Indian Economic Service Paper III (General Economics) Solution 2017

IES, Solution of General Economics-III, 2017

1.     What is a Deadweight Loss Of Taxation?

The deadweight loss of taxation refers to the harm caused to economic efficiency and production by a tax. In other words, the deadweight loss of taxation is a measurement of how far taxes reduce the standard of living among the taxed population. 

English economist Alfred Marshall (1842-1924) is widely credited with first developing deadweight loss analysis.

BREAKING DOWN Deadweight Loss Of Taxation

The difference between the imposition of new taxes and the total reduction in output due to these new taxes is the deadweight loss. After a tax is imposed, it forces the supply curve of some good, service, or consumer spending left along the demand curve. A deadweight loss of taxation is customarily represented graphically. 

Causes of Deadweight Loss

Not everyone agrees deadweight loss can be accurately measured. However, virtually all economists acknowledge that taxation is inefficient and distorts the free market.

Taxes result in a higher cost of production or higher purchase price in the market. This, in turn, creates a smaller production volume than would otherwise exist. The gap between the taxed and tax-free production volumes is the deadweight loss. 

2.     The Green Climate Fund (GCF) is a fund established within the framework of the UNFCCC as an operating entity of the Financial Mechanism to assist developing countries in adaptation and mitigation practices to counter climate change. The GCF is based in Incheon, South Korea. It is governed by a Board of 24 members and supported by a Secretariat.

The objective of the Green Climate Fund is to "support projects, programmes, policies and other activities in developing country Parties using thematic funding windows". It is intended that the Green Climate Fund be the centrepiece of efforts to raise Climate Finance under the UNFCCC.

3. The price level at which the existing firms can gain excess profits without stimulating an entry is called as the Entry-Preventing Price. And the entry-preventing price is based on the barriers to new entry, which means the existing firms' advantages over the potential competitors. Assumptions:

1. There is a determinate long-run demand curve for industry output, which is unaffected by price adjustments of sellers or by entry. Hence the market marginal revenue curve is determinate. The long-run industry-demand curve shows the expected sales at different prices maintained over long periods.

2. There is effective collusion among the established oligopolists.

3. The established firms can compute a limit price, below which entry will not occur.

The level at which the limit price will be set depends:

(a) On the estimation of costs of the potential entrant,

 (b) On the market elasticity of demand

(c) On the shape and level of the LAC,

(d) On the size of the market,

(e) On the number of firms in the industry.

4. Above the limit price, entry is attracted and there is considerable uncertainty concerning the sales of the established firms (post entry).

5. The established firms seek the maximization of their own long-run profit.

·       Carbon trading is an exchange of credits between nations designed to reduce emissions of carbon dioxide.

Why We Have the Carbon Trade?

When countries use fossil fuels, and produce carbon dioxide, they do not pay for the implications of burning those fossil fuels directly. There are some costs that they incur, like the price of the fuel itself, but there are other costs, not included in the price of the fuel. These are known as externalities. In the case of fossil fuel usage, often these externalities are negative externalities, meaning that the consumption of the good has negative effects on third parties.

These externalities include health costs, (like the contribution that burning fossil fuels makes to heart disease, cancer, stroke, and lung diseases) and environmental costs, (like environmental degradation, pollution, climate change and global warming). Interestingly, research has found that, often, the burdens of climate change most directly effect countries with the lowest greenhouse emissions. So, if a country is going to burn fossil fuels, and produce these negative externalities, the thinking is that they should pay for them.

The carbon trade originated with the 1997 Kyoto Protocol, with the objective of reducing carbon emissions and mitigating climate change and future global warming. 

How It Works?

Basically, each country has a cap on the amount of carbon they are allowed to release. Carbon emissions trading then allows countries that have higher carbon emissions to purchase the right to release more carbon dioxide into the atmosphere from countries that have lower carbon emissions.

The carbon trade also refers to the ability of individual companies to trade polluting rights through a regulatory system known as cap and trade. Companies that pollute less can sell their unused pollution rights to companies that pollute more. The goal is to ensure that companies in the aggregate do not exceed a baseline level of pollution and to provide a financial incentive for companies to pollute less. 

