A C J C Economics

H1 Revision Package
(2014 JC1 Promo Exam)
Revision Paper 2
Section A: Case Study Question
London Olympics 2012 (Adapted from ACJC 2013 Promos)

(a)

(i)

Describe the trend in tourist arrivals to the UK from 2006 to 2012.

[2]

Option 1

Option 2

General trend: Tourist arrivals to the UK were

generally falling from 2006 to 2010 before rising
thereafter.

General trend: There was a falling/downward trend

in tourist arrivals to the UK from 2006 to 2012.

Refinement: The biggest fall was registered in

2008-2009
(ii)

Refinement: The exception was a rise in tourist

arrivals in 2010-2012.

Using Extract 1, explain the fall in tourist arrivals to the UK during the
Olympics month, August 2012.

[4]

There was decrease in demand for visits to UK due to:

1) Extract 1: fears of overcrowding due to the Games, potential visitors decided not to visit the UK to
avoid any disruption caused by the Games
Demand factor: expectation of crowds alters visitors preference of traveling to the UK
Visitors change their holiday plans to avoid travelling to the UK in anticipation of jams and crowds
during the Olympics period.
2) Extract 1: unseasonal wet weather
Demand factor: bad weather
Visitors are aware of the bad weather in the UK and decide to do away with travelling to the country.
Rainy skies impede good travelling experience and confine people indoors. These affect the quality
of travel and holidaying.
3) Extract 1: exchange rates
Demand factor: strong pound (currency of UK)
The UK pound () was strong against other foreign currencies and visitors may find it more
expensive to travel to the UK and choose to change their holiday destination to elsewhere.
OR
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Demand factor: weak US dollar as compared to

With the US dollar weakening, holiday makers will find tourism in UK comparatively more expensive than
USA (assuming that both destinations are substitutes) and thus make a switch to USA instead.
Students should note that there should not be excessive lifting from extracts, answer should
instead only use short phrases from extract or paraphrase the statement in your own words.

(b)

(i)

Explain the economic costs and benefits of having the Olympics

Games Lanes.

[4]

Introduction
During the period of the Games, dedicated lanes are reserved for use by authorised Olympic Family
vehicles only.
Economic costs refer to both actual (explicit costs) and opportunity costs (implicit costs)
Implicit Costs
As the government will spend a lot on the Olympics Games Lanes, this will incur the opportunity
cost of not being able to use the government expenditure on other areas such as education or
healthcare.

Explicit Costs
The introduction of 30miles of Games Lanes will incur explicit costs such as the wages of workers
as well as the costs of raw materials that go into the construction of the lanes.

Economic benefits
People may abandon the habit of driving and experience the alternative of using public transport as
many drivers will switch to public transport. Even when the Games are over, they may continue to
use public transport and contribute less to traffic congestion in future.
The Olympics Games Lanes ensure the smooth-running and success of the Olympics by ensuring
that the athletes and officials get to their events on time by minimising the time they spend travelling.
Besides ensuring that competitors arrive on time, they can also be in good physical condition to
perform at their best and brings joy to the spectators.

Student should note that answer should be supported using case evidence (avoid excessive
lifting)

(ii)

With reference to the data, identify the market failure arising from the
Olympics Games.
The market failures arising from the Olympics games is due to negative

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[2]

externalities in production.
The creation of Games Lanes will generate negative externalities.
Evidence from extract 2:
It will cause inevitable traffic chaos on already busy road networks, as
well as delays on the London Underground as those trying to escape
queues opted for public transport as many drivers will switch to public
transport. There will be chaos on public transport. The Tube will get
even busier, and with major delays or hot summer weather, travelling
could become unpleasant.
The traffic jam resulting from the operation of games lanes will also
result in greater pollution with adverse impact on the health of people as
4300 people a year die prematurely due to pollution mostly disgorged
from exhaust pipes.
As taxis and private-hire vehicles are not able to use the lanes and
need to make detours or get caught in traffic jams, the costs of road
journeys will increase and consumers need to pay more while the drivers
takings will be down as fewer people will want to take taxis.
As some pedestrian crossings will not be operational when the games
lanes are operational, the removal of pedestrian crossings and changes
to traffic lights will therefore reduce pedestrian safety.

