1.4 Government intervention Flashcards
Define government provision
Government provision is a government intervention method where the government tries to correct a market failure by supplying a good/service
Define government failure
When government intervention leads to an inefficient or misallocation of resources/ welfare loss
indirect tax
Define pigouvian tax
Tax that is calculated to the size of the external cost, which will be implemented on firms that pollute/ produce demerit goods.
Imposition of tax: effect on price
P↑ , firms ↓ supply as CoP↑= P closer to socially optimum price P☆.
↑P= ↓ in external CoP
Firms have to pass on ↑P to consumers to maximise proft. Consumers cannot maximise utility= ↓ in negative consumption externality
Imposition of tax: effect on quantity
Q↓= closer to socially optimum quantity (Q ☆) as private costs ↑
↓ in negative production externality
↓ deadweight loss that occurs from externality
Further from free market equilibrium (MPC=MPB) as firms prioritise private costs and private benefits
Disadvantage of pigouvian tax
- Difficult to know size of the externality, so its difficult to target tax and govt suffers from imperfect infomation when setting tax –> if the tax is too high, it may put firms out of businesses and if the tax is too low, it wont discentivise production
- Depends whether revenue from tax will be ringfenced and allocated to projects that protect or enhance the environment to decrease negative production externality
- Incidence of tax: If PED is price inelastic, firm will pass on higher proportion of tax to consumers
Define subsidy
Government grant to firms
govt grant given to firms to increase production
Subsidy chain of reasoning
- Increase in production of merit good (Q1-Q2)
- Decrease price as CoP fall for firms
- Firms may pass on lower costs to consumers via lower prices –> lower income households can afford G/S = increase in CS = consumers can maximise utility
- Prevents firms from buying overseas
- Firms are competitive–> increases profit
- Encourages other firms to supply merit goods and decrease suppply of demerit G/S
- Fall in external costs
- Producers receive P2 from consumer & subsidy per unit from govt
Disadvantages of subsidies
- Opportunity cost - £ could have been used elsewhere eg education, NHS =merit goods –> may result in increase in tax to fund subsidy = regressive (lower income equality)
- Firms may become too reliant on govt subsidies–> if govt stops subsidising = may go out of business= market failure
- If PED is inelastic = lower P = increase QD by lesser amount –> waste of taxpayer money and economic resources
- Difficult to know what size of subsidy is effective in increase quantity
- Decrease efficiency
Minimum price chains of reasoning
- P↑ (P1-P2)
- Disequilibrium- supply doesnt meet demand= EXCESS SUPPLY
- contraction along D (consumers cannot maximise utility with P↑)
- Extension along S (profit maximisers P↑ incentivise to ↑QS)
- CS falls as they are less willing to pay at ↑P and PS ↑
- Fall in negative consumption externality
- ↑in social welfare
How can minimum/ maximum pricing lead to government failure
Leads to distortion of price signals
* Absence of price mechanism (SIRA)- cannot eradicate excess supply/ demand
* Leads to misallocation of resoucres - inefficent
Minimum pricing definition
A price floor: government cannot legally sell good or service at a lower price
Define pollution permits
States how much firms are legally allowed to pollute in order to decrease carbon emissions
Pollution permits chains of reasoning
- Govt issues a fixed amount of pollution permits in the economy - supply is perfectly inelastic
- Overtime govt decrease supply of permits (S1-S2)
- P↑ due to scarcity of permits –> ↑ CoP so firms either: pay more for the right to pollute or incentivised to decrease pollution and switch to greener technology
- Firms= profit maximisers = decrease amount they pollute to decrease costs
- May engage in R&D for greener technology
- Carbon trading decrease emissions in lowest cost way as each permit is worth more to the most carbon efficient businesses
- Externality internalised –> maximises social welfare = decrease Q of pollution
Disadvantages of pollution permits
- Tradable pollution permits not standardized globally –> needs international cooperation
95 euros per tonne for UK permit but 0.58 euros in Brazil
UK firms may move production to Brazil ==C02 emissions are just displaced from 1 country to another rather than eradicating externality - Difficult to know how many permits govt should allow if P too low = excess supply (issueing too many permits) = no incentive to invest in green alternative or cut CO2 as P too low
In the UK, as seen from the extract, the PES for housing is less than 0.5.
What is the disadvantge of this
This means supply is inelastic, and therefore, prices have to increase severely in order to encourage a significant boost to housing supply.
With a growing population, this presents a problem. Over time, people will find it more and more difficult to get on the housing ladder, unless incomes increase dramatically so people can afford the high deposits necessary.
Why does government provide infomation for goods and services and what are the benefits
- Ensures economic units can maximise decisions when consuming and producing G+S
- Allows consumers to make rational decisions = allocative efficiency
What does the provision of flood defences depend on
The success of provision of flood defences would depend on the government figures being correct. If the data is not accurate, and the government is not sure of the costs vs benefits, then the government should not intervene as there is a high risk of government failure. This would, therefore, waste taxpayer money and economic resources.
The government’s data could also be accurate, but it may have come at an extremely high cost to gather. This must also be taken into account. It is very difficult to calculate this accurately, because everybody has a different valuation of the environment so any flood damage can only be seen as an estimate and not a real figure.
Why might the quality of production carried out by a private firm be worse than that of the government.
The government is less likely to cut costs at the expense of quality and is likely to prioritise making their buildings safe for occupants. This is because the government’s objective is to maximise social welfare and ensuring people’s safety.
Disadvantage of free market approach
Without government intervention, there would be missing markets.
The free rider problem would mean most economic agents would rely on others to provide public goods like education, defence, and street lighting.
These goods would be under consumed and have positive externalities, and self-interest would prevent a free market alone to provide adequate public good provision.
This would inevitably affect the lowest income earners the most and increase inequality.
It’s the poorest that have the most income elastic demand and so are important for the success of a free market.
Define unintended consequences
Distortion of consumer or producer behaviour due to the impact of an economic decision
