market failure - negative externalities

efficiency

• efficiency is the key criterion used to assess the performance of markets

market failure: failure of the free market to allocate resources efficiently

• allocative efficiency is achieved when:

  1. resources are allocated to produce the combination of goods and services most wanted by society ⇒ when there is allocative efficiency, social welfare is maximised

  2. sum of consumer and producer surplus is at its maximum

  3. MSB = MSC

social welfare for most forms of market failure → negative externalities, positive externalities and information failure

• compare marginal social benefit (MSB) and marginal social cost (MSC)

  • MSB: additional benefit to society from the consumption or production of an additional unit of a good or service

  • MSC: additional cost to society from the consumption or production of an additional unit of a good or service

• using the marginalist principle, the good will be consumed or produced at Q*, where MSB = MSC, maximising social welfare

  • Q* is known as the socially optimal quantity

  • producing at Q1 where MSB > MSC or Q2 where MSC > MSB ⇒ deadweight loss for the society and hence a lower
    level of social welfare

differences from a demand and supply diagram

1. y-axis also includes benefit and cost

2. take the perspective of consumers when analysing consumption activities, and take the perspective of producers when analysing production activities

3. instead of a supply curve, it is the MSC curve

   • when studying the decision of firms: includes the cost of production of the good + any other costs incurred by society from the production of the good

   • when studying the decision of consumers: includes the cost of purchasing the good + any other costs incurred by society from the consumption of the good

4. instead of demand curve, it is the MSB curve

   • when studying the decision of consumers: includes the utility that consumers gain from the good + any other benefits gained by society from consumption of the good

   • when studying the decision of firms: includes the revenue that producers gain from producing the good + any other benefits gained by society from the production of the good

decision-making process by consumers

• consider private benefits and costs → enjoyed and incurred by consumers themselves

• marginal private benefit (MPB): additional benefit to consumers (or producers) from the consumption (or production) of an additional unit of a good or service

• marginal private cost (MPC): additional cost to the consumers (or producers) from the consumption (or production) of an additional unit of a good or service

• using marginalist principle, consumers will consume Qp units, where MPC = MPB ⇒ Qp is the private optimal quantity

  • when there is no market failure, the marginal social and marginal private curves coincide ⇒ private optimal quantity Qp (where MPB = MPC) is also the socially optimal quantity Qs (where MSB = MSC)

negative externalities → definition

negative externalities/external costs, of a good or service are the spillover costs to third parties who are not directly involved in the consumption or production of the good or service itself

• costs are not internalised (i.e. taken into account) by the consumers or producers of the good in the market

• borne by the third parties who are not involved in the consumption or production of the good or service

negative externalities

• express social costs (total cost to all members of society) = sum of private costs (total cost to the decision-makers → consumers or producers) and external costs (total cost to others → third parties)

  • marginal external cost (MEC): additional cost to third parties from the consumption (or production) of an additional unit of a good or service

  • MSC = MPC + MEC

negative externalities in production

• producers will consider their private costs (e.g. wages paid) and private benefits (e.g. greater revenue)

• however, the production process may result in external costs incurred by third parties, which are all ignored by the producers when making production decisions

• the presence of marginal external cost (MEC) creates a divergence between the marginal social cost (MSC) and marginal private cost (MPC), where MSC > MPC

• the MSC curve lies above the MPC curve by the amount of the
  MEC, and assuming that there are no positive externalities, the
  marginal private benefit (MPB) = marginal social benefit (MSB)

• if left to the free market, the firms produce Qp units, where MPB=MPC as they only consider their own private costs and benefits, however, the socially optimal level of production is Qs units, where MSB=MSC

• since Qp > Qs, there is an overproduction of steel and an over-allocation of resources to the production of it

  • at Qp, MSC > MSB → the additional unit of output adds more to society’s costs than to society’s benefits

  • from Qp to Qs units, the total social costs (area QsacQp) exceed the total social benefits (area QsabQp)

