FACULTY OF ECONOMIC AND MANAGEMENT SCIENCES

DEPARTMENT OF ECONOMICS
ECONOMICS 310 – SEMESTER TEST 1
15 March 2023 Total: 50 marks
Examiners: Mr FJ Scholtz Time: 90 minutes

SECTION A
Answer ALL questions of this section in your scripts
(Please write legibly)

Question 1
Distinguish between the following two related concepts by providing a concise definition and an
example (or graphical depiction) as illustration of each:
1.1 Positive economics v. normative economics (3)
1.2 Incomplete markets v. non-competitive markets (3)
1.3 Mixed goods v. merit goods (3)
1.4 Allocative efficiency v. technical efficiency (3)
1.5 Justice in acquisition v. justice in transfer in Nozick’s Entitlement Theory (3)
[15]

Question 2 (Multiple Choice Questions)

Write ONLY the question number and your chosen alternative’s alphabet letter next to it in your
script, i.e. 2.6 B

2.1 General government …

A. refers to the general divisions of public corporations.
B. consists of all the general departments of government.
C. refers to the activities of national, provincial and local government.
D. refers to all arms of government including state-owned enterprises. (1)

2.2 Which of the following factors best explain why private markets fail to supply pure public
goods?
A. Private firms tend to oversupply these pure public goods, leading to budgetary distortions.
B. Private firms lack the technological expertise to provide pure public goods.
C. It is impossible to exclude those who are unwilling to pay for using pure public goods.
D. All of the above options are correct. (1)

2.3 Which of the following are global or regional merit goods?

A. “Brain drain” of skilled human capital from Zimbabwe to South Africa.
B. A Lighthouse on the SA/Mozambique sea border.
C. Electricity generated in South Africa and sold to Zimbabwe.
D. Purchase of a high-quality gem diamond by De Beers from Lesotho. (1)

2.4 Consider the examples below, choose the examples where "justified" redistribution in the
Pareto sense.
A. Poor individuals loots furniture from a factory showroom in a shopping mall.
B. An ATM explodes in a shopping complex where Chad is buying goods. He runs to the ATM to
collect all the money dispersed in the area due to the explosion.
C. The mandatory income tax payments since they adhere to Nozick’s entitlement theory.
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D. Individuals see their mandatory Unemployment Insurance Fund deductions as a cheap insurance
alternative if they become unemployed. (1)

2.5 Taxing the rich to subsidise the poor could have the effect of ...
A. a guaranteed decrease in labour supply, depending on the relative sizes of the tax or the subsidy.
B. an increase or decrease in labour productivity.
C. a guaranteed decrease in saving and investment.
D. large-scale foreign disinvestment. (1)
[5]

SECTION B
Answer ALL the questions listed below (make use of graphs to illustrate your arguments where
possible)
(Please write legibly)

Question 3 (Chapter 3)
Society is becoming increasingly aware that the amounts of plastic waste that end up in the world’s
oceans are starting to show its harmful effects on marine life. This is directly ascribed to producers’
insistence on cheap packaging material for consumables coupled with the poor standards of waste
management in a society.

3.1 Explain how these poor packaging choices using single-use plastics constitute an externality in
production. What type of externality is this? (1)

3.2 What are the effects of this externality on the affected parties? Supplement your answer by
means of a graph to illustrate the extent of the private and social costs or benefits.
(6)
3.3 State what potential remedies are available to government to internalise the effect of this
externality. Suggest a remedy that would probably be the most useful in this case and explain
your reasoning. (3)
[10]

Question 4 (Chapter 4)

Eskom (and in particular its almost R500bn debt burden) is and will for some time remain one of the
biggest threats to the overall fiscal stability of South Africa.

