15/04/2014

Dr Louise Fitzgerald
Education Development Unit

ECON1101
In-class Test, week 8

The goals of Test 2

Knowledge (ASB Learning Goal)
Explain the assumptions of standard models of microeconomics. Explain the different market environments in which individual, social and government decisions are made.
Explain the reasons for and outcomes of government intervention in the economy.

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The goals of Test 2

Critical thinking and problem solving
(ASB Learning Goal)
Use the standard models of microeconomics to determine the outcome of changes in a variety of economic variables. To use simple mathematical models to calculate the result of changes in the economy.

The goals of Test 2

Written communication (ASB Learning Goal)
Construct written work which is logically and professionally presented

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Sample Question
“A chemical manufacturing company uses a production process which takes clean water, at no cost from a river and then releases it back as dirty water into a lake where a commercial fishing fleet operates.”
1. Use a simple demand and supply diagram to help explain with reference to the paragraph above why the existence of externalities means that the market will provide an inefficient outcome.
2. Use your diagram to help explain what policies the government might use to correct the externality.

Marking Rubric
Good

Criteria

Accuracy and relevance of information Below
Average

Information is appropriately and accurately selected to fully answer the question.

Structure and relations in text Average

Text is well-structured, coherent with logically sequenced sentences and appropriate transitions. Text adds meaning to the diagram through elaboration and interpretation.

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Good

Average

Below average Diagram is clearly set out and
Use of diagram, labelled, curves with correct shape and slope. The diagram is located graph in the appropriate part of the text.

Clarity, grammar, spelling

All sentences are complete and grammatically correct. Expression is clear i.e. appropriate terms and, academic language is used throughout. There are minimal spelling errors.

Model answer: well structured, coherent, logically sequenced
An externality is an unintended cost or benefit which spills over to people other than those who undertook that activity The paragraph above is referring to the presence of a negative externality in the production process. This means that the producer of the good is creating spill-over costs on to other agents in the market. In this case by polluting the river he is reducing the fishing stock and thereby affecting the catch and the revenue of the fishing industry.
He is creating costs which fall on to another producer.
Efficiency in the market refers to the fact that when there is a perfectly competitive industry with perfect knowledge and when the demand curves captures all the benefits and the supply curve captures all the costs; the operation of the price mechanism leads to a Pareto efficient situation where one person cannot be made better off without another person being made worse off. This also means that economic surplus is maximised. A position that is not efficient is inefficient.

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Use a simple demand and supply diagram to help explain… The diagram below depicts the market when an externality is present

why the existence of externalities means that the market will provide an inefficient outcome …
On the diagram above, PMC is the Private l Marginal Costs while SMC represents the Social Marginal Costs (which is PMC with the external costs added). These external costs are the costs which are created by the chemical company but which are borne by the fishing industry.
The demand curve (D) is both the Private Marginal Benefit curve and the
Social Marginal Benefit curve because there are no