Essay Question Definitions
Supply and Demand
a) Explain the Supply: The supply of an
meaning of the law of individual firm indicates the
various quantities of a good
supply, and using (or service) a firm is willing
examples and and able to produce and
diagrams, distinguish supply to the market for
sale at different possible
between movements prices, during a particular
along and shifts of the
time period, ceteris
supply curve. paribus.
b) Analyse, using
Law of Supply: There is a
positive relationship
diagrams, and with
between the quantity of a
reference to excess
good supplied over a
demand or excess
particular time period and
supply, how changes its price, ceteris paribus: as
in any three the price of the good
increases, the quantity of
determinants of
the good supplied also
supply result in a new
increases; as the price
market equilibrium. falls, the quantity supplied
also falls, ceteris paribus.
Market Supply: The sum
of all individual supplies for
Diagrams
(a)-Shift in supply
The diagram shows the
initial S1 supply curve. If
the price of corn
increases, the farmer may
switch to corn production
as it is now more
profitable, resulting in a
fall in wheat supply and a
leftward shift of the supply
curve to S3. If soon, there
is a fall in the price of
corn, there will be an
increase in wheat supply,
and a rightward shift of the
supply curve to S2.
Real World Examples
For example, if a farmer in
India who can grow wheat
or corn, chooses to grow
wheat. In India, both corn
and wheat are staple
foods, and eaten
regularly. If the price of
corn increases, the farmer
may switch to corn
production as it is now
more profitable, resulting
in a fall in wheat supply
and a leftward shift of the
supply curve. If soon,
there is a fall in the price
of corn, there will be an
increase in wheat supply,
and a rightward shift of the
supply curve.
Evaluation Points
Determinants of
Supply
Costs of the factors of
production- The firm buys
various factors of production
(land, labour, capital,
entrepreneurship) that it uses to
produce its products. Prices of
the factors of production are
important in determining the
firm’s costs of production. If a
factor price rises, production
costs increase, production
becomes less profitable and the
firm produces less; the supply
curve shifts to the left. If a factor
price falls, costs of production
fall, production becomes more
profitable and the firm produces
more; the supply curve shifts to
the right. For example, if the
price of wheat increases, then
less bread would be produced.
Technology- A new improved
technology lowers costs of
production, thus making
a good. The market supply
curve illustrates the law of -Movement along production more profitable.
Supply increases and the supply
supply, shown by a positive supply curve
curve shifts to the right. In the
relationship between price (less likely) event that a firm
and quantity. uses less productive technology,
costs of production increase and
Non-price determinants the supply curve shifts leftward.
For example, new machinery
of supply: Factors other can allow the caps of toothpaste
than price which influence tubes to be fit on automatically.
supply such as resource
prices, technology,
competitive supply, joint
supply, firm price Prices of related goods;
competitive supply & Joint
expectations, Taxes on
Any change in price supply- Competitive supply of
profits, subsidy, the two or more products refers to
number of firms, shocks. produces a change in the production of one or the
quantity supplied, shown other by a firm; the goods
Competitive Supply: Of as movement on the compete for the use of the same
resources, and producing more
two or more products refers supply curve. Initially of one means producing less of
to the production of one or when the price is the other. For example, a
the other by a firm; the constant, on the S curve, farmer, who can grow wheat or
goods compete for the use we are at point A. When corn, chooses to grow wheat. If
of the same resources, and there is a change in price the price of corn increases, the
of the goods, as it farmer may switch to corn
producing more of one production as this is now more
means having less of the increases, Point A moves profitable, resulting in a fall in
other. along the curve to Point B. wheat supply and a leftward
shift of the supply curve. A fall in
the price of corn results in an
Joint supply: of two or increase in wheat supply and a
more products refers to the rightward shift of the supply
production of goods that curve.
are derived from a single
product, so that it is not
possible to produce more (b) Market equilibrium Joint supply of two or more
of one without producing products refers to the production
of goods that are derived from a
more of the other. single product, so that it is not
possible to produce more of one
Shift in Supply: A without producing more of the
rightward shift (increase) other. An increase in the price of
one lead to an increase in the
indicates that more is
quantity supplied and also an
supplied for a given price; a
increase in supply of the other
leftward shift (decrease)
joint products.
indicates that less is
supplied for a given price.

Movement along the The market is at Producer Expectations- If

supply curve: Any change equilibrium with Qe and firms expect the price of their
in price produces a change Pe. Allocative efficiency. products to rise, they may
in quantity supplied, shown withhold some of their current
supply from the market (not offer
as movement on the supply it for sale), with the expectation
curve. that they will be able to sell it at
a higher price in the future; in
this case, a fall in supply in the
present results in a leftward shift
Equilibrium: The state of of the supply curve. If the
balance between different expectation is that the price of
forces, such that there is their product will fall, they
no tendency to change. increase the price in the present
Quantity demanded is to take advantage of the current
higher price, and hence there is
equal to quantity supplied. a rightward shift of the supply
In a market disequilibrium, curve.
there is excess demand
(shortage) and excess
supply (surplus), and the
forces of demand and Taxes- Firms treat taxes as if
they were costs of production.
supply cause the price to Therefore, the imposition of a
change until the market new tax or an increase of an
reaches equilibrium. existing tax represents an
increase in production costs, so
Excess Demand: supply will fall, and the supply
curve will shift left. The
Shortage, when too much
of the good is demanded
relative to the supply.
Excess Supply: Surplus,
when too much of the good
is supplied relative to the
demand.
Allocative Efficiency: An
allocation of resources that
results in producing a
combination and quantity of
goods and services mostly
preferred by consumers.
elimination of a tax or a
decrease in an existing tax
represents a fall in production
costs; supply increases and the
supply curve shifts right.
Subsidies- A subsidy is a
payment made to a firm by the
government and so, also has
the opposite effect of the tax.
(subsidies may be given in order
to increase the incomes of
producers or to encourage an
increase in the production of a
good). The introduction of a
subsidy or an increase in an
existing subsidy is equivalent to
a fall in production costs, and
gives rise to a rightward shift in
the supply curve, while the
elimination of a subsidy or a
decrease in an existing subsidy
shifts supply leftwards. For
example, if the governments
choose to support farmer, so
they can increase the production
of agriculture goods, they
subsidize them.
The Number of Firms- An
increase in the number of firms
producing goods increases
supply and gives rise to a
rightward shift in the supply
curve; a decrease in the number
of firms decreases supply and
produces a leftward shift. This
follows from the fact that market
supply is the sum of all
individual supplies.

Shock- The sudden

unpredictable events. These can
affect supply (mostly negative),
for example, weather conditions,
war, natural or man-made
disasters, etc. A real life
example is the Louisiana Oil
spill in 2012 resulted in a
decrease in supply of locally
produced seafood. A positive
shock could be bumper crops
which is when we receive a
better outcome than anticipated
(in agriculture).

