WELCOME Quote of the Year: "People are like teabags; you need to put them into hot water before you know how strong they are."
Linking You With Green & Me
Sunday, August 17, 2008
“Bad news: Wednesday we’ll need all of you to remove newspapers out of the Greenlink room… Good news: We’re doing something for the environment :D”
- Jasly Koo, Head of Greenlink’s Recycling Committee (2007-2008), 28 April 2008 a) Explain how recycling can be a source of market failure. (8m)
Market failure occurs when the price mechanism of the free market fails to allocate resources in an efficient and optimum manner. There are several sources of market failure such as imperfect competition, externalities and provision of public goods. Recycling slows down the pace which raw materials is used currently, and helps to conserve these raw materials for future generations. Therefore it provides a positive externality.
By collecting newspapers for recycling, Greenlink is engaging in the production of recycled goods. This is a positive externality as it provides an external benefit to third parties for whom no payment was made to the private consumer (i.e. students) and producer (Greenlink). This external benefit is captured in the Marginal External Benefit (MEB) as raw materials (paper) are conserved for usage by future generations. The more immediate benefit is less waste is produced, so that the landfill at Pulau Semakau can be sustained for a longer period of time. In addition, the reduction of waste will also result in less waste being incinerated, so smoke emissions will potentially be minimized. This will contribute to a better air quality in Singapore. Clearly third parties such as the average person benefit from this private production.
This MEB creates a divergence between Marginal Private Benefit (MPB) and Marginal Social Benefit (MSB). Assuming that Marginal Social Cost (MSC) = Marginal Private Cost (MPC), Greenlink will produce at the equilibrium point 1 where MPB meets MSC, as it fails to internalise this external benefit. However, the socially optimum level of production is actually at the equilibrium point 2 where MSB meets MSC. The quantity of recycling at equilibrium point 2 is greater than that at equilibrium point 1. Therefore there is under-production of recycling and this leads to an inefficient allocation of resources.
The benefits are greater than the costs incurred by shifting production from equilibrium point 1 to equilibrium point 2. As production is at the socially inefficient level of equilibrium point 1, the net benefit lost is considered the deadweight loss to society. Society’s welfare is not fully maximized. Hence as there is a lack of efficient and optimal allocation of resources by the price mechanism, market failure has occurred in the production of recycled goods. This justifies government intervention in the market.