OR
There is a missing market in general security at the Olympics as it is a public
good which is both non-excludable and non-rival.
Evidence from extract 3:
The total costs of over 1 billion will be fully funded by the UK government,
the in-venue security alone costs 553 million.
For your own understanding (not required in answer):

Non-excludable: General security is non-excludable as once the

good is produced, it becomes generally available to all. It is not
possible to exclude non-payers from enjoying the good. Should a
security situation arises in the stadium, everyone will receive the
protection regardless of who they are, whether they have paid for the
games tickets or they are working there.
Non-rivalry: General security is non-rival as the consumption of the
good by someone will not diminish others ability to consume the
good. For example, everyone will benefit from the 24,000 security
staff who will be working at the 34 Olympic venues to perform venue
security roles bag checks and general security at venue gates.
The security protection is offered to all. A spectator who receives
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such protection does not reduce the amount of protection to another

spectator. Everyone receives the same amount of general security so
its consumption is non-rival.
Due to the characteristic of non-excludability, everyone wants to be a free
rider. It is therefore not possible to impose a price and therefore there is no
possibility of making any profits. Hence no willingness of private security
firms to provide.
As it is non-rival, once general security is provided, the marginal cost of
providing the good to an additional user is zero. For example, there is no
need to deploy another security personnel in the stadium just because there
is one more spectator arriving in UK. With zero marginal cost, the basic
principle of optimal resource allocation calls for provision of public goods at
zero price or no charge. However, if the price is zero, no private firm would
want to supply the good!
Due to the non-excludable and non-rival characteristics of general security,
private security firms which are motivated by profits will not provide this
good. Hence there is a missing market and market fails.
(c)

(i)

Define the term Gross Domestic Product.

[2]

It measures the monetary value of all the goods and services produced within geographical boundary of
the country during a year.
(ii)

Which is the most important component of Gross Domestic Product for

the UK?

[2]

As AD = C+ G+ I+ (X-M),
Household Consumption (C) represents the most important component of AD for UK in relation to the
proportion of the UKs total GDP. It forms the largest proportion of GDP over the years as seen in Figure
2 where Household Consumption (C) forms 65.9% (1,028,756) of the total GDP of UK in 2012.
(iii)

Explain what is meant by healthy and sustained economic growth.

[3]

Economic Growth an increase in the countrys real GDP which is the value of output/earnings
produced within the domestic boundaries of a country during a period of time. Usually obtained
through increase in AD. To sustain growth in the long run, its productive capacity (LRAS) has to
expand, too.
Governments aim not only for economic growth per se, but healthy and sustained growth. This
means working towards actual growth and potential growth. (Potential growth defines the limit of
growth a country can attain; actual growth is the actual increase in production within this limit.) While
potential growth is determined by the efficiency and quantity of resources and production, actual
growth is dependent on the strength of aggregate demand.

(d)

With the use of an AD/AS diagram, explain the effect of an increase in

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[3]

investment on economic growth.

There is a positive/direct relationship between investment and economic growth. Investment spending is
a component of AD. When investment increases and this raises AD, assuming AS constant, real GDP
will increase. Hence this leads to actual economic growth.
However, investment could contribute to the productivity of the economy, expanding the productive
capacity, leading to a shifting of LRAS to the right. Hence this leads to potential economic growth.

GPL
Yf1

Yf2

AD2
AD1
Y1

Y2

National Output

2m accurate explanation on the increase in investment on AD and AS as well as the impact on

economic growth
1m accurate diagram drawn

(e)

To what extent would the hosting of the Olympic Games in 2012 affect
the economic growth of the United Kingdom?

[8]

The hosting of the Olympic Games in 2012 has contributed positively to the economic growth of the
UK. The extent of the contribution can be analysed using the AD/AS framework.
Outline the components of AD and AS

Identify components of AD and AS

o

AD = C + I + G + (X - M)

AS represents the total value of output that can be produced by the economy with a given
amount of resources and technology.

Diagrams are encouraged, but optional.

Explain some impact (mainly positive) of the Olympics Games on the various components of
AD and AS in the UK:

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Impact on AD& AS
o

Though the number of visitors to UK dropped in Olympic month as seen in Extract 1, the
revenue on hotels and restaurants rose, suggesting an increase in tourist spending despite a
fall in tourist numbers. (London hotels had over 90% occupancy rates in August 2012 and
revenue rose.)

