Practise explaining why markets misallocate resources, using externalities, public goods, information gaps and data or diagrams.
Sources for use with Section C
New Zealand’s housing market and national parks
Figure 1 Percentage change in house prices between March 2020 and March 2021, by region
Extract A Rapid increase in house prices
House prices in New Zealand increased by 15.7% between March 2020 and March 2021. The average house price had risen to NZ$925 000. This increase in house prices was caused by increasing real incomes, low interest rates and a rise in immigration following the global health crisis. Real incomes increased as a result of an above average rate of economic growth. Between March 2020 and March 2021 the base interest rate in New Zealand was just 0.25%, making it relatively cheap to borrow to purchase houses.
Research showed that house prices in New Zealand were about 40% overvalued relative to income. House prices were rising faster than real incomes and were 8.6 times median income in 2020 and 10 times median income in 2021. In Auckland, the average property-price increased to NZ$1.4 million in 2021. This was 35 times median income.
According to New Zealand’s Prime Minister, Jacinda Ardern, many buyers are speculators. In 2020 approximately 15 000 people buying houses owned five or more. She is worried that the speculators could cause a dangerous housing bubble and market failure. She is also concerned that 1% of the population are homeless, the highest rate of homelessness among developed countries.
Between 2000 and 2021 house prices increased by 256% in New Zealand. By comparison, house prices in the USA increased by 68% and in the UK by 110.
Extract B House building in New Zealand
In 2017 the Government promised to build 100 000 new homes. Between June 2018 and July 2020 the Government built just 6 000 homes. It is expensive to build houses and there is much paperwork needed to obtain planning permission. Many local authorities limit the land on which houses can be built in order to protect the environment. There is a shortage of over 55 000 construction workers.
Between 2011 and 2020 the average annual growth rate in housebuilding was 13%. However, in 2021, the significant increase in house prices created an incentive to build new houses. Consequently, the number of new houses under construction increased by 26.
Extract C New Zealand’s national parks
New Zealand has 13 national parks covering 30 000 km2 that the public can explore on foot, by boat, car or air. For much of the year there is so much space that an individual will rarely meet another person. However, in the summer season the national parks are very popular. This means that the national parks become more crowded and car parking spaces are hard to find.
Some activities within the national parks, such as skiing and kayaking, have to be paid for. However, individuals can walk, run or cycle across the national parks without charge.
Define the term 'market failure' (Extract A, line 14).
With reference to Extract C, examine whether national parks in New Zealand are public goods.
With reference to Figure 1, Extract A and Extract B, discuss the likely microeconomic effects of a housing market bubble in New Zealand.
Which one of the following is an example of market failure?
The free-rider problem that results in the underprovision of public goods
Higher prices create an incentive for firms to increase the production of a good
New government regulations that result in excessive administration costs
Government provision of healthcare to move towards the social optimum output
Emiliana Lucas owns a farm in Tanzania on which she grows sunflowers. In 2020 Tania, her neighbour, started a honey bee farm. The honey bees pollinated Emiliana's sunflowers. As a result, seed production on Emiliana's farm increased from 300kg in 2019 to 620kg in 2020.
With reference to the information provided, explain the difference between private benefits and external benefits.
Sources for use with Section C
New Zealand’s housing market and national parks
Figure 1 Percentage change in house prices between March 2020 and March 2021, by region
Extract A Rapid increase in house prices
House prices in New Zealand increased by 15.7% between March 2020 and March 2021. The average house price had risen to NZ$925 000. This increase in house prices was caused by increasing real incomes, low interest rates and a rise in immigration following the global health crisis. Real incomes increased as a result of an above average rate of economic growth. Between March 2020 and March 2021 the base interest rate in New Zealand was just 0.25%, making it relatively cheap to borrow to purchase houses.
Research showed that house prices in New Zealand were about 40% overvalued relative to income. House prices were rising faster than real incomes and were 8.6 times median income in 2020 and 10 times median income in 2021. In Auckland, the average property-price increased to NZ$1.4 million in 2021. This was 35 times median income.
According to New Zealand’s Prime Minister, Jacinda Ardern, many buyers are speculators. In 2020 approximately 15 000 people buying houses owned five or more. She is worried that the speculators could cause a dangerous housing bubble and market failure. She is also concerned that 1% of the population are homeless, the highest rate of homelessness among developed countries.
Between 2000 and 2021 house prices increased by 256% in New Zealand. By comparison, house prices in the USA increased by 68% and in the UK by 110.
Extract B House building in New Zealand
In 2017 the Government promised to build 100 000 new homes. Between June 2018 and July 2020 the Government built just 6 000 homes. It is expensive to build houses and there is much paperwork needed to obtain planning permission. Many local authorities limit the land on which houses can be built in order to protect the environment. There is a shortage of over 55 000 construction workers.
Between 2011 and 2020 the average annual growth rate in housebuilding was 13%. However, in 2021, the significant increase in house prices created an incentive to build new houses. Consequently, the number of new houses under construction increased by 26.