4. Following are the three important objectives of decentralised planning:

1. Effective implementation of poverty eradication programme;

2. Ensuring balanced regional development for meeting minimum needs of the people, and

3. Ensuring active public participation in the development process of different sectors.

6. What are social discount rates and what is their relevance to climate change?

Social discount rates (SDRs) are used to put a present value on costs and benefits that will occur at a later date. In the context of climate change policymaking, they are considered very important for working out how much today’s society should invest in trying to limit the impacts of climate change in the future. In other words, they calculate how much guarding against future carbon emissions is worth to us now, weighing up the benefits future generations would experience against the costs that today’s society would have to bear.

How are social discount rates calculated?

There are two reasons for discounting the future. The first is because it is assumed that societies will grow wealthier over time due to economic growth and therefore a dollar today is worth more than a dollar in the future, when we will enjoy higher incomes. The second, and more controversial, reason is to take account of pure time preference (or impatience). This describes people’s propensity to prefer income today rather than tomorrow, even if they expect to be no more or less rich tomorrow. The controversy stems from whether this feature of people’s attitudes to time should be reflected in policymaking. When applied to inter-generational problems it effectively weighs future generations lower than the present generation.

12. Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. ... The concept has been introduced to ascertain the actualdeficit in the revenue account after adjusting for expenditure of capital nature.

Primary deficit refers to difference between fiscal deficit of the current year and interest payments on the previous borrowings. Primary Deficit = Fiscal Deficit – Interest Payments

The total borrowing requirement of the government includes the interest commitments on accumulated debts. Primary deficit reflects the extent to which such interest commitments have compelled the government to borrow in the current period.

9. What is Ability-To-Pay Taxation?

Ability-to-pay taxation is a progressive taxation principle that maintains that taxes should be levied according to a taxpayer's ability to pay. This progressive taxation approach places an increased tax burden on individuals, partnerships, companies, corporations, trusts, and certain estates with higher incomes. 

The ability-to-pay taxation theory is that individuals who earn more money can afford to pay more in taxes.

Taxation concept that those who benefit more from government expenditure should pay more taxes to support such expenditure.

10. System of Environmental-Economic Accounting (SEEA)^[1] is a framework to compile statistics linking environmental statistics to economic statistics. SEEA is described as a satellite system to the United Nations System of National Accounts (SNA).^[2] This means that the definitions, guidelines and practical approaches of the SNA are applied to the SEEA. This system enables environmental statistics to be compared to economic statistics as the system boundaries are the same after some processing of the input statistics. By analysing statistics on the economy and the environment at the same time it is possible to show different patterns of sustainability for production and consumption. It can also show the economic consequences of maintaining a certain environmental standard.

Environmental economic statistics[edit]

Economic variables that are already included in the national accounts but are of obvious environmental interest, such as investments and expenditure in the area of environmental protection, environment-related taxes and subsidies, and environmental classification of activities and the employment associated with them, etc. In principle, environmental taxes and environmental protection expenditures can be regarded as two sides of the same coin. Both entail costs involved in production processes that are related to the exploitation of the environment in different ways. On the one hand, environmental protection expenditures record spending on measures aimed at improving the environment, while on the other hand, taxes record the costs set by a government for the exploitation of the environment. Thus, in the total cost of production, the environmental taxes paid can be added to expenditure on environmental protection.

11. Different types of planning models http://www.economicsdiscussion.net/india/top-9-plan-models-used-in-indian-plans/13255

12. Definition of MRTP Act

MRTP Act or otherwise known as Monopolistic and Restrictive Trade Practices Act, was the first-time ever, competition law in India, that came into force in the year 1970. However, it underwent amendment in different years. It aimed at:

• Controlling and regulating the centralization of economic power.
• Controlling monopolies, restrictive, unfair trade practices.
• Prohibit monopolistic activities

Further, the act makes a distinction between Monopolistic Trade Practices and Restrictive Trade Practices, summarized as under:

1. Monopolistic Practices: The practices adopted by the undertaking, on account of their dominance, which harm the public interest. It includes:

