(a) Using relevant examples from the video, define negative externality.

Negative externalities refers to a negative spillover effect on a third party resulting from the
production and consumption of a good. For instance, the consumption of fossil fuels results in
climate change and extreme weathers in India, which results in the destruction of public
infrastructure, negatively affecting commuters such as Viviani as they lose productivity due to
longer commutes to and from work.

(b) Discuss whether banning the use of fossil fuels would improve the efficiency of
resource allocation in the market for energy supplies in Singapore.

Banning is a command and control measure which aims to control consumption and production
activities through laws and administrative rules. Given this extreme case where the magnitude
of the external effects of consuming fossil fuels is very large, as seen by the rapidly increasing
rate of climate change, the banning of consumption of fossil fuels will improve the efficiency of
resource allocation in the market for energy supplies in Singapore.

Referring to Figure 1, the private optimal quantity where MPB = MPC is Qp. In the case of using
fossil fuels, the marginal private benefit (MPB) is the utility derived from the energy generated
upon consuming fossil fuels. The marginal private cost (MPC) is the prices paid for consuming
fossil fuels. There exists a very large magnitude of external costs, being the loss of income to
others from the effects of climate change, which is resulted from their decrease in their
productivity. This is shown by the divergence of the MPC and MSC, at the output level Qp with
the socially optimal quantity existing at a very small output quantity Qs where MSC = MSB. For
units QsQp consumed and produced past Qs, additional cost to society of area QscaQp exceeds
additional benefit to society of area QscbQp, resulting in a deadweight loss of area abc.

The government thus imposes a total ban on fossil fuels. Though society still incurs a welfare
loss, it is reduced with the ban. The original welfare loss is area abc. After the ban, quantity
consumed fell to 0, causing an under-consumption of 0Qs units. The welfare loss becomes area
cef, the excess of MSB over MSC if 0Qs units were produced and consumed. Comparing the
deadweight loss before and after the ban, the ban thus reduces the size of the deadweight loss.

Banning, unlike market-based policies like taxes, will produce more certain outcomes given its
mandatory nature. Its success is independent of PED or PES, the ability of the government to
determine the size of the marginal external cost or receptiveness of individuals. There is no
information failure on the part of the government to consider. Instead, whether the government
can support the ban with strong legislation and harsh consequences to deter ban-breaking is
what determines its success. Thus, banning is a policy that is likely to achieve immediate and
effective success.

However, the policy of banning faces the limitation of costly monitoring and enforcement as
doing so will take up scarce resources such as labour. Firms as rational profit-maximisers and
consumers as rational utility-maximisers, have the incentive to evade such policies if it means
that costs can be saved through the lower cost of production or lower prices paid for energy.
The government therefore needs to have effective means to deter evasion of the policy. Without
the capacity or the will to monitor and enforce, the policy would be unsuccessful in getting firms
to reduce production or get consumers to reduce their consumption level of fossil fuels to the
socially optimal level.

Nevertheless, given the large external cost of consuming fossil fuels as evident by the rapidly
increasing rate of climate change, the ban is bound to serve as a significant stride in tackling
this alarming issue. While this policy undeniably incurs significant costs in the short term, it is
deemed highly beneficial in the long run. With such policies in place to reduce climate change,
people may avoid potential loss of income through their decreased productivity or loss of crops
resulting from the effects of climate change. Coupled with ongoing policies such as moral
suasion through ongoing public campaigns like “Save My World” in Singapore, the costs of
monitoring and enforcement may also be reduced in the short run. Banning, being a surefire
way to improve efficiency, will also help to improve allocative efficiency, provided that the
government takes proper measures to enforce this policy. Given the context of Singapore,
banning is likely to be effectively enforced due to our thoroughness in ensuring government
aims are met. Weighing out the pros and cons, the policy of banning can indeed improve the
efficiency of resource allocation in the market for energy supplies in Singapore.
Marking Scheme
Part (a), Describe the trend (2m)
Content Correct definition of negative
externality.
Marks 1m
allocated
Part (b), Discussion question (8m)
How banning improves efficiency
Content Detailed explanation including a
labelled graph, showing how the ban
will result in a reduction of
deadweight loss. Graphical analysis
displays how the ban affects the
market in terms of shifting the private
equilibrium level to the socially
optimal level of output. Effectiveness
and benefits of the ban are thoroughly
explained (eg. success being
independent of PES and PED).
Marks 4m
allocated
Use of relevant examples from the video to
describe negative externality, stating the spillover
costs to third parties that are not directly involved in
the market transaction.
1m
Limitations of banning Evaluation
Explain in what context Evaluation, explaining the
could the ban be extent of effectiveness of
unsuccessful or result the ban given the context
in other problems which of Singapore, and whether
may hinder its ability in the ban should be
improving efficiency. imposed after considering
both the positives and
negatives.
2m 2m