1.4 Government Failure Flashcards
What are examples of government intervention?
- Indirect taxes (VAT)
- Subsidies
- Regulation/legislation
- Maximum prices
- Minimum prices
- Tradeable pollution permits
- Education
- Government provision
What is a negative externaility?
(in production)
A loss to a third party, who were not involved in the transaction
What is a positive externaility?
(in consumption)
Benefit to a third party, not directly involved in the transaction
What is government failure?
When government intervention leads to a misallocation of resources
What are reasons for government failure?
- Political self interest (lowering taxes before reelection)
- Policy Myopia (looking for a quick fix)
- Regulatory capture (looking after producers more than consumers)
- Disincentives arising from polocies
- Tax evasion
- Imperfect information within government
- The law of unintended consequences (minimim wage)
- Costs of administation could be large (opp cost)
What is indirect tax?
A type of tax that is imposed on producers (suppliers) by the government
What are problems with indirect taxes?
- Can encourage tax evasion (e.g - buying cigarettes from the black market)
- Can be perceived as aggressive - wealthier people may be able to afford to pay indirect tax, but poorer people will struggle
How does indirect tax work?
Tax is added onto a product before it is sold in the shop, this money then goes to the government, which allows them to have more money to inject into the economy to hopefully grow the economy
What type of market failure is indirect taxes?
Negative externalitites
What is a subsidy?
Financial assistance provided by the government to encourage economic activity
How does a subsidy work?
A payment is made to a business to reduce the marginal cost of supply.
What are problems with subsidies?
- Producers may become dependent on subsidies
- Can distort resource allocation
environmental risks due to excessive production - Subsidies are expensive
What type of market failure is subsidies
Positive externalities
What is maximum pricing?
A legally-imposed maximum price in a market that suppliers cannot exceed - in an attempt to prevent the market price from rising above a certain level
How does maximum pricing work?
It increases the allocation of resources in the market by: setting a maximum price, which is lower than the market price, suppliers cannot exceed this price, this protects consumers so they can still afford to buy essentials like food and medicine
What are problems with maximum pricing?
- Maximum prices can lead to shortages, as producers may not be able to cover their costs at a lower price, this may reduce production or exit the market altogether
- Maximum prices can lead to black markets
What is minimum pricing?
Government imposed price controls that set the lowest legal price at which a good and service can be sold
How does minimum pricing work?
A minimum price is set above the equilibrium price, which prevents the price from falling below that level, producers benefit because they receive a higher price, consumers may lose out as they have to pay more for the goods than they otherwise would.
What are problems with minimum pricing?
- Surplus production - when quantity demanded exceeds quantity supplied
- Inefficient resource allocation
Higher prices for consumers
What are tradeable pollution permits?
Uses the market mechanism to change relative prices and the incentives of producers/ consumers to alter behaviour to reduce their carbon emissions.
How do tradeable pollution permits work?
Governments calculate an optimum level of pollution. They then create a pollution permit market and issue permits to polluting firms. Firms that pollute more have to buy additional permits from less-polluting firms. The price of the permit represents an additional cost of production. The price of the permit changes as it is determined by demand and supply
What are problems with tradeable pollution permits?
- hard to measure the level of CO2 output
- still gives permission to pollute
- increased cost of production for firms
What is state provision?
When a nationalised industry is the main provider of a good or service. Often the case for public and merit goods.
Nationalised industry - when a government takes control or ownership of private property, like a company
What are problems with state provision?
- Paid through general taxation
- Opportunity cost
- free products can create excess demand and long waiting times
