In Unit 3 of A2 CIE economics course you will no doubt have come across externalities – see graphs below. In simple terms the cost to the consumer must also be accompanied by the external costs (referred to as externalities) which is normally not paid by the consumer. Externalities are common in virtually all economic activities. They are defined as third party (or spill over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid.
Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption. The study of externalities by economists has become extensive in recent years, not least because of concerns about the link between the economy and the environment.
This all seems very straight forward as you would assume the external cost (externality) of driving a car (emissions) would be added to the private cost of running the car (petrol etc). However carbon taxation is politically elusive as only 20% of global emissions are covered by schemes that put a price on carbon and only 1% of emissions subject to such schemes face a price as high as $40 per tonne of carbon dioxide. The Green New Deal proposes to a move to a 100% clean and renewable energy within a decade or two, and to zero net emissions by mid-century. Those who support the idea are sceptical about costs and funding as decarbonising the economy will require some serious capital.
For the Green New Deal to work it must mobilise a majority that are more passionate than the remainder. A carbon tax with a dividend may be appealing but the financial benefits are small when divided by the number of voters. Remember that an associated tax would encourage an aggressive response from wealthy fossils-fuel firms. A Green New Deal, in contrast, might promise sufficient goodies to organised interest groups, such as labour unions and domestic manufacturers, to gather a winning political coalition.
Some see the Green New Deal is something more radical. Roosevelt saw the Depression as both a threat to liberal democracy and the product of an economic system that put profits ahead of the welfare of the working man. Similarly, left-wing activists view climate change as the result of unbridled capitalism. They aim to solve it by redistributing economic and political power.
Source: The Economist – A bold new plan to tackle climate change ignores economic orthodoxy. 7th February 2019
James Surowiecki wrote an interesting piece in the New Yorker about the deadly outbreak of Ebola and the fact there is no real medication to stop it. Ebola was discovered in 1976 and although there has been no drug approved to treat the disease this is not surprising.
A pharmaceutical company is a business and they will direct investment into medication that they see will generate income for them which will ultimately satisfy the shareholders. Therefore it makes sense for them to target higher income groups that have the purchasing power to buy the medication. Furthermore it is in their favour that the medication needs to be ongoing e.g. drugs for lowering your cholesterol. Although this works quite well in developed countries it does lead to significant underinvestment in diseases and certain categories of drugs. Ultimately the big pharmaceutical company does not see the developing world as a potential market for their products. Therefore diseases like malaria and tuberculosis receive less attention from companies than high cholesterol. However initially Ebola looked like a bad investment as it was confined to West Africa but as it has now spread to the developed world investment might start to be more prevalent.
The big question that Surowiecki alludes to is how do we get the drugs we need without transforming the industry. One way would be for the government to make a payment to a company and in exchange the company would give up the right to sell the product and therefore save on all the marketing costs. Furthermore public health officials would be able to control how it was promoted and used. Economists see payments as cost-effective as you only have to pay if the product works and it encourages investment into public goods where the benefits extend not only to the consumer but to third parties – e.g. vaccinations etc.
One of the biggest threats to world health is that of obesity and sugar is the source of the weight gain amongst many people. It is ironic that sugar consumption was accelerated in the 1980’s after it were introduced into processed foods to deal with the health scare concerning saturated fats. Governments are now becoming more aware of this issue as it starts to absorb their health budget – UK spends £4bn on obesity related health issues. Norway, Mexico and the states of California and Illinois have introduced a tax on full-calorie soft drinks. Taxing sugar drinks does increase the cost of consumption and generates revenue to pay for the health costs that the overweight impose on society. But are there other options that they should be trying? Taxation might reduce some consumption but information about public awareness could be a more efficient option.
Information about sugar – a better solution?
A simple solution to obesity is to eat less and take more exercise. The World Health Organisation recently halved its recommended daily allowance, saying we should have no more than six teaspoons a day – less than one fizzy drink. However much of the sugar we consume is hidden within processed foods – high-fructose corn syrup which is a cheaper alternative to sugar. Food needs to be properly labelled and it is interesting to see the UK government are changing the way foods are labeled to assist shoppers to monitor their intake of harmful food using a simple traffic light system. But it doesn’t help that the US and EU governments still subsidise sugar production. However the real aim of focusing on sugar is that we start to lead healthier lives.
This maybe useful for Unit 3 of the AS course. The Fire Service in New Zealand is currently funded on levies on fire insurance. However the incidence of fires in the last 20 years has dropped dramatically and the fire service has increasingly been attending to tasks not related to fires – this includes emergency situations like flooding, car crashes, hazardous waste problems to name but a few.
The New Zealand Herald mentioned that approximately 19% of calls for the Fire Service are transport-related incidents but only 8% of funding comes from that sector. Currently people pay a levy of 7.6 cents per $100 of a property’s insured value and this is capped at $100,000 = total levy up to $76 per year. Suggestions have been mooted with the idea of reducing the levy but increasing the cap – 4.6 cents per $100 capped at $250,000 = total levy up to $115 per year.
There is also those who do not insure against fire but still expect assistance from the fire service – between 5-10% of householders contributed no money to the Fire Service. Free-Riders!
Here is a powerpoint presentation on market failure. It includes:
– Reasons for failure
– Deadweight Loss
– Policies to correct
– Effectiveness of policies
It also goes through some essays questions with suggested answers in the AS CIE Economics Paper 2 – essay and data response. Click Market Failure Keynote to download.