Since the tourism industry refers to foreigners expenditure on UKs goods and services, there
will be an increase in X which is in line with Figure 2 whereby total export revenue climbed to
492 810m in 2012 Shift AD to the right.

In Extract 3, Visa has estimated UK GDP will be boosted by 750m of spending during the
Games. This spending is likely to be contributed by an increase in household consumption on
domestic goods and services due to increase in confidence and growth. UK residents are
optimistic of the market outlook and they are likely to be confident of their employment and thus
are more willing to spend. The excitement of London Olympics 2012, along with the many
Olympics merchandise, spurred spending. In addition, with many lanes closed for cars as
highlighted in Extract 2, there will be an increase in consumption of public transport that
contribute to more domestic spending as well. Many drivers will switch to public transport.
Thus, there will be an increase in C. This is in line with Figure 2 with Household consumption
going up to 1028 756m in 2012 AD shifts to the right

As confidence picked up, firms are more willing to increase in inventory and capital investment
as they expect more sales. For security, as more personnel are being hired to take on the roles,
they will have to be trained and this is a form of investment with an impact on LRAS. I
increases AD shifts to the right, LRAS shifts to the right as well

Government expenditure increased as well with an investment of 9.3bn (Extract 3) to

develop the venues and necessary infrastructures. This will have an impact on LRAS as well
with some of the government expenditure being supplied-side policies LRAS shifts right

Government expenditure is also pumped up due to the total security costs of over 1 billion
(which was) fully funded by the UK government. G increases AD shifts to the right

However, Figure 2 showed that import expenditure has risen as well. This could be due to
import of raw materials to build the various infrastructure for the Olympics AD shifts left

However, there could be a cumulative impact on the various components of AD, especially
when effects are multiplied across various industries. Though AD may dipped due to an
increase in M, the net impact is that of AD increase as the other components register strong
positive increase.

Assess the extent to which hosting of the Olympics Games in 2012 has contributed to the
economic growth of the United Kingdom:

There will be economic growth experience but it may not be sustainable for the UK economy. Extract
3, the Games could provide an economic growth spurt, albeit short-lived, to the UKs shrinking
economy.

The Governments pre-occupation with the tourism industry could result in more government
expenditure being made to fund tourism projects or to subsidise training and upgrading of workers
skills, at the expense of expenditure on other industries like manufacturing and communications
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infrastructure.

The industrial growth will be short-lived if there is insufficient development of supporting

industries and infrastructure to support expansion in tourism (including insufficient training or
manpower needs).

After the games, the government needs to continue on its effort to make the economic growth prolonged. This is echoed in Extract 1 where the spokesman of the Association of the British Travel
Agents mentioned that he would expect a tourism boost from the Games to come in the next few
years and it will be essential for the UK to continue to market itself at home and overseas to make
the most of the opportunities that being a host nation has opened up."

Level Descriptors for (e)

L3 An answer that integrates the contribution of tourism on AD & AS with the
benefits on economic growth.
Answer also incorporates the extent of contribution to economic growth.

L2

L1

E2

E1

5-6

Answer correctly attempts to apply AD/AS concepts and components to the

tourism industry but undeveloped.
Max 3 marks for answers that are one-sided, only AD or AS examined.
Max 4 marks for answers without an assessment on the contribution of
tourism industry to economic growth.

3-4

Very weak attempt at explaining components of AD-AS.

Conceptual explanation is mostly flawed unable to make correct linkages
between growth of tourism with AD & AS.
One or two evaluation ideas on tourism explained with depth. OR
Able to see that tourism provides a complementary focus for UK to achieve
stability in the countrys economic growth, along with the development of other
industries.

1-2

One or two evaluation ideas on tourism briefly mentioned without considering the
need for diversification in economic structure for stability in economic growth.
Section B: Essay
Suggested Answer to Qn 1a
1.
(a)
Explain whether public housing is considered an example of a
public good or a merit good.

[10]

Introduction
Define:
Public good: Goods that are non-excludable and non-rival in the way they are consumed.

Merit good: Goods that produce significant positive externalities and are deemed by the
government to be socially desirable.

A good must be both non-excludable and non-rival to be considered a public good. A

merit good is therefore a private good.

Hence public housing is considered as a merit good as it is excludable, rivalrous and

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produces positive externalities.

