1.4 Government intervention (government intervention in markets and government failure) Flashcards
What are indirect taxes?
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
What are the two types of indirect taxes?
- Specific tax
- Ad valorem tax
What is an Ad valorem tax?
Where the tax payable increases in proportion to the value of the good
- e.g. VAT
What is a specific tax?
Where an amount is added to the price
When a good has a negative externality, how does adding an indirect tax prevent market failure?
As the tax would cause a fall in supply and increase the costs to the individual, causing the supply curve to shift in
What are the advantages of using tax to prevent market failure? (2)
- it internalises the externality: the market now produces at the social equilibrium position and social welfare is maximised
- it raises government revenue which can be reinvested
What are the disadvantages of using tax to prevent market failure? (2)
- it could lead to the creation of a black market
- the revenue generated by the government may not be reinvested in facilities that tackle the externality
What is a black market?
An economic activity that takes place outside government-sanctioned channels
In order to solve positive externalities (and information gaps), what can the government introduce?
subsidies
How will subsidies solve positive externalities?
As it will shift the supply curve to the right by lowering the costs of production
What are the advantages of using subsidies to correct market failure?
- society reaches the socially optimum output and welfare is maximised
- they can have other positive impacts such as encouraging small businesses and encouraging exports
What are the disadvantages of using subsidies to correct market failure?
- the government has to spend a large amount of money, which will have a high opportunity cost
- subsidies can cause producers to be inefficient
What is a maximum price?
a legally imposed price for a good that the suppliers cannot charge above
What kind of goods are maximum prices set on?
goods with positive externalities
What is a minimum price?
a legally imposed price at which the price of the good cannot go below
What kind of goods can minimum prices be set on and why?
goods with negative externalities, so that the price is raised to the social optimum point and consumption is discouraged
For a maximum price to have an affect what must it be set below?
the current price equilibrium
For a minimum price to have an affect, what must it be set above?
the current price equilibrium
What are the advantages of maximum/minimum prices? (1)
- A maximum price will ensure that goods are affordable and a minimum price will ensure that producers get a fair price
What are the disadvantages of maximum/minimum prices? (1)
- It is difficult for the government to know where to set the prices, because of the difficulty of knowing the size of the externalities
How do pollution permits work?
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.
How do pollution permits incentivise firms to use greener technologies?
As companies have to buy permits in order to pollute, so to cut costs and increase profits, companies may use greener technologies
How are pollution permits tradeable?
As unused permits can be sold to other companies
What will companies exceeding their limit of pollution face?
legal action
What are the advantages of using pollution permits to correct market failure? (1)
- the government can raise revenue by selling permits and by fining firms who exceed their pollution limit
What are the disadvantages of using pollution permits to correct market failure? (2)
- 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
What are the advantages of the state provision of public goods? (2)
- 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
What are the disadvantages of the state provision of public goods to correct market failure?
- expensive and represents a high opportunity cost for the government
What are the advantages of regulation to correct market failure?
- ensures the consideration of externalities, prevents the exploitation of consumers and keeps them fully informed
What are the disadvantages of regulation to correct market failure? (2)
- laws may be expensive for the government to monitor
- firms may pass on costs to consumers in the form of higher prices
What is government failure?
when government intervention in the market leads to a net welfare loss and a misallocation of resources