Extract C New Zealand’s national parks
New Zealand has 13 national parks covering 30 000 km2 that the public can explore on foot, by boat, car or air. For much of the year there is so much space that an individual will rarely meet another person. However, in the summer season the national parks are very popular. This means that the national parks become more crowded and car parking spaces are hard to find.
Some activities within the national parks, such as skiing and kayaking, have to be paid for. However, individuals can walk, run or cycle across the national parks without charge.
Define the term 'market failure' (Extract A, line 14).
Sources for use with Section C
The markets for copper, electricity and battery electric buses (BEBs)
Figure 1 World price of copper, $ per metric tonne, March 2020 to December 2020
Extract A Copper prices rise
Between May and December 2020 the world price of copper increased significantly. Speculators expected the global rate of economic growth to recover from the global health crisis and started to buy more copper. In addition, the Chinese Government made a substantial investment in infrastructure that required copper. Output of electric vehicles also increased. Each vehicle requires approximately 59 kg of copper in its production. Most plumbers prefer to use copper pipes rather than plastic pipes. With the increased demand for copper for other purposes, it is likely that the price of copper pipes will increase significantly in the future.
Figure 2 Electricity generation by different sources in Denmark, 2018
Extract B Battery electric buses (BEBs)
Diesel buses are used in city locations with large concentrations of people. They create external costs, including reducing air quality. Children who ride the bus to school are more likely to develop respiratory diseases, such as asthma, and to have higher rates of cancer.
BEBs are powered by electric batteries that run an electric motor. Bus batteries are recharged using the national electricity grid. BEBs do not have engines that use fossil fuels. Therefore, BEBs help to reduce greenhouse gas emissions and pollution in city centres. They also produce much less noise pollution than diesel buses.
In 2018 the price of a diesel bus was $480 000, whereas the price of a BEB was $887 000. This price difference has started to decrease. For a transport company, it is 2.5 times cheaper to run a BEB than a diesel bus. The maintenance costs are also far lower for a BEB as there are fewer component parts within the motor. On average, a BEB can travel 150 miles on a fully charged battery, whereas a diesel bus can travel 690 miles on a full tank of diesel.
In 2018 there were 386 000 BEBs globally. 99% of these were in China and 0.09% were in the USA. In response, the US Government allocated $979 million of subsidies to increase the number of BEBs.
Define the term 'external costs' (Extract B, line 3).
Sources for use with Section C
Cotton and clothing
Figure 1 World price of cotton, $ per lb, April 2020 to January 2021
Extract A World cotton price rises
Between 1 April 2020 and 1 January 2021 the demand for face masks, bedsheets and surgical gowns increased. All require cotton in their production. During the same period there was a reduced cotton crop in Pakistan, the world’s fourth largest supplier. High temperatures resulted in a decrease in the amount of cotton produced. Both these factors caused an increase in the price of cotton.
Extract B Clothing manufacturers should reduce environmental costs
Clothing retailers and manufacturers earn $2.4 billion globally and directly employ 75 million people. The clothing industry is the world’s third largest manufacturing sector.
The manufacture of clothing involves significant environmental costs. For example, on average, producing one pair of jeans requires 3 781 litres of water and creates 33.4 kg of carbon emissions. This includes the production of the cotton through to the delivery of the final product to stores.
According to the United Nations, each year clothing manufacturers use 93 billion cubic metres of water; 20% of all wastewater comes from clothes dyeing by manufacturers; after use, 87% of clothing is burnt or disposed of in landfill; and clothing manufacturers produce 10% of annual global carbon emissions. This is more than all international flights and shipping combined.
Clothing retailers used to have four seasonal clothing ranges per year. However, many clothing stores now offer new ranges weekly. Between 2000 and 2020 the number of clothing items produced yearly increased from 50 billion to 100 billion. In 2019 a person bought, on average, 60% more clothing than in 2000 and more items of clothing are thrown away. Less than 1% of used clothing is recycled into new garments.
In response to the environmental damage caused by the clothing industry, Ireland’s Government is considering the introduction of an indirect tax on clothing.
Extract C Indian Government to remove clothing subsidy
India employs 35 million workers in clothing manufacturing. Clothing accounts for 12% of India’s exports. To protect this important industry the Indian Government used to pay a subsidy to clothing manufacturers. However, the US Government and the Turkish Government argued that this gave Indian manufacturers an unfair advantage. Consequently the Indian Government removed this subsidy in 2018.
With reference to Extract B, examine two external costs associated with the production of clothing.
The diagram shows the market for museum visits in Spain.
Costs and benefits
Which one of the following can be deduced from this diagram?
The market equilibrium quantity is at
The social optimum quantity is at
The welfare gain area would be equal to UVW
The welfare gain area would be equal to UWX
Sources for use with Section C
The market for rice
Figure 1 Index of the world price for rice, July 2022 to July 2023 (July 2016 = 100)
Extract A Rice price rising
The global price of rice increased by over 19.6% between July 2022 and July 2023. Rice consumption in Africa and Asia is growing rapidly, as populations increase and incomes rise. In 2022 the population grew by 2.45% in Africa and by 0.83% in Asia. This compared to a 0.06% increase in Europe. In 2022 average real income growth was approximately 4% in Asia and 3.85% in Africa. In advanced economies the average increase in real incomes was only 2%.