• area abc represents the deadweight loss which is the welfare loss to society when output is not produced at the socially optimal level

• there is market failure as the private optimal quantity of Qp is allocative inefficient and social welfare is not maximised

• since the external costs are not factored in the decision-making of producers there is distortion of price signals ⇒ price mechanism hence fails to bring about a socially optimal allocation of resources, resulting in an over-allocation of resources in this case

negative externalities in consumption

• consumers will consider their private costs and private benefits

• however, the consumption may result in external costs borne by third parties, which are all ignored by the consumers when making consumer decisions

• the presence of marginal external cost (MEC) creates a divergence between the marginal social cost (MSC) and marginal private cost (MPC), where MSC > MPC

  • MSC curve lies above the MPC curve by the amount of the
    MEC, and assuming that there are no positive externalities, the marginal private benefit (MPB) = marginal social benefit (MSB)

• if left to the free market, the consumers consume Qp units, where MPB = MPC as they only consider their own private costs and benefits, however, the socially optimal level of consumption is Qs units, where MSB = MSC

• since Qp > Qs, there is an overconsumption of motor vehicle usage, and an over allocation of resources to the consumption of it

  • at Qp, MSC > MSB → additional unit of motor vehicle usage adds more to society’s costs than to society’s benefits

  • from Qp to Qs units, the total social costs (area QsacQp)
    exceeds the total social benefits (area QsabQp)

• area abc represents the deadweight loss which is the welfare loss to society when motor vehicle usage is not at the socially
  optimal level ⇒ market failure as the private optimal quantity is allocative inefficient and social welfare is not maximised

• since the external costs are not factored in the decision-making in the consumption, there is distortion of price signals ⇒ price mechanism hence fails to bring about a socially optimal allocation of resources, resulting in an over allocation of resources in this case

government intervention for negative externalities → indirect taxes

• governments can intervene by levying taxes on activities that generate external costs on third parties to make producers or consumers internalise (take into account) the negative externalities

• taxes incentivise producers and consumers to reduce production and consumption by forcing them to internalise the negative externalities in their decision making

  • if firms are taxed due to pollution from their production activity, the higher cost of production encourages firms to reduce output and hence the pollution generated, or to find cleaner ways of production

  • consumers are incentivised to reduce their consumption of the good that generates negative externalities and are encouraged to turn to alternatives instead

government intervention for negative externalities → indirect taxes in context of production activities

• the government can levy an indirect tax on the producers leading them to face higher private costs

• levying an indirect tax equal to the amount of marginal external cost (MEC) at the socially optimal level of output Qs (i.e. t = MEC at Qs) will lead to a rise in MPC of producing by that amount, forcing producers to internalise the MEC to third parties ⇒ upward shift of the MPC curve by the amount of the tax from MPC to MPC’

• outcome of levying the tax is that the new private optimal quantity Qp’ (where MPB = MPC’) now coincides with the socially optimal quantity Qs (where MSB = MSC)

• fall in production from Qp to Qp’ has caused the deadweight loss (area abc) to be eliminated ⇒ allocative efficiency is achieved and
  social welfare is maximised

government intervention for negative externalities → indirect taxes in context of consumption activities

• for greater administrative ease and accountability, the government generally levies the tax through producers, and producers would then pass on the tax to consumers in the form of higher prices OR the government can levy the tax directly on the consumers ⇒ the consumers face higher private costs as they internalise the external costs

• levying an indirect tax equal to the amount of marginal external
  cost (MEC) at the socially optimal quantity Qs will lead to a rise in MPC by that amount, forcing consumers to internalise the MEC to third parties ⇒ upward shift of the MPC curve from MPC to MPC’

• outcome of levying the tax is that the new private optimal quantity Qp’ (where MPB = MPC’) now coincides with the socially optimal quantity Qs (where MSB = MSC)

