24) Government Intervention To Correct Market Failure Caused By Externalities And Missing Markets Flashcards
What is taxation
⚫️works through price mechanism
➡️increase firm cost of production
➡️reducing supply
⚫️reduces production or consumption
➡️of good that emits negative externalities
⚫️internalise the externality
➡️forcing producer pay external costs of their production
⚫taxation is example of ‘️polluter pays principle’
➡️polluting business should pay for any damage it creates
What are the 6 main ways the government can intervene to correct market
⚫️taxation
⚫️subsidy
⚫️state provision
⚫️advertising/information campaigns
⚫️regulation
⚫️tradable pollution permits
⚫️extendable property rights
Describe the taxation diagram
⚫️tax on polluting activity
➡️adds to firms cost of production
➡️MPC curve shift to the upwards
⚫️reduces quantity supplied
➡️from Qfm to Qso
⚫raise price
➡️from Pfm to Pso
⚫️welfare lost will be almost eliminated
Evaluate taxation
⚫️level of tax should equal
➡️external costs to be effective
➡️external costs difficult to measure
➡️due to imperfect knowledge
⚫️if demand is price inelastic
➡️ineffective at reducing quantity supplied and demanded
➡️tax would be very high
➡️to reduce quality demanded
⚫️burden on tax falls disproportionally on poor
➡️e.g if coal-fired electricity generation is price inelastic
➡️burden of taxation
➡️passed onto the consumer as the form of higher prices
What is subsidy
⚫️increases supply
➡️reduces price
➡️encourage production and consumption
➡️of services with external benefits
Describe the subsidy diagram
⚫️reduces firms cost of production
➡️shifting supply curve to the right
⚫️increase quantity supplied
➡️from Qfm to Qso
⚫️reduce price
➡️from Pfm to Pso
⚫️if government equal subsidy ➡️to value of external benefits created ➡potential welfare loss ➡️from under consumption of the service ➡almost be full eliminated
What are the limitations of subsidy to correct positive externalities
⚫️expensive for government
➡️opportunity cost
➡️money used for subsidy
➡️could have been spent elsewhere
➡️higher government spending on subsidy
➡️increase taxes
➡️or borrow more, adds to debt
⚫️external benefit difficult to measure because of imperfect knowledge
➡️level of subsidy should equal external benefit to fully be effective
➡️if subsidy set too low
➡️only increase supply by small amount
➡️little impact on price
➡️so have minimal impact on consumption on service that promotes positive externalities
⚫️producers may take subsidies
➡️but not increase supply or reduce prices
➡️need to be monitored of subsidy scheme
➡️further increase cost for government
What is state provision
⚫️government provide services
➡️unlikely to be fully provided by the market
➡️which have external benefit of consumption
➡️e.g. Education and healthcare
⚫️government provides public goods
➡️not provided at all in free market
➡️due to free-rider problem
➡e.g. ️street lighting and defence
What is the limitations of state provision to correct positive externalities and provide public goods
⚫️expensive for government
➡️opportunity cost
➡️money used for spending on defence
➡️could be spent elsewhere
➡️higher government spending on state provision
➡️tax increase
➡️or borrow money adding to national debt
⚫️monopoly in the provision of services result inefficiency
➡️NHS worlds third largest employer
➡️with 1 million employees
➡️can be slow to respond to consumers needs
➡️difficult to manage
➡️adding further cost to provide for the service
⚫️difficult to maintain consistent standards ➡️need further regulation ➡️OFSTED for education ➡️requires expenditure by government ➡️increasing costs and opportunity costs
What is advertising and information campaigns
⚫️aim to increase consumption of goods
➡️with positive externalities
➡️reduce consumption of goods and negative externalities
What are the limitations of advertising and information campaigns to correct externalities
⚫️expensive for governments
➡️opportunity costs
➡️money used spending on campaigns
➡️could be spent somewhere else
⚫️evidence suggest people immune to negative advertising
➡️ignore messages that campaign spread
➡️advertisers need to think of more shocking ways
➡️to spread message of harmful effects of habits
➡️smoking, drug abuse, unhealthy eating
What is regulation
⚫️government impose laws
➡️regarding production, sale, use of good/services
➡️enforces these laws through legal prosecution
⚫aim to reduce negative externalities
️➡️by limiting quantity of output allowed
➡️of a particular good/services
Describe the diagram for regulation
⚫️Government sets regulation limit at Qso
➡️producers not allowed to produce beyound this amount
⚫️reduces amount supplies
➡️from Qfm to Qso
⚫️raises price
➡️from Pfm to pso
⚫️will reduce welfare loss triangle
What are the limitations of regulations to correct market failure
⚫️laws costly to enforce
➡️need to administer department to set up to monitor regulations
➡️adds to government cost
➡️opportunity cost
⚫️difficult to know what types of deterrent to use
➡️if fines and other deterrent are lenient
➡️may not change their behaviour, continue with economic activity, that creates external costs
➡️if fines and other deterrent too severe
➡️firms may be put off entering industry
➡️leading to output falling below the social optimum
⚫imperfect knowledge estimating external costs
➡️difficult to now where socially optimum level is
➡️difficult to know where to set the regulation limit
What is tradable pollution permits (caps and trade)
⚫️tfirst agreeing on a socially efficient level of CO2 pollution
➡️a set of number of permits are issues up to this level
➡️each polluting firm issued quota of these permits to pollute
➡️any firm that doesn’t use
➡️can be traded
How can government reduce the amount of CO2 emission using caps and trade
⚫️by reducing amount of permits to pollute each year
➡️incentivising all producers
➡️become cleaner in the long run
Who favours the tradable permits
⚫️favoured by free market economists
➡️as a method of dealing with CO2 emissions
➡️as they create a market in the rights to pollute
How do tradable permits work through incentive function of the price mechanism
⚫️encourage firms
➡️to have cleaner method of production
➡️or pay a higher price
How do tradable permits internalise the externality
⚫️by paying a permit to pollute
⚫️paying for the costs of cleaning their emissions
What are the limitations of tradable pollution permits to correct negative externalities
⚫️difficult to know what the socially efficient level of pollution is
➡️due to imperfect knowledge in the market
➡️so difficult to set the right level of permits
⚫️cost of monitoring the scheme
➡️government expenditure
➡️opportunity cost
⚫️environmental groups criticise the scheme
➡️large firms make a lot of money trading free permits
➡️given by government
➡️even if there’re clean, they still pollute the environment
➡️some groups argue that they should not make money from this
Whats extending property rights
⚫️externalities arise because property rights not fully allocated
➡️solution is for government to extend property rights
➡️give someone ownership if the air
How does extending property rights internalise the externality
⚫️firms compensate
➡️if their external costs rise above a certain level
➡️adding to the costs of production
➡️requires little government intervention
➡️so cheap to run on
What are the limitations of extending property rights to reduce negative externalities
⚫️difficult to allocate
➡️whos pollution are u breathe
➡️how much pollution reasonable
➡️questions due to imperfect knowledge
⚫️compensation difficult to assess
➡️due to imperfect knowledge
➡️how much is your health worth
➡️is everyones health worth same amount
⚫️legal system to solve disputes
➡️expensive
➡️time consuming
