4.1.8 Market failures, policies and regulations Flashcards
1
Q
What is an indirect tax?
A
An expenditure tax that increases a firm’s cost of production but can be transferred to consumers via higher prices
2
Q
Why do governments levy taxes? (5)
A
1- To raise revenue to fund essential public expenditure and transfer payments. They can borrow for this but most must come from taxation to avoid inflation and excessive increases in national debt over time
2- To redistribute income. If Gov thinks distribution of income is inequitable, it may impose or increase progressive taxation to reduce the income of some groups in society and use money to increase income of other groups
3- To correct market failures. Can intervene in markets such as cigarettes, carbon, alcohol etc to raise taxes to reduce consumption and production. Taxation can be used to reach allocativrky efficient outcomes in failing markets.
4- To manage the macro economy. Can change tax rates in order to influence variables such as growth, inflation, unemployment and the current account
5- To protect domestic firms from foreign competition. Tariffs are taxes on imports that raise the price of imports -> reducing imports -> allow domestic firms to survive and grow
3
Q
What is the impact of indirect taxation on a diagram?
A
See flashcard
Indirect tax is an expenditure tax that increases a firms costs of production, and can be transfered to consumer via higher prices -> Supply curve shifts to the left from S1 to S1+tax as firms costs of production increase -> Vertical distance is value of tax -> Price increases from P1 to P2 -> law of demand, higher price discourages consumption -> Q decreases from Q1 to Q2 -> Gov revenue P2BCD -> Consumer burden P1P2BE -> Producer burden P1ECD -> Welfare loss ABC
4
Q
How does an indirect tax affect the consumer?
A
Consumers suffer, paying share of the tax P1P2BE due to higher prices from P1 to P2, reducing CS. The poor will suffer proportionally more than the rich as indirect taxes are regressive, meaning they take a greater proportion of the poor’s income than the rich -> could widen income inequality in society
5
Q
What are the evaluation points of how an indirect tax affects the poor? (3)
A
1- Consumers burdened more of demand for product is price inelastic, for example addictive in nature. Producer know they can transfer more of tax. Opposite is true when demand for good is price elastic, in this case would burden producers more.
2- short term pain BUT MAYBE long term gain of tax generate enough revenue for spending on Ed, health, infra -> improve lives of poor.
3- If taxes are to discourage consumption of de merit good, solving a market failure, argument of burdening consumer may be weak. By reducing consumption, production and Q could reach social optimum level of output, increasing welfare and not generate a welfare loss as diagram suggests
6
Q
How are producers and workers affected by an indirect tax?
A
Producer suffer, increased costs of production, paying tax to gov indicated by rectangle P1ECD, leading to fall in revenue from P1AQ10 to DCQ20. / Producers could reduce size of workforce to reduce costs and due to lower Q produced, impacting workers by increasing unemployment
7
Q
What is the evaluation for and indirect tax affecting producers and workers?
A
Argument strong if demand for good is price elastic, however if inelastic producer can transfer price rise onto consumer
8
Q
How does an indirect tax affect the government?
A
Tax will be set to raise revenue of P2BCD or solve market failure of overconsumption and /or over-production exists, in bother ways the gov benefits. -> increased fiscal intake -> long term spending on key areas such as H/Ed/Infr -> IF to solve market failure, revenue can be used to further reduce consumption through advertising campaigns or subsidising production of better alternatives
9
Q
What is the evaluation of the affect of an indirecg tax on the government?
A
Burdening producers and consumers -> net loss of both producer and consumer surplus -> DWL of societal surplus, triangle ABC -> if market was initially efficient then gov is distorting efficient allocation generating welfare loss -> gov failure if value of loss exceeds tax revenue gained -> BUT argument REDUCED if tax has solved a pre-existing misallocaton of resources (market failure)
10
Q
What is a subsidy?
A
A money grant given to firms to reduce costs of production and to encourage an increase in output
11
Q
Why do Gov issue a subsidy? (3)
A
1- Correct market failure and improve AE -> subsidising merit/ public goods where underproduction or lack of supply exists -> promoting socially optimum levels of output
2- Improve affordability of essential goods and services (vaccinations, education etc) -> no one should be excluded as there is private and external benefits of consumption -> subsidies improve affordability -> improve living standards -> increase the of party benefits.
3- Protectionism -> subsidies to domestic producers -> reduce costs of production -> produce at greater level of output -> reducing imports
12
Q
What is the impact of a subsidy on a diagram?
A
see flashcard.
Subsidy is a money grant given to producers that lowers costs of production and encourages an increase in output -> Supply curve shifts right from S1 to S1+sub as costs of production decrease -> Vertical distance between two is value of sub -> Reduces price of product from P1 to P2 -> due to law of demand, lower price encourages consumption, quantity increases from Q1 to Q2.
