ECON1020 Prices and Markets
Assessment Task 2 Brief
Perform a microeconomic analysis of one appropriate economic issue or phenomenon of your choice. Clearly explain your chosen question, method and conclusions.
Your task is to conduct economic analysis of an issue that you select yourself, just as businesspeople and policymakers do. You will be assessed on what you learnt in the course by correctly choosing and applying definitions, methods and theories from lectures and tutorials. As this is a microeconomics assignment you should specifically use concepts from this course, rather than writing a general news-style report or using concepts from other courses.
• Look at the business and economics news for ideas for an appropriate issue. It needs to fit the purpose of microeconomics (lecture 1) – a topical, important example of resource allocation with questions you can answer by applying microeconomic methods. State the question, why it’s interesting and economically significant. Present facts or data to illustrate.
• Select the right method (i.e. microeconomic model, theory or tool from this course) to answer your question. Explain your method. Assume your reader needs to be explained enough to follow your analysis.
• Apply the method to your issue. Report the steps of your analysis and your findings. Typical analysis discusses the economic agents, how they exchange, the equilibrium and factors that change it and finally welfare implications. Use diagrams or models as they answer the question better than only words.
• Your conclusion will directly answer the question and maybe look at the big picture – the significance and limitations of your work.
Clearly structure your report (depending on topic), for instance using numbered sections for each of the parts of the task, i.e. introduction, method, analysis and conclusion. Introduction and conclusion will normally be shorter than method and analysis.
Each student submits two reports: an interim report and a final report.
The interim report is worth 10 marks with a limit of 400 words.
The final report is worth 30 marks with a limit of 1500 words.
Both reports should be word-processed and provide word count and bibliography. For every additional 10% word count (not counting bibliography) over the limit you will lose 10% of the assignment marks. On the respective due dates, each report should be submitted only once via Canvas. As per University regulations late assignments receive a 10% penalty per day until the mark reaches zero. Marks will be given according to the rubrics on Canvas.Sample: Prices’ differentials for cars between Singapore and world markets
Singapore is widely recognised for its exorbitant cost for vehicle ownership in the world. According to Reuters 2017, a mid-range car in Singapore can cost four times the price in the United States. Despites this, the exorbitant cost is imperative in managing traffic congestion in Singapore, a densely populated city state with land constraints. Recognizing that social costs such as air pollution and loss of man hours spent on traffic congestion heavily outweigh the social benefits.
Singapore has implemented policies such as the Certificate of Entitlement (COE) which entitles the road usage and the Additional Registration Fee (ARF) which incentivised the de-registration of a vehicle (Chu 2015) to correct the market failure caused by negative externalities. While these policies decrease cars consumption, the repercussion affects the consumers as tax are heavily levied on them, leading to the economy inefficiency due to the loss in consumer surplus.
In this economic analysis report, key economic concepts and factors of demand which affects the price differentials for cars between the Singapore and world markets will be covered. Government policies will be reviewed and analysed based on theories and findings. New policy suggestions will be recommended to facilitate a better distribution of welfare and correcting market failure caused by negative externalities.
2. An Economic Explanation for the prices’ differentials for cars between Singapore and world markets
Figure 1: Imported cars of Singapore in Free Trade Market
When the market is open to international trade, buyers purchase goods from other countries. Figure 1 shows the graph of imported cars in Singapore. There is no domestic supply of cars as Singapore does not produce cars. However, there are car dealers who import and sell cars in the market. In figure 1, the supply line will not intersect with the domestic demand curve and is aligned with price line, hence there is no domestic price.
In the international trade, world price determining the price for goods in all countries is represented by a horizontal line across the graph. Intersection of world prices and domestic demand curve determines the quantity demanded and car prices. Since there is no domestic price, consumers are unable to compare and accept the world price set for cars. Due to free trade and law of demand, if the cars prices decrease, the quantity demanded and consumer surplus will increase.
In the free market without any government intervention, the car prices are determined by consumer demand as there is no domestic supply. When consumers demand increases, the car prices will increase. Under Land Transport Authority (LTA), duties and taxes are not levied on goods that are brought into the free trade zone. Hence, if cars could trade freely in Singapore, the car price is the world price seen in Figure 1.
