25 marker on behavioural economics as a way to fix demerit good market failure

Question 1

Intro

Answer 1

Behavioural economics is a method of economic analysis that uses psychology to explain human decision making. Government intervention is a regulatory action taken by a government that directly interferes with decisions made by individuals and organisations to correct market failure.

Question 2

Indirect taxation

Answer 2

Indirect taxation is a tax levied on the consumption of a good. Indirect taxation on unhealthy food will increase production costs for a firm. As a result of these increased costs, firms are likely to reduce supply and pass on the increase in production costs in the form of a higher price to the consumer, shown on the diagram as the increase in price from P1 to P2 and the inward shift in supply from S1 to S2. Price increase means the external cost to a third party is paid for by the consumer and producer themselves, and acts as a disincentive for consumers to purchase healthy food. Consumers have limited incomes and assuming they remain constant, they will have to switch consumption away from unhealthy food to healthier food which remains untaxed.

Question 3

Evaluation of indirect taxation

Answer 3

However, the effectiveness of the tax will depend on the elasticity of the good. Unhealthy food is still food, and food is a necessity, so it could be deemed unethical for a government to place a tax on it. Demerit goods like unhealthy food are addictive and consumers are predictably irrational so it is unlikely that they will immediately switch to healthy food due to an increase in price. Moreover, an unintended consequence of the tax may be malnutrition as unhealthy food is more often consumed by low income workers as it is cheap. The tax may only be effective in reducing the consumption of low income households, while those who can afford to pay the higher price continue.

Question 4

Nudges

Answer 4

The behavioural theory of nudges suggests that consumer behaviour can be influenced by policies that include small suggestions and positive reinforcement. This policy in this situation could include displaying health warnings on the packaging of unhealthy food to give the consumer the information they need to make a rational decision. Nudge theory is effective as it leaves the final decision up to the consumer and allows them to choose for themselves.

Question 5

Nudge evaluation

Answer 5

Effectiveness of nudges is dependent on how transparent the policy is. Nudges are most effective when there are no hidden costs associated with the choice. Allowing full sovereignty over the final decision is important in the implementation of nudge theory i.e. giving more evidence allows the consumer to make a decision they feel is correct.

Question 6

Choice architecture

Answer 6

BT of CA suggests CB can be changed by how food is presented in supermarkets. Changing how unhealthy food is presented can be a strong deterrent against purchasing it and can be effective in reducing the number of people who eat it, improving labour productivity.

Question 7

Choice architecture evaluation

Answer 7

Will become ineffective if consumers feel as if they are being coddled or herded into a decision they would not have originally made. If they feel strongly, they are likely to revert to their unhealthy food consumption pattern

Question 8

Conclusion

Answer 8

BH policy is the best. Depends on rationality of consumers. Short term traditional better as they have instant impact but long term BH better as consumers are better informed. Opp cost in growth of healthy food market = decline in unhealthy food. Govt will have to pay to implement BH policies, which may fail and worsen situation. Recommendation - integrated approach to reduce risk of either one failing