4.1 Government has been forced by the inefficiencies within the present structure of Eskom to
consider “competitive restructuring”. State the “business components” that Eskom is likely to
be divided into and whether these constitute natural monopoly or not. What implications does
the monopoly status (or not) have on the process of competitive restructuring? What will the
impact of this process likely be on jobs at Eskom? (5)

4.2 Government (at this stage at least) is officially opposed to any form of privatisation during this
“reconfiguration” of the Eskom business model. The only viable alternative available to
government to improve overall efficiency of this monopoly is regulation – should it manage to
attract private sector involvement to keep Eskom afloat. Discuss why regulation would be
necessary and what type of regulation would you advise government to opt for? (4)

4.3 The president recently appointed a Minister of Electricity to oversee the efficiency
improvements at Eskom. Who is the new Minister of Electricity? (1)
[10]

2
Question 5 (Chapter 5)

Suppose the Minister of Finance proposed the following in this year’s budget: As part of an initiative
to encourage citizens to adopt a healthy lifestyle, they proposed that sin taxes obtained from
tobacco products is earmarked and used to subsidise the price of fresh fruit and vegetables to
encourage the consumption of healthy products.

5.1 By making use of a PPC and community welfare indifference curves, illustrate and explain what
would happen to the quantity consumed of tobacco products and the fresh fruit and vegetables,
as well as the community's welfare, if all goes according to plan. (4)

5.2 Treasury also proposed that the tax be imposed on producers of tobacco products (rather than
consumers) and the subsidy be allocated to producers of healthy food products (rather than
consumers). Explain why they would have structured this initiative in this way. (1)

5.3 In the paper by Rodrik and Stantcheva (2021) discussed in class, they make suggestions why
capitalism has failed to effectively redistribute income effciently in a society. Briefly summarise
their views on how this could be improved? Briefly elaborate on how they suggest inequality be
addressed by giving an example of a policy intervention at every stage of production.(5)

[10]

3
Memorandum

Question 1 – Definitions and examples

1.1. Positive economics – Part of economics that studies the nature and consequences of
decisions taken, i.e. the objectively testable theory of economics b.m.o proving/disproving a
hypothesis. () E.g. if govt. raises the income tax, what will happen to labour supply. (½)

Normative economics – Part of economics that investigates the desired outcomes in the
economy, i.e. the economic policy – what the outcomes ought to/should be. () E.g. if
government wants a more equitable income distribution in society, what tax instruments
ought to be used. (½)

1.2. Incomplete markets – Markets that often do not meet the demand for certain goods, due
to consumers not willing to pay for public goods etc. or where they do not fully account for
the costs associated with externalities. () Eg. Street lights (½)

Non-competitive markets – Where monopolies and oligopolies are present in the market or
where labour unions operate in labour markets – it generally leads to inefficiencies and
wider welfare losses. () Eg De Beers; Cosatu operating in a market. (½)

1.3. Mixed goods – Goods that lacks one of the features of a pure public good, i.e. excludable,
but non-rival () (e.g. subscription tv/streaming service) or rival, but non-excludable (e.g.
congested public roads). (½)

Merit goods – Goods that are provided by government because they deem it meritorious
for society to do so. These could be either pure public, mixed or even private goods. () E.g.
Education/health services. (½)

1.4. Allocative efficiency – part of economic efficiency describing the situation where a
country’s limited resources are allocated according to the wishes of its consumers – thus
optimal mix of products (consumables) – on both the demand- and supply side of the
economy. In the benchmark model it is where the indifference curves (MRS) is tangent to
the price ratio – on the contract curve. () (Graph or description or formula (𝑀𝑅𝑃𝑇𝑥𝑦 =
= ) (½)

Technical efficiency – part of economic efficiency describing the top-order condition of

Pareto optimality. Where resources that are distributed allocatively efficient but also
Implies that existing resources are utilised in most efficient manner possible. () Eg. Implies
that a point ON the PPC should be reached, while all the conditions for allocative efficiency
are also met. (½) (Could also gave given a graph as an example).

