(b) In the UK, entry to the national museums and art galleries is free of charge and tickets to see the opera are heavily subsidised. In contrast, in Japan, entry to national museums and art galleries comes at a high price and a ticket to see the opera is among the most expensive in the world. Assess the economic case for these two different approaches [13]. (2010 P2A Q3)
Question Analysis: Identify the aim(s)/effect(s) of the respective “economic case.” Allocative efficiency and/or equity
UK
- Zero/low price
Japan
- High price
Use demand and supply analysis (economic case) to determine zero price in the UK and high price in Japan.
Introduction: The UK uses free provision to achieve allocative efficiency and/or equity, while Japan uses the free market to achieve allocative efficiency.
Thesis: Free provision of merit goods in the UK is to achieve allocative efficiency and equity.
Free provision achieves allocative efficiency. The government can give the producer a specific subsidy per unit s which =MEB. This decreases the firm’s cost of production and increases supply such that MPC shifts rightwards to MPC1 (MPC with subsidies) and intersects with MPB at Qs. The equilibrium price has decreased from Pm to 0 while the equilibrium quantity has increased from Qm to Qs, which is the allocative efficient quantity, thereby addressing the problem of underconsumption. Since s = MEB = Ps0, the MEB has been internalised.
Free provision improves equity. The good takes up a greater proportion of poorer consumers’ income such that without government intervention, they may not be able to afford it. Free provision ensures that all consumers, rich and poor alike, are not being deprived of the good due to the inability to pay.
Thesis: High price of merit goods in Japan is because the government is using the price mechanism to achieve allocative efficiency.
Note that equity cannot be used as an aim because of the high price. Since most countries subsidise merit goods such that prices are lowered, the fact that Japan is not subsidising museum entry means that the price becomes relatively much higher.
The market equilibrium under the price mechanism is at Es (Ps, Qs) where D=S. D=MPB while S=MPC. Assuming no externalities, MPB=MSB while MPC=MSC. At Qs, MSB=MSC and allocative efficiency is attained. Allocative efficiency is defined as the situation whereby society’s welfare is maximised. At Q1 (Q1MSC. From Q1 to Qs, society’s benefits = aEsQsQ1 while society’s costs = bEsQsQ1. The underconsumption of Q1Qs leads to a deadweight loss (DWL) of aEsb. DWL is defined as the welfare loss to society which does not go to any party. Society’s welfare can be increased if the consumption of the good is increased from Q1 to Qs. At Q2 (Q2>Qs), MSC>MSB. From Q2 to Qs, society’s costs = EscQ2Qs while society’s benefits = EsdQ2Qs. The overconsumption of QsQ2 leads to a DWL of Escd. Society’s welfare can be increased if the consumption of the good is decreased from Q2 to Qs.
Anti-thesis: Free provision (zero price) in the UK may lead to government failure and creates a strain on government finances.
Government failure occurs as allocative inefficiency increases. When MEB is small, s which = P10 is > MEB and government intervention exceeds the extent of market failure. This increases allocative inefficiency as it creates a larger DWL (Esbc > aEsEm) due to overconsumption of QsQf.
Free provision requires large government expenditure and creates a strain on government finances. To finance, tax rates may need to be increased. An increase in indirect tax rates (eg, GST) increases firms’ cost of production. As firms reduce production, the short run aggregate supply (SRAS) decreases and this increases the general price level and cost push inflation occurs. There is no need to subsidise the richer households who have the ability to pay for themselves.
Anti-thesis: In Japan, using the price mechanism to achieve allocative efficiency may lead to market failure instead.
Elaborate on how positive externalities lead to market failure.
Synthesis
In the UK, museum entry is deemed as a merit good by the government while in Japan it is not. Therefore, there is government intervention in the UK but not in Japan. In a welfare-oriented state like the UK, the government’s main aim is equity and large subsidies are given such that merit goods may be provided freely. In contrast, Japan has been in a prolonged recession and the government may be focusing on macro aims such as economic growth and full employment. Therefore, government expenditure is more focused on increasing consumer expenditure through transfer payments such as handouts instead. Therefore, without subsidies, entry to museums and art galleries, etc, remains expensive.