Directorate: FET Curriculum

TOPIC and GRADE Economics Grade 12

TERM 3 Week 3 Lesson 1
TOPIC Microeconomics: Market Failures - Reasons for Market Failure, Consequences of Market Failure
OBJECTIVES Learners learn / understand the reasons and consequences of market failures
RESOURCES Paper-based resources Digital resources
(Indicate what will be
Refer to the Mind-the-Gap: p 115 - 129 Grade 12 Economics - Quizlet links.pdf
used in the lesson, e.g.
Core notes The document has links / QR codes to Quizlet flashcards that
Handbook, Mind-the-
Any approved textbooks test a wide range of study and choices.
Gap, etc.)

https://quizlet.com/_43bzhd
PRE- KNOWLEDGE Grade 11: Dynamics of markets: The relationship between markets
Grade 12: Dynamics of imperfect markets
VALUES As a learner in Economics, it is important that you have thorough knowledge of issues such as the role of markets in
a mixed economy, market failure and government intervention.
CONCEPTS AND SKILLS Learners must be able to explain / describe / define the key concepts and be able to:

CONSOLIDATION (1) List and explain the reasons for market failure.
ACTIVITIES (2) Distinguish between private costs and private benefits, and social costs and social benefits.
(3) Distinguish between negative externalities and positive externalities by using examples and graphs.
(4) Explain what is meant by "missing / missed / lost markets" in the provision of public, community, merit and non-
merit goods.
(5) Explain what is meant by imperfect competition.
(6) Explain how a lack of information affects different participants in the economy, namely consumers, workers,
entrepreneurs.
(7) Explain how immobility of factors of production can affect labour, capital and the impact of structural changes.
(8) Uneven distribution of income and wealth: Explain in the South African context the reasons for unequal
distribution of income and wealth and the socio-economic consequences.
(9) Distinguish between and explain productive efficiency (or inefficiency) and allocation efficiency (or
inefficiency).
(10) Explain Pareto-efficiency by means of a diagram.

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 Lesson unit 1.1 -1. 3: Reasons for / Causes of market failures 2. Missing markets
- The functioning of markets is sometimes incomplete in the sense that
Description of market failure the demand for certain goods is not satisfied.
● Market failure occurs if the market does not function effectively. - The public sector then provides such goods and services, called
● Sometimes free markets fail to produce maximum goods and public goods.
services from a given set of resources. - Public goods are divided into community goods (water drains and
● The market also fails to produce an optimal mix of goods and lighthouses) and collective goods (parks, sidewalks).
services, as desired by consumers.
Public goods Merit goods Non-merit goods
Causes / reasons for market failures (essay question) • Non-exclusion, e.g. • desirable for the • Use of this is
1. Externalities lighthouse general welfare considered to be
- also known as the spill-over effects • Non-competitive, • not very high rated socially harmful
- in ideal market conditions people suffer or benefit from the e.g. TV license by the market when consumed,
existence of externalities
• Social benefits> • if market prices e.g. cigarettes,
- are costs and benefits to third parties not included in the
private benefits, have to be paid alcoholic
market price of goods
e.g. education less will be beverages.
- Four important concepts: • Infinite consumed - the • Demerit goods are
Private costs Costs that consumers incur when buying goods, consumption, e.g. market will fail - oversupplied.
e.g. R1500 for a bicycle traffic lights state must • Some consumers
Private Benefits of those who produce the goods, e.g. • Non-refusal, e.g. therefore provide. are unaware of the
benefits profit for the producer. street lights • E.g. safety, health true cost of
Social costs Costs for producers and the community - care, education consumption, e.g.
include additional costs such as landfill disposal, medical costs, the
decrease in the area's aesthetic appeal. negative
Social Positive externalities such as clean water lead externalities.
benefits to a reduction in disease, a healthier workforce • Its use should be
and higher productivity. discouraged by
Externalities convert private costs and benefits banning, taxing and
to social costs and benefits.
providing more
Externalities are the difference between social
information about
costs and benefits and private costs and
benefits. the harmful effects.