1.5. Justice in acquisition – situation where individuals are only allowed to acquire things not
belonging to others and not allowed to make others worse off than before the acquisition.
() Things: only property and capital goods. E.g. unclaimed land. (½)

Justice in transfer – individuals only allowed to transfer material things on a voluntary basis,
() E.g. Gifts, grants, bequests and voluntary exchange.
(½)

4
Question 2
2.1 C
2.2 C
2.3 B
2.4 D
2.5 B

Question 3

Society is becoming increasingly aware that the amounts of plastic waste that end up in the world’s
oceans are starting to show its harmful effects on marine life. This is directly ascribed to producers’
insistence on cheap packaging material for consumables coupled with the poor standards of waste
management in a society.

3.1 Explain how these poor production choices constitute an externality in production. What
type of externality is this? (1)

Negative externality (infers a cost/negative benefit) to society due to production patterns. ()
or MPC < MSC thus MEC > 0

3.2 What are the effects of this externality on the affected parties? Supplement your answer by
means of a graph to illustrate the extent of the private and social costs or benefits.
(6)
P SS = MSC ()
SP = MPC ()

H F
P1
K E1
P0 E0
J

DS = MSB ()

0 Q1 Q0 Q

Supply (i.e. production externality)

Negative (MSC > MPC) ()
Typical market situation:
Equilibrium @ E0 with 0P0 and 0Q0
Negative externality (polluted oceans) introduced:
New equil. @ E1 with 0P1 and 0Q1
Social cost:
Social benefit MEC > 0 ()
Raises EC above MPC
MSC>MPC
Total private cost = 0Q0E0K (½)
Total (negative) external cost = KE0F (½)

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 Therefore: comp.market: overprovision (½)
underpricing (½)

3.3 State what potential remedies are available to government to internalise the effect of this
externality. Suggest a remedy that would probably be the most useful in this case and
explain your reasoning. (3)

Pigouvian taxes/subsidies
Regulation
Permits
Assigning property rights (for purposes of the Coase Theorem)
(any 2 – for half mark each)
Most useful in this case would be either an ad valorem tax (Pigouvian); or regulation (i.t.o.
banning the use of single-use plastics as done in a number of countries worldwide). Latter will
be more effective; but governments may go for former if revenue is one of their objectives.
(1 mark for appropriate choice – and 1 mark for reasoning)
[10]

Question 4 (Chapter 4)

Eskom (and in particular its almost R500bn debt burden) is and will for some time remain one of the
biggest threats to the overall fiscal stability of South Africa.

4.1 Government has been forced by the inefficiencies within the present structure of Eskom to
consider “competitive restructuring”. State the “business components” that Eskom is likely to
be divided into and whether these constitute natural monopoly or not. What implications
does the monopoly status (or not) have on the process of competitive restructuring? What
will the impact of this process likely be on jobs at Eskom? (5)

Generation: artificial monopoly – new entrants could be attracted to generation market, think
about Independent Power producers; ()

Transmission: Establishment of infrastructure very expensive, though once established

sufficient to satisfy the market demand for the product/service; ()

Distribution: artificial monopoly – already bulk purchasers and distributors of electricity (other
than Eskom and municipalities) providing “prepaid options” in the market. ()

Supply – provision from municipalities to end users: could be seen as either a natural
monopoly or artificial monopoly - evidence seem to lean towards artificial monopoly.

Implication: both generation & distribution could be privatised (or at least get substantial
private sector involvement in improving efficiency in financing and delivery of such services).
()
Anticipated effect on jobs at Eskom: likely job losses – one of the reasons why Cope26 offered
a “just” energy transition in poorer countries. ()

6
4.2 Government (at this stage at least) is officially opposed to any form of privatisation during
this “reconfiguration” of the Eskom business model. The only viable alternative available to
government to improve overall efficiency of this monopoly is regulation – should it manage
to attract private sector involvement to keep Eskom afloat. Discuss why regulation would be
necessary and what type of regulation would you advise government to opt for? (4)

Regulation would be necessary to avoid the standard private monopoly outcomes; i.e. limited
provision of services at much higher prices ()

