Question

Suppose it is estimated that for every $1 spent on fatty fast food that government must increase health expenditure by $0.25 to pay for the medical treatment caused by its consumption through the Medicare System. The Medicare System is funded by Australian taxpayers. a. Draw a diagram to illustrate the market for Fatty Fast Food in Tasmania in 2021, showing the: i. Private MB and MC and Market Equilibrium price (PM) and quantity of (QM). ii. Social MB and MC and Socially Efficient price (PE) and quantity of (QE). iii. Dead Weight Loss. b. Explain why there a Dead Weight Loss? c. If a Pigouvian Tax could be applied to fatty fast food at what rate should it be set? How would this achieve the Socially Efficient outcome? d. If there was no Medicare System would there be any externality that needs correcting?

Answer 1

The medical treatment expenditure that is incurred by the government for the treatment of people who consume more fast food creates a market failure and misallocation of resources as the Healthcare expenditure benefits that are provided to people that consume more fast food create an extra cost for people who consume less fast food in the form of taxes they pay which the government uses to pay for the medical treatment through the Medicare system. A negative externality of consumption is created where eating habits of some peoplel leads to indirect usage of money of the people who have healthy food habits creating an external cost for them.

In the given figure, the marginal social benefit is less than the marginal private benefit due to negative utility suffered by people who have healthy food habits . As the consumers will maximise their habits to the point where MSC = MPB leading to over consumption of fast food marked by quantity Q and price P respectively.

The loss of welfare to the society is marked by DWL triangle representing a dead weight loss .

The socially optimal level of consumption would be where the marginal social benefit curve is equal to the marginal social cost curve which is represented by Qso level of quantity and Pso level of price.

The solution to the above externalities imposition of taxes on the consumption of Fast Food by the government. The imposition of taxes by the government will lead to increase in price of the The Fast Food goods to P2 which will automatically their consumption to the socially optimal level and the new equilibrium Will be established at point B where the optimal quantity will be Qso and the price of the goods will be P2. If there was no Medicare system, there would have been no externality caused as the people who have consumed fast food would have paid there own Medicare expenses and the burden of their treatment would not have fallen on the people who follow healthy diet.