3.6 - Impact of government intervention

Question 1

The impact of government intervention on:
> Prices

Answer 1

• Governments can prevent monopolies charging consumers excessive prices, which
  might result in a loss of allocative efficiency
  > as prices no longer reflect true balance of supply and demand, leading to misallocation of resources.
• can make services from utility companies, such as water, gas and electricity more affordable and stable, which is especially beneficial to low and fixed income households.
• Limiting how much a firm can increase its prices by also encourages the firm to become more efficient.
  > This is so that they can lower their costs and increase their profit margins.
• However If corporation tax is high, firms might pass the extra cost onto consumers, resulting
  in higher prices, rather than losing their own profits

Question 2

Impact of government intervention on:
> Profit

Answer 2

• Permitting enough to keep firms in the industry (normal profit) but limiting how much they make so that household income is protected
• If governments impose strict price caps, investment could be limited, since the
  amount of profit that a firm makes is restricted

Question 3

The Impact of Government Intervention on:
> Quality

Answer 3

• Governments can ensure firms are meeting minimum targets, which ensures firms
  focus on increasing social welfare.
• Firms which profit maximise might compromise on quality. However, if private sector
  firms have the expertise and knowledge which the government might not have, then
  they might be able to produce goods and services of a higher quality.

Question 4

The Impact of Government Intervention on:
> Choice

Answer 4

• If governments regulate monopolies and encourage the start-up and growth of
  SMEs, consumer choice in the market widens, since there are more firms competing.
• However a stringent price ceiling might force some suppliers out of the markets, which
  reduces the quantity supplied and narrows choice for consumers.
• If governments can reduce the price of a good or service, it could allow those on low
  and fixed incomes to access goods and services they previously could not afford to increasing choice

Question 5

The Impact of Government Intervention on:
> Efficiency

Answer 5

• Reducing wastage of valuable resources and one of the best ways to achieve this is by developing rigorous competition
• The diagram shows where public sector and private sector firms operate. Private
  sector firms are more likely to operate at Q1 P1, which is the profit maximising level
  of output and price.
• A public sector firm is more likely to operate at Q2 P2, which is
  the allocatively efficient level of output (AR=MC). Therefore, government
  intervention might lead to an increase in economic efficiency, since the objectives change from profit maximisation to maximising social efficiency.
• However, free market economists argue that by operating in a competitive
  environment, firms have an incentive to become efficient.
• This is because they are
  forced to lower their average costs in order to profit maximise.
• This makes private
  sector firms more productively efficient.
• They might also argue that private sector firms have to produce the goods and
  services that consumers want in order to keep earning profits.
• This might increase
  allocative efficiency.

Question 6

Limits to government intervention

Answer 6

• Regulatory capture
  > Regulatory capture occurs when firms influence the regulators to change their decisions/policies to align more with the interests of the firm
  > Some lobbying activity is corrupt and there is a fine line between influencing activity and bribing.
  > Naturally, regulatory capture can completely prevent fair outcomes in the markets concerned
• Asymmetric information
  > Many times governments do not make the best decisions due to the fact that the government or regulators either do not have the full and relevant information - or they do not understand the market they are trying to regulate
  > This existence of asymmetric information can be responsible for government failures
  > It is hard to determine government policies when intervening where there is market failure, since the extent to which the market fails involves a value judgement
  > Without sufficient information, governments could make poor decisions and it could
  lead to a waste of scarce resources.