• Charging unreasonably high prices.
• Policy the lessens existing and potential competition.
• Restricting capital investment and technical development.
1. Restrictive Practices: Acts that prevent, distort or restrict competition comes under restrictive practices. These are adopted by a few dominant firm with an agreement to hinder the growth of competition, called as cartelization. It includes:
• Restricting the sale or purchase of goods to/from specified persons.
• Tie-in-sale, i.e. forcing the customer to purchase a particular product, so as to purchase another product.
• Restricting areas of sale.
• Boycott
• Formation of cartels
• Predatory pricing

Definition of Competition Act

Competition Act, 2002 is meant to create a Commission that prevents activities which adversely affect competition and initiate and sustain competition in the industry. Further, it aims at protecting consumer interest and corroborating freedom of trade. The commission is empowered to:

• Ban certain agreements: Agreements which are anti-competitive in nature are prohibited. It includes:

• Tie-in arrangement
• Refusal to deal
• Exclusive Dealings
• Resale price maintenance
• Abuse of dominant position: It includes activities such as limiting production of goods or services, the imposition of unfair conditions or engaging in such activities which lead to denial of market access.
• Regulation of combination: It regulates the activities of combinations, i.e. mergers, acquisition, amalgamation, which is likely to adversely affect competition.

The act applies to whole India, except in Jammu & Kashmir. It was enacted to enforce competition policy in the country and also to stop and penalize anti-competitive trade activities of the undertaking and undue intervention of the government in the market.

Key Differences Between MRTP Act and Competition Act

The fundamental points of difference between MRTP Act and Competition Act are given as follows:

1. MRTP Act is a competition law, that was created in India, in 1970 to prevent concentration of economic power in few hands. On the other hand, Competition Act emerged as an improvement over MRTP act to shift the focus from controlling monopoly to initiating competition in the economy.
2. MRTP Act is reformatory in nature, whereas Competition Act is punitive.
3. In Monopolies and Restrictive Trade Practices (MRTP) Act, the dominance of a firm is determined by its size. On the other hand, the dominance of a firm in the market is determined by its structure in the case of Competition Act.
4. MRTP Act focuses on the interest of consumers. Conversely, Competition Act focuses on the interest of the public at large.
5. In MRTP Act, there are 14 offenses, which are against the rule of natural justice. On the contrary, there are only four offenses listed out by the competition act which violates the principle of natural justice.
6. MRTP Act does not specify any penalty for offenses but Competition Act states penalty for the offence.
7. The basic motto of MRTP Act is to control monopolies. As against this, the Competition Act intends to initiate and sustain competition.
8. Monopolies and Restrictive Trade Practices (MRTP) Act, requires that the agreement to be registered. In contrast, the Competition Act is silent on the registration of agreement.
9. In MRTP Act, the appointment of chairperson was done by Central Government. On the contrary, in Competition Act the appointment of chairperson was done by Committee that comprises of retired.

13. What is Economic Efficiency

Economic efficiency implies an economic state in which every resource is optimally allocated to serve each individual or entity in the best way while minimizing waste and inefficiency. When an economy is economically efficient, any changes made to assist one entity would harm another. In terms of production, goods are produced at their lowest possible cost, as are the variable inputs of production.

Economic Efficiency and Welfare

Measuring economic efficiency is often subjective, relying on assumptions about the social good, or welfare, created and how well that serves consumers. At peak economic efficiency, the welfare of one cannot be improved without subsequently lowering the welfare of another. In this regard, welfare relates to the standard of living and relative comfort experienced by people within the economy.

Even if economic equilibrium is reached, the standard of living of all individuals within the economy may not be equal. Pareto’s efficiency does not include issues of fairness or equality among those within a particular economy. Instead, the focus is purely on reaching a point of optimal operation in regards to the use of limited or scarce resources. It states that efficiency is obtained when a distribution strategy exists where one party's situation cannot be improved without making another party's situation worse.

Factors for Analysis of Economic Efficiency

Basic market forces like the level of prices, employment rates, and interest ratescan be analyzed to determine the relative improvements made toward economic efficiency from one point in time to another. The amount of waste during the production of goods and services can also be considered if the current allocation of resources is ideal in regards to consumer demand.

