Discuss the view that 'cuts in COE quotas" may not be the best solution to address the market failure in the private transport industry. [10]
Question Requirement
- 3 Specific Policies to address Market Failure
- How does each Policy work?
- Pros & Cons of each Policy
- Final Evaluation
Policy 1: Cuts in COE Quotas
Ref Fig 1 (Negative Externality Diagram)
- Current consumption level of cars: Qp, where MPB=MPC
- However, we did not consider MEC (congestion). There is convergence between MPB and MSB.
- The full opportunity cost to society is denoted by MSC, which lies above the MPC curve by the amount of additional external cost. Assuming MEB=0, MSB=MPB.
- The socially optimal level of output is Qs, where MSC=MSB.
*This part has already been explained in an earlier CS Question.
- There is a presence of negative externality in consumption.
- Overconsumption of QsQp units.
- There is misallocation of resources.
- This results in Market Failure, which gives rise to a DWL (Area AE0E1). Thus, there is allocative inefficiency.
Ref Fig 2 (Price Inelastic Demand, Perfectly Price Inelastic Supply)
- When there are cuts in COE quota, the supply curve for COE shifts leftwards from S0 to S1. This drives the price up from P0 to P1.
- When the price of COE increases, the MPC of owning cars will increase. (bc you must pay more!!)
- The MPC curve shifts upwards from MPC0 to MPC1=MPC0 + COE Price.
- Consumers thus consume at output Qs.
Pros
- From the sales of COE, you can gain welfare ITO increased revenue. (why so? later, you'll see that the 'demand curve' aka MPB=MSB is relatively price inelastic, so driving the price up will result in a less than proportionate decreases in quantity of COE, thus revenue increases!)
Cons
- Regressive in nature: This penalises the lower-income groups as compared to the higher-income groups. --> Not equitable
- It controls ownership, not car usage. Considering that the price of COE is driven up, drivers are incentivised to drive more often so as to ensure that the COE was 'worth it'. When consumption increases, it decreases the AFC for the consumer. This may lead to worsened congestion. (think of it as a buffet: after you pay your lump sum of $80 at the line, you will definitely want to eat to your heart's content, right? just so that your money is spent really well, aka spread across as large an output as possible!)
Policy 2: Improvement in Public Transport
- When public transport is improved (i.e. shorter waiting time, lesser train breakdowns), taste and preferences of consumers will change favourably towards public transport.
- Demand for public transport will increase. Considering that public transport and private transport are substitutes in consumption, demand for private transport will decrease.
- MPB Curve shifts leftwards.
Pros
- Sustainable
- Can have additional benefits such as an improved transport network and possible economic growth.
Cons
- Very costly to improve Public Transport
- Takes a long time to implement
- May be ineffective if consumers don't find it substitutable
Policy 3: ERP
- It increases the MPC of using a particular road.
Pros
- It directly addresses the issue of car usage --> discourages car usage.
- It's a flexible policy as the government can change ERP rate.
Cons
- It is difficult to measure the monetary value of MEC at Qs.
➡ If the MEC at Qs is overestimated, ERP charges will be too high, causing MEC to shift up too much. This results in underconsumption of the road.
- Ineffective as the PED value for road usage is low (remember what was said earlier on cuts in coe quota = increase revenue?)
- Possible diversion of congestion to other roads
Evaluation
Use ERP as a ST policy as it is not viable in the LR (consider the disadvantages of erp!) The tax revenue from ERP can be utilized to improve public transport, where it is sustainable and has many added benefits.
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