1.4 Government Intervention

Question 1

What is the definition of government intervention?

Answer 1

Government intervention is when government take certain actions such as tax, subsidies etc to overcome market failure.

Question 2

What is indirect tax?

Answer 2

Indirect tax is tax placed on the price of goods and services.

Question 3

How does indirect tax decrease negative externality?

Answer 3

An indirect tax placed on a product which
- increases its price
- which decreases its demand
- which decreases the marginal social cost

Question 4

Advantages of indirect tax?

Answer 4

• Internalises the externality - market now produces at social equilibrium/social welfare maximised.
• Raises government revenue, can be used to solve externality in other ways such as education. However, will only work if revenue is used efectively.

Question 5

Disadvantages of indirect tax?

Answer 5

• Difficult to measure size of externality; difficult to set correct tax amount; imperfect information
• Lead to creation of black market
• Regressive; poorer people spend larger proportions of their money than richer people on the tax.

Question 6

What is a subsidy?

Answer 6

A subsidy is a grant given to firms by the government to help stabilize economy.

Question 7

How does a subsidy decrease market failure?

Answer 7

• Fixes information gaps
• Lower cost of production
• which shifts supply curve to the right, increases production
• social welfare maximises, best allocation of resources

Question 8

Advantages of subsidies?

Answer 8

• Society reaches social optimum output and welfare is maximised
• encourages small business

Question 9

Disadvantage of subsidies?

Answer 9

• Government revenue reduces, high opportunity cost
• Can cause producers to become inefficient
• Exact size of externality unknown, hard to target correct subsidy price

Question 10

What is a maximum price?

Answer 10

Maximum price is a legally imposed price under equilibrium price for a good that suppliers cannot charge over. Set on positive externalities.

Question 11

What is the purpose of a maximum price?

Answer 11

Prevents monopolies from increasing their prices too high to exploit customers. Prevents unfair consumer pricing.

Question 12

What is a minimum price?

Answer 12

A minimum price is a legally imposed price which the price of a good cannot go below. Set on goods with negative externalities to discourage consumption.

Question 13

Disadvantage of minimum price?

Answer 13

Can cause excess supply as Qd is smaller than Qs

Question 14

What is a merit good?

Question 15

What is a demerit good?

Question 16

What is a tradeable pollution permit?

Answer 16

Allows the owner to pollute upto a specific amount;
government control how many permits to limit max pollution

Question 17

How does tradeable pollution permits affect firms?

Answer 17

Firms incentivised to produce less pollution.
In attempt to cut costs, companies may use greener technology.

Question 18

Advantages of Tradeable pollution permit

Answer 18

Guaranteed fall in pollution
- Caps regulated by government
Govt revenue increase
- Selling permits to firms; fining firms exceeding limit
Investment in green technology

Question 19

Disadvantages of Tradeable pollution permit

Answer 19

Expensive to manage
- Monitor and police costs money
Raise costs for business
- Passed onto consumers via higher price

Question 20

What is government failure?

Answer 20

Govt failure is when govt intervention in the market leads to net welfare loss and greater misallocation of resources.
Total social costs arising from the intervention greater than social benefit