Body
Point 1: Public goods are non-excludable while merit goods are excludable.

Non-excludable: once a good is provided, it is not possible or economically feasible to

exclude someone from using the good even if he does not pay for it.

Example: Once street lights are provided for, everyone (regardless of whether they have
paid taxes) can enjoy it as it is not possible to stop people from enjoying the lights as they
walk pass on the street.

Public housing is excludable because it is possible to make consumers pay for the
flat before they can own it. Those who do not pay will not be able to own and
legally stay in the flat.

Point 2: Public goods are non-rival while merit goods are rival.

Non-rival: When the good is made available, everyone can consume the same level at
the same time. The consumption of the good by one additional person does not diminish
the amount of the good available for another.

Example: Street lights can be enjoyed by everyone on the same street at the same time
at the same level. Just because one person is enjoying the light, does not diminish the
amount of light available for another person on the street at the same time.

Public housing is rival, because if one family owns and stays in the flat, another
family cannot own and stay in the same flat due to limited space. One consumer
buying one flat reduces the number of flats available for other consumers to
purchase.

Point 3: Public goods will not be produced at all if left to the market, while merit goods
will be provided, but will be under-produced or under-consumed.
Public goods:
Non-excludability will result in a free rider problem because non-payers can avoid paying
for the good but still enjoy it. Thus consumers will not reveal their demand for public
goods. No expression of demand means the absence of price signals, thus the inability of
private firms to provide.
Non-rivalry means there is no need to produce additional unit of goods for an addition
consumer. This means that the marginal cost of producing for one more unit is zero.
Firms who choose to maximise profits will produce at where MC=MR. Since MC=0, this
means that the profit maximising condition is now MC=MR=0, thus there is no incentive
for any private firm to produce the good.
Since there is no demand for and supply of the good, there will be a missing market in
the case of public goods.
There is total market failure.
Merit goods:
Merit goods like public housing produce significant positive externalities. The external
benefits from public housing include population growth leading to potential economic
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growth, promotion of family values, and overall greater social cohesion. Due to these
external benefits, the government deems public housing to be socially desirable.
Individuals are only concerned about their own interests, and do not consider these
external benefits in their decisions to consume these goods. They only take into account
their marginal private benefit, which in this case would be a shelter and home for their
families and themselves.
Therefore due to the positive externalities generated, the marginal social benefit will be
greater than the marginal private benefit.
If left to the market, the market equilibrium output (Q m) will be lower than the socially
optimal output (Qs) as shown in the diagram.
There will be under consumption of public housing and therefore the market fails.
There is partial market failure because demand-supply forces are at work, but the level of
production/consumption is below the socially-optimal level.
The welfare loss arising from this market failure is shown by the shaded area, CEsEm.

Qty of
housing

Conclusion:
Since public housing is excludable and rival, and also produces significant positive
externalities and is deemed by the government to be socially desirable, it is a merit good and
not a public good. Given that it is a merit good, there is some scope for government
intervention to correct the resulting market failure.
Answer
should
adopt
a
comparative
approach
in
comparing
each
point/characterisitics between the public goods & merit goods (characteristics such
as non-excludability, non-rivalry and resource allocation issue).

L3

Level Descriptors for Essay 1(a)

Well-developed explanation on the characteristics of public and merit goods,
integrating the example of public housing into the analysis.

Clear explanation on the implications of the characteristics of public and merit

goods on their impact on resource allocation, using public housing as an example
for merit goods.

Max 7 marks for answers without clear use of examples, but correct classification
of public housing as a merit good.

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L2

L1

Underdeveloped explanation on the characteristics of public and merit goods

Some attempt to explain how public housing is neither non-excludable nor nonrival, but produces significant positive externalities.
Able to identify public housing as a merit good.
Mere listing of points with no explanation
Conceptual errors
Shows some knowledge about public and merit goods but no application to the
case of public housing
Classifies housing as a public good

Suggested Answer to Qn 1b)

(b)

Discuss whether government intervention can lead to a more

efficient allocation of resources where goods with externalities exist
in markets.