When the supply curve shifts

rightward, the quantity
supplied is greater, and when
it shifts leftward, the quantity
supplied is lesser. Therefore,
when, for example, a good
receives support (subsidy) its
production increases, and
more of it is produced (a
rightward shift of the supply
curve).
Essay Question Definitions Diagrams Real World Examples Evaluation Points

Elasticities

a) Explain what price Elasticity: The YED example: For Significance of PED
and income responsiveness of a good (a)Income elasticity of example, if income for Firms:
variable to changes in price demand: increases for certain Businesses must take
elasticities of demand or any other variable groups after covid-19 PED into account when
measure. determinants. budget cuts are over in considering changes in
India, the employees have the price of their product.
PED: Price elasticity of more income, and hence if If a business wants to
b) Using real world demand is the measure of they buy food and grains increase total revenue, it
examples and the responsiveness of a which are necessities, it is must drop its price if
diagrams where good demand to changes income inelastic, however, demand is elastic, or
in its price. PED = % △ Q/-YED> 0 Income if they choose to buy a increase its price if
appropriate, discuss % △P. car, which is a necessity,
elasticity of demand is demand is inelastic. If
the significance of it is a luxury, income demand is unit elastic, the
positive (YED> 0) when
PeD for both firms Price Inelastic: Quantity elastic good. firm is unable to change
demand and income
demanded is relatively its total revenue by
and government. change in the same
unresponsive to price. changing its price.
direction (both increase PED example: Remember that PED falls
Price elastic: Quantity or both decrease). A For example, in the as price falls along a
demanded is relatively positive YED indicates market for wheat in India, downward-sloping
responsive to price. that the good in wheat is heavily inelastic, straight-line demand
question is normal. as it is a staple food. Due curve. In the upper left
Unit Elastic demand: % △ Most goods are normal to seasonal unpredictable portion, where prices are
Q=%△P goods. factors, a drought, supply high, demand is highly
decreased. elastic, and a firm can
Perfectly Inelastic: Qd is -YED< 0 A negative increase its total revenue
completely unresponsive to by lowering prices. Total
income elasticity of
price. revenue will continue to
demand (YED <0)
 indicates that the good increase as price falls until
Perfectly Elastic: Qd is is inferior : demand for price reaches the point on
infinitely responsive to the good and income the demand curve where
price. move in opposite PED is unit elastic. If price
falls further, total revenue
directions (as one
YED: The measure of will begin to fall because
responsiveness of demand
increases the other price is now in the
to changes in income. decreases). Examples inelastic range of the
include bus rides, demand curve. This
Income inelastic demand: second- hand clothes means that total revenue
(YED <1) Necessity, a % and used cars; as is at a maximum when
increase in income income increases, the price is at the point where
produces a smaller % demand for these goods demand is unit elastic.
increase in Qd. necessities falls as consumers
are common inelastic switch to consumption
goods. of normal goods. Many primary
commodities have a
Income elastic demand: relatively low PED (price
(YED >1) Luxuries and
• YED < 1 : Necessities inelastic demand)
services. A % increase in If a good has a YED because they are
income produces a larger that is positive but less necessities and have no
percent increase in Qd. than one, it has income substitutes (for example,
inelastic demand: a food and oil). The PED of
Primary Goods: Primary percentage increase in manufactured products is
commodities are goods income produces a relatively high (price
arising directly from the use smaller percentage elastic demand) because
of natural resources, or the increase in quantity they usually have
factor of production ‘land’. demanded. Necessities substitutes.
Including agricultural,
are income inelastic
fishing, and forestry
products, and extractive
goods.
industries. • YED > 1 : Luxuries If a
good has a YED that is
greater than one, it has
 Manufactured Goods:
Goods manufactured from
primary products or factors
of production.
a) Explain why Price Elasticity: The
Elasticity of Supply responsiveness of a good
variable to changes in price
income elastic demand:
a percentage increase
in income produces a
larger percentage
increase in quantity
demanded. Luxuries are
income elastic goods.
(b)
Price Elasticity of demand:
Market for wheat in India.
The demand curve is
relatively steeper, which
indicates it is more
inelastic. The market
starts at Q1 and P1.
For example, farmers in Why PES for Primary
India are shifting their Products is lower
resources to respond to
than PES for
for primary goods is or any other variable
relatively low, while determinants.
PeS for manufactured
PES: The measure of
goods is relatively responsiveness of supply
high. to changes in price.
YED: The measure of
b) Examine the responsiveness of demand
relevance to to changes in income.
producers and the
economy of differing Primary Goods: Primary
values of income commodities are goods
arising directly from the use
elasticity of demand
of natural resources, or the
for primary products, factor of production ‘land’.
manufactured Including agricultural,
products and fishing, and forestry
products, and extractive
services. industries.
Manufactured Goods:
Goods manufactured from
primary products or factors
of production.
price changes. manufactured
products: primary
commodities usually have
a lower PES than
manufactured products.
The main reason is the
time needed for quantity
supplied to respond to
price changes. In the case
of agriculture, it takes a
long time for resources to
be shifted in and out of
agriculture. Farmers need
at least a planting season
to be able to respond to
higher prices. In most
areas there is a limited
amount of new land that
can be brought into
cultivation. In some
Explanation of this in the
regions of the world land
last section.
appropriate for agriculture
is shrinking due to
environmental destruction
(caused by overfarming
that depletes the soil of
minerals needed by
crops). Under such
conditions, what is needed
is an increase in output
per unit of land cultivated
(crop yields), but this
requires technological
change in agriculture,
involving new seeds or
other inputs that are more
productive, and takes a
great deal of time. Also
needed are more and
better irrigation systems,
although many countries
face a growing water
shortage. All these factors
explain why a long time is
needed for the quantity of
an agricultural commodity
to respond to increases in
price, as seen on the
diagram, from P1 to P2.
In the case of other
primary products, such as
oil, natural gas and
minerals, time is needed
to make the necessary
investments and to begin
production. Because of
the costs involved, firms
do not respond quickly to
price increases, and wait
for a serious shortage
(excess demand) in the
commodity to arise before
they take actions to
increase production,
hence a leftward shift of
the demand curve.
Relevance to
Producers and the
economy of differing
values of YED for
Primary and
Manufactured
Products:

Goods and services with

high income elastic
demand stand to gain the
most from rising consumer
incomes as elastic goods
tend to be more
manufactured goods,
which tend to be luxury
goods. As a consumer's
income rises, the
proportion they spend and
demand for primary goods
decreases. Since they
have more income, they
can look beyond their
necessities and demand
luxuries like manufactured
goods and services.

As society’s income grows

over time, the demand for
agricultural output grows
more slowly than growth in
income. By contrast,
manufactured products
have a YED that is usually
greater than one (income
elastic), so that as
society’s income grows,
the demand for these
products grows faster than
income. Many services
have even higher YED
values as the percentage
increase in demand for
these is much larger.

