1.4.1 - government intervention in markets Flashcards
What is the aim of indirect taxes?
Indirect taxes aim to internalise the externality by moving the market equilibrium closer to the social optimum and eliminating dead-weight welfare loss
What incentive do indirect taxes provide?
Provides an incentive to reduce production
How do indirect taxes benefit the government financially?
A source revenue for the government to reduce administration costs. This may help goods to become elastic in the long-run, though the effect will depend on how the government spends their revenue
Why is it hard to set the correct indirect tax level?
As it is difficult to work out the size of the externality as it tends to be placed on value judgements, since it is difficult to monetise external costs, therefore also hard to identify how much to tax.
What does the effectiveness of indirect taxes depend on?
Its effectiveness depends on the price elasticity of demand for the good
Why are indirect taxes considered regressive?
They are regressive as those with a higher income spend a lower proportion of their income in indirect taxes than those with a lower income
What is the aim of subsidies?
Subsidies aim to increase market equilibrium quantity to match that of the social optimum
How do subsidies affect consumption and firms?
Provides an incentive to increase consumption as reduces costs of production for firms, this can have other positive impacts, such as encouraging small businesses, bringing about equality and encouraging exports
What is a drawback of subsidies for taxpayers?
There is a cost to the taxpayer providing subsidies
Why is it difficult to determine the right subsidy amount?
As it is difficult to work out the size of the externality as it tends to be placed on value judgements, since it is difficult to monetise external costs, therefore also hard to identify how much to subsidies
What does the effectiveness of subsidies depend on?
Its effectiveness depends on the price elasticity of demand for the good
What happens once subsidies are introduced?
Once introduced they are difficult to remove
What is the opportunity cost of subsidies?
Creates and opportunity cost for other government expenses
What are tradeable pollution permits?
Tradeable pollution permits are a mechanism used to regulate pollution using market forces.
What is carbon trading?
Carbon trading is a form of pollution control that uses the market mechanism to change relative prices and the incentives of producers and consumers to reduce their total carbon emissions.
How do carbon permits work in a cap-and-trade system?
One way this occurs is by creating market for carbon permits (cap-and-trade system), which give companies the right to pollute up to a certain amount. The government controls how many permits so limits the maximum amount of pollution. As they can be traded on the market, companies that need to pollute more can buy permits from companies that don’t need to use all their allotted pollution allowance. The fixed supply of permits is capped and gradually reduced which leads to a higher price.
What incentive do tradeable permits create?
Consequently, this system creates and incentive for companies to reduce their pollution, as they make revenue from selling their unused pollution permits and to reduce costs of production since an increase in demand will significantly increases the price of permit due to the fixed supply of permits
How do tradeable permits guarantee emission reductions?
Guaranteed that pollution will fall to the targets set by the government as they cap the number of permits
What is a limitation of the pollution permit system?
However, it doesn’t completely eradicate pollution and produces a risk of larger firms purchasing many permits so they can continue to pollute.
What are the operational difficulties of the permit scheme?
It is also expensive and difficult for governments to operate this scheme since they don’t know how many permits they should allow, creating an opportunity cost for other government expenses.
How might pollution permits affect businesses and consumers?
It will raise the costs for businesses, and is likely that they will be passed onto the consumers
What is another form of carbon trading besides permits?
Another form of carbon trading is a carbon tax on carbon emissions, which is an indirect tax on producers that raisers the price of emissions. Though it mandates a specific price on carbon, it carries the limitation of an indirect tax.
What is a maximum price?
Maximum prices is a legally impose price for a good that the suppliers can’t charge above. They are set on goods with positive externalities
When must a maximum price be set to be effective?
For it to have an effect it must be set below the current price equilibrium.
What are benefits of maximum prices for consumers?
This enables consumers on low incomes to be able to afford a product whilst preventing increases in inflation and preventing monolopies from exploiting consumers, increasing equality
What is a potential downside of maximum prices?
There is a danger that shortages result in some people being unable to purchase the product since there is excess demand
Why might producers exit the market under maximum prices?
Producers might exit market to produce something which makes more profit, or if the government subsidises firms to ensure they continue producing, there is a cost to the taxpayer to fund the subsidy
What black market risk comes with maximum prices?
May also lead to illegal bribes or discriminatory policies in allocating goods
What is a minimum price?
Minimum prices is a legally imposed price at which the price of the good can’t go below. They are set on goods with negative externalities, so that the price is raised to the social optimum level and consumption is discouraged
When must a minimum price be set to be effective?
For it to have an effect it must be set above the current price equilibrium
What benefit does minimum price offer producers?
This means producers know in advance the price they will receive, allowing them to plan investment and output, increasing equality
What risk comes from surpluses under minimum pricing?
There is a danger that surpluses can cause inefficient resource allocation since there is excess supply, and there is a cost to the taxpayer for the cost of storage.
What happens under a legal minimum price system?
Suppliers can’t sell all their goods at the higher price, so they end up with unsold surplus. To avoid losses, they reduce supply, which lowers output and can lead to job cuts.
What happens under a guaranteed minimum price system?
The government buys the surplus at the set price, which is expensive and takes money away from other things. The extra goods then need to be stored, resold, or destroyed, adding more costs.
What if a minimum price is set too high?
If the minimum price is set too high, there would be an annual surplus
Why is it hard for governments to set prices correctly?
It is difficult for the government to know where to set the prices, as it is difficult to work out the size of the externality and because it will have implications on the size of excess supply/demand. Both can also lead to the creation of black markets.
What is state provision of public goods?
State provision of public goods is when the government uses tax revenue to pay for the provision of public goods
How does state provision of public goods address market failure?
Corrects market failure and improving social welfare as it provides goods which would otherwise not be provided and ensures everyone has access to basic goods. The provided goods themselves can also carry economic benefits
What is the opportunity cost of public goods provision?
However, there is an opportunity cost surrounding the spending on public goods and decisions are made by government officials on how these resources are allocated
Why might government provision be inefficient?
This is especially because the market is not involved and the government may be inefficient at production since they have no incentive to cut costs, meaning they may produce the wrong combination of goods.
What political issues can affect public good provision?
Government officials also may suffer from corruption and conflicting objectives
What is the aim of government provision of information?
Provision of information by governments to close information gaps, though there is no guarantee that that compaigns will work and there is a cost associated with such campaigns. It is therefore best if the government uses this alongside other policies.
What are regulations by governments?
Regulation by governments involve legal restrictions which can be placed on either the consumers or producers, which should in theory restrict activity to the required level.
What benefit can regulation bring?
This should limit the extent of the activity and might act as an incentive for firms to develop new technology.
What issues can arise with regulation?
However, the government faces issues such as the cost of enforcement, problems with determining socially optimal levels and black market issues.
How can excessive regulation harm markets?
Excessive regulation may reduce competition in a market and efficiency, by increasing bureaucracy and reducing innovation
