Tuesday, 17 May 2016

11:38 AM

At P* and Q*, the market is in equilibrium

However, society has deemed the market equilibrium as market failure.
This is because the good is recognised as a demerit good in society.
As such, it is currently overproduced (o/p) and underpriced (u/p)
The govt decides to internalise this externality by placing an indirect tax on the good eg.
Cigarettes
Externality - the unintended consequences to third parties
By doing so, the new price (P1) and quantity (Q1) will be overpriced and underproduced,
creating social welfare equilibrium.

Topic 3 Page 1