14. Community Participation:- It enables communities and local stakeholders to define their goals, needs and related priorities in a municipal area. ... The communities should be informed, consulted and be allowed to participate in the planning process that concerns their needs and future

15. There are two basic measures of efficiency: allocative and technical efficiency.Allocative efficiency (an economic concept) refers to how different resource inputs are combined to produce a mix of different outputs. Technical efficiency on the other hand is concerned with achieving maximum outputs with the least cost.

16. The EU emissions trading system (EU ETS) is a cornerstone of the EU's policy to combat climate change and its key tool for reducing greenhouse gas emissions cost-effectively. It is the world's first major carbon market and remains the biggest one.

The EU ETS works on the 'cap and trade' principle.

A cap is set on the total amount of certain greenhouse gases that can be emitted by installations covered by the system. The cap is reduced over time so that total emissions fall.

Within the cap, companies receive or buy emission allowances which they can trade with one another as needed. They can also buy limited amounts of international credits from emission-saving projects around the world. The limit on the total number of allowances available ensures that they have a value.

After each year a company must surrender enough allowances to cover all its emissions, otherwise heavy fines are imposed. If a company reduces its emissions, it can keep the spare allowances to cover its future needs or else sell them to another company that is short of allowances.

Trading brings flexibility that ensures emissions are cut where it costs least to do so. A robust carbon price also promotes investment in clean, low-carbon technologies

Developing the carbon market

Set up in 2005, the EU ETS is the world's first international emissions trading system. It remains the biggest one, accounting for over three-quarters of international carbon trading.

The EU ETS is also inspiring the development of emissions trading in other countries and regions. The EU aims to link the EU ETS with other compatible systems.

Delivering emissions reductions

The EU ETS has proved that putting a price on carbon and trading in it can work. Emissions from installations in the system are falling as intended – by slightly over 8% compared to the beginning of phase 3 (see 2016 figures).

In 2020, emissions from sectors covered by the system will be 21% lower than in 2005.

In 2030, under the revised system they will be 43% lower.

Reports on EU's progress in cutting emissions

Sectors and gases covered

The system covers the following sectors and gases with the focus on emissions that can be measured, reported and verified with a high level of accuracy:

·       carbon dioxide (CO₂) from

o   power and heat generation

o   energy-intensive industry sectors including oil refineries, steel works and production of iron, aluminium, metals, cement, lime, glass, ceramics, pulp, paper, cardboard, acids and bulk organic chemicals

o   commercial aviation

·       nitrous oxide (N₂O) from production of nitric, adipic and glyoxylic acids and glyoxal

·       perfluorocarbons (PFCs) from aluminium production

Participation in the EU ETS is mandatory for companies in these sectors, but

·       in some sectors only plants above a certain size are included

·       certain small installations can be excluded if governments put in place fiscal or other measures that will cut their emissions by an equivalent amount

·       in the aviation sector, until 31 December 2023 the EU ETS will apply only to flights between airports located in the European Economic Area (EEA).

1.     Cournot Competition

Cournot Competition describes an industry structure (i.e. an oligopoly) in which competing companies simultaneously (and independently) chose a quantity to produce. The total quantity supplied by all firms then determines the market price. According to the law of supply and demand, a high level of output results in a relatively low price, whereas a lower level of output results in a relatively higher price. Therefore, each company has to consider the expected quantity supplied by its competitors to maximize their own profits.

Bertrand Competition

Bertrand Competition describes an industry structure (i.e. an oligopoly) in which competing companies simultaneously (and independently) chose a price at which to sell their products. The market demand at this price then determines quantity supplied. As a result, each company has to consider the expected price of their competitors’ products. However, unlike in Cournot competition, in this case, the firm’s won’t share the market. Instead, the company that chooses the lowest price can serve the entire market.

2.     Meaning of SCBA (Social cost-Benefit Analysis):

The economic analysis in project appraisal for evaluating investment projects an important consideration is the analysis of social cost and benefits. In this analysis, the direct economic benefits and cost of the project on distribution of income in society, level of savings and investments in society, the contribution of the project towards fulfilment of certain merit-wants (e.g. employment, social orders, self-sufficiency etc.) are analysed.

