1.4-1.3 Gov intervention/market failure

Question 1

What is indirect tax
-e.g.

Answer 1

A specific tax that is placed on a demerit good
e.g.
-wine, spirits, beer duties
-VAT
-Tabacco duties
-Collected by the customs and excise

Question 2

Advantages of indirect tax

Answer 2

1. Can target particular industries (externalities) therefore the polluter pays
2. Tax can be used as an incentive to reduce externality
3. Based of the principle that the polluter pays
4. Tax funds collected by the gov can be use to clean up the environment/ compensate victims
5. The level of pollution/ seize of the externalities should fall as output of the goods/services is reduced and the price increases

Question 3

Disadvantages of indirect tax

Answer 3

1. It is very difficult for the gov to fix a monetary value on an externality and therefore its hard to decide what the optimum tax level should be
2. Not all costs/ externalities can be split this way
3. Indirect tax increase the costs of production for firms, making them less competitive, compared to other countries where this tax doesn’t apply.
4. If price inelastic then reduction on pollution levels may be small
5. Taxes raised may not be used the compensate/clean up
6. I might encourage development of illegal activity

Question 4

Tax incidence is

Answer 4

Tax incidence is a measure of who ultimately pays a tax, either directly or through the tax burden

The consumers burden of tax increase reflects the amount by which the market price rises

Question 5

The producer burden is

Answer 5

The decline in revenue they get after paying the tax

Question 6

What is a subsidy

Answer 6

The gov provides money, often in the form of a grant to firms and businesses

Question 7

Advantages of subsidy

Answer 7

1. Reduces price and increases quantity.
2. Leads to an increase in production/consumption of merit goods.
3. Encourages firms to take part in activities that are beneficial.
   4.In the long term subsidies for a good change preference. They encourage firms to develop more products with positive externalities.

Question 8

Disadvantages of subsidy

Answer 8

1. The money to pay for the subsidy will have to be met through taxation
2. All subsidies have an opportunity cost
3. Its difficult to estimate the extent of the positive externality therefore its hard to work out how much subsidy to give.
4. The government may have poor information about the product/service and therefore don’t know how much to subsidise.
5. There is a danger that government subsidies encourage firms to be inefficient and they come to rely on the subsidy rather than improve their efficiency.

However… it depends on the size of the subsidy, how long the subsidy is given for and the elasticity in the market.

Question 9

Maximum prices are

Answer 9

A Max price or price ceiling is set to increase consumption of a merit good or to make a necessity more affordable.
(Help consumers)

-If a market price is set above the market equilibrium, it will have NO IMPACT.
-If it is set below the market equilibrium then it will lead to excess demand and a shortage in supply.
-The excess supply cannot be cleared by market forces since the max price level prevents this so to prevent shortages the product needs to be rationed out.
-The PES and PED of the good has a huge effect on the amount of excess demand.

Question 10

Maximum prices Benefits

Answer 10

1. Leads to lower prices for customers
2. Max price can help to increase fairness, by allowing more people to purchase certain goods/services
3. Max prices can be used to prevent monopolies exploiting customers and suppliers with higher profits
4. Usually reserved for important goods

Question 11

Maximum price disadvantages

Answer 11

1. Leads to a shortage
2. Since demand is higher than supply some people who want to buy the goods aren’t able to
3. Can lead to black markets emerging
4. Gov may need to introduce a rationing scheme to allocate the good
5. Excess demand can lead to the creation of a black market for the goods

Question 12

Minimum prices are

Answer 12

A Min price or price floor is set to make sure suppliers get a fair price. (higher prices for customers)

-A Min price set below the market equilibrium will have no impact.
-If set above the market equilibrium it will reduce demand and increase supply leading to excess supply.
-To make the minimum price for a good work the government might buy the excess supply at that guaranteed price. It will either stockpile or destroy the good.
-Government expenditure would be the shaded area.
PES and PED have a big effect on the amount of excess supply.

