1.4 Government Intervention

Question 1

What can the government do to prevent negative externalities

Answer 1

When the good has a negative externality, the governor can introduce indirect taxation to prevent market failure. This will cause a fall in supply and increase the costs to the individual.

Question 2

Advantages of indirect taxation to solve externalities

Answer 2

• it internalised the externality - the market now produces at the social equilibrium position and social welfare is maximised
• it raises government revenue

Question 3

Disadvantages of indirect taxation to prevent negative externalities

Answer 3

• difficult to know the size of the externality so it is difficult to target the tax
• there could be conflict between the government goal of raising revenue and solving the externality
• could lead to black market
• taxes are politically unpopular and governments may be reluctant to introduce them
• they are regressive, meaning that the poor spend a larger proportion of their income than the rich do

Question 4

Examples of indirect taxes used for externalities

Answer 4

Landfill taxes, fuel duties, alcohol duties, tobacco duties, air passenger duties and sugar duties

Question 5

Government use of subsides to solve positive externalities

Answer 5

The government can introduce subsidies to fix information gaps. This will shift the supply curve to the right as it will lower cost of production.

Question 6

Advantages of subsidies to solve positive externalities

Answer 6

• society reaches the social optimum output and welfare is maximised
• they can have other positive impacts, such as encouraging small business bring about equality and encouraging

Question 7

Disadvantages of subsidies to solve positive externalities

Answer 7

• the government has to spend a large amount of money, which will have a high opportunity cost
• difficult to target since the exact size of the externality is unknown
• can cause producers to become inefficient
• one introduced, difficult to remove

Question 8

what needs to happen for a maximum price to have an effect

Answer 8

it must be set below the current equilibrium price

Question 8

what needs to happen for a minimum price to have an effect

Answer 8

it must be set above the current equilibrium price.

Question 9

What is a maximum price

Answer 9

A maximum price is a legally imposed price for a good that the suppliers cannot charge above. They are set in goods with positive externalities. For example, they are set in gold as a lack of food will have a negative impact on the NHS

Question 10

What is a minimum price

Answer 10

A minimum price is a legally imposed price at which the price of the goods cannot go below. They can be set in goods with negative externalities, so that the price is raised to the social optimum point and consumption is discouraged. Also encourage producers to produce goods

Question 11

Advantages of min and max prices

Answer 11

They can be set where MSB = MSC, so allow for some consideration of externalities, and so help to increase social welfare

A max price will ensure that goods are affordable, whilst a minimum price will ensure that producers get a fair price.

Both are able to reduce poverty and can increase equality

Question 12

Disadvantages of min and max prices

Answer 12

• distortion of price signals which causes excess supply / demand

• difficult for government to know where to set prices

• can lead to the creation of black markets

Question 13

What is a buffer stock scheme

Answer 13

Where both maximum and minimum prices are implemented at the same time. This is often the case with agricultural products whose prices fluctuate massively, such as in the EU common agricultural policy.

Question 14

What is a pollution permit

Answer 14

A pollution permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution. Unused permits can be sold to other companies, hence why there are tradeable. Companies exceeding limit will face legal action

Question 15

Advantages of pollution permits

Answer 15

• since gov caps number of permits, it’s gara that pollution will fall
• gov can raise revenue by selling permits and by fining firms who exceed their pollution limit
• encourages use and investment in green tech

Question 16

Disadvantages of pollution permits

Answer 16

• can be expensive to monitor and police, but will only work if monitored well
• will raise costs for businesses, which will likely be passed onto consumers
• may be difficult to now how many permits the government should allow

Question 17

Advantages of state provision of public goods

Answer 17

• corrects market failure by providing important goods which would otherwise be not provided
• can help to bring about equality
• there will be benefits of the goods themselves, for example, providing healthcare, the gov ensures that the workforce is healthy and so this can improve economic growth

Question 18

Disadvantages if the provision of public goods

Answer 18

• expensive and represents a high opportunity cost for the gov
• since the market is not involved, The gov may produce the wrong combination of goods as consumers can not provide their preference.
• government may be inefficient at production since they have no incentive to cut costs
• government officials may suffer from corruption and conflicting objectives

Question 19

Examples of the state providing public goods

Answer 19

UK government provides:
• roads
• education
• healthcare.

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. They may also force companies to provide information

Question 21

Advantages of provision of information

Answer 21

• helps consumers to act rationally, which allows the market to work properly
• it is best if the government uses this alongside other policies. For example; it 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

• this can be expensive for the government to do, incurring an opportunity cost
• the government themselves may not always have all the information, so it may be difficult to inform consumers
• consumers may not listen to the info provided due to irrational behaviour

Question 23

Examples of provision of information

Answer 23

• labels on fag packets
• info campaigns on Speeding, obesity, drinking and smoking
• consumer protection laws and industry standards
• food traffic light system

Question 24

What is governemt regulation

Answer 24

Governments are able to impose laws and caps to ensure that levels are set where MSB = MSC or to ensure that companies provide full info on products

Government can also introduce regulatory bodies such as OFCOM and OFGEN

Question 25

Advantages of government regulation

Answer 25

Can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed. This will help to overcome market failure and maximise social welfare

Question 26

Disadvantages of government regulation

Answer 26

• laws may be more expensive for gov to monitor, incurring opportunity cost
• government can suffer from regulatory capture
• firms may pass on costs to the consumer in the form of higher prices
• may reduce competition and efficiency

Question 27

What is government failure

Answer 27

Government failure is when government intervention in the market leads to net welfare loss and a miss allocation of resources. The total social costs arising from the intervention are greater than the social benefit

Question 28

Causes of government failure

Answer 28

• distortion of price signals
• unintended consequences
• excessive admin costs
• information gaps

Question 29

Explain distortion of price signals

Answer 29

• some types of gov int change price signals in market and destroy the free market mechanism. This keeps companies in business when they are inefficient so the resources should be switched to somewhere else.

• for example, subsidies to farmers when they cannot produce cheaply enough

Question 30

Explain unintended consequences

Answer 30

• some interventions cause consequences which the government did not intent to happen
• some may react differently to policies which is unexpected
• one example is the buffer stock scheme CAP in the EU. Meant to smooth out price fluctuations but ended up leading to overproduction in the EU.

Question 31

Explain excessive administration costs

Answer 31

• in many cases, a lot money that is allocated by the government is actually used up on basic administration costs. The social costs may be higher than social benefits when taken into account.
• a lot of NHS money is acc spent on organisational admin rather than into med care.

Question 32

Explain information gaps

Answer 32

• any decisions that the government makes must be based on some data but the info they have always going to be limited. For example, cannot predict number of cars on road
• costs and benefit forecasts of investment are often wrong and so the government invests in a system where the costs are higher than the benefits, so there is a welfare loss.
• Ususally and practically impossible for the government to get every piece of info their need