1.4 government intervention

Question 1

pros to indirect tax

Answer 1

• internalises the externality
• Source of revenue for the government that
  can be used by those affected by the
  externality
• Few administrative costs

Question 2

cons to indirect tax

Answer 2

• If demand is inelastic will be ineffective in reducing pollution
• Difficulty in setting an appropriate tax
• Increased business costs
  -creation of a black market
  -taxes are unpopular

Question 3

pros to subsidies

Answer 3

• Reduction in costs of production, therefore reduction in price
• Incentive for people to increase consumption
• Might help reduce inequality
• social optimum is reached so maximises welfare

Question 4

cons to subsidies

Answer 4

• Cost to the taxpayer of providing subsidies
• If demand is inelastic can be ineffective in the increase of consumption
• Difficulty setting the appropriate amount for the subsidy

Question 5

pros to max prices

Answer 5

• Enable consumer on low incomes to afford the good or service
• Help prevent an increase in the country’s rate of inflation
• Prevent exploitation of consumer by monopolies

Question 6

cons to max prices

Answer 6

• Danger that shortages mean some consumers are unable to find supplies of the product
• Producers may exit the market to use resources in something more profitable
• If government subsidises producers to maintain output this is a significant cost to the taxpayer

Question 7

what is tradeable pollution permits

Answer 7

• Government issues permits to firms allowing them to pollute to a certain limit
• Any pollution above this limit is then fined
• The permits can be traded between firms
• Cleaner firms can sell their surplus permits to other firms that are polluting more
• Used to reduce external costs

Question 8

pros to tradeable pollution permits

Answer 8

• These schemes work through the market mechanism
• Incentive for firms to reduce pollution
• Administration costs are low compared to systems of regulation
• Can be planned reduction in pollution over time

Question 9

cons to tradable pollution permits

Answer 9

• Pollution will continue (at a lower level than previously)
• Large, efficient firms can buy up the permits and continue to pollute
• Need to be internationally enforced to be effective
• Might make country’s goods less competitive internationally

Question 10

pros to state provision of goods

Answer 10

• Ensures the product or service is being provided and available to everyone

Question 11

cons to state provision of goods

Answer 11

• Politicians determine the amount of resources allocated to these public goods without direct reference to the consumers

Question 12

pros to provision of information

Answer 12

• allows for consumers to act rationally

Question 13

cons to provision of information

Answer 13

• expensive
• has to be used with other methods
• consumers may not listen

Question 14

pros to regulation

Answer 14

• Act as an incentive to producers to develop new technologies that reduce the external costs
• Limit external costs without an impact on the price

Question 15

cons to regulation

Answer 15

• Enforcement of laws/regulations have a cost
• firms may pass on costs

Question 16

what is gov failure

Answer 16

• When government intervention in an attempt to correct market failure causes output and consumption to move further away from a socially efficient output
• Results in a more inefficient allocation of resources leading to a net welfare loss

Question 17

what is distortion of price signals

Answer 17

• The manipulation of prices
• Maximum and minimum prices controls

Question 18

what is administration costs

Answer 18

• The costs of some government intervention systems and schemes can have excessive costs

Question 19

Why might a government intervene into the economy

Answer 19

• Address marker failures
• Raise revenue
• Social or political reasons

Question 20

Forms of government intervention

Answer 20

• Indirect taxes
• Subsidies
• Minimum and maximum prices
• Tradable pollution permits
• State provision of public goods
• Provision of information
• Regulation

Question 21

Indirect taxes impact

Answer 21

• Increase in the cost of supply
• Leftward shift to the supply curve

Question 22

What can indirect taxes deal with

Answer 22

• Deal with external costs
• Internalise the externality so that output and consumption are at the level where SMB = SMC

Question 23

what’s a subsidy

Answer 23

• Government grants to businesses that reduce production costs, causing a rightwards shift in supply curve

Question 24

When might subsidies be used?

Answer 24

• When there are external benefits of production or consumption

Question 25

How will subsidies affect demand?

Answer 25

• Good or service will be provided at a lower price
• Encourage production so socially optimal level is reached

Question 26

Why do subsidies effect the supply curve?

Answer 26

• Because they affect the cost of production
• Therefore they do not effect the demand curve

Question 27

pros to min prices

Answer 27

• Producer know in advance the price they will receive for the product
• Greater certainty allows producers to plan investment and output
• Prevents exploitation of producers by wholesalers and retailers with significant buying power

Question 28

cons to min prices

Answer 28

• Minimum price set too high there will be surpluses each year
• Schemes involve costs of storage which is borne by taxpayers
• Encourage overproduction resulting in inefficient allocation of resources

Question 29

How does the manipulation of prices lead to government failure?

Answer 29

• They undermine the key functions of the price mechanism: signalling, rationing and incentives
• Leading to distortion of price signals
• Resources are not allocated efficiently

Question 30

How can policies lead to government failure?

Answer 30

• Some types of government intervention may have an impact that policy-makers did not anticipate

Question 31

How do information gaps lead to government failure?

Answer 31

• When a government intervenes it is unlikely they have all the required information
• Intervention could them move output further away from the socially optimum level

Question 32

Indirect taxes (government failure example)

Answer 32

• Very high indirect taxes can result in smuggling to avoid tax
• No tax revenue
• Further away from socially optimum level of output