OCR F581 Markets in Action - 11 May 2015

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Right so I was doing a question to do with how indirect taxes work with negative externalities (18 marks).

I am not too sure what to put for L3. Like surely there isn't much you could say. I would have said an indirect taxes increases cost of production to firm causing supply to shift to the left from S to S1. As a result we see an increase in the price of the good from P to P1 this in turn reduces the quantity from Q to Q1. Negative externalities have the characteristics of over consumption and over production. By using taxes it reduces the over consumption so moves it to a more more socially optimum level.

The actual question is:

"Discuss whether indirect taxation is the most effective policy measure to correct market failure arising from the negative externalities of pollution".

How on earth do you get L2 for this. Also apart from what I have previously mentioned what other L3 is there. Need help with L4 as well I just mentioned about the PED and if it is inelastic the quantity demanded will decrease less than the increase in the price. Thanks

Right so I was doing a question to do with how indirect taxes work with negative externalities (18 marks).

I am not too sure what to put for L3. Like surely there isn't much you could say. I would have said an indirect taxes increases cost of production to firm causing supply to shift to the left from S to S1. As a result we see an increase in the price of the good from P to P1 this in turn reduces the quantity from Q to Q1. Negative externalities have the characteristics of over consumption and over production. By using taxes it reduces the over consumption so moves it to a more more socially optimum level.

The actual question is:

"Discuss whether indirect taxation is the most effective policy measure to correct market failure arising from the negative externalities of pollution".

How on earth do you get L2 for this. Also apart from what I have previously mentioned what other L3 is there. Need help with L4 as well I just mentioned about the PED and if it is inelastic the quantity demanded will decrease less than the increase in the price. Thanks

Ive got another plan, how else can I improve it

Qs: Discuss the effectiveness of regulation as a way of correcting market failure caused by information failure


Define market failure, information failure and regulation

Application - Cigarettes, demerit good ie over consumed and over provided. Generates a lot of neg ext + definition, e.g. risk of cancers, second hand smoke etc ...A social cost bc everyone is paying tax for your NHS treatment

Regulation such as requiring producers to post health warning labels
Diagram > D falls, P falls, Q falls
D falls because people are aware of the neg ext and the costs etc
The fallin Q, shows the reduction of neg ext and market failure so it is considered that is it an effective policy but to an extent because...

Id like to give 3 arguments, but thought of 2 so far
>People ignore the information thus not helpful...elaborate
>Cigs are habit forming goods, people still buy it regardless having perfect knowledge so health warning is no effective ...elaborate

Conclusion, it is not very effective...since habit forming good is one major properly should subsidies e-cig to encourage people to quit smoking and e-cigs are less harmful due to lack of nicotine and other toxic substances etc or possibly taxation on firms, to pay for the social cost ie funding to NHS for the lung cancer risk or smoking related illness

You don't need to worry about L2 since you can go straight to L3 if developed correctly.

L3- Band 1: increase cost of production, decrease in supply, diagram, price rises P1 to P2, quantity falls Q1 to Q2
L3- Band 2: internalising negative externalities, reducing overconsumption, reaching allocative efficiency
L4- PED inelastic, may not be successful
L4- regressive an impact on income inequality
L4- government failure, imperfect information, difficult to calculate the correct amount of tax
Conclusion: magnitude + combination of policies with examples may be more successful

This essay would require approx 3 body paragraphs, two of which focus on indirect taxation alone and one which focuses on another measure such as regulation (the reason for this is that the prompt uses the word "MOST effective", suggesting that other methods should be explained as well).

The assessment objectives would be as follows:

L1 - Knowledge and understanding of indirect taxation, negative externalities, market failure from pollution and the other method you choose to explain later on (ie definitions and brief description).

L2 - Application of indirect taxation and of the other method, in the context of negative externalities and the market failure.

L3 - For an one sided approach; in this case, the advantages of taxation and of the other method to correct market failure arising from negative externalities. This should be an ANALYSIS, which means thoroughly explained!

L4 - For the other side of the matter; the "what if?" part. This is the EVALUTATION, and the reasons why both taxes and the other method may not work. Eg, PED may be inelastic and so taxes would be rendered ineffective.

The frame would be:

Intro - Define key terms in the question and start describing your conclusion; what is the point you'll be making throughout the essay.

Par 1 - a) Make your point - what is it you're writing for. b) Explain it. c) Link it back to the question (eg using taxes for the correction of market failure) and perhaps add an example. This is the L3 part, which is the ANALYSIS and should be pretty thorough!

d) Evaluate what you said in this paragraph, using punch words like "However. This is the L4 part, the EVALUATION, which is very, very important to unlock the last 6-8 marks.

Par 2 - Same

Par 3 - Same (REMEMBER; in this part you should refer to something else other than taxation!).

Conclusion - Reiterate on what you have said thus far (ie. summarise) and EXPLICITLY state your firm opinion on which method is the best!

The par you wrote above is both L2 and L3. The diagram on its own is L2 material -the inclusion of the explanation you provided moves it to L3 as well.

Hope this can help

You don't need to worry about L2 since you can go straight to L3 if developed correctly.

L3- Band 1: increase cost of production, decrease in supply, diagram, price rises P1 to P2, quantity falls Q1 to Q2
L3- Band 2: internalising negative externalities, reducing overconsumption, reaching allocative efficiency
L4- PED inelastic, may not be successful
L4- regressive an impact on income inequality
L4- government failure, imperfect information, difficult to calculate the correct amount of tax
Conclusion: magnitude + combination of policies with examples may be more successful

Surely L3 band 2 wouldn't be more than two sentences?

Do we have to draw an externality graph for the 18marker if its based on externalities/market failure?

This is very helpful thank you both. Do you guys mind giving an L2 example that you would have used in the essay. I just want to ensure I know what L2 looks for.

I just noticed that the 'provision of information' is on the spec as a policy to correct market failure, What would you use as a definition as ive never come across an official one

Ive got another plan, how else can I improve it

Qs: Discuss the effectiveness of regulation as a way of correcting market failure caused by information failure


Define market failure, information failure and regulation

Application - Cigarettes, demerit good ie over consumed and over provided. Generates a lot of neg ext + definition, e.g. risk of cancers, second hand smoke etc ...A social cost bc everyone is paying tax for your NHS treatment

Regulation such as requiring producers to post health warning labels
Diagram > D falls, P falls, Q falls
D falls because people are aware of the neg ext and the costs etc
The fallin Q, shows the reduction of neg ext and market failure so it is considered that is it an effective policy but to an extent because...

Id like to give 3 arguments, but thought of 2 so far
>People ignore the information thus not helpful...elaborate
>Cigs are habit forming goods, people still buy it regardless having perfect knowledge so health warning is no effective ...elaborate

Conclusion, it is not very effective...since habit forming good is one major properly should subsidies e-cig to encourage people to quit smoking and e-cigs are less harmful due to lack of nicotine and other toxic substances etc or possibly taxation on firms, to pay for the social cost ie funding to NHS for the lung cancer risk or smoking related illness

Good, but price doesn't fall and the majority of e-cigarettes have nicotine



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If you assume that regulation causes a fall in demand for tobacco you can state the price will fall. Whether or not e-cigarettes have nicotine is not really important in this question, it would still be considered as part of L2

Provision of information is when the government tries to reduce market failure by ensuring that producer and consumers are well informed and can understand the true costs/benefits of consumption.

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