2.11 Government Intervention Flashcards
Why do governments intervene in the market
To correct market failure
For example, they might provide healthcare and education
What are indirect taxes and what do they do
They are taxes on expenditure. They increase production costs for producers, so they supply less. This increases market price and demand contracts. They can be used to discourage the production or consumption of cigarettes
What are the two types of indirect taxes
Ad valorem
Specific taxes
What are ad valorems
They are percentages, such as VAT, which adds 20% of the unit price. This is the main indirect tax in the UK
Describe what an ad valorem diagram looks like
Explain the ad valorem diagram
The incidence of tax might fall differently on consumers and producers. Producers could make consumers pay the whole tax, but if they feel this would lower sales, they may choose to pay some of the tax.
What does the incidence of the tax depend on
The price elasticity of the good. A more price inelastic good wouod mean the consumers might have the larger burden of tax. This should discourage the consumption of the demerit good and reduce negative externalities
What is a specific tax
A set tax per unit
Describe how a specific tax diagram looks
What effect does a good with a more inelastic demand have on specific taxes
The more inelastic the demand, the higher the tax burden for the conusmer, and the lower the burden of tax for the producer
How can indirect taxes reduce the quantity of demerit goods consumed
By increasing the price of the good. If the tax is equal to the external cost of each unit, then the free market equilibrium becomes the socially optimum. This means the polluter pays for the damage
What is a subsidy
A payment from the government to a producer to lower their costs of production and encourage them to produce more
What do subsidies encourage
The consumption of merit goods. This includes the full social benefit in the market price of the good
Give an example of a subsidy
The government might subsidise recycling schemes so it is cheaper for consumers to recycle waste, which gives positive externalities for the environment
What does a subsidy graph look like
What happens the the supply curve after a subsidy
The supply curve shifts to the right
What on a subsidy graph shows the value of the subsidy per unit
The vertical distance between the supply curves
When do the consumers and producers gain more from a subsidy
Consumers gain more when demand is price inelastic, whilst producers supply more when demand is price elastic
What are the disadvantages of subsidies
The opportunity cost to the government and potentially higher taxes, the potential for firms to become inefficient if they rely on the subsidy and government failure, if they subsidise less efficient industries
What is a maximum price
The government might set a maximum price where the consumption or production of a good is to be encouraged. This is so that the good does not become too expensive to produce or consume
Where do maximum prices have to be set
Below the free market price, otherwise they would be ineffective
What does a maximum price diagram look like
What do maximum prices prevent
They prevent monopolies exploiting consumers
What do maximum prices control
They control the market price, but this could lead to government failure if they misjudge where the optimum market price should be
What can maximum prices lead to
Welfar gains for consumers by keeping prices low, and they could increase efficiency in firms, since they have an incentive to keep their costs low
What could a maximum price do to firms profits
It could reduce then which could lead to less investment in the long term
What is a minimum price
Where the consumption ir production of a good is to be discouraged by ensuring the good never falls below a certain price
Give an example of where minimum price is used
The government might impose a minimum price on alcohol, so it is less affordable to buy
The national minimum wage is another example
What do minimum prices reduce
They reduce the negative externalities from consuming a demerit good, such as alcohol
Where do minimum prices have to be set
They must be set above the free market price otherwise they would be ineffective
What does a minimum price diagram look like
Explain a minimum price diagram with the example of a national minimum wage
The diagram suggests that a minimum wage leads to a fall in the employment rate. It does depend on what level the wage is set. An inelastic labour demand will mean there is only a small contraction in demand for labour
In which market is a buffer stock system usually used
This is mainly in agricultural markets, where prices are volitile
Why might a government use a buffer stock system
In order to smooth out these fluctuations
How do the government implement a buffer stock system
Governments buy up harvests during surpluses, then sell the goods onto the market when supplies are low
Advantages on a buffer stock system
Farmer income remains stable because fluctuations are reduced
Benefits rural areas where farming is a main source of income
Increases consumer welfare by ensuring prices are not in excess
Disadvantages of a buffer stock system
Governments may not have the financial resources to buy up stock
By guaranteeing minimum prices farmers may over produce which can be expensive and damaging to the environment
Storage can be difficult and expensive
What are regulations
The government might use laws to ban consumers from consuming a good. They could also make it illegal not to do something
Give an example of a regulation
The minimum school leaving age means young people have to be in school until the age of 16, and education or training until they turn 18.
What is a benefit from a regulation on minimum school leaving age
There are positive externalities in the form of a higher skilled workforce
What are the effects of regulations on firms
It could raise costs of firms, who might pass on the higher costs to consumers
Firms which fail to follow regulations could face heavy fines
What is a tradeable pollution permit
Something that allows firms to pollute up to a certain amount, and any surplus on their permit can be traded
What are benefits of tradeable pollution permits
They could limit the amount of negative externalities, in the form of pollution, created by industies
Advantages on tradebale pollution permits
Benefits the environment in the long run by encouraging firms to be greener
Governments can raise revenure by selling permits which can be reinvested in green technology
Disadvantages of tradeable pollution permits
Some firms may relocate to where they can pollute whitout limits
Firms might pass higher costs of production onto the consumer
Can be expensive for governments to monitor emissions
What is state provision of public goods
The government could provide public goods which are underprovided in the free market, such as education and healthcare
Benefits of state provision of public goods
This makes merit goods more accessible, which might increase their consumption and yield positive externalities
Drawback of state provision of public goods
It could be expensive for governments to provide education, and the government will incur an opportunity cost of spending their revenue
What is provision of information
By providing information, governments can ensure there is no information failure, so consumers and firms can make informed economic decisions
What is government intervention
When the government intervenes in a market economy. The market is controlled by both the government and the forces of supply and demand. Governments often provide public goods such as streets lights, roads and the police, as well as merit goods, such as healthcare and education
How can government intervention fail
Governments can fail when they intervene in markets. They could worsen the market failure already present or a new failure might occur. This results in a net welfare loss to society
Advantages of government intervention
Might be easier to coordinate resources in times of crisis
Government can compensate for market faikure by reallocating resources
Reduce inequality in society
Disadvantages of government intervention
Governments fail as they may not be fully informed for what to produce
They may not meet consumer preferences
What are the causes of government failure
Distortion of price signals
Unintended consequences
Excessive administrative costs
Information gaps
What is meant by distortion of price signals
Government subsidies could distort price signals by distoring the free market mechanism.
For example, the government may end up subsidising an industry which is failing or has few prospects
What is meant by unintended consequences
This is when actions of producers and consumers have unexpected, or unintended consequences. With government policies, consumers act in unexpected ways
For example, a policy could be undermined, which could make government policies expensive to implement
What is meant by excessive administrative costs
The social benefit of a policy might not be worth the financial cost of administering the policy. The government have to consider whether the policy is good value for money
What is meant by information gaps
Some policies might be decided without perfect information. They may require a full cost-benefit analysis which could be time-consuming and expensive. It is not possible to know every but of information so some assumptions have to be made