3. Cross Price Elasticity of Demand: Complements Goods
Figure 2: Gasoline Prices against the Quantity Demanded of Cars in Singapore
Cross-price elasticity of demand (CPED) measures the responsiveness of quantity demanded of a product to change the price of another good. Cars and gasoline are complementary goods and the decline in gasoline prices from P1 to P2 would lead to a rise in quantity demanded for cars from Q1 to Q2 as seen in figure 2. Car owners save more from reduced gasoline prices which can be utilized for a new car purchase. In addition, car ownership becomes much more appealing and affordable to potential new car owners.
4. Income Elasticity of Demand: Luxury Goods
Figure 3: Consumer incomes against the Quantity Demanded of Cars in Singapore
Owning a car is classified as a luxury in Singapore and luxury goods have a large income elasticity. When consumer income rises from Y1 to Y2 would lead to a rise in the quantity demanded for cars from Q1 to Q2 as seen in figure 3. When consumers have more money, they are more likely to purchase a car. The higher income level leads to an increase in the quantity demanded.
5. Demand and Supply Curve of Cars
Figure 4: Demand and Supply curve of Cars in Singapore
Both depressed gasoline prices and the rise in consumer incomes may lead to an increase in quantity demanded for cars from Q1 to Q2 and causing the demand curve to shift to the right from D1 to D2. However, this is regulated by restraint transport policies such as the COE. With the fixed supply of COEs in the market and a greater demand for cars ownership leads to the exorbitant car prices in Singapore from P1 to P2.
6. Price Elasticity of Demand of Cars
Figure 5: Relationship between the COE premium and the demand for luxury and normal cars
Price elasticity of demand (PED) measures the responsiveness of demand to changes in price. According to a chart prepared by Chandrasekar 2019, assessing the effects of increased COE premiums on the demand for both luxury (Mercedes Benz) and normal cars (Toyota).
It was observed that the number of Mercedes Benz cars registered is rather consistent but a great decrease in the number of Toyota cars registered as COE premium increases over the years. This concludes that the price elasticity of demand for luxury cars is inelastic and consumers with higher annual incomes are insensitive to price changes of cars. Whereas, the demand for normal cars are price elastic and middle-income consumers are sensitive to price changes.
7. Government Implementation on Cars consumption
Goods and services tax (GST) is a consumption tax imposed on imported goods. Consumers are taxed by 7% as cars are categorized as standard-rated supplies. Car dealers registered for GST collects the 7% from consumers during transaction. Additional registration fee (ARF) is a tax and excise duty tax are tariff imposed based on the open market value (OMV).
Car owners also pay road tax biannually for road usage. Besides these policies, Certificate of Entitlement (COE) is used to curb vehicular growth via auction of license. Resultantly, car dealers end up selling cars at a higher margin to cover costs and profit gains. Consumers paying a higher price due to car dealers’ margins, heavy taxes levy and quota imposed on cars.
Figure 6: Impact of world price and tariff of cars on the quantity demanded of cars in Singapore
Figure 6 shows the effect of tariff in the car market in the free market, Q1 is the quantity consumed and P1 is the price that consumers are purchasing at. After tariff implementation, it shifts the world price, the new price line is set at P2 and new quantity consumed would be at Q2. Since the supply curve is aligned with the price line, the import of the free market starts from 0 to Q1. After tariff, the new import with government intervention starts from 0 to Q2. Therefore, tariff reduces the quantity of import. The new price set is higher than before, and consumers are paying more because of excise duty tax.
Figure 7: Impact of Import Quota on Quantity Demanded of Cars in Singapore
Figure 7 shows the effect of import quota on the car market. In the free market, P1 is the price consumers are purchasing at and Q1 is the quantity consumed. After COE is implemented, the vertical line seen in the graph, setting a new price line at P2, new quantity consumed at Q2. Since the supply curve is aligned with the price line, the import is originally at 0 to Q1. After the implementation of COE, imports have decreased to 0 to Q2. Therefore, COE limits the amount of imports that car dealers can bring into the market and consumers are purchasing at P2, consuming at Q2.8. Negative welfare implications (consumer and producer surplus) of higher car prices
Figure 8: Consumer surplus in Free Market
Figure 9: Consumer Surplus with Tariff Implementation
Figure 10: Consumer Surplus with Import Quota Implementation
In the free trade market, there is no producer surplus since Singapore is a car importer and total surplus based solely on consumer surplus represented by area A in figure 8. With the tariffs implementation, the world price shifts horizontally upwards and setting new price (P2) and quantity (Q2) in the market. Consumer surplus has decreased to a smaller size represented by area B in figure 9, due to decreased consumption and higher purchase price. Similarly, with the implementation of quota, which is a vertical line in the market, it sets a new price (P2) and quantity (Q2) in the market.
