13 Economics Test — Eco3.3 ANSWERS QUESTION ONE: MARKET FAILURE Marker’s use only The Land transport Safety Authority (LTSA) publishes car crash safety information for all models of cars sold in New Zealand on their website www.crashtestdummy.co.nz (a) What is market failure? When the market does not result in equitable or efficient use of resources (b) A1 Describe why the government feels justified to intervene when the market fails. When the market fails the government is justified to intervene to result in more acceptable outcomes A1 (c) With reference to conditions that are required for markets to operate perfectly, explain why the LTSA provides car buyers with this information. (I) For markets to operate perfectly buyers and sellers need perfect information. (E) by providing consumers M2 with safety information they can make a more informed decision (R) when purchasing a car. (d) Apart from the situation above, identify two other conditions that are required to be present for a market to operate perfectly. No spillover costs/benefits Consumer sovereignty Perfect competition/price takers Mobility of factors A1 2 QUESTION TWO: EXTERNALITIES 1. 2. Marker’s use only Pure private goods have no externalities. List TWO further characteristics of private goods. (1) Rival/Depletable (2) Excludable (by price) A1 For each type of externality in List 1, identify an example from List 2. Enter the correct letter into the appropriate box. List 1 List 2 (a) Negative Externality of Production (b) Positive Externality of Production H A. Car dealers benefiting from other car dealers locating nearby B. Drinking a can of soft drink A C. Eating a Sandwich D. Employing an extra worker (c) (d) Negative Externality of Consumption F Positive Externality of Consumption E E. Car parks being made available because more people are taking public transport ¾ A1 F. Passive smoking G. Production of fireworks H. Water pollution from a factory 3. What does it mean to ‘internalise an externality’? Whoever creates the externality pays or is rewarded Bringing together the social costs and benefits 4. A2 How would establishing appropriate property rights help to control the over-fishing of New Zealand’s coastal shellfish beds. Eg: the allocation of quotas to establish property rights and limit catches M2 3 QUESTION THREE: PUBLIC GOODS There are 13 national parks in New Zealand which are administered by the Department of Conservation. 1. 2. Marker’s use only State TWO reasons why a national park might be considered a public good. (1) Non-excludable by price (2) Either A1 and non-depletable, non-rival, no marginal cost Define a collective good. A good provided by government and/or funded from taxation A1 3. In what way could international tourists visiting New Zealand’s national parks be considered ‘free-riders’? A1 The idea that they are not contributing toward the cost Graph 1: Benefit Received from Visiting a National Park Capacity Costs and Benefits MB price Visitors 4. Assume that the marginal cost of an extra visitor to a national park is zero. a. On Graph 1 above, show and label appropriately the effect of charging an entrance fee to a national park. A1 b. Explain why it might be considered economically inappropriate to charge an entrance fee to a national park. Any of the following ideas: welfare loss when benefit Is denied despite zero marginal cost / consumer benefit is not being max’ed / there is no need to ration this resource / costs of gaining revenue might exceed revenue gained M1 4 QUESTION FOUR: INCOME DISTRIBUTION 1. Marker’s use only Distinguish between equity and equality of income distribution. Equity = fairness A1 Equality = same Table 1: New Zealand Distribution of Household Income 2. a. % of Households % of Income Cumulative % of Households Cumulative % of Income 20 5 20 5 20 11 40 16 20 15 60 31 20 23 80 54 20 46 100 100 all A1 Complete the last column of Table 1. b. Use Table 1 to plot New Zealand’s Lorenz Curve (label it L1) on the grid below. Fully label the graph. L1 % Income Labels Scales Plotting A1 % Households c. The government has dropped the top marginal tax rate from 39% to 30%. Show on the graph above the effect of an decrease in the overall tax rate. Label it appropriately. A sketched and labeled curve bowed further than L1 A2 5 3. State what the diagonal line on the graph indicates and explain its significance in displaying equitable income distribution. Marker’s use only Equal distribution of income, providing a means of comparison if more equal equates with more equitable M1 Two policies the government could use to help low-income households are: 4. • reduce regressive taxes (eg remove GST from basic necessities such as food) • increase transfer payments to low-income households (eg increase the unemployment benefit). a. Explain why GST (Goods and Services Tax) is a regressive tax. (I) A regressive tax taxes low-income earners at a higher rate than high income earners. Low income earners spend a higher proportion of their income than high income earners (who can afford to save) one point A2 (E) so a greater percentage of their income is exposed