(a) Explain why the tidal floodgate system can be considered a public good and why the government intervenes in the tourism market in Venice [10]

R1: Tidal Floodgate (Public Good)

Non-Rival: Consumption of the flood prevention service does not reduce the amount / quantity of service available to others.

Implication: marginal cost of provision = zero. (meaning the cost of providing the service to 1 person equals the cost of providing the service to 1000 persons)

Allocative efficient price, P = MC = 0; profit maximising firms do not the incentive to produce at the allocative efficient price of 0, hence if the government compels the firm to produce at P = 0 to achieve AE > non-provision.

Non-Excludable: Prohibitively costly / Impossible to exclude non-payers from enjoying the good once it has been produced.

Implication: consumers can enjoy the service without contributing to its production  free-rider problem > “unwillingness to pay” > lack of effective demand OR concealed demand > inability of firms to generate revenue > non-provision

Non-rejectable: Not possible for consumer to reject the service even if he/she refuses to pay for the service.

Implication: unfair to charge consumers who do not wish to consume the service  justifies free provision.

R2: Excessive Tourism >> overcrowding and environmental damage (negative externalities in consumption) – MSB < MPB (RI Framework) OR MSC > MPC (General Framework)

MPB = satisfaction generated from C of tourism service

MPC = costs to tourist, tourism expenses, hotel stay expenses

External costs of consumption – noise pollution, air pollution, land pollution (littering), over-crowding – third party to the residents of the city (healthcare costs, clean-up costs, envt restoration costs)

Diagram Analysis > over-C of tourism > welfare loss

(b) Discuss how the Italian government can intervene to overcome both sources of market failure [15]

R1: Government Intervention in Tidal Floodgate: Direct Provision (Free)

Due to the non-provision by private firms, the government has to directly produce the tidal floodgate in order to provide flood prevention service to the residents of Venice. The expenditure on MOSE barrier is financed through taxation. The Venice government engages in the direct provision of public goods as other measures such as tax, subsidy, regulation and education do not solve the free-rider problem caused by non-excludability which is the root cause of the non-provision of public goods. Further, due to inability to charge users for the service, the government has to provide the service for free, which incidentally also aids in achieving allocative efficiency, since the AE price = 0.

EV: However, state-owned firms engaged by the government to construct and maintain the MOSE barrier do not need to consider factors such as profitability and survival and hence are more likely to be cost-inefficient and hence productively inefficient than private firms. Also, the government may have imperfect information about MSB and MSC of this service, so it could over-provide or under-provide the service.

R2: Government Intervention to deal with Excessive Tourism:

1)    Indirect Taxation on Tourist > shifts the MPC upwards such that it intersects MPB at the socially optimal level of tourist arrivals. Limitation: imperfect information about the external cost could lead to over or under-taxation.

2)    Limits to Tour Group Size (Quota) > shifts MPC vertical at the Qs level of output > reduces qty of tourists > achieve AE > eliminates DWL. Limitation: adverse macro impact on tourism on sectors such as hotels, restaurants etc. Distorts price mechanism. Exerts enforcement and monitoring costs on the government.

3)    Campaigns to educate tourists about the potential environmental damage > “nudge” them to preserve the environment > reduce external cost > brings MSC / MSB closer to MPC / MPB (depending RI or general framework). Limitation: long effectiveness time lag

Overall EV: Tidal Floodgate > only appropriate measure is direct govt provision since there is “missing” market or complete market failure. Govt provision hampered by govt finances > raise funds or generate revenue from taxation > comes from tourism taxation. Excessive Tourism > slew of measures > depends on effectiveness time horizon. Quota may be more effective as there is certainty on the number of tourists entering Venice – immediate impact on reducing tourism numbers. Policy Mix Reasoning in Excessive Tourism: SR + LR measures or tourism tax financing the provision of tidal floodgate > policy mix to address both types of market failures and alleviating possible budgetary constraint issues.