Positive Externalities Policies

Question 1

What are subsidy

Answer 1

Subsidies or monetary payments given to firms by the government which allows the producers to boost production, allowing greater consumption of the good by society.

Question 2

What is the method of subsidy

Answer 2

When a subsidy is given to producers, their cost of production falls . The producers will be more willing and able to produce the good which leads to an increase in supply such that the new market equilibrium is that socially optimal level of Q2, where MSC= MSB, were society’s welfare is maximised and allocative efficiency is achieved, solving market failure.

Question 3

Draw the graphs for subsidy

Answer 3

State the size of subsidy
Deadweight loss
Shift of the supply curve

Question 4

What is the graphical analysis for subsidy graph

Answer 4

1. Seen in the graph above, subsidy will lead to an increase supply from S1 to S2
2. Assuming that the size of subsidy is the marginal external benefit at Q2, socially optimal level. Consumers now consume the good at a lower price of P2 instead of P1.
3. Therefore subsidy allows firms to internalise the external benefit and increase production to socially optimal level which will solve market failure.

Question 5

Advantages of subsidy

Answer 5

Easy implementation and equity

Question 6

How is subsidy easy to implement

Answer 6

Unlike Taxes which penalise users of the good to deter production and consumption of demerit goods, subsidies encourage greater usage of the good. The government will have little to no difficulties in implementing this policy face little resistance from citizens as the majority of them will benefit from subsidy.

Question 7

How to subsidy lead to equity

Answer 7

Subsidies lower prices of the good as well as increased amount of good produced to socially optimal level this will make the good much more affordable and accessible to the poor majority, which will help government achieve its microeconomic goal of equity.

Question 8

What are the limitations of subsidy

Answer 8

Budget, imperfect info and inefficiency

Question 9

How is budget related to subsidy

Answer 9

Subsidy is financed by the government and this requires high amount of government expenditure, thus government budget position has to be healthy in order to implement subsidy.
If the government is facing budget deficit, they will have to increased taxation, borrow money or divert spending from other sectors to provide for this policy. But if the government borrows money this would increase government’s debt and burden will be borne by the future taxpayer via higher taxes. In addition there will also be opportunity cost when diverting funds from other measures towards providing for a subsidy, government must forego the benefit of spending funds on other sectors. And diverting funds will not be feasible if government is facing a more serious problem for example recession or epidemic.

Question 10

How does imperfect info affect subsidy

Answer 10

Since it is difficult to measure the level of positive externalities, government failure in the form of in perfect info may occur. Government may not be able to accurately measure the marginal external benefit and will be unable to determine the right amount of subsidy and may over or under estimate the amount of subsidy.
Over estimating good result in too large of the subsidy which will lead to an even greater deadweight loss , resulting in the extent of market failure to be bigger, with more allocative inefficiency outcomes.
While underestimating subsidy may lead to insufficient subsidy to be provided does there was still be deadweight loss and market failure still occurring

Question 11

Why does subsidy lead to inefficiency

Answer 11

Subsidy may breed inefficiency as firms COP is lowered, this may lead to them having higher profits that little improvement to the production process, leading to complacency
In addition , firms are less pressured to find more efficient/ lower cost of production methods, firms may also have little incentives to innovate and improve quality.

Question 12

What is full provision

Answer 12

Full provision is a policy taken when the government has full control over the market. The government is directly involved and undertakes the entire production of the good, this allows them to not only lower prices but more importantly ensure production of the good is that socially optimal level.

Question 13

What is the method for full provision

Answer 13

Government will determine that socially optimal level is at Q2 where MSB= MSC, that’s government will take full responsibility introducing the good at this level leading to the supply curve being perfectly price in elastic (totally unresponsive price) this allows government to ensure that the good is provided at socially optimal level.

Question 14

Draw a graph for full provision

Answer 14

Ensure that the supply curve is perfectly price-inelastic
produce at Q2

Question 15

What is the graphical analysis for full provision graph

Answer 15

1. As seen in a graph above, government identifies the socially optimal level to be at Q2 where MSB the=MSC, and supply for the good will be perfectly price in elastic as seen in S1
2. Hence the new market equilibrium will be at Q2 , socially optimal level, instead of previous market equilibrium of Q1.

Question 16

Advantages of full provision

Answer 16

Equity

Question 17

How does Full provision lead to equity

Answer 17

Full provision beats to equitable outcome since government is fully responsible in producing the good. Since the government have control over prices, they can lower the price of a good even to the point that it is free in order to allow for consumers to consume the good.

Question 18

Limitations of full provision

Answer 18

inefficiency and imperfect info

Question 19

How does full provision lead to inefficiency

Answer 19

When government has sole responsibility over production of the good, this leads to inefficiency as bureaucratic non-profit nature of government lacks the incentives that profit motivated firms have to innovate and cut costs. Does government will likely to produce a good at higher cost and firms while at the same time failing to provide the same quality of the good.