Prodcuer revenue from P1XQ10 to BCQ20
Gov cost BCDP2
Consumer savings P1XYP2
welfare loss CDX
13
Q
What is the impact of a subsidy on consumers?
A
Benefit paying lower prices from P1 to P2 -> increasing CS ->Purchas same Q1 units but at lower price leading to savings of P1P2XY -> Q in market has increased benefiting from greater output and choice
14
Q
What are the evaluations points for the affect of a subsidy on consumers? (4)
A
1- Not fully benefiting as not all of it is passed on -> gain in CS and prices are not as much as could be -> producers may instead use subisidies to DELEVERAGE, increase salaries, save in bank, dividends. -> more this happens, less consumer surplus gains
2- Demand for good is price inelastic means more subisidy passed on and larger increase in consumer gain
3- If subsidiesed good is necessity price falling can help affordability -> improve equity -> reducing exclusion.
4- Short term benefit of lower prices BUT may lose out in long term if have to pay for burned of subsidy through future taxes OR cuts
15
Q
What are the affects of a subsidy on producers and workers?
A
Increase in revenue for producers from P1XQ10 to BCQ20. As not all sub is passed on, producer keeps rest, can delerverage, increase salaries, save in bank or increase shareholder dividends. Can benefit workers if more labour is needed to produce extra output
16
Q
What are the affects of subsidies on the government?
A
Suffers from large cost -> BCDP2 -> opportunity cost -> where does money come from if there is no excess tax revenue -> CUTS -> burdening poor -> Tax rising on rich -> laffer curve -> reduces economic growth as consumer spending decreases OR skilled workers leave. ONLY IF COST OF SUBISIDY OUTWEIGHS GAINS, there will be DWL of triangle CDX, gov distorting efficient market outcomes, mis allocation of resources, gov failure
17
Q
What are the evaluation points of the affects of a subisidy on the gov? (2)
A
1 - Gov failure is guaranteed if gov cannot control how subsidy is spent, costs of intervention will outweigh benefits. Subsidy may even promote wastefulness, inefficiencies and subsidy dependency overtime -> increasing Gov costs with Subisidy simply being used to cover costs of production that are higher than they should be.
2- the DWL argument is reduced if gov has solved a market failure given a pre-existing misallocatiom of resources. For example the underconsumption/prodcution of merit goods. Gov increasing Q and improving affordability -> improve welfare and allocation of resources -> benefit of intervention outweighs cost.
18
Q
What is a minimum price?
A
A price floor, normally set above the equilibrium market price
19
Q
Why do governments impose minimum prices? (3)
A
1- Protect producers of primary commodities from price volatility. D/S curve of primary commodities is v inelastic, meaning when there is a shift in D/S curves due to changing weather, can be large price swings, destabilising income of agriculture farmers.
2 - discourage consumption of de-merit goods. Min prices can be used to raise price above free market price to internalise the negative externality and discourage consumption-> bring market to allocative efficiency.
3- Reduce income inequality and protect workers in the labour market -> a MINIMUM WAGE
20
Q
Explain the affects of a minimum price using a diagram.
A
see flashcard.
Price floor set above free market equilibrium price -> increasing prices from P1 to P2 -> extension of supply to QS -> contraction of demand to Qd causing excess supply AB
dwl triangle on diagram
21
Q
What is the affect of a minim price on consumers?
A
Lose out by paying higher prices -> reduced CS -> poor suffer more as min prices are regressive taking a greater portion of poors income -> widening income inequality
Also lose out from intervention buying of excess supply as large Gov cost
22
Q
What are the evaluation points of the affects of minimum prices on consumers?
A
1- Consumers may like the fact that domestic producers are remaining in industry, may be willing to pay higher price.
2 - in primary commodity market there is usually intervention buying of excess supply from government, burdening poor with future tax rises/ cuts
23
Q
What are the affects of a minimum price on producers?
A
Benefit, especially if there is intervention buying of excess supply -> min price provides stable incomes for farmers -> sustain livelihoods when at free market price would be much lower -> allows industry to survive. ALSO with intervention buying, revenues from producer increases from P1CQ10 to P2BQs0
24
Q
What are the evaluation points for the affects of a minimum price on producers? (2)
A
1- Benefits depend on whether intervention buying actually takes place. Might not in developing countries -> storing or destroying excess stock -> waste of resources and hit to profitability of producer
2- If min price is used to save de-merit good market failure, there would be no buying up of excess stock thus producers are more likely to suffer if excess stock is produced.
25
What are the effects of a minimum price on the government?
The gov having created the excess supply must now buy it up which is costly. Intervention buying has a cost equal to ABQdQs. First issue is what happens to excess stoc -> destroying it is wasteful, storing it costly, dumping abroad can be politically inssensitive. -> Large financial cost of intervention buying -> tax rises in future -> spending cuts -> hurt consumers. "In distorting efficient market outcomes the government has reduced total CS and PS in the market, generating a deadweight welfare loss of triangle ACD, reducing society surplus
26
What are the evaluation points of the affects of a Min. Price on the government? (4)
1) Can overcome issue with excess stock by paying farmers to leave land aside and not produce stock. Still carries opportunity cost but less.
