Chapter 6: Market Failure

1. a.     What are positive externalities and how do they arise? Give examples.

Positive externalities are where a third party enjoys positive benefits off of someone else’s transactions. When an externality occurs, society and a private/individual firm no longer share the same experience. They arise in situations where a company producing a good benefits other goods that aren’t really related. These positive externalities normally arise with products that are good for the environment or products that have caused advance technology or something like that. For example, if a product is good for the environment then people living around that product will be positively benefited because the environment will be cleaner.

Examples taken from textbook:

Tree farms created for production of wood oxygenate the atmosphere to everyone’s benefit.

A school placed in a neighbourhood may improve the property values of families with no children in school.

Research and development by one firm can be used by another to make further advances in a particular field.

Software companies create new technologies that may not succeed on their own but inspire others to create valuable new imitations.

1. b.    To what extent should governments attempt to influence markets where positive externalities exist?

In my opinion, if a good or service has positive externalities I think the government should try and influence the market as much as possible as long it doesn’t have a large impact on other goods that do not have negative externalities. Governments should provide subsidies and advertisements so that a good’s positive externalities are maximized.  Governments can also begin to provide the good or service themselves if it has positive impacts on a third party. For example, since trees product oxygen and promote a cleaner environment, a government could give a firm more land to grow more trees. This would be beneficial to the firm and to the people because the positive externalities have been increased. Another example of how government could intervene to try and increase positive externalities is with research and development. If a firm built new technology that other firms began to use because it was so good, the government could provide subsidies to the original firm so that it can continue to improve on the technology. As a result, the positive externalities will increase.

Japan’s Rice Stockpile

MercoPress — South Atlantic News Agency
Thursday, August 5th 2010 – 16:11 UTC

Japan rice stockpiles to reach the highest in eight years in 2011

Japan’s food rice stockpiles may reach the highest level in eight years at the end of June 2011, leading to a price drop and planting curbs by growers next year. Private and government inventories are forecast to climb 2.5% to 3.24 million metric tons from 3.16 million tons a year earlier, the Ministry of Agriculture, Forestry and Fisheries said in a report Wednesday.

It will be the largest volume since 2003 as consumption is expected to drop by 51,000 tons to 8.05 million tons in the year to June 30.

Increasing supply may pressure Japanese rice prices, which declined 6.4% on average in the past year. It may also force local growers to cut production further next year, after reducing output by 4%t to a six-year low in 2009.

“The current level of private stockpiles is already very excessive,” said Shigeo Fuji, senior executive director at Central Union of Agricultural Cooperatives, Japan’s biggest farmers’ organization. Out of 3.16 million tons in the June 30 stockpiles, 980,000 tons were held by the government and the rest was kept by farmers and distributors.

“Rice growers may have to cut production by 600,000 to 700,000 tons next year,” Fuji said at the ministry’s advisory panel meeting, which approved the forecast today. Japan’s food rice production is planned at 8.13 million tons this year, compared with last year’s 8.15 million.
The Japanese government increased subsidies to reduce food rice sowing to balance supply with declining consumption. Demand is expected to keep shrinking as the nation’s population ages and declines, Masachika Murai, director at the ministry’s rice policy planning division, said at the meeting in Tokyo.

Wholesale prices of Japanese rice harvested last year averaged 235 yen per kilogram in June, declining from 251 yen a year earlier, according to the ministry.

The government started subsidy payments this fiscal year to support incomes of local rice growers. It also increased payments to farmers who switch rice paddy production to crops for alternative uses, such as animal feed.

Japan, the world’s largest corn importer, is self- sufficient in rice as the government protects growers from foreign competition with a 778% tariff on imports. The country agreed to give minimum market access to rice- exporting countries at the Uruguay Round of world trade talks in 1993, buying 770,000 tons a year.

Japan imported a total of 10.12 million tons of rice from April 1995 to March 2010. Of this, 3.52 million tons was sold to domestic food processors, 2.53 million tons was used as aid to foreign countries, 1.8 million tons was sold to Japanese feed makers and 1.08 million tons was used as table rice, the ministry’s report showed today.

Stockpiles of foreign rice stood at 970,000 tons as of March 31, compared with 1.11 million tons a year earlier, according to the report.

Question 1

Using diagrams, as appropriate, describe the methods used by the Japanese government to protect Japanese rice farmers.

There are two main things that the Japanese government does to protect Japanese rice farmers. The government has begun subsidy payments in order to protect and support local rice growers. Another thing that the Japanese government does is it stamps a 778% tariff on any imported rice. This means that the rice will be very expensive to the public, so then they will buy locally grown rice instead. The government also polices the amount of rice that exporting countries like Uruguay are allowed to import into Japan.

Question 2

Explain the reasons for the decline in demand for rice.

The two reasons behind the decline in demand that are mentioned in this article are the shrinking population, while the population ages. Because the population is declining it means the market size for demand of rice will be smaller, which causes a shift left. Also the aging population has a large impact because rice is more popular among the older because it is more of a routine or tradition, while younger people still have some bread in their diets.

Economics Photograph: Rokko Island’s Flower Shop

Some of the first things you see when you walk into the big hall near Island Centre are bright, colourful flowers. Flowers are rather useless; you can’t eat them or use them for anything in particular. You can only really just look at them and get a good feeling.

By putting flowers on display outside of the shop to stand out, they are advertising this good feeling. If you walk into this hall, no matter what direction your going you will always see the flowers, which I think is a key component to success when selling a product like flowers. It is an elastic good, so it means it is a more of a spur of the moment thing when you buy flowers.