Hence, over time, the

share of agricultural output
in total output in the
economy shrinks, while
the share of manufactured
output grows. With
continued growth, the
service sector expands at
the expense of both
agricultural and
manufacturing.
a) Referring to the Elasticity: The
concept of income responsiveness of a good
variable to changes in price
elasticity of demand
or any other variable
(YED) and using determinants.
examples, explain the
YED: The measure of
factors that cause responsiveness of demand
YED to have (i) a to changes in income.
positive or negative
Income inelastic demand:
value, and (ii) a value (YED <1) Necessity, a %
less than one or a increase in income
value greater than produces a smaller %
increase in Qd. necessities
one.
are common inelastic
goods.
b) Using real world
Income elastic demand:
examples and the
(YED >1) Luxuries and
concept of YED, services. A % increase in
examine why income produces a larger
agriculture is often percent increase in Qd.
referred to as a
Primary Goods: Primary
‘declining industry’. commodities are goods
arising directly from the use
of natural resources, or the
factor of production ‘land’.
Including agricultural,
Explanation in the last
fishing, and forestry
section about the
products, and extractive
shrinking agricultural
For example, due to a
government stipend for
consumer expenditure on
food and grains for elderly
women in India by the
BJP government, an
Explanation ^ in the last increase in income
section produces a smaller
increase in Qd, income
inelastic demand, as
necessities are common
inelastic goods.
Inelastic demand curve.
Factors of YED:
-YED> 0 Income
elasticity of demand is
positive (YED> 0) when
demand and income
change in the same
direction (both increase
or both decrease). A
positive YED indicates
that the good in
question is normal. Most
goods are normal
goods.
-YED< 0 A negative
income elasticity of
demand (YED <0)
indicates that the good
is inferior : demand for
the good and income
move in opposite
directions (as one
increases the other
decreases). Examples
include bus rides,
second- hand clothes
and used cars; as
income increases, the
demand for these goods
industries.
Manufactured Goods:
Goods manufactured from
primary products or factors
of production.
Normal Good: A good
which the demand for it
varies positively with
income; this means that as
income increases, demand
for it increases.
Inferior Good: A good
which demand for it varies
negatively with income; this
means as income
increases, demand for it
decreases.
sector. falls as consumers
switch to consumption
of normal goods.
• YED < 1 : Necessities
If a good has a YED
that is positive but less
than one, it has income
inelastic demand: a
percentage increase in
income produces a
smaller percentage
increase in quantity
demanded. Necessities
are income inelastic
goods.
• YED > 1 : Luxuries If a
good has a YED that is
greater than one, it has
income elastic demand:
a percentage increase
in income produces a
larger percentage
increase in quantity
demanded. Luxuries are
income elastic goods.
Why Agriculture is
often referred to as
a ‘declining’
industry:

Agriculture, the main

part of the primary
sector, produces food,
which as noted above
has a YED that is
positive but less than
one (it is income
inelastic). As society's
income grows over time,
the demand for
agricultural output
grows more slowly than
the growth in income.
Other primary products
also have a low income
elasticity of demand.
For example, cotton and
rubber have synthetic
substitutes, so as
income increases a
relatively larger
proportion of it is spent
on the synthetic
materials, while a
relatively lower fraction
goes towards cotton
and rubber. By contrast,
manufactured products
(cars, televisions,
computers, and so on)
have a YED that is
usually greater than one
(income elastic), so that
as society's income
grows, the demand for
these products grows
faster than income.
Many services have
even higher YEDs, so
the percentage increase
in the demand for these
is much larger.
Therefore, over time,
the share of agricultural
output in total output in
the economy shrinks,
while the share of
manufactured output
grows. With continued
growth, the services
sector expands at the
expense of both
agriculture and
manufacturing.
The historical
experience of both more
and less developed
countries shows that
with economic growth,
the primary sector
becomes less and less
important, and is partly
replaced by
manufacturing and
services. As the
economy grows further,
the relative importance
of the primary sector
continues to shrink, and
manufacturing becomes
increasingly replaced by
services. Thus, while
less developed
countries are usually
dominated by the
primary sector, more
developed countries are
dominated by services.
In the developed world
today, among the
industries experiencing
the fastest growth are
services, including
education, health care,
travel and financial
services.
Essay Question Definitions Diagrams Real World Evaluation Points
Examples

Government
Intervention

a) Explain why Subsidy: Assistance -Subsidy diagram: Indian education Subsidy -For example, in Consequences
governments by the government to the United States, Effects on
individuals or groups the government
provide of individuals, such grants an Stakeholders:
subsidies, and as firms, consumers, agricultural
describe industries or sectors subsidy on corn, Consumers- are affected
of an economy. since they follow by the fall in price of the
examples of Why? → Subsidies the Agricultural good from P* to Pc and
subsidies. can be used to Adjustment Act of the increase in quantity
increase government 1933. purchased from Q* to
revenues and
b) Using real incomes of
Qsb. Both these changes
world examples, make them better off.
producers, they can -For example,
discuss the make certain goods education is
which are necessities subsidised via the Producers- also better off
consequences of because they receive a
more affordable to political campaign
providing a In figure 1, initially the market begins at Q* and
low income by the BJP higher price (Pp> P*) and
P* equilibrium. When a subsidy is introduced
subsidy on the consumers, they can
for the market of education in India by the BJP
government which produce a larger quantity
stakeholders in a be used to translates to “save (Qsb > Q*). The price and
government via the “Save your daughters,
encourage your daughters, quantity effects translate
market. educate your daughters” campaign, the new
production and educate your into an increase in
supply curve is S2 = S1-Subsidy, the distance
consumption of daughters”.
between the S1=Mc and S2=S1-subsidy is the revenue. Before granting
particular goods and
subsidy per unit for education. This gives rise to of the subsidy, firms had
services that are
a lower consumer price. The price received by revenues of P* X Q*.
believed to be the producers increases to Pp. The amount of Following the subsidy,
desirable for subsidy given by the government is (Pp-Pc) x -For example, firm revenues increased
consumers, they can Qsb. The whole area represents government research and PpX Qsb.
be used to support spending to provide the subsidy. There is an development is
the growth of the overallocation of resources to the production of subsidised by the Government pays the
economy, to the good: Qsb is greater than the free market government of
subsidy, which is a
encourage exports of quantity of Q*. USA, for HIV/Aids
burden on its budget. To
particular goods, relief. This is a
method to improve merit good as obtain revenues for the
the allocation of people are subsidy, the government
resources (reduce benefiting from may have to reduce
allocative this healthcare expenditures elsewhere in
inefficiencies) by research, with the economy, or it may
correcting positive positive effects on have to raise taxes, or it
externalities. society. may have to run a budget
deficit (government
Government
expenditures greater than
Intervention: When
tax revenues). Whatever
the government
intervenes in the the case, the impact on
market and performs the government’s budget
actions which is negative.
interfere with the free
market to reach Workers- as output
economic goals. expands from Q* to Qsb,
firms are likely to hire
Stakeholders: more workers to produce
People who have an extra output, therefore
effect due to
workers who find new
something.
jobs are better off.
Allocative
Efficiency: An Society as a whole:
allocation of consumer and producer
resources that results surplus, and welfare
in producing a loss- worse off because
combination and there is an overallocation
quantity of goods and of resources to the
services mostly production of the good:
preferred by
Qsb > Q*. In addition the
consumers. The
society is worse off
condition for
allocative efficiency is because the higher price
given by MSB= MSC received by the producers
(marginal social protects relatively
benefit =marginal inefficient ones, allowing
social cost) or P = them to continue to
MC (price = marginal produce. Consumer and
cost; alternatively, it producer surplus areas
is when social increase, but the
surplus is maximum.
government loses
because of the burden on
Equilibrium: The
state of balance its budget. The subsidy is
between different paid for by taxes that
forces, such that have opportunity cost.
there is no tendency There is a welfare loss
to change. Quantity triangle representing lost
demanded is equal to benefits for society. The
quantity supplied. In subsidy has caused
a market overproduction relative to
disequilibrium, there what is socially desirable,
is excess demand
and an overallocation or
(shortage) and
excess supply allocative inefficiency.
(surplus), and the
forces of demand Foreign Producers- if
and supply cause the the subsidy were to be
price to change until granted on exports
the market reaches (goods sold to other
equilibrium. countries), it lowers price
and increases the
Opportunity cost: quantity of exports. While
The value of the this is positive for
next best alternative
domestic producers, it is
that must be given
negative for producers of
up or sacrificed in
other countries who may
order to obtain
be unable to compete
something else.
with the lower prices of
the subsidised goods.

Overallocation and
Underallocation:
Overallocation is
when too much of a
good is produced
relative to the social
optimum level of
output, and under
allocation is when too
little of the good is
produced relative to
the optimum level of
output. Both
instances result in
allocative
inefficiency.