• the fall in consumption from Qp to Qp’ has caused the deadweight loss (area abc) to be eliminated ⇒ allocative efficiency is achieved and social welfare is maximised

limitations of indirect taxes

• information gap: information is incomplete in the real world → a government is likely to have difficulty in attaching a monetary value to the amount of external costs incurred ⇒ over-estimation or under-estimation of MEC

  1. if the external costs are overestimated, the government could levy excessively high taxes, depicted by the new MPC curve being higher than the MSC curve ⇒ government failure where the welfare loss is greater after the government intervened

  2. if the external costs are underestimated, the government could levy a tax rate that is lower than necessary, depicted by the new MPC curve being lower than the MSC curve

  • in both cases, production or consumption will not be at the socially optimal level ⇒ allocative efficiency is not achieved and social welfare is not maximised

• high administrative costs → unsustainable in the long term

  • a government may incur high administrative costs for the tax collection process ⇒ manpower and resources are needed to collect taxes from firms and consumers, to monitor whether taxes have been paid, and to enforce the accurate and timely paying of taxes

  • such high administrative costs could cause the implementation of taxes to be unsustainable and hence ineffective in the long term

• uncertainty and time lag

  • the government needs time to determine the amount
    of external costs generated, and hence the amount of tax to be imposed + after implementing the tax, there may be uncertainty and time lag in correcting the market failure, as producers and consumers may require time to fully respond to the disincentives of taxes ⇒ allocative inefficiency in the market may continue to persist even after the implementation of the tax

• sunk cost fallacy → consumers’ cognitive biases

sunk cost fallacy: the situation where an economic agent chooses to continue with the decision because of the resources that were heavily invested, even when it is more beneficial to abandon the decision

unintended consequences of indirect taxes

• inequity → for essential goods such as petrol only

  • taxes are politically unpopular in general → taxes can be deemed too high by the economic agents in question

  • taxes can have adverse consequences on equity, which also makes it politically unfavourable

    • when they are levied on goods and services with demand that is price-inelastic relative to supply, consumers bear a greater burden of the tax

    • as consumers bear a larger burden of the tax in the form of higher prices, lower-income groups may no
      longer be able to afford certain essential goods, thus leading to greater inequity

• opportunity cost of implementation

  • the high administrative costs of implementing the policy measure may outweigh the benefits arising from reducing
    the extent of market failure, resulting in government failure

  • an opportunity cost is incurred if the implementation and enforcement of the tax is financed through a reduction of spending in other areas

    • if the welfare loss in the other market is larger than the welfare gained in the initial market, government failure results

other arguments for indirect taxes

• revenue collected from the tax

  • used by the government to address the external damages from the production or consumption of the good or service

  • used to fund research & development (R&D) for cleaner production methods

• loss aversion

  • taxing may be more effective that providing incentives like subsidies or discounts

loss aversion is a cognitive bias where for individuals, the pain of losing is psychologically twice as powerful as the pleasure of gaining

government intervention for negative externalities → rules and regulations

• firms and consumers could be prohibited by law from producing or consuming more than the socially optimal quantity or to adopt certain production or consumption practices

  • fear of punitive measures/penalties ensures that producers and consumers abide by the law

1. quotas

2. complete ban

3. rules and regulations on production or consumption methods

rules and regulations → quotas

legal limits on output or pollution level

• the government could set a quota on the output produced, at the socially optimal quantity, Qs ⇒ limits production of the good to Qs, thus achieving allocative efficiency

• may also be used to limit the amount of emissions produced → directly limits the external costs
  generated, reducing MEC and MSC ⇒ Qs increases, reducing the extent of overproduction and hence social welfare loss, achieving greater allocative efficiency

• examples include environmental regulations for air pollution, which are commonly used across countries, where governments set a maximum permitted
  level of pollution that firms are allowed to emit

  • in Singapore, these are set with reference to guidelines by the World Health Organisation (WHO) to ensure good air quality