Question 13

Minimum price benefits

Answer 13

1. Designed to give producers more income
2. Protects businesses and industries
3. Protects consumers from over buying harmful/ demerit goods

Question 14

Minimum price disadvantages

Answer 14

1. Higher prices for consumes
2. Market is in disequality
3. Higher tariff necessary on imports to keep prices high
4. What would you do with the oversupply of products. Destroy them?

Question 15

Regulation / Legislation is

Answer 15

-Regulations are rules enforced by an authority (government). They are normally backed up by laws.

-Legislation (laws) mean legal action can be taken against those who break the rules.

Question 16

Regulation / legislation benefits

Answer 16

-Legally binding. Businesses (and other economic agents) must adjust their behaviour or risk prosecution.
-Can reduce demerit goods and services
-Can reduce the power of monopolies
-Can provide protection for consumers and producers from problems arising from asymmetric information e.g. -The Sale of Goods Act protects against substandard goods.
-Can have a relatively quick impact
-Easy to Understand
-Cheap to Implement
-Revenue from the fines can be used to correct the cause of market failure or compensate those affected by the externality.
-Most effective when the cost of the fine is greater than the benefits of ignoring the regulation.

Question 17

Regulation / legislation disadvantages

Answer 17

-Difficult to fix the right level of regulation.
For example, what is the correct age to be allowed to buy alcohol? Doctors may want the age limit increased but producers may want it decreased.
-Regulations might be too tight or too lax.
-New Regulations need monitoring and enforcing. This creates extra costs.
-Is likely to push up the cost of production and therefore reduce businesses profits.
-Businesses may simply increase prices to cover the cost of the new regulations.
-Ideally the correct level would be where the economic benefit arising from the reduction in externality would be equal to the economic cost imposed by the regulation.
-Can put firms at a competitive disadvantage if similar regulations are not applied overseas.
-Regulations don’t discriminate between the costs of reducing externalities.

Question 18

-Symmetric info
-Asymmetric info

Answer 18

-Symmetric info- consumers and producers have the same knowledge
-Asymmetric info- When either producers or consumers knows more than the other one

Question 19

Information provision

Answer 19

-Often there is a mis-allocation of resources due to a lack of information with customers paying too much or too little and firms producing too much or too little.

The information is given to try and help consumers make rational decisions and prevent market failure caused by consumers and producers having asymmetric information.

Question 20

Information provision benefits

Answer 20

-Can be tailored to the needs of the particular market.
-The provision of info should impact the demand for the goods. Government will try to increase demand for merit goods (things beneficial for society) and reduce the demand for demerit goods (harmful goods)
-Can be supported by regulation to ensure all firms carry it out.

Question 21

Information provision disadvantages

Answer 21

-Difficult to identify exactly what information is missing so that accurate decisions can be made.
-Unless regulated it has no hard edge.
-Firms and customers may still choose to behave the same way e.g. drink alcohol
-Information campaigns can be expensive. In particular, if they rely heavily on advertising.
-Some markets and products/services are complex. It is difficult to provide the right information.
-Might require regulation to force the firms to provide the necessary information e.g. salt content in food.
-The effectiveness of government information campaigns is often questioned. The growing obesity problem suggests healthy eating campaigns are not working.

Question 22

Pollution permits are

Answer 22

• Permit a certain amount of something with the aim of reducing it overall.

-Gov issues a permit to pollute
-Government allocates these permits to individual firms.
-The permits are then tradable for money between the different polluters
-Firms that succeed in reducing their pollution can sell their spare permits onto other producers exceeding their limits.

Question 23

Pollution permit benefits

Answer 23

-Reduce pollution as they encourage firms to be more efficient and pollute less.
-Using Permits tends to cost industry less than if you were to use regulation.
-A market is created for buying and selling the permits.
-Businesses that don’t use their permits can sell them on.
-This creates a strong incentive to reduce the pollution (externality).
-The number of permits can be reduced over time to ensure that pollution targets are met.
-Gov can sell additional permits and use this money to compensate victims and reduce the externality.
-Production costs will increase for firms that exceed their pollution allowances, since they have to purchase additional permits
-The Government can use any money gained from any fines to invest in pollution reducing schemes.
-These schemes internalise the externality of pollution since the polluter is the one trying to fix the problem.