Allocative
Inefficiency: When
 the market is not
achieving social
optimum levels of
price and quantity.
There can be an
underallocation or
overallocation of the
production of the
good relative to
social optimum,
leading to shortages
and surpluses, and
welfare loss, which
are lost benefits for
society.

a) Explain the Price Controls: the Price ceiling/rent control diagram figure 1: -For example, in Effects on
possible setting of minimum or New York City, Stakeholders:
maximum prices by rent control
consequences of the government (or operates under -Consumers (tenants)
rent controls on private organizations) the Maximum partly gain and partly
the market for so that prices are Base Rent (MBR) lose. They gain area c
unable to adjust to system. A from producers but lose
rental housing in their equilibrium level maximum base area b. This is because
a city of your determined by rent is established some consumers who
choice. demand and supply. for each are able to buy the
Price controls result apartment and goods at the lower price
in market In figure 1, initially the market is at equilibrium adjusted every are better off. However,
b) Using real disequilibrium, and for the housing in New York. Consumer surplus two years to some consumers remain
world examples, therefore shortages is equal to the areas a + b. Producer surplus reflect changes in unsatisfied since they
(excess demand) or equal to c + d + e. Consumer surplus would be operating costs. don’t get to buy the
explain to what maximum, and equal to a + b+ c + d + e. MB =
surpluses (excess -For example, in goods at all, because at
extent tenants supply). MC, and there is allocative efficiency. France, since 1st the ceiling price (rent
(i.e households When the rent control is imposed which is a July 2019, in Paris control here) there is not
price ceiling, Pc, quantity Qs is produced and
who rent an Price ceiling: consumed. Consumer surplus is now the area and potentially in enough of the goods
apartment) maximum price set under the demand curve and above Pc, but certain other (housing) to satisfy all
below the equilibrium only up to Qs, since that is all that is consumed. major cities, there demands.
benefit from rent price, in order to Therefore, consumer surplus becomes a +c. is a cap on the
controls? make goods more Producer surplus is the area above the supply maximum rent -Producers are worse
affordable to people curve and below Pc, also only up to Qs as it is that can be off, because with the
on low incomes. This what is produced. Producer surplus therefore charged in a legal price ceiling rent control
creates a welfare falls to area e. Total social surplus after the rent control called they sell a smaller
loss, indicating that control price ceiling is a + c + e. Compared with l’encadrement des quantity of the goods at
there is allocative total social surplus before the rent control price loyers. The rent a lower price; therefore,
inefficiency due to an ceiling, we see that the shaded areas b and d levels are set by their revenues drop from
underallocation of have been lost to welfare loss, which are the the distinct size, Pe X Qe to Pc X Qs.
resources to the benefits lost to society because of resource district and age of This is clear also from
production of the misallocation. This leads to allocative construction. their loss of some
good. MB>MC or inefficiency as MB > MC at the point of producer surplus, area c
Qs<Qe, society is not production, Qs: the benefit consumers receive (which is given to
getting enough of the from the last unit of the good they buy is greater consumers) as well as
good. than the marginal cost of producing it. area d (welfare loss.
Therefore society is not getting enough of the
Rent Controls: a good, as there is underallocation of resources -Workers- the fall in
maximum legal rent to its production. Not enough housing. output (from Qe to Qs)
on housing which is means that some
set below the market- workers are likely to be
determined level of fired, resulting in
rent. It is undertaken unemployment; clearly
by governments in these workers will be
some cities around worse off.
the world to make
housing more Government- there will
affordable for low be no gains or losses for
income earners. the government budget,
yet the government may
Welfare loss: gain in political
represents the social popularity among the
surplus or welfare consumers who are
benefits that are lost better off due to the
to society because price ceiling.
resources are not
allocated efficiently.

Allocative
Efficiency: An Evaluation of Rent
allocation of Controls on the
resources that results market:
in producing a
combination and -Housing becomes more
quantity of goods and affordable to low income
services mostly earners
preferred by
consumers. The -A shortage of housing,
condition for as the quantity of
allocative efficiency is housing demanded at
given by MSB= MSC the legally maximum
(marginal social rent is greater than the
benefit =marginal quantity available.
social cost) or P =
MC (price = marginal -Long waiting lists of
cost; alternatively, it interested tenants
is when social waiting for their turn to
surplus is maximum. secure an apartment/flat.
Government -A market for rented
Intervention: When units where tenants
the government sublet their apartments
intervenes in the at rents above the legal
market and performs maximum (an
actions which underground market)
interfere with the free
 market to reach -Run-down and poorly
economic goals. maintained rental
housing because it is
Stakeholders: unprofitable for landlords
People who have an to maintain or renovate
effect due to their rental units since
something. low rents result in low
revenues.
Equilibrium: The
state of balance
between different
forces, such that
there is no tendency
to change. Quantity
demanded is equal to
quantity supplied. In
a market
disequilibrium, there
is excess demand
(shortage) and
excess supply
(surplus), and the
forces of demand
and supply cause the
price to change until
the market reaches
equilibrium.

a) Explain why a Price Controls: the Minimum wage diagram: India For example, in Consequences of
government might setting of minimum or Russia, as of 1st minimum Wage for
maximum prices by January 2021, the
choose to
the government (or Minimum wage is
the economy:
establish a private organizations) 12,792 rubles per
minimum wage. -Labour surplus
 so that prices are month (this value (excess supply) and
b) Using real world unable to adjust to changes). unemployment:
examples, discuss their equilibrium level The imposition of
determined by minimum wage in the
the possible demand and supply. For example, in labour market creates a
market outcomes Price controls result India, the surplus of labour equal
of adopting a in market minimum wage is to Qs-Qd which is
minimum wage disequilibrium, and 178 INR per day, unemployment, as it
therefore shortages this was set to corresponds to people
policy.
(excess demand) or guarantee who would like to work
surpluses (excess adequate income but are not employed.
supply). to low income The unemployment tis
workers, and to due partly to the
Price floor: a reduce poverty decrease in quantity of
minimum price set rates. labour demanded by
below the equilibrium Initially the market for labour in India starts at firms and partly to an
price in order to Qe and We. The demand for labour curve increase in the quantity
provide income shows the quantity of labour that firms are of labour supplied. This
support to farmers or willing and able to hire at each wage, and the occurs because the
to increase the supply of labour curve shows the quantity of higher wage makes work
wages of low-skilled labour that firms are willing and able to supply more attractive, causing
workers. at each wage. When the minimum wage policy a movement up the
is imposed in India, in order to guarantee labour supply curve.
Minimum wage: income for low income unskilled workers and to This unemployment is
laws that determine reduce poverty, the Wm lies above equilibrium likely to involve unskilled
the minimum price of wage We. At Wm the quantity of labour workers.
labour that an supplied Qs, is larger than the quantity of
employer must pay. labour supplied when the labour market is in -Illegal workers at
The objective is to equilibrium (Qe). The quantity of labour wages below the
guarantee an demanded Qd is less than the quantity at minimum wage: Illegal
adequate income to equilibrium. There results a surplus of labour in employment of some
low-income workers, the market equal to the difference between Qs workers at wages below
who tend to be and Qd. The labour market does not clear when the legal minimum may
mostly unskilled. there is a minimum wage. result; this often involves
Governments illegal immigrants who
typically introduce may be willing to supply
minimum wages to their labour at very low
reduce poverty, wages.
advance social
justice, and -Misallocation of
accelerate growth. labour resources:
The minimum wage
Welfare loss: affects allocation of
represents the social labour resources, asit
surplus or welfare prevents the market
benefits that are lost from establishing
to society because market-clearing prices of
resources are not labour. Wage acts as a
allocated efficiently. signal and incentive to
workers and firms to
Allocative determine the optimal
Efficiency: An allocation of labour
allocation of resources. The
resources that results imposition of a minimum
in producing a wage changes thesen
combination and signals and incentives
quantity of goods and for unskilled labour,
services mostly whose wage is affected
preferred by by the price floor.
consumers. The Therefore, industries
condition for that rely heavily on
allocative efficiency is unskilled workers are
given by MSB= MSC more likely to be
(marginal social affected, and will hire
benefit =marginal less unskilled labour.
social cost) or P =
MC (price = marginal -Misallocation in
cost; alternatively, it product markets- Firms
is when social relying heavily on
surplus is maximum. unskilled workers
experience an increase
Government in their costs of
Intervention: When production, leading to a
the government leftward shift in their
intervenes in the product supply curve,
market and performs resulting in smaller
actions which quantities of output
interfere with the free produced. Therefore, the
market to reach misallocation of labour
economic goals. resources leads also to
misallocation in product
Stakeholders: markets.
People who have an
effect due to Consequences of
something. Minimum wages
Equilibrium: The
for various
state of balance stakeholders:
between different
forces, such that -Firms- firms are worse
there is no tendency off as they face higher
to change. Quantity costs of production due
demanded is equal to to the higher labour
quantity supplied. In costs.
a market
disequilibrium, there -Workers- The impacts
is excess demand on workers are mixed.
(shortage) and Some gain because they
excess supply receive a higher wage
(surplus), and the than previously (Wm
forces of demand >We), but some lose
and supply cause the because they lose their
price to change until jobs. Workers who lose
the market reaches their job are represented
equilibrium. by Qe-Qd. This is not
the full amount of
unemployment created
by the minimum wage
because the minimum
wage leads to additional
unemployment of Qs-
Qe, since more workers
supply their labour in the
market the wage
increases.

