A-Level Economics Essay: Plastic Pollution and Emissions (2020 H2 Econs Past Paper)

Discarded plastic and carbon emissions are among the biggest causes of pollution. The environmental damage to the air and water runs into billions of dollars and this affects not only our health but also our food supply.

(a) Explain how pollution leads to market failure. ([10]

(b) Discuss the extent to which government policy measures are likely to address this market failure.[15]

Part (a): Market Failure from Pollution (10 Marks)

Market failure occurs when the free markets leads to allocative inefficiency, which means that the allocation of resources fail to maximize societal welfare. One such cause is negative externalities generated in consumption and production, where external costs are being inflicted on third parties, who are neither the consumer or producer of the good  in question.

Carbon emissions are largely an issue of negative externalities in production (though it does also happen in consumption). When firms make production decisions,  they only care about marginal private benefits (MPB), which is the additional revenue that they can earn from selling an additional unit  good as well as marginal private cost (MPC), which includes additional raw material costs and wages incurred  to produce an additional unit of the good.  Firms will ignore marginal External cost (MEC) generated from carbon emissions such as how it will result in Ozone layer depletion, which may in turn cause climate changes that will result in  disruptions  to food production, harming  the standard of living of future generations (third parties).

As seen in the figure below, there is a marginal social cost (MSC = MPC + MEC), above the MPC. As rational firms only seek to maximize profits, they will produce up to where MPB=MPC, at Qp, ignoring the MEC. However the socially optimal amount occurs at Qs, where MSB=MSC. At Qp, MSC is greater than MSB, which means that the additional cost to society of the last unit of the goods produced is greater than the additional benefit to society. Thus there is over-allocation of resources to this good (for example Electricity generation) of amount Qs-Qp. For these units that have been “over-produced”, the total cost to society (include notations from diagram) is greater than the total benefit to society (include notations from diagram), which is the deadweight welfare loss to society (indicated by ABC). Hence pollution in the form of carbon emissions, leads to market failure as societal welfare is not maximized. Emissions from the consumption of cars would also follow the same explanation above, resulting in market failure.

[Insert Diagram: Negative Externality]

There could also be consumer ignorance or imperfect information about the harmfulness of pollution in particular with regards to the use of single-use plastics. This is because the consumption of single-use plastics will result in a lot of plastic pollution, which will end up in landfills and pollution in the oceans and eventually lead to presence of micro plastic particles in our water supply and food sources, which eventually could be ingested, harming our own health. This is knowledge that the masses may not possess as it requires quite technical scientific and ecological expertise. Therefore, the MPCactual may exceed MPCperceived. Consumers, in seeking to maximize their private welfare, will consume the single-use plastics up to where MPC(perceived) is equal to MPB. The MPB includes convenience, as with single-use plastics, one does not need to be bringing bags along everywhere they go, and the MPC will be equivalent to the price they have to pay for single-use plastics (which typically is zero as producers tend to absorb the cost).

As a result, consumption will be at  Qp, where MPCperceived=MPB. This maximizes consumer welfare (as perceived), as for every quantity where MPB exceeds the MPCperceived,  it brings net benefit to the consumers, while for quantities where MPB is lower than MPC perceived, they will not be consumed since they brings about a net cost to consumer.  However due to Cconsumer ignorance,  the Optimal amount of consumption should be at Qopt, where MPCactual=MPB. This is the amount that will truly maximize consumer welfare, hence there is over-consumption by the amount Qopt-Qp. This leads to the welfare loss area of ABC,  since for those units that have been “over-consumed”,  the total benefits to the consumer (include notations from diagram) is greater than the total actual costs (include notations from diagram) to them. This is also a welfare loss to society since the consumers are part of the society,  and thus plastic pollution also leads to market failure as societal welfare is not maximized. 

