4 market failure and government intervention Flashcards
market failure definition
market failures occur when the price mechanism causes inefficient allocation of resources, leading to a net welfare loss
what are the 3 types of market failure?
- externalities - a cost or benefit that is imposed on a third party that is not involved in the transaction
- information gaps - where buyers and/or sellers have imperfect knowledge about a product e.g. vaping
- public goods - now obvious way in how a private firm could charge all users
what is a positive externality?
when the social benefit exceeds the private benefit. e.g. education = people get jobs = more tax is payed
what is a negative externality ?
when the social cost exceeds the private cost. e.g. pollution
how do you work out social costs and benefits ?
social cost = private cost + external costs
social benefits + private benefits + external benefits
explain the negative externalities diagram
negative externalities are priced too low and are overconsumed and produced.
- normal demand curve
- 2 supply curves increasing in distance away from each other
- 1 supply curve MSC is greater than the 2nd supply curve MPC
- deadweight welfare loss
explain the positive externalities diagrams
positive externalities are priced to high and are underconsumed and produced.
- normal supply curve
- 2 demand curves increasing in distance away from each other
- 1 demand curve (MSB) is higher up than the MPB (second demand curve)
- welfare loss
what is the definition of indirect tax?
tax that is imposed on producers by government and is passed onto the consumers by raising prices
what is the definition of direct tax ?
such as income or corporation tax. tax levied on income which is payed directly to the governement
what are the two types of indirect tax ?
- Ad valorem tax (VAT) = a tax levied as a percentage of the value of the good
- Specific/Unit tax = tax levied on the volume of goods bought but does not change with the value of the goods e.e.g excise duties (alcohol, tobacco and petrol)
describe and explain the difference between the Ad valorem tax and the specific/unit tax diagram ?
Both have normal demand curve and normal s1 supply curve.
The difference is in the second supply curves, s2 on VAT diagram is increasing at an angle (gap keeps increasing) becausethe tax payed increases and price increases, so the supply curves diverge. Specifit / unit tax diagram has the second supply curve s2 parrallel to s1 as the tax is levied off of volume.
what is the incidence of tax ?
is the tax burden on the taxpayer . the share of the tax falls partly on the consumer and partly on the producer.
how does the PED effect the incidence on tax on the consumer and on the producer?
If the demand is inelastic, the consumer pays a higher burden than the producer.
- the tax is then effective at raising revenue but ineffective at decreasing consumption
if the demand is elastic the producers burden is greater than the consumers burden.
- tax is then effective at reducing consumption but ineffective at raising revenue
arguments for using indirect tax?
- internalises negative externalities
- can be targeted at specific problems / goods and services (e.g. excise duties)
- essential goods and services could carry lower rates
- harder to evade indirect tax than direct tax
- tax revenue from tobacco sales could then be used to fund educational programmes on risks of smoking
arguments against indirect tax?
- regressive = falls hardest on low income earners because its a higher % of their income spent on tax than the rich
- loss of consumer surplus especialy if the good is inelastic
- if its too high the UK becomes internationaly uncompetitive
- ‘blunt’ intrument = the responsible drinkers pay the same tax as the irresponsible drinkes
- ineffective at reducing consumption of highly inelastic goods e.g. cigarrets
What are the ways government intervien in markets which produce negative externalities?
- indirect tax
- minimum prices
- tradable pollution permits
- provision of information
- regulation
whats the definition of minimum price ?
the lowest price a good is allowed to be sold for
why are minimum prices used ?
describe the effect of them shown by the minimum price diagram
minimum price is imposed on goods with negative externalities by the governemnt when they see the market price as ‘too low’.
If the minimum price is set above equilibriom the quantity demanded will fall from Q1 to QD and quantity supplied will rise from Q1 to QS. Causing a surplus in the SR
what are the arguments for a minimum price?
- reduces consumption of goods that create negative externalities e.g. alcohol
- the minimum price reduces the consumption of cheap alcohol bought by irresponsible drinkers but does not effect expensive alcohol bought by responsible drinkers
what are the arguments against minimum price?
- no tax revenue generated for the governement (extra profits go to supermarkets)
- regressive = minimum prices effect those on lower incomes than those on higher incomes because the poor have to pay a higher % of their incomes
- may encourage smuggling where people bring alcohol into the UK from abroad
whats the definition of tradeable pollution permits ?
a limit placed on firms carbon emissions through the issue of permits. Permits can be purchased and sold, and fines are imposed if firms exceed limits.
how do tradable pollution permits work?
- Government issues Q1 of permits to emit x amount of CO2 (supply is perfectly inelastic)
- Because permits can be traded more profit to other firms this incentivieses firms to become greener so that they can sell the permits for profits
- Given the demand is D1 the price is p1
- as firms become greaner the demand for permits decreases to D2 pushing down the price (p2) so pollution becomes cheaper
- to mitigate this the government reduces the supply of free permits therefore shifting the inelastic supply to S2 so quantity falls to Q2 and price rises back to p1
AND THE CYCLE BEGINS AGAIN
LEARN THE DIAGRAM
what are the advantages for having permit schemes ?
- encourage firms to reduce pollution , so they can sell their permits for profit
what are the disadvantages of permit schemes?
- policy would not encourage firms to reduce emisions if to many permits are used
- policy is ineffective unless all countries participate
- costs for firms rise if they have to cut emissions
