Paper 1 Essay Plans

Rising Fuel Prices

• One reason for riding fuel prices is the rise in excise duty (specific indirect tax on the production of / sale of particular goods)

• This is because as fuel tends to be price inelastic business (such as Esso, Texaco & She’ll) decide to pass on the higher fuel duty to consumers

• This means a raise in price in fuel (diagram)

• However strong price competition might cause some suppliers to hold back from raising prices - petrol retailing is an oligopoly and often there is intense localised competition between firms (kinked demand curve)

Explain how perfect competition should lead to outcomes which are both productively and allocatively efficient

• Productive efficiency is where firms produce at the bottom of their AC curve oo

• Allocative efficiency is where P=MC, when the price is the cost of producing one more unit (maximising social welfare

• Perfect competition is where there are many buyers and sellers, low barriers to entry, homogeneous products, and full information where firms are price takers (demand is horizontal and PED is infinite)

• In the long run, firms can’t make super normal profit - make spn in the short run, more firms join, supply shifts left, price goes down, firms price takers, normal profit

Evaluate two policies a government could implement to reduce effect of negative externalities

• One policy could be indirect tax (taxes on spending”

• For example, as plastic doesn’t decompose and is bad for environment, the UK government has imposed a plastic package tax which is a ok finished plastic containing finished plastic packaging containing less than 30% recycled plastic

• This is because in a free market - demerit good of plastic is over consumed and therefore over produced - indirect tax

• This means costs to suppliers to increase (shift of MPC to MPC + tax), closer to socially optimum level, less DWLA, also tax revenue to government

• Good because quantity supplied decrease + quantity consumed because of price

• However depends on PES, if inelastic not much change, won’t reach optimum level, also government may not have sufficient knowledge to set appropriate tax, difficulty quantifying it

Evaluate two policies a government could implement to reduce effect of negative externalities (P2)

• Tradable Pollution Permits, permits that the government set which dictate how much pollution you are allowed to produce

• This is because - diagram, certain firms may be willing to cut down on pollution due to the high ‘cost’ of it

• This means - any pollution above this limit - fines - works through market system - people can buy and sell permits - incentive to become green to sell permits - profit - reduce pollution

• EU ETS cuts emissions from 47% from 2005 -2023

More firms in the market is good - evaluate?

• One way more firms in the market is good is that increases economic welfare for consumers

• This is because in perfect competition- many firms in the market - low barriers to entry - price takers

• This means - allocative efficiency (P=MC) - consumers are willing and able to pay exactly the cost of production - productive efficiency - max output for min cost

• This is good because - prices are lower - increase consumer surplus - better quality - firms more efficient - increase in economic welfare for

• However due to the intense level of competition firms cannot be dynamically efficient- in the short run firms make spn profit - more firms join market - supply shift - normal profit - no profit to invest in R&D - meaning goods may not improve

More firms in the market is good - evaluate? (P2)

• There are other ways of improving outcomes for consumers such as price caps

• This is because price caps in markets with small numbers of firms in particular can reduce produce surplus and increase consumer surplus

• This means firms are incentivised to cut their costs - allocative efficiency- productive efficiency - reduction in dead weight loss (show on diagram) - prices are lower increasing consumer surplus

• However it depends on whether regulators know the position of a firms cost curves due to imperfect information- cannot judge how efficient firms are - may cause government failure if the price caps is placed incorrectly - increased consumer outcome may be sacrificed in the long run - less spn - less allocative efficiency

Perfect Competition is more efficient

• Perfect competition is when there are no barriers to entry - perfect information - many small firms - homogeneous products - price takers

• This means - some firms make losses in the SR - can’t cover their fixed costs - some firms will leave the market - increase price normal profits in the long run - allocative and productive efficiency- paying marginal cost of producing the good

• However the assumptions are very unrealistic- there will always be elements of barriers to entry - brand loyalty - there will always be elements of product differentiation - no spn profits so no opportunity for dynamic efficiency- no R&D spending