1.4.1 Government Intervention In Markets

Question 1

Main types of government intervention

Answer 1

• indirect taxation (ad valorem and specific)
• subsidies
• maximum and minimum prices

Question 2

Purpose of indirect taxation

Answer 2

• reduces supply = increase in price
• an attempt to discourage production/consumption of a good with negative externalities

Question 3

Ad valorem tax (diagram)

Answer 3

• a percentage e.g VAT
• the supply curve shifts to left and becomes steeper
• the consumer and suppliers pays some

Question 4

Specific tax example

Answer 4

• 20% tax on smoking

Question 5

Specific tax (diagram)

Answer 5

• the supply curve shifts left
• the consumer pays due to higher price and supplier pays since they make less revenue

Question 6

Subsidies as a form of government intervention

Answer 6

• for the under consumption of merit goods
• increases supply = reduced price
• this encourages production/ consumption of a good with positive externalities (reduces welfare loss to society)

Question 7

Minimum price

Answer 7

• where goods cannot be sold at a price below this
• set by a government to discourage consumption of a particular good

Question 8

Minimum price diagram

Answer 8

• set above the market price
• Pmin is the minimum price
• Qd is the quantity demanded by consumers and Qs is the quantity supplied
• Qs-Qd gives an excess supply

Question 9

Minimum price diagram explanation

Answer 9

• Compared to the market equilibrium, firms have extended supply due to the higher prices but the consumers contracted demand.
• Demand decrease since consumers need to pay higher price but firm’s have profit motive since price increases

Question 10

Minimum price example

Answer 10

In 2018, Scotland’s minimum price for alcohol at 50p per unit

Question 11

Maximum price

Answer 11

• where goods cannot be sold at a price above this
• set by a government to encourage the consumption of a particular good

Question 12

Maximum price diagram

Answer 12

• set below the market equilibrium
• Qd is the quantity demanded by consumers and Qs is the quantity supplied
• Qd-Qs gives excess demand

Question 13

Maximum price diagram explanation

Answer 13

• Compared to the market equilibrium, firms have contracted supply due to lower prices but consumers have extended demand
• supply decreases since the lower price incentivises producers to continue producing the same level of g/s

Question 14

Other methods of government intervention

Answer 14

• trade pollution permits
• state provision of public goods
• provision of information
• regulation

Question 15

Trade pollution permits

Answer 15

• to tackle negative externalities
• the govt decides the desired level of pollution and releases a number of permits
• these permits can be trade by firms so that low polluters can sell to high polluter for profit (rewards low polluters & punishes high polluter)

Question 16

State provision of public goods

Answer 16

• the govt provides a good or services, using tax revenue to fund it
• these goods are not provided by the private sector due to the free rider problem (there’s no welfare loss)
• e.g NHS

Question 17

Provision of information:

Answer 17

the government provides information to consumers to correct any problem of information gaps

Question 18

Regulation

Answer 18

• to tackle negative externalities
• the government imposes rules regarding the production or consumption of g/s
• this is usually backed up legally by fines/prison sentences etc

Question 19

Government failure

Answer 19

exists when the government intervenes to correct a market failure, but the result is a more inefficient allocation of resources and there is net welfare loss

Question 20

Consequences of government failure

Answer 20

• distortion of price signals
• unintended consequences
• excessive administrative costs - information gaps

Question 21

Example of government intervention (maximum price)

Answer 21

• In 2013, Cyprus implemented a price cap of 1.41 euros per litre on milk to control excessive prices and increase consumption
• maximum price

Question 22

Subsidy example

Answer 22

In 2012 around 35% of university funding came from subsidies given out by the government. = reduce under consumption

Question 23

Subsidy evaluation

Answer 23

• it is expensive for government to implement

Question 24

Example of government intervention (externalities)

Answer 24

UK government to ban petrol and diesel cars by 2035 (addressing climate change and driving down carbon emissions)

Question 25

Example of govt intervention

Answer 25

- In 2015, 20% tax on soft drinks - the provision of information to reduce info gaps (anti smoking campaigns)

Question 26

Indirect tax evaluation

Answer 26

The extent of demand depends on elasticity

Question 27

Cigs indirect tax with graph (see essay)

Answer 27

- Cigs = demerit good so it’s over-consumed = neg externality = q & p are at private optimum point rather than social = welfare loss to society

Question 28

Cigs indirect tax with graph (see essay) evaluation

Answer 28

It might not be effective due to habitual behaviour - Evaluation: it doesn’t matter if it’s not effective since tax received can be used to cover neg externality

Question 29

Subsidy example

Answer 29

In 2012, 35% of uni funding

Question 30

Subsidies as a form of government intervention evaluation

Answer 30

- It’s expensive to implement (might be ineffective) and has opportunity costs - if the subsidy to producer = too reliant to survive in market = inefficiency = distorts free market outcomes

Question 31

Trade pollution permit graphs

Question 32

Trade pollution example

Answer 32

China’s national cap-and-trade program

Question 33

Trade pollution permit evaluation

Answer 33

- an assumption is made - to do this, govt must have perfect information - but this isn’t true so gov can give out too may permits = little impact or too few = increase costs = force outside market - it’s difficult to measure

Question 34

State provision of goods graph

Question 35

Provision of information evaluation

Answer 35

As price = 0, there’s no price rationing function = excess demand from Q1 to D1 - there’s also a opportunity cost

Question 36

Provision of information evaluation example

Answer 36

In 2018, the govt planned to spend 18% of budget on healthcare. If unsuccessful = costly - also there’s no profit motive = inefficiencies - benefit on state provision depends on the govt’s ability to ration excess demand. If they can’t = large amount of consumers = miss out

Question 37

Evaluating government intervention

Answer 37

* effectiveness * efficient * equity * is it crucial (can market forces provide the necessary impetus to address these issues)

Question 38

Examples of environmental interventions

Answer 38

* carbon tax * carbon trading * renewable subsidy *

Question 39

Environmental interventions through carbon tax

Answer 39

* aims internalise externalities by making the polluter pay * it leads to tax revenue

Question 40

Evaluation of carbon tax

Answer 40

* inelastic demand * loss of cost competitiveness * inequity

Question 41

Environmental interventions through carbon trading

Answer 41

* aim is a market-based approach to pricing carbon * it favours pollution efficient firms

Question 42

Evaluation of carbon trading

Answer 42

* volatile carbon price can hold back clean energy investment

Question 43

Environmental intervention through renewable subsidy

Answer 43

* aims to lower the cost & risk of renewable investment * encourages economies of scale

Question 44

Evaluation of renewable subsidy

Answer 44

* cost to taxpayers & risk of long run subsidy dependence

Question 45

What is the graph like for specific tax?

Answer 45

A direct parallel shift