6. Uneven distribution of income and wealth

3. Imperfect competition - The market system is neutral to the issue of income distribution.
- Competition is often distorted by the power of market - Discrimination disrupts the earnings of women, minority groups and
economies - the power lies with the producers. people with disabilities.
- Illnesses and incompetence disrupt income.

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 - Most businesses operate under conditions of imperfect - Price discrimination - a phenomenon where identical goods and
competition: they limit output, they raise prices where prices services are sold to different consumers at different prices - leads to a
exceed the marginal costs, they prevent the entry of new situation where certain consumers pay lower prices, e.g. where
businesses and prevent the full adjustment of changes in airlines on the same flight sell flight tickets at different prices to
demand. different customers.
- Modern markets do not allow for price negotiations.

4. Lack of information ACTIVITY 1

- Businesses, consumers and workers do not always have the
necessary information to make rational decisions. ESSAY QUESTION: Main section
- Consumers need complete knowledge of the products they
want to buy from producers. Discuss in detail how the following factors lead to the misallocation of
- Technological advances make more information available, but resources in the market:
it is not always perfect. - Externalities
- Workers may be unaware of job opportunities. - Lost markets
- Imperfect competition
5. Immobility of production factors - Lack of information
- Most markets do not adapt quickly to changes in supply and - Immobility of production factors
demand. This is due to a lack of information and the immobility - Imperfect distribution of income and wealth (26)
of resources.
- Labour takes time to move between occupations and In your opinion, how can government intervention counter the negative
geographies and it adjusts slowly and inadequately. effects of market failures? (10)
- Unskilled workers are unable, unwilling, or do not have the time
to acquire the necessary skills.

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 Lesson unit 1.4: Consequences of market failure ACTIVITY 2
Productive inefficiencies and allocation inefficiencies (allocation 2.1 Name any TWO characteristics of public goods. (2 x 1) (2)
inefficiencies (and graph
2.2 Study the graph below and answer the questions that follow:
Productive inefficiencies Businesses do not produce at the
lowest possible cost.
There is room to reduce costs -
without producing less goods or
delivering a poorer quality product.
Allocative inefficiencies Resources are not allocated in the
right quantities.
● Allocative inefficiency could be
improved if the producer made
changes to the variety to reflect
the market demand in two types of
bicycles.
● At point B, more stunt bikes and less
racing bikes are produced.
2.2.1 Identify the number of homes that the market will provide if
● Move along the production
all the resources are spent on homes. (1)
possibility curve from point B to
2.2.2 How many schools should the government provide to
point C.
achieve the social optimum allocation? (1)
● At point C, more racing bikes and
2.2.3 Briefly describe the term market failure. (2)
fewer stunt bikes are produced.
2.2.4 Why are markets unwilling to build public goods such as
● Production inefficiencies are
roads? (2)
eliminated,
2.2.5 How can the government ensure macroeconomic stability
● Point A represents inefficient
(ENJOY Economics, p.117) through their involvement in production? (2 x 2) (4)
production, can increase
production and move up to any 2.3 Briefly discuss productive inefficiencies and allocative
point on the production possibility inefficiencies as causes of market failure. (2 x 4) (8)
curve. 2.4 Analyse productive inefficiencies using a production
possibility curve. (4 x 2) (8)

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 Lesson unit 1.5: Consequences of market failure
- positive and negative externalities Example of negative externality = cigarettes ● If the market goes its own way, a
quantity of Q will be produced at
Definition: Externalities: Graph: price P.
An effect of consumption or production that is ● It is a socially ineffective solution.
not taken into account by the consumer or the ● Social efficiency requires that MSC be
producer, but which takes into account the
equal to the product price (MSC = P).
utility or cost affecting other consumers or
● This happens at P1 and quantity Q1.
producers.
● Thus, fewer goods should be
Negative externalities carry: produced at a higher price.
● a private cost, the cost of producing the ● The shaded part represents the
actual product, and negative externality (loss of wealth)
● a social / social cost, cost to the for the community.
community.
But when the market takes into account
Consequences of a negative externality external costs, the following happens:
(Mind the Gap, p. 123)
● If the social cost of a good is added to the ● If the external cost (cost to society) is
private cost of the good: included in the price, the supply
Practice how to draw the graph.
- the final price will increase and curve (MPC) will shift to the left to the
less goods will be produced. MSC.
- Explanation:
● At the new equilibrium (where MPB =
● The demand for cigarettes is represented
The state uses three methods to reduce MSC) - the price increases from P to
by DD.
negative externalities: P1 per unit and the quantity sold
● Campaigns to persuade people not to ● The supply of the product, which is also the
decreases from Q units to Q1 units.
cause negative externalities. marginal private cost (MPC) of the
● Tax levies on goods, e.g. taxes on industry, is represented by SS.
cigarettes and alcohol. ● Due to the pollution, the marginal social
● Use of laws and regulations, e.g. tobacco cost (MSC) is greater than MPC.
company is not allowed to advertise. Laws
regulate pollution levels and waste.