Question 24

Pollution permits disadvantages

Answer 24

-Deciding upon the right number of permits to allocate can be difficult.
-Gov might allocate too few permits.
-Firms production costs rapidly rise due to the additional permits and fines they face. Which reduces international competitiveness.
-Who gets them and how many do they get?
-Some firms have taken legal action against the government and the EU if they feel they should have received a bigger allowance.
-Firms might pass on the cost of buying the pollution permits onto the customer. This leads to higher prices.
-Not worldwide. China and the USA are still polluting.
-There is a cost to the gov of monitoring pollution emissions
-There is less pressure on major polluting firms to actually clean up their act if it is easy to buy permits from elsewhere.
-Pollution permits may create an entry barrier for new firms to enter the industry, so restricting competition.
-The pollution permit creates another market and there might be market failure here too.
-There are admin costs involved in permit schemes to both the firm and the government.

Question 25

Public goods are

Answer 25

Public goods cause market failure due to the problem of missing markets – the main characteristics of public goods are as follows:

-Non-excludability
-Non-rival consumption
-Non-rejectable

Question 26

Non-excludability is

Answer 26

Benefits derived from pure public goods cannot be confined solely to those who have paid for it. Non-payers can enjoy the benefits of consumption at no financial cost to themselves – economists call this the ‘free-rider’ problem

Question 27

Non-rival consumption is

Answer 27

Each party’s enjoyment of the good or service does not diminish others’ enjoyment– in other words the marginal cost of supplying a public good to an extra person is zero. If a public good is supplied to one person, it is available to all.

Question 28

Non-rejectable is

Answer 28

The collective supply of a pure public good for all means that it cannot be rejected by people, an example is a national nuclear defence system or major flood defence projects.

Question 29

Private Goods is

Answer 29

Covers most types of goods. Consumption by one individual means that it is not available for another to use.

Question 30

The free rider problem

Answer 30

If provision of Public Goods was left to the market mechanism then there would be market failure because of the FREE RIDER PROBLEM. A free rider is someone who received the benefit but allows others to pay for it.

Question 31

Should Government provide public goods?

Answer 31

1.The non-rival nature of consumption provides a strong case for the gov rather to provide and pay for public goods
2.Many public goods are provided free at the point of use and then funded by taxation or a charge e.g. BBC’s licence fee
3.State provision may help to prevent under-provision and under-consumption of public goods so that social welfare is improved
4. If gov provides public goods they may be able to do so more efficiently because of economies of scale
5. Providing essential public goods helps affordability and access to important services for lower income households and therefore help to address inequalities of income
6. If the .gov becomes a monopoly provider, there is a danger of a lack of efficiency arising from a lack of competition
7. In some cases the state will fund and the private sector provides public goods e.g. Public Private Partnerships

Question 32

Externalities are

Answer 32

-Externalities are spill-over effects from production and consumption for which no appropriate compensation is received and are a major cause of market failure

-Externalities lie outside the initial market price
-Externalities cause market failure if the price mechanism does not take account of the social costs and benefits of production and consumption
-Externalities can be positive and/or negative

Question 33

Negative externalities are

Answer 33

A negative externality arises where actions of one group results in a negative side effect/impact on a third party i.e. where social costs of an activity are greater than the private
(de-merit goods cause neg externalities)
e.g. airplane (noise pollution)

Question 34

Why is neg externalities market failure

Answer 34

-These goods are overproduced and overconsumed in
the free market.
-Plus the Market price is different to the socially optimum price.
-Negative externalities result in a Welfare Loss. This
represents the loss to society caused by ignoring the external costs (externalities).

Question 35

Positive externalities

Answer 35

Merit goods cause pos externalities
(under produced and under consumed)

Question 36

How is positive externalities market failure

Answer 36

-Extra benefit not included in price
-Price too high
-Producing too little
-Welfare gain