1.4 - Government Intervention Flashcards
Introduction to Markets and Market Failure - Microeconomics
Why does the government intervene in markets?
To correct market failure and improve the allocation of resources, often using policies like taxes, subsidies, and regulation.
2 main types of indirect taxes?
- Specific tax (fixed amount per unit)
*Ad valorem tax (percentage of the price)
Ways in which the government corrects market failure?
*Indirect tax
*Subsidies
*Max and min prices
*Tradeable pollution permits
*Provision of public goods
*Provision of information
* Regulation.
How do indirect taxes correct market failure?
They increase the price of demerit goods, internalising the external cost and reducing overconsumption.
How do subsidies help correct market failure?
They lower the cost of merit goods, increasing supply or demand to a more socially optimal level.
What is a maximum price (price ceiling)?
A legal limit on how high a price can be, used to make essential goods more affordable (e.g., rent controls).
Set below the free market price
What is a minimum price (price floor)?
A legal minimum price set above equilibrium to support producers (e.g., minimum wage, alcohol pricing).
Set above the free market price
What are trade pollution permits?
Government-issued rights to pollute up to a certain level, which can be bought and sold between firms to incentivise lower emissions.
How does the state provision of public goods correct market failure?
It ensures the supply of goods that would be underprovided by the market due to the free rider problem.
How does government-provided information reduce market failure?
It helps overcome information gaps and allows consumers and producers to make more rational decisions.
What is regulation and how does it help?
Rules or laws to control market behaviour (e.g., bans, safety standards), helping to limit harmful externalities.
Merit good
A good/service which provides greater social benefits when consumed than private benefits. They tend to be underconsumed.
Demerit goods
A good/service which has greater social costs when it’s consumed than private costs. They tend to be overconsumed.
What is government failure?
When government intervention leads to a net welfare loss, making the allocation of resources worse than before.
Net welfare loss
An overall loss of economic welfare when compared to the starting position
What are the causes of government failure?
*Distortion of price signals
*Unintended consequences
*Excessive administrative costs
*Information gaps
What is meant by distortion of price signals?
When interventions like subsidies or minimum prices disrupt the natural function of supply and demand, causing inefficiency.
What are unintended consequences?
Unexpected negative effects of government policy (e.g., black markets due to price controls).
How do administrative costs contribute to government failure?
Monitoring, enforcing and running interventions may be so costly that the costs outweigh the benefits.
How do information gaps cause government failure?
The government may make poor decisions due to lack of accurate information (e.g., over-subsidising).