Therefore, consumer surplus has decreased to a smaller size represented by area C in figure 10, due to decreased consumption and higher purchase price. With government intervention, consumers are disadvantaged by paying higher prices for lower quantity consumed. Thus, the loss of consumer surplus is a deadweight loss in the market represented by area D and E in figure 9 and 10.
9. How the Singapore government has addressed or can potentially better address this issue?
For simplicity, the analysis in this section will be based on a closed economy case since the principles are similar. Market failure is seen in Singapore from cars consumption due to the negative externalities arises, adding external costs to the market. Negative externalities such as harmful carbon emissions are produced causing air pollution; vehicular noise pollution from excessive noise emission cars; road congestion and delays in public transport from vehicles overpopulation.
Figure 11: Negative externality of consumption cars in Singapore
Figure 11 displays how negative externality in consumption can cause market failure. At P1, the quantity consumed is based on a free-market equilibrium when the supply curve intersects with the demand curve. However, considering the negative externality, the original demand curve would shift to the left as it lessens the value of consumption. This new curve is identified as social value.
This creates a new market equilibrium and at P2, quantity consumed is socially optimal. However, at the free market equilibrium, the level of output delivered is Qmarket and it is allocatively inefficient. Comparing Qmarket and Qopt, there is a difference of quantity consumed. There is cars overconsumption in the free market resulting in a deadweight welfare loss represented by the black triangle in the graph. There is a loss of social welfare due to Qmarket is consumed higher than Qopt.
To correct the market and reduce losses, Vehicle Emission Schemes (VES) was introduced to encourage buyers to purchase vehicles that emits less pollutants. Based on the VES scheme, surcharges or rebates are given to buyers accordingly. Mandatory periodic inspection by LTA for road tax renewal to prevent illegal modified and excessive noise emission cars, reducing noise pollution. Implementation of COE and ERP to control and implement toll on vehicles to reduce car overpopulation.
As taxes are levied on consumers and this would cause a leftward shift in the demand curve, quantity consumed would decrease to socially optimal quantity. This corrects the market failure as the new price and quantity includes the negative externality of the market.
However, cars are luxury goods to consumers and rational consumers driving their cars frequently due to high costs and value. Economists analyse that car owners who incurred large sunk costs increase their driving (Pang, 2012). Thus, it remained as a debate on whether government intervention is successful in correcting market failure as negative externality still exists.
Bounded rationality is a type of consumer behaviour where consumers acknowledge the existence of negative externalities due to cars consumption yet consistent car usage. Such rationality can be corrected by creating awareness like campaigning and advertising on how cars consumption has adverse effects on third parties. Government should encourage electric car sharing services as an alternative of transportation, emphasis on the cost benefits of electric cars rental for temporary car use which in turn reducing negative externalities.
In addition, the next generation of ERP system will be introduced in 2020, charging drivers based on distance travelled, costs incur increases with increased mileage. Real time traffic information will also be provided for efficient driving. With these, consumers might be able to make decisions at lower private value and quantity will decrease to social optimal level.
Government intervention is needed to manage traffic congestion and reduce pollution due to cars consumption, but at the expense of consumer surplus. Implementing transport policies should be coupled with alternatives such as having reliable public transport system and car-sharing services for optimal results.
When alternatives are attractive enough to draw consumers away from vehicle ownership or driving by themselves, consumers are more receptive to sacrifice comfort and privacy, and this leads to lower demand and car prices.
However, bounded rationality will remain as the driving force in the minority group. Consumers who are able to afford a car are unlikely to leave their cars at home which attributes to high car usage. The government has realised that there are loopholes in existing policies which brings them to move towards car-lite society and shift to road usage charges.
12. Reflection on the usage of the time and work management plan
Janice: Breaking my assigned part into a series of smaller tasks, planning and monitoring time needed for each task and using matrices to prioritising tasks.
Jasmine: Settings datelines for my part according to the priority of the tasks and engaging in project meetings. Doing research and reading up on different articles to have a better understanding of the concept.
Joan: Hold regular meetings according to dates set by the team, led teammates during difficulties at work, doing research for relevant government policies and car market in Singapore
Jing Ting: Prioritizing my tasks, setting deadlines for each before researching for relevant information. Active discussion for clear direction with members for the assignment. (Wordcount: 2141)
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