[15]

Introduction
Define:
More efficient allocation of resources: This refers to allocative efficiency, which is
achieved when all firms produce output which consumers want to maximize their
satisfaction. This is achieved when firms sell the good at P=MC and MSC=MSB.
Externalities: These arise when production/consumption of a good affects a 3 rd party not
involved in the production/consumption of the good, and this 3rd party does not
receive/pay any compensation for this effect.
o Externalities can be both positive and negative
Body
Point 1: Why should the government intervene?
The existence of both positive and negative externalities will lead to market failure, where
the market fails to allocate the goods efficiently.
The case of positive externalities leading to market failure has been explained in (a)
Explanation of negative externalities resulting in market failure:
Some goods, like cigarettes, produce negative externalities when they are consumed.
Individuals pursue self-interests and only take into account their private cost, such as
their personal health and money spent on cigarettes. They do not take into account
external costs such as other people breathing in second-hand smoke. Thus marginal
social cost is higher than the marginal private cost.
Quantity at the market equilibrium will be higher than the socially optimal quantity and
there is over consumption of the good if left to the market. Resources are over allocated
to the production and consumption of cigarettes.
Benefits/ Costs

MSC
B
Es
MPC

Em
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paper 2/ANS
MPB = MSB
O

Qs

Qm

Qty of cigarettes smoked

Point 2 (a): Thesis - Government can intervene to correct the market failure in a market
with negative externalities to achieve a better allocation of resources
Example of measure - taxes on producers:
Point: Taxes can be used by the government to lower the consumption of a good with
negative externalities.
Elaboration: Taxes are compulsory payments made by firms or individuals to the
government. They force the households and firms to internalise the external cost.
Example: For example, in the case of cigarettes, the government taxes heavily on the
import of cigarettes. This raises the cost of production (MPC) to producers. MPC curve
shifts leftward to MPCt, and consumption falls to the socially optimal level of Qs.
Elaboration: The amount of tax imposed will depend on the value of negative externalities
produced at the socially optimal quantity.
Link: As the tax has resulted in a lower level of cigarette consumption, the government
has achieved a more efficient allocation of resources.
Benefits/ Costs
MSC
B
Ps

MPCt

MPC
C

Pm
D
O

Qs

MPB = MSB
Qm

Qty of cigarettes

Note : Students may use any example of a good with negative externality and therefore may
explain and evaluate any relevant policy (tradable permits, education or legislation). It is
important for students to show how government intervention may or may not lead to a better
allocation of resources.
Strengths of using taxes:
Using taxes allows the markets to continue operating according to market forces
Taxation also provides revenue for the government to finance social and community
development projects
Point 2(b): Anti-Thesis - Government intervention may not achieve a more efficient
allocation of resources in a market with positive externalities

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Constraints of using taxes:

It is difficult to measure external cost, and hence difficult to impose an accurate amount
of tax. Over-valuation or under-valuation would result in over- or under-consumption of
the good.
If PED of the good is very low, as is the case for cigarettes which is an addictive good,
the tax will not be effective in reducing consumption significantly. Those who are heavy
smokers will continue to consume at a high level even with the higher prices.
Point 3 (a): Thesis - Government can intervene to correct the market failure in a market
with positive externalities to achieve a better allocation of resources
The government may also intervene in a market with positive externalities, such as the
market for public housing as mentioned in part (a).
Subsidies to producers:
Point: The government can give subsidies to producers to raise the consumption of a
merit good like public housing. (subsidy works through production but aimed at
consumption)
Example: For example, in Singapore, public housing is heavily subsidised by the
government. Consumers are eligible to apply for different levels of subsidy given their
household income and marital status.
Elaboration: The subsidies are then given directly to the producer to lower the cost of
production and therefore encourage a higher production level.
Elaboration: The amount of subsidy given depends on the value of external benefits
generated at the socially optimal level of output.
Elaboration: With the subsidy, cost of production falls and MPC shifts rightward.
Equilibrium output will now be raised to the socially optimal level of output of Qs.
Link: As the subsidy has helped to raise the level of public housing, the government has
achieved a more efficient allocation of resources.
Cost,
Benefits

MSC = MPC
MSCs = MPCs
B

Pc
Pm
Ps

MSB
D
MPB

Qm

Qs

Qty of public housing

Strengths of using subsidies:

Subsidies are easily implemented to raise consumption and production as it works
through demand and supply forces of the market mechanism
It is well received by households and firms
Point 3(b): Anti-Thesis - Government intervention may not achieve a more efficient
allocation of resources in a market with positive externalities