to GST tax. both points So it is regressive. (Q) M2 Increasing the unemployment benefit could result in an equity / efficiency trade-off. b. Explain the likely impact of an increase in the unemployment benefit on efficiency. (I) An increase in the unemployment benefit will result in a decrease in efficiency (with an one point attempt to answer why). (E) Guaranteeing income will result in a decrease in the supply of labour because some people receiving A2 the unemployment benefit will opt not to work (because they get paid even if they don’t work). OR funds could be used to improve infrastructure OR funds could be wasted paying for administration costs. So less is produced and a loss of efficiency occurs. (Q) both points M2 Note: logical explanations of why efficiency increased acceptable. c. Explain the likely impact of an increase in the unemployment benefit on equity. Eg: (I) An increase in the unemployment benefit will increase equity (with an attempt to answer why). (E) one point A2 Since low-income families receive an increase in income, the number of low-income families will decrease, resulting in a more even income distribution. both points So equity improves. (Q) Note: logical explanations of why efficiency increased acceptable. if 2 x M’s awarded M2 E2 6 QUESTION FIVE: NATURAL MONOPOLIES 1. Marker’s use only Name an example of a natural monopoly. Any appropriate example of a firm or industry e.g. telecom, railways A1 Graph 1: Natural Monopoly Cost / Revenue Pm AC MC Ps D = AR Qm 2. MR Qs Output On Graph 1 a. Draw an appropriate labelled average cost curve (label AC) for a natural monopoly. b. Label the profit maximising price (Pm) and output (Qm). c. Label the socially desirable price (Ps) and output (Qs). 3. Explain how a natural monopoly can benefit society more than if a natural monopoly is broken up into competing firms. One firm is more efficient that two or more firms Because competition/deregulation leads to duplication / waste of resources. A1 A1 one point A1 both points M1 7 4. Two possible policies that the government could use to regulate a natural monopoly are: a. Average cost pricing Marker’s use only b. Marginal cost pricing (i) Which policy would be the most economically efficient? No grade MC pricing (ii) Explain how the policy you chose in (i) would improve economic efficiency. Reduce price leads to quantity increasing from Qm to Qs one point A2 both points Therefore more efficient as no DWL / sum of CS and PS maximised M2 Accept appropriate answer for AC pricing (iii) Explain how the policy you chose in (i) would be more efficient than the other policy. MC pricing: because reduces price to the socially desirable equilibrium / no DWL / sum of PS and CS one point A2 maximised whereas average cost pricing only reduces DWL / does not maximise sum of PS and CS both points M2 (iv) Explain how both marginal cost pricing and average cost pricing could result in an increase in equity. AC or MC pricing reduces price making the good more affordable one point A2 those on lower incomes benefit more as their purchasing power increases more relative to high income both points earners M2 if 2 x M’s awarded E2 8 QUESTION SIX: MERIT GOODS 1. Marker’s use only Classify the following as merit or demerit goods by placing a tick in the correct column. Merit goods Goods Fire extinguishers Party pills Burglar alarms Anti virus software all correct A1 Sugary fizzy drinks Bike lights Gambling – slot machines 2. Demerit goods Explain why merit goods are under consumed without government intervention. I) merit goods are goods that society/government considers that consumers should use. (E) As they have positive benefits/spillover benefits that are not internalised (included in the price) As a result prices of merit goods are higher than they would be if the spillover benefits were internalised. As a result the quantity demanded is lower than “should” be. (Q) Eg everyone benefits from a fire extinguisher so the private price M1 paid by a consumer should be lower to reflect this. 3. Explain why demerit goods are over consumed without government intervention. (I) demerit goods are goods that society/government considers that consumers should’nt use. (E) As they have negative effects/spillover cost. As a result prices of demerit goods are lower than they would be if the spillover costs were internalised. As a result the quantity demanded is higher than “should” be. (Q) Eg everyone (taxpayers) have to pay hospital costs that result from people who develop type 2 diabetes from the consumption of sugary fizzy drinks. For Assessor’s Use only Achievement Criteria Achievement Define market failure. 9 x A1s or better Describe government interventions used to correct for market failure. 4 x A2 or better Merit Explain market failure. 3 x M1 or better Explain government interventions used to correct for market failure and their impact on equity and efficiency. 4 x M1 or better Excellence Explain market failure. no further evidence Fully explain government interventions used to correct for market failure and evaluate their impact on equity and efficiency. 1 x Es M1