2)Despite huge cost of intervention buying, if producers remain in market and consumers willing to buy local product at higher price, benefits may outweigh the costs reducing government failure arguments.
**3)** In case of discouraging consumption of de merit goods, a **black market** may form -> dangerous for consumer as product not regulated -> worsening negative externalities -> Gov created new market failure which needs spending policy to reduce.
**4)** If Gov manages to reduce over consumption of de merit food, social welfare will improve, not resulting in the welfare loss that theory suggests -> improvement in the allocation of resources and welfare gain
27
What is a maximum price? (Price ceiling)
A price ceiling normally set below the equilibrium market price
28
What is the diagram for a maximum price? Explain it.
See flashcard.
**got dwl on wrong side**
Set below free market equilibrium -> decreasing prices from P1 to P2 -> Extension of demand to Qd and Contraction of supply to Qs -> Excess demand (shortage) of AB to exist in market
29
Why do governments impose maximum prices? (2)
1) To improve the affordability of essential goods and services like housing or food. -> **improving living standards.**
2) reduce income inequality. Max wages or caps on bonuses reducing income gap -> reducing income inequality
30
What are the impacts of a maximum price on consumers?
Lower prices -> increased CS -> increased affordability of essential goods -> increase living standards of poor. BUT shortage of AB -> consumers without access to for example housing despite lower prices as many existing suppliers have now left the market or are not willing to supply at lower prices -> these consumer receive no benefit and suffer from long waiting lists and significant competition
31
What are the evaluation points for the impact if maximum prices on consumers?
Consumer not able to purchase may go to black market -> here there is price exploitation and loss of tax revenue
32
What is the impact of a maximum price on producers and workers?
Produces lose out with lower revenue **from P1CQ10 to P2AQs0** and lower producer surplus. May leave market for low cost housing and switch their resources instead to more lucrative forms of housing, lowering Q supply from Q1 to Qs. Workers could lose jobs with less Quantity produced.
33
What is the impact of a maximum price on the Government?
Improved living standards of some consumers, but had excess demand AB which must be dealt with. Can subisidse producers, reducing costs of production, shifting supply right / Gov themselves could supply excess demand by building more houses . BOTH options costly, opportunity cost. Summary - "In distorting efficient market outcomes, the government has reduced total consumer and producer surplus in the market generating a DWL of triangle ACD, reducing societal surplus.
34
What are the evaluation points of the impact of a maximum price on the government? (3)
1) Black market formed by suppressing the rationing function of the price mechanism, a market failure. Needs policing which is costly, increasing cost of poverty, costs of intervention could outweigh benefit, creating a mis allocation of resources that didn't exist before.
2) **Gov can exclude those who can clearly afford good or service, reducing extent of excess demand.**
3) Can be argued that income inequality and lack of access to essential goods and services is a market failure. In which case, reducing price and allowing the rich to overconsume may be improving resources allocation, negating Gov failure and DWL arguments.
35
What are the assumptions made when analysing how price works to allocate scarce resources? (6)
1- Perfect information for consumers and producers
2- Conpetition exists between may suppliers with no dominant firm
3- Entry and exit into market is cost less
**4- Consumers are rational utility maximisers**
**5- Firms are profit maximisers**
6- There is perfect mobility of factors of production
36
What is market failure?
When the free market fails to allocate scarce resources at the socially optimum level of output
37
What are the studied causes of market failure? (10)
Negative externality in production / Negative externality in consumption / De-merit goods / **Tragedy of the commons** / Imperfect information / Factor immobility / volatile commodity prices / **Monopoly power / income inequality.**
38
How do the diagrams work for each positive and negative externality in production and consumption?
NE in Pro = MSC > MPC
PE in Pro = MPC > MSC
NE in Cons = MPB > MSB
PE in Pro = MSB > MPB
For production, its costs
For consumption, its benefits
**BENEFIT SLOPES DOWN**
39
What is a negative externality in production?
Costs to 3rd parties as a result of the actions of producers. I.E Local residents inhaling toxic smoke of chemical factories
40
Using a diagram, explain the affects of a negative externality in production
See flashcard for diagram.
In a free market, individual producers only consider their private costs of production, they ignore the full social cost of their actions, the negative externality, due to self interest. As a result, resources allocated at **private equilibrium** of P1, Q1 instead of social optimum at P#Q#-> **overproduction and overconsumption** -> price in market is too low at P1 rather than P#, not reflecting full social cost of production -> end result is a misallocation of resources, AIE, too many resources being allocated to market -> welfare loss with society bearing more cost than benefit with units behind Q# being produced.
