JC Economics Essay Series #77 – Market Failure & Indirect Taxes

JC Economics Essay Market Failure & Indirect Taxes Model Answers 

It is a well known fact that the excessive use of plastic carrier bags is a serious environmental problem. The extensive use of mainly single-use bags, oil-based plastic bags is a waste of resources and an environmental challenge. The first country in the world to impose a tax on use of plastic bags is Denmark, introduced in 1994, was to reduce the use of plastic carrier bags and to prevent waste production.
(Note: The first country in the world to impose a ban on use of plastic bags on ships is India in 2021.)

And Singapore is working on a charging model, to impose a levy on the use of plastic  for disposable carrier bags in supermarkets.

Here is a sample Q&A submitted by one of our JC Econs students:

Singapore is working on a charging model, to impose a levy on the use of plastic for disposable carrier bags in supermarkets.
Explain why the use of plastic bags may lead to market failure and discuss whether indirect tax is adequate and desirable in solving the market failure. [25]


Single-Use Plastic Bag as a Form of Negative Externality in Consumption

Suggested Answer:

Explain why the use of plastic bags may lead to market failure
Market occurs when the price mechanism fails to allocate scarce resources efficiently. Allocative efficiency refers to the production mix society’s welfare is also maximised. Resources cannot be re-allocated to increase the welfare of one person without reducing the welfare of another. This occurs when price is equal to marginal cost (P-MC). Society values the good as much as the additional cost required producing it.


However, plastic bags are demerit goods. Usage of plastic bags generate negative externalities. They are deemed to be socially undesirable by the government but it is afraid that the public may not be fully aware of the full costs of usage. Negative externalities are third party costs from consumption that are incurred without compensation.


The users of plastic bags only consider their private cost and ignore the externals costs to third parties. E.g. Firms producing plastic bags consider their private cost such as wages and raw materials. However, used plastic bags are often discarded carelessly as litter and additional cost is incurred to clear the litter. Hence society’s cost is higher than private costs. Disposal of plastic bags also poses a threat to the environment and wildlife and thus imposes cost on third parties (e.g. land pollution and water pollution if thrown into the seas) who may not be directly involved in the consumption or production of plastic bags.


This divergence is illustrated in the diagram below where consumers only consider the marginal private cost using plastic bags and consume up to Q. where MPC MPB. However the true cost to society is represented by the marginal social cost and consumption should only be up to Qs, where MSC-MSB. There is overconsumption of plastic bags and a welfare loss from Qs to Q where the MSB<MSC denoted the shaded triangle. Moreover, there is allocative inefficiency at output Q. P<MC – the additional cost of producing plastic bags exceeds the value society places on it. Society’s welfare would improve if resources are diverted from the production of plastic bags to other goods instead.
(Sketch the diagram on your own, as an exercise)


Hence, the existence of negative externality leads to a divergence between MPC and MSC and causes an overconsumption of plastic bags. This is exacerbated by the lack of awareness by consumers of the true costs of using them. Hence, there is inefficient resource allocation of resources and it is necessary for the government to take necessary measures to correct this market failure.


Discuss whether indirect tax is adequate and desirable in solving the market failure. The government may use taxation to correct market failure arising from the excessive use of plastic bags. The desirability of the measure would depend on its ease of implementation, effectiveness in reducing inefficiency and welfare loss in both the long and short-term.


Thesis: Indirect tax is adequate and desirable in solving the market failure
The S’pore government can choose to impose a tax on plastic bags that is equal to the external cost (shown by MEC in the diagram) at the social optimal level of output, Q, The tax forces producers to internalize the external costs due to the use plastic bags. MPC shifts upward to coincide with MPB at the socially optimum level of output and an efficient allocation of resources results. Tax is flexible and can be adjusted according to magnitude of the negative externality. Taxes enables the market to continue to operate unlike legislation or ban which will totally remove all the benefits of the use of plastics, e.g. to collect and dispose rubbish. Taxes have an advantage in that it provides an incentive to reduce the use of plastic bags further by seeking low-cost alternatives such as reusable bags. It can also be easily adjusted by the government if changes are required. Taxation generates revenue for the government which can be used to clean up the environment.
(Insert the tax into the diagram sketched earlier.)


Antithesis 1: Indirect tax is NOT adequate and desirable in solving the market failure
There is a practical problem in the tax system. It is hard to find the correct amount of tax (imperfect information). If the external costs are overestimated, the government may levy. excessively high taxes that more than correct for the actual external cost, resulting in underproduction and thus greater inefficiency in resource allocation. Moreover, plastic bags are very cheap and they take up very little of consumers income. There are also few substitutes that can match it in terms of convenience. This means that demand for plastic is inelastic and a very high percentage tax may be required to make a small impact on the quantity used. Consumers remain ignorant of the full costs of its use and may continue to use excessive amounts of plastic bags.


Antithesis 2: “Adequate”: suggest 1 alternative: education campaign or quota or regulation (avoid ban)
Explain how edu campaigns work


The use of taxes in SG to by itself is unlikely to be effective in solving the market failure resulting from the use of plastic bags. It also fails to address the lack of information on the consumer’s part and may in fact cause resource allocation to worsen. Thus, it is undesirable to use taxation alone. To ensure the long term solution, the government needs to complement this measure with others such as public education and rules and regulations.

Public campaigns (can be carried out with help of supermarkets, main issuers of plastic bags) would raise consumer awareness and cause them to voluntarily reduce their demand for plastic bags. 

Rules can be implemented to stop retailers from providing shoppers with plastic bags on certain days. This forces consumers to inculcate the habit of bringing their own reusable bags and would reduce consumption of plastic bags in the long term. The government also need to ensure that alternatives such as reusable or biodegradable bags are made readily available.

Explain the overlap of taxation policy and education campaign.


Indirect taxation alone cannot tackle this market failure. Encourage use of reusable or biodegradable bags in Singapore is the long term strategy is strive for.


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