1.4.1 - Government intervention in markets Flashcards
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Indirect taxation to reduce negative externalities in production - unrealistic version
(draw diagram & explain).
When the good has a negative externality, the government can introduce indirect taxation to prevent market failure. This will cause a fall in supply of the demerit good and increase the costs to the individual.
- Following the introduction of the tax, the Supply curve/MPC curve = will shift from S1 to S2 where the social optimum is. he tax internalises the externality and social welfare is now maximised.
Advantages:
●It internalises the externality- the market now produces at the social equilibrium position and social welfare is maximised.
● It raises government revenue, which could be used to solve the externality In other
ways such as through education.
Disadvantages:
●It is difficult to know the size of the externality and so It is difficult to target the tax; the effect depends on where the tax is set.
●The government suffers from Imperfect
information when setting the tax.
●It could lead to the creation of a black market
●If demand for the good is inelastic, then the tax will be Ineffective at reducing output.
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Indirect taxation to reduce negative externalities in production - realistic version
(draw diagram & explain).
Governments frequently tax firms that pollute or create harmful external costs in production
link
Positive externality in underconsumption - realistic version
(draw diagram & explain).
In order to solve the underconsumption of positive externalities the gov can provide subsidies to increase the quantity of this merit good and decrease the price so that more people can afford it e.g electric cars.
Advantages:
- Society reaches the social optimum output and welfare is maximised.
Disadvantages:
●The government has to spend a large amount of money to provide subsides meaning they may increase taxes to increase gov revenue so they can finance subsidies in the long run.
●Subsidies can cause producers to become Inefficient, especially if they are in place
for a long time
Minimum Prices
(draw diagram & explain)
- Governments will often use minimum prices in order to help producers or to decrease consumption of a demerit good e.g. alcohol in Scotland
- A minimum price is set by the government above the existing free market equilibrium price and sellers cannot legally sell the good/service at a lower price.
- Minimum prices are also used in the labour market to protect workers from wage exploitation. These are called minimum wages.
- In agricultural markets, if a minimum price is set by the government producers benefit as they receive a higher price
Governments will often purchase the excess supply and export it.
Advantages:
- They help to reduce the consumption of demerit goods.
Disadvantages
- It depends on the externality of the good.
- It’s difficult for the gov to know where to set the prices, because of the difficulty of knowing the size of externalities and because it will have implication on the size of excess supply/demand.
- Can lead to the formation of black markets as the firms are unable to make a profit at those prices.
Maximum Prices
(draw diagram & explain)
A maximum price Is a legally imposed price for a good that the suppliers cannot charge above.
They are set on goods with positive externalities
- A maximum price is set by the government below the existing free market equilibrium price and sellers cannot legally sell the good/service at a higher price.
Advantage:
- Will ensure that merit goods are affordable.
Disadvantages
- It depends on the externality of the good.
- It’s difficult for the gov to know where to set the prices, because of the difficulty of knowing the size of externalities and because it will have implication on the size of excess supply/demand.
- Can lead to the formation of black markets as the firms are unable to make a profit at those prices.
Other methods of gov intervention
o trade pollution permits
o state provision of public goods
o provision of information
o regulation
Trade pollution permits
- Governments implement a trade pollution permit scheme to address market failure caused by
excessive pollution. - Government sets a cap on how much pollution it will allow each year.
- Permits are distributed based on the size of businesses to ensure realistic pollution requirements.
- Firms can either reduce pollution levels or buy permits from other firms.
- Firms that exceed the pollution limit will face fines.
- Firms are incentivized to reduce pollution as they can sell unused permits.
- Fines must exceed the cost of investing in greener technologies and buying permits.
- Supply decreases, reducing pollution, when firms face increased costs.
State Provision of Public Goods
- Public goods are beneficial for society and are not provided by private firms due to the free rider problem.
- They are usually provided free at the point of consumption, but are paid for through general taxation.
Examples include roads, parks, lighthouses, national defence
Provision Of information
The government may decide to solve market failure through the provision of information. This can be an effective policy decision when trying to fix markets that have failed as a result of information gaps or asymmetric information.
Regulation
- Governments create rules to limit harm from negative externalities of consumption/production.
- They create regulatory agencies to monitor that the rules are not broken
There are more than 90 regulators in the UK
Individuals or firms may be fined/imprisoned for breaking the rules. - Examples of some industry regulators include the Environment Agency, Ofsted, and the Financial Conduct Authority.
subsidies diagram
Social cost formula
Social cost = Private costs + external costs
Social benefit
Social benefit = Private benefit + external benefit
Welfare formula (not necessarily welfare loss)
MSocial benefit - Msocial cost
Draw an increasing negative externality diagram. (mainly used for exams).
What diagram should you use if a question asked you to fix a negative externality in overconsumption
A tax diagram as edexcel doesn’t require you to know that diagram.
