2.11 government intervention to target market failure Flashcards
what is an indirect tax?
taxes on expenditure, they increase the production costs so producers supply less and demand contracts
what are the two types od indirect tax?
ad-valorem - a percentage of the price, e.g 20% VAT
specific tax- tax per unit e.g 58p per litre on unleaded petrol
what is the incidence of tax?
the tax burden- who pays what
where does the consumer burden lie on a tax diagram?
at new equilibrium price, to old equilibrium price, ending at new equilibrium.
where does the producer burden lie on a tax diagram?
from old equilibrium price to where new equilibrium hits the old supply curve
what does an inelastic demand curve mean for the tax burden?
the more inelastic, the higher the tax burden for the consumer as they are able to pass this on as a higher price for consumers.
what are the evaluating arguments for indirect taxes?
-unintended consequences?
- does it actually work?
- is the tax revenue substantial enough?
-how is the revenue used?
-loss of jobs?
- less investment therefore higher costs of production and lower productive efficiency
-less competition?
- is the tax fair?
- is the tax regressive?
what is a subsidy?
a payment from the government to a producer to lower their costs of production, encouraging them to produce more. this does not need to be paid back.
what does a subsidy encourage?
production of a good as it lowers firms costs
the consumption of merit goods (the full social benefit)
what will a subsidy do to a supply curve?
pushes it out, lowering price and increasing output.
what are the evaluating arguments for subsidies?
-does it achieve its desired stimulus?
- are other incentives also needed?
-positive spillovers?
- do firms become dependent?
-self financing by increasing tax revenue?
-extra burden for tax payers?
-unintended consequences?
what is a maximum price?
a price set below the free market price.
why would a government set a maximum price?
to encourage consumption or production of a good so it does not become too expensive.
what are the disadvantages of a maximum price?
-shortages
- encourages black markets and arbitrage
- queues
-the market becomes less profitable for firms.
- firms may raise prices of other goods
therefore, it may benefit some consumers- those whom are able to get the good.
what are the reasons for setting a maximum price?
- to reduce monopoly exploitation
- to make the good affordable for essential living
what is a minimum price?
a price above the free market price to discourage consumption or production.
e.g on alcohol and minimum wage
what are the disadvantages of a minimum price?
- excess supply/surplus
-black market - people switch to alternatives e.g drugs
-firms may fail
-deters firms from entering market so there is less competition.
what are the reasons for setting a minimum price?
- to protect producers earnings
-to create a surplus to be stored
-to guarantee a level of earnings - to reduce consumption of a demerit good.
what is a buffer stock system?
where both a minimum and maximum price is set and prices can fluctuate between them.
what happens if price is too high in a buffer stock system?
the government will sell the stocks, increasing supply and therefore lowering price.
what will happen if price is too low in a buffer stock system?
the government will buy up the good and store it for future needs. this will decrease supply, increasing price.
what are the advantages of a buffer stock system?
- farmers are protected from volatile prices due to weather and commodity trading.
-lower risk of extreme poverty for the poorest consumers
-macroeconomic stability
-self financing
what are the disadvantages of a buffer stock system?
- may not be large enough to influence price
- expensive therefore an opportunity cost
-goods may be perishable
-rising surplus - better long run alternatives e.g diversifying the market
what is regulation?
- laws banning consumption and production or creating a standard.
e.g buying alcohol under 18 or staying in education until 18