Thus SCBA is also referred to as economic society benefit analysis, is a part of the economic analysis in project appraisal. It is a methodology developed for evaluating investment projects from the point of view of the society (or economy) as a whole.

As such doing SCBA is to subject project choice to a consistent set of general objectives of national policy, such as:

1. Choices of project in the context of total national impact.

2. Evaluation of total impact in terms of consistent and appropriate set of objectives having bearing on nations economy and on society.

3. Correlation to national planning.

4. Consequences on employment and output.

5. Consumption, savings, Foreign exchange earnings, income etc.

6. Distribution and relevant things to national objectives.

The following social desirability factors will be considered in accept or reject decisions of a project:

1. Employment Potential:

The employment potential of a project is looked into. A project with high employment potential is considered highly desirable.

2. Foreign Exchange:

A project with potential to earn foreign exchange to the country or an import substitution project which saves the country’s foreign exchange reserves is highly desirable.

3. Social Cost-Benefit Analysis:

A project with net benefits to the society over the costs to the society is preferred.

4. Capital-Output Ratio:

If the value of expected output in relation to the capital employed is high, the project is given priority over the others.

5. Value Added Per Unit of Capital:

The amount invested in the project should generate the value addition to the capital employed by earning surplus profits which can be used for further capital investments to contribute development of the national economy.

17. Economic Efficiency and Equity

The two primary criteria used to evaluate systems of resource allocation are economic efficiency and equity.

Economic efficiency occurs when a society obtains the largest possible amount of output from its limited resources. Each country in the world has labor, capital, and natural resources. Countries differ, however, in the sizes of their population (and thus their labor force) and the types and quantities of capital and natural resources. Regardless of its resource endowment, however, a society can produce some maximum quantity of output if it uses its resources wisely. This output is composed of goods and services. A good is a tangible commodity or piece of merchandise that is produced for sale, such as a car, a sweater, or a book. A service is useful labor that does not create a tangible commodity or piece of merchandise. Examples of services are haircuts, financial and legal advice, and many forms of entertainment. To illustrate the difference between goods and services, consider a vacation trip to Walt Disney World in Florida. Admission tickets to theme parks are services because they provide access to the entertainment within the park. Souvenirs, such as stuffed animals, clothing, and jewelry, are goods. Restaurants also illustrate the difference between goods and services. The reason meals cost more in restaurants than when you prepare them at home is that part of the cost of the meal is for the service of having the food prepared for you. A general name for an output is a product. A product is the output of human labor and can be either a good or a service.

Economic efficiency is an important consideration for societies that desire more goods and services. Being efficient with resources allows a society to satisfy more needs and wants than if the resources are allocated inefficiently. Economic efficiency is not the only consideration, however.

Equity occurs if a society distributes its economic resources fairly among its people. Different opinions about fairness, however, cause people to debate how resources should be allocated and are a primary determinant of political affiliation. People who think markets provide a generally fair distribution of output among the population tend to oppose government intervention in the marketplace. This is the position of most traditional conservatives, who usually favor a very limited government role in the economy. People who think markets create an unfair distribution of output tend to favor a larger role for government in the redistribution of wealth. Traditional liberals tend to favor this position.

Some systems of resource allocation may be efficient without being fair. Other systems may be fair without being efficient. Societies choose different types of political and economic systems based in large part on different perceptions and valuations of efficiency and equity.

When a society chooses to have a government, then citizens pay taxes to generate revenue for the provision of government services. Efficiency and equity are also the two primary criteria used to evaluate tax systems.

18. The world’s progress in meeting the Sustainable Development Goals (SDGs) depends to a large extent on India’s progress. India plays a strong leadership role at the global level around meeting these targets set by the international community in 2015. In July 2017, India reiterated its commitment to meeting the SDGs when it submitted a Voluntary National Review report on seven goals including poverty, health, hunger and nutrition, as well as gender equality at the High-Level Political Forum on Sustainable Development.

3.     Conditions for Price Discrimination

Price discrimination is possible under the following conditions:

1.     The seller must have some control over the supply of his product. Such monopoly power is necessary to discriminate the price.