  • the National Environment Agency (NEA), which is the regulating authority, then monitors the level of pollution and takes actions against any producers found to be violating the law ⇒ ines and criminal penalties for violating the rules can help to
    correct market failure as they deter the firms from exceeding the limit

rules and regulations → complete ban

an extreme case of output quota being set at zero

• in severe cases where large amounts of negative externalities are generated (the extent of MEC is large), governments may choose to completely ban the production or consumption activity altogether

  • e.g.: banning the production of chlorofluorocarbon (CFC) under the Montreal Protocol, a compound which depletes the ozone layer, contributing to global warming and the rise in skin cancer cases, and
    banning the consumption of narcotic drugs as it can lead to substance abuse

• a complete ban can be seen as a quota where the output is set at zero → imposition of a complete ban is socially optimal when the MEC is very large such that MSB
  intersects MSC where the socially optimal quantity Qs is at or close to zero

  • with a complete ban, there is no production and consumption ⇒ eradicates all negative externalities as well as benefits generated from the production or consumption of the good or service

  • with the imposition of a ban in a market where there is
    significant MEC, the welfare loss will be area A, since MSB > MSC for output between 0 and Qs. Since area A is less than area B (which is the original welfare loss without a ban), it is better to ban the good when the extent of MEC is large, as social welfare improves overall

the higher the MSC and the lower the MSB of the production or consumption activity, the smaller the welfare loss (area A) will be ⇒ makes the complete ban more effective

rules and regulations on production or consumption methods

• laws can also be passed to make the installation of cleaner technologies mandatory

• as a result, the external costs (MEC) of consumption will be reduced → MSC will shift downwards and thus the socially optimal quantity Qs will increase and be closer to the private optimal quantity Qp ⇒ reduces the extent of over-consumption and hence deadweight loss generated, achieving greater allocative efficiency

• e.g.: industries in Singapore are required to install, operate and maintain air pollution control equipment efficiently to meet emission standards

  • through the implementation of stringent emission standards by NEA, all petrol-driven vehicles are fitted with catalytic converters before they can be registered for use in Singapore

  • in particular, diesel vehicles in Singapore have to comply with the Euro VI emission standards from 2018.

limitations of rules and regulations

information gap

• in order to design effective rules regarding pollution abatement methods, governments need to have a good understanding of the specific industries and alternative technologies available to these industries ⇒ often not easy to obtain, making it difficult to implement the policy

• due to imperfect information, government may not know the optimal level of output or emissions

  • if the legal level of output or emissions is set too low, it could lead to greater deadweight loss than without government intervention, causing government failure

• due to imperfect information, governments may not know the level of penalty or consequence that is harsh enough to deter firms

  • if penalties are not harsh enough, consumers and firms may not be deterred from violating the
    regulation, rendering the policy ineffective

  • on the other hand, overly harsh penalties will result in unintended consequences ⇒ determining
    the appropriate level of penalties can be challenging

  • in the case of a ban, the government may not have perfection information on the extent of the negative externalities, to help decide if such an extreme
    measure is required

    • if the amount of MEC is not significant, a complete ban can result in greater welfare loss than no intervention at all

    • a complete ban also removes all the benefits of producing or consuming the good or service ⇒ deadweight loss to society, and allocative inefficiency will continue to persist

if the extent of MEC is small and/or the extent of MSB is large, banning the production or consumption of the good or service tends to result in a larger welfare loss as compared to the situation without intervention ⇒ government failure results

high administrative costs → unsustainable in the long term

• rules and regulations can incur high administrative and monitoring costs

  • includes administrative costs of deploying inspection teams, installing of monitoring equipment and the prosecution of offenders

• such high administrative cost could cause the implementation of rules and regulations to be unsustainable and hence ineffective in the long term

unintended consequences of rules and regulations

• high costs to firms

  • legal restrictions are blunt instruments where all firms are
    subjected to the same rules regardless of their pollution abatement costs

  • for firms that incur high pollution abatement costs, they are subjected to the same limit on emissions as firms with lower abatement costs, and have no choice but to adhere
    to the regulation