[Insert Diagram: Imperfect Information where MPCactual > MPCperceived]

Part (b): Government Policy (15 Marks)

Where carbon emissions are concerned, a carbon tax can be imposed as a direct way to address this market failure, by forcing the internalization of external costs through the tax. This can be done via a tax on fossil fuels, with the tax amount in accordance to the MEC that the individual fossil fuel is likely to cause.

As seen in the diagram below, for example in the market for coal, a tax per unit equivalent to the MEC, will be able to increase the MPC to coincide with the MSC. Therefore, now at this higher MPC’, the purchase of such fossil fuels will be at the socially optimal amount, Qs, since now the MPB=MPC’ at Qs. Essentially this will reduce the amount of fossil fuels that producers will utilize, encouraging a switch to less pollutive sources of energy,  leading to lower carbon emissions, removing the deadweight welfare loss in the market for coal, which arose from the over usage of coal.

[Insert Diagram: Tax in Coal market]

This can be quite immediately effective since the carbon tax does not take a very long time to achieve its effects and the tax revenues earned (refer to diagram) can be used to fund R&D efforts to further assist the firms in discovering viable alternatives  to fossil fuels such as renewable sources. Therefore this provides an additional mechanism to reduce emissions, further aiding in tackling the market failure.

[Evaluation] However, the above analysis assumes that the government will be able to correctly estimate the MEC. In reality, this is a lot more difficult, as a lot of the harmfulness may occur only much further in the future, and therefore the MEC may still be difficult to concretely determine. As a result, the tax amount may be too low, and hence over-utilization of fossil fuels and the welfare loss to society may still persist. It may also be the case that there is still a major lack of viable substitutes. Hence the demand for fossil fuels like coal may be price inelastic. Thus, the tax may do little to reduce its usage as the quantity demanded falls less than proportionately to the increase in price arising from the tax.

As seen in the diagram below, where single-use plastics are concerned, a ban can be an effective policy to tackle the market failure. This is because as seen in the diagram, the socially optimal amount may be near zero, given that two sources of market failures co-exist – negative externality and imperfect information, which will likely result in a large divergence between the marginal social cost and MPCperceived. The ban on single use plastic will likely be implemented as a ban on sale and a ban on usage by retailers, forcing consumption to zero. Although there may be some welfare loss (area A) as seen in the diagram below,  it is a much smaller welfare loss compared to  the market failure’s (area B). Hence societal welfare increases, so this helps to tackle the market failure.

[Insert Ban Diagram]

[Evaluation] Nevertheless this may not work as there may be great enforcement difficulty. In every country there are likely to be many retailers, and it will be too costly for the government to expend resources to closely monitor and enforce against this,  as high opportunity costs such as funding for merit goods like education and healthcare may have to be foregone. Moreover, with consumers fundamentally still believing in the great convenience of the use of single plastics and still ignorant about the full private costs incurred, they will also pressure retailers to continue providing such plastics, which may not be difficult to be smuggled across borders. Even if caught,  it may be difficult for the government to impose a very stiff penalty for such an offence, hence there may be a lack of deterrence to violating this regulation.

[Concluding Section / Synthesis] I believe there is a strong likelihood that government policies will be able to tackle the market failure,  provided multi-pronged approaches are adopted. For example, where emissions are concerned, it is important to not only impose the carbon tax but also provide incentives and funding assistance to enable transition to renewable energy sources. This will greatly enhance the effectiveness of policy intervention. Similarly in the case of plastics pollution, it will not be enough to simply impose a ban. It will also require education campaigns to correct the imperfect information,  so that consumers will be more supportive of the ban, which will then allow the retailers to more easily abide by the regulation. Finally, as much of the  pollution and its consequences are global in nature,  the effectiveness would not just depend on the policies of any single government but would also require international cooperation,  a more coordinated cross country policy implementation in order to really reduce the levels of ozone layer and ocean pollution, hence more effectively tackling the market failure.

💡 Chief Tutor’s Tip: It is quite important to recognise that such pollution creates global problems. This is pertinent to answering the question on whether policy measures will be effective.

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