Microeconomic Objectives

Price Determination
Price Mechanism
Price mechanism functions well in allocating resources because it helps in
determining what to produce, in what quantities and for whom to produce. Societys
welfare is also maximised. The price mechanism refers to the free-market forces of
demand and supply from which the market equilibrium price and quantity are
derived.
Firstly, prices perform a signalling function. This means that market prices adjust to
demonstrate where resources are required and where they are not. Prices rise and
fall to reflect scarcities and surpluses. For example, if market prices are rising
because of high and rising demand from consumers, this is a signal to suppliers to
expand their production i.e. to increase their quantity supplied to meet the higher
demand. Conversely, a rise in the cost of production induces suppliers to decrease
supply, while consumers react to the resulting higher prices by reducing their
quantity demanded for the good and services. That is how the price mechanism
allocates resources to the production of goods and services demanded by
customers.
Prices serve to ration scarce resources when the quantity demanded in a market
exceeds the quantity supplied. When there is a shortage if a product, the price is bid
u leaving only those with the willingness and ability to pay with the effective
demand necessary to purchase the product, which could be anything from the
demand for movie tickets to the demand of tickets for a musical shown in Marina
Bay Sands in Singapore, or even the demand for mobile phones. The market price
acts as a rationing device to equate the quantity demanded with the quantity
supplied.
The price for using public roads is a good example of the rationing function of the
price and vehicles that are not willing or not able to pay the charges. In this sense,
motorists and space has a market price instead of being regarded as a free good.
The phenomenal success of eBay is evidence of the power of the market process as
a rationing and market clearing mechanism as Internet usage has grown.
At the market equilibrium, societys welfare is maximised when both consumer
surplus and producer surplus are maximised. These refer to the welfare received by
both groups when the market price is less than the prices consumers are willing to
pay and higher than the prices that producers are prepared to receive for the
equilibrium output.
Efficiency
Efficiency is about a society making the best or optimal use of its scare resources to
satisfy consumer wants and needs.
Productive Efficiently

Productive efficiency is achieved when the output is produced at the minimum

average total cost i.e. when a firm is exploding most of the available economies of
scale (EOS). Productive efficiency exists when producers minimise wastage of
resources in their production processes. Whenever output is not produced at the
lowest cost, there is wastage, which means that the excess cost could have been
used to produce more output to make someone else in society better off without
making anyone worse off.
Allocative Efficiency
Allocative efficiency is concerned with whether the available resources are actually
used to produce the goods and services that society wants and on which it places
the greatest value. It asks the question: Are businesses in the economy and also the
government (or public) sector supplying the products that are required to meet
needs and wants? Allocative efficiency is achieved when no one can be made better
off without making someone else worse off.
Allocative efficiency occurs when the value that consumers place on a good or
service (reflected in the price they are willing and able to pay) equals the cost of the
resources used up in production. The technical condition required for allocative
efficiency is price = marginal cost (MC). When this happens, total economic welfare
is maximised.
The socially efficient level of output and or consumption occurs when social
beneficial = social cost. At this point, social welfare is maximised. In the absence of
market failure, the market equilibrium is the point where: Social Benefit = Private
Benefit = Private Cost = Social Cost.
When the price mechanism fails, then there is divergence between them.
The main causes of market failure are summarised below:
Negative externalities (e.g. the effects of environmental pollution), which
cause the marginal social cost of production to exceed the MPC.
Positive externalities (e.g. the provision of education and healthcare), which
cause the marginal social benefit of consumption to exceed the marginal
private benefit.
Imperfect information, which means that merit goods are under-produced
while demerit goods are over-produced or over-consumed.
The private sector in a free market cannot profitably supply to consumers
public goods that are over-produced or over-consumed.
The private sector in a free market cannot possibly supply to consumers
public goods that are needed to meet peoples needs and wants. There is
complete market failure when the market simply does not exist to supply
products at all.
Market dominance by monopolies can lead to under-production and higher
prices than would exist under conditions of perfect competition.
Equity (fairness) issues, where markets can generate an unacceptable
distribution of income and consequent income disparities.
Definitions

o
o

Externalities is the presence of external costs of benefits distorting the

social and private equilibrium, resulting in over- or under-production.
Public goods is the presence of goods with features of non-rivalry and
non-excludability, which makes it difficult for private producers to
remove free riders or to collect payment directly, resulting in missing
markets.
Imperfect markets are caused by the presence of barriers to entry or
monopoly power, resulting in P>MC.

