3.8 Limitations of Markets Flashcards
Externality
An effect of an economic activity on a third pNegatarty
Negative externality
A harmful effect of an economic activity on a third party. Also known as an external cost.
Positive externality
A positive effect of an economic activity on a 3rd party. Also known as an external benefit
Example of negative externality
Air pollution from smoking
Example of positive externality
Less air pollution from someone riding their bike instead of taking a car
What are 5 things the government can do to prevent positive and negative externalities
- Taxation
- Subsidies
- State provision
- Legislation and regulation
- Information provision
How does taxation correct positive and negative externalities
Higher taxes means
Less profit for firms
So in a competitive market they would supply less
Vice versa
What are costs and benefits of correcting externalities with taxes
Cost: Indirect taxes affect people with lower incomes more as it is a larger proportion of their money.
Can lead to unofficial markets- black markets
Benefit: Provide revenue to the government so that they can spend more on preventing negative externalities like information provision
How do Subsidies correct positive and negative externalities
Subsidy given
Investment can be made to increase efficiency of production process
COP lowers
More good produced
What are costs and benefits of correcting externalities with subsidies
Cost: Could have used money elsewhere
Benefit: Consumption of that good will rise
What is state provision
Goods and services provided directly by the government
How does state provision correct positive and negative externalities
As the government provides it free of charge at the point of consumption
People don’t have to worry if the price is too high
So they can always access it (healthcare)
What are costs and benefits of correcting externalities with state provision
Costs: Demand will often exceed supply
Pressure will be put on the government to spend on some areaas and there will always be opportunity cost
Demand may increase at a faster rate than supply- Ageing population
Benefits: consumers who are able to gain access will benefit greatly, but this may not be everyone all of the time
Legislation
Laws to control the way people and organisations behave
Regulation
Rules, Directives or government orders to control the way people and organisations behave
How does legislation and regulation correct positive and negative externalities
Legislation to ban certain products can be put in place
This means that the supply for the product is 0
This makes the consumption 0 and the externality is gone
What are costs and benefits of correcting externalities with legislation and regulation
Costs: Dangers of unofficial markets- black markets
Have to spend money policing that
Opportunity cost of money spent elsewhere
Information provision
The government provides information to enocurage people and organisations to change their behaviour
How does information provision correct positive and negative externalities
If the government can educate people about the harms of demerit goods
Through things like education programmes or adverts
Demand will decrease
Reducing the quantity and the negative externality
What are costs and benefits of correcting externalities with information provision
Benefits: Cheaper than subsidising alternatives
Costs: Not always effective as some people are addicted to demerit goods like smoking
