1.4 - Government Intervention Content Flashcards
1.4 - Government Intervention
Give the extra disadvantage to indirect taxes
If demand for a good is inelastic, the tax will be ineffective at reducing output.
(Still increases govt. rev tho).
2 Benefits of indirect taxes in essay writing with evaluation
- Internalises externality (polluter pays [pigouvian tax]).
- Generates govt. revenue, hypothecated tax. [Double dividend theory].
Eval: regressive, shadow markets, ineffective at reducing demand if PED is inelastic.
If an indirect tax is imposed on a good and demand is price inelastic, who has to pay the majority of the tax? Consumers or producers
Draw the diagram
The tax will mainly be passed onto the consumers since they are unresponsive to price changes.
This means that the tax will not be very effective at decreasing output, but will raise revenue for government.
If an indirect tax is imposed on a good and demand is price elastic, who has to pay most of the tax burden?
The more elastic the demand curve, the lower the incidence of tax on the consumer.
When PED is elastic, a tax will only lead to a small increase in price and the supplier will have to cover the majority of the cost of the tax
Why is distortion of price signals government failure?
Price mechanism aims to allocate resources to their best use.
Distortion can keep producers allocating resources to an inefficient product.
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What is an ad valorem tax?
An indirect tax imposed on a good, where the value of the tax is dependent on the value of the good.
The tax is a percentage of the cost of the good.
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What is a minimum price
Minimum prices are government-imposed limits on the price of a good or service.
They are typically set above the equilibrium price to support producers, ensuring they receive a fair income
Such as in agriculture
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What does a minimum price diagram look like
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What are some cons of minimum prices
- Increased prices for consumers.
- Resources are wasted when excess goods are destroyed (goods = oversupplied).
- Inefficient allocation of resources, due to excess supply.
- Higher tariffs necessary on imports. To keep minimum prices, the EU also had to put tariffs on food to keep prices artificially high.
- Could lead to less innovation and efficiency as producers are guaranteed a minimum income
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Pros of a minimum price
- Ensures fair income for suppliers.
- Boosts competitiveness and may improve allocative efficiency (AE).
- Higher profits (π) lead to increased disposable income (DE) and economic demand
- Protects vulnerable industries, preventing market collapse.
- Encourages long-term investment by stabilizing producer earnings.
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What are maximum prices
Maximum prices are government-imposed limits on the price of a good or service.
They are typically set below the equilibrium price to protect consumers from high prices.
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What does a maximum price look like
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What is an example of maximum prices
Rent Controls
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Arguments in favour of rent controls for housing
- Reduces rents, easing pressure on disposable incomes and welfare systems.
- Improves labour mobility, reducing structural unemployment.
- Curbs excessive landlord profits, protecting vulnerable renters.
- Enhances housing stability, reducing evictions and homelessness.
- Makes housing more accessible for lower-income groups, reducing inequality.
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Evaluation points – Drawbacks of rent controls for housing
- May lead landlords to replace rental homes with housing for sale, driving property prices higher in already unaffordable areas.
- Could reduce maintenance spending, lowering housing quality and increasing risks for tenants.
- Risk of landlords withdrawing investment, diminishing the supply of private rented housing.
- Encourages black market rentals, as landlords may illegally charge higher prices to bypass controls.
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What are two problems associated with rent controls
- Rent controls may have unintended consequences, such as encouraging landlords to convert rental properties to other uses or sell their properties altogether. This can make the supply shortage for rental housing even worse.
- Could lead to a deterioration in the quality of rental housing and reduced investment in maintenance and upgrades. This has external costs such as increasing risk of damp which worsens people’s health.
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What are 2 alternative government policies that might improve housing affordability in UK cities in the long-term
- Subsidies for self-build, modular housing & tax incentives to encourage co-living spaces. Changes in land-use policies. Grants for property conversions.
- Incentives for developers to build affordable housing (such as zero VAT on building materials) & allowing local councils to raise finance through bonds to expand the construction of new energy efficient social housing
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Pros of max prices
- Protects consumers from exploitation, ensuring fair pricing for essential goods.
- Increases affordability, making essential goods accessible to low-income households.
- Improves efficiency of firms, pushing them to manage costs effectively to remain profitable.
- Controls inflation, preventing excessive price hikes in critical markets.
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Cons of max prices
- Creates shortages as demand exceeds supply, leaving some consumers unable to access the goods.
- Reduces producer incentives, leading to lower supply and diminished market efficiency over time.
- Encourages black markets with illegal sales at higher prices, bypassing the price cap.