  • such laws lead to lower pollution levels at a relatively high cost to the industry

• trade-off with macroeconomic aims

  • if penalties for violating the rules are too harsh (or cause firms to incur high cost), a government runs the risk of chasing firms away to other countries, driving away potential investments ⇒ slow down economic growth and increase unemployment

• opportunity cost of implementation

  • the high administrative costs of implementing the policy measure may outweigh the benefits arising from reducing the extent of market failure ⇒ government failure

  • an opportunity cost can be incurred if the implementation and enforcement of the rules and regulation is financed through a reduction of spending in other areas → if the welfare loss in the other market is larger than the welfare gained in the initial market ⇒ government failure

other arguments for rules and regulations

• laws compel producers and consumers to take actions to limit the level of production or consumption to the socially optimal level ⇒ more straightforward to devise, more easily understood by firms, and easier to implement, as compared to taxes

• outcomes in terms of reduction in production and consumption are more certain and can be achieved faster as compared to taxes and tradable pollution permits

  • as long as the penalties are harsh enough and there are effective monitoring, rules and regulation would serve as an effective deterrent to prevent violation of the legislation and the desired reduction within the stipulated time frame could be achieved

tradable pollution permits → for case of pollution (negative externalities)

• when there is pollution generated from production activities, a measure is to issue tradable pollution permits to firms to limit the amount of pollution

  • e.g. the European Union Emissions Trading System (EU ETS) is a greenhouse gas emissions trading scheme to combat global warming, under the ‘cap and trade’ principle, a maximum (cap) is set on the total amount of greenhouse gases that can be emitted by all participating plants and countries, and permits for emissions are then auctioned off or allocated for free

• the government first decides on a permissible level of pollution for the entire industry and sets a quota on the level of emissions produced → should coincide with the socially optimal level of production

• the permissible level of pollution is then divided into smaller units, and corresponding permits are issued to firms based on certain criteria, for example, firms’ past output or emissions level

• these permits can then be traded between firms, where the permit price is determined by the market demand and supply of such permits

  • a firm whose pollution abatement (reduction) costs exceed the current permit price will find it cheaper to buy more
    permits to pollute than to reduce its level of pollution

  • a firm that faces lower pollution abatement costs than the current permit price will choose to reduce its level of pollution and sell its excess permits to other firms

• this gives firms the incentive to adopt cleaner production techniques to avoid an increase in their cost of production due to the larger number of permits required, or to increase their revenue through the sale of their permits

• when firms adopt cleaner methods of production, external costs are also reduced, causing MSC to shift downwards towards MPC in the long run, reducing deadweight loss

limitations of tradable pollution permits

• high administrative costs → unsustainable in the long term

  • it is difficult to measure and monitor firms’ adherence to their respective pollution limits, and this will lead to the government incurring high administrative costs

  • such high administrative cost could cause the implementation of the tradable permits to be unsustainable and hence ineffective in the long term

• information gap

  • as information is imperfect, regulating authorities may not
    know the socially optimal level of pollution in reality

  • if the government underestimates the optimal level of pollution, too few permits may be introduced ⇒ underproduction of the good or service, which leads to welfare loss

• increased pollution in certain regions

  • may lead to emission being concentrated in certain geographical areas if many firms in that particular region
    has the purchasing power to buy the excess permits from other firms in other regions ⇒ severe air pollution in that region and lowering the non-material living standards of the residents

unintended consequences of tradable pollution permits

• trade-off with macroeconomic aims

  • as the need to purchase permits would increase firms’ cost of production, there could be a fall in investment, employment and economic growth if heavy polluting firms find permits too costly and choose to relocate their production to other countries instead

• opportunity cost of implementation

  • the high administrative costs of implementing the tradable permits may outweigh the benefits arising from reducing the extent of market failure ⇒ government failure

