JC Economics Market Imperfections & Allocative Inefficiency Essay Model Answers
Did you know that, with respect to the essays on Market Failure topic, JC Econs students have to explain the concept of market imperfects in your H2 Econs exams too, including imperfect information, market dominance or factor immobility?
Here is an important example of a typical question on this section of inefficiency that is common in Promos exams and even the Prelim exams.
Question
(a) Explain why market imperfections may lead to an inefficient allocation of resources. [10m]
(b) Evaluate the policies currently used by the S’pore government to achieve an efficient allocation of resources with the above inefficiency. [15m]
JC Economics Essay – Market Imperfections
Suggested Answer:
1. Market power As firms produce at the profit-maximising level output where P> MC, the value that society places on the production of the last unit of the good is greater than the marginal cost producing it. This leads to an inefficient allocation of resources. In particular, the resource misallocation in monopolistic and oligopolistic industry could be shown with appropriate diagram.
(Sketch the monopoly diagram to show market dominance and its harmful effects)
2. Imperfect information As market participants lack information in making decisions, resources are allocated inefficiently. This could be attributed to imperfect information such as moral hazard and adverse selection.
Either: Buyer know more than seller» insurance » only individuals with greater risk buy insurance >> adverse selection, individuals with health risk » may overconsume. Example: Insurance company» too many with health risks buying insurance, resulting in adverse selection. Buyers of insurance do not take the efforts to maintain health after buying insurance » problem of moral hazard
Or: Sellers know more than buyers» doctors » over prescription » overselling case of supply
Induced demand » leading to overconsumption of healthcare services and products o Second hand car markets » due to lack of perfect information buyers are unwilling to offer high Price sellers of 2nd hand car of good quality are hence unwilling to sell as prices are low. This results in only poor quality 2nd hand cars to be put up for sale » adverse selection
3. Factor Immobility
To achieve economic efficiency, one assumption of the perfectly competitive market is that factors of production are perfectly mobile: they can be easily moved from one type of production to another in respond to changes in market conditions. This means that firms should be able to direct idle resources in markets that are experiencing surpluses to produce goods and services in markets that are facing shortages to maximise social welfare.
Often, this is not likely to be the case. Factor immobility will prevent the markets from achieving economic efficiency. Specifically with regards to labour, there may be both occupational and geographical immobility that obstructs the market mechanism from functioning properly.
1. (LABOUR) OCCUPATIONAL IMMOBILITY
Occupational immobility occurs when factors of production cannot move between different industries and occupations due to mismatch of skills. Workers made redundant in the declining industry (eg manufacturing) may possess job specific skills that are not necessarily transferable to the growing industries (eg services) in the economy. This implies that there is a mismatch between the skills on offer from the unemployed and those required by employers looking for extra workers. Unemployed are unable to fill the job vacancies available in the economy due to lack of skills, AND Structural unemployment results.
People remaining unemployed -> wastage of scarce resources -> social welfare is not being maximised -> economy producing inside PPC -> Productive inefficiency Allocative inefficiency in labour mkt -> surplus of workers in declining industries + shortage of workers in expanding industries. Allocative inefficiency in product mkt -> firms in expanding industries unable to increase production to meet rising demand due to unavailability of workers -> shortage results.
2. (LABOUR) GEOGRAPHICAL IMMOBILITY
Geographical immobility exists when there are barriers to prevent people moving from one area to another to find work. Likely to exist in large countries (eg UK, USA, China, India etc.)
Family and other social ties, Costs involved in moving home (aka social costs or psychic costs). Also, regional variations in house prices, as well as the differences in the general cost of living between regions. Locational or regional unN results: Unemployed in regions associated with certain declining industries are not reallocated to other parts of the country where job opportunities exist.
Allocative inefficiency in labour mkt-> surplus of workers in certain regions + shortage of workers in other regions. Also no AE in product mkt -> firms in regions where expanding industries are located are unable to increase production to meet rising demand due to unavailability of workers -> shortage results.
Productive inefficiency: Wastage of scarce resources-> economy producing inside PPC (note: this is actually optional, can omit. Why?)
JC Economics Essay – Policy Measures for Market Imperfections
A. Polices to tackle market dominance
For specific examples, you can refer to Competition and Consumer Commission of Singapore or CCCS. It is a statutory board under the Ministry of Trade and Industry (MTI). It administers and enforces the Competition Act (Chapter 50B) in S’pore.
There is this specific anti- competitive policy.
Chicken suppliers fined
Sistic fined
‘Huat kueh’ aka ‘fa gao’ sellers warned
What examples do you prefer and what diagrams can we use?
POLICIES TO TACKLE IMPERFECT INFO:
B. Lemon Law
Link to : what’s the lemon law
In SG, the gov attempts to protect consumers by passing the Lemon Law. When a consumer purchases a defective good or rather unsatisfactory service , aka a lemon, instead of a peach, the Law allows to buyer to seek compensation from the seller. Yes, this is to discourage producers from providing poor goods and and services.
POLICIES TO TACKLE FACTOR IMMOBILITY:
C: Skills Upgrading Programme
This is simply the supply side policy in Macro Economics. To be more occupational mobile, and move from industry to industry (especially from lower-skilled to higher skilled ones in S’pore), SG government provides training subsidies to workers to enhance their skills and productivity. As of now, technology skills such as cloud computing, cyber security, agile methodologies, Internet of things, etc, are in huge demand, and Singaporeans are pushed to go reskilling asap!
Besides resulting in economic inefficiency, governments are concerned about factor immobility because it leads to worsening income inequality a loss of national output and other economic and social costs to the economy. Govt’s aim is to achieve econ efficiency by improving factor immobility by i) Improving occupational mobility (Reduce structural unemployment), and ii) Improving geographical (Lower locational or regional UnN)
For instance: SSP to subsidise the provision of industrial training by private sector firms to raise the skills level of workers to improve mobility between jobs and industries. Also, to invest in increased provision of training schemes for the unemployed – particularly those workers structural unemployed -> boost the human capital of employees to give them skills that can be transferred from one occupation to another. If successful, labour market become more flexible in response to changes in labour demand and labour supply.
Raise total spending on education and move towards increased investment in vocational training for students to equip them with transferable skills and knowledge -> more adaptable to changes in lab mkt conditions.
As for improving geographical mobility, Increase labour dd in regions with high unemployment, on top of offering tax incentives to encourage firms to conduct investment in areas with regional unN.
In addition, lower cost of relocation by increase supply and reduce the cost of accommodation or rental housing, etc. Specific subsidies for people moving into areas where there are shortages of labour -for example housing subsidies, transfer payments, tax incentives, plus improvement in transport network system to increase accessibility and ease of travelling to work. (Note: it should be very obvious that in SG, geographical immobility is negligible.)
Policy Limitations:
Uncertainty of Success
Effectiveness of training and education depends on worker’s receptivity, attitudes and mindsets. Furthermore, social and emotional ties are difficult to overcome when tackling geographical immobility. Besides, investment depends on other factors besides tax incentives, e.g. economic climate.
Costly
May involve high government expenditure which needs to be financed by high taxes in the future lowers incentives to work and invest and conflict with economic growth in the long term.
Long term
Training and education to equip workers with relevant skills is a long term process, require months and years of training for workers to be productive. Finally, improvement in transport network cannot be achieved over time – time to build up infrastructure.
Evaluation: more judgement options to be discussed more in class (“,)
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