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 Positive externalities ● The demand for school education, which is ● More learners (Q1) will receive quality
● When people realize the social benefit of also the marginal private benefit (MPB) of the education without having to pay more for
a good, the result is… industry, is represented by DD. it.
● School fees = P, Quantity demanded and ● The wealth gain (positive externality /
Result / effect of positive externalities:
provided = Q. External benefit / wealth advantage) is
People want more of them. The price of the
● If school fees are P, most learners will not be indicated by the shadow triangle.
goods will therefore increase.
able to afford it.
Example of a positive externality = ● Demand curve V1V1 also represents the
The state encourages positive externalities
education marginal social benefit (MSB), that is, the
through:
level of education required.
● Advertising on the radio and on television.
Graph: ● Because of the benefit of education, (MSB) is
● Provision of education, healthcare and
greater than (MPB).
other services free of charge or at a low
● If the market goes its own way, quantity Q will
cost.
be produced at price P.
● Provision of consumer subsidies.
● There will be social inefficiency in the market
Consumer subsidies reduce the cost of a
because not enough education is provided.
product and encourage its use.
● If the social benefits are realized, quantity Q1
will be produced at the price P1.
● More education will be provided and this will ACTIVITY 3
lead to social efficiency.
● The shaded part shows the positive 1.1 Give any TWO examples of
externality (welfare benefit) for the positive externalities. (2 x 1) (2)
community. 1.2 Name any TWO examples of
● If the market is left to its own, too little negative externalities. 2 x 1) (2)
(Mind the Gap, p. 124) education will be provided. 1.3 Why should governments intervene
● The problem is solved when the government when negative externalities exist? (1x2) (2)
joins the market and subsidizes education. 1.4 How is the community benefiting from
Practice how to draw the graph.
● When government subsidizes education, the positive externalities? (1x2) (2)
Explanation: demand curve shifts to the right from DD
● The supply of education, which is also the (MPB) to D1D1 (MSB).
marginal social cost, is represented by SS.

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 2.2 Study the pictures below and 2.3 Study the graph below and answer the 2.4 Use the graph below to explain the
answer the questions that follow. questions that follow. effects of positive externalities in the
market. (8)

2.2.1 Name the causes of market failure 2.3.1 Give ONE example of a negative
as depicted in picture 3. (1) externality. (1)
2.2.2 What type of externality is represented 2.3.2 Which curve indicates the social costs
2.5 Describe the following using
by picture 1? (1) for the community? (1)
fully labeled graphs:
2.2.3 Explain the term market failure. (2) 2.3.3 Define the concept of market failure.
(2) - Negative externalities (8)
2.2.3 How will a lack of information as a - Positive externalities (8)
cause of market failure affect 2.3.4 What is the result of negative
consumers? (2) externalities? (2)
2.2.5 Explain how the government can 2.3.5 Explain how negative externalities
intervene in markets affected by can lead to market failure by using the
externalities (pictures 1 and 4). given data in the graph above.
(2 x 2) (4) (2 x 2) (4)

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 Directorate: FET Curriculum

