neither a context nor an eg. You have to intro one yourself as early as possible to make explanation easier. Congestion is a context, so, it’s easier.

2. I intro egs very often along the way. When in doubt, use egs to rescue yourself!

3. Other possible approaches/answers:
i) Income inequality leads to over-consumption of luxury goods and under-consumption of necessities. Egs are luxury cars, bungalows and public transport, housing and healthcare respectively.

ii) Income inequality in rural-urban areas of an economy. Luxurious in urban, yet poor lifestyle in rural.

Understand that CAMBRIDGE will accept a variety of approaches, not just one and only one.

4. Unsuitable approaches:
i) No credit for explaining WHY income inequality occurs in the 1st place. Income inequality is the “cause” here, not “effect”.

ii) No credit for explaining how income inequality leads to higher unemployment in certain industries and lower unemployment in other industries. The effects are correct, but the ONLY “effect: the qn wants is “market failure”.


JC Economics Income Inequality Essay – Evaluation

Suggested Answer Part (b): (Evaluation of Policies Question):

One of the micro goals of the S’pore Govt is to achieve an equitable distribution of income in the economy. Hence, several policies are currently adopted to correct market failure due to income inequality.


The most apt choice of policies depends on the root of the problem. For eg, in order to reduce the root problem of income inequality, one of the policy option has been to impose taxes on the working population.
(use a diagram to show the tax shift. Or use the same diagram in part a to show it.)


In S’pore, higher tax rates are imposed on the high-come and lower taxes on the low-income. Such a progressive tax system ensures that the former is taxed at a higher % while the former is taxed at a lower %. Another form of tax differential is on property tax, whereby again a higher tax rate is imposed on private property, usually owned by the rich. A lower tax rate is only imposed on public housing, i.e. HDB flats, usually owned by the low-income.


However, such taxes gave an incentive for consumers to mis-state their income levels or wealth. For eg, there is a income bracket that is considered middle-income level. They have an incentive to under declare their incomes so that they can be considered low-income group. Thus, they may be able to bear a smaller tax burden. Though tax system in Spore is sufficiently sophisticated to prevent tax evasion, it is still likely that it is not 100% enforceable.


In addition, the Spore Govt has some degree of imperfect info on this case. For eg, it has difficulty in selecting which income level is the benchmark of which consumers earning less than that income level is considered as low income. Moreover, as inflation sets in, real purchasing power falls, yet that particular income level can hurt the low-income more as now, many more consumers would have earned beyond that. This can be overcome by setting that income level as inflation-adjusted. However, that also means the S’pore Govt has to set up a team to monitor and revise the concern for income inequality.


Next, the Govt can also provide subsidies to the low-income in order to reduce income inequality. The subsidies can go to key areas like healthcare, housing, education, etc. And more subsidies can go to consumers who earn lower Incomes than others, the elderly, school-going children, single-parent families, etc.
(use a diagram to show the subsidies shift the SS curve. Or use the same diagram in part a to show it.)


However, the outcome can be rather unfair. For eg, a % of the elderly are from the high income group. Also school-going children can be from richer families. Yet they still receive the subsidies. Furthermore, subsidies are considered a blanket policy, and it does not into account the preferences of individual consumers. For eg, subsidies are given a lot to public schools that specialise in the teaching of math and science. This is aligned with the goals of the Govt to equip Singaporeans with such knowledge and skills to drive the economy in working years. Yet, relatively little subsidies go to other areas like arts, music, sports. Such areas do not contribute significantly to S’pore economic performance, so to receive less subsidies again can be unfair.


Another policy has been to “educate” the rich. The Govt attempts to encourage more charitable acts by the rich to give the low-income. For eg, it can be argued that by giving more to the low-income, the latter can maintain their demand for goods and services. Many of the business are probably owned by the rich, so the high income can benefit in return by giving. Such a policy involves a change of mindset and of heart, and surely takes me.


The second micro goal of the S’pore Govt is to achieve social efficiency in the economy.. Below are several policies are currently adopted to correct market failure due to congestion. (The rest is left for you to complete. See full length answer on congestion.) In S’pore, tackling inequality has faced limitations. Any policy implemented may need to be revised very quickly. The reason is that incomes rise relatively fast in S’pore. Due to globalisation, and the resultant need to continuously restructure our economy, income inequality is expected to worsen. The more value we add to our key exports, the more income the export oriented sectors and workers will earn. Likewise, the other sectors will experience less increases in earnings.
(See a sample on the macro goals of Economic Growth here)


It is debatable that such source of inequality needs to be tackled in the first place. Hence, the most appropriate policy seems to be to raise the skills of the lower-income groups, so that they have the opportunity to switch to jobs that offer higher wages. Such a policy, obviously, requires a significant level of mindset change in the labour force of workers that are accustomed to low-skilled jobs. Moreover, another concern is: how much equality do we really want in Singapore? In terms of the Gini coefficient, do we wish to settle for an arbitrary figure of 0.5, less than that?


