1.4. Government Intervention

Question 1

Define “minimum price” and why might it be introduced in a market

Answer 1

A minimum price is a price set by the government below which the price is not allowed to fall
To be effective it needs to be above the free-market equilibrium
Raising the price maybe to reduce the consumption and therefore production of negative externalities

Question 2

Explain the problems that might be encountered by a government implementing a minimum price

Answer 2

A minimum price creates a surplus and disequilibrium needs to be maintained
Some producers would be happy to sell below the minimum price
- potential for a blackmarket
Poorer households are likely to be disproportionately affected

Question 3

Define “maximum price” and why might it be introduced in a market

Answer 3

A maximum price is a price set by the government above which the price is not allowed to rise
To be effective it needs to be below the free-market equilibrium
Introduced to reduce prices of positive externality or reduce price of natural monopoly

Question 4

Explain the problems that might be encountered by a government implementing a maximum price

Answer 4

A maximum price creates a shortage and disequilibrium needs to be maintained
Some consumers may be prepared to pay above the maximum price to get the goods they want
- potential for a black market
Normally with a shortage the price rises and acts as a rationing device, so the market clears - with a maximum price the rationing device disappears and so as different method must be used (e.g. waiting lists)

Question 5

Summarise the aim of pollution permits

Answer 5

An alternative way of reducing pollution in the production of goods
They reduce pollution at a lower cost than a “command and control” method

Question 6

Explain how pollution permits work

Answer 6

1) a fixed number of emission permits are allocated each year to polluting factories
2) the total number of permits is the limit on pollution “the cap”
3) annual emissions of each factory must be less than or equal to permit holdings
4) permits can be traded (cap and trade)
5) factories which can reduce pollution for less than the price of a permit can sell spare ones
6) factories that find it more expensive to reduce pollution can buy extra permits
7) the government can reduce permits over time, by buying them and removing them from the market

Question 7

Explain how command and control methods can be used to reduce carbon emissions

Answer 7

These methods specify exactly what the maximum amount of carbon emissions is and what technologies should be used to reduce them

Question 8

What are the advantages of using pollution permits instead of “command and control”

Answer 8

+ Costs of running permit system are less when an industry is subject to direct regulation
+ Selling permits to businesses creates revenue which can be used for other schemes
+ Permits can create incentives for firms to invest in green technologies
+- The higher the cost of the permit the more likely a firm is to go green

Question 9

What are the advantages and disadvantages of using pollution permits instead of taxation

Answer 9

+ Permits create a stronger financial incentive to cut pollution than taxes
- Taxation creates greater revenue for the government, which can be spent on other forms of intervention
– although the initial selling of permits would create revenue for the government

Question 10

Define the term “public good”

Answer 10

A good that is not provided privately due to a lack of profitability
non-rival and non-excludable

Question 11

What are the advantages and disadvantages of direct provision of public goods by the government

Answer 11

+ The government can provide the exact level deemed optimal to society
+ Government provision means that all members of society will benefit
- Government can lack information and provide the wrong number of goods

Question 12

Explain why a government may have to provide information

Answer 12

If a market fails due to a lack of information or
asymmetric information, the government can
provide the information itself

Question 13

How might government fill information gaps

Answer 13

Governments can conduct awareness campaigns to give people a better understanding of the downsides
Children can be taught about the dangers of consumption
Governments require banks to provide clear information about products so that customers are less confused and can make more informed decisions

Question 14

Give the advantages and disadvantages of providing information to solve market failure

Answer 14

+ Overtime this may lead to more significant changes to society’s habits than raising prices through tax could
+ Allows greater individual liberty than banning or controlling goods
- Awareness campaigns can be ignored
- May not have much impact in the short run

Question 15

Explain what is meant by “regulation”

Answer 15

Regulation by the government that involves setting rules and requirements that must be followed by businesses and consumers

Question 16

Summarise the range of different ways the government regulates industries

Answer 16

Government regulation could impose maximum levels of something (like pollution)
Regulation could ban the production of product completely (like drugs)

Question 17

Give the advantages and disadvantages of government regulation of industries

Answer 17

+ It is relatively easy to make consumers and producers aware of the requirements
+ It is a relatively cheap process to run and enforce
- Finding the right level of intervention can be difficult (too tight or too relaxed)
- If the government does not back up regulations with sanctions, people can ignore it

Question 18

Define “government failure”

Answer 18

Intervention that results in a net welfare loss
Or
When the outcome of intervention is worse than if it were left to the free market

Question 19

Explain how the distortion of price signals may lead to government failure

Answer 19

Some government policies distort the prices that would otherwise be created by the market (taxes, subsidies)
- Government can award firms subsidies, but could protect inefficient firms from competition or create barriers to entry because prices are kept artificially low
- Minimum wage raises income levels but may mean businesses lay off the lowest paid, who the government intended to protect

Question 20

Explain how unintended consequences may lead to government failure

Answer 20

Policy interventions may lead to effects that are unanticipated
Individuals can be unpredictable and may respond to policies in ways that are unintended

Question 21

Explain how the excessive administration costs may lead to government failure

Answer 21

Sometimes the bureaucracy involved in administering a policy may become very “bloated” and costly

Question 22

Explain how the information gaps may lead to government failure

Answer 22

If government officials lack the information required they may struggle to make proper informed decisions:
- assessing the size of the external costs
- how big a tax or subsidy should be