Q.69 market-imperfections-and-immobility-of-factor-inputs

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Q.69 market-imperfections-and-immobility-of-factor-inputs

  1. 1. (a) Explain why market imperfections and immobility of factor inputs are market failures. [10] (b) Discuss whether the Singapore government is more concerned about these two types of market failure or the other types of market failure. [15] (a) A market failure occurs when the free market fails to achieve social efficiency or income equity. Social efficiency is achieved when marginal social cost (MSC) is equal to marginal social benefit (MSB) where MSC is the sum of marginal private cost (MPC) and marginal external cost (MEC) and MSB is the sum of marginal private benefit (MPB) and marginal external benefit (MEB). External costs and benefits, or simply externalities, are costs and benefits of consumption or production experienced by society other than the producers or the consumers. Market imperfections are deviations from the assumptions of perfect competition that lead to under-production and this is a matter of concern particularly if the market is monopolistic. A monopolistic market is a market where there is a single large firm selling a unique product that has no close substitutes. Due to lack of competition in the market, a monopoly is a price-setter in the sense that it is able to set its price by setting its output level. The presence of barriers to entry in a monopolistic market allows a monopoly to make supernormal profit in the long run. A monopoly has substantial market power which it can use to restrict output and charge a higher price to make more profit resulting in under-production. In the above diagram, the socially efficient output level where MSB is equal to MSC is QS. However, if the monopoly increases its output level above QM where its MPC is equal to its MR, the increase in its total cost will be greater than the increase in its total revenue as its MPC will be higher than its MR. If the happens, its profit will fall. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  2. 2. Therefore, the monopoly will restrict its output level to QM which is lower than QS. The deadweight loss, which is the loss of surplus due to market failure or government intervention, is represented by the shaded area. Immobility of factor inputs may prevent a market from achieving equilibrium resulting in social inefficiency. When changes in demand occur, firms will respond by changing their output and hence the amount of factor inputs they employ. However, owners of factor inputs may be slow to respond due to immobility. For instance, workers may be immobile occupationally or geographically. Occupational immobility occurs when workers do not have the relevant skills and knowledge to move to the industry immediately. Therefore, they need time to undergo education and training before they can move to the industry. Geographical immobility occurs when workers do not reside in the place where the industry is located. Therefore, they need time to relocate before they can move to the industry. As workers move to the industry over time and hence the market moves towards the equilibrium, the equilibrium moves and this causes the market to be in a constant state of disequilibrium resulting in social inefficiency. In the above diagram, the demand (D0) and the supply (S0) lead to the equilibrium (e0). When the demand changes from D0 to D1, the equilibrium changes from e0 to e1. However, as the market moves slowly to the new equilibrium (e1) due to immobility of factor inputs, the demand changes again from D1 to D2 which leads to another new equilibrium (e2). In conclusion, the government should correct the market failures that have serious social implications and these normally involve merit goods, demerit goods or public goods. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  3. 3. (b) The question on whether the Singapore government is more concerned about these two types of market failure or the other types of market failure can be discussed with reference to the various types of government intervention in the markets. The Singapore government intervenes in the markets that may correct the market failure of market imperfections. The public bus services and the public train services in Singapore are operated by two large firms, namely SMRT and SBS Transit. Therefore, the public transport market in Singapore is an imperfect market. In order to regulate the public transport market in Singapore, the government has set up the Public Transport Council. For instance, SMRT and SBS Transit are required to seek approval from the Public Transport Council for any fare increments. Further, the Public Transport Council has implemented a fare adjustment formula which allows a maximum fare increment of 2.8 per cent. These price regulations effectively act like a maximum price regulation which will increase the output level in the public transport market and hence may correct the market failure of market imperfections. In the above diagram, a maximum price (PMAX) set at PS results in the new profitmaximising output level (QM’) equal to QS. The Singapore government intervenes in the markets that may correct the market failure of immobility of labour. Education and training will reduce occupational immobility of labour. The Singapore government provides education and training directly by setting up educational institutes. Examples include the Institute of Technical Education, Polytechnics and Continuing Education and Training campuses. It also provides education and training indirectly by giving subsidies and tax incentives to firms to induce them to send their workers for education and training. Examples include Workfare Training Support, Skills Programme for Upgrading and Resilience, Workforce Skills Qualifications System and Skills Training for Excellence Programme. Business expenses on education and training are tax deductible in Singapore. A better transport system will reduce geographical immobility of labour. The Singapore government has © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  4. 4. taken measures to improve the transport system such as building the Mass Rapid Transit system, the Light Rapid Transit system and expressways, and improving the traffic signal system through implementing the Green Link Determining System. The Singapore government also intervenes in the markets to correct the other types of market failure. The Singapore government intervenes in the markets to correct the market failures of externalities and imperfect information which involve merit goods. Merit goods are goods that society deems desirable and the government thinks people should be encouraged to consume. Examples of merit goods include education and healthcare. Merit goods will be under-consumed in the absence of government intervention due to the positive externalities they produce and imperfect information about the beneficial effects. For instance, to correct the market failure of healthcare, the Singapore government gives a subsidy to public hospitals for the provision of subsidised healthcare to increase the supply, has created the 3M framework to increase the demand for healthcare, provides healthcare directly alongside private hospitals through public hospitals that are run as private companies wholly-owned by the Singapore government to increase the supply, has made childhood immunisation against certain diseases mandatory and has used education such as launching campaigns and incorporating the values of good health into the school curriculum to increase the awareness of the beneficial effects of good health to increase the demand for healthcare. The Singapore government intervenes in the markets to correct the market failures of externalities and imperfect information which involve demerit goods. Demerit goods are goods that society deems undesirable and the government thinks people should be discouraged to consume. Examples of demerit goods include tobacco and alcohol. Demerit goods will be over-consumed in the absence of government intervention due to the negative externalities they produce and imperfect information about the detrimental effects. For instance, to correct the market failure of tobacco, the Singapore government has imposed an excise tax on cigarettes to reduce the supply, has passed several regulations to reduce the demand for cigarettes and has used education to reduce the demand for cigarettes. The Singapore government intervenes in the markets to correct the market failure of public goods. For instance, national defence and street lighting are provided by the Singapore government directly through tax. In the final analysis, the Singapore government is more concerned about the market failures which involve merit goods, demerit goods and public goods. Due to lack of factor endowments in Singapore, increasing labour productivity is extremely important for good economic performance. Therefore, under-consumption of merit goods and overconsumption of demerit goods which may impede the growth of labour productivity is rather undesirable in Singapore. Further, public goods are essential to the operation of the Singapore economy. Although the Singapore government does intervene in the public transport market, the main objective is to ensure the affordability of public transport © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek
  5. 5. rather than to correct the market failure. Similarly, the Singapore government’s main objective of reducing immobility of labour is to lower structural unemployment rather than to correct the market failure. © 2011 Economics Cafe All rights reserved. Written by: Edmund Quek

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