06 Government intervention and Government Failure Flashcards
1
Q
What are the main reasons for government intervention?
A
- Correct any market failure
- Achieve a fairer (or equitable) distribution of income and wealth
- Achieve the government’s macroeconomic objectives for the economy
2
Q
Define indirect tax.
A
A tax on spending, sometimes used to reduce consumption of demerit goods.
3
Q
How can governments use indirect tax?
A
- To alter the supply of certain goods or services
- Indirect taxes have the effect of increasing the costs of firms, which means that they lead to the supply curve shifting leftward.
4
Q
What two types of indirect taxation can the government use?
A
- Specific, or unit taxes: these involve a fixed amount being added per unit of a good or service, such as that on bottles of alcohol
- Ad valorem taxes: involve adding a percentage of the price of a good or service. E.g., VAT at 20% would add 20p to a product costing £1 but £20 to a product costing £100
5
Q
What are the advantages of using indirect taxation?
A
- Indirect taxes are often placed on goods and services that have inelastic demand - strong tax revenues can be gained for governments, which can then be assigned to specific areas of speding, such as health care
- Use of the price mechanism leaves it up to consumers and producers to decide how to adjust thier behaviour
- Assuming governments have applied the correct rate of taxation, the tax helps to internalise an external cost, i.e. to reflect more accurately on the impact of a negative externality on price and quantity
6
Q
What are the disadvantages of using indirect taxation?
A
- Are often placed on inelastic goods, therefore quantity demanded may not fall very much unless the tax is very large, which reduces the impact of the tax
- UK firms may be concerned that their international competitiveness may be reduced by the imposition of indirect taxes, which increase their production costs relative to those of foreign competitors
- Tend to be regressive in nature, meaning they take a larger percentage of a poorer persons income
- It can be extremely difficult to place an accurate monetary value on external costs, which makes it almost impossible to correctly ‘internalise’ a negative externality
7
Q
Define subsidies.
A
A payment made to producers to encourage increased production of a good or service.
8
Q
Why are subsidies used?
A
- To encourage increased production of certain goods or services, such as merit goods
- By reducing the price of specific goods and services, the government is also attempting to increase their consumption
- Can also be used to promote the use of products that reduce external costs, such as public transport
9
Q
The government granting a subsidy will shift supply…
A
to the right.
10
Q
What are the advantages to using subsidies?
A
- Subsidies on merit goods can increase their consumption, bringing the equilibrium quantity closer to the social optimum, helping to internalise the external benefit
- Subsidies reduce the price of a good, making it more affordable for those on lower incomes, so reducing the effects of relative poverty
11
Q
What are the disadvantages of using subsidies?
A
- When taxing negative externalities, it is difficult to place an accurate monetary value on the size of external benefits
- Funding for subsidies carries on opportunity costs
- Firms receiving subsidies may become reliant on them, encouraging productive inefficiency and laziness, and reducing international competitiveness in the long run
- Subsidies for UK firms may be viewed by foreign governments as a form of artificial trade protection
- If subsidies are placed on goods or services with inelastic demand, they may reduce price but not significantly increase consumption
12
Q
Define a minimum price.
A
A price floor placed above the free market equilibrium price.
13
Q
Give examples of a minimum price.
A
The setting of the NMW and guaranteed minimum prices paid to farmers for their agricultural products.
14
Q
What are the advantages of minimum prices?
A
- Give producers a guaranteed minimum price and income, which helps to generate a reasonable standard of living, such as in the case of farmers in less-developed countries
- They encourage production of essential products, such as the foodstuffs produced by farmers
- Excess supplies may be bought up and stored, to be released in times of future shortage
15
Q
What are the disadvantages of minimum prices?
A
- Consumers must pay a higher price, reducing their disposable income
- They can encourage over-production, especially in the case of agriculture, which is an inefficiency use of resources - excess supply may need to be put into storage, which generates further costs
- If governments or other authorities have to purcahse excess supplies, this leads to opportunity costs, i.e. these funds could have been used elsewhere
- They may reduce international competitiveness if the price is raised above those of foreign competitors
- In the case of interventions to reduce the affordability of demerit goods, they may encourage people seek cheaper, potentially more harmful alternatives
- Black markets
