1.4. Government intervention Flashcards
What is government intervention?
Government intervention in markets is when the state actively sets rules, regulations or introduces measures to change the workings of the free market economy
What are the advantages of indirect tax as a type of government intervention?
- Decreases supply of demerit goods (higher COP) -> reduces incentive to produce
- Raises gov revenue which could be used to solve the externality in other ways (e.g. education)
- Internalises the externality -> the market now produces at social equilibrium position and social welfare is maximised
What are the disadvantages of indirect tax as a type of government intervention?
- Emergence of black markets (could already exist)
- Inelastic demand -> tax will be ineffective at reducing output
- Regressive policy -> the poor spend a larger proportion of their income than the rich do
What are the advantages of subsidies as a type of government intervention?
- Society reaches social optimum and welfare is maximised
- Might attract other firms into the market
- Reduced demand for demrit goods, increased demand for merit goods
- Reduced COP -> increased global compeptiveness of firms - encoruages exports
- Increased incentive to produce -> more consumption of merit goods
What are the disadvantages of subsidies as a type of government intervention?
- Gov has to spend a large amount of money -> high opportunity cost
- May encourage laziness from producers because they do not need to be as efficient
- Elasticity of demand
What is a minimum price?
A legally imposed price floor set by government regulation which prevents prices from falling below a certain level
What are the advantages of minimum price as a type of government intervention?
- Decreased consumption of demerit goods
- Protects the stability of producers’ income -> more investment in agriculture
- Tax revenue rises as business profits rise
- Gov will own large stocks of food -> gives nation food security
What are the disadvantages of minimum price as a type of government intervention?
- Elastic PED -> will harm businesses
- Emergence of black markets
- Opportunity cost
- Distorts price signals -> excess supply
- Waste of perishable resources
- Lower demand for domestically produced goods
What is a maximum price?
When the government sets a legal limit on the price of a good or service - also known as a price ceiling - with the aim of reducing prices below the market equilibrium
What are the advantages of maximum price as a type of government intervention?
- It makes socially important goods more available
- Reduces price volatility
- Prevents price exploitation from producers
- Increases consumer surplus
- Reduces power of monopolies
- Increased consumption of merit goods (lower price)
What are the disadvantages of maximum prices as a type of government intervention?
- Reduces incentive to produce
- Leads to an imbalance in the market -> excess demand
- Decreased price competitiveness
- Emergence of black markets -> costly for society due to increase in criminal activity - cost to government
What are tradable pollution permits?
- Regulated allowances that allow producers to generate pollution
- If pollution over the permitted allowance is created, a fine will occur
- If firms find they produce less pollution than allotted, they can sell the excess permits to another firm for money
What are the advantages of tradable pollution permits as a type of government intervention?
- Government can raise revenue by selling permits and fining firms who exceed their pollution limit -> can be used to clean up environment so negative externality is internalised
- Encourages firms to lower pollution levels - more benefit
- Encourages firms to use and invest in green technology
- Maximises social welfare
What are the disadvantages of tradable pollution permits as a type of government intervention?
- Complex system to implement
- Expensive to monitor and police
- Firms can outsource production
- If firms are large, making huge profits, they won’t care about the fines (monopoly)
- All countries must use it for it to be effective
- Firms can manipulate their emissions data - difficult to quantify
- Firms may find it profitable to just pay the costs
What are the advantages of state provision of public goods as a type of government intervention?
- Corrects market failure by providing important goods that otherwise would not be provided (non-profitable) -> improved social welfare
- Reduced inequality by redistributing money from wealthy to poor
- Can help bring about equality -> ensures everyone has access to basic goods
- There will be the benefits of the goods themselves, e.g. providing healthcare ensures workforce is healthy
What are the disadvantages of state provision of public goods as a type of government intervention?
- Expensive & high opportunity cost for government - administrative costs are a problem
- The gov may be inefficient at production as they have no incentive to cut costs -> the economic incentives for efficiency could be eroded
- Gov officials may suffer from corrupt officials or conflicting objectives
- With asymmetric information, there is a risk of government failure
What are the advantages of provision of information as a type of government intervention?
- Helps consumers act rationally which allows the markets to work properly
- Decreased consumption of demerit goods
What are the disadvantages of provision of information as a type of government intervention
- Expensive for gov -> incurs opportunity cost
- Consumers may not listen to the information provided due to irrational behaviour
- The gov themselves may not always have all the information -> difficult to inform consumers
What is regulation as a type of government intervention?
Governments can impose laws and caps to ensure that levels are set where MSB=MSC or to ensure companies provide full information on products
What are the advantages of regulation as a type of government intervention?
- Can correct market failures that arise from externalities
- Can control monopolies and stop them from taking advantage of customers and reducing welfare
- Legislation provides a means of punishing firms for their anti-competitive behaviour
- Regulation can be used to protect the environment
What are the disadvantages of regulation as a type of government intervention?
- Laws may be expensive for government to monitor -> incur opportunity cost
- Firm may pass on costs in the form of higher prices (expensive to follow)
- Excessive regulation may reduce competition in a market & efficiency -> increasing bureaucracy & reducing innovation
What is government failure?
Government failure happens when government intervention leads to a net welfare loss
What are the 4 main causes of government failure?
- Unintended consequences
- Distortion of price signals
- Excessive administrative costs
- Information gaps
What are unintended consequences as a cause of government failure?
- Some interventions cause effects that the government didn’t 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
What is distortions of price signals as a cause of government failure?
- Some types of government intervention change price signals in the market & distort the free market mechanism
- Keep some companies in business when they are inefficient so the resources should be switched to elsewhere or consumers pay too much for a good
- E.g. max/min prices lead to excess demand/supply, making it difficult to allocate resources
What are excessive administrative costs as a cause of government failure?
- A lot of money allocated to the gov is used on basic admin costs
- Social costs > social benefits once admin costs are taken into account -> intervention may not be worthwhile
What are information gaps as a cause of government failure?
- Asymmetric information limits the governments’ ability to critically assess market failures and possible solutions
- The right decision isn’t always made and government failures may arise
Minimum price - real world example
- EU Common agricultural policy
- Subsidies to UK farmers worth £3.5 billion (2018)
Maximum price - real world example
Rent controls in New York
- Landlord can increase rent by up to 7.5% annually until they reach the maximum
