1.4.1 (Government Intervention)

Question 1

Indirect Taxation

Answer 1

• Used to correct market failure when the good has a negative externality
• Cause a fall in supply and increase costs to the individual

Question 2

What are advantages of indirect taxation?

Answer 2

• Internalises the externality and the market produces at social equilibrium so the social welfare is maximised
• Raises government revenue which could be used to fund things like education, may help goods become more elastic but depends on what government does with revenue

Question 3

What are disadvantages of indirect taxation?

Answer 3

• Difficult to know size of externality and therefore hard to target the tax (imperfect information)
• Conflict between gov goal of raising revenue and solving externality
• Lead to creation of black market
• If demand is inelastic then tax is ineffective
• Taxes are politically unpopular
• Regressive, the poor spend more income on indirect taxes than the rich

Question 4

Subsidies

Answer 4

• In order to solve positive externalities gov can use subsidies
• Shift supply curve to right and lower cost of production

Question 5

What are advantages of subsidies?

Answer 5

• Society reaches the social optimum output and welfare is maximised
• Other positive impacts e.g encouraging small businesses, bringing equality and encouraging exports

Question 6

What are disadvantages of subsidies?

Answer 6

• Gov has to spend a large amount of money, will have a high opportunity cost
• Difficult to target since size of externally is unknown
• Subsidies can cause production inefficiency
• Subsidies are difficult to remove

Question 7

What is a maximum price?

Answer 7

• A legally imposed price for a good that suppliers cannot charge above
• Set on goods with positive externalities
• Prevent monopoly from exploiting consumers
• Leads to excess demand

Question 8

What is a minimum price?

Answer 8

• A legally imposed price of the good that it cannot go below
• Set on goods with negative externalities to raise the social optimum point and consumption discourages
• Leads to excess supply

Question 9

What are advantages of max and min prices?

Answer 9

• Can be set where MSB=MSC so allow for consideration of externalities and help increase social welfare
• Min price ensures goods are affordable, max price ensure producers get a fair price, this reduces poverty and increases equity

Question 10

What are disadvantages of max and min prices?

Answer 10

• A distortion of price signals cause excess supply and demand
• Less allocative efficiency
• Difficult for gov to know where to set prices, difficulty of knowing size of externality
• Both can lead to creations of black markets

Question 11

What are tradable pollution permits?

Answer 11

• Allows the owner to polite up to a specific amount of pollution
• Gov controls numbers of permits
• Companies have to buy permits (may use greener tech as a result)
• Companies who don’t use them can trade them

Question 12

What are advantages of tradable pollution permits?

Answer 12

• Guarantees the fall of pollution due to cap on number of permits, maximising social welfare
• Gov can raise revenue by selling permits
• Encourages use of green technology
• Efficiency increases by firms

Question 13

What are disadvantages of tradable pollution permits?

Answer 13

• Expensive to monitor and police, only will work if it is policed and monitored
• Raise costs for businesses, this will be passed to consumers
• May be difficult to know the number of permit a government should allow

Question 14

State provision of public goods

Answer 14

• Public goods are non-excludable and non-rivalrous
• Free rider problem says that they will be under-provided by the free market leading to market failure
• Gov provide this through taxation, merit good

Question 15

What are advantages of state provision of public goods?

Answer 15

• Corrects market failure by providing goods that would otherwise not be, improving social welfare
• Help bring about equality
• Benefits of goods, e.g healthcare and functioning work force therefore economic growth

Question 16

What are disadvantages of state provision of public goods?

Answer 16

• Expensive and high opportunity cost for the government
• Market is not involved therefore gov may produce wrong combination of goods as consumers cannot express their needs
• Gov may be inefficient at production since they have no incentive to cut costs
• Government office may suffer corruption and conflicting objectives

Question 17

Provision of information

Answer 17

• When there is asymmetric information the government provide information to allow people to make informed decisions
• May also force companies to provide information

Question 18

What are advantages of provision of information

Answer 18

• Helps consumers act rationally which allows market to work properly
• Best that gov uses this alongside other policies
• Makes demand more elastic in the long run and helps indirect axes to become effective at reducing output

Question 19

What are disadvantages of provision of information?

Answer 19

• Can be expensive for gov and incurs an opportunity cost
• Gov themselves may not have information
• Consumers may not listen

Question 20

Government Regulation

Answer 20

• Able to impose laws and caps to ensure levels are set to MSB=MSC
• Regulatory bodies such as OFCOM for communications and OFGEN foe energy
• Ensures firms don’t exploit their workers

Question 21

What are advantages of regulation?

Answer 21

• Ensure consideration of externalities, prevent exploitation of consumers and keep them fully informed
• Helps overcome market failure and maximise social welfare

Question 22

What are disadvantages of regulation?

Answer 22

• Laws may be expensive for the gov to monitor and incur opportunity cost
• Don’t take into account different costs of following laws for different companies
• Firms may pass on costs to consumers
• Excessive regulation reduces competition in market and therefore efficiency