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Constraints of using subsidies:

Point: The use of subsidies may not lead to a more efficient allocation of resources.
Elaboration: The government may fail to make an accurate valuation of the external
benefit. This will result in the market over- or under-consuming the good and allocative
efficiency is still not achieved.
Elaboration: High government expenditure is required to finance the subsidy. This may
result in an increase in taxes or reduction of spending in other public projects, or a strain
on the government budget.
Elaboration: More subsidies are given for the lower income group. Thus the middleincome group may not be able to enjoy sufficient subsidies to raise their level of
consumption to the optimal amount.
Link: Therefore, government intervention may lead to a less efficient allocation of
resources when it fails to bring consumption to the optimal amount.
Note: Student may explain other government policies like joint production, legislation, or
education. As this question has a very wide scope, students do not need to mention all the
possible measures for both positive and negative externalities. Instead, students can focus
on explaining market-based solutions for this question. Students may also use another
examples other than housing. It is important for students to show how government
intervention may or may not lead to a better allocation of resources.
Evaluation/Conclusion:
Evaluation of government intervention in a market with externalities:
Government intervention could lead to a more efficient allocation of resources when there
is market failure due to externalities.
However, due to the limitations of each policy as discussed earlier, there is also a
possibility of government failure whereby intervention by the government could lead to a
less efficient allocation of resources.
Criteria: Therefore whether the government can achieve a better allocation of resources
depends on the effectiveness of government intervention, and the suitability of
policies undertaken by the government given the context of the country.

Context 1: In Singapore, the government has been successful in raising the consumption
of public housing through subsidies. This can be seen as more than 80% of the
population resides in HDB flats provided for and heavily subsidised by the government.
This could be because Singapore is a relatively small country with a small population.
Thus it is easier for the government to manage and monitor the provision of public
housing, and the burden of the government budget is not as heavy.

Context 2: However in some developed cities like London with a large population, the
number of homeless people is still extremely high. This could be due to the government
already spending a lot in other areas like healthcare and having insufficient funds to
subsidise public housing enough. In other cities like Hong Kong where land is extremely
scarce, public housing is still insufficient and overcrowding in flats is a common
occurrence. Thus government in these cases has not led to a better allocation of
resources.

In conclusion, the government must carefully access the state of the economy and the
characteristics of the country. In doing so, they can select an appropriate policy, or

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combination of policies, to achieve a more efficient allocation of resources.

L3

L2

Good use of examples and good application of the measures to a context

A balanced discussion on how the government intervention may or may not lead
to a better allocation of resources

Adequate analysis of how negative externalities lead to market failure, and how
various measures can help to correct market failure in a market with
externalities
Some use of examples and attempts to apply the measures to a context
Max L2 for answers that do not address limitations of policies/government
failure
Some knowledge of what measures a government can use but does not use
economic concepts
Superficial listing of measures with weak explanation
Incorrect/inaccurate explanation of measures or conceptual errors

L1

Level Descriptors for Essay 1(b)

Well-developed analysis of how negative externalities lead to market failure, and
how various measures can help to correct market failure in a market with
externalities

E2

E1

Evaluative discussion that refers to how a government may or may

not be able to solve market failure based on criteria (e.g. policies chosen,
country)
Superficial evaluation of the effectiveness of government
intervention, with no basis for judgements.

Suggested Answer to Qn 2a)

2
.

(a)

Using appropriate examples, explain why the existence of negative

externalities and public goods causes market failure.

[10]

Introduction
1

Define market failure

Less than desirable outcome where resources are not used in the most efficient way.
Hence, there is allocative and productive inefficiencies.
Partial market failure: where there is over or under production/consumption which
leads to inefficient allocation of scarce resources. This arises when there are
externalities.
Define externalities
1 3rd party effects on someone not directly involved in the production &/or
consumption of a gd.
2 may be negative( external cost or 3rd party cost) or positive ( ext. benefit or
3rd party benefit)
Body
1 State that traffic congestion is a form of partial market failure where there is negative
externality
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Define negative externalities (by making reference to any e.g.: road congestion,
smoking): external cost to 3rd parties who are not directly involved in the production
and/or consumption of the good. For example, road congestion generates noise and air
pollution that affect the quality of living for residents living near the congested roads or
road congestion leads to a delay in arrival time for work for other road users such as
passengers on public buses. This could lead to a fall in the revenue for firms when the
workers report late for work./ Smoking generates second hand smokers which can cause
other non-smokers to have health problems like breathing difficulties.
Because of the presence of negative externalities, there is a divergence between private
costs and social costs by the extent of the external costs.
2. Explain how road congestion/second hand smoke results in negative externalities and
hence, market failure.

