RATIONING SCARCE RESOURCES

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Felicity Kelly
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1 ECONOMIC METHODOLOGY RATIONING SCARCE RESOURCES By Market Price By Consumer Income By Assessment of People s Need By Household Postcode By Education Level By Age By Gender By Nationality

2 4.1.1 ECONOMIC METHODOLOGY RATIONING SCARCE RESOURCES Rationing is one way of allocating scarce goods and services when market demand exceeds available supply Examples of rationing Health rationing occurs when demand for health care services outstrips the available resources leading to waiting lists and delays for health treatments Cash rationing in Indian banks when the government in 2016 took larger denominations of bank notes out of circulation in a bid to reduce corruption Ticket rationing by clubs when demand for tickets for a big match exceeds capacity of a stadium

3 4.1.2 INDIVIDUAL DECISION MAKING LOSS AVERSION 29 The basic idea behind loss aversion is that people feel losses much more than gains. Value Losses Gains Reference Point Loss aversion is often seen in financial markets: There is some evidence that stock market investors hold their investment positions with paper losses too long and sell their investment positions with paper gains too early.

4 4.1.2 INDIVIDUAL DECISION MAKING LOSS AVERSION Marketing emphasises discounts rather than avoiding a surcharge Example: 1. Renew a season ticket before 1 st July to get a discount of Season ticket renewed after 1 st July increases in price by 50 Professional golfers put better for a par than for a birdie they really don t like losing a shot to par Save More Tomorrow (Nobel-winner Professor Richard Thaler) Richard Thaler created a pension plan where investors signed up for a pension that costs nothing until they receive a pay rise At which point a percentage of their pay rise would automatically be directed into their pension fund By making sure the saver never saw a reduction in his disposable income, pension contributions among this group rose 200%

5 PRICE DETERMINATION INFERIOR GOODS Own label discounters Urban bus transport Cigarettes Economy class travel Own-label cereals Economy Foodstuffs

6 4.1.3 PRICE DETERMINATION INFERIOR GOODS What is an inferior good? If, following an increase in real income, less of the good is purchased, then the good is an inferior good. Inferior goods have a negative YED, i.e. YED < 0 When real incomes are rising during a period of economic growth, then demand for inferior goods will fall causing an inward shift of the demand curve When real incomes are falling during a period of recession or more generally, if wages are rising more slowly than prices, then market demand for inferior goods will rise. Inferior goods are sometimes called counter-cyclical products

7 4.1.8 MARKET FAILURE & INTERVENTION POSITIVE EXTERNALITIES FROM CONSUMPTION 80 Health programmes e.g. HNS services Early years education e.g. nursery provision Subsidised Bike Schemes in urban areas Public libraries / community spaces Museums and Galleries Free school meals / nutritional advice

8 4.1.8 MARKET FAILURE & INTERVENTION POSITIVE EXTERNALITIES FROM CONSUMPTION Costs, Benefits s This is the area of social welfare loss because the market output Q1 is lower than the socially efficient level Marginal Private Cost P2 P1 Marginal Social Benefit If the market price ignores positive externalities, then there will be underconsumption Social optimum position is output Q2 whereas the market equilibrium is Q1 Q1 Q2 Marginal Private Benefit Output/Quantity

9 4.1.8 MARKET FAILURE & INTERVENTION INDIRECT TAXES AND ELASTICITY OF DEMAND 100 If the co-efficient of price elasticity of demand >1, then most of the burden of an indirect tax will be absorbed by the supplier If the co-efficient of price elasticity of demand <1, most of an indirect tax can be passed on to the final consumer Price Paid by consumer Price S1 + tax Paid by supplier S1 + tax Tax Per Unit P2 S1 P2 S1 P1 P3 D P1 P3 Paid by consumer Paid by supplier Demand Q2 Q1 Quantity Q2 Q1 Quantity

10 4.1.8 MARKET FAILURE & INTERVENTION INDIRECT TAXES AND ELASTICITY OF DEMAND Perfectly Inelastic Demand All of the tax is paid by the consumer Perfectly Elastic Supply All of the tax is paid by the consumer Price Total tax paid by the consumer Demand Price S1 + tax To ensure that suppliers receive the required minimum price after an indirect tax, the market price must rise by the full amount of the tax. P2 S1 P2 S1 + tax P1 Tax Per Unit P1 S1 Total Tax Revenue (paid by the consumer) Demand Q1 Quantity Q2 Q1 Quantity

Edexcel Economics AS-level

Edexcel Economics AS-level Unit 1: Markets in Action Topic 7: Government Intervention in Markets 7.1 Methods of government intervention Notes The existence of market failure, in its various forms, provides