1.4 Government Intervention Flashcards
Methods of goverment intervention (in markets)
- indirect taxation (ad valorem/specific)
- subsidies
- maximum / minimum prices
- trade pollution permits
- state provision of public goods
- provision of information
- regulation
Purpose of indirect taxation as a government intervention on markets
- passed onto consumers = effective policy to reduce consumption through higher prices
- deals with production / consumption negative externalities
- can be an ad valorem tax or a specific tax
Ad valorem vs Specific indirect tax (definition, eg, graph)
Ad valorem tax: percentage tax , percentage of final valuation of good/service paid
More expensive good = more tax paid
Eg. VAT (20% in UK)
Specific tax: fixed amount of money paid on each unit of goods/services
Tax remains same regardless of product price
Eg. Excise duty (tax on demerit goods like alcohol to reduce negative externalities)
Advantages & Disadvantages (evaluation) of indirect taxation
+ government revenue, can be invested in other schemes to reduce negative externalities further
Eg. Sugar tax, revenue spent on school programs to encourage physical activity & balanced diets to reduce obesity further
+ reduces negative externalities on over-consumed demerit goods, moves price & quantity towards socially optimum point = reducing welfare loss to society
- if goods/services taxed are relatively price inelastic (addictiveness), big increase in price only causes small decrease in consumption = indirect tax ineffective
Eg. Excise duty on demerit goods (cigarettes, alcohol) - rise in black markets due to increase in price, resources spent to tackle this problem, reducing benefit of indirect tax revenue
Purpose of subsidies as a government intervention on markets (+ graph)
Increases supply (shit of supply curve to right) due to increased profit revenue (lower costs of production) & lower consumer prices
Fixes market failure (caused by under consumption and under production of merit goods)
Eg. Solar panels, apprenticeship schemes, wind farms, rail industries
Advantages & Disadvantages of subsidies:
+ reduces welfare loss to society by reducing under consumption & under production as quantity increases , brings economy closer to social optimum output
Eg. UK education system subsidies, uni funding from gov (35% in 2012) = lower prices for students = reduced under consumption of higher education = increased positive externalities
+ encourages business startups = encouraging exports
Consumer benefit = P1-d-e-P2
Producer benefit = a-b-f-P1
- very expensive for gov to implement (cost = a-b-c-P2) = large opportunity cost if subsidy is ineffective, taken away from other important areas (police force, information campaigns)
- if demand of good/service is price elastic, a lot of subsidy passed onto producer instead of consumer = problem if subsidy implemented to increase consumption (vice versa)
- subsidies result in producer inefficiency as producers become reliant on them to survive in market
Purpose of Maximum prices as a government intervention on markets (+ graph) (advantages/disadvantages)
Maximum price: legally imposed price for a good, set below current price equilibrium, suppliers cant charge above,
Set to increase consumption of good/service (with positive externalities) that are under consumed
+ causes increase in quantity of good/service demanded
- but lower prices decrease supply of good/service (disincentivises producers as lower profits, forces inefficient firms out of market)
= excess demand
Eg. Food (Cyprus implemented €1.32 pet litre price cap on wholesale milk in 2013 to control prices & increase consumption)
Eg. Rent control in NY/Paris
Eg. Energy caps in UK
Purpose of Minimum prices as a government intervention on markets (+ graph) (advantages/disadvantages)
Minimum price: legally imposed price for a good, set above price equilibrium, suppliers cant charge below
Set to reduce consumption of good / service with negative externalities (demerit goods) (to raise price to social optimum)
- higher prices reduce demand
+ but encourages firms to increase quantity of good / service due to profit motive
= excess supply
Eg. Scotland implemented min price on alcohol in 2018 at 50p a unit to reduce negative health effects on alcohol
Eg. EU common agricultural policy (to protect farmers with stable incomes)
Eg. Minimum wage in labour market
Trade pollution permits (purpose as a form of gov intervention on markets)
(+ graph, example)
Govs implement trade pollution permit schemes to tackle market failure for excessive pollution (distributes pollution permits according to pollution limit) permits represent size of business to make requirement realistic
Firm can reduce pollution or buy pollution permits from other firms & face a fine if they dont (incentive)
Fines must be more than cost of investing in greener tech / cost of buying other permits to work
Diagram: S1= pollution permits available to firms (vertical as fixed quantity)
D1 = demand for pollution permits by firms
P1 = price of permit
Eg. China’s national cap-and-trade program (national carbon trading scheme to tackle China’s high pollution problem)
Eg. Kyoto protocol (to reduce global pollution but not signed by all countries)
Trade pollution permits advantages & disadvantages
+ incentivises firms to reduce pollution levels as they can sell remaining permits for more profit
+ firm faces increased costs in short term = decrease in supply = decrease in pollution
+ gov can set pollution limit to socially optimum point = reduces problem of overproduction
- gov needs perfect info to set permits at right level, often dont = too many permits leads to small impact on pollution levels or too few permits leads to many firms being forced out of market
- high administration costs (gov must hire ppl to monitor firms in policy)
- policy difficult to implement as hard to measure pollution levels
State provision of public goods (purpose of gov intervention on markets)
Graph, eg
Gov provides merit/public goods if free market isn’t providing as a good standard and quantity
Paid for by taxes but free consumption
Graph: vertical supply line (S1) = fixed quantity (Q1) of resources provided by gov
Price is 0 so no price rationing function = excess demand from Q1 to D1
Eg. Education & NHS in UK
State provision of public goods advantages & disadvantages
+ allows gov to provide good/service at socially optimum point (gov takes into account external costs & benefits) = no welfare loss from positive externalities & missing markets
+ reduction in inequalities within society as poorer people can enjoy benefits of goods & services for free
- big opportunity cost to gov
Eg. Gov spent 18% of budget on healthcare in 2018, very costly if unsuccessful in fixing market failure - no profit motive = more costly inefficiencies
Overall benefit derived based on state’s ability to ration the excess demand (if unable, many consumers won’t get benefits)
Eg. Use of waiting lists for NHS service & outsourcing some of healthcare to private sector in UK
Provision of information (purpose of gov intervention on markets)
(examples)
- effective when fixing market failures due to information gaps / asymmetric information (leading to underconsumption (healthy food) or overconsumption (cigarettes, unhealthy food)
Eg. UK legislation requires cigarette packets to be sold in packaging with warning of dangers of smoking to deter consumption & make consumers aware of negative health impacts
Eg. Change4life campaign launched by Public Health England encouraging families to choose healthier snacks & reduce children sugar intake = leads to positive externalities (improvement of consumer health = reduction in strain on NHS services)
Provision of information advantages & disadvantages
+ moves market closer to socially optimum point (if consumers act rationally and change spending habits) due to reduction in negative externalities / increase in positive externalities) = reduction in welfare loss to society
+ can be used with other policies (indirect taxes)
- can be expensive for gov = opportunity cost if ineffective
- gov may not have all info needed themselves = difficult to inform consumers
- consumers may not listen to info due to irrational behaviour (habitual behaviour)
Regulation (purpose of gov intervention on markets)
examples
Aim to reduce negative externalities & correct market failure, backed by legislation
Those who break regulations receive fines / prison sentences
Eg. Polluter pays principle = regulation by EU to tackle damage to environment through overproduction, agents compensate others for damage caused by pollution emissions = reduces negative externalities of overproduction & forces firms to consider impact on society
Eg. EU fishing quotas, smoking vans, minimum age laws, maximum vehicle CO2 emissions
