1.4 Flashcards
Government intervention is when the state
Gets involved in markers and takes action to correct market failure, improve economic efficiency and change the distribution of income and wealth
What can governments use to change price signals, get better information or change resource allocation?
Regulations, taxes, subsidies, max and min prices to change price signals,
Direct provision to change resource allocation
Main reasons for government intervention
- To correct for one or multiple market failures.
• To achieve a more equitable final distribution of income and wealth.
• To improve the performance of the macroeconomy i.e. reduce unemployment or stimulate growth
Fiscal policy can be used to alter the level
Of demand for different products and the pattern of demand.
How can indirect taxes be used to alter the level of demand
Indirect taxes can be used to raise the price of de-merit goods and products with negative externalities designed
to increase the opportunity cost of consumption and thereby reduce demand towards a socially optimal level.
How can subsidies be used to alter the level of demand
Subsidies to consumers will lower price of merit goods. They are designed to boost consumption and output
of products with positive externalities
– remember that a subsidy causes an increase in market supply and leads
to a lower equilibrium price.
How does tax relied alter the level of demand
government may offer financial assistance such as tax creditsfor business investment in research
and development. Or a reduction in corporation tax (a tax on company profits) designed to promote new capital
investment and extra employment.
Evaluation on Government Intervention
- value judgements
- changing prices
- combination of polices
- power of markets?
- costs and benefits
- law of unintended consequences
help your evaluation of government intervention in an exam – it may be helpful to consider these questions:
- efficiency of a policy
- effectiveness of a policy
- equity effects of intervention
- sustainability of a policy
- does the policy need to be used alongside something else
4 reasons why implementing taxes is difficult
- setting the correct tax rate
- cost of collection
- inelastic demand
- Increased costs
Arguments in favour of a sugar tax
- External costs of consuming sugary drinks – are a cause of market failure
- Information failures – people under-estimate the long-term costs of their consumption
- Sugar tax raises revenue – ring-fenced for other projects e.g. to help fund school sports / breakfast clubs
- Tax encourages manufacturers to re-formulate and offer healthier
alternatives e.g. in vending machines
Arguments against a sugar tax
- Might be regressive on lower income families – i.e. the tax might be inequitable
- Other policies might be more effective in cutting consumption in the long-term (e.g. better information)
- People might simply switch to other sugary products = ineffective
- Risk of lost jobs in pubs and shops that rely heavily on drink sales
Exam hint: Always worth stating that marginal social costs are
Difficult to measure - can make it hard to assign the right level of taxation to correct for externalities and overcome the market failure
Are subsidies effective in meeting their aims?
o Will they achieve the desired stimulus to demand / consumption?
o Is a subsidy sufficient? Might other incentives be needed to change behaviour e.g. some “nudges”
Will a subsidy affect productivity / efficiency?
o Subsidies for investment and research can bring positive spill overs
o But firms may become dependent on state aid / financial assistance and innovate less over time
How much does a subsidy cost and who benefits?
o Is a subsidy part self-financing? Will it create more tax revenue?
o Or does a subsidy create an expensive extra burden for taxpayers who may not have benefitted and therefore be inequitable?
What is a maximum price?
Main aim, how to set price effectively
• legally imposed maximum price in a market that suppliers cannot exceed.
- A maximum price is introduced in an attempt to prevent price from rising above a certain level.
• aim of max is equity so that goods are more widely available to the general population.
• To be effective as a form of intervention, a maximum price has to be set below the existing free market equilibrium price
If quantity is restricted,then some consumers will be willing to pay
A higher ‘unofficial’ price , so producers can extract extra consumer surplus at higher price
Question: Assess the case for introducing rent controls in the UK
- rent controls are form of max price
- to be effective in changing resource allocation, needs to be set below normal equilibrium price
- effects of rent control shown in diagram
- as a result of capped R2, demand expands, so is more affordable
- see from diagram that supply decreases
- = disequilibrium as shortage due to excess demand
What is a minimum price?
price floor
It is a legally imposed price floor below which the normal market price cannot fall. To
be effective, a minimum price has to be set above the normal equilibrium price.
Many environmental economists recommend applying the polluter pays
principle and placing a price on carbon dioxide and other greenhouse gases
What is carbon emissions trading?
- uses the market mechanism to change relative prices and the incentives
- Businesses need to buy enough emissions allowances – the higher the price, the greater the incentive to cut pollution
- Carbon trading provides a quantity adjustment to CO2 emissions
increasing the scarcity of carbon permits leads to an increase in
price
= more expensive to emit carbon, so capital investment into low carbon tech
Advantages of a carbon tax
- A pollution tax internalizes the externality and makes the polluter pay
- A tax raises extra revenue which can be ear-marked for other use