1.4 Government Intervention Flashcards
What is the purpose of government intervention in markets, and how does it relate to market failure?
Government intervention aims to correct market failure, where markets fail to allocate resources efficiently. This includes addressing issues such as externalities, public goods, and information asymmetry to improve societal welfare.
Differentiate between ad valorem and specific taxes.
Ad valorem tax: A percentage-based tax, such as VAT, that increases with the price of the good.
Specific tax: A fixed amount charged per unit of a good, regardless of its price.
Explain with a diagram how an indirect tax can correct negative externalities.
An indirect tax increases the cost of production, shifting the supply curve upward (or left). This raises the equilibrium price, reducing quantity consumed and aligning private costs with social costs, potentially eliminating overconsumption.
How do subsidies address market failure?
Subsidies reduce production costs, shifting the supply curve downward (or right). This lowers the price and increases the quantity consumed, encouraging the production or consumption of goods with positive externalities, like education or green energy.
Define maximum and minimum prices and provide an example for each.
Maximum price: A legally imposed upper limit below the market equilibrium price (e.g., rent controls).
Minimum price: A legally imposed lower limit above the market equilibrium price (e.g., minimum wage).
What is a potential drawback of implementing a minimum price?
A minimum price may lead to excess supply or surpluses, as producers supply more than consumers are willing to buy at the higher price.
What are trade pollution permits, and how do they work?
Trade pollution permits are allowances given to firms for a certain level of emissions. Firms can trade these permits, creating a market for pollution. This incentivizes firms to reduce emissions to sell unused permits.
Explain the state provision of public goods with an example.
Public goods, like national defense or street lighting, are provided by the government because they are non-excludable and non-rivalrous, making it unprofitable for private firms to supply them.
How does the provision of information help correct market failure?
Governments provide information to reduce information asymmetry. For example, health campaigns about the risks of smoking help consumers make informed decisions, correcting market failure caused by imperfect information.
Describe the role of regulation in correcting market failure.
Regulation imposes rules, such as emission limits or safety standards, to curb negative externalities or ensure fair practices in markets where the free market fails.
What is government failure?
Government failure occurs when government intervention leads to a net welfare loss rather than improving market outcomes.
How can distortion of price signals cause government failure?
Price controls, such as minimum or maximum prices, can prevent markets from reaching equilibrium, leading to surpluses or shortages and inefficient resource allocation.
Give an example of unintended consequences in government intervention.
A subsidy for biofuels may increase crop prices, making food less affordable, or lead to deforestation as farmers expand land for biofuel crops.
Why might excessive administrative costs lead to government failure?
The costs of implementing, monitoring, and enforcing policies may outweigh the benefits, reducing overall welfare.
