Economics and Public Policy Analysis
Economics and Public Policy Analysis tests microeconomic reasoning, market failure, policy appraisal, and the policy cycle. Expect numerical work on elasticity, cost-benefit analysis, and incidence, plus conceptual questions on government failure.
Core rules
- Opportunity cost is the value of the next best alternative forgone.
- Market failure includes public goods, externalities, imperfect competition, and information asymmetry.
- A Pigouvian tax equal to marginal external cost can internalize a negative externality; a subsidy can address positive externalities.
- Cost-benefit analysis compares present values of incremental social benefits and costs; use a social discount rate and include non-market effects where feasible.
- The policy cycle runs agenda setting, formulation, adoption, implementation, evaluation, and revision.
Worked example
A factory emits pollution causing external damage of 8 per unit. Private marginal cost is 20; social marginal cost is 28. At the unregulated competitive output, price equals 20, so output is too high. A tax of 8 per unit shifts private cost to 28, aligning private incentives with social cost. The tax works best if damage is measurable and firms cannot easily relocate emissions; otherwise a permit scheme or regulation may be preferable.
Traps
Do not treat sunk costs as relevant to forward-looking decisions. Do not confuse average with marginal values. Do not infer causation from correlation. Do not double-count benefits in CBA. Do not ignore implementation capacity and regulatory capture when recommending a tax.