1.4 government intervention

Question 1

what are indirect taxes?

Answer 1

-taxes are put on expenditure (e.g cigarettes)
-increase production costs for producers so they produce less
-increases market price so demand contracts

Question 2

what are the two types of indirect taxes?

Answer 2

-ad valorem tax
-specific taxes

Question 3

what is an ad valorem tax?

Answer 3

-percentages, such as VAT which adds 20% of the unit price

Question 4

what is a specific tax?

Answer 4

a set tax per unit, such as 58p per litre fuel on unleaded petrol

Question 5

advantages of indirect tax

Answer 5

1. internalises the externality- market now produces at social equilibrium and social welfare is maximised
2. raises government revenue which may help goods become more elastic in the long run

Question 6

disadvantages of indirect tax

Answer 6

1. difficult to know the size of the externality so it is difficult to target the tax
2. could be conflict between government goal of raising revenue and solving the externality
3. could lead to creation of black market
4. if the demand for the good is inelastic then the tax will be ineffective at reducing output

Question 7

what is a subsidy?

Answer 7

a payment from the government to a producer to lower their costs of production and encourage them to produce more

Question 8

advantages of subsidy

Answer 8

1. society reaches the social optimum output and welfare is maximised
2. may encourage small businesses bringing about equality and encouraging exports

Question 9

disadvantage of subsidies

Answer 9

1. government has to spend a large sum of money leading to a high opportunity cost
2. difficult to target as the exact size of the externality is unknown
3. producers can become inefficient especially if they are in place for a long time
4. once introduced, they are hard to remove

Question 10

what is a maximum price?

Answer 10

-the government may set a maximum price where the consumption or production is to be encouraged
-this is so the good does not become too expensive to produce or consume
-have to be set below the free market price

Question 11

what is a minimum price?

Answer 11

-where consumption or production is to be discouraged and ensures the hood never falls below a certain price
-have to be set above the free market price
-e.g minimum wage

Question 12

advantages of min/max prices

Answer 12

1. help increase social welfare
2. max price will ensure goods are affordable whilst min prices ensure producers get a fair price, both able to reduce poverty and increase equality

Question 13

disadvantages of min/max prices

Answer 13

1. distortion of price signals causing excess supply/ demand
2. difficult for government to know what prices to set
3. can lead to creation of the black market

Question 14

what is a tradeable pollution permit?

Answer 14

-limits the amount of pollution created in industries (a negative externality)
-firms can buy and sell allowances between themselves

Question 15

advantages of pollution permit

Answer 15

1. should benefit the environment in the long run
2. government can raise revenue from permits as they can sell them to firms
3. firms can sell their permits which raises revenue for greener firms

Question 16

disadvantages of pollution permit

Answer 16

1. could lead to some firms relocating to where they can pollute without limits which can reduce their production costs
2. firms might pass on higher costs to the consumer
3. expensive for government to monitor emissions

Question 17

what is a public good?

Answer 17

-they are non-excludable and non-rivalry
-free rider says they are under provided by the free market leading to market failure

Question 18

advantages of public goods

Answer 18

1. corrects market failure by providing goods which otherwise wouldn’t be provided leading to improved social welfare
2. by providing something like healthcare this ensures the workforce is healthy so it will improve economic growth

Question 19

disadvantages of public goods

Answer 19

1. expensive with a high opportunity cost for the government
2. government may be inefficient at production since they have no incentive to cut costs
3. since market isn’t involved the government may produce the wrong combination of goods e.g many soldiers and not enough hospital beds

Question 20

what is provision of information?

Answer 20

when there is asymmetric information the government provides information to allow people to make informed decisions

Question 21

advantages of provision of information

Answer 21

1. helps consumers act rationally which allows the market to work properly
2. best if used alongside other policies e.g can make demand more elastic in the long run and so help indirect taxes to become more effective at reducing output

Question 22

disadvantages of provision of information

Answer 22

1. can be expensive for the government to do so, incurring an opportunity cost
2. government may not always have all the information so it is difficult to inform consumers
3. consumers may not listen to the information provided due to irrational behaviour

Question 23

what is regulation?

Answer 23

governments imposing laws and caps to ensure that levels are set where MSB=MSC or to ensure companies provide full information on products

Question 24

advantages of regulation

Answer 24

1. can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. this will help overcome market failure and maximise social welfare

Question 25

disadvantages of regulation

Answer 25

1. laws may be expensive for the government to monitor incurring an opportunity cost
2. don’t take into account the different costs of following the laws for different companies
3. firms may pass costs to consumers
4. excessive regulation may reduce competition and efficiency, increasing bureaucracy and reducing innovation

Question 26

the 4 causes of government failure

Answer 26

-distortion of price signals
-unintended consequences
-excessive administration costs
-information gaps

Question 27

what is distortion of price signals

Answer 27

-when government intervention changes price signals in the market and distorts the free market mechanism
-e.g subsidies keeping a farmer in employment when they cannot produce cheaply enough to be competitive as a result the government keeps them in business when they should close down and find an alternative use for their resources

Question 28

what is unintended consequences?

Answer 28

-when the actions of producers and consumers have unexpected or unintended consequences

Question 29

what is excessive administrative costs?

Answer 29

-the social benefits of a policy are not worth the financial cost of administering the policy and might cost more than the government anticipated
-government has to consider whether the policy is good value for money

Question 30

what are information gaps?

Answer 30

-limited information is available which the government makes decisions on
-costs and benefit forecast of investment is often wrong and so the government invests in a system where the costs are higher than the benefits so there is a welfare loss for the government to get info they need