Explain the concept of positive externalities of consumption.

Discuss the view that tradable permits are more effective than taxes in reducing pollution.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of externalities, positive externalities of consumption
• diagram to illustrate positive externalities of consumption
• explanation of positive externalities of consumption in terms of MSB being greater than MPB
• examples of positive externalities of consumption in practice.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of tradable permits, taxes
• supply and demand diagram(s) to show the use of tradable permits, and/or supply shifting left due to taxes, to tackle pollution
• explanation that both methods represent market-based policies, tradable permits working via set allowances to pollute with implications for profits for over- or under-shooting, and taxes working via the effect on supply, price and quantity
• examples of the use of taxes and/or tradable permits in practice
• synthesis or evaluation (discuss).

Discussion may include: The advantage of tradeable permits over taxation is they create an incentive for firms to develop systems to reduce pollution and taxes just penalize all producers in a market and add to costs and the final selling price to households. The weakness of tradeable permits is the system is complicated to set up and administer and taxes are easier for a government to use.

Award a maximum of [9] if only tradeable permits or only tax is addressed.

There were plenty of good answers to this question. Effective responses showed a clear understanding of the positive externalities of consumption, using examples from areas such as healthcare and education. Responses were generally well illustrated by using cost/benefit diagrams to show the associated market failure. The strongest answers localised their examples to specific situations with many effective points made about the positive externalities of vaccines. 

Students generally had a good understanding of how tradeable permits and taxes can be used as policy options to reduce pollution. It was good to see a clear understanding of the market failure associated with pollution and how tradable permits and taxes can be used to deal with external costs associated with, for example, electricity production. If there was a weakness, it was probably the explanation of tradable permits, although this is quite a difficult policy to explain. The answers on the use of taxes to reduce pollution was generally very strong. Students were generally good at evaluating the respective policies by, for example, considering the difficulties for governments of judging the level of intervention needed to achieve a socially efficient level of output.