1.4.1 Government Intervention

Question 1

What are the 4 main ways the government can intervene in the free market?

Answer 1

• indirect tax
• subsidy
• minimum price
• maximum price

Question 2

What is an indirect tax?

Answer 2

A cost put on by the government that raises the costs of production

Question 3

What does an indirect tax do to the negative externality diagram?

Answer 3

An indirect tax shifts the MPC to the left which in theory should bring it inline to the MSC eliminating the negative externality

Question 4

Explain the analysis of an indirect tax being imposed on the negative externality

Answer 4

• indirect tax rises cost of production
• define market failure
• explain how the market failure occurs (1st party ect)
• such good is overconsumed and overproduced
• indirect tax shifts MPC
• reduces demand for such good

Question 5

Evaluation points for the use of indirect tax to remove a negative externality

Answer 5

• underestimates or overestimates size of the tax
• elasticity of demand
• inflation pressures
• regressive

Question 6

What is a subsidy?

Answer 6

A grant given by the government to lower the costs of production

Question 7

What does a subsidy do to a positive externality diagram?

Answer 7

Shifts the MPB to the right in line with MSB

Question 8

Explain the analysis of a subsidy being used to solve a positive externality

Answer 8

• define subsidy
• define market failure
• explain how the failure occurs (1st party)
• underconsumed and underproduced
• subsidy encourages production and consumption which shifts MPB right to MSB
• externality is removed

Question 9

Evaluation points for a subsidy being used to remove a positive externality

Answer 9

• underestimate or overestimate size of subsidy
• conflict with govt polices
• opportunity cost

Question 10

What is a maximum price?

Answer 10

A price legally imposed that suppliers cannot charge above

Question 11

Where does the maximum price lay?

Answer 11

Below the equilibrium point

Question 12

What does a maximum price solve?

Answer 12

Positive externality

Question 13

What is the effect of a maximum price on suppliers?

Answer 13

A maximum price would cause a contraction along the supply curve to Qs. This means suppliers supply less due to the profit motive

Question 14

What is the effect of a maximum price on consumers?

Answer 14

A maximum price causes an extension along the demand curve as people are willing to buy more.

Question 15

What is the result of a maximum price?

Answer 15

Excess demand

Question 16

What is a minimum price?

Answer 16

A price which is legally imposed at which the price cannot go below

Question 17

Where does the minimum price sit on a demand and supply diagram?

Answer 17

Above the equilibrium point

Question 18

What does a maximum price solve?

Answer 18

Negative externality

Question 19

What does a minimum price do?

Answer 19

Raise the price, therefore consumers are deterred from consuming such product

Question 20

What is the impact of a minimum price on suppliers?

Answer 20

There is an extension along the supply curve so producers are willing to supply more due to the profit motive

Question 21

What is the impact of a minimum price on consumers?

Answer 21

There is a contraction along the demand curve, meaning people are less willing to consume the product

Question 22

What does a minimum price result in?

Answer 22

Excess supply
Producers willing to supply more
Consumers willing to consume less

Question 23

Evaluation points for maximum prices?

Answer 23

• depends on where the max price is
• PES of energy
• PED for energy
• government failure
• reduction of investment by suppliers
• loss of consumer surplus or higher prices in the future

Question 24

Evaluation points for minimum prices?

Answer 24

Hidden markets

Must lay above the equilibrium point