SUBJECT AND GRADE Economics - Grade 12

TERM 3 Week 3 Lesson 2
TOPIC The consequences of market failures: government opinion
LESSON OBJECTIVES Learners should have an understanding of government intervention to prevent market failures and how cost-
benefit analysis can be used to determine whether or not interference will be beneficial.
RESOURCES Paper-based resources Digital resources
Mind the Gap Study guide, p. 125-129
Core notes https://quizlet.com/_43bzhd
Any approved textbook
PRIOR KNOWLEDGE Grade 12: reasons for market failures, Pareto efficiency (Pareto optimality) and how to illustrate it on a graph,
positive and negative externalities (consequences of market failures).
Grade 10: Minimum prices, maximum prices, minimum wages, taxes and subsidies
VALUES This section of the work contains many practical, everyday applications. Think about the prices of staple foods
(bread, mealies, oil, etc.) and how you are personally affected. Think about the measures that the government
has taken to improve wage equality (economic as well as political implications) and the role of government in
providing equality in agricultural markets. Make sure you can argue in favour of or against such interventions.
CONCEPTS AND SKILLS You should be able to:
(1) explain government direct intervention
(2) explain what is an imperfect market
(3) explain the purpose and consequences of a minimum wage, with or without the aid of a diagram
(4) the purpose and consequences of a price ceiling (maximum price), with or without the aid of a diagram
(5) explain the purpose and consequences of a price floor (minimum price), with or without the aid of a
diagram.
(6) explain what a tax is; illustrate and explain the effect of a tax using a diagram
(7) explaining what a subsidy is; illustrate and explain the effect of a subsidy by a diagram
(8) to describe and evaluate the various measures instituted by government to improve the redistribution of
income and wealth in South Africa.
(9) describe what cost-benefit analysis is; from a case study / data response, identify who will use CBA,
and why; give at least four reasons for using CBA; Identify private costs and benefits using a case study /
data response; external costs and benefits; evaluate a project using CBA and make recommendations.

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 ASSESSMENT Activities 1 to 7
CONSOLIDATION Activities 1 to 7

Lesson unit 2.1: Consequences of Market ▪ In some cases, removing or reducing o Statutory requirements
Failure tariffs has made local markets more
▪ In rare cases, laws are used to curb
competitive, e.g. textile industry.
Government Intervention - Direct Control harmful pricing practices.
o Promoting competition
Direct control measures ▪ Oligopolies are known for collusion
▪ In SA, the government established the and other practices that violate
● Governments can use laws and
Competition Tribunal, the Competition market principles.
regulations and the legal system to control
Commission, and the Competition
and limit the actions of businesses and
Appeal Court.
industries that cause negative
externalities. ▪ They must ensure that competition is
strengthened.
● In SA, the potentially dangerous gases, air
pollution, environmental pollution are o Governing Bodies ACTIVITY 1
controlled by laws and regulations.
▪ In SA, there are governing bodies that
● E.g. cigarette advertising Is Illegal in SA. oversee certain industries.
1. Briefly discuss the four instruments that
Non-competitive markets ▪ E.g. NERSA for electricity supply, ICASA the government uses to correct or limit
for communication, broadcasting, etc. allocation discrepancies due to non-
● There are TWO types of non-competitive
competitive markets. (4x2) (8)
markets, namely artificial and natural ▪ Businesses (even a single monopoly)
monopolies. need permission from the governing
bodies to raise their prices.
Governments use the following FOUR 2. Briefly explain the direct control
instruments to correct or mitigate allocation ▪ These governing bodies often limit measures that the government applies
discrepancies arising from non-competitive price increases and tariff increases when market failures occur. (4x2) (8)
markets. based on the inflation index.

o Competition from abroad * NERSA = National Energy Regulator of

▪ Sometimes it is only overseas South Africa
competition that can curb harmful
* ICASA = The Independent
practices of local monopolies.
Communications Authority of South
▪ E.g. SAA will compete locally with
Africa
British Airways.

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 Lesson unit 2.2 – 2.3: Consequences of market failure
Minimum wages, Maximum prices, Minimum prices
Minimum wages Graph ● A minimum wage is set above 0W by
0W1. (Minimum wage is set above the
● Politicians feel that laws regarding
market wage)
minimum wages are necessary to
enforce redistribution. - Workers can earn more but not less.