41
What is a negative externality in consumption?
Costs to 3rd parties as a result of the actions of consumers. I.E Passers by inhaling second hand smoke from cigarettes / individuals who over consume fast food more likely to become obese and diabetic, imposing cost on tax payer.
42
Explain the affects of negative externalities in consumption using a diagram.
See flashcard for diagram.
In a free market individuals only consider their private benefits in consumption -> ignore full social benefit, the negative externality, due to self interest -> resources allocated at private equilibrium of P1 and Q1 instead of social optimum P* Q* -> over
**consumption and over production** in the market as Q1 is greater than Q# -> misallocation of resources, AIE -> welfare loss with society bearing more cost than benefit given units beyond Q* being produced
43
What is a positive externality in consumption?
Benefits to 3rd parties as a result of the actions of consumers. I.E Individuals consuming healthy food, increasing their productivity at work
44
Explain positive externalities in consumption using a diagram.
See diagram
In a free market, individuals only consider their private benefits in consumption -> ignore positive externality due to self interest -> resources allocated at private equilibrium of P1 Q1 instead of social optimum at P# Q#-> underconsumption and underproduction in market as Q1 is less than Q# -> miss allocation of resources -> AIE where too few resources are allocated to this market.
45
What is a positive externality in production? Give an example and its benefits
Benefits to 3rd parties as a result of the actions of producers. I.E Benefits in the form of lower costs to a 3rd party that poaches highly trained and skilled workers from other companies that have borne the cost of a training program. Can offer slightly higher wage to poach workers and not need to train them, lowering cost. Economy benefits from more productive worker working for higher pay and better working conditions with more tax revenue paid to gov.
46
Explain positive externalities in production using a diagram.
See diagram.
In a free market, individual producers only consider their private costs of production. They ignore the full social cost of their actions (the positive externality to third parties) due to self interest. As a result, resources are allocated at the private equilibirium of P1 and Q1 instead of the social optimum P# Q#. There is an under production and consumption in the market as Q1 is less than Q# . The end result is a misalocation of resources, allocative inefficiency where too few resources are allocated to this market than are socially desirable, generating a welfare loss where society lose ouit on untis that are not producec beyond Q1 up to Q* *that would have generated more benfeit to society than cost.
47
What is a de-merit good? What occurs with them? Why?
A de-merit good is a good that is more harmful to individual consumers than they realise.
**They are over consumed and over provided by the free-market due to imperfect imformation** and negative externalities that arise from their consumption. I.E: Fast food, cigarretes, alcohol
48
What is the diagram for a de-merit good? Explain it
see flashcard Ne in Cons for diagram
*for explanation, same as Ne in Cons but add in imperfect information*
In a free market, individuals only consider their private benefits in the consumption of **de-merit goods**, they ignore the full social cost of their actions (the negative externality) due to self interest and **because they lack adequate information to understand the true private and social cost**. As a result, resources are allocated at the private equlibrium of P1 and Q1 instead of the social optimum P# Q#. -> overconsumption and production in the market as Q1 is greater than Q# with consumers making **irrational decision due to the problem of imperfect information**. -> end result is missallocation of resoujrces, allocative inefficiency where too many resourcs are allocated to this market than is socaillt desirable -> generates a welfare loss with society bearing more cost than benefit when units beyong Q# are produced.
49
What is a merit good? What occurs with them?
Merit goods are goods that are more beneficial to consumer than they realise. They are under consumed and under provided by the free market due to imperfect information and positive externalities that arise form their consumption. I.E healthcare, education, sun cream.
50
What is the diagram for a merit good? Explain it.
See flashcard, positive externality in consumption
In a free market, individuals only consider their private benefits in the consumption of merit goods, they ignore the full social benefit of their actions (the positive externality) due to self interest and because they lack adequate information to understand the true private and social benefot. As a result, resources are allocated at the private equlibrium of P1 and Q1 instead of the social optimum P# Q#. -> under consumption and production in the market as Q1 is less than Q# with **consumers making irrational decision due to the problem of imperfect information**. -> end result is missallocation of resoujrces, allocative inefficiency where not enough resourcs are allocated to this market than is socaillt desirable -> generates a welfare loss with society losing out on units that are not produced beyond
Q1 up to Q# that woudl have generated more benefit to society than cost.
51
In an essay about common access resources, what do we discuss?
What they are, why there cannot be privat ownership
They cause the market failure of the Tradgedy of the commons
**The diagram**
The consequences of the Tradgedy
52
What are common access resources? Why is this so?
Natural resources over which no private ownership has been estbalished: Forest, Seas, Air.
**It is too costly and innefficient to find ways to exclude other producers from accesing these resources.**
53
What market failure stems from common access resources?
Tradgedy of the Commons.
Where individual producers exploit the resource that maximises their profit, ultimately leading to depletion or degradation of the resource.