-Consumers-
Negatively affected,
because the increase in
labour costs leads to a
decrease in supply of
products, causing higher
product prices and lower
quantities.

In the Real World:

Effects of minimum
wages are controversial
as it is questionable
whether they lead to
unemployment to the
extent that economic
theory predicts.There is
agreement that if a
minimum wage is set at
a high level relative to
the free market
equilibrium wage, it is
likely to create some
unemployment. Yet a
large and growing
number of studies show
that minimum wage may
have no effect or even a
positive effect on total
employment. Some firms
respond to minimum
wage by maintaining the
same number of workers
but cutting on non-wage
benefits (such as paid
holidays, or sick leave).
Also, it is possible that
labour productivity
(defined as the amount
of output produced per
worker) may increase
due to the minimum
wage, as workers feel
motivated to work
harder, with the result
that some firms hire
more unskilled labour, in
response to minimum
wages. The debate is
basically not about
whether or not there
should be minimum
wages, but rather what
 their level should be.

a) Distinguish Specific Taxes: A Ad Valorem Tax: For example, in Why Governments

between specific tax which has a the market for impose Indirect
constant value, luxury clothing, Taxes
and Ad Valorem
irrespective of the there is an ad-
taxes using price of the good. valorem tax, -Indirect taxes are a
appropriate which is a source of government
diagrams and Ad Valorem Taxes: percentage of the revenue.
examples. The tax is price of goods
proportional to the paid as a tax, on -Indirect taxes are a
value; a percent of Sabyasachi method to discourage
b) Using real world the price. Couture. consumption of goods
examples, that are harmful for the
evaluate the Indirect Taxes: individual.
possible Taxes levied on
spending to buy -Indirect taxes can be
consequences to
goods and services, used to redistribute
stakeholders of called indirect income. Payment of a
adopting an because whereas tax on luxury goods
indirect tax. payment of some or For example, reduces after tax
all of the tax by the taxes on food at income, thus narrowing
consumer is involved, the grocery store differences with the
they are paid to the The pre-tax equilibrium of D and S is initial. If are fixed, they are
the government imposes an Ad- Valorem tax on a specific tax. incomes of lower-income
government earners.
authorities by firms goods, S2= (S1 + tax). The demand curve Taxes on
that is, indirectly. remains constant at D. The supply curve shifts cigarettes are
from S1 to S2 = (S1 + tax). Price paid by -A method to improve
fixed and not allocation of resources
Allocative consumers rises to Pc whereas the quantity variable to the
decreases to Qt. The amount of tax per unit of by correcting negative
Efficiency: An actual prices of externalities.
allocation of output is shown on the vertical axis by Pc- Pp, the cigarettes. -
resources that results or the vertical difference between the two part b reference to
in producing a supply curves. The producers receive PCs per part a diagrams
combination and unit. Therefore, Pp is the final price received by and examples. Consequences for
producers after the payment of a tax. various
quantity of goods and stakeholders:
services mostly Specific Tax:
preferred by -Consumers- are
consumers. The affected in two ways: by
condition for the increase in the price
allocative efficiency is of the good from P* to
given by MSB= MSC Pc, and by the decrease
(marginal social in the quantity they buy
benefit =marginal from Q* to Qt. Both
social cost) or P = these changes make
MC (price = marginal them worse off as they
cost; alternatively, it are now receiving less of
is when social the good and paying
surplus is maximum. more for it.

-Producers- are
Stakeholders: affected in two ways: by
People who have an The pre-tax equilibrium of D and S is initial. If the fall in the price they
effect due to the government imposes a specific tax on receive from P* to Pp,
something. goods, S2= (S1 + tax). The demand curve and by the fall in the
remains constant at D. The supply curve shifts quantity of output they
Overallocation and from S1 to S2 = (S1 + tax). Price paid by sell from Q* to Qt. These
Underallocation: consumers rises to Pc whereas the quantity effects translate into a
Overallocation is decreases to Qt. The amount of tax per unit of fall in their revenues,
when too much of a output is shown on the vertical axis by Pc- Pp, from P* x Q* before the
good is produced or the vertical difference between the two tax to Ppx Qt. Firms are
relative to the social supply curves. The producers receive PCs per therefore worse off as a
optimum level of unit. Therefore, Pp is the final price received by result of the tax.
output, and under producers after the payment of a tax.
allocation is when too -The Government- is
little of the good is the only stakeholder that
produced relative to gains, as it now has
the optimum level of revenue equal to (Pc-
output. Both Pp) x Qt. This is positive
instances result in for the government
allocative budget.
inefficiency.
-Workers- A lower
amount of output from
Q* to Qt, means that
fewer workers are
needed to produce it;
therefore, the tax may
lead to some
unemployment. Workers
are worse off if they
become unemployed.