1. Rate-of-return regulation
Also known as profit regulation.
In above graph, regulated firm’s capital and operating costs is area THQr0.
Total profit is PrGHT (profit GH*0Qr).
Profit thus added to costs; thus determining the price.
Price will vary depending on rate-of-return (r-o-r) allowed by regulator.
Problems with setting the r-o-r: cost padding; capital-intensifying production, etc.
2. Price-cap regulation
Regulation by setting maximum price (while taking revenues, acceptable r-o-r).
Incentivises firms to cut costs/increase productivity.
Formula: P = RPI – X
Where P = allowed price by regulator; RPI = retail price index; X= rate of
productivity growth.
Drawbacks for regulators: dense information requirements; close monitoring of firm’s
compliance in absence of competition.
3. Sliding-scale regulation
• Combines elements of r-o-r regulation and price cap regulation.
• Regulation primarily based on capping prices (to maximise the inherent
advantages) for firm efficiency; but allows for price cap to be reduced at a pre-
determined higher profit level reached by firm.
• Incentivises additional profits as proceeds will now be shared by firm and
consumers.
• Drawback: equally formidable information requirements for effective
regulation.

Probably should opt for sliding-scale regulation, but marks are awarded for understanding
what these methods entail and your reasoning behind your choice. ()()()

4.3 The president recently appointed a Minister of Electricity to oversee the efficiency
improvements at Eskom. Who is the new Minister of Electricity? (1)

Kgosientso Ramokgopa () [10]

7
Question 5 (Chapter 5)

Suppose the Minister of Finance proposed the following in this year’s budget: As part of an
initiative to encourage citizens to adopt a healthy lifestyle, they proposed that sin taxes obtained
from tobacco products is earmarked and used to subsidise the price of fresh fruit and vegetables to
encourage the consumption of healthy products.

5.1 By making use of a PPC and community welfare indifference curves, illustrate and explain
what would happen to the quantity consumed of tobacco products and the fresh fruit and
vegetables, as well as the community's welfare, if all goes according to plan. (4)

The community is initially at point C, consuming Yc and Xc .

After implementing the sin taxes the consumption of tobacco should decrease and due to the
subsidy the consumption of fresh fruit and vegetables should increase – now we are at point S. ()

Point S is better for the community since we are on a higher welfare indifference curve (W2) which
means that the community as a whole is experiencing higher welfare due to citizens becoming
healthier. ()

Illustrating the movement from point C to S on graph. ()

Illustrating that the community is on a higher indifference curve (W2) on graph.

Note Y on this graph represents tobacco products; X represents fruit and vegetables.

[5]

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5.2 Treasury also proposed that the tax be imposed on producers of tobacco products (rather than
consumers) and the subsidy be allocated to producers of healthy food products (rather than
consumers). Explain why they would have structured this initiative in this way. (1)

Reason: more efficient administration – far less producers than consumers to collect taxes from
and provide subsidies to. ()

5.3 In the paper by Rodrik and Stantcheva (2021) discussed in class, they make suggestions why
capitalism has failed to effectively redistribute income effciently in a society. Briefly summarise
their views on how this could be improved? Briefly elaborate on how they suggest inequality
be addressed by giving an example of a policy intervention at every stage of production.(5)

Creation of “good jobs” is key to more equitable distribution in most societies ()

(Establishment of ribust middle class – and thus a proper tax base)

In past, redistributions focussed on (at best) pre-production and post-production intervention

and at worst only on post-production intervention - unsustainable. ()

Proposed approach:

Pre-production intervention – e.g. providing good, effective education and training to the work
force. ()

Production intervention – assistance to producers in society with infrastructure etc. to enable

them to lower costs and retain middle class jobs (such as manufacuring etc.). This depends on
more co-operative/collaborative efforts between state and the private sector, rather than a top-
down approach where state dictates the growth sectors in an economy. ()

Post-production intervention where a pregressive tax system and equitable redistribution were
to from the proceeds of production. ()

[10]