54
Explain the tradgedy of the commons using a diagram.
See flashcard for diagram. (negative externalities in production diagram)
In a free market, individual prodycers only consider their private costs of production, they ifnore the full social cost of their actions (the negative externalities in the form of costs to 3rd parties) due to self interest. **In this case, self interest is profit maximisation where it is in the best interest of produceers to continue to fish/cut down trees for profit and to gain resources befor other producers do and deplete/degrade the resource.**
As a result, resources are allocated at the private equilibrium of P1 and Q1 in the market instead of the social optimum P# and Q# -> over production and over consumption in the market as Q1 is greater than Q# -> price of market is too low at P1 rather than P#,not reflecting the full social cost of production, inscentivising consumption and thus more production, making the problem worse. End result is misallocation of resources, AIE where too many resources are being allocated to this market than is socially desirbale -> generating a welfare loss with society bearing more cost than benefit with units beyond Q# being produced.
55
What are the consequences of the tradgedy of the commons?
-Even if a producer cares about resource depletion and stops producing, another producer will step in and take their place.
-Consequences of resouce depletion such as future generations lose a source of income / lose access to the resource / lose out on the goods derived from the resource / CURRENT generations could lose out if resource depletes rapidly.
56
When talking about public goods, what do we mention?
Definition - characteristics - free rider problem, missing market - quasi public goods - **technology**
57
What are public goods?
Goods provided by the government and not through the market. I.E Flood defences, traffic lights, road signs, street lights
58
What are the characteristics of pure public goods?
-Non Excludable = No price can be charged for the good for two reasons; the benefits cannot be confined to the individual that has payed + there is no cost efficient way of pricing.
-Non rival = The quantity of the good does not diminish upon consumption
*got right but in wrong order*
59
How can public goods cause a market failure?
**The Free Rider Problem**
Where individuals have no inscentive to contribute towards the provision of the public good because they will wait for others to contribute. -> This means no private firm has an inscentive to supply the good as consumers have no inscentive to pay-> Leading to an end result of market failure in the form of a missing market.
60
How can we evaluate the market failure caused by public goods?
By looking at Quasi Public Goods.
Not all public goods are pure public goods, some are Quasi, meaning they posses one but not the other characteristic of a public good OR they sometimes possess the characteristics of a pure public good and sometimes not. For example roads ; normally non-excludable and non-rival, there is no reasonable way to charge drivers for every road they travel on and on a free flowing road, spaces do not diminish.
HOWEVER toll roads make roads excludable and during peak rush hour times when there is stand still congestion, roads become rival.
This means we can create an argument for the private allocation of resources instead of goverment funding for these goods
61
How can technology help solve the market failure of public goods?
Technology is making it easier to exclude consumers from the consumption of public goods for example ULEZ, Congestion Charges, music and video streaming, encryption file sharing.
If public goods are actually Quasi in nature or can become more of a private good through technological advancements, complete or partial provision could actually occur rather than pure state provision to solve this market failure.
62
How does imperfect inforation cause a market failure?
Free markets assume information is perfect thus consumers and producers will make rational decision that maximise their benefit. HOWEVER information failure due to missing, confusing or poorly targeted can scupper this I.E lack of knowledge of how good/bad a product is, leading to over/udner consumption.
-> End result is consumers making irrational decisions, either under or over consuming where total utility is not being maximised. There is too many or too few resources being allocated to such markets, causing a misallocation of resources and allocative inefficiency, a market failure.
63
What is Asymmetric information?
When information exists but is not equally shared between two parties. I.E Mechanics forcing extra payments and consumers accepting given their lack of knowledge.
64
How can asymmetric information cause market failure? (3)
-Consumers making **irrational decisions** due to a lack of knowledge, under or over consuming where utility is not being maximised ->too few/many resources being allocated toi such markets causing a misallocation of resources, allocative inefficiency and market failure.
-**Moral Hazard**; when excessive risk is taken as a 3rd party will bear the cost of risk due to asymetric information. I.E Consumers (drivers) driving with high risk knowing that insuracne companies will bear cost of claim if accident is caused. Resulting in sub-optimal decisions that can reduce social welfare.
-**Adverse Selection**; When asymetric information results in worst quality products being sold for example an unregulated used car market.
65
What is factor immobility and how can it cause a market failure?
Factor Immobility refers to factors of productions being unable to be moved to where they are needed.
If demand and supply in a market change whereby a reallocation of resources need to take place,factor immobility can prevent this I.E a need for increased production is prevented by labour resources lacking the skiols or desire to transfer into area of higher demand. As a result, the Q in the market may not reach the social optimum resulting in a misallocation of resouces, AIE and market failure.
66
Why are the prices of commodities so volatile?
Because they have very inelastic PED and PES.
Inelastic PED cuz - few substitues available, the % of income a price change takes is low as these goods are necessities for either producers or consumers
Inelastic PES cuz - Large production lag involved and low stocks due to the perishable nature of some commodities
67
How can volatile commodity prices cause a market failure?