2.     The seller should be able to divide the market into at least two sub-markets (or more).

3.     The price-elasticity of the product must be different in different markets. Therefore, the monopolist can set a high price for those buyers whose price-elasticity of demand for the product is less than 1. In simple words, even if the seller increases the price, such buyers do not reduce the purchase volume.

4.     Buyers from the low-priced market should not be able to sell the product to buyers from the high-priced market.

Example

The single monopoly price of a product is Rs. 30. The elasticities of demand for the product in markets A and B are 2 and 5 respectively. Therefore, the marginal revenue in market A (MR_A) is

MRA=ARAe−1e=302–12=15

Similarly, the marginal revenue in market B (MR_B) is

MRB=ARBe−1e=305–12=24

Hence, we can see that the marginal revenues of the markets A and B are different when the elasticities of demand at a single price are different. Further, we also find that the MR of the market with higher elasticity is higher than the MR of the market with a low elasticity of demand.

A monopolist, in such a case, transfers some amount of product from market A to market B. This is because, in market B, the high elasticity of demand implies larger marginal revenue. It is important to note here that when units are transferred from A to B, price in A will rise and fall in B. https://www.toppr.com/guides/business-economics/determination-of-prices/price-discrimination/

http://www.economicsdiscussion.net/monopoly/price-discrimination-under-monopoly-types-degrees-and-other-details/3741

4.     What is Coase Theorem?

Coase Theorem is a legal and economic theory developed by economist Ronald Coase that affirms that where there are complete competitive markets with no transactions costs, an efficient set of inputs and outputs to and from production-optimal distribution will be selected, regardless of how property rights are divided. Further, the Coase Theorem asserts that if conflict arises over property rights under these assumptions, then parties will tend to settle on the efficient set of inputs and output. Application of the Coase Theorem

The Coase Theorem is applied to situations where the economic activities of one party impose a cost on or damage the property of another party. Based on the bargaining that occurs during the application of the Coase Theorem, funds may either be offered to compensate one party for the other's activities or to pay the party who's activity inflicts the damages to forgo that activity.

For example, if a business is subject to a noise complaint initiated by neighboring households, the Coase Theorem leads to two possible settlements. The business may choose to offer financial compensation to the affected parties in order to be allowed to continue producing the noise. Or the business might refrain from producing the noise if the neighbors can be induced to pay the business to do so, in order to compensate the business for additional costs or lost revenue associated with noise abatement.

If the full market value produced by the activity that is producing the noise exceeds the market value of the damage that the noise causes to the neighbors, then the efficient market outcome to the dispute is the former. The business can continue to produce the noise, and compensate the neighbors out of the revenue generated thereby, keeping any extra revenue in excess of the damages.

If the value of the business's additional output associated with the offending noise is less than the cost imposed on the neighbors by the noise, then the the efficient outcome is the latter. The neighbors can pay the business enough not to make the noise to compensate for the business's forgone revenue, but less than the value they place on the absence of the noise.

This Coase Theorem has been widely viewed as an argument against legislative or regulatory preemption of conflicts over property rights and privately negotiated settlements thereof. It was originally developed by Ronald Coase when considering the regulation of radio frequencies. He posited that regulating frequencies were not required because stations with the most to gain by broadcasting on a particular frequency had an incentive to pay other broadcasters not to interfere.

However, as stated above, in order Coase’s Theorem to apply, conditions for efficient competitive markets around the disputed property must occur. If not, the efficient solution is unlikely to be reached. These assumptions: zero transaction (bargaining) costs, perfect information, no market power differences, and efficient markets for all related goods and productive factors, are obviously a high hurdle to pass in the real world, where transaction costs are ubiquitous, information is never perfect, market power is the norm, and most markets for final goods and productive factors do not meet the requirements for perfect competitive efficiency.

Because the conditions necessary for the Coase Theorem to apply in real world disputes over the distribution of property rights virtually never occur outside of idealized economic models, some question its relevance to applied questions of law and economics. Recognizing these real world difficulties with applying the Coase Theorem, some economists view the theorem not as a prescription for how disputes ought to be resolved, but as an explanation for why so many apparently inefficient outcomes to economic disputes can be found in the real world.