In summary, the Spore Govt has implemented several policies to correct market failure due to income inequality and congestion. Congestion is a more serious problem than income inequality in S’pore. This is because the base line of the poorest Singaporean is said to even own at least SGD $100,000 in assets. The govt is prudent to focus more attention on the former than on the latter.


JC Economics Market Failure Essay – Evaluation

In order to reduce the deadweight loss imposed on the society, the Singapore government has already implemented a series of measures and policies to prevent the over-usage of cars on roads. One of the policies involves the raising of price of car ownership to reflect the true costs of driving through the imposition of taxes such as Road Tax, Additional Registration Fee, Excise duty on cars and Registration tax. These measures were heavily relied upon during 1970s and 1980s. Through increasing the price to own a car, the government could dampen the demand for private motor vehicles, thus reducing the problem of traffic congestion. Theoretically, the amount of such taxes should be equivalent to the amount of MEC so that the socially optimal level of traffic flow could be attained at Q2.


However, the imposition of such taxes does have its limitations in reducing the traffic congestion. This is because it is difficult to estimate the amount of MEC imposed on the third party. In other words, it is difficult to measure the opportunity cost of longer waiting time incurred by the third party and the impact on the environment in order to give a value to the tax amount imposed to discourage the purchase of cars. If the MEC or the road tax value is underestimated, the demand for cars may not be reduced to the socially optimum level of traffic flow, thus undermining the effectiveness of using taxes to reduce the problem of traffic congestion.


Another current policy implemented to reduce the problem of traffic congestion in Singapore is known as the Electronic Road Pricing (ERP) system, which is a form of congestion charging, with vehicles automatically charged time and location-point charges for passing a set of gantries set up within the city centre and a number of other locations. Such ERP system is pioneered by Singapore government and is currently very effective in reducing the problem of road congestion as the additional ERP charges during peak periods force the motorists to internalize the external cost of congestion and pollution and encourages some of these users to switch to non-peak periods or to use alternative modes of transport. The effect is illustrated by a shift in the MPC to MSC as shown in diagram 1. This helps to bring down the level of road usage to the optimal level of traffic flow at Q2.


ERP has been appropriate in curbing congestion especially during peak hour in Singapore since Singapore is a small country and thus implementation and monitoring are made much easier. In addition, there is sufficient flexibility in the ERP system as the ERP charges are made to vary according to the time of usage and the routes taken. However, if the demand for usage of the road is price inelastic (the motorist may only have one route to reach their destination), then ERP will have its limitation in curbing traffic congestion effectively.


Even though Singapore’s ERP system has been widely being praised as an effective policy, it has essentially remained unchanged since 1998. It is critical that we review the ERP system and enhance it to better address current and future traffic conditions. In the future, ERP may not help to ease congestion on the highest demand roads like the CTE. ERP rate increases have little impact on travel behaviour and that even though people pay ERP, they still face congestion on priced roads. The reason is that rising affluence has led to a greater propensity to drive and pay for the ERP rates which in turn has caused a dramatic rise in traffic volumes. In order to manage congestion effectively, it is necessary to make the policy changes by refining the method of measuring traffic speeds so that the ERP charges could better reflect the costs of driving. Another change could be through updating the ERP rate structure to a variable one which is based on the congestion levels on the roads.


Comments from our H2 Econs Essay tutor: 
1 As context is not chosen at all under income inequality, you can vary your egs anytime you wish. In the above sample, I have demo with consistent egs in parts (a) and (b), You NEED NOT do so. This should prove to be easier for you to conquer this essay.

2 Other approaches/answers:
1. Direct provision in healthcare: polyclinics for low-income and elderly

ii. Direct provision in education: compulsory education for P1 to P6 primary education in public schools.

iii. Subsidies/ funding to non-profit orgs or charitable orgs: encourage charity works to reduce income inequality

3 Answers not suitable:
a. Legislation

b. Quotas

Obviously, I added more points (analysis and evaluation) than needed to secure a level-3 answer in this sample. Cambridge – UCLES – SEAB marks more leniently than your tutors. However, they are still very strict on ANALYSIS. Remember, breakdown for more linkages, and use egs and/or diagrams to provide good analysis.


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