1.4 - Government Intervention

Question 1

Give objectives of government intervention to reduce market failure.

Answer 1

• Reduce and eliminate negative externalities
• Increase and strengthen positive externalities
• Increase supply of merit goods
• Decrease supply of demerit goods
• Provide public goods which the price mechanism or market would undersupply.

Question 2

Give methods of government intervention to reduce market failure.

Answer 2

• Indirect taxation
• Subsidies
• Maximum and Minimum prices
• Regulation
• State provision of public goods
• Provision of information
• Buffer stocks
• Trade pollution permits

Question 3

Define minimum prices.

Answer 3

Minimum prices is a form of price control (max or min prices are set for a good or service by the government), where a price floor is established and this price floor is set above the equilibrium price, resulting in excess supply.

Question 4

Give an application of minimum prices.

Answer 4

Minimum prices are widely used in the national minimum wage, the minimum wage for workers. This wage helps redistribute incomes of low-paid workers, contributing to excess supply of workers.

Question 5

Define maximum prices.

Answer 5

Maximum prices are the highest prices a producer, group of producers or an industry can set. This involves the establishment of a price ceiling where the maximum price is set below the equilibrium price.

Question 6

Why do governments use maximum prices?

Answer 6

Governments use maximum prices to prevent consumers being exploited by large corporations.

Question 7

Give another application of minimum prices.

Answer 7

Minimum prices can be used for farmers, where a minimum price is guaranteed for farmers to sell their goods or services.

Question 8

State an application of maximum prices.

Answer 8

Maximum prices are used by the government to strengthen affordability of houses.

Question 9

Describe another application of maximum prices.

Answer 9

Maximum prices can also be used in developing countries, where fixed prices are set for food and other essential resources.

Question 10

Give the first step of how trade pollution permits work.

Answer 10

Trade pollution permits are supplied at a fixed quantity by the government, so supply is perfectly inelastic here.

Question 11

State the second step regarding trade pollution permits.

Answer 11

Secondly, if demand for these trade pollution permits rise then there will be a shift outwards to the right in the demand curve from D to D1 and the price of pollution permits will also rise.

Question 12

Describe the third step of trade pollution permits.

Answer 12

Thirdly, firms can either pay more continuously for more pollution and lose more money, or they can adhere to the rules, protecting their finance. This will give them a financial incentive to cut down on CO2 emissions.

Question 13

What can firms do if they don’t want to use pollution permits?

Answer 13

If they don’t need trade pollution permits, then firms can trade these permits on the market to firms who are emitting pollution outside legal levels.

Question 14

List the fourth step of trade pollution permits.

Answer 14

If governments feel firms aren’t taking the permits seriously, then they can introduce stricter laws. This is done by reducing the supply of permits, causing a shift to the left in the supply curve. This inwards shift will increase the equilibrium price, further increasing the costs to firms who don’t comply with the rules.

Question 15

What is the state provision of public goods?

Answer 15

The state provision of public goods is where the government intervenes in markets to supply goods and services.

Question 16

What type of goods and services does the state aim to supply?

Answer 16

One type of good which the state aims to supply is the merit good. Merit goods are goods from important sectors such as health and education which are beneficial to consumers but undersupplied by the price/market mechanism.

Question 17

Give another type of good or service the state wishes to supply.

Answer 17

Public goods are another type of good the state aims to supply to reduce market failure. Public goods include goods such as state schools, street lights, defence force, police forces… which wouldn’t be supplied properly in the public sector as a result of the free-rider problem.

Question 18

Define provision of information.

Answer 18

Provision of information is another method of government intervention to reduce market failure. This involves the government providing a proper quantity of information to consumers where the private sector may not have done. This helps bridge the information gap, reducing the risk of market failure.

Question 19

Give examples of provision of information.

Answer 19

Notable examples include nutritional labeling on foods, warnings on smoking, economic data to help firms plan for the future, gamble aware campaigns…

Question 20

What is regulation?

Answer 20

Regulation is a method of government intervention to reduce market failure. This involves the government creating more competitive markets. Through competitive markets, this will increase innovation of goods and services, giving consumers more choice, and also the information gap can be closed.

Question 21

Define government failure.

Answer 21

Government failure is where the government misallocates resources, contributing to a net welfare loss.

Question 22

List the four factors contributing to government failure.

Answer 22

• Distortion of price signals
• Excessive administrative costs
• Information gap/inadequate information
• Unintended consequences

Question 23

Describe the distortion of price signals.

Answer 23

Distortion of price signals is where the minimum or maximum prices negatively change price signals, or negatively affect the price mechanism; e.g. maximum prices cause excess demand where there is a shortage of goods or services; if there is high demand for homes but there isn’t enough homes, then homelessness can arise and less houses are rented. Or for minimum prices, excess supply occurs where there is too much supply to be stocked.

Question 24

Describe excessive administrative costs.

Answer 24

Administrative costs are costs spent by the government to intervene in markets. However, certain methods of government intervention where the government constantly intervenes can pile up these costs; in regulations, the government has to constantly monitor to ensure people are adhering to the rules. This can significantly increase administrative costs. Or for indirect taxation, the government has to constantly intervene to ensure no one is evading or avoiding their tax, or they can intervene to change the tax.

Question 25

Describe the law of unintended consequences.

Answer 25

The law of unintended consequences is where a method of government intervention results in an unexpected consequence; for indirect taxation, people can smuggle in goods which are taxed or organised crime can occur as a result. For subsidies, there can be inefficiency or overdependent and for trade pollution permits, some firms can still avoid permits; big companies can buy small permits instead of investing to reduce pollution.

Question 26

Describe information gap as a factor contributing to government failure.

Answer 26

Information gap is the provision of information by the government where the private sector may not provide. However, the government may not always be accurate in this provision; a lack of research or predictability for the future can result in inaccurate information such as wrongly projecting prices or benefits. For example, to increase tourism of an island, you can’t always build a bridge from the mainland to the island.