-society as a whole- is
worse off as a result of
the tax, because there is
an underallocation of
resources to the
production of the good
(Qt<Q*). A portion of
consumer surplus
became the government
tax revenue and another
portion was lost to
triangle B. The
consumer and producer
surplus that is
transformed into
government tax revenue
comes back to society in
the form of government
spending from the tax
revenues. Welfare loss
 appears as the tax
causes a smaller than
optimum quantity
produced. The tax has
caused underproduction
of the good relative to
what is socially
desirable;
underallocation of
resources or allocative
inefficiency.

a) ‘Price controls, Price Controls: the Price Control: Price Ceiling For example, in Price controls don’t let
like indirect taxes setting of minimum or the market for the market clear
maximum prices by petrol, the according to theory. By
and
the government (or government sets placing a fixed price
subsidies, are a private organizations) a price ceiling in above or under the
form of so that prices are order to set a equilibrium price, a fixed
government unable to adjust to maximum price disequilibrium occurs,
intervention in the their equilibrium level for it in India. causing shortages
determined by (excess demand) and
market, yet they
demand and supply. surpluses (excess
differ in that price Price controls result supply). Whereas in
controls give rise in market For example, Indirect taxes and
to disequilibrium disequilibrium, and there is a subsidies, there is an
market outcomes.’ therefore shortages shortage of additional supply curve
(excess demand) or education in India which influences the
Explain.
surpluses (excess so the production and
supply). government consumption of
b) Examine the subsidies (or goods/services, and
consequences of Price floor: a directly provides) allows for an opportunity
the policy of petrol minimum price set education for the to correct it.
below the equilibrium Initially, The market status at Pe and Qe citizens, this leads
price ceilings on equilibrium. When a price ceiling is introduced
price in order to to an overall
the economy to set a maximum price for petrol in the market,
(including provide income there Pc. Pc gives rise to Qs and Qd. The allocation of Consequences of
resource support to farmers or distance between the two is the shortage= resources to the Petrol Price Ceiling:
to increase the excess demand. Hence, this leads to good.
allocation and
wages of low-skilled underallocation. The market is unable to clear Consumers partly gain
welfare) and workers. because of the price ceiling set under the and partly lose. They
stakeholders. equilibrium price. There are negative welfare gain area c from
Price ceiling: impacts, welfare loss due to the underallocation producers but lose area
maximum price set of resources relative to the social optimum. b. This is because some
below the equilibrium consumers who are able
price, in order to to buy the goods at the
make goods more Subsidy: lower price are better off.
affordable to people However, some
on low incomes. This consumers remain
creates a welfare unsatisfied since they
loss, indicating that don’t get to buy the
there is allocative goods at all, because at
inefficiency due to an the ceiling price there is
underallocation of not enough of the goods
resources to the (oil) to satisfy all
production of the demands.
good. MB>MC or
Qs<Qe, society is not -Producers are worse
getting enough of the off, because with the
good. price ceiling they sell a
(6 label: P is price, Q is quantity) smaller quantity of the
Initially, the market starts at P1 and Q1 with S1 goods at a lower price;
and D. When the government provides therefore, their revenues
Subsidy: Assistance education in India due to the shortage, the drop from Pe X Qe to Pc
by the government to government subsidises the education market as X Qs. This is clear also
individuals or groups it is a merit good. This results in a shift of the S from their loss of some
of individuals, such curve right to S2= (s1-subsidy). As a result, the producer surplus, area c
as firms, consumers, price of education decreases from P1 to P3. (which is given to
industries or sectors The blue shaded area is the cost of the subsidy consumers) as well as
of an economy. to the government. There is a welfare loss due area d (welfare loss.
 to the negative welfare impacts of
overallocation of the good, too much of the -Workers- the fall in
Allocative good is produced relative to the social optimum. output (from Qe to Qs)
Efficiency: An means that some
allocation of workers are likely to be
resources that results fired, resulting in
in producing a unemployment; clearly
combination and these workers will be
quantity of goods and worse off.
services mostly
preferred by Government- there will
consumers. The be no gains or losses for
condition for the government budget,
allocative efficiency is yet the government may
given by MSB= MSC gain in political
(marginal social popularity among the
benefit =marginal consumers who are
social cost) or P = better off due to the
MC (price = marginal price ceiling.
cost; alternatively, it
is when social
surplus is maximum.

Government
Intervention: When
the government
intervenes in the
market and performs
actions which
interfere with the free
market to reach
economic goals.

Stakeholders:
People who have an
effect due to
something.

Overallocation and
Underallocation:
Overallocation is
when too much of a
good is produced
relative to the social
optimum level of
output, and under
allocation is when too
little of the good is
produced relative to
the optimum level of
output. Both
instances result in
allocative
inefficiency.

Indirect Taxes:
Taxes levied on
spending to buy
goods and services,
called indirect
because whereas
payment of some or
all of the tax by the
consumer is involved,
they are paid to the
government
authorities by firms
 that is, indirectly.

Essay Question Definitions Diagrams Real World Evaluation Points

Examples

Market Failure

-Externality: occurs Positive externality or I mentioned examples Government

when the actions of
a) Explain what
positive externalities consumers or producers
give rise to negative or
are and how they
positive side effects on
might arise.
other people who are not
part of these actions, and
b) Using real world whose interests are not
examples, discuss taken into consideration.
whether governments
should always -Market Failure: the
failure of the market to
intervene in markets
where significant allocate resources
externalities arise. efficiently. Market failure
results in allocative
inefficiency, where too
much or too little of goods
production:
The MSC curve lies below the S=MPC
curve. The difference between the two
curves is the value of the external
benefits. The demand curve represents
both the MPB and MSC. The optimum
is at Qopt and Popt, by the intersection
between MSC with MSC. As the
with the explanation Responses +
of diagrams
evaluation:
Negative Production
Externality
-Government Regulations-
The Government can impose
regulations to correct a
negative production
externality by lowering the
quantity of the goods
produced.
-Tax- By imposing a tax per
unit produced of a good, the
government can reduce the
quantity produced.(-) hard to
measure external costs.
or services are produced
and consumed from the
point of view of what is
socially more desirable.
Overprovision of a good
means too many
resources are allocated to
its production
(overallocation).
Underprovision means
that too few resources are
allocated to its production
(underallocation).
-Positive Externality of
production: A positive
externality caused by
production activities,
leading to a situation
where marginal social
costs are less than
marginal private costs
(MSC<MPC)
-Positive Externality of
consumption: A positive
externality caused by
consumption activities,
leading to a situation
Qm<Qopt, the market under allocates
resources (just like in all positive
externalities).
Example: -If a firm engages in research
and development, and succeeds in
developing a new technology, that
spreads throughout the economy,
there are external benefits for the
society as well, as they are able to
utilise those technologies.
-Firms can train workers to later switch
jobs and work elsewhere; external
benefits are created as the new
employers and society benefit from the
trained workers.
-A pharmaceutical company develops
a new medication that benefits not only
its users but also those around them
from the improved quality of life and
increased life expectancy.
Positive Externality of
consumption:
Doesn’t Internalise the
externality as only the
producers need to be
punished.
-Tax on Emissions- By
imposing a tax on emissions
(a tax on a factor of
production for the good). (+)
Internalizes the externality.
-Tradeable Permits- These
are rights granted by the
government which can be
traded. The firms which hold
the permits are allowed to
produce their goods. These
permits have the aim of
decreasing the production of
goods with negative
externalities. (-) Not as
effective and commonly used
as other policies.
Negative Consumption
Externality
-Government Regulations-
Regulations can be imposed
to prevent or limit consumer
activities that impose costs
on third parties.
-Advertising- Negative
where marginal social advertising by the
benefits are greater than government can help reduce
consumption. (-) costs to the
marginal private benefits
government budget. (+)
(MSB>MPB).
Effective