Figure 2 Estimated price elasticities of demand in Japan for selected food groups
Extract B The impact of rice production
Rice production contributes 12% of global methane emissions and 1.5% of all greenhouse gas emissions. Vietnam’s paddy fields, where the rice is grown, produce more carbon emissions than the country’s transportation network. Producing one kilogram of rice requires 2 500 litres of water. Rice production uses over 33% of the world’s irrigation water.
Rice growers often use an insecticide to protect the crop from insects. In the USA these insecticides contributed to a 44% decline in the bee population in 2020. On average, 90% of rice is consumed in the country in which it is grown. This limits the environmental damage caused by transporting rice abroad.
Extract C Indian Government intervention in the market for rice
The rice sector contributes $51.58 billion to the Indian economy. India exports rice to 150 countries. The Government supports rice growers by providing subsidies. These subsidies are used by farmers to invest in capital goods and to purchase fertiliser and water used in 5 production. This can lead to over-farming that results in lower quality rice crops. In 2021 the Indian Government spent $6.9 billion on subsidising rice production. In 2022 the Government decided to reduce expenditure on these subsidies. However, this caused mass protests from farmers that led to the Government increasing these subsidies to their previous levels. 10
With reference to Extract B, examine two external costs associated with rice production.
In 2022 there were 24300 lighthouses globally. Between 2013 and 2022 the number of losses of ships at sea fell from 109 to 38.
With reference to lighthouses, explain the difference between 'non-rivalry' and 'non-excludability'.
Between 2017 and 2022 the Singapore Government replaced 95000 streetlights along its roads.
Explain one microeconomic reason why the Singapore Government provides streetlights.
Sources for use with Section C.
The market for sugar
Figure 1 World price of sugar, US$ per kg, June 2016–June 2019
Extract A Global production of sugar
Between August 2017 and August 2018 the world price of sugar fell as a result of favourable weather leading to good harvests. In 2018, India, the world’s second largest sugar producer, and Thailand, the world’s fourth largest sugar producer, had record levels of production. In 2018 global production was 11% higher than in 2017. In 2018 world production was so high that there was a surplus of 17 million tonnes. This led to large quantities of sugar being held in storage.
In recent years, consumption of sugar has fallen because of increasing health concerns. There is also competition from substitutes such as artificial sweeteners. In the USA, Europe, China and Australia sugar consumption has fallen or remained unchanged.
Sugar is grown in 119 countries. It takes sugar cane one year to mature in countries with warm temperatures and two years in cooler countries.
Extract B Overconsumption of sugar
In the USA the recommended maximum amount of sugar consumption is 50 grams per day. In the USA average consumption is 73 grams per day. The human body can comfortably process 25 grams a day. However, any sugar consumption in excess of 25 grams per day will normally be processed into body fat. This is contributing to obesity. One study found that a high sugar diet increased the risk of heart disease by 38%. Another study found that excess sugar consumption caused an increased risk of many types of cancer. A further study found that men who consumed 67 grams or more of sugar per day were 23% more likely to experience depression than men who consumed less than 40 grams per day.
Extract C Indian subsidy for sugar production
The Indian Government subsidises sugar growers that export sugar. Before the subsidy, exports were 620 000 tonnes per year. After the subsidy was introduced exports rose to 3.3 million tonnes per year, helping to make India the world’s second largest producer of sugar. The size of the subsidy will increase from 55 rupees a tonne in 2018 to 138 rupees a tonne in 2019. This increase in subsidy is expected to increase exports to over seven million tonnes per year. Production in India was 20.3 million tonnes in 2017 and increased to 33.0 million tonnes in 2019.
The Governments of Brazil and Australia have complained to the World Trade Organization that these subsidies give Indian producers an unfair advantage. They argue that these subsidies contribute to lower world prices, making the market unprofitable for many growers outside India.
With reference to Extract B, examine two possible effects of information gaps on the consumption of sugar.
Before the global financial crisis of 2008, commercial banks expected that their governments would not allow them to fail because of the threats to the rest of the economy. This meant that some staff at banks took excessive risks when lending and investing.
Which one of the following concepts best describes the behaviour of staff at these banks?
Inertia
The free-rider problem
Moral hazard
Market bubble
In 2020 the German city of Munich had the highest risk of a housing market bubble in the world. Between 2010 and 2020 the average price of a house more than doubled.
With reference to Munich's housing market, explain what is meant by a 'market bubble'.
Between 2000 and 2019 in China the average price of a house increased from 4000 yuan per square metre (m^2) to 60000 yuan per m^2. The ratio of average house prices to average incomes increased from 5.6 to 7.6, showing that houses were becoming less affordable.
Evaluate the impact of market bubbles in the housing market.