Figure 1 illustrates a perfectly competitive flu vaccination market, it achieves this by displaying consumer surplus and producer surplus maximised. Consumer surplus is the difference between the price a consumer is willing to pay and the real price, while producer surplus is what the producer is paid minus the minimum acceptable pricing (McConnel and Brue, 2018). Finally, the equilibrium is where demand and supply meet.
This assumes there would be no interventions in the market. For example, there’s no VAT on vaccinations in the UK, however, if there was a tax the market would appear like figure 2 and would be inefficient (GOV.UK, 2018). Furthermore, one would assume that figure 1 would act as a free market, meaning resources would be allocated efficiently. The implications of this are that consumers will be maximising utility and producers will be maximising profits (Mankiw and Taylor, 2014).
Markets failures can be caused by externalities, which are a cost or benefit to a third party, due to a decision made without considering them (Mankiw and Taylor, 2014). Figure 3 shows the result of a positive consumption externality, which when consumed has a positive effect on particular third parties (Mankiw and Taylor, 2014). The specific externality, in this case, would be a health benefit to third parties by reducing the spread of flu amongst the population.
This type of externality moves the demand curve on figure 3 to the right as it increases demand. However, this would create a social loss as a result, which can be illustrated in figure 4. A social loss means there is an under-allocation of resources to a particular good or service. This means the market isn’t taking all benefits into account and society is missing out on a social benefit as a result (McConnel and Brue, 2018). For society to realise these social benefits consumption would have to be increased and the social loss would have to be corrected.
This externality could be corrected through private solutions such as charities, the self-interest of parties and social contracts (Mankiw and Taylor, 2014). These solutions show that a government intervention is not always needed, this is supported by Coase theorem which is the theory private groups can bargain to solve externalities if costs to bargain are sufficiently low (Mankiw and Taylor, 2014). However, this doesn’t always succeed due to factors such as transaction costs, issues bargaining and a lack of cooperation between parties (Mankiw and Taylor, 2014). An alternative way the social loss could be corrected is through government interventions such as regulation, taxation and subsidies, we shall discuss this possibility in the following section (Mankiw and Taylor, 2014).
Part C (300)
As previously mentioned, a social loss can be corrected by utilising a government intervention. To reiterate, an intervention is an action by the government in order to change the decisions of economic agents. There are several interventions that could be used in these circumstances such as subsidies and price ceilings. A subsidy is a payment to the consumers and producers of a good to increase consumption (Mankiw and Taylor, 2014). This would move the supply curve right, thus correcting the social loss created by the externality as shown in figure 5. The implementation of a price floor is where the government places a maximum price for a good/service, this would create a shortage if applied below the equilibrium point (Mankiw and Taylor, 2014).
Figure 6 shows the potential correction of the social loss and the product of this correction, a deadweight loss. A deadweight loss is a reduction in efficiency caused by an intervention which distorts the market, and which will cause a reduction in both consumer and producer surplus (Mankiw and Taylor, 2014).
The main advantages of subsidies are increased consumption of the product, as this is a positive consumption externality this will create a social benefit for society. Another advantage is that it increases the welfare of economic agents as a result of the social benefit that is gained. On the contrary, the main disadvantages of subsidies include the result of a deadweight loss, which means that the consumer and producer surplus cannot be maximised thus the allocation of resources would be inefficient. Moreover, the subsidy may be applied ineffectively by the government, this could be caused by a variety of factors such as inelastic price elasticity of demand or by applying a subsidy that is too large or too small.