1.4 Government Intervention

Question 1

How can governments intervene in markets? (7)

Answer 1

1. Indirect taxation.
2. Subsidies.
3. Maximum/minimum prices.
4. Trade pollution permits.
5. State provision of public goods.
6. Provision of information.
7. Regulation.

Question 2

Why do governments intervene in markets?

Answer 2

To move the market equilibrium closer to the optimal level if the price mechanism has failed to do so.

Question 3

What is a specific tax?

Answer 3

A specific tax is a tax that has a set value per unit.

Question 4

How are the supply curves drawn on a specific tax diagram?

Answer 4

The supply curves are parallel to each other.

Question 5

What is an ad valorem tax?

Answer 5

An ad valorem tax is a percentage tax based on the value added by the producer i.e. the more expensive the good, the greater the tax placed upon it.

Question 6

How are the supply curves drawn on an ad valorem tax diagram?

Answer 6

The supply curves are in a V shape.

Question 7

What is the impact of elasticity upon subsidies?

Answer 7

For inelastic goods, the consumer receives a larger share of the subsidy. For elastic goods, the producer receives a larger share of the subsidy.

Question 8

What is a maximum price?

Answer 8

A maximum price is set by the government to prevent prices from rising above a certain level. This acts as a price ceiling and can result in shortages.

Question 9

What is a minimum price?

Answer 9

A minimum price is set by the government to prevent prices from falling below a certain level. This acts as a price floor and can result in surpluses.

Question 10

What are trade pollution permits?

Answer 10

Trade pollution permits allow firms to emit a fixed amount of pollution. They can be bidded for and resold. Governments can reduce the number of permits in circulation to reduce pollution. The value of permits rise as pollution falls.

Question 11

What are the advantages of trade pollution permits? (3)

Answer 11

1. Act as an incentive for firms to reduce pollution.
2. If firms reduce their pollution to below the permit level, they can sell the permit.
3. Offers a reward for taking action.

Question 12

What are the disadvantages of trade pollution permits? (4)

Answer 12

1. External costs cannot always be measured.
2. High administrative costs in monitoring pollution.
3. Pollution may be concentrated in certain areas.
4. “Certified reductions” by least developed countries can be bought up by bigger countries.

Question 13

What is state provision of goods?

Answer 13

State provision of goods is when the government produces goods/services themselves.

Question 14

What are the advantages of the state providing goods? (3)

Answer 14

1. Government controls the price, so may be free.
2. Governments can try to directly provide market with Q*.
3. Brings in consumers that may otherwise have been priced out.

Question 15

What are the disadvantages of the state providing goods? (4)

Answer 15

1. Government may struggle to set quantity/price due to lack of information.
2. Very expensive. Increases debt.
3. Lack of competition means less quality.
4. Usually costs more for the government to provide than it would the private sector.

Question 16

What is provision of information?

Answer 16

The government reduces the information gap, allowing consumers/producers to make more rational decisions. Closes the welfare loss triangle on positive externality diagrams.

Question 17

What are the advantages of provision of information? (3)

Answer 17

1. Economic agents are aware of potential benefits and costs.
2. Supports economic agents in making informed, rational decisions.
3. Increases demand (MPB moves towards Q* for positive externalities).

Question 18

What are the disadvantages of provision of information? (3)

Answer 18

1. Economic agents may choose to ignore information/advertising.
2. Increased costs to firms to comply with law.
3. Government must increase expenditure.

Question 19

What are regulations?

Answer 19

Regulations are laws set out in order to reduce negative externalities. Can be restrictions or complete prohibition.

Question 20

What are the advantages of regulation? (2)

Answer 20

1. Provide clear boundaries that are easily understood by economic agents.
2. Individual circumstances can be analysed and appropriate action can then be taken.

Question 21

What are the disadvantages of regulation? (4)

Answer 21

1. Difficult to decide which fine will be the most successful deterrent - must be greater than external costs for firms to have an incentive.
   2, External costs are not always measurable.
2. Investigations are expensive and time consuming.
3. Expensive to employ inspectors.

Question 22

What is government failure?

Answer 22

Government failure is when the government intervenes within a market and there is consequently a greater misallocation of resources (net welfare loss increases).

Question 23

What are the causes of government failure? (4)

Answer 23

1. Unintended consequences (e.g. unemployment).
2. Information gaps.
3. Distortion of price signals (e.g. shortages and surpluses).
4. Excessive administrative costs.

Question 24

Why is the NHS an example of government failure?

Answer 24

As the NHS is free at the point of consumption, there is high demand and long waiting times.

Question 25

Why is the tobacco tax an example of government failure?

Answer 25

As the tobacco tax is very high in the UK, smugglers are more likely to bring in tobacco from abroad, costing the government potential revenue.

Question 26

Why are rent controls an example of government failure?

Answer 26

Rent controls were a maximum price that led to shortages, as more affordable prices increased demand but land lords lost incentive to supply.