Singapore has limited land area and almost no natural resources. Labour is also in
short supply, given the current low birth rate. To ensure efficient allocation of scarce
resources, the government intervene in most markets but in varying degrees. In
most markets, the government does not intervene unless absolutely necessary, e.g.
in food, and only when prices of basic necessities rise too quickly and affects lowerincome groups. The government steps in to moderate price increases or to provide
subsidies like food vouchers. These are only short-term remedies since such
intervention also distorts market prices. Subsidies also come with other opportunity
costs in the loss of other goods and services that the government could have
provided to society. Besides, subsidies encourage reliance on handouts and are
often difficult to remove. In the case of external costs, when there are issues with
public health or safety, such as in the consumption of cigarettes, food
contamination, the use of additives or indiscriminate dumping of wastes. The
government intervenes to narrow the divergence between social and private costs
by taxation or through legislation. For example, taxes on cigarettes have been
increasing every fiscal year of cigarettes to the socially efficient price. In addition,
the banning of smoking in public places, places of entertainment and eating places
require monitoring, policing and prosecution. All these mean scarce resources are
being channelled to ensuring that the legislation is enforced. Hence, government
intervention also results in welfare losses and inefficiency of another kind.
In the case of public goods like defence, the government does not leave this in the
hands of market mechanisms. Defence is such a strategic priority that is wholly
taken by the Ministry of Defence with tis Singapore Armed Forces (SAF). As for
monopolies, the government has set up the privatised Singapore Power to distribute
electricity and gas to industrial and domestic customers. The Public Utilities Board,
is the national water agency in Singapore, responsible for the collection, production,
distribution and reclamation of water. These are owned by the government not
because they are natural monopolies with natural cost barriers to entry but more
because they are strategic industries vital to the survival of Singapore.
Transport
Current Situation
In Singapore, traffic congestion occurs in the city area and the main roads leading to
it during the morning and evening peak periods. A motorist would consider using
the roads leading to it during the morning and evening peak periods. A motorist
would consider using the road where marginal private benefit is equal to the
marginal private cost of road usage.

Definition
Private benefit is the benefit gain by reaching their destination faster.
Private costs is the petrol, engine oil, maintenance, taxes and time cost of
travel.
Negative externalities arises when congestion causes other motorists to suffer from
higher opportunity cost of time travel as well as air pollution as a result of stationary
vehicles. This is shown by the divergence between the marginal private cost and
the marginal social cost. For every additional motorist using the congested road, it
slows down the traffic and increases the cost and journey time of the motorist and
other motorists. The additional cost is the reduction in the quality of environment to
others, such as the contribution to global warming and other respiratory illness
resulting of the inhalation of smog (third party).
Assuming there is no positive externality, MSC = MPC + MEC.
Without government intervention, the actual level of traffic flow could be where MPB
= MPC. However, the social efficient level of traffic flow is flowing, at MSB = MSC.
Assuming no positive externality, motorists would not take into the account the
longer waiting time and other costs that are imposed on other motorists or the
negative effect of pollution on society.
Hence, this results in the excessive use of roads in the city during peak hours. There
is thus over consumption of roads.
Current Policies
To reduce the problem of over-usage of roads, the Singapore government has
implemented a series of measures to alleviate this problem. Tools for correcting the
inefficient allocation of resource includes taxes (Road Tax, Additional Registration
Free, excise duty on cars and registration tax), regulation (COE, ERP, Exhaust filters,
Inspectors on car conditions, Electronic Road Pricing) and others (including the
provision of quality public transport, green cars, etc.).
Policy 1: Electronic Road Pricing
ERP has been appropriate in curbing congestion especially during peak hours in
Singapore. Because Singapore is a small country, it is easy to implement and
monitor these measures. In addition, there is sufficient flexibility in the ERP system,
as ERP charges are made to vary according to the tie of usage and routes taken.
Additional ERP charges during peak periods force motorist to internalise the external
cost of congestion and pollution and encourages some of these users to switch to
non-peak periods or to use alternative modes of transport. The effect is illustrated
by a shift in the MPC to MSC. This helps to bring down the level of road usage to the
optimal level Q.
Limitation

 However, it the demand for usage of the road is price-inelastic (the motorist
may only have one route to reach their destination), the effectiveness of the
ERP in curbing traffic congestion will be limited
Policy 2: Efficient Public Transport
In order to provide quality public transport, it is necessary to increase the
frequency, reliability and affordability of public transport. Constant improvements to
public transport in terms of convenience as well as cleanliness and frequency may
result in the public turning away from car usage. As public transport becomes more
affordable, public transport usage will increase. With better and cheaper substitutes
available, car usage can be reduced. If these measures are successful, private
vehicles usage can fall drastically as more people turn to the MRT or buses. This
may also lead to better utilisation of already available transportation and hence
reduce wastages.
Limitation 1: Cars are not only seen as a mode of transport but as a status symbol.
Hence, people may not be willing to cut down on purchasing cars or using them.
Limitation 2: It is difficult to identif the third parties being affected. It is difficult to
measure the opportunity cost of logner waiting times and the impact on the
environment.
Policy 3: Certificate of Entitlement (COE)
The COE has been an appropriate policy because the additional cost of owning a car
( which itself is already very expensive) would deter potential car buyers from
getting one (adding to the congestion). Implementing the COE in Singapore is
also easy since all car buyers are required to purchase a COE before they can
purchase and register their vehicle. In the near future, however, limitatiosn to
the use of the COE may surface.
Limitation
As the national income and material standard of living (SOL) of Singapore
increases, the Coe may not be appropriate in curbinb car ownership as the
purchasing power of individual increases. This is evident in the recent
increase in te number of car ownership. Thus, there is a need for the
Singapore government to address the flexibility of the COE scheme so as to
match up with current economic changes (there may be a need to increase
COE charges as the economy progresses). There is also an impending need
for the government to ensure that the supply of road space meets up with
increase in car ownership.