● This is because unskilled workers often - The amount of labour demanded

fall short when it comes to working drops from 0Q to 0Q1.
conditions.
- The amount of labour offered
● They cannot be assured that real
increases from 0Q to 0Q2, but less
wages will rise, i.e. their wages remain
labour is employed.
relatively low and this contributes to an
uneven income distribution.

● Examples: farm workers and domestic

(Source: Enjoy Economics)
workers.
Maximum prices (also called Price ceilings)
● In SA, there are laws that require
employers to pay a minimum wage to ● The government can interfere in the
workers and to pay Unemployment Practice how to draw the graph. market and set a maximum price.
Insurance Fund contributions.
● Maximum prices are usually set; set on
● Current minimum wage since 1 basic goods, such as food and
January 2019 = R20 per hour or R3 500 Remember: minimum wage, 0W1, lies transport.
per month, depending on the number above the market wage, 0W.
● This is done to benefit the poor.
of hours worked.
● In SA, there is a maximum price for
Result / consequences of a minimum wage:
Explanation paraffin.
● demand for labour is declining.
● If the government does not interfere in ● The price is adjusted regularly.
● the amount of employment the market:
● If the market price is too high, the
decreased.
- Wage level is 0W and number of government can set a price that is
● wages will increase. labourers employed is 0Q. below the market price.

● income distribution among those who ● Less than the maximum price may be
work has improved. charged but no more.

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 Graph ● A black market for paraffin will develop. Graph

● Maximum prices increase the wealth of

people who can buy the product.

● Some people will not be able to buy it

because of

- the market shortage and

- the higher prices on the black market.

Minimum prices (also called Price floors)

● It is important for the agricultural sector to
Source: Enjoy Economics) (Source: Enjoy Economics)
produce enough food to feed the
population.
Practice how to draw the graph. ● Minimum prices (floor prices) allow Practice how to draw the graph.
producers to make a profit and
encourage them to deliver important
Remember: maximum price, P1, is below essential goods. Remember: the minimum price, P1, is
the market price, P. ● Some foods are more important than above the market price, P.
others because they are a staple.
Explanation ● Poor people will suffer if there is no staple
● 0P = market price for paraffin. food and this leads to famine.
● 0Q = the quantity of liters of paraffin Explanation
● Governments intervene in markets to
purchased. ensure there is enough of such foods. ● When the government is not involved in
● Government announces a maximum ● They sometimes set minimum prices on the market is:
price = 0P1. such staples. o 0P = Equilibrium price
● The quantity supplied decreases from 0Q ● They want to make it worthwhile for o 0Q = Equilibrium quantity
to 0Q1. farmers to produce enough. o Point a = market price
● The quantity demanded increases from ● In SA, maize and wheat is a staple. ● The government intervenes and a
Q to Q2. ● Prior to 1994, farmers were guaranteed a minimum price is set above the market
● There is a shortage of paraffin on the minimum price on their foods. price, fixed at 0P1
market. ● Determining minimum prices has o Prices increase from 0P to 0P1.
● This creates major problems in the disadvantages / side effects. o The demand drops from 0Q to 0Q1.
market. o The supply increases from 0Q to 0Q2.

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 ● There is a surplus supply on the market, ACTIVITY 3 ACTIVITY 4
ie supply is more than demand.
3.1 Study the graph below and 4.1 Study the information and the graph
● Farmers are faced with a surplus = below and answer the questions that
answer the questions that follow.
problem that they have to solve. follow.

● They can dump it in other markets.

(dumping = selling goods on foreign
markets at a price lower than the
country of origin)

● This is prohibited by the WTO.

● The only way to get rid of it is to throw it

away or feed it to animals.

