1.2

Question 1

Market Failure

Answer 1

Market failure happens when the price mechanism fails to allocate scarce resources efficiently or when the operation of market forces lead to a net social welfare loss.Market failure exists when the competitive outcome of markets is not satisfactory from the point of view of society. What is satisfactory nearly always involves value judgments.Market failure refers to a situation in which a market fails to allocate resources efficiently. This can occur for a variety of reasons, such as externalities, lack of competition, public goods or information failure (including merit/ demerit goods)

Question 2

Externalities

Answer 2

Positive and negative externalities of production and consumption. Where consumption or production of a good impacts on society other than producers or consumers of that good (ie third party). The customer and business are those involved in the transaction (first and second party). However other may be affected - these individuals or groups are known as the third party.

Key Point: Externalities lie outside the initial market transaction and (without state intervention), they are not reflected in the market price.

Question 3

Externalities of production

Answer 3

Externality of production is a popular term in economics that refers to the cost/benefit that accrues to an unknowing third party from the production of a good or service. An externality can be positive or negative. In welfare economics, social benefit is viewed as the sum of private benefit and external benefit.
E.g. Air pollution from factories, industrial waste and pollution from fertilisers

Question 4

Externatilities of consumption

Answer 4

In the present context, consumption externalities are the (unpaid) social costs imposed on others through conspicuous consumption of goods, when these impacts have their effect purely through information about the choice and ability to consume, rather than from (material) side effects or by-products of consumption.
E.g. Household waste, air pollution from cars, traffic congestion, spillover costs from rising levels of obesity.

Question 5

Public goods

Answer 5

In economics, a public good refers to a commodity or service that is made available to all members of society. Typically, these services are administered by governments and paid for collectively through taxation.

Examples of public goods include law enforcement, national defense, and the rule of law. Public goods also refer to more basic goods, such as access to clean air and drinking water.

Question 6

Asymmetric information

Answer 6

Asymmetric information, also known as “information failure,” occurs when one party to an economic transaction possesses greater material knowledge than the other party. This typically manifests when the seller of a good or service possesses greater knowledge than the buyer; however, the reverse dynamic is also possible. Almost all economic transactions involve information asymmetries.

Question 7

Merit goods

Answer 7

Merit goods are those goods and services that the government feels that people will under-consume, and which ought to be subsidised or provided free at the point of use so that consumption does not depend primarily on the ability to pay for the good or service.

Question 8

Demerit goods

Answer 8

The consumption of de-merit goods can lead to negative externalities which causes a fall in social welfare. Consumers may be unaware of the negative externalities that these goods create - they have imperfect information.

Question 9

Government failure

Answer 9

Policies that cause a deeper market failure. Government failure may range from the trivial, when intervention is merely ineffective, to cases where intervention produces new and more serious problems that did not exist before.

Government failure refers to the situation where government intervention in the economy or in a specific market fails to achieve its intended goals or creates unintended negative consequences.

Government failure can occur when the government lacks the necessary information or expertise to effectively design and implement policies, or when the government creates incentives that are misaligned with its intended objectives.

Government failure can also occur when the government attempts to intervene in a market that is already functioning efficiently, disrupting the natural operation of the market and leading to negative outcomes. Examples of government failure include policies that create unintended incentives, such as subsidies that lead to overproduction or overconsumption of a particular good or service, or regulations that create barriers to entry that limit competition and lead to higher prices for consumers.

Question 10

What are the key ways the government intervenes to correct market failure.

Answer 10

Market failures can be corrected through government intervention, such as new laws or taxes(indirect and specific), tariffs, subsidies, maximum and minimum prices and trade restrictions.

Question 11

Partial Market failure

Answer 11

in some markets there is partial market failure where the market exists but there is over production or under production of goods (and over/under consumption)

Question 12

Complete market failure

Answer 12

In some cases there is complete market failure where markets fail to lead to any production of goods and services - a missing market ( public goods)

Question 13

Social costs

Answer 13

In welfare economics, social cost is viewed as the sum of private cost and external cost. Private costs are costs to the firm of making a good and external costs are costs to the third parties after production / consumption of goods and services (negative externalities) . the social cost is the total cost to society of producing goods and services.
Where there are negative externalities of production/ consumption social costs will exceed private costs. If left to the free market the full costs would not be reflected in the price

Question 14

Externalities causing market failure

Answer 14

Because externalities lie outside the initial market transaction they are not reflected in the market price. Externalities cause market failure because the price mechanism does not take into account of the full social costs and benefits of production and consumption.

