1.4 Government intervention (government intervention in markets and government failure)

Question 1

What are indirect taxes?

Answer 1

A tax on expenditure where the person who is ultimately charged the tax is not the person responsible for paying the sum to the government

Question 2

What are the two types of indirect taxes?

Answer 2

• Specific tax
• Ad valorem tax

Question 3

What is an Ad valorem tax?

Answer 3

Where the tax payable increases in proportion to the value of the good
- e.g. VAT

Question 4

What is a specific tax?

Answer 4

Where an amount is added to the price

Question 5

When a good has a negative externality, how does adding an indirect tax prevent market failure?

Answer 5

As the tax would cause a fall in supply and increase the costs to the individual, causing the supply curve to shift in

Question 6

What are the advantages of using tax to prevent market failure? (2)

Answer 6

1. it internalises the externality: the market now produces at the social equilibrium position and social welfare is maximised
2. it raises government revenue which can be reinvested

Question 7

What are the disadvantages of using tax to prevent market failure? (2)

Answer 7

1. it could lead to the creation of a black market
2. the revenue generated by the government may not be reinvested in facilities that tackle the externality

Question 8

What is a black market?

Answer 8

An economic activity that takes place outside government-sanctioned channels

Question 9

In order to solve positive externalities (and information gaps), what can the government introduce?

Answer 9

subsidies

Question 10

How will subsidies solve positive externalities?

Answer 10

As it will shift the supply curve to the right by lowering the costs of production

Question 11

What are the advantages of using subsidies to correct market failure?

Answer 11

1. society reaches the socially optimum output and welfare is maximised
2. they can have other positive impacts such as encouraging small businesses and encouraging exports

Question 12

What are the disadvantages of using subsidies to correct market failure?

Answer 12

1. the government has to spend a large amount of money, which will have a high opportunity cost
2. subsidies can cause producers to be inefficient

Question 13

What is a maximum price?

Answer 13

a legally imposed price for a good that the suppliers cannot charge above

Question 14

What kind of goods are maximum prices set on?

Answer 14

goods with positive externalities

Question 15

What is a minimum price?

Answer 15

a legally imposed price at which the price of the good cannot go below

Question 16

What kind of goods can minimum prices be set on and why?

Answer 16

goods with negative externalities, so that the price is raised to the social optimum point and consumption is discouraged

Question 17

For a maximum price to have an affect what must it be set below?

Answer 17

the current price equilibrium

Question 18

For a minimum price to have an affect, what must it be set above?

Answer 18

the current price equilibrium

Question 19

What are the advantages of maximum/minimum prices? (1)

Answer 19

• A maximum price will ensure that goods are affordable and a minimum price will ensure that producers get a fair price

Question 20

What are the disadvantages of maximum/minimum prices? (1)

Answer 20

• It is difficult for the government to know where to set the prices, because of the difficulty of knowing the size of the externalities

Question 21

How do pollution permits work?

Answer 21

A pollution permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are, so limits the maximum amount of pollution.

Question 22

How do pollution permits incentivise firms to use greener technologies?

Answer 22

As companies have to buy permits in order to pollute, so to cut costs and increase profits, companies may use greener technologies

Question 23

How are pollution permits tradeable?

Answer 23

As unused permits can be sold to other companies

Question 24

What will companies exceeding their limit of pollution face?

Answer 24

legal action

Question 25

What are the advantages of using pollution permits to correct market failure? (1)

Answer 25

• the government can raise revenue by selling permits and by fining firms who exceed their pollution limit

Question 26

What are the disadvantages of using pollution permits to correct market failure? (2)

Answer 26

• they can be expensive to monitor and police
• it will raise costs for businesses, and these higher costs are likely to be passed onto consumers

Question 27

What are the advantages of the state provision of public goods? (2)

Answer 27

• it can help bring out equality, by making sure everybody has access to basic goods
• there will be benefits of the goods themselves, by providing healthcare, there’s a more productive workforce leading to economic growth

Question 28

What are the disadvantages of the state provision of public goods to correct market failure?

Answer 28

• expensive and represents a high opportunity cost for the government

Question 29

What are the advantages of regulation to correct market failure?

Answer 29

• ensures the consideration of externalities, prevents the exploitation of consumers and keeps them fully informed

Question 30

What are the disadvantages of regulation to correct market failure? (2)

Answer 30

• laws may be expensive for the government to monitor
• firms may pass on costs to consumers in the form of higher prices

Question 31

What is government failure?

Answer 31

when government intervention in the market leads to a net welfare loss and a misallocation of resources