3.8 Limitations of markets Flashcards
• explain what is meant by positive and negative externalities • explain government policies to correct positive and negative externalities, including taxation and subsidies, state provision, legislation and regulation and information provision • evaluate the use and impact of government policies to correct positive and negative externalities • evaluate the costs, including opportunity cost, and the benefits of government policies to correct positive and negative externalities.
What does the term ‘externalities’ mean?
An effect of an economic activity on a third party.
What does the term ‘positive externality’ mean and examples?
Beneficial effect of an economic activity on third parties, also known as external benefit, e.g. gym memberships and Christmas lights.
What does the term ‘negative externality’ mean and examples?
Harmful effect of an economic activity on third parties, also known as external cost, e.g. pollution, congestion & fish stocks in the future.
What are the 5 government policies used to correct positive and negative externalities?
- Taxation
- Subsidies
- State provision
- Legislation and regulation
- Information provision
How can taxation correct positive and negative externalities?
Excise duties can discourage consumption of petrol to reduce negative externalities such as congestion and pollutions as supply decreases. Also a lack of VAT on necessities like food to encourage consumption of positive externalities.
What are the uses and impact of using taxation to correct externalities?
The tax on demerit goods causes the supply curve to shift to the left but is less effective because demand is inelastic due to it’s addictiveness and so quantity demanded will only fall by a small amount if taxation is imposed.
What are the costs and benefits of using taxation to correct externalities?
Costs
- Inequality of distribution of income (due to regressive VAT)
- Encourage unofficial markets (e.g. black market)
Benefits
- Reduction in quantity traded
- Provides revenue for the government
How can subsidies correct positive and negative externalities?
Subsidies are given to firms that produce products with positive externalities (e.g. buses and trains) to encourage consumption which could replace products with negative externalities.
What are the uses and impact of using subsidies to correct externalities?
Supply shifts to the right so price falls and quantity bought rises. However quantity bought change is only greater than the fall in price if it is an elastic good.
What are the costs and benefits of using subsidies to correct externalities?
Costs
- Opportunity cost for the government
Benefits
- Consumption of goods with positive externalities
What does the term ‘state provision’ mean?
Goods and services provided directly by the government.
How can state provision correct positive and negative externalities?
The government provides health and educations service that provide positive externalities ensuring it benefits everyone instead of leaving it to the market.
What are the uses and impact of using state provision to correct externalities?
Supply shifts to the right and becomes perfectly price inelastic because there is a limited amount of spaces causing quantity to rise but price to fall to zero.
What are the costs and benefits of using state provision to correct externalities?
Costs
- Demand often exceeds supply for healthcare
- Pressure to increase supply from those without access
- Opportunity cost
Benefits
- Those with access benefit greatly due to positive externalities
What does the term ‘regulation’ mean?
Rules, directives or government orders to control the way people and organisations behave.
What does the term ‘legislation’ mean?
Laws to control the way people and organisations behave.
How can legislation and regulation correct positive and negative externalities?
Some legislations aims to eliminate the market entirely, e.g. illegal drugs. Some reduce the supply of goods with negative externalities, e.g. licences to run pubs and clubs. Forced attendance of school is also a law used for positive externalities.
What are the uses and impact of using legislation and regulation to correct externalities?
Laws against illegal drugs and firearm greatly reduces its consumption and negative externalities but not necessarily fall to zero. Also prevention of selling cigarettes to those under 18.
What are the costs and benefits of using legislation and regulation to correct externalities?
Costs
- Encourage unofficial markets (e.g. black market)
- Criminal activity rise
- Opportunity cost
- Money spent on regulating policies
Benefits
- Prevention of consumption of goods with negative externalities
What does the term ‘information provision’ mean?
The government provides information to encourage people (especially consumers) and organisations to change their behaviour.
How can information provision correct positive and negative externalities?
It educates and informs the public about the harmful effects of a good, e.g. programmes in school about smoking discouraging people to buy such products with negative externalities. Publicity campaigns can also encourage consumption of goods with positive externalities.
What are the uses and impact of using information provision to correct externalities?
Consumers will demand more for certain goods and services that have positive externalities due to education of its benefits, causing demand to shift to the right and price to fall and quantity to rise but by how much depends on the elasticity of the good.
What are the uses and impact of using information provision to correct externalities?
Benefits
- The opportunity cost is lower than subsidising alternatives
Costs
- It may be less effective for habit-forming goods
- Consumers might not notice the information
