Suggested Answers of BT2 Revision Package - ASKnLearn

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Costs/BenefitsMSCMPCabMECcMPB= MSB0Q*QpQuantitySince rare earth extraction factories pursue their self-interest and seek to maximise profits,they only take into account private costs and private benefits and produce to the point whereMPC = MPB at Qp. The socially optimum level, however, occurs at Q* where MSB = MSC.Thus, the free market leads to an over-extraction of rare earths by the amount Qp - Q*. Atthe private output Qp, MSC>MSB and society will be better off if one less unit is produced.For all the additional units produced in excess of Q*, the welfare loss is represented bytriangle abc. Since society’s welfare is not maximised, there is market failure, defined by thefree market failing to allocate resources optimally and efficiently, hence need for govtinterventionExplain how taxes work to “internalise the negative externality”:Taxation allows the government to charge a tax equivalent to the value of the MEC on therare earth extraction factories such that they take into account of the negative spillovereffects as result of their extractions. By increasing the MPC to MSC, the producers willinternalize the negative externality such that the socially optimal level of emission isachieved at Q*. In addition, the tax also provides revenues which may be used to counteractthe negative effects of the rare earth extractions.A key problem with the tax is that of determining the MEC and then charging the amount oftax equivalent to it. An over-valuation of external cost means that output is below socialoptimal and the society’s welfare is reduced. An under-valuation of external cost implies thatalthough output is lowered by the tax, it is not enough to bring output to the socially optimallevel. With the lack of precision, society’s welfare cannot be maximized.Evaluation:- Tax policy necessary but may not be sufficient.- Suggest alternative policy/policies to complement tax policy
Marks Scheme:L3( 7 – 8m)L2(4 – 6m)L1(1 -3m)Evaluation(1m)Evaluation(2m)- Clear use of economics framework- Sufficient depth/ scopeo Clear explanation of the type of market failureo Clear explanation of the tax policyo Evaluation of the tax policy- Apt reference to case evidence- Clear explanation of how the tax policy works and itseffectiveness- Insufficient depth/scope- Some application to context/case- Max 5m without explanation of the type of market failure- Lack economics framework in analysis especially in explanationof the type of market failure and the working of the tax policy- No application to context/case- Unexplained assessment made, merely stating synthesis- Evaluative assessment supported by economic analysis, i.e.suggestion of alternative policies and the need for them.
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