-Negative Externality of -Market-Based Policies- The

production: A negative
externality caused by
production activities,
leading to a situation The MSB curve lies above the MPB.
where marginal social The difference between the two curves
costs are greater than are the external benefits to society.
Qopt is given where MSB=MSC, Qm is
marginal private costs given by MPB= MPC. Since Qopt>Qm,
(MSC>MPC). the market under allocates resources
to the production of the good; too little
is produced. (just like all positive
-Negative Externality of externalities.
Consumption: A Example: -The consumption of
education benefits the person who
negative externality
receives the education, but it also gives
caused by consumption additional external benefits, involving
activities, leading to a social benefits for a more productive
workforce, lower unemployment, higher
situation where marginal rate of growth, more economic
social benefits are less development, lower crime rates, etc.
than marginal private -The consumption of healthcare
benefits society similarly.
benefits (MSB < MPB).
-Merit Goods: Goods
that are held to be Negative Externality of
desirable for consumers, Production:
Government can impose a
tax on the production of
goods (so it can reduce
consumption). These taxes
are placed on the production
as it has the same effect if it
were imposed on consumers,
however more convenient.
Positive Production
Externalities
-Direct Government
Provision- The government
can intervene by providing
goods and services in order
to increase production.
-Subsidies- If the government
subsidises the production of
a good with positive
externalities, it can increase
its production.
Positive Consumption
Externality
but which are
underprovided by the -Advertising- Government
can encourage the use of
market. Reasons for
certain goods/services.
underprovision are
usually that the goods -Legislation- The government
have positive can make the consumption of
consumption externalities; certain goods/services
in addition, consumers compulsory.
The
with low incomes may be supply curve, s=MPC, reflects the -Direct Government
unable to afford them, firm’s private costs of production, and
the MSC- Marginal social curve Provision- The government
and so not demand them, represents the full cost to society of can directly intervene.
or there is a consumer producing cement. For each level of
output Q, the social costs for producing
ignorance about the cement (MSC) are much greater than -Subsidy- By subsidising the
benefits of the goods. the firm’s private costs (MPC). The good, the consumption can
vertical difference between the MSC
be increased.
and MPC represents the external
costs. Since the externality involves
only production (the supply curve), the
-Demerit Goods: Goods demand curve represents both the
that are considered to be Marginal Private benefits (MPB) and
the Marginal Social Benefits (MSB).
undesirable for The free-market outcome is determined
by the intersection of MPB with MPC at
consumers and are Qm & Pm. The social optimum is given
overproduced by the by the intersection between MSB and
MSC at opt and Popt.
market. Reasons for Example: The problem of
overprovision are usually environmental pollution. As a cement
that the goods have factory emits smoke into the air and
disposes its waste by dumping it into
negative consumption the ocean. There are consequences for
externalities; in addition local inhabitants, swimmers, sea life,
the fishing industry, and the marine
there may be consumer
ecosystem.
ignorance about the
harmful effects.

-Allocative Efficiency:
An allocation of resources
that results in producing
the combination and
quantity of goods and
services mostly preferred
by consumers. The
condition for allocative
efficiency is given by
MSB =MSC or P+ MC.
When social surplus is
maximum.
-Internalise the
Externality: To punish
the party which caused
the externality.
Subsidy: Assistance by
the government to
individuals or groups of
individuals, such as firms,
consumers, industries or
sectors of an economy.
Why? → Subsidies can be
used to increase
Negative Externality of
Consumption.
The
MPB does not reflect the MSB. The
external costs cause the MSB curve to
lie below the MPB. The vertical
distance between the MPB and MSB
represents the external costs. Since
the externality involves consumption,
(demand curve) the Supply curve
represents both the MPC and MSC.
The market determines equilibrium at
Qm Pm , given by the intersection of
the MPB and MPC curves. The social
optimum at Qopt and Popt is
determined by the intersection of the
MSB and MSC curves.
Example: -When consumers smoke in
public places, there are external costs
that spill-over to society (second-hand
smoking).
-Heating homes and driving cars by the
use of fossil fuels that pollute the
atmosphere.
-Partying with loud +music until the
early hours of the morning, and
disturbing the neighbours.
government revenues and
incomes of producers, they
can make certain goods
which are necessities more
affordable to low income
consumers, they can be
used to encourage
production and
consumption of particular
goods and services that
are believed to be
desirable for consumers,
they can be used to
support the growth of the
economy, to encourage
exports of particular goods,
method to improve the
allocation of resources
(reduce allocative
inefficiencies) by correcting
positive externalities.

-Government Provision:
When the government
directly provides a good,
usually a merit good.

-Opportunity cost: The

value of the next best
alternative that must be
 given up or sacrificed in
order to obtain something
else.
a) Explain, using Common Access
examples, why common Resources: Are rivalrous
but non excludable. The
access resources may
combination poses serious
be overused and threats to the environment.
depleted.
Rivalry means that the use
of resources reduces their
availability for others. Non-
b) Using real world
excludability means that
examples, evaluate
the resources can be used
alternative government abundantly without
policy responses to restrictions and therefore
correct production and may be overused,
consumption degraded and depleted.
externalities that
Tragedy of the
threaten sustainability commons: The story
about cattle feed on fertile
pasture that is owned in
common by a group of
herders. In the beginning
each herder had a small
number of cattle and all the
animals had plenty of
space and grass on which
to feed. As this was a
profitable business, each
herder began to increase
the number of cattle
Sustainability diagram:
As the supply of the fish was
more and more depleted, it
became increasingly difficult
to catch fish, so the average
quantity of fish brought back
fell with the addition of each
boat. With the addition of the
seventh boat, the fish supply
was overused; the fish
population was no longer able
to reproduce itself and
therefore the quantity of fish in
the ocean began to drop. On
the diagram, we can see the
specific labels of constant
average yield margin,
decreasing average yield
For example, Fish are Negative Production
common access Externality:
resources, as fishing The overuse of many
in India off the coast common pool resources
of Goa is open to the
is a negative externality,
public. If people
as its usage
overuse this common
access resource, this (consumption) results in
threatens negative effects on a
third party. When fishing
sustainability.
in a common lake,
overuse can pollute the
lake, endanger the fish,
harm the ecosystem,
and decrease
availability of fish for
others, thereby
threatening
sustainability.
Government
Responses to
externalities that
threaten
sustainability:
grazing on pasture. But as margin, and absolutely
the cattle increased, after
some time the pasture
became overfilled with
grazing cattle that had to
increasingly compete with
each other for food that
was becoming more and
more scarce. In the end the
grass was all gone, the soil
was eroded and the
pasture could no longer be
used for grazing. This story
illustrates the concepts of
rivalry and
nonexcludability. The fertile
pasture is rivalrous
because whatever grass is
eaten by one animal is not
available for another. It is
non-excludable since one
herder cannot exclude
others from using it.
Sustainable resource
use: resources are used at
a rate that allows them to
reproduce themselves, so
that they do not become
degraded or depleted.
decreasing yield to illustrate
this.
-Market based policy I:
Indirect taxes- The
government could impose
an indirect tax on the firm
per unit of output
produced.
-MBP II: Carbon taxes- a
tax per unit of carbon
emissions of fossil fuels in
order to decrease it.
-MPB III: Tradable
permits- cap and trade
schemes involving permits
to pollute issued to firms
by the government.
-Government legislation-
restrictions on emissions
of pollutants from factories
and industrial production
by setting the maximum
level of pollutants
permitted. Requirements
for steel mills and
electricity generation
plants to install
smokestack scrubbers to
reduce emissions.
Banning the use of toxic
harmful substances.
Issuing permits.
Prohibiting industrial
activities in protected
areas. Restrictions on
quantity of logging.
Establishment of protected
areas for the protection of
biodiversity and
endangered ecosystems.

-Collective self-
governance- a solution to
the use of common access
resources where the users
take control of the
resources and use them in
a sustainable way. This
concept runs counter to
the idea of tragedy of the
commons, where each
user makes use of the
resource at the expense of
others with the result to
ultimately degrade and
deplete it.