Question 15

Issue and its affect on third party- Air pollution

Answer 15

-Health affects lead to problems for NHS, time of work, lung issues and impacts on businesses.
-Environmental issues lead to global warming following increased co2 emissions

Question 16

Issue and its affect on third party- Land fill/ industrial waste

Answer 16

-Affects animals, environmental impact, groundwater pollution, co2 gas, habitats destroyed

Question 17

Issue and its affect on third party- Transport

Answer 17

-Pollution- global warming - NHS- emissions , people late for work so stress and impact on businesses , road rage which could lead to accidents. Also use of fuel so depletion of scarce resources.

Question 18

Issue and its affect on third party- Ocean pollution

Answer 18

Environmental as animals affected, decrease in tourists as ruins landscapes and could therefore impact local economy. Affect on fisherman

Question 19

Issue and its affect on third party- Noise pollution

Answer 19

Neighbours can’t sleep- so tired, less productive, fatigue , stress which can impact businesses and lead to hearing problems. Also impact on wildlife.

Question 20

Marginal cost- Marginal benefit Graph

Answer 20

We say the Welfare of Society is maximised when the market (without government intervention) successfully allocates its resources efficiently. Therefore when MSC = MSB we do not have market failure.
Marginal means one more
The MB curve is downward sloping - this shows that each additional unit of the good/ service consumed , the less is added to total benefit.
The MC curve is upward sloping - therefore each additional unit produced /consumed becomes increasingly expensive
When MC = MB the welfare is optimal and the market is efficient

Question 21

Social welfare loss on a Negative Externalities of Produciton graph

Answer 21

On a graph with marginal social benefit, marginal private cost and marginal social cost. The shaded area is the area of social welfare loss because the market output supplied is higher than the social optimum position. The dead-weight loss of social welfare happens when MSC > MPC.
This is becuase firms ignoring full social cost and acting in own self interests( only consider private cost). So over production and consumption. Price too low. Therefore Missallocation of resources, allocatative inefficiency.

Question 22

Positive externalities of consumption

Answer 22

Positive externalities exist when third parties benefit from the spill over effects of consumption. Therefore where positive (consumption) externalities exist social benefits exceed private benefits. If left to the free market, the consumer and producer don’t take this into account and it would be under consumed and under priced

Question 23

Social Benefit

Answer 23

Social benefit is the benefit to the whole of society. It is the sum of Private Benefits (benefit to individual or firm) and the External Benefits ( benefits to third party) (positive externalities)

Question 24

Benefits of a Vaccine

Answer 24

External Benefits- wider society have a lower chance of catching the disease so wider society less likely to get sick or hospitalised
Leading to the NHS not becoming overrun or burdened, work places have less people sick so more productive

Social benefit- greater benefit to society than the private benefit

If left to a free market it would be under consumed and under priced
If moved to socially optimum level there would be an increase in consumption and increase in price

Question 25

Benefits of university

Answer 25

Private Benefit- Individuals gain degree- get a job- earn a wage
External benefit- more educated workforce, more productive, well educated- advancement, Outward shift in PPF/LRAS. Business in area does better so increase in regional demand.
Social benefit- Greater than private benefit
If left to a free market , under consumed and under priced

Question 26

Diagram of positive externalities of consumption

Answer 26

Socially optimum position is output Q2 whereas market equilibrium is Q1.
Area of social welfare loss because the market output Q1 is lower than the socially efficient level
If the market price ignores positive externalities then there will be under consumption
If left to free market we might under consume as consumer act in own self interest (only look at private benefit- ignoring external) and there is a misallocation of resources (allocative inefficiency).