Diagram showing socially optimal level of consumption (MSC=MSB) and the equilibrium
level of consumption without government intervention (MPC=MPB).
Show that there is overconsumption of cars/smoking and hence, welfare loss to society.
Cost, benefit

MSC

MPC

E
C

MPB=MSB

0
Qs Qm
Assuming that there is no external benefit, marginal private benefit (MPB) is equal to
marginal social benefit (MSB). In this case, marginal private cost could include cost of
petrol and the depreciation cost of the car for the additional trip, and the time lost when
the driver is caught in traffic congestion/ cost of cigarettes, personal health problems.
Marginal private benefit could be in terms of the convenience one gets from driving a
car/satisfaction from smoking. The private equilibrium occurs at MPC equals to MPB, i.e.
0Qm level of traffic flow/smoking in a not crowded place.
The social equilibrium occurs at MSC, which is the summation of marginal private cost
and marginal external cost, equals to MSB, i.e. 0Qs level of traffic flow. If left alone, the
price mechanism will bring about a level of traffic flow that is higher than what is deemed
to be socially desirable.
As a result, there is a deadweight or welfare loss to society of area EDC. There is welfare
loss because the MSC exceeds the MSB for each additional trip taken beyond 0Qs.
Hence, the government should deal with traffic congestion.
When the number of cars exceeds the road capacity, traffic congestion arises, which is a
form of market failure. As resources are allocated inefficiently by the market mechanism,
the government has to intervene.

acjc/JC1 H1 Econs/Promos Revision Package/2014/Revision paper 2/ANS

Quantity

How Public Goods cause markets to fail:

Private sector will not be willing to provide such public goods as the free rider problem
make it difficult to charge people.
Important to highlight the non-excludable and non-rival nature of public goods with the
use of appropriate examples
It is impossible for the producer to know where, when, how much and who to charge and
hence no profits can be made.
But public goods are vital or essential to the nation Eg: National Defence, Policing for
keeping law and order .etc
Provision of public goods results in positive externalities (MSB>MPB),
No resources will be allocated to the production of public goods in the private sector.
Market fails as there is no provision of public goods at all (absence of market).
Mark Scheme
L3

7-10

Good analysis of welfare loss using relevant marginal cost and benefit
concepts, with help of appropriate diagram. Competent explanation with
good description of terms and a clear understanding of the concepts
involved..

L2

5-6

L1

1-4

Shows understanding the market failure which results in welfare loss

and/or with little explanation
Diagram is drawn but with errors
Examples are missing but may show some inaccuracies; if they are
included, concept of external cost is not clearly explained.
Showed little/ some basic concepts. May contain inaccuracies and/or
irrelevant information

Suggested Answer to Qn 2b)

(b)

Discuss the various policies which the Singapore government adopts in

correcting the market failures above.

[15]

Introduction

Negative externalities like smoking occurs when there is over consumption of the use of
cigarettes. It is again necessary to implement policies to reduce the market failure./
Traffic congestion occurs when there are too many cars on the road, given the road
capacity. Therefore, it is necessary to note that policies implemented to reduce the
problem of traffic congestion must tackle the problem of car ownership and car usage.
The Singapore government has implemented a range of policies to tackle the problem of
smoking. These policies include taxation, moral suasion and education. / The Singapore
government has implemented a range of policies to tackle the problem of traffic
congestion. These policies include COE, ERP system and improvement of the public
transport system. It is important to note that main cause of Singapores current traffic
congestion problem arises primarily due to excessive car ownership.

