1.4.1 Government intervention in markets Flashcards
Purpose of intervention with reference to market failure and using diagrams in various contexts:
indirect taxation (ad valorem and specific)
when a good has negative externality, the government can introduce indirect taxation to prevent market failure. this is because the tax causes a fall in supply and decreases output, this in turn reduces and internalises the size of the externality
box between Q2, S1-S2 along to price axis is government revenue
Advantages
- internalises externality, market now produces closer to the social optimum position and welfare loss is decreased
- raises government revenue which can be used to reduce externality in other ways such as education, this may help goods to become more elastic in the long run
Disadvantages
- it is difficult to know the size of an externality and so it is difficult to target the tax, the government suffer from imperfect information
- the revenue may not necessarily be hypothecated due to corruption or conflicts of interest
- it could lead to the creation of a black market, this would mean the externality isn’t actually reduced
- If demand for the good is inelastic, then the tax will be ineffective at reducing output
- taxes are politically unpopular
- they are regressive, the poor spend a larger proportion of income on indirect taxes than the rich
examples of taxes include: fuel duties, alcohol duties, tobacco duties, sugar taxes
Purpose of intervention with reference to market failure and using diagrams in various contexts:
subsidies
In order to solve positive externalities, the government can introduce subsidies. subsidies lower costs for firms and therefore allow them to increase output, this helps to solve the positive externality
box between Q1, S2-S1along to price axis is government spending
Advantages
- increases supply and therefore output, market now produces closer to social optimum and decreases welfare loss
- they can have other positive impacts such as encouraging small businesses, bringing about equality and encouraging exports
Disadvantages
- the government has to spend a large amount of money, this will have a high opportunity cost
- they are difficult to target since the size of the externality is unknown
- subsidies can cause producers to become inefficient, especially if they are in place for a long time
- once introduced, subsidies are difficult to remove
examples of subsidies include: subsidies on biofuels, apprenticeship schemes, rail industries
Purpose of intervention with reference to market failure and using diagrams in various contexts:
maximum and minimum prices
for a maximum price to be effective, it must be set below the current equilibrium price, this is because they are used to solve positive externalities and to increase demand for the good the price must be below the equilibrium
for a minimum price to be effective, it must be set above the current equilibrium price this is because they are used to solve negative externalities and to decrease demand for the good the price must be above the equilibrium
Advantages
- they can be set at where MSB=MSC, so allow for some consideration of externalities and so helps decrease welfare loss
- a maximum price ensures goods are affordable and minimum price ensures producers get a fair price, both are able to reduce poverty and increase equality
Disadvantages
- distortion of price signals and causes excess supply/demand, this could lead to market failure is goods are allocated inefficiently
- difficult for the government to know where to set the price as size of externality is unknown and the extent of excess supply and demand
- both can lead to black markets which will mean the externalities remain unsolved
- maximum prices may able lead to illegal bribes or discriminatory policies in allocating goods
examples include:
- maximum prices in Manhattan on rent prices
- in Venezuela there are price caps on milk, toilet paper, medicine, petrol and other keys goods, this has led to the creation of a black market and those goods are no longer sold in supermarkets as they are unprofitable
- in Scotland there is a minimum price imposed on alcohol, targets cheapest drinks to cut down on binge drinking, but will have regressive effects on addicted people in poverty
- in Nashville there is a minimum price on limousines, this has stifled competition as the most price competitive firms are forced out
Other methods of government intervention:
trade pollution permits
a pollution permit allows the owner to pollute up to a specific amount of pollution and the government controls how many permits there are so limits the maximum amount of pollution
Advantages
- since the gov caps the number of permits, it is guaranteed that pollution will fall to the targets set by the gov, this will help maximise social welfare
- raise revenue by selling permits and fining those who exceed the limit
- encourages companies to invest in green energy
- firms have to make their own decisions whether to cut pollution or buy more permits, this helps encourage increasing efficiency
Disadvantages
- they can be expensive to monitor and police, gov needs to impose fines large enough to ensure firms follow the regulation
- raise costs for businesses, likely those costs will be passed onto consumers, much more likely if demand is inelastic
- due to imperfect information, it is difficult for the gov to know how many to allow
successful example:
- US sulphur trading scheme, which reduced sulphur dioxide by 40%
- the EU emissions trading scheme was launched in 2005 and it represents a 21% reduction in greenhouse gases
Other methods of government intervention:
state provision of public goods
public goods are non excludable and non rivalry and so the free rider problem says they will be under provided by the free market, leading to market failure, due to this the government can provide public goods directly through taxation and they can provide merit goods
Advantages:
- corrects market failure by providing goods which otherwise would not be provided, improved social welfare
- bring about equality by ensuring everyone has access to basic goods
- there will be the benefits of the goods themselves, i.e. providing healthcare ensures the workforce is healthy
- by using competitive tenders, the gov can ensure efficiency
Disadvantages
- this is expensive and represents a high opportunity cost
- since the market is not involved, the gov may produce the wrong combination of goods as consumers can not indicate their preferences
- the gov may be inefficient at production since they have no incentive to cut costs
- may suffer from corruption and conflicting objectives
example
- in the uk the government provides a number of public goods including roads, education and healthcare, the nhs suffers from severe underfunding and many schools having budget cuts,
- money is spent on improving railways rather than roads even thought 92% of all journeys in the uk are made on roads, suggesting misallocation of resources
Other methods of government intervention:
provision of information
when there is asymmetric information the gov provides information to allow people to make informed decisions, they may also force companies to provide information
Advantages
- this helps consumers to act rationally
- it is best if gov uses this alongside other policies, for example it can make long run demand more elastic increasing the effectiveness of indirect taxes in the long run
Disadvantages
- can be expensive for the government to do, incurring an opportunity cost
- the government themselves may suffer from information failure
- consumers may not listen to the information due to irrational behaviour
Other methods of government intervention:
regulation
governments are able to impose laws and caps to ensure that levels are set where MSB=MSC or to ensure that companies provide full information on products
Advantages
- this can ensure consideration of externalities, prevent exploitation of consumers and keep consumers fully informed, this will help to overcome market failure and maximise social welfare
Disadvantages
- laws may be expensive for the gov to monitor
- they don’t take into account different costs of following the laws for different companies. compared with tradable pollution permits, regulation is a less efficient method of reducing pollution
- the government can suffer from regulatory capture
- firms may pass on costs to consumers in the form of higher prices
- excessive regulation may reduce competition in a market and efficiency by increasing bureaucracy and reducing innovation
examples include:
- EU fishing quotas
- smoking bans
- minimum age laws
- maximum co2 emissions (ulez)