Question 20

How does full provision lead to imperfect info

Answer 20

The problem is in perfect in. Exist as it is difficult to measure the marginal external benefit hence it will be difficult to estimate the socially optimal level of production. This may lead to over or under production of the good whereby overproduction leads to overallocation of the good and other production leads to under allocation of resources, ultimately still contributing to market failure due to inefficiency allocation of resources.

Question 21

What is joint provision

Answer 21

Joint provision is the preferred way by the government to ensure that level of consumption or production is it socially optimal level. Government allows private enterprises to be responsible for the initial production of the good and interns arguments the market by producing the remainder of the good required for production to reach socially optimal level.

Question 22

What is the method of joint provision

Answer 22

Unregulated, the market consist of firms producing at current market equilibrium Q1, where MPB= MPC, since they do not consider the MEB of producing the good. Therefore, government will enter the market and increase the supply of the good in order for the new market equilibrium to be at socially optimal level of Q2.

Question 23

Draw a graph of joint provision and check

Answer 23

Rightward shift in the supply curve due to increase in firms which increases total supply.

Question 24

Graphical Analysis for supply curve

Answer 24

1. Seen in the graph above, the government enters the market which results in the total number of producers to increase, and in turn increasing the total supply, causing a rightward shift in the supply curve.
2. Hence, new market equilibrium is it socially optimal level of Q2 instead of previous market equilibrium at Q1, leading to the government achieving allocative efficiency, solving market failure.

Question 25

Advantages of joint provision

Answer 25

Equity, efficiency, flexibility

Question 26

How does joint provision lead to equity

Answer 26

Joint provision leads to actable outcome since an increase in supply with lower equilibrium price in the market the government also like profit motive, Tuscan decide to lower price of the good in order to allow for majority to consume the good.

Question 27

How does joint provision lead to efficiency

Answer 27

Compare it to full provision, joint provision leads to efficiency generated through the competition between private friends were profit motivated and aims to cut cost while improving quality , and government to his concern about the level of consumption of the good. This ensures higher quality products and lower priced products through competition, encouraging innovation and pressure to keep prices low.

Question 28

How is joint provision flexible

Answer 28

When too little quantity is produced, government can increase the number of producers, which increases supply and increases quantity.
When too much quantity is produced , government can decrease the number of producers, which decreases supply and decreases quantity.
Government has flexibility in deciding the appropriate level of competition in the market , this flexibility allows government to have the right level of competition that maximises social welfare.

Question 29

Limitations of joint provision

Answer 29

Imperfect info

Question 30

How does joint provision leads to imperfect info

Answer 30

Problem of being perfect info still exist as the marginal external benefit cannot be measured easily, does it is difficult to estimate the social optimal level of production this may lead to overproduction where there is over allocation of resources in producing the good, or underproduction where there is under allocation of resources both which ultimately contributes to market failure due to inefficient allocation of resources.

Question 31

What is rules and regulation/ legislation

Answer 31

Rose and regulations are targeted at increasing consumption of goods and services that generates positive externalities to socially optimal level through enacting laws. When they are not adhered to, penalties such as find may be imposed.

Question 32

Method of rules and regulation/ legislation

Answer 32

Government will impose mandatory consumption of goods and services which will increase the demand for the good. Since consumers the man is also reflected in their MPB, and PP will increase and shift to the right, leading to quantity to increase to socially optimal level at Q2.

Question 33

Draw graph and check for rules and regulation

Answer 33

Demand increase so there is a rightward shift in the demand curve from D1 to D2

Question 34

Graph Analysis for rules and regulation

Answer 34

1. As seen in a graph above, the existence of rules and regulation will increase the demand, causing a rightward shift of the demand curve from D1 to D2
2. Hence the new material will be at Q2 ,socially optimal level, instead of previous equilibrium at Q1, does the government achieves allocative efficiency and solving market failure

Question 35

Advantages of rules and regulations/ legislation

Answer 35

Financial constraints

Question 36

Explain financial constraints as advantage of rules and regulation

Answer 36

Monitoring costs will be incurred as inspectors and police must be deployed to conduct checks to ensure that legislation is being obeyed. However additional cost incurred for hiring additional manpower to monitor and enforce are usually lesser than other policies such as subsidy/provision. Hence this creates lesser financial strain on government budget, making legislation feasible for government to continue the policy in the long-run.

Question 37

What are the limitations of rules and regulation

Answer 37

Harshness of the penalties, effectiveness

Question 38

Explain both limitations of rules and regulation

Answer 38

1.Effectiveness of the legislation also depends on the harshness of the penalties imposed. The penalties for non-compliance must be sufficiently harsh to enhance the effectiveness of any legislation.

2. In addition effectiveness also depends on whether the country has good system and law-enforcement institution as the government needs to enforce regulations. In countries where lost enforcement officials are corrupt it or not well established, legislation will not be well enforced.