1.4.1 Government intervention

Question 1

Define government intervention

Answer 1

The intentional interference of the government in an economy through regulatory actions.

Question 2

Methods of government intervention

Answer 2

• indirect taxes (VAT and specific unit)
• subsides
• maximum/minimum prices
• trade pollution permits
• state provision of public goods
• provision of information
• regulation

Question 3

Why do governments impose indirect taxation?

Answer 3

Governments often put indirect taxation on demerit goods/services to decrease the overconsumption of them, by forcing producers to increase prices to discourage people from buying them (aiming to internalise the externality, making the producer/consumer pay for the cost of their externality).

Governments can also set landfill tax or road tax to decrease the environmental impact of dumping or decrease congestion and carbon emissions in certain areas.

Question 4

Advantages of indirect taxation

Answer 4

• increased prices on goods which have the tax imposed may reduce demand, therefore reducing the effects of negative externalities (e.g. smoking/petrol/alcohol)
• the government gains revenue from the tax, even if consumption/demand is not reduced

Question 5

Disadvantages of indirect taxation

Answer 5

• hard to put a monetary value on the ‘cost’ of negative externalities
• if demand for a good is price inelastic: the tax may not discourage consumption
• cost of the tax to production may reduce a product’s international competitiveness
• firms may leave the country to avoid taxation: removal of contributions from the economy
• money raised by taxes on demerit goods may not necessarily be spent on reducing the effect of their externalities

Question 6

Why do governments pay subsidies to producers?

Answer 6

To encourage/incentivise the production and consumption of goods and services with positive externalities (e.g. merit goods) OR encourage the production and consumption of goods and services that reduce negative externalities (e.g. public transport).

Question 7

Advantages of subsidies

Answer 7

• internalises the benefit of goods with positive externalities (cost of the externalities is covered by the subsidy)
• makes merit goods more affordable/cheaper, which may increase the demand for them
• positive externalities present
• can help domestic industries grow to the point where it can exploit economies of scale and become internationally competitive

Question 8

Disadvantages of subsidies

Answer 8

• difficult to put a monetary value on the ‘benefit’ of the positive externalities
• opportunity cost
• may make producers inefficient and reliant on subsidies
• the effectiveness relies on the PES
• the subsidies on some goods/services may not be as good as they’re aiming to replace (e.g. imports may be better quality than domestic goods)

Question 9

Maximum price/price ceiling

Answer 9

A price set by the government which the prices of the chosen goods/services cannot exceed (set below the equilibrium)

Question 10

Minimum price/price floor

Answer 10

A price set by the government in which the prices of chosen goods/services have to be at least (set above the equilibrium)

For a minimum price to work, the govt. must purchase the excess supply for the good, to be either stockpiled or destroyed (govt. expenditure)

Question 11

Why do governments set a maximum price (for a good/service)?

Answer 11

Price ceilings are often set to increase consumption of merit goods and make necessities more affordable and to stop firms from exploiting consumers

Question 12

Why do governments set a minimum price (for a good/service)?

Answer 12

Price floors are often set to make sure that suppliers get a fair price and to limit/discourage the consumption of demerit goods

Question 13

Advantages of maximum prices

Answer 13

• increases fairness: allows more people the ability to purchase certain goods/services
• prevents monopolies from exploiting consumers

Question 14

Disadvantages of maximum prices

Answer 14

• excess demand: some people aren’t able to buy the product
• governments may need to introduce a rationing scheme
• can lead to the creation of shadow economies

Question 15

Advantages of minimum prices

Answer 15

• producers have a guaranteed minimum income (encourages investment)
• stockpiles can be used when supply is reduced or as overseas aid
• can reduce the consumption of certain goods (e.g. demerit goods)

Question 16

Disadvantages of minimum prices

Answer 16

• consumers have to pay a higher price than the market equilibrium
• excess supply: resources used to produce this could be used elsewhere (inefficient allocation of resources)
• opportunity cost for the government: government expenditure
• destroying excess goods: waste of resources

Question 17

Tradable pollution permits

Answer 17

Licenses that allow firms to emit a certain amount of pollution over a period of time, which can be traded with other firms

Question 18

Why do governments issue pollution permits?

Answer 18

To try and limit the amount of pollution in an economy, by giving firms an incentive to cut emissions

Question 19

Advantages of pollution permits

Answer 19

• may encourage firms to pollute less and become more efficient
• selling permits can allow firms to invest more and expand
• government gains revenue
• may help to internalise the externality of pollution

Question 20

Disadvantages of pollution permits

Answer 20

• hard for the government to set an optimal emission level and to measure the amount of pollution
• could cause firms to leave the economy and relocate
• firms may try to find other ways to offset pollution
• administrative costs for both firms and the government
• if the price is too low, larger firms may not mind paying for permits

Question 21

Why do governments provide public goods?

Answer 21

State provision of public goods:
Since public goods are non-rival and non-excludable, these goods are under provided by the free market as producers have no incentive to produce them due to the free-rider problem

Question 22

State provision of public goods

Answer 22

When the government provides goods using revenue gained from tax, such as public goods and merit goods, either providing them directly or purchasing them from the private sector

Question 23

Advantages to state provision of public goods

Answer 23

• corrects market failure
• improved social welfare/reduces inequalities/redistribution of income
• increases the consumption of merit goods, leading to long-term benefits to society

Question 24

Disadvantages to state provision of public goods

Answer 24

• high opp. cost for the govt.
• the government may produce the wrong combination of goods (failure to respond to cons. demands)
• production may be inefficient
• may reduce the self-reliance of individuals

Question 25

Government provision of information

Answer 25

When the government provides information (normative statements) on the full costs and benefits of goods and services to allow people to make informed decisions

Question 26

Impacts of provision of information

Answer 26

Impacts the demand for goods:
Governments will try to give positive advertising/information on goods that are good for us and under consumed as we don’t understand the true benefit (usually merit goods)

Governments will also try to give negative advertising for demerit goods (over consumed) as we as consumers don’t understand the true cost of consuming it

Question 27

Examples of government provision of information

Answer 27

• school and hospital performance league tables
• advertising campaigns that encourage healthy eating
• cigarette packagings: health warnings, unpleasant imagery, ugly colours
• compulsory food labelling on foods
• menus showing calories of dishes

Question 28

Government regulation

Answer 28

Rules enforced by the govt., usually backed with legislation so legal action can be taken upon those who break the rules

Question 29

Why do governments set regulations?

Answer 29

They are used to try and reduce market failure and its impacts, also used to control the activities of prod. and cons. to try and change undesirable behaviour

Question 30

Examples of government regulation

Answer 30

• banning/limiting the sale of demerit goods
• setting price caps to reduce the powers of monopolies
• providing protection for consumers (e.g. the Consumer Rights Act)
• if rules are broken, you could be fined/arrested
• the Clean Air Act and Environment Protection Act were created to limit the damage caused to the environment by ec. activity

Question 31

Limitations to government regulation

Answer 31

• difficult for the government to work out what is best for society
• excessive regulations can be expensive and can cause firms to relocate
• having a regulation in one area doesn’t mean that the effect is reduced as it may be offset elsewhere
• monitoring compliance can be expensive for the government, and may be hard to record/track