2011 JC1 H1 Economics Market Failure: Public, Merit & Demerit Goods Handout 2

1) Singapore has been spending more on healthcare over the years.

National healthcare expenditure as a share of GDP has grown from 2.7% in 1990 to 3.8% in 2005. This includes government as well as private expenditure. Source: Budget 2007 (a). Using examples, differentiate between public good and merit good, and consider under which of these classifications healthcare should be placed. [10m] (b). Discuss the desirability of healthcare in a country to be supplied entirely by the public sector. [15m] Answer: a) Yardsticks Public Good Merit Good merit good is private good that is both rivalry and excludable in nature. . It is a good that is viewed by the government as having substantial benefits for the individuals themselves. Merit good such as education is rivalrous in consumption where vacancies available in Tampines Junior College for enrollment for the next student will be reduced when one enrolls it.

Definition / Public Good is a good Characteristics that is non-rivalry and non-excludable while

Explanation of characteristics using Examples (NonRivalrous)

For example, public good such as street lighting is non-rivalrous in consumption where the dimness brightness available to the next user will not reduce when one consume (passes by) the street-lighting, whereas.. Street-lighting is also non-excludable where individual can free-ride and utilize the lighting once it is installed without having to pay for it. The source of market
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(NonExcludable)

On the other hand, education is excludable where students are required to pay school fees to consume education in a school. In contrast, the sources of

Source of

market failure

failure in public good is the non-provision of it in the free market economy.

market failure for merit good such as education are the underestimation of true private benefits and If left to the free market the presence of positive economy, public good externality which resulted such as street-lighting will in under-consumption and not be produced since hence welfare loss. the brightness of streetlighting does not diminish Consumers tend to when one consumes underestimate the true (passes by) hence, there private benefits of is no need for supplier to education as they are not produce an extra unit of fully aware of the long term street-lighting for the next benefits of education for consumer (passer-by) themselves such as which explains zero commanding higher salary marginal cost. Therefore, in the future due to if marginal cost is zero, imperfect information. As the efficient price to such, their demand is charge should be zero registered at a lower level (P=MC) to avoid any than what the government welfare loss to society. viewed it should be. Hence, there will be no In addition, merit goods supply since no profitexhibit external benefits in motivated private firms would be willing to supply consumption where the consumption of education the good if P=0. that increases the At the same time, due to knowledge and skills of the property of nonindividuals will eventually excludability which gives improve the productivity of rise to free-rider problem, the entire economy, the desire to be a free bringing economic growth rider weakens the that is enjoyed by those incentive for consumers who did not consume to offer to pay for streeteducation. However, lighting. Since there is no private consumers do not expression of demand, it take into account these is not possible to charge external benefits. Hence, a market price for it. they consume at Qpte where MPB=MPC. As a result, if streetHowever, the socially lighting were left to efficient level of output is at private firms, they would Qsoc where MSB=MSC. not be provided at all. As such, they underconsume education, resulting in welfare loss to the society. It is important to note that
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Provision

However, merit good such

public good such as street-lighting has substantial benefits to the society by providing a safer place for the people to walk at night. Hence, public good is provided by the government.

as education is being provided by both the private sector and the government. Due to the property of rivalry and excludability, education will be provided by the free market economy. However, underestimation of true private benefits to the consumers themselves and the presence of positive externality mean that merit goods are underconsumed and hence, under-produced by the private sector. As merit good is viewed by the government as having substantial benefits for the consumers themselves and other members of the society, the government will step in with means to either encourage or provide the shortfall. Hence, merit good is provided by both the private sector and government while public good is provided only by the government.

Healthcare

Healthcare is rivalrous in consumption where the consumption of one person (consultation with the doctor) deprives the other person from consulting the same doctor at the same time. Healthcare is also excludable as one needs to pay for consultation and medication. Hence, healthcare is a private good, not a public good which is provided by the private sector in the free market economy. Healthcare is also viewed by the government as having substantial private benefits for the consumers themselves and other members of the society just like education. When consumed, individual will be healthier and fit to work and contribute to the societys
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production (increase productivity of the entire economy) hence increasing both individual and national income. As such, healthcare is a merit good. Similar to education, healthcare as a merit good is under-consumed due to underestimation of true private benefits and presence of positive externalities. However, with the substantial benefits to both the consumers themselves and other members of the society, healthcare is therefore also provided by the government.

2)The Ministry of Health has made vaccination against diseases such as measles and diphtheria compulsory by law through the National Childhood Immunisation programme in Singapore. Communicable Disease Surveillance, MOH Report, 2004 (a) Explain the possible sources of market failure that can arise in the case of vaccination. [10] (b) Discuss the measures that the government can adopt to correct the above market failure. [15] a) Introduction: 1) Define market failure: 2) Identify what type of good vaccination is: Merit Good 3) Define merit good: 4) Sources of market failure: i) Identify sources of market failure:

(1) Underestimation of true private benefits by the consumers themselves (2) Positive externality in consumption

Body: 1) Explain the first source of market failure:

i) Identify source of market failure: Underestimation of the true private benefits of vaccination:
ii) Brief explanation source of market failure (include examples of

true private benefits): Consumers tend to underestimate the true private benefits to themselves as they may not be fully aware of the true private benefits of vaccinations, such as protection from contracting certain serious illnesses in future due to imperfect information 2) Diagram:

3) Explain diagram: With reference to the above diagram, Identify the mkt eqm level of output: As consumers underestimate the true private benefits of vaccination for themselves due to imperfect information, demand is registered at a lower level of D1. This leads to consumption of Qpte. Identify the socially optimal level of output: However, the socially desirable level of demand should be D2 as the government feels that with the desirable qualities of merit goods, more should be consumed. The socially efficient output level is Qsoc. Elaborate on why market fails: There is under-consumption of vaccination. A welfare loss equal to the shaded area is incurred. By increasing consumption from Qpte to Qsoc, the welfare loss can be avoided. The market fails because economic efficiency has not been achieved at Qpte. b) Policy to correct underestimation of true private benefits: Education / Campaign
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What: Since the reason of the underestimation is due to ignorance as a result of imperfect information, the government should use Education or Campaign to raise the awareness of the true benefits for the consumers. How it works: Public Education Campaigns to inform the public of the private benefits and importance of vaccination and hence encourage the public to increase the consumption of vaccination. With more information on the benefits of vaccination, individuals will increase demand towards the desirable level of demand (D2 in Fig 1 in part (a)). Consumption of vaccination will hence increase towards the socially efficient level, Qsoc. This policy will address the failure to recognize true private benefit of vaccination. How well it works: Campaigns mainly serve to encourage people to increase consumption of vaccination. However, people may not heed the advice due to stubborn-ness and the fact that campaigns merely encourages but is not compulsory to follow since there is no penalty for not following.

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