Chapter 5 · Microeconomics
Government Intervention and Behavioural Economics
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Behavioural Economics Concepts
Loss aversion
- Losses feel about twice as powerful as equivalent gains.
- Explains the concert-ticket dilemma and reluctance to sell possessions at fair market price.
- Explains holding on to losing investments rather than cutting losses.
Sunk cost fallacy
- Past, unrecoverable costs incorrectly drive current decisions.
- Examples: overeating at a buffet to 'get the money's worth', persisting with uncomfortable expensive shoes, and finishing a boring movie.
- Note: the time spent should be treated as the opportunity cost.
Salience bias
- Vivid or recent information overrides statistics in decision-making.
- Examples: fast-food advertising and paying a premium for branded goods.
Government Policies
Direct provision
- Government supplies the good itself, for example education in Singapore and national defence.
- Ensures equity of access.
- Limitations: budget constraints, red tape, low innovation and higher costs.
Joint provision / public-private partnership (PPP)
- Joint ventures and DBFO (Design, Build, Finance, Operate) arrangements.
- Risk sharing and greater efficiency from private incentives.
- Limitations: complex contracts and monitoring.
Taxes (corrective taxes)
- Raise MPC to internalise the marginal external cost.
- Electronic Road Pricing (ERP) in Singapore is an example whose cost is salient to drivers.
- Limitations: hard to measure the MEC, and over-taxation creates deadweight loss.
Subsidies
- Used for goods with positive externalities.
- Limitations: hard to identify the marginal external benefit (MEB), budget cost, and hard to remove once introduced.
Quotas
- Limit quantity supplied to Qs, creating a shortage and higher price; raises equity issues.
- Singapore's Certificate of Entitlement (COE) for cars leads owners to keep using their cars through a sunk-cost effect.
Tradable permits
- An emissions cap allows permits to be traded, achieving the target at the lowest cost.
- Limitations: hotspots can form where permits are concentrated, and monitoring costs are high.
Rules and regulations
- Total bans, for example on drugs and vaping.
- Partial bans, for example restricting alcohol sales after 10.30pm in Singapore.
- Trade-off with productive inefficiency, plus enforcement costs.
Information and public education
- Addresses information failure by correcting misperceptions so consumers can make informed choices.
Evaluation Points
- The best policy depends on how accurately the government can measure external costs and benefits.
- Command-and-control tools (bans, quotas) are certain in effect but inflexible and costly to enforce.
- Market-based tools (taxes, permits) are flexible and cost-effective but sensitive to measurement error and may create hotspots.
- Behavioural insights, such as salience and sunk-cost effects, change how effective ERP and COE policies turn out to be.