THey are prone to changes in demand and supply frequently, espeically due to weather changes. With price inelasitc demand and supply, a shift in D/S will cause a sharp change in price, making it very difficult for producers to interpret the change in price and whether to icnrease or decrease production as a result. The signalling function of the price mechanism becomes confusing, potentially resulting in an over or under allocation of resouces, AIE and market failure.
68
How does monopoly power cause a market failure?
Restricted output at Qm and higher prices at Pm, explointing consumers. Much worse than social op[timum where D=S at Pc and Qc at AE.
The Q in the market is below social optimum indicating a misalocation of resources, AIE and a welfare loss to society.
69
How can an indirect taxation solve negative externality in production market failure?
See flashcard for diagram
-Indirect tax such as carbon tax will increase costs of production for pollutin firms, shifting MPC curve to left from MPC to MPC+tax...now equal to MSC
-Price increases in market from P1 to P# with Q decreasing from Q1 to Q#, the socially optimum level of output
-Externality has been fully internalised with price now reflecting social cost of production, polluter is now paying full cost for their actions
-Over production and consumption ios now solved with resources allocatred efficiently at Q#, **welfare has been maximised**
70
How can an indirect taxation solve negative externality in consumption / de-merit good market failure?
See flashcard for diagram
-Increase costs of production for firm, shifting MPC curve left from MPC to MPC+tax
-Price increass in market from P1 to P2 and due to law of demand, consumption is discouraged, decreasing Q from Q1 to Q#, the socially optimum level of output.
-Externality has been internalised with the overconsumption and overproduction issues now solved -> no longer misallocation of resources with resources allocated efficiently at Q#. Welfare is now maximsied.
**Also mention GOV REVENUE**
71
What are the evaluation point/cons for indirect taxation to solve market failure? (5)
**1) Price inelastic demand for certain goods.**
Goods like cigarettes, alcohol, sugar and fuel have price inelastic demand because they are either necessities, addictive or have limited substitutes.
Therefore is price increase through the indirect tax, quantity decreases from Q1 to Q2 but proprtionally less than the price increase, therefore the reduction in Q will help reduce the misallocation of resources but not by enough to fully solve the market failure if Q# is below Q2.
-Consumers are absorbing a large portion of the price rise and not reducing ocnsumption greatyke meaning oversonumption and overproduction problems will remain
2) Knowing correct level of taxation to set is extremely difficult.
In reality, putting an accurate value on the negative externalities generated is highly complex. Taxes may be set to low where externality is not internalised and quanitity does not reduce to socially optimum level of output. If too high ->unintended consequences that can lead to Gov.failure where costs of intervention outweigh beenfits
3) Unintended consequences
Firms may shut down/emigrate ->unemployment ->reducing productive capacity of economy
Black market may form -> dangerous for consumer -> worsening extent of negative externality generated -> Gov created new market failure that iut needs to police ->costly
Consumers may cross border and smugg;e where taxes are non-existent -> not reduce consumption and further will not generate tax revenue
4) Regressive taxes, poor suffer proportionaly more than rich
take a greater portiong of poors income than the rich -> consumer burdened FURTHER if demand is price inelastic as producers can transfer more tax onto consumers with a proportionally smaller decrease in Q demanded -> burdening low income consumers the most -> income inequality can widen -> gini coefficient moves towards 1 -> pushing low income households into poverty -> consumers may find alternqatives such as black market or home made goods -> all leading to further market failure
**5) Negatively impacts individual freedom, liberty and choice**
If households feel thaty consumer decision making is solely individual responsability and therefore heavy handed intervention is overly paternalistic -> as a consequence, individuals feel hurt by such intervention -> likely to find a way around tax -> black market / protesting -> costly to gov and ineffecitve and reducing Q consumed
72
How can a subsidy solve positive externality in consumption / merit good market failure?
See flashcard for diagram
Subsidy such as public transport will reduce costs of production for firms -> shifting MPC curve right from MPC to MPC+sub -> price decreases from P1 to P2 -> due to law of demand, consumption is encouraged -> increasing Q from Q1 to Q#, the soicially optimum level of output -> under consumption and production issues are solved -> no longer a misallocation of resources, there is allocative efficicieny with resources allocated at Q# -> welfare is now maximised due to this intervention
73
How can a subsidy solve positive externality in production good market failure?
