1.3 - Government intervention in markets

Question 1

Reasons for government intervention

Answer 1

• Correct market failure
• Earn government revenue
• Promote equity
• Support firms
• Support poorer households

Question 2

Types of indirect tax

Answer 2

1) Ad valorum taxation
2) Specific taxation

Question 3

Indirect tax

Answer 3

A tax on spending/consumption. Only paid if good/service is purchased.

Question 4

Ad valorum tax

Answer 4

are taxes calculated as a percentage of the price of a good or service.

Question 5

Specific tax

Answer 5

Specific taxes are fixed amounts per unit of a good or service sold

Question 6

Methods of government intervention to correct market failure

Answer 6

1) Indirect taxes
2) Subsidies
3) Maximum and minimum pricing

Question 7

Advantages of indirect tax

Answer 7

• Internalises the externality
  > market now produces at the social equilibrium position and social welfare is maximised
• Raises government revenue
  > could be used to solve externality in other ways (Eg:education)
  > which may help the good become more price elastic to demand in the long run

Question 8

Disadvantages of indirect tax

Answer 8

• Difficult to know the size of the externality
  > government suffers from imperfect information when setting tax
  > difficult to target the tax - the effect depends on where the tax is set

Question 9

Purpose of setting ad valorem tax

Answer 9

The purpose of imposing ad valorem taxes is to internalize external costs (negative externalities) or generate government revenue.

Question 10

Purpose of setting specific tax

Answer 10

They are often used to target specific industries or products.
Specific taxes can also be imposed to address negative externalities or generate revenue.

Question 11

Subsidies

Answer 11

Subsidies are financial assistance/grants provided by the government to firms to encourage the production or consumption of certain goods or services by lowering production costs, increasing the supply.

Question 12

Aim of subsidies

Answer 12

Subsidies aim to correct market failures by promoting the provision of public and merit goods, correcting positive externalities, or supporting strategic industries

Question 13

Maximum prices/price ceilings

Answer 13

Maximum prices are government-imposed limits on the price of a good or service.
They are set below the free market equilibrium price to protect consumers from high prices.

Question 14

Example of maximum pricing

Answer 14

Rent control policies in cities like New York and San Francisco impose maximum rents to make housing more affordable for low-income residents.

Question 15

Minimum prices/price floors

Answer 15

A legally imposed price on goods or services at which the price of the good cannot go below - set above the free market equilibrium price

Question 16

Why might governments impose minimum prices

Answer 16

• Support producers
• Decrease consumption of demerit goods

Question 17

Advantages of subsidies

Answer 17

• society reaches the social optimum output and welfare is maximised
• can bring about other positive outcomes
  > EG: encouraging small business, bringing about equality (less price discrimination)

Question 18

Disadvantages of subsidies

Answer 18

• Opportunity cost
  > government budget could have been spent elsewhere
• Difficult to target as exact size of externality is unknown
• Can cause producers to become inefficient, especially if they are in place for a long time
• Difficult to remove if firms become dependent on the subsidy

Question 19

Advantages of minimum price

Answer 19

• They can be set where MSB = MSC, so allow for some consideration of externalities and so help to increase social welfare
• Ensures producers recieve a fair price - earn profits - innovate/invest - increase worker wages

Question 20

Disadvantages of minimum price

Answer 20

• Distortion of price signals and this can cause excess supply
• Difficult for government to know where to set the prices, because of imperfect information on the size of the externality
• Can lead to creation of black markets

Question 21

Advantages of maximum prices

Answer 21

• They can be set where MSB=MSC, so allow consideration of externalities - help increase social welfare - increase consumption of merit goods
• Ensures goods are affordable - reducing poverty and can increase equity/equality

Question 22

Disadvantages of maximum prices

Answer 22

• There is distortion of price signals - excess demand
• Difficult for government to know where to set price - imperfect information on size of externality
• Can lead to black markets, illegal bribes or discriminatory policies in allocating goods

Question 23

Other methods of government intervention

Answer 23

• trade pollution permits
• state provision of public goods
• provision of information
• regulation

Question 24

Trade pollution permits

Answer 24

• Tradeable pollution permits are a market-based approach to reducing pollution.
• Governments allocate a limited number of permits to firms (perfectly inelastic supply) , allowing them to emit a certain amount of pollution.
• Firms can buy and sell permits, creating incentives to reduce emissions efficiently.

Question 25

State provision of public goods

Answer 25

• Governments provide public goods, which are non-excludable and non-rivalrous.
• Public goods are typically funded through taxation.

Question 26

Provision of information

Answer 26

• Governments often provide information to consumers to ensure informed decision-making.
• Information provision can improve market efficiency and protect consumers

Question 27

Regulation

Answer 27

• Regulation involves government rules and standards to ensure market participants follow specific guidelines.
• It can address issues like safety, environmental protection, and consumer rights.