acjc/JC1 H1 Econs/Promos Revision Package/2014/Revision paper 2/ANS

Body
1 Taxation
Singapore has implemented various forms of taxes to curb the problem of congestion.
a Motor Vehicle Taxes & Road Tax and tax on complementary good i.e. petrol
o Explain how the traffic congestion leads to market failure or deadweight loss using
relevant examples and the aid of a diagram (see below).
o Taxation is done with the purpose to internalise the external cost to reduce the
road usage. This can be achieved by imposing taxes that is equal to marginal
external cost.
o This policy has been implemented by the Singapore government and can be seen
from the taxes on petrol and the imposition of motor vehicles taxes and road taxes.
o When the tax is imposed, the MPC curve shifts up by the amount of the tax to the
MPC+tax curve. As a result, traffic flow is reduced from 0Qm to the socially optimal
level of 0Qs.

costs, benefits

MSC = MPC + tax

MPC
E
C
tax
MPB = MSB

Qs

Qm

traffic flow (number of cars on the road)

Evaluation (for both Taxation and ERP, unless otherwise stated)

This policy of taxation is suitable if the country is able to obtain accurate estimates of the
level of external cost and hence, the amount of tax or ERP charge. This is because
overtaxing or overcharging may result in underutilising of roads while under-taxing or
undercharging may still result in congestion. Therefore, for a developing country that has
problems in data collection, the amount of tax imposed may not be optimal.

Unit tax on cigarettes to discourage smoking. In Singapore, the total tax as a % of retail
price is 69%. The high tax is to reduce the consumption of cigarettes in order to reduce
the negative externality. (Theoretical explanation as above).

Evaluation
Hard to determine how much to tax

Over- correction may also result in market failure.

Direct controls through quotas

In Singapore, the government also uses tradable permits to reduce the problem of
congestion.
Essentially, the government limits the number of cars that can be bought or sold. This is

acjc/JC1 H1 Econs/Promos Revision Package/2014/Revision paper 2/ANS

done through Certificate of Entitlement (COE), which are essentially tradable permits.
The number of COEs determines the number of cars on the roads. And this number
depends on the annual rate of car growth and the number of vehicles deregistered in the
previous period.
Evaluation
COE is effective in controlling car ownership. However, because it controls car ownership
but not car usage, this means that current car owners are not affected by the fall in the
number of COEs issued. As a result, traffic congestion may not be reduced if car usage
does not fall.
3

Improve public transport system and road system

With the above policies in place to reduce car ownership and car usage, it is therefore
necessary for the government to improve public transport so as to make demand for
private transport price elastic.
Build more roads and expressways, widen existing roads to ease traffic flow,
underground tunnels, etc.
Improve the existing infrastructure through building a more efficient public transport
system. E.g.: The Circle Line in the Mass Rapid Transit system.
Subsidies for public transport to keep travelling by public transport affordable

Evaluation
The difficulty in implementing this policy is to balance between providing quality public
transport and keeping costs low and hence, affordable for users.
4. Moral Suasion/ Education
Through the use of imageries and advertisement messages, persuade and discourage
the consumption of cigarettes.
Public goods

Government adopts appropriate policies (i.e direct provision) in correcting non-provision

of public goods
E.g. National defense/ street lighting
As a result of the lack of market, government provision is needed.

Evaluate appropriateness of policies

Economic analysis of how the non-provision is being addressed

Evaluation: Can analyze amount of deadweight loss before and after government
intervention
Defence takes up the largest proportion of government budget in Singapore.
Could be a case of government failure, over- consumption. However, situation has
been improved from a case of non-provision. In view of the increasing threat of
terrorism (Changing situations)
Requires government to constantly review their policies e.g. Cyber security are
we spending sufficiently on that?

acjc/JC1 H1 Econs/Promos Revision Package/2014/Revision paper 2/ANS

Conclusion
As far as dealing with road congestion is concerned, the Singapore government has
implemented a package of policies that seek to reduce traffic congestion by addressing car
ownership, car usage and quality of public transport.
In addressing the issue of complete market failure of the public goods, such as national
defense, Singapore government has been playing a crucial role to enable a collective
consumption of the good for the society.
Answer Scheme
L3

For an analytical discussion referring to policies employed by the

Singapore government with well-developed evaluative comments.

9 11

L2
L1
E1
E2

Under-developed answer with insufficient depth in economic analysis

Sputtering of points
For unexplained assessment
For evaluative assessment based on economic analysis on most
appropriate policies.

68
15
12
34

acjc/JC1 H1 Econs/Promos Revision Package/2014/Revision paper 2/ANS