1.4 Government Intervention Flashcards
What are the advantages of an indirect tax on a good with negative externalities?
● It internalises the externality - the market now produces at the social equilibrium position and social welfare is maximised
● It raises government revenue, which could be used to solve the externality in other ways such as through education
What are the disadvantages of an indirect tax on a good with negative externalities?
● Difficult to know the size of the externality so it is difficult to target the tax. The government suffers from imperfect information
● Could be conflict between the government goal of raising revenue and solving the externality, which makes setting the tax difficult.
● Could lead to the creation of a black market
● If demand for the good is inelastic, then the tax will be ineffective at reducing output
● They are regressive
● Taxes are politically unpopular, governments may be reluctant to introduce them
What are some disadvantages of subsidies to solve positive externalities?
● The government has to spend a large amount of money, which will have a high opportunity cost.
● They are difficult to target since the exact size of the externality is unknown.
● Subsidies can cause producers to become inefficient, especially if they are in place for a long time.
● Once introduced, subsidies are difficult to remove.
What is a maximum price?
A maximum price is a legally imposed price for a good that the suppliers cannot charge above
They are set on goods with positive externalities
What does the orange shaded area on the maximum price diagram show?
Excess demand
What is a minimum price?
A minimum price is a legally imposed price at which the price of the good cannot go below
They can be set on goods with negative externalities, so that the price is raised to the social optimum point and consumption is discouraged. They also encourage producers to produce goods, so can be set on goods with social benefits that are underprovided by the market
What does the orange shaded area on the minimum price diagram show?
Excess supply
What are the advantages of implementing a maximum/minimum price?
● They can be set where MSB=MSC, so allow for some consideration of externalities, and so help to increase social welfare.
● A maximum price will ensure that goods are affordable, whilst a minimum price will ensure that producers get a fair price. Both of these are able to reduce poverty and can increase equity/equality.
What are the disadvantages of implementing a maximum/minimum price?
● There is a distortion of price signals and this causes excess supply/demand. Excess demand will lead to questions about how to allocate goods and excess supply will lead to questions about what to do with the surplus goods.
● It is difficult for the government to know where to set the prices, because of the difficulty of knowing the size of externalities and because it will have implications on the size of excess supply/demand.
● Both can lead to the creation of black markets. Maximum prices may also lead to illegal bribes or discriminatory policies in allocating goods.
What has been a negative effect of price caps on milk, toilet paper, medicine, petrol and other key goods in Venezuela?
It has led to the creation of a black market and the goods are no longer sold in supermarkets as the firms are unable to make a profit at those prices
What is a tradable pollution permit?
A pollution permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are. Companies have to buy permits in order to pollute so, in an attempt to cut costs and increase profits, companies may use greener technology. Unused permits can be sold to other companies, hence why they are tradable
What are the advantages of a tradable pollution permit?
● Since the government caps the number of permits, pollution will fall to the targets set by the government. This will maximise social welfare.
● The government can raise revenue by selling permits and by fining firms who exceed their pollution limit.
● This encourages companies to use and invest in green technology.
What are the disadvantages of a tradable pollution permit?
● Can be expensive to monitor and police, it will only work if it is monitored well. The government needs to impose fines that are large enough to ensure firms follow the regulation.
● It will raise costs for businesses, it is likely that these higher costs will be passed onto consumers
● It may be difficult to know how many permits the government should allow
How much did the US Sulphur trading scheme reduce sulphur dioxide by?
US Sulphur trading scheme reduced sulphur dioxide by 40%
When was the EU Emissions Trading Scheme launched and how did it impact greenhouse gas emissions?
The EU Emissions Trading Scheme (ETS) was launched in 2005 and it represents a 21% reduction in greenhouse gases
Since then, other greenhouse gases like nitrous oxide have been included and the scheme has been extended to the airline industry
What are the advantages of the government providing public goods?
● This corrects market failure by providing important goods which would otherwise not be provided. It will lead to improved social welfare.
● It can help to bring about equality, by ensuring everyone has access to basic goods.
● There will be benefits of the goods themselves, for example by providing healthcare, the government ensures that the workforce is healthy, this can improve economic growth.
● By using competitive tenders (contracting out the provision) the government can ensure efficiency.
What are disadvantages of the government providing public goods?
● Expensive and represents a high opportunity cost for the government. Administration costs are a problem
● Since the market is not involved, the government may produce the wrong combination of goods as consumers can not indicate their preferences. Democracy aims to reduce this problem, since consumers can vote for political parties whose aims are similar to their own.
● The government may be inefficient at production since they have no incentive to cut costs.
● Government officials may suffer from corruption and conflicting objectives.
What are the advantages of the government providing information to try and close information gaps?
● 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.
What are disadvantages of the government providing information to try and close information gaps?
● 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 information provided due to irrational behaviour
What are the disadvantages of government regulation?
● Laws may be expensive for the government to monitor, incurring an opportunity cost.
● The government can suffer from regulatory capture
● Firms may pass on costs to the consumer in the form of higher prices.
● Excessive regulation may reduce competition in a market and efficiency, by increasing bureaucracy and reducing innovation.
What is government failure?
Government failure is when government intervention in the market leads to net welfare loss and a misallocation of resources
The total social costs arising from the intervention are greater than the social benefit
What are some of the causes of government failure?
● Distortion of price signals
● Unintended consequences
● Excessive administration costs
● Information gaps
How can the distortion of price signals lead to government failure?
Some types of government intervention change price signals in the market and distort the free market mechanism. As a result, they keep some companies in business when they are inefficient. By intervening, the government distorts the mechanism and so resources may be allocated inefficiently
Maximum and minimum prices lead to excess demand/supply and make it difficult to allocate resources
How did the buffer stock scheme CAP (Common Agricultural Policy) in the EU suffer from unintended consequences?
and lead to government failure
It was meant to smooth out the price fluctuations but it ended up leading to overproduction in the EU and a fall in agricultural prices in other parts of the world as EU surpluses were disposed of at cheap prices outside of Europe; this was not the intention of the scheme.