see flashcard for diagram
Subsidy such a in work training -> reduce costs of production for firms -> shifting MPC curve right from MPC to MPC+sub, equal to MSC -> Price decreases P1 to P# -> Q increases from Q1 to Q#, the socially optimum level of ouput -> under production and under consumption are fully solved -> there is no longer any misallocation of resources, resources allocated efficiently at the socially optimum levels of output -> welfare is now maximised
74
What are the cons/evaluation points for using a subsidy to solve market failure? (5)
1) Subsidies are expensive
All firms in given industry must recieve them for the subsidy to prevent discrimination and unfair competitive advantages -> oppportunity cost in spending -> furture tax payer / cutting costs in other areas ->worsening market failure in other areas -> welfare spending cut -> IF COST OUTWEIGHS welfare gains, Gov failure and a worsening of resource allocation
2) Unintended consequences
-If firms use subsidy for other reasons I.E deleverage, increase salaries, save in bank, increase dividends ETC.. -> the financial costs of subsidy will outweigh benefits
-Subsidy may promote wastefulness, ineffiecncy and dependancy over time, where subsidy is sued to cover costs of production that are higher than they should be -> this risk is larghe if value of subsidy is high -> increasing costs to Gov etc
3) Knowing correct level of subsidy to set is extremely difficuly
-Putting an accurate value on the positive externalities generate is highly complex
-If set too low; price decrease is not large enough to increase Q to socially optimum levl
-if too high; Unintende consequences mentioned above are much more likely
**4) Demand for good is price inelastic**
If so, majority of price decrease will be passed onto consumer with there being a substantially larger decrease in price than increase in Q -> good news for consumer with gain in CS -> not increase Q by enough to fully solve market failure
EXAMPLE = public transport. If price decreases Q may increase a little but no much as there are non-price demand factors that dominate the reduction in price; many cosumer may own cars and simply do not like the infelxabilty of public transport therefore wont start using it just befcuase it is cheaper
**5) If G/S being subsidies is a necessity** such as education or healthcare, prices falling can help afforability and imporve equitable outcomes -> reducing exclusion and improve living standards -> HOWEVER depsite short term benefit consumers may lose out in the long term having top pay fior the financing of subsisdies in the form of higher taxes -> if regressive, burden poor more, widening income inequality
75
What is regulation?
Regualtion are rules or laws enacted by the government which economic agents must operate within.
76
How can regulation be used to solve market failure?
They are a non-market based approach to solving market failure; by introducing rules that are intended to either increase or decrease consumption/production to reslove market failures without the use of the price mechanism. **They can overcome problems of market based approaches such as taxation and subsidies where inelastic demand plays a major role in their effectiveness.**
There is also strong isncentive to follow rules set by goverment due to consequences if not adhered to, there is also strong enforcement of the policy via policing.
Behaviour of economic agents will be altered wherby Q in the market will decrease/increase **to socially optimum levels where AE is achieved and welfare maximised.**
77
What are the cons/evaluation points for using regulation to solve market failure?
**1) Very costly**
Admin if drawing up regulation, passing them through political processes, the cost of enforcement. Opportunity cost -> tax payer -> borrinwg, national debt -> cuts in spending -> welfare payments.
Can questio whether this is the best use of tax payer money, especially if cheaper policies exist. If gov cant afford to properly police, then individual will not adhere to it.
IF COSTS OUTWEIGH gains, Gov failure and worsening of the missallocation of resources
2) Difficult to set at right level
-Measuring the value of externalities is in reality very complex and knowing the exact affects of how a regulation will alter the actions of an economic agent is imperfect.
Too lax = Behaviour is not altered enough to bring Q in market to social optimum
Too strict = Increase risk of unintended consequences
3) Unintended consequences
-Shut down/emigrate -> unemployment
**-Black market** where consumer find alternative supply at a lower price ->dangerous for conusumer -> worsening extent of negative externalities -> costly to Gov to police
-Firms may look to cheat/avoid regulation ->make market ourcomes worse than before
IF UNINTENDED CONSEQUNCES ARE SIGNIFICANT, costs can outweight benefits.
4) **May be inequitable in its impact on different firms**
Example; pollution caps, where all firms are forced to meet pollution caps regardless of costs involved.
Some firms will find it disproportionately easier than others, burdening those who find the change unbearbly costly. Those firms may shut down/emigrate where regulation is not so severe -> causing unemployment and carbon leakages where pollution simply moves -> gov failure
**5) Negatively impacts individual freedom, liberty and choice**
If households feel thaty consumer decision making is solely individual responsability and therefore heavy handed regulation is overly paternalistic -> as a consequence, individuals feel hurt by such intervention -> likely to find a way around tax -> black market / protesting -> costly to gov and ineffecitve and reducing Q consumed
78
How can tradable pollution permits solve market failure? (short version)
A tradable pollution permits scheme brings together regulation and market forces to reduce pollution to socially optimum levels.
79
How does a tradable pollution permit scheme work?
see flashcard for diagram
Step 1) Governments set a pollution cap for the economy, the amout of CO2 emission that the economy is allowed to emmit in a year
- We assume the Gov. value externalities of pollution correctly
- Cap is set at Q1#, socially optimum level of pollution.
