1.4

Question 1

give three reasons for governments to intervene in markets

Answer 1

• correct market failure
• to improve the UK economy’s performance
• to address politically and morally unacceptable situations such as providing health and education for free so there is access to all.

Question 2

how can government intervention lead to an increase in economic welfare?

Answer 2

by correcting market failure, e.g. taxing a demerit good which encourages the market to provide a socially optimum quantity of this good, and not over producing this good.

Question 3

what are the four main methods for governments to intervene in markets?

Answer 3

• price control
• government legislation and regulation
• direct provision
• financial intervention/taxes and subsidies

Question 4

name three kinds of price control

Answer 4

• maximum prices - encourage consumption
• minimum prices - discourage consumption
• buffer stocks - to minimise price fluctuations in volatile commodity markets

Question 5

draw a diagram and explain how maximum prices work.

Answer 5

maximum prices are a way of keeping a product/service affordable by not allowing the price to rise above a certain point. it is only effective if the max price is set below the equilibrium price

• supply and demand diagram
• maximum price below equilibrium (Qe/Pe)

Question 6

draw a diagram and explain how minimum prices work

Answer 6

minimum prices are a way of incentivising producers to produce more, as this guarantees a source of income for the producers. prices cannot fall below this level. a disadvantage is that it causes excess supply, as the quantity supplied is higher than the quantity demanded

• supply and demand diagram
• minimum price above equilibrium (Pe/Qe)

Question 7

draw a diagram and explain how buffer stocks work

Answer 7

prices are volatile, and for primary producers like farmers, their incomes are unpredictable. this causes problems in the economy and causes GDP to fluctuate dramatically. this means there are times where primary producers create unemployment to cut costs and may have to shut down. so the government introduces buffer stocks where there is a maximum and minimum price level set so that prices can only fluctuate between these 2 limits, which limits volatility in this market and guarantees incomes for primary producers.

• diagram in notes
• supply increases from S1 to S3 in the first time period due to excellent harvest (for farmers)
• without intervention, the price would fall to P1, which is below the minimum price, so the government have to buy the excess supply and store it, so it is removed from the market
• in the next time period there is terrible harvest and supply drops from S3 to S2.
• without intervention, the price level would increase to P2 which is above the maximum price, so the government have to release the buffer stock onto the market to increase supply

Question 8

what are the advantages and disadvantages of buffer stocks

Answer 8

ADVANTAGES:
- keeps incomes stable
- keeps output and employment stable
- encourages investment
DISADVANTAGES:
- the max price is often set too high so the government is more often buying the buffer stock and not selling it
- the costs of continuing to buy are too expensive, creating opportunity costs
- the cost of storing products is high, and some products perish so they cant be sold
- most schemes break down in the long run

Question 9

give four examples of government regulation and legislation

Answer 9

• age restrictions
• restrictions on where products can be sold
• bans on products (eg illegal drugs)
• legislation controlling packaging (eg health warnings)

Question 10

give two reasons for the direct provision of goods and services by the government

Answer 10

• if the good is a ‘public’ good or quasi-public good and therefore not provided by the market
• if the good is a human right eg education and health

Question 11

draw a diagram to illustrate the effect of VAT and excise duty on a market - show how much tax revenue would be raised by this tax

Answer 11

Diagram + explanation in notes for government intervention

Question 12

draw a diagram to illustrate the effect of subsidies on the market - show how much the subsidies would cost the government

Answer 12

diagram + explanation in notes

Question 13

what could be an appropriate intervention for a merit good?

Answer 13

subsidy
market price
direct provision
regulations to make consumption mandatory

Question 14

what could be an appropriate intervention for a demerit good

Answer 14

indirect tax
minimum price
regulations and legislations

Question 15

what could be an appropriate intervention for a negative externality of production

Answer 15

an indirect tax

a carbon emissions trading scheme

Question 16

what could be an appropriate intervention for a positive externality of production

Answer 16

a subsidy

Question 17

what would be an appropriate intervention for when there is asymmetry of information?

Answer 17

regulations around the provision of information to close information gaps, such as food package labels, calorie content on restaurant labels etc

Question 18

what would be an appropriate intervention for when there is a missing market/public good

Answer 18

direct provision - gov does it themselves e.g state schools

Question 19

how do pollution permits work?

Answer 19

it is permission to pollute up to a certain level which is the value on the permit. polluting up to that level is free, but polluting after that level brings a fine to the firm, or the firm has to purchase more permits. so the cost of production for the firms that pollute most increases, and they have an incentive to find more environmentally friendly ways to produce

Question 20

what is meant by internalising an externality?

Answer 20

where the cost to the third party is transferred to the consumer and producer who were actually involved in the transaction. e.g. a fine to the firm who caused the negative externality.

Question 21

what is meant by government failure

Answer 21

when government intervention leads to a net welfare loss

Question 22

give six sources of government failure with examples - hint ICAUSE

Answer 22

1. Inadequate information - e.g. setting the tax on cigarrettes too high or too low due to there not being enough information to set the optimum tax level.
2. Cost and opportunity cost - e.g. spending on education rather than health
3. Administration costs - e.g. drug laws cost a lot to enforce.
4. Unintended consequences - e.g. intervening to correct one market failure but also causing an issue elsewhere
5. Self-interest / regulatory capture - e.g. when power stations persuade gov. regulators to issue more pollution permits than is necessary as the regulator sympathises with the firm
6. Expertise - when non experts are making policy decisions about areas in which they have limited knowledge and understanding