Diagrams should always point towards desired socially optimum equilibrium

Question 27

Positive externalises examples

Answer 27

-Health Programmes e.g. NHS
-Early years of education e.g. nursery
-Subsidised bike schemes in urban areas
-Public libraries / community spaces
-Museums and galleries
-free school meals/ nutritional advice

Question 28

Market failure

Answer 28

where the market mechanism fails to allocate resources efficiently- there is a misallocation of resources

Question 29

Private good characteristics

Answer 29

Private goods have two characteristics:
-The benefit of using the good/service are exclusive to the user so we say the good is excludable. Others can be excluded from enjoying the product if they are not willing and able to pay for it. Excludability gives the seller the opportunity to make a profit.
-If the good is consumed by one person, it is partially or fully used up- so the good is rivalry in consumption one persons consumption of the good reduces the amount left for others to consume

e.g. clothing, chocolate, seat on aeroplane, Coca Cola, tap water, hair cut

Question 30

Public goods characteristics

Answer 30

-The principle of exclusion and rivalry do not apply.
-Non-excludable - the good/service can be jointly consumed by many individuals simultaneously. Those that have not paid for it can still enjoy the benefits of consumption at no financial cost (the free rider problem). Businesses cannot exclude others from the benefit.
-Non- rivalrous means that when one person uses a good it is not all used up

e.g. park, street lighting, army, swimming in sea/beaches, BBC/Terrestrial TV

Question 31

Public goods

Answer 31

A public good is one that a free market will not provide. There is no incentive to produce it as businesses cannot charge for it and therefore making a profit as it is nearly impossible to prevent anyone else from consuming it for free.
If left to free market they will become a missing market

Question 32

Why would the free market fail to provide public goods?

Answer 32

The free rider problem
A public good is one where it is impossible to prevent people from receiving the benefits of the good once it has been provided. This means that non-payees can still enjoy the benefits of consumption at no
financial cost . It is non excludable.
* Therefore there is very little incentive for people to pay for the consumption of the good and consequently impossible for businesses to charge a price. The business is unlikely to generate any revenue in the long run.
* A free rider is someone who consumes / benefits from the product but allows someone else to pay for it.

Question 33

Quasi Public Goods

Answer 33

-Quasi or non-pure public goods
-Some goods have elements of both public and private goods
-Ways can be found to exclude customers from benefitting from some public goods
-Tolls can be charged for road use
-Where it is profitable, private companies may provide the service
-Roads, police and parks

Question 34

The changing nature of public goods

Answer 34

Advances in technology are causing a blurring of the distinction between public and private goods. Here are some examples:
-Encryption devices - In some cases, encryption allows suppliers to exclude non-payers - although the product remains non-rival
-Smart Electronic Road Pricing- Technological progress reduces the cost of smart- metering used in road pricing - this makes roads more of a private (excludable) good
-Open Source Software - The open source / creative commons movement has made much information
public good in nature
-Live streaming of events -

Question 35

Information Failure

Answer 35

Occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so potentially make the wrong choices.

Question 36

Symmetric Information

Answer 36

A situation in which all participants in a market (buyers and sellers) have the same information about market conditions

Question 37

Asymmetric information

Answer 37

A situation in which some participants in a market have better information about market conditions that others.
Basically someone knows more than someone else:
There is an imbalance:
-The seller knows more than the buyer
-The buyer knows more than the seller

Question 38

Information Gaps

Answer 38

Information gaps exist when either the buyer or seller does not have access to the information needed for them to make a fully-informed decision.

-Ignorance of real costs/ benefits (over estimating benefits, underestimating benefits, under estimating costs ) e.g. cigarettes
-Technical ignorance/ complex information e.g. pensions/ insurance
-Addiction- leading to wrong choices e.g. Cigarettes
-Misleading information e.g. buying fakes online
-Hidden charges e.g. plane ticket
-Asymmetric Information e.g. car sales man
-Myopia - Short term thinking / choices (leading to retrospective regret) e.g. smoking, drinking

Question 39

Situations where there could be information Failure

Answer 39

-Dentistry - The customer has a lack of knowledge on teeth compared to the dentist as they are an expert. Customer may be mislead to get treatment they didn’t need. Market failure as time and resources wasted as a result
-Second hand cars- The seller has more information on the cars than the buyer. The seller may sell the car knowing that there is a problem without telling the the buyer in order to gain a seller as the buyer will trust the seller. Therefore this could have a consequence if the buyer has to pay for maintenance or sell the car on a loss. Therefore resources fixing the car and money wasted because of information failure
-Insurance- the buyer may lie and tell the seller they are healthier than they are in order to gain cheaper health insurance as the seller won’t know if they are being truthful or not. This could lead to larger costs to the seller as they are insuring the buyer for less than they would normally to someone with the same conditions.

Question 40

Adverse selection

Answer 40

Occurs when the expected value of a transaction is known more accurately by the buyer or the seller due to an asymmetry of information. Buyers or sellers are then able to use their private knowledge of the risk factors involved in the transaction to maximise their outcomes at the expense of the other. e.g. when buying health insurance

Question 41

Consumption externality in education

Answer 41

In education there is a consumption externality arising from private individuals not having the full information about the value of education
The external benefits may be:
-Higher efficiency and productivity
-Health spillovers ie better education about nutrition and need for exercise
-Lower crime rates
-Better informed political debate

Question 42

Marginal Social Benefits and Marginal Social Costs

Answer 42

Marginal benefit represents the total benefit gained from the production or consumption of an extra unit of a good or service, while marginal cost reflects the cost implication to society through the production of additional goods or services.

Question 43

Government intervention

Answer 43

When the state gets involved in markets and takes action to try to correct market failure, improve economic efficiency, impact upon the macroeconomic performance of the country and or change the distribution of of income and wealth.

Question 44

Methods of government intervention

Answer 44

-Indirect taxation
-Subsidies
-Maximum and minimum pricing
-Trade pollution permits
-State provision of public goods
-Provision of information/ education
-Regulation

Question 45

Advantages of indirect taxation

Answer 45

-Internalises the externality - ie provides funding for some of the external costs of consuming sugary drinks
-Raises revenues to fund healthier choices ie sports clubs
-Persuades some consumers to switch to better alternatives
-Encourages drink manufacturers to reformulate their drinks and offer healthier alternatives

Question 46

Disadvantages of indirect taxation

Answer 46

-Might be regressive on lower income families (inequitable)
-Other policies may be more effective in cutting consumption
-People may switch to other sugary products other than drinks
-Alternatives ie low calorie sweeteners may also be detrimental to health
-Cost of collection may be high- ie the London pollution levy had high set up costs
-Setting up the right amount is difficult (it is hard to measure the exact monetary value of the externality)

Question 47

Market Failure + consequences and examples of most common methods of intervention

Answer 47

-Public goods
-Failure of market to provide goods that are beneficial to society/ free rider problem
-government intervention

-Negative externalities of production
-Over- production/ consumption of goods that are bad for us/ society
-Tradable permits/ green taxes

-positive externalities of production
-under consumption of products that are good for society
-subsidies/ provision of information

-information failure
-damaging consequences for consumers due to poor choices
-Provision of information/statutory information/ labelling/ Better education. Where there Is a market that information has lead to overconsumption- taxes may also be used

Question 48

Subsidies

Answer 48

Any type of financial assistance from the government offered to producers (and potentially consumers)
In terms of market failure this might be to encourage production and consumption of goods that generate positive externalities.
Subsidies increase supply, leading to a reduced price which encourages production/consumption of a good with positive externalities.

Question 49

Government spending on subsidies

Answer 49

The size of the subsidy is the vertical distance between the two supply curves
* The benefits of the subsidy are shared between buyers and sellers. depending upon the elasticity of demand.
* The benefit of the subsidy to the consumer is the dark pink area and represents the fact consumers are now paying less. The benefit of the subsidy to the producer is given by the lighter pink area and represents the fact they earn more revenue per item. The total cost of the subsidy to the government will be the sum of the benefits to both the consumer and producer.
* The consumer used to pay PI, now it is P2; therefore we can see that not all the subsidy has been passed on by the producer.

Question 50

Effects of a subsidy

Answer 50

-If demand is price inelastic the subsidy will have a large effect on equilibrium price. This gives a greater consumer gain than when demand is elastic.
-If demand is price elastic the subsidy will have a large effect on quantity and therefore benefit producers more.
-This is likely to lower market prices and encourage the consumption of goods and services that are believed to have positive externalities/considered to be good for us and society.

Question 51

Examples of producer subsidies

Answer 51

-electrical vehicle subsidies
-low-cost affordable heating

Question 52

Advantages of Subsidies

Answer 52

-Enables greater social efficiency. Consumers end up paying the socially efficient price which includes the external benefit.
-By subsidising the better alternative to society ie public transport, it will encourage people to drive less and reduce the negative externalities. In the long term, subsidies for a good will help change preferences. It will encourage firms to develop more products with positive externalities ( or lesser negative externalities )

Question 53

Disadvantages of Subsidies

Answer 53

-The cost may have to be met through taxation. Not all those being taxed will receive the benefit of the subsidy- is this equitable? It may be considered that a more efficient way to raise revenue for subsidising positive externalities would be to tax goods with negative externalities, e.g. tax cars driving in city centers and use the money to pay for more environmentally friendly methods of public transport (London low emission zone).
-Difficult to estimate the extent of the positive externality. Therefore the government may have poor information about the service and how much to subsidise.
-There is a danger that government subsidies may encourage firms to be inefficient and they come to rely on subsidies rather than improve efficiency.
-The effect depends on the price elasticity of demand
-Significant opportunity cost of putting government money towards subsidies.
-To what extent does the subsidy meet the desired aims? Is a subsidy alone sufficient?

Question 54

Maximum pricing

Answer 54

This is a legally imposed maximum price (or price ceiling/cap) in a market that supplies cannot exceed. To be effective a maximum price has to be set below the existing free market equilibrium.
The government may be tempted to use this approach to prevent the harmful effects of wrong choices or if the good is essential for daily living - without a maximum price, some people may be unable to afford the good. By reducing the price, it can help reduce relative poverty.
Examples:
-Rent capping
-Energy price caps
-Caps on interest rates charged by payday loans

Question 55

Intended consequence of Maximum pricing

Answer 55

The intended consequence is to reduce the prices of rent to maybe those on low incomes to help them afford a basic necessity.

Likely outcome/ unintended consequence:

-Renting now becomes less profitable - some landlords are likely to reduce/ leave the market (sell)
-More people looking for less available properties
-May mean more people are homeless ( government failure)
-Unofficial markets may develop due to the scarcity of supply ( some consumers may be willing and able to pay above the regulated price)

Question 56

Minimum pricing

Answer 56

A minimum price is a price floor. It is a legally imposed price floor below which the normal market price cannot fail. To be effective the minimum price has to be set above the market equilibrium.
An example that has been particularly effective is the minimum price of a plastic bag.

Question 57

Adv and Disadv of Minimum pricing

Answer 57

ADV:
-Consumers demand less- demand decreases
-Reduces the negative externalities of goods that are considered to be bad for us
-Is likely in the long term to reduce premature death, and workplace absenteeism and reduce the burden on the NHS
-May reduce alcohol-related crimes and disturbances
-If the differential between drinking at home and in pubs becomes smaller; it may mean that businesses benefit from increased customers and sales revenue.
-Rules are simple for firms to implement and follow

DISADV:
-Emergence of black markets
-Depends on elasticity (demand may be inelastic) such as heavy drinkers so the effect may be minimal
-Leads to imbalances in the market - supply outweighs demand
-Won’t affect the rich so much
-Can be difficult to find the socially optimum level- if the minimum price is set above but close to equilibrium, the impact will be negligible.
-Cost of enforcement
-Affects all consumers- responsible drinkers have to pay the price- is this fair?
-Better alternatives such as alcohol tax which would raise revenues that could be used for socially beneficial projects. It also internalizes the externality.

Question 58

State Provision

Answer 58

This means that the government funds and supplies the good and pays for it through taxation. This is particularily the case for public goods- these goods benefit society as a whole and without government intervention they are unlikley to be provided for by the private sector. The government also provide merit goods which generate external benefits.
The state either provides these goods directly ie defence or it contracts private companies to provide the good/ service.

Question 59

Adv and Disadv of State Provision

Answer 59

ADV:
Society benefits from the provision of public goods - these often meet the basic needs necessary for a functioning society ie legal system, defence, roads etc.
Businesses benefit from having a good infrastructure & and a robust legal system which in turn helps them to compete effectively in international markets.
State provision redistributes income and wealth: tax
received from the relatively well-off in society is used to pay for goods/services that poorer people are unable to access. It helps lessen inequality
It increases consumption of merit/public goods: things like education /health/flood defences, if provided will be consumed at higher levels than if the free market were to provide itself. This is because state provision is usually free or largely free. These generate external benefits ie a better educated population helps to make the economy more competitive.

DISADV:
Absence of market forces: the government provides the goods/services without acting on information it receives from market forces. Firms in the free market react to the price mechanism, and most of the time it produces an efficient outcome. The government does not have this information so excess demand/supply is more probable. Furthermore, the government is not under threat of going out of business, so they can get away with not understanding the customer’s needs. A lack of consumption may mean that these organisations are inefficient and badly run.
Opportunity Cost: the government is spending taxpayer money on providing goods/services. This means that there is less revenue available to spend on other alternatives.
Reduces independence of the consumer: if the government is too relaxed, it can attract unwanted behaviour. For example, overuse of the NHS - calling a doctor when you have a cold is not what you should be using the NHS for. People learn to expect healthcare to be free, when in other countries healthcare is a premium service that you must pay for!
Higher taxes: In order to provide these goods, taxes have to be raised. The increase of National insurance contributions recently was exceptionally unpopular.
Technological change has increasingly changed the degree to which public goods are non-excludable.

Question 60

Adv and Disadv of Provision of Information

Answer 60

ADV:
-Shifts demand up (merit) or down (demerit)
-Consumers understand the benefits/costs of consuming merit/demerit goods so will make rational decisions by knowing the true MPB
-Solve over/under consumption of these goods
-Can hit a socially optimum level in the market - allocative efficiency

DISADV:
-Cost of implementing
-No guarantee of success - policy may be poor or badly targeted
-Long Run not Short Run as consumption habits change and advertising usually has to be repeated to work

Question 61

Regulation

Answer 61

A set of rules (including the law) imposed by the government to modify/ determine business behaviour.
It is a command and control approach to intervention, it sets standards and then monitors and imposes penalties for non-compliance.

Question 62

Regulators

Answer 62

An Independent (of government) organisation that ensures rules are followed and potentially may punish or impose penalties if not.
For example
In Education, Ofstead ( office of standards in Education, Children’s Services and Skills)
In Business and Finance, Bank of England
In Energy Sector, Ofgem (the Office of Gas and Electricity Markets)

Question 63

Market Deregulation

Answer 63

Deregulation is the reduction or elimination of government power in an industry which opens up markets to competition by reducing barriers to entry. The aim is to increase market supply, stimulate competition and innovation, and drive prices down for consumers. There is a reduction of regulation.

Question 64

Fine

Answer 64

A fine is a mandatory monetary penalty that is imposed by a court, commission, or other government authority and is paid to a public treasury.

Question 65

Prohibition

Answer 65

Prohibition is the act or practice of forbidding something by law. It is a total ban on a product, illegal to sell or consume

Question 66

Regulations/Legislation used in markets

Answer 66

Cigarettes- Offence to sell products to anyone born on or after 1st Jan 2009.
-Legal age is over 18
-Must contain 20 cigarettes per box and only be sold in original packaging

Movies- BBFC must classify films that have a cinema or DVD release

Financial sector
-FCA - regulates the behavior of financial services
-PRA- Superiveses all major banks and societies
-FSCS- Protects consumers when authorised financial services firms fail
-Financial Ombudsman Service- Settles complaints between consumers and businesses which provide financial services

Question 67

OFGEM

Answer 67

Office of Gas and Electricity Markets is the government regulator for electricity and downstream natural gas markets in GB.
Aim to protect energy consumers, especially vulnerable people, by ensuring they are treated fairly and benefit from a cleaner, greener environment. Aim towards Net Zero, Fair treatment and drive competition.
They have the power to carry out market reviews of activities, can introduce price caps, impose bans, and enforcement orders and require disclosure of information.

Question 68

Advantages of Regulators

Answer 68

-Prevents exploitation
-Increases efficiency
-Allow markets to work effectively- potentially self regulate
-Fines may act as deterrent to improper behaviour

Question 69

Disadvantages of Regulators

Answer 69

-Regulatory capture- regulator more influenced by industries pov rather than consumers, so not an independent body as works closely with one industry so not regulating for consumers effectively.
Companies may need profits to reinvest back into industry for example energy companies back into green energy, make this argument to regulators leading to astronomical profits and higher prices for consumers so they suffer and in turn regulators arent doing their job properly.

Question 70

Government Failure

Answer 70

Occurs when an intervention leads to a deeper market failure or even worse a new failure may arise

Question 71

Government failure policies

Answer 71

-Policies may have damaging long-term consequences
-Policies may be ineffective in meeting their aims
-Policies may create increased inequalities of income and wealth
-Policies may have unintended consequences

Question 72

Causes of government failure

Answer 72

-Political self-interests/ lobbying
-Policy myopia - search for quick fixes
-Regulatory capture
-Information failure
-Disincentive effects
-High enforcement / compliance costs
-Conflicting policy objectives
-Damaging effects of red tape

Question 73

Examples of government failure

Answer 73

-Smoking ban introduced in all public places inc pubs and restaurants- reduces business for these companies, increases in littering, doesnt necessarily reduce smokers just shifts them outside.
-Govt introduces landfill tax- increase in fly tipping
-UK govt offers a guarantee to all bank deposits to protect the financial system - creates moral hazard, banks take on excessive risk.
-Min price on alcohol - illegal market, with no regulation.
-Introduce import tariff on steel to protect profits and jobs in domestic steel manufacturing firms- possible retaliation from countries, increase in cost of production and price, increased consumer surplus
-NHS - set wait times- hospital given goals to meet wait times, prioritise wait times over quality of care.
-Fishing quotas - decrease in consumer surplus, less profitable, unemployment hard to regulate (costly), if fishers caught lying then fish already caught, cant be undone.
-Max rent - decrease in supply of rental problems, excess demand, black market, land lords may skimp on maintenance and health and safety to keep costs down in order to make profit.

Question 74

Tradeable Pollution Permits

Answer 74

A carbon pollution tradable permit works by giving firms maximum levels of carbon that they can emit during production. They can acquire additional permits by bidding for them at an auction. If firms are efficient they can sells surplus permits they do not need to inefficient producers who exceed their allocation, generating additional income.
* Such schemes are designed to encourage firms to encourage the use of cleaner fuels.
* Tradable permits seek to combine market incentives with command and control measures.
* If a firm is efficient and reduces its pollution below the permitted limit, it can then gain a credit which can then be sold to less efficient companies who exceed their permitted levels. The scheme therefore benefits those firms that are efficient and punishes those that are not.
* It also internalises the externality/polluter pays principle!
*Countries such as UK Canada and Austrailia use tradebale permits.
*EU emmision trading scheme operates a similar system, fine of 100 euro per tonne, helps to decrease emissions and increase revenue to finance EU green transition. From 2026 free allocation will be dependent on investment in energy-efficient tech

Question 75

Carbon trading market supply and demand

Answer 75

Over time it is likely that the government reduces the number of permits over time. This means that the price will steadily increase and create a growing incentive to reduce pollution over time. The idea is that it gives firms time to try and invest in different technology which creates less pollution.

In the longer term if the scheme is successful it is likely that in the long term there will be less demand for the permits because firms have invested in and converted to methods that of production and pollute less (so that they can avoid paying permit fines)

Question 76

Internalizing the externality

Answer 76

refers to the process of making the party responsible for the external cost or benefit themselves. In other words, it is a way of making sure that the cost or benefit is taken into account when decisions are made. The ‘polluter pays’ principle is the commonly accepted practise that those who produce pollution should bear the cost of managing it to prevent damage to human health or the environment.

Question 77

Advantages of pollution permits

Answer 77

Internalises the externality it creates a market for the externality e.g. CO2 pollution. Therefore those that pollute more pay the cost of that pollution by having to pay for more permits.
Incentivises the firm to cut pollution: the firm can actually make money by producing less CO2. Therefore there is an incentive to innovate. Stimulates investment.
* Revenues can be ring fenced for greener projects.

Question 78

Disadvantages of pollution permits

Answer 78

-What is the right amount of CO2?: the right amount of CO2 pollution is difficult to calculate and some firms argue that they should be entitled to more pollution than others.All of this can be very difficult and costly to work out accurately.
-How much pollution has been emitted?: it can be difficult to work out exactly how much has been emitted into the atmosphere in terms of CO2.The firms can estimate, but a rational firm will always try to underestimate what they have really produced.
-Administration costs: these costs also have to be considered. The scheme does not run itself!
-Can lead to cheating: take a look at VW as an example of this. The emissions scandal of 2015 led them to producing cars with inaccurate emissions figures, purposely designed to cheat emissions tests. If this is possible, then what else are firms up to that we don’t know about?
-Firms may relocate: in the case of the EU and the ETS, firms may dispute that abiding by the emissions rules increases their cost of production and therefore can make them less competitive in the marketplace. Some firms may decide to relocate.
-Rich businesses/countries can exploit the system: richer countries are able to buy more permits from less developed countries. So it can mean that pollution in richer countries may not be going down. However, with a joint global effort for CO2 reduction and time, this point becomes less valid -Levels are set on current levels of emissions. This may penalise businesses who are currently operating at their most efficient level. They may have invested in new technology and further cuts in emission may be impossible to achieve.
-Such a scheme needs full international agreement in order that all firms operate on a level playing field. If one firm is internalising the cost of production and pollution it will mean their costs of production will increase, however if they were competing against other firms not involved in such a scheme it would lead to a lack of competitiveness.
-The biggest carbon trading scheme is the EU Emissions Trading Scheme (ETS), however political interference has created a glut of permits and it has done little to reduce carbon dioxide and reverse global warming.
-No global scheme, just EU countries

Question 79

Arguments for regulation as a way of correcting market failure

Answer 79

-Regulation may act as a spur for businesses to innovate to cut the level of carbon emissions. For example, a ban on petrol and diesel new vehicles from 2035 incentivises car manufacturers to design electric cars.
-Regulation may be more effective if demand is unresponsive to price changes ie inelastic
-Regulations can be graduated ie cutting the maximum levels of CO2 emissions for new cars.
-They are often straightforward and easy to apply. The consequences are clear and easy to understand.

Question 80

Arguments against regulation as a way of correcting market failure

Answer 80

-High cost of enforcement/ administration of laws to police businesses (ie the cost of checking health and safety standards)
-Regulation can lead to unintended consequences (a source of government failure)
-There is a cost for businesses of meeting regulations and may make them less competitive globally. This may particularly affect smaller businesses.
-Tight/strict regulation can lead to illegal trading and the knock on cost implication of policing this.

Question 81

Regulatory capture

Answer 81

A form of government failure where those bodies regulating industries become sympathetic to the businesses they are supposed to be regulating. Regulatory capture can mean monopolies can continue to charge high prices.
-regulators may limit innovation in fast-growth markets
-capping prices might prevent new firms from entering a market
- Regulation becomes bureaucratic and costly
-May lack the powers to be truly effective in protecting consumers
- Regulator might be ‘behind the curve’ with new technologies
-Frequent rule changes can stifle business investment

Question 82

Evaluating the effectiveness of government intervention

Answer 82

-Value judgement - many people want a particular intervention because of their own vested interests
-Changing prices to change incentives and behaviour- PED has a big effect on the effectiveness of policy.
-Social science - the effect of intervention cannot be forecast with great accuracy - peoples behaviour is subject to change
-Combinations of policy - one single intervention is unlikely to produce a solution to deep-rooted problems- build a variety of policy options into your discussions e.g. policies that work on market demand + market supply
-Power of markets - market forces can be powerful in finding profitable solutions to problems
-The law of unintended consequence- intervention does not always work in the way in which it was intended or the way in which economic theory predicts it should.