Step 2) Government issues permits equally, equivalent to 1 CO2 ton, to firms accross the economy...creating a market for permits.
Supply = perfectly inelastic because n of permits is fixed to match cap, will not change with price
Demand = Normal, where two meet is price of permits
Step 3) Firms have a choice to make
a) reduce pollution by cutting production / investing in green technoloy OR
b) to buy excess permits from firms that have succesfully reduced pollution to what it needs to be
----firms will choose whatever is most cost effective, either way, negative externailty of pollution is internalised in the market with pollution cap being met
RESULTS = Much better than blanket regulation as there is reduced cost burden to firms, It is important that strong regulation exists to prevent firms polluting beyong their allowed level. -> Socially optimum level of pollution is reached with AQ and welfare maximisation.
-ALSO there is always an inscentive for firms to invest in green technology, which is beneficial for society. Firms want to have spare permits so they can sell them and increase revenue, and they themselves will be unaffected if permit prices rise with high demand (D1 to D2) or when goverment tightens cap by reduceing number of permits (S1 to S2)
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What are the cons/evaluation points for a tradeable pollution scheme? (4)
**1) Costly to enact.**
Admin of drawing up permits, organising distribution, strict enforcement. Opportunity cost -> tax payer -> borrinwg, national debt -> cuts in spending -> welfare payments.
If not policed properly then scheme will fail.
Is it possibel to measure emisions and enforce? can Gov afford technology to do so? If tech is not accurate, market failure may still exist
2) Difficult to set cap at right level
-Measuring value of negative externality is difficult in reality
If set too low; pollution does not reduce to sociall optimum level
too high; firms finding it costly regardless of choice they make -> unintended consequences and Gov failure where costs outweigh benefits
3) Pollution is international market failure that require international sollution
This is extremely difficult to organsie in reality. Some countries dont believe in climate change, for others it is not in their best interest to burden their incumbent firms with costs.
If one country acts this way, firms will move to areas where envirmoental regualtions are more laxed, creating carbon leakages.
4) Unintended consequences
Firms may shut down or leave -> unmeployment and carbon leakages -> may find ways to cheat, noit reducing pollution ->costs can outweigh benefits.
81
What is state provision?
State provision occurs when the state provides all resources in a given market **free at the point of consumption** using tax payer's money to fund it.
82
What market failures can state provision solve and how? Diagram
1) Missing market problem with public goods
-Allows a supply of public goods, in theory at socall optimum level, where if left to the private market there would be no supply at all
*see flashcard for diagram*
2) Under consumption and underproduction of merit goods
2a) State is assumed to maximise social welfare thus will consider all private and external benefits in the consumption of merit goods -> Q will be fixed at Q#, the socially optimum level, improving allocation of resources and maximising welfare/
2b) For merit goods like education and healthcare, it can be argued that noone should be excluded from consumption given how important they are for individuals and society, therefore a price charged in a free market to ration consumption is inequitable. State provision allows for universal access with these services free at the point of consumption, solving under consumption issue and improcving welfare. Diagram shows how resources are now allocated at Q#, the social optimum, a supply fixed by government with a price of 0.
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What are the cons/evaluation points for state provision? (5)
1) Very expensive policy
Because state provides all resources with very little private sector involvement. Opportunity cost if surplus tax revnue does not exist -> cuts -> future generations burden with tax rises -> welfare payments/ public transport -> worsening existing market failures and widening income inequality -> regressive taxes. If cost of state provision outweighs gains in welfare, then gov. failure and a worsening of the missallocation of resources.
2) Excess demand
*see previous flashcard*
Becuase at price 0, demand of Q1 but supply is at Q#. In a free market price would rise to ration scarce resources but with state provision there can be no price rationing.
-Gov must use non amrket based approaches to deal with excess demand they have created such as treating patients based on severity of condition.
-> this is highly normative and can lead to inefficient decision being made as treatment is purely based on someones opinion.
-This overconsumption is a major issue putting large strain on public services and those that work in the public sector -> workers may leave
This occurs becuase supplying more is simply too costly.
**3) Knowing the right levl for the state to provide is very difficult**
-Assuming state have full info regarding true private and external benefits in consummption is unrealistic. Gov suffering from lack of information leads
-Too small Q being produced = not at socially optimum level, problems with excess demand are further exagerated
-Too much provided = costs of extra units are waste and would outweigh benefits, risking gov failure.
**4) State run organisations tend to be inefficient**
Due to lack of profit inscentive, more likely to be complacent and wasteful in production -> tax payers may not be getting the best value from their payments with a large opportunity cost of where money could have been used instead -> higher costs of production will burden taxpayer further
5) Is there a role for the priavte sector?
Given excess demand, argument can be made for mix and match private sector and public sector provision. Where those who can afford to go private do so, reducing wait times in public sector. Reduces burden on state schools and hospitals -> freeing up more resources to be used on those who need them.
Argