1.4 Govement Intervention

Question 1

What is government intervention

Answer 1

This is where the government intervenes when there is market failure so resources are allocated efficiently.

Question 2

What is indirect taxation and when can it be used

Answer 2

When the good has a negative externality, the government can introduce indirect taxation to prevent market failure.

Question 3

What is the effective of indirect taxation

Answer 3

This will cause a fall in supply and increase the costs to the individual. The tax internalises the externality and social welfare is now maximised.

Question 4

What are the advantages of indirect taxation

Answer 4

● It internalises the externality- the market now produces at the social equilibrium position and ​social welfare is maximised.

● It raises ​government revenue​, which could be used to solve the externality in other ways.

Question 5

What are the disadvantages of indirect taxation

Answer 5

● It is difficult to know the size of the externality and so it is ​difficult to target the tax​

● It could lead to the creation of a ​black market

● If demand for the good is inelastic, then the tax will be ineffective at reducing output.

● Taxes are ​politically unpopular and so governments may be reluctant to introduce
them.

● They are ​regressive​, meaning they the poor spend a larger proportion of their
income on indirect taxes than the rich do

Question 6

What is a subsidy

Answer 6

In order to solve positive externalities, the government can introduce subsidies, this helps the good to reach its social equilibrium. This means that social welfare is maximised since the market produces at the output that best allocates resources.

Question 7

What are advantages of a subsidy

Answer 7

● Society reaches the social optimum output and ​welfare is maximised​.
● They can have ​other positive impacts​, such as encouraging small businesses,
bringing about equality and encouraging exports.

Question 8

what disadvantages of a subsidy

Answer 8

● The government has to spend a large amount of money, which will have a ​high opportunity cost​.
● As with taxes, they are ​difficult to target since the exact size of the externality is unknown.
● Once introduced, subsidies are ​difficult to remove​.

Question 9

how do maximum and minimum prices work

Answer 9

For a maximum price to have an effect, it must be set below the current price equilibrium. For a minimum price to have an effect, it must be above the current price equilibrium.

Question 10

what are advatntages of maximum and minimum prices

Answer 10

● They can be set where MSB=MSC, so allow for some consideration of ​externalities​, and so help to increase social welfare.
● A minimum price will ensure that goods are affordable, whilst a maximum price will ensure that producers get a fair price. Both of these are able to ​reduce poverty ​and can increase equity/equality

Question 11

What are some disadvantages of maximum and minimum prices

Answer 11

● There is a distortion of price signals and this causes ​excess supply/demand​.
● It is ​difficult for the government to know where to set the prices​, because of the difficulty of knowing the size of externalities and because it will have implications on the size of excess supply/demand.
● Both can lead to the creation of ​black markets​.

Question 12

What are tradable pollution permits

Answer 12

A pollution permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution.

Question 13

How do tradable pollution permits work

Answer 13

Companies have to buy permits in order to pollute so, in an attempt to cut costs and increase profits, companies may use greener technology. Unused permits can be sold to other companies, hence why they are tradeable. Companies exceeding their limit of pollution will face legal action.

Question 14

What are the advantages of tradable pollution permits

Answer 14

● Since the government caps the number of permits, it is ​guaranteed that pollution will fall ​to the targets set by the government. This will maximise social welfare.
● The government can ​raise revenue by selling permits and by fining firms who exceed their pollution limit.
● This encourages companies to use and invest in ​green technology.

Question 15

What are the disadvantages of tradable pollution permits

Answer 15

• This can be ​expensive to monitor and police​, but it will only work if it is monitored well. The government needs to impose fines that are large enough to ensure firms follow the regulation.
  ● It will ​raise costs for businesses, and it is likely that these higher costs will be passed onto consumers

Question 16

What are state provisin of public goods

Answer 16

the government provides these public goods directly through taxation. Similarly, the government can provide merit goods.

Question 17

What is the reason for state provision of public goods

Answer 17

Public goods are non-excludable and non-rivalry and so the free rider problem says they will be under-provided by the free market, leading to market failure.

Question 18

What are the advantages of state provision of public goods

Answer 18

● This ​corrects market failure by providing important goods which would otherwise not be provided.
● It can help to bring about ​equality,​ by ensuring everyone has access to basic goods.
● There will be ​benefits of the goods themselves​, for example by providing healthcare, the government ensures that the workforce is healthy and so this can improve economic growth.

Question 19

What are disadvantages of state provision of public goods

Answer 19

● This is ​expensive and represents a ​high opportunity cost ​for the government. Administration costs are a problem
● Since the market is not involved, the government may produce the ​wrong combination of goods as consumers can not indicate their preferences.
● The government may be ​inefficient at production since they have no incentive to cut costs.

Question 20

What is provision of information

Answer 20

When there is asymmetric information, the government provides information to allow people to make informed decisions. They may also force companies to provide information.

Question 21

What are the advantages of provision of information

Answer 21

● This helps consumers to act​ rationally,​ which allows the market to work properly.

Question 22

What are the disadvantages of provision of information

Answer 22

● This can be ​expensive​ for the government to do, incurring an opportunity cost.
● The government themselves may not always have all the information, so it may be
difficult to inform consumers.
● Consumers may ​not listen ​to the information provided due to irrational behaviour.

Question 23

What is regulation

Answer 23

Governments are able to impose laws and caps to ensure that levels are set where MSB=MSC or to ensure that companies provide full information on products.

Question 24

What are the advantages of regulation

Answer 24

● This can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. This will help to overcome market failure and maximise social welfare.

Question 25

What are disadvantages of regulation

Answer 25

● Laws may be ​expensive​ for the government to monitor, incurring an opportunity cost.
● Firms may ​pass on costs​ to the consumer in the form of higher prices.

Question 26

What is government failure

Answer 26

Government failure is when government intervention in the market leads to net welfare loss and a misallocation of resources.

Question 27

What are unintended consequences in government failure

Answer 27

Some interventions cause effects which the government did not intend to happen. Consumers and producers may react to new policies in unexpected ways and so the policy doesn’t have the effect it should.

Question 28

What are Excessive administration costs on government failure

Answer 28

In many cases, a lot of money that is allocated by the government is actually used up on basic administration costs. The social costs may be higher than social benefits, once administration costs are taken into account.

Question 29

What are information gaps in government failure

Answer 29

Any decisions that the government makes must be based on some data but the information they have is always going to be limited,

Cost and benefit forecasts of investment are often wrong and so the government invests in a system where the costs are higher than the benefits, so there is welfare loss.

Question 30

What is distortion of price signals in government failure

Answer 30

Some types of goverment intervention change price signals in the market and distort the free market mechanism. As a result they keep some companies in business when they are so inefficient there resources should be switched somewhere else

Maximum and minimum prices lead to excess demand/supply and make it difficult to allocate resources