1.4 government intervention Flashcards
what are indirect taxes?
-taxes are put on expenditure (e.g cigarettes)
-increase production costs for producers so they produce less
-increases market price so demand contracts
what are the two types of indirect taxes?
-ad valorem tax
-specific taxes
what is an ad valorem tax?
-percentages, such as VAT which adds 20% of the unit price
what is a specific tax?
a set tax per unit, such as 58p per litre fuel on unleaded petrol
advantages of indirect tax
- internalises the externality- market now produces at social equilibrium and social welfare is maximised
- raises government revenue which may help goods become more elastic in the long run
disadvantages of indirect tax
- difficult to know the size of the externality so it is difficult to target the tax
- could be conflict between government goal of raising revenue and solving the externality
- could lead to creation of black market
- if the demand for the good is inelastic then the tax will be ineffective at reducing output
what is a subsidy?
a payment from the government to a producer to lower their costs of production and encourage them to produce more
advantages of subsidy
- society reaches the social optimum output and welfare is maximised
- may encourage small businesses bringing about equality and encouraging exports
disadvantage of subsidies
- government has to spend a large sum of money leading to a high opportunity cost
- difficult to target as the exact size of the externality is unknown
- producers can become inefficient especially if they are in place for a long time
- once introduced, they are hard to remove
what is a maximum price?
-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
what is a minimum price?
-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
advantages of min/max prices
- help increase social welfare
- max price will ensure goods are affordable whilst min prices ensure producers get a fair price, both able to reduce poverty and increase equality
disadvantages of min/max prices
- distortion of price signals causing excess supply/ demand
- difficult for government to know what prices to set
- can lead to creation of the black market
what is a tradeable pollution permit?
-limits the amount of pollution created in industries (a negative externality)
-firms can buy and sell allowances between themselves
advantages of pollution permit
- should benefit the environment in the long run
- government can raise revenue from permits as they can sell them to firms
- firms can sell their permits which raises revenue for greener firms
disadvantages of pollution permit
- could lead to some firms relocating to where they can pollute without limits which can reduce their production costs
- firms might pass on higher costs to the consumer
- expensive for government to monitor emissions
what is a public good?
-they are non-excludable and non-rivalry
-free rider says they are under provided by the free market leading to market failure
advantages of public goods
- corrects market failure by providing goods which otherwise wouldn’t be provided leading to improved social welfare
- by providing something like healthcare this ensures the workforce is healthy so it will improve economic growth
disadvantages of public goods
- expensive with a high opportunity cost for the government
- government may be inefficient at production since they have no incentive to cut costs
- since market isn’t involved the government may produce the wrong combination of goods e.g many soldiers and not enough hospital beds
what is provision of information?
when there is asymmetric information the government provides information to allow people to make informed decisions
advantages of provision of information
- helps consumers act rationally which allows the market to work properly
- 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
disadvantages of provision of information
- can be expensive for the government to do so, incurring an opportunity cost
- government may not always have all the information so it is difficult to inform consumers
- consumers may not listen to the information provided due to irrational behaviour
what is regulation?
governments imposing laws and caps to ensure that levels are set where MSB=MSC or to ensure companies provide full information on products
advantages of regulation
- can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. this will help overcome market failure and maximise social welfare
disadvantages of regulation
- laws may be expensive for the government to monitor incurring an opportunity cost
- don’t take into account the different costs of following the laws for different companies
- firms may pass costs to consumers
- excessive regulation may reduce competition and efficiency, increasing bureaucracy and reducing innovation
the 4 causes of government failure
-distortion of price signals
-unintended consequences
-excessive administration costs
-information gaps
what is distortion of price signals
-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
what is unintended consequences?
-when the actions of producers and consumers have unexpected or unintended consequences
what is excessive administrative costs?
-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
what are information gaps?
-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