-Education and awareness

creation

-Nudges- nudged by the

government to make
certain decisions

International agreements
Advantages and
Disadvantages of
Responses:
-Market based policies:
(+) Effective and creates
incentives
(-) Hard to measure the
value of external costs and
place an appropriate
amount of tax, tradable
permits can be misused
and not as effective as
other policies.
-Government
legislations and
regulations:
(+) Simply put into effect
and easy to oversee.
Easier to implement than
market based policies.
Commonly used.
(-) do not offer incentives
to reduce emissions by
using less polluting
resources, to increase
energy efficiency and to
switch to alternative fuels.
There are costs of
monitoring and
supervision.
-Collective self
 governance:
(-) For people who
manage common access
resources on their own,
there are two important
conditions that must be
satisfied: the ability to
communicate with each
other in order to create
rules for the use of the
common access
resources, and a boundary
for the resource.
-Education and
awareness creation:
(+) Firms are very much
influenced by the opinions
of customers and want to
keep them happy,
otherwise they will suffer
drops in sales.

(-) It can only make a

small difference, not as
effective on a broader
scale.

a) Explain, using the Externality: occurs when -Market Equilibrium: For example, a smoke A market producing at
terms social surplus, the actions of consumers factory emits smoke equilibrium is achieving
into the air and allocative efficiency,
marginal benefit and or producers give rise to
disposes of its waste
marginal cost, the negative or positive side by dumping it in the meaning that resources
meaning of allocative effects on other people are allocated in the best
efficiency. who are not part of these
actions, and whose
b) Explain, using interests are not taken
appropriate diagrams into consideration.
and examples, why
social surplus is not Marginal Social Cost:
maximised if either (MSC) The extra or
more or less than the additional costs to society
allocatively efficient of producing one more
level of output is unit of a good; are equal
produced. to marginal private costs
(MPC) when there are no
production externalities.
Marginal Social benefit:
(MSC) The extra or
additional benefits to
society of consuming one
more unit of a good; are
equal to marginal private
benefits (MPB) when
there are no consumption
externalities.
Marginal Private Cost:
(MPC) The extra or
additional costs to
producers of producing
one more unit of a good.
ocean off the coast of possible manner to
Japanese Islands. maximise total welfare
among consumers and
producers. Allocative
efficiency is achieved
when the price in the
market equals the
marginal benefit (MB) and
the marginal cost
(MC).When market output
The market is at equilibrium occurs at a quantity and
with the optimum price and price at which
the optimum quantity. The D=
MB=MC
MPB = MSB, and S = MPC
=MSC. . Neither too much nor too
little is produced, and
resources are allocated
-Market Disequilibrium: efficiently.
Negative Production
When a market is
Externality
allocatively inefficient, the
MB does not equal, MC
at the prevailing price and
quantity combination.
Either too much or too little
of the good is being
produced. Total welfare is
only maximised when the
market produces at its
equilibrium price and
quantity, if there is less or
 (Q is quantity, P is price) more produced of either
Marginal Private benefit: The market begins at price or quantity, the
equilibrium with Qopt and impact on welfare, would
(MPB) The extra or
Popt initially. D = MSB= MPB not be optimum as there
additional benefit received and the MSC curve is above
would be a loss in
by consumers when they the s= MPC curve. When a
consumer and producer
consume one more unit of Japanese company emits surplus, and a deadweight
a good. smoke into the air as a cost of
loss.
their production activity, they
dump the waste off the coast
-Market Failure: the of Japan creating a negative
failure of the market to production externality. As a
allocate resources result the S= MPC curve is
efficiently. Market failure lower than the MSC curve and
the distance between the
results in allocative
curves depicts the external
inefficiency, where too cost which arises due to the
much or too little of goods negative production
or services are produced externality. The market is at a
and consumed from the disequilibrium, as Qm is
greater than the optimum
point of view of what is
quantity and Pm is lower than
socially more desirable. the optimum price.
Overprovision of a good
means too many
resources are allocated to
its production
(overallocation).
Underprovision means
that too few resources are
allocated to its production
(underallocation).
-Allocative Efficiency:
An allocation of resources
that results in producing
the combination and
quantity of goods and
services mostly preferred
by consumers. The
condition for allocative
efficiency is given by
MSB =MSC or P+ MC.
When social surplus is
maximum.

-Consumer Surplus: The

difference between the
highest prices consumers
are willing to pay for a
good and the price
actually paid.

-Producer Surplus: The

difference between the
price received by firms for
selling their good and the
lowest price they are
willing to accept it
produce a good.
 Social Surplus:
Consumer and Producer
surplus, total surplus in
welfare on society

-Welfare Loss: Loss of

welfare (total) due to
allocative inefficiency.

Overallocation and
Underallocation:
Overallocation is when too
much of a good is
produced relative to the
social optimum level of
output, and under
allocation is when too little
of the good is produced
relative to the optimum
level of output. Both
instances result in
allocative inefficiency.

a) Explain, with -Public Goods: A good For example, in Implications of direct

reference to the free that is non-rivalrous and Russia, when a provision of public
rider problem, how the non-excludable. SInce it is lighthouse is built by goods by the
lack of public goods is a not possible to exclude
market failure. someone from using the
goof even though they do
not pay for it, firms do not
b) Using real world have an incentive to
examples, discuss the produce it. Public goods
are therefore provided by
implications of direct
provision of public the government. This is a
type of market failure.
goods by governments.
-Non-Rivalrous: A good
where its consumption by
one person does not
reduce consumption by
someone else.
-Non-excludable: A good
where it is not possible to
exclude someone from
using the good.
Market Failure: the
failure of the market to
allocate resources
efficiently. Market failure
results in allocative
inefficiency, where too
much or too little of goods
or services are produced
and consumed from the
point of view of what is
socially more desirable.
the government, ships government
from many regions evaluation:
will benefit from it
even though they are -Direct Government
not contributing to its
Provision: Since the
costs, and are thus
free riding on their
market fails to allocate
resources to the
navigation aid.
production of public
goods, it means that the
For example, government must step
Hundreds of millions in and produce it at
of people use socially desirable levels.
Wikipedia every While it is easy to
measure the cost of
month but only a tiny
fraction of users pay providing public goods,
to use it. A large it is hard to measure the
majority of Wikipedia
benefit received from it.
users do not pay to
-Contracting out to the
use the site but are
public sector- when the
able to benefit from
government provides a
the information public good, it may
provided by the either provide it itself
website. directly, or it may
contract it out to a
private firm. When a
government makes an
agreement with a
private firm to carry out
an activity the
government was
Overprovision of a good previously doing itself.
means too many This is advantageous as
resources are allocated to it provides a better
its production quality of public goods.
(overallocation). Disadvantage as the
government loses
Underprovision means
control over and is less
that too few resources are
accountable for the
allocated to its production public good it provides,
(underallocation). also the costs may be
greater as the
government may also
-Free Rider Problem: need to monitor it.
Occurs when people can
enjoy the use of a good
without paying for it, and
arises from non-
excludability. Is often
associated with the public
goods, which are a type of
market failure: due to the
free rider problem, private
firms fail to produce these
goods.

Externality: occurs when

the actions of consumers
or producers give rise to
negative or positive side
effects on other people
who are not part of these
actions, and whose
interests are not taken
into consideration.

Government
Intervention: When the
government intervenes in
the market and performs
actions which interfere with
the free market to reach
economic goals.

Direct Provision: When

the government directly
provides a good or service,
which is usually a merit
good.