1.4 government intervention

Question 1

what are the advantages of indirect taxation?

Answer 1

it internalizes the externality so social welfare is maximised. it raises government revenue which could be used to solve the externality in other ways such as education which will help goods become more elastic in the long run.

Question 2

what is the disadvantages of a indirect tax?

Answer 2

difficult to know the size of the externality so difficult to target tax (government imperfect information). could lead to conflict between government objectives such as raising revenue and solving the externality. may lead to black market. if demand for good is inelastic then tax will be ineffective. politically unpopular. they are regressive.

Question 3

what is the effect of a subsidy on the supply curve and why?

Answer 3

This will shift the supply curve to the right as it will lower the cost of production.

Question 4

what are the advantages of a subsidy?

Answer 4

society reaches the social optimum output and welfare is maximised. bring other positive impacts such as encouraging small businesses and encouraging exports

Question 5

what are the disadvantages of a subsidy?

Answer 5

the government has to spend a large amount of money so high opportunity cost, difficult to target since the exact size of externality is unknown. subsidies can cause producers to become inefficient especially if they are there for long time. subsidies become difficult to remove

Question 6

what is a maximum price?

Answer 6

A maximum price is a legally imposed price for a good that the suppliers cannot charge above

Question 7

what are maximum prices set on?

Answer 7

They are set on goods with positive externalities so price is lowered to socially optimum point and consumption is encouraged

Question 8

what is a minimum price?

Answer 8

A minimum price is a legally imposed price at which the price of the good cannot go below.

Question 9

what are mininum prices set on?

Answer 9

They can be set on goods with negative externalities, so that the price is raised to the social optimum point and consumption is discouraged.

Question 10

what is the effect of a minimum price on producers?

Answer 10

They also encourage producers to produce

goods, so can be set on goods with social benefits that are underprovided by the market

Question 11

what are the advantages of min and max prices?

Answer 11

they can be set where MSB=MSC, so allow consideration for externality’s which will improve social welfare. a min price will ensure goods are affordable, whilst a max price will ensure producers get a fair price. both reduce poverty and increase equality.

Question 12

what are disadvantages of max and min prices?

Answer 12

there is distortion of price signals which can lead to excess supply/demand. difficult for government to know where to set the prices because of difficulty knowing the size of externalities. both can lead to the creation of black markets. max prices may lead to illegal bribes and discriminatory policies in allocating goods

Question 13

what are examples of maximum prices?

Answer 13

Maximum prices have been implemented in Manhattan in the from of rent controls on properties. On top of this, there are price caps on milk, toilet paper, medicine, petrol and other key goods in Venezuela: this has led to the creation of a black market and the goods are no longer sold in supermarkets as the firms are unable to make a profit at those prices.

Question 14

what are examples of minimum prices?

Answer 14

In Scotland, a minimum price has been imposed on alcohol. It targets the cheapest drinks, which aims to cut down on binge drinking, but it will have negative effects on poverty for those who are addicted. Minimum prices on Limousines in Nashville have stifled competition
as the most price competitive firms are forced out of business.

Question 15

what are tradeable pollution permits?

Answer 15

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. 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

Question 16

what are the advantages of pollution permits

Answer 16

government caps the permits so it is guaranteed pollution will fall so welfare is maximised. government can raise revenue by selling permits and through fines. encourages green investment. firms are able to make their own decisions about whether to cut pollution or buy more permits which encourages efficiency.

Question 17

what are the disadvantages of pollution permits?

Answer 17

this can be expensive to monitor and police, but only works when monitored well. the fines need to be large enough to be effective. it will raise costs for businesses and is likely these higher costs will be passed to consumer. it is difficult to know how many permits the government should allow.

Question 18

what is an example of tradeable pollution permits?

Answer 18

One successful example is the US Sulphur trading scheme, which reduced Sulphur dioxide by 40%. The EU Emissions Trading Scheme (ETS) was launched in 2005 and it represents
a 21% reduction in greenhouse gases. Since then, other greenhouse gases like nitrous oxide have been included and the scheme has been extended to the airline industry. The
permit scheme has also been introduced in China.

Question 19

what are the characteristics of a public good?

Answer 19

Public goods are non-excludable and non-rivalry

Question 20

what is a problem that occurs with public goods and why does it occur?

Answer 20

the free rider problem. To the free rider, there is little incentive to contribute to a collective resource since they can enjoy its benefits even if they don’t. As a consequence, the producer of the resource cannot be sufficiently compensated. The shared resource must be subsidized in some other way, or it will not be created.

Question 21

how does the government provide public goods?

Answer 21

the government provides these public goods directly through taxation

Question 22

what are the advantages of the state provision of public goods?

Answer 22

corrects market failure by providing important goods that would otherwise not be provided , this leads to improved social welfare. can help bring about equality by ensuring everyone access to basic goods. there will be benefits from the actual goods themself (ensuring healthcare will mean workforce is healthy so more productive)

Question 23

what are the disadvantages of the state provision of public goods?

Answer 23

this is expensive and represents a high opportunity cost for the government. administration costs are a problem. since market is not involved, government could produce the wrong combination of goods as consumers can not indicate their preferences. government may be inefficent at production since they have no incentive to cut costs. government officials may suffer from corruption and conflicting objectives.

Question 24

what is an example for the state provision of public goods?

Answer 24

In the UK, the government provides a number of goods including roads, education and healthcare. The NHS suffers from severe underfunding and many schools are having their budgets cut. Moreover, more money is spent on improving railways than roads, even though 92% of all journeys in the UK are made on roads, suggesting incorrect resource allocation.

Question 25

what is the provision of information?

Answer 25

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 26

what are the advantages of the provision of information?

Answer 26

this helps consumer to act rationally, which allows the market to work properly. it is best if used alongside other policies. for example, it can make demand more elastic in the long run and so help indirect taxes to become more effective at reducing output.

Question 27

what are the disadvantages of the provision of information?

Answer 27

it can be expensive for the government, so will incur an opportunity cost. the governments themself have all the information so it may be difficult to inform consumers. consumers may not listen to the information provided due to irrational behavior.

Question 28

what is regulation?

Answer 28

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 29

what are the advantages of regulation?

Answer 29

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 30

what are the disadvantages of regulation?

Answer 30

laws may be expensive for government to monitor, incurring an opportunity cost. they don’t take into account the account the different costs of following laws for different companies, regulation is less efficient method of reducing pollution. government can suffer from regulatory capture. firms may pass on costs to the consumer in the form of higher prices. excessive regulation may reduce competition in a market and efficiency by increasing bureaucracy and reducing innovation.

Question 31

what is government failure?

Answer 31

Government failure is when government intervention in the market leads to net welfare loss and a misallocation of resources. The total social costs arising from the intervention are
greater than the social benefit.

Question 32

what is the distortion of price signals?

Answer 32

Some types of government 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 inefficient so the resources should be switched to somewhere else (subsidies) or make consumers pay too much for a good (taxes).

Question 33

what is unintended consequences?

Answer 33

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 34

what is excessive administration costs?

Answer 34

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 35

what are information gaps?

Answer 35

Any decisions that the government makes must be based on some data but the
information they have is always going to be limited, for example you cannot
accurately predict the number of cancer patients or the number of cars on the road. 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. It is impractical, and usually impossible, for the government to get every piece of information they need.