ACTIVITY 2

2.1 Briefly describe the term minimum wage. 3.3.1 What is the equilibrium price in the
4.1 Identify any ONE sector in South Africa in the
(2) graph above? (1)
extract above where minimum wages are
2.2 What effect do minimum wages have 3.3.2 Identify the amount of goods
on the supply of labour? (1 x 2) applied. (1)
above that will be set if a maximum
2.3 What is the effect of maximum prices on 4.2 What is the market wage in the graph
price of R70 is set. (1)
the market? (1 x 2)
above? (1)
3.3.3 Briefly describe the term
2.4 What effect do minimum prices have on
4.3 Briefly describe the term minimum wage. (2)
the market? (1 x 2) market failure. (2)
4.4 What is the benefit of having a national
2.5 Why do the authorities sometimes set 3.3.4 Why would an authority set maximum
minimum prices (lower price limits) for minimum wage, rather than a minimum
certain products? (1 x 2) prices for certain goods? (2)
wage per sector? (2)
2.6 Explain, with the aid of a graph, the 3.3.5 Use the graph to explain the impact of
impact of minimum prices on the 4.5 Refer to the graph above and explain
maximum prices on the market.
market. (8)
the implication of the government's R3 500
(2 x 2) (4)
minimum wage. (2 x 2) (4)

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 Lesson unit 2.4 – 2.5: Consequences of market failure - Government intervention: Taxes, Subsidies, Production
& Cost-benefit analysis
● The government interferes in the market and ● A subsidy paid directly to producers
levies a tax on e.g. cigarettes and this (with a profit motive) causes the
Taxes:
causes the supply curve for cigarettes to shift production cost of the product or
Indirect taxes, e.g. excise tax to the left, from SS to S1S1. service to decrease.

● A new market equilibrium price of P1 and a ● Merit goods provided by the private
quantity demanded of Q1 are formed at b. sector are examples of such types of
Graph products.
● Tax increases the price from 0P to 0P1 and
production will fall from 0Q to 0Q1. ● Private school education where
parents pay for their children's
● The idea is that less of the goods will be
education and the government usually
offered on the market.
pays a subsidy to support such
● Equilibrium will shift from point a to point b. education.

● In SA, cigarette and liquor taxes are levied.

Graph
● The tax is known as excise duty.

(Source: Enjoy Economics)

Subsidies (on goods and services)

● Subsidies are a form of financial donations

Practice how to draw the graph.
(financial assistance) by the government to
support the production of goods or services.

Explanation ● Subsidy can be:

● The appropriate way for governments ▪ Direct = cash donations or interest free
to interfere in the market is to raise loans. (Source: Enjoy Economics)
taxes to recover external costs.
▪ Indirect = depreciation on value, interest
● The original market equilibrium price is P discount, pay expenses on behalf of
Practice how to draw the graph.
and the quantity demanded at this producers and persons.
price is Q - that is without the taxation.
● It can be used for production, income,
employment and exports.

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Explanation ● The subsidy amount is = P2cbP1
● 0Q = quantities produced. ● The consumer benefits from a subsidy paid by 1. Identify the price of cigarettes
● 0P = price of product. the government - consumers pay less for the before a tax is imposed on them. (1)
● DD = Demand for the product. goods, the price has dropped from P to P1. 2. What amount is demanded after the
● SS = Supply of the product. ● The producer benefits from a subsidy paid by state imposes a tax on cigarettes? (1)
the government - the profit of the producer 3. What is the impact on supply after tax on
● The original market equilibrium price is at increases due to the increase in price from P to cigarettes? (2)
P and the quantity at Q - it is without the P2 (the difference between P and P2). 4. Briefly describe non-merit goods. (2)
subsidy ● Producers receive the subsidised price 0P2. 5. Use the graph above to explain how a tax on
● Government intervenes in the market cigarettes will reduce market failure. (4)
and pays a subsidy to the producers - ACTIVITY 5
causing the supply curve to shift to the 1. Using a graph, discuss producer subsidies as a
right - from SS to S1S1. result of market failure. (8) Wealth redistribution (Improved income
● A new equilibrium is formed at point b, distribution)
where the market equilibrium price is P1 ACTIVITY 6 SA government uses the following methods to
and the quantity offered is Q1. Study the graph below and answer the questions improve the distribution of income and wealth.
● Leads to drop in market price. that follow. ● Tax to provide free goods and services
● The market price drops from P to P1, and ● Subsidising goods and services
the quantity produced / offered ● Transfer of income to the poor
increases from Q to Q1 - due to the ● Job creation program / Expanded Public
subsidy paid by the government. Works Program
● The subsidy amount paid by the ● Labour legislation: Basic Conditions of
government is higher than the initial Employment Equity Act
price = P. ● Preferential access to previously
● Farmers will no longer produce if they disadvantaged to government contracts
can no longer earn. ● BEE policies
● The government has to compensate for ● Affirmative action
the higher production costs. ● Land redistribution
● 0Q1 intersects the original supply curve ● Land restitution
(SS).
● That is at point c = at a price of 0P2.

