1.4.1 Government intervention

Question 1

Indirect tax

Answer 1

Tax on consumer expenditure
-> Specific tax - tax increases with the amount amount bought
-> Ad valorem - Tax as a percentage of the proportion of price of the good.

Question 2

Indirect taxation: Advantages

Answer 2

• It internalises the externality - the market now produces at social optimum, so social welfare is maximised.
  -It raises government revenue, which could be used to solve the externality in other ways e.g. education.

Question 3

Indirect taxation: Disadvantages

Answer 3

-Regressive poor spend a larger proportion of their income on indirect taxes than the wealthy do.
-It is difficult to know the size of the externality, and so it is difficult to target the tax. The government suffers from imperfect information when setting the tax.

Question 4

Subsidies

Answer 4

A grant given by the government to encourage the production or consumption of a good. It increases output at a lower market price.

Question 5

Subsidies: Advantages

Answer 5

-Society reaches the social optimum output and welfare is maximised.

Question 6

Subsidies: Disadvantages

Answer 6

-The government has to spend a large amount of money which will have a high opportunity cost.
-As with taxes, it is difficult to target, as the size of the externality is unknown.

Question 7

Maximum price

Answer 7

A legally imposed price (or price ceiling) for a good or service, which suppliers cannot exceed.

-Maximum prices have been implemented in Manhattan over rent controls on properties.
-Price caps have been set on milk, toilet paper, medicine, petrol and other schemes in venezuela have created a black market, these goods are no longer sold in supermarkets as they are unable to make a profit at those prices.

Question 8

Minimum price

Answer 8

A legally imposed ‘price floor’ for a good or service, supplier cannot go below.

Question 9

Maximum/Minimum price: Advantages

Answer 9

-They can be set where MSB=MSC, at the social optimum. Reducing externalities to maximise social welfare.
-A maximum price ensures that goods are affordable, whilst minimum prices help ensure that producers get a fair price. Both of these are able to reduce poverty, enhancing equality.

Question 10

Maximum/Minimum price: Disadvantages

Answer 10

-Leads to the distortion of price signals. This causes excess demand/supply. Excess demand creates a shortage, and excess supply will lead to a surplus.
-Both can lead to the creation of a black market.

Question 11

Tradable pollution permits

Answer 11

-A limit is placed on carbon emissions through the issue of permits.
-These permits allow firms to pollute up to a specific amount of pollution - this is set by the government.
-Firms have to buy permits in order to pollute, this forces them to save with greener energy.
-Firms that exceed this limit without buying permits are fined.

Examples:
-EU Emissions Trading Scheme (ETS) saved about 1.2 billion tonnes of carbon between 2008 and 2016.

Question 12

Tradable pollution permits: Advantages

Answer 12

-Firms have an incentive to invest in cleaner technology, and then sell existing permits to other firms.
-The government can raise revenue by selling and fining firms who exceed their pollution limit. This can be used to subsidise green energy.

Question 13

Tradable pollution permits: Disadvantages

Answer 13

-Heavy polluting firms can purchase surplus permits from other firms rather than invest in expensive cleaner technology.
-A cost to the government of monitoring and policing. The government needs to impose fines that are large enough to ensure firms abide by the regulation.

Question 14

State provision of public goods

Answer 14

The free market fails to allocate public goods due to the free rider problem. Thus, the government has to provide these goods.
-The UK the government provides a number of goods including roads, NHS, and education.

Question 15

State provision of public goods: Advantages

Answer 15

-State provision corrects market failure by providing goods that would not have been provided by the free market. Maximising social welfare.
-The provision of merit good e.g. healthcare, benefits society through ensuring the workforce is healthy, bringing economic growth.

Question 16

State provision of public goods: Disadvantages

Answer 16

-Expensive cost to the government, and represents a high opportunity costs for the government.
-Since the government is involved they may produce the wrong combination of goods as consumers cannot indicate their preferences.

Question 17

State provision of information

Answer 17

-The UK government provides information on cigarette packets, information campaigns on obesity, ‘traffic light system’, showing the fat, calories, sugar, salt etc. helps to show consumers the healthier options.

Question 18

State provision of information: Advantages

Answer 18

-This corrects market failure, resources are allocated to allow consumers to make rational decisions.

Question 19

State provision of information: Disadvantages

Answer 19

-Consumers may not listen to the information provided due to irrational behaviour.
E.g. ignoring labels on cigarette packets….

Question 20

Regulation

Answer 20

-The government can legislate laws and impose caps to ensure that levels are where MSB=MSC.
-The government can introduce regulatory bodies such as OFCOM (communications) or OFGEM (energy). These ensure that firms follow regulation and do not exploit their customers or take advantage of their position.

Question 21

Regulation: Advanatges

Answer 21

Corrects market failure, by addressing externalities, prevents exploitation of consumers and keep them fully informed. Resources are allocated, maximising social welfare.
-Smoking ban 2024
-Competition ban 1998 - monopolies
-Economic Crime and Corporate Transparency Act 2023

Question 22

Regulation: Disadvantages

Answer 22

-Excessive regulation may reduce competition in a market, by increasing bureaucracy.