  • opportunity cost can be incurred if the implementation and
    enforcement of the tradable permits is financed through a reduction of spending in other areas → if the welfare loss in the other market is larger than the welfare gained in the initial market ⇒ government failure

other arguments for tradable pollution permits

• firms with lower pollution abatement costs would have the financial incentive to reduce the externalities produced, as they can increase their revenue by selling excess permits ⇒ firms are motivated to develop methods to reduce pollution as much as possible

  • in contrast, for other government interventions like
    rules and regulations, firms may not have the incentive to reduce emissions further once they meet the limit stipulated by the government

• emissions trading, by allowing the firms to trade the pollution permits ensures that pollution abatement is carried out by the firms that can do so at the lowest cost

  • these firms, by cutting down emissions, will be left with unused permits that they can sell to offset their costs

  • the other firms that find it costly to cut pollution
    can buy the unused permits

  • the target can still be met but at a much lower total cost as compared to rules and regulations, where all firms regardless of pollution abatement costs, have to reduce their pollution levels

• compared to taxes, the outcome in terms of reduction in pollution level can be achieved with more certainty (by placing a legal maximum on total negative externalities produced) with strict monitoring and enforcement

case study of singapore → policies targeted at reducing congestion and pollution to address negative externalities arising from car usage [taxes]

• the government can intervene to improve society’s welfare by levying an indirect tax equal to the amount of MEC generated at the socially optimal level, Qs ⇒ raise the MPC by the amount of the indirect tax (tax = MEC at Qs)

• with increased costs of road usage, motorists are compelled to internalise the negative externalities

  • as MPC shifts upwards to MPC’, traffic volume will be reduced to Qs, reducing congestion + reduces the amount of emissions, hence reducing pollution

  • at Qs, deadweight loss is eliminated and allocative efficiency (MSB = MSC) is achieved

• in singapore, the Electronic Road Pricing (ERP) system acts like a tax, raising the MPC to discourage motorists from the use of specific roads during peak hours

  • based on a pay-as-you-use principle, motorists are charged when they use priced roads during peak hours

  • charges are flexible and vary according to peak travel times and road use

case study of singapore → policies targeted at reducing congestion and pollution to address negative externalities arising from car usage [quota to control car ownership]

• in Singapore, the Land Transport Authority (LTA) also implemented a Vehicle Quota System (VQS) to limit vehicle population per annum → regulates the growth rate of vehicles by restricting the number of new vehicles allowed for registration

  • under the VQS, a newly registered vehicle in Singapore must first obtain a Certificate of Entitlement (COE) → represents a right to vehicle ownership and use of the
    limited road space for 10 years

• under the VQS, the supply of new cars is perfectly price
  inelastic in any given month as it is determined by the number of COEs released

  • the price of new cars is determined by the supply of COEs and the demand for new cars

  • with the quota of COEs set at Q2, the quantity of new cars is
    now lower at Q2 ⇒ the price of cars is at P2, which is higher than the market clearing price, P1

  • with a lower quantity of new cars and hence lower emissions, congestion and pollution are reduced

• as the number of new cars on the road falls, the number of car trips falls and becomes closer to the socially optimal level, the deadweight loss and extent of allocative inefficiency is reduced

case study of singapore → policies targeted at reducing congestion to address negative externalities arising from car usage [improving alternative means of transport]

• public transport is a substitute for private transport

  • subsidising train and bus fares, increasing the supply of trains, buses and taxis, and developing the road
    infrastructures to improve the public transportation network ⇒ make public transport a more attractive option to commuters

• in Singapore, the LTA has made plans to shorten waiting time and reduce crowding by increasing the capacity of the rail and bus systems, improving reliability and spreading out demand by encouraging off-peak travel + the bus network will be
  complemented with more extensive infrastructure for cycling and walking, so that alternative modes of transport could be made more attractive for people + the rail network will also be expanded significantly

  • besides extensions to existing Circle, North East and Downtown line, the LTA will build a new 50-km Cross Island Line to provide a faster commute between the East and West regions in Singapore