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 ● Property subsidies Macroeconomic stability Public sector

● RDP ● Markets can operate freely if they do Compare the expected social costs and
not reach the economic goals of benefits of the expected life of a new project.
● Minimum wages
growth, employment, price stability and
- A cost-benefit analysis must be done.
● Maximum prices exchange rate stability.

● Minimum prices ● It may be considered a market failure.

When is a cost-benefit analysis (CBA) done?
● Free education and training ● The government can see this as a
necessity and interfere in the markets. - This is done for projects where there is a
GOVERNMENT INTERVENTION IN significant difference between private and
● They can focus on the demand-side or
PRODUCTION social costs and benefits.
the supply-side of the market.

Incomplete markets / Public goods ● Two causes of inflexibility are lack of

● Market failure due to incomplete information and immobility of Private costs Social costs
markets are particularly important production factors.
causes of allocation discrepancies.
Difference between the two
● Government blends into the markets to
COST BENEFIT ANALYSIS
provide community goods and services
and collective goods and services.
- The social benefits must always exceed the
● People pay taxes to the government so social costs.
Definition: It is a technique for recording
that the government can provide these and evaluating the total social costs and - CBA is commonly used by the government.
goods and services. total social benefits associated with an
economic project.
● People pay income tax, indirect tax,
wealth tax. Rationale for a Cost-Benefit Analysis (CBA)

● Community goods are provided free of Private sector - Better decision making about allocating
charge scarce resources to meet needs.
Compare the expected private costs and
● E.g. police services, defense, street benefits of the expected life of a new - Comparison of economic benefits with
lighting, etc. project. economic costs of a project.

● Some collective goods are supplied at a - A feasibility study must be done.

consumer rate, e.g. garbage disposal.
- Legal aspects must be provided for.
● Some collective goods are subsidised.

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- The feasibility of the project = benefits - Seven stages of a CBA 2.1 In which sector is the Cost-benefit
costs - Identification and quantification of all Analysis usually used? (1)
- Benefits > costs = the project will be private costs.
undertaken. - Identification and quantification of all 2.2 Give any ONE corrective method that
- CBA also ensures that the right external costs. the government uses to enforce the
combination of goods is produced. - Calculation of social costs - this is the sum of redistribution of income. (1)
- It also provides us with alternative the private and external costs.
solutions to specific problems. - Identification and quantification of all 2.3 Briefly describe the term Cost-benefit
- A project is chosen where the private benefits. Analysis. (2)
advantages are greatest compared to - Identification and quantification of all
the disadvantages. external benefits. 2.4 Why is it important to do a Cost-benefit
- This time value of money is being - Calculation of social benefits - this is the sum Analysis for large projects? (2)
considered because the project will only of the private and external benefits.
be launched in the future. - Comparison of social costs with social 2.5 Why are some projects being tackled
- Therefore, future benefits and costs will benefits. despite high financial costs? (2 x 2) (4)
be offset to current values. ACTIVITY 7
- In a market economy, resources are 1. Give TWO reasons for a cost-benefit 3. Why is a Cost-benefit Analysis (CBA)
allocated through the interaction of analysis. (2 x 1) (2) necessary for public sector projects? (8)
supply and demand in the market. 2. Study the extract below and answer the
- Decisions by people, businesses and questions that follow. 4. Explain why authorities sometimes
authorities are important to the COST BENEFIT ANALYSIS (CBA) proceed with a project, even if the
community - involving the allocation of We live in a world of scarce resources where private cost exceeds the private
scarce resources. we have to set priorities and make choices benefits in a Cost-benefit Analysis. (8)
- Objective decision making - identify about how resources should be allocated.
relevant benefits and costs of the The CBA gives us a tool that we can use in this
project and quantify it in monetary terms decision-making process. Calculations in a
to make informed decision making. CBA must be done using market prices.
(Source: www.google.com)

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