Another thing you see when you walk in is the variety and the colours. This variety and colour gets the consumer’s attention, which could lead to more sales. There is also a strong smell that intrigues you as you walk past the flowers.

Location. This is one of the most important factors to selling flowers. When you buy flowers it is usually a spontaneous feeling so it is important to think about where people might get a feeling to buy flowers. The flower shop is located just outside of the main supermarket on Rokko Island, which is very smart because it is normally Japanese women that do shopping and demand for flowers is higher in women than it is for men. So when women finish their shopping and they walk past nice smelling, colourful flowers, they decide to buy some.

If you decide to walk into this flower shop you feel inclined to buy something. It is a very small business run by a very friendly old lady. You walk down the entrance and you get to a very compact dome with flowers all around you. It is a very homely feeling, which I think is what makes you feel inclined to buy something once you have walk in.

Chapter Five: Government Intervention

Explain the concepts of maximum and minimum price controls.

Often, because the market can be such a competitive place, there are times when not everyone can afford some of a necessity. In these kinds of situations a government might choose to intervene by implementing a maximum price on specific products. When a government does this, it is called enforcing a price ceiling. If this were to happen it would have been because the government saw a potential rise in price, which would have made the product unaffordable to poorer residents. Although, intervening in this manner has its faults – it can cause shortage, rationing, decreased market size, elimination of allocative efficiency and informal (black) markets.

Governments also have to intervene in situations where the price is too low. This is called minimum price control. When a government does this, it will enforce a price floor, which means it will artificially the prices of some goods and resources. These instances normally happen when a good is a necessity or is supporting employment. But just like maximum price control, it has several faults – it can cause surplus, reduced market size, cost inefficiency, allocative inefficiency, and informal markets.

Evaluate the idea that government intervention in the form of price ceilings and price floors is well intentioned, but often leads to undesirable side effects.

Whenever a government intervenes to enforce a price ceiling or a price floor, it is almost always for the good of the people so that necessities are affordable. However, often these interventions will lead to undesirable side effects. A common circumstance where the government might choose to intervene is with rent prices. New York city is one of the most expensive places to live in the world, which is why it might not be affordable to those that aren’t earning a big figure for their salary. For this reason, the government might decide to enforce a price ceiling so that the maximum price of an apartment to rent is affordable to those involved in professions like teaching. But when this happens, there might be a shortage, the low price for apartments will increase the amount of demand but also there will be a decrease in supply because they will not be making as much profit. This will also cause rationing, while will result in a decreased market size. Also an informal market might begin to form so that producers are making as much money as they can do. Also owners of apartments will lose all incentives to maintain their building because they are not making as much profit.

Select a product and create a market supply and demand diagram.

• Show the equilibrium price and quantity, and set a binding price ceiling
• Calculate the change in consumer expenditure/producer revenue
• Identify and calculate the government subsidy expenditure needed to eliminate the shortage

Select a product and create a market supply and demand diagram. (Mr. Nguyen, I’m not sure about the consumer expenditure and the subsidy needed to eliminate surplus in this question)

• Show the equilibrium price and quantity, and set a binding price floor
• Calculate the change in consumer expenditure/producer revenue
• Identify and calculate the government subsidy expenditure needed to eliminate the surplus

What is the effect of price controls on allocative efficiency?

Allocative efficiency refers a time in a market when the marginal benefit equals the marginal costs (MB = MC). However, when a government tries to control price (often by enforcing price ceilings and price floors), it can be fatal to allocative efficiency. This is because a price control like a price ceiling means that the marginal benefit will not be equal to the marginal cost. By exerting a price ceiling there will be a shortage in supply, because society is not producing enough of the good with the price ceiling in place. Or if a government exerted a price floor the high price will inspire producers to produce at a quantity where the marginal cost is a lot higher than the marginal benefit. Supply will not equal demand.

Evaluate the effectiveness of rent control.

One type of a price ceiling is rent control. Rent control is implemented when housing is too expensive for low-income citizens. Although rent control is enforced with good intentions, it is not very effective. Producers or renters will become frustrated and try to find loopholes. One of these loopholes is to bid the effective price higher by paying direct payments to owners. Another negative impact rent control has is it lowers the amount of supply of housing, renters will take their houses or apartments off of the market and try and rent it out somewhere where they will receive a higher payment (often on black markets, which is illegal). The producers that do decide to stay on the market lose incentive to maintain their buildings, which can lead to unsafe and poor-quality housing.

Chapter Four: Elasticities

Carefully explain what it is that price, income and cross-elasticity’s of demand are meant to measure:

These three variables are meant to measure elasticity. All three things are in some way related to it. Price elasticity of demand measures the responsiveness of those buying an item when the price of an item changes. For example, it would measure the effects on consumers that increasing the price of a pencil from 1000 yen to 1200 yen. Income elasticity of demand will measure the responsiveness of a consumer on demand when their income changes, what will happen to demand if a consumers experience a pay-cut or the opposite, a raise? Cross elasticity of demand will measure what happens to demand when the prices of complement good’s change. Each different branch measures how demand is affected; will something cause a large change or just a minor change?

 

Discuss the practical importance of the concept of price elasticity of demand for the government:

Price elasticity is very important to governments, because it will determine what goods are the best to tax, what goods will make the government money. If a good is inelastic, more likely than not the government can tax the product because the demand will remain relatively similar. However taxing a very elastic good would not benefit the government in any way. For example if you have gum at a price of 100 yen, and then the government stamps a tax on it, the price raises to 150 yen, then demand will decrease substantially because the price rose so much, and consumers will no longer want to buy this gum. This whole concept of price elasticity controls what products will be taxed, and how much profit a government will make.