  • the first phase of the Cross-Island Line (CRL), Singapore's eighth MRT line and its longest fully underground line, will be opened by 2029

• as the alternative modes of transport become more attractive, more individuals may switch to public transport

  • as the other modes of transport become more accessible, the MPB of travelling by cars falls, causing the MPB curve to shift downwards to MPB’ ⇒ reduces the private optimal quantity to Qp’, thus reducing the extent of overconsumption of car trips and the resultant deadweight loss

• improvements to public transport can also be justified on grounds of equity

  • making public transport, an essential service more affordable and easily accessible, poorer members of society who cannot afford to travel by car benefit, thus reducing inequity in society

case study of singapore → policies targeted at reducing congestion to address negative externalities arising from car usage [rules and regulations]

1. to reduce the amount of pollution produced from vehicle usage, the Singapore government introduced a new Vehicular Emissions Scheme (VES) in 2018 to encourage consumers to shift to less pollutive vehicle model

   • takes into consideration a vehicle’s carbon dioxide emissions as well as its emissions of four other pollutants (hydrocarbons (HC), carbon monoxide (CO), nitrogen oxides (NOX) and particulate matter (PM))

   • cars with low emissions will qualify for rebates while
     cars with high emissions will incur a corresponding registration surcharge

2. government has mandated all in-use vehicles to undergo periodic inspection at an authorised vehicle inspection centre at regular intervals

   • owners of vehicles that fail the smoke emission tests during the inspection are not allowed to renew their vehicle road taxes

   • ensure that vehicles on the roads are properly
     maintained to minimise emissions. In addition, it is illegal to remove the catalytic converters and muffler from the vehicles as these systems help to minimise the air and
     noise pollution posed by the vehicle engines

• these measures reduce the MEC generated from consumption of car trips ⇒ the MSC curve shifts downwards, increasing the socially optimal quantity, and reducing the extent of overconsumption of car trips → deadweight loss is reduced, thus reducing the extent of allocative inefficiency

government considerations → policies to address negative externalities arising from car usage

• policies through controlling car usage and car ownership

  • the COE quota and the ERP system

  • car owners in Singapore pay for high car, road and petrol taxes

• although these policies have helped to reduce car usage and car ownership in Singapore, there are also limitations to these policies

limitations of ERP

• although the ERP is targeted at car owners who contribute to the congestion, demand for road use in Singapore is highly price inelastic especially during peak hours when car owners may find it more challenging to find alternatives to get to work on time

  • a given increase in price of road usage due to the ERP will lead to a less than proportionate fall in its quantity demanded

• the effectiveness of ERP as a traffic management policy may be limited → in order to reduce road usage significantly, a high
  ERP charge is necessary, which is politically unpopular

limitations of VQS

• can be a rather blunt instrument because all car owners are penalised regardless of whether they actually contribute to congestion

  • regulates the overall level of car ownership, but does not directly control the car usage on a particular stretch of road that causes the congestion

• the high COE prices substantially raise car prices ⇒ car owners increase their vehicle usage to spread out the high ownership costs due to the sunk cost fallacy, thus worsening the congestion problem

limitations of improving public transport

• although measures have been taken to make public transport a more attractive alternative, motorists (i.e. car drivers) may not perceive public transport to be a close substitute to private transport due to the difference in convenience and comfort ⇒ motorists might not be willing to switch to public transport

• the effectiveness of such a policy depends on how users perceive the closeness of the alternative substitute to be → a weak perceived substitute would make the policy less effective

unintended consequences of rules and regulations

• although measures have been taken to make public transport a more attractive alternative, motorists (i.e. car drivers) may not perceive public transport to be a close substitute to private transport due to the difference in convenience and comfort ⇒ motorists might not be willing to switch to public transport

• the effectiveness of such a policy depends on how users perceive the closeness of the alternative substitute to be → a weak perceived substitute would make the policy less effective