- Lowers quality, as producers may cut costs to offset reduced revenue.
- Disrupts price signals, preventing efficient resource allocation and market adjustments.
- Adds administrative burden for governments, as monitoring and enforcing price caps can be complex and costly
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What are the 8 forms of government intervention for theme 1?
- Indirect taxes
- Subsidies
- Tradable pollution permits
- Max prices
- Min prices
- Provision of good / service
- Provision of information
- Regulation
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What are tradable pollution permits?
They allow firms to produce up to a certain amount of pollution and can be traded amongst firms.
Reduces total amount of pollution.
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How are pollution permits traded?
Permits are traded through the price mechanism, where supply and demand determine their value. For example, in the EU Emissions Trading System (ETS), firms needing more permits can buy them from others, incentivizing reductions in emissions.
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What do pollution permits allow governments to do?
Governments can set an optimal limit on pollution by allocating permits to firms
EU emissions trading sysem (ETS) issues permits but annually cuts the number of permits to incentive firms to reduce emissions
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Diagram for pollution permits:
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What are the advantages of pollution permits?
- Ensure pollution reduction by internalizing externalities (Pigouvian principle).
- Increase government revenue through the sale or auction of permits.
- Encourage green technology investments, reducing emissions cost-effectively.
- Preserve business autonomy, allowing firms flexibility in meeting targets.
- Improve market efficiency by allocating pollution rights via the price mechanism.
- Facilitate global cooperation through international trading schemes.
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What are some disadvantage of pollution permits
- Expensive to monitor and enforce, requiring substantial fines to ensure compliance.
- Raises business costs, potentially leading to higher consumer prices.
- Difficult to determine the correct number of permits due to dynamic market conditions.
- Imperfect information may result in suboptimal pollution limits set by the government.
- Risk of carbon leakage - occurs when companies move production to countries with lower carbon prices, to avoid paying for carbon credits
- May disadvantage smaller firms, as larger corporations can absorb permit costs more easily, increasing market concentration.
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What are the advantages of state provision of good/ services?
- Improves social welfare by addressing societal needs directly.
- Ensures access to basic goods and corrects market failures where private firms may not provide essential services.
- Increases external benefits, like better public health or education, that benefit society as a whole.
- Promotes equity by ensuring everyone, regardless of income, can access key services.
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Disadvantages of state provision of good/ services
- Expensive with high opportunity costs: State provision requires substantial spending, which may divert funds from other crucial areas, such as healthcare or infrastructure, with administrative costs adding further strain.
- Risk of inefficiency and waste: Without profit motives or strong accountability structures, government-run services may lack incentives to minimize costs or improve productivity, potentially leading to inefficiency and corruption.
- Potential for incorrect provision levels: Imperfect information can lead to over- or under-provision of goods and services, resulting in unmet societal needs and misallocated resources.
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What is state provision of goods and services
When the government supplies essential goods and services directly to the public, often to address market failures, improve social welfare, and ensure universal access (e.g., healthcare, education, and infrastructure).
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Advantages of provision of information:
- Allows consumers to act rationally by reducing information asymmetry, leading to better decision-making.
- Can be used alongside other policies, such as making demand more elastic to enhance the effectiveness of measures like indirect taxes in reducing output.
- Encourages socially beneficial behaviors, such as healthier lifestyles or environmentally friendly choices, through public awareness campaigns.
- Leads to better allocation of resources and reduced market failures, as informed decisions improve overall market efficiency.
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What are the disadvantages of provision of information?
- Expensive with high opportunity costs: Costs of producing and distributing information may divert funding from essential areas like healthcare.
- Government may lack correct information: Imperfect knowledge can result in ineffective or misleading campaigns.
- Consumers may ignore advice: Irrational behavior or resistance to change can limit the impact of informational efforts.
- Hard to measure effectiveness: Assessing the success of campaigns can be challenging, complicating resource allocation.
- Risk of unintended consequences: Poorly designed initiatives may confuse consumers or lead to harmful actions.
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What is provision of information
A policy where the government provides accurate and accessible data to inform consumer and producer decisions, aiming to address information gaps, correct market failures, and promote socially beneficial behaviors
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What are the disadvantages of regulation?
- Laws are expensive: Significant government spending is required for drafting, implementing, and enforcing regulations.
- Regulatory capture: Industries may influence regulators, skewing rules in their favor and undermining fairness.
- Increased costs: Compliance expenses for businesses often lead to higher consumer prices.
- May reduce competition: Elevated regulatory burdens can force weaker firms out, limiting market dynamism.
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What are the advantages of regulations?
- Addresses Externalities: Regulations ensure that companies account for social costs, reducing negative external impacts.
- Prevents Exploitation: By setting enforceable standards, regulations protect consumers and workers from unfair practices.
- Promotes Social Welfare: They help overcome market failures by prioritizing maximum societal benefits over pure profit motives.
- Non-Market Approach: Operating outside the price mechanism, regulations avoid issues related to demand elasticity and market fluctuations.
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What is regulation
A set of government-imposed rules and standards designed to manage behavior in markets and society, correct market failures (e.g., externalities), and protect public welfare by preventing exploitation and ensuring fairness.
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What are the 4 main types of government failure?
Distortion of price signals
Unintended consequences
(Excessive) Admin costs
Information gaps
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Examples of possible government failure from
imposing quotas and tariffs on imported steel into the UK.
- Tariffs and quotas leads to higher costs for downstream users of steel. It might lead to higher construction costs which makes new housing less affordable or e-vehicles more expensive (unintended consequences)
- Risk of a tit-for-tat trade war – with other countries imposing retaliatory trade barriers – this can cost jobs in other export industries. You might want to introduce some game theory here.
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Examples of possible government failure from imposing rent controls in Scotland.
- Possible exit of landlords from the market due to sub-normal profits. This reduces supply and leads to a greater shortage of rental properties – increasing the risk of shadow markets operating. (Deepens existing market failure)
- Fall in the quality of the stock of rented housing as landlords find ways to cut costs. This can lead to negative externalities such as tenants experiencing worsening health + limits progress in reducing carbon emissions. (Policy conflict)
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Examples of possible government failure from banning high-caffeine drinks to people under the age of 16.
- Black Market and Illegal Sales: Prohibiting the sale of high-caffeine drinks to young people may create a black market where these beverages are sold illegally at high prices.
- Enforcement costs: Enforcing a ban on high-caffeine drinks can be expensive. Failure to impose the ban would make it less effective. + a ban does not address the underling causes of rising consumption such as inadequate nutrition education or parental guidance
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Possible causes of government
failure from imposing a minimum retail price for high-caffeine drinks
- Low PED and low effectiveness: The policy might be ineffective if demand for these drinks is price inelastic. It would take a high minimum price to have a substantial effect which might have regressive effects on lower-income families.
- Substitution Effects: Imposing a minimum retail price on high-caffeine drinks may lead to unintended substitution effects. Young people might shift their consumption to potentially unhealthy alternatives such as energy drinks that contain additives and artificial sweeteners
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How is distortion of price signals government failure
Government-set prices (e.g., minimum prices) disrupt the natural communication of supply and demand. For instance, a minimum price in agricultural markets can signal producers to oversupply, creating surpluses that go to waste, while in demerit markets like alcohol, it may send misleading signals that result in production losses. This misallocation of resources is a government failure.
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How is unintended consequences a government failure
Government interventions intended to correct market issues can backfire when producers and consumers, driven by self-interest, exploit legal or illegal loopholes. This behavior may inadvertently foster illegal markets or unplanned production and consumption patterns, undermining the original policy goals while creating additional inefficiencies.
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How is excessive administration costs a government failure
When the expenses of regulating and administering policies exceed the social welfare benefits generated, resulting in a net loss in efficiency. This failure occurs because excessive costs undermine the intended gains from government intervention.
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How is information gaps a government failure
Government decision-makers often operate with incomplete data and are influenced by cognitive biases (e.g., anchoring) as well as political pressures. This imperfect information can lead to policies that fail to fully address issues, resulting in suboptimal outcomes.
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What are advantages of indirect taxes when used to combat a negative externality?
- The market produces at the social equilibrium position and social welfare is maximised.
- Raises tax revenue - which could be used to solve the externality through other ways - investment in carbon capture.
- Polluter pays principles - polluter pays external costs, fairer to society.
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What are the disadvantages of indirect taxes to combat negative externalities?
- Imperfect information - Difficult to know where to set the tax. May be set too high/low.
- Government might be too focused on raising revenues.
- Might lead to the creation of a black market.
- If demand for the good is inelastic, then taxes will be ineffective at reducing output.
- Taxes are politcally unpopular, so governments may be reulcant to introduce them.
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What are the methods to resolve a negative externality?
- An indirect tax diagram - this reduces production from Qe to Q*.
- Tradable pollution permits
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Why might a tax not be a good way at resolving negative externalities?
- If demand is price inelastic, then the tax will only lead to a small fall in Q.
- Unintended consequences - smuggling, black market.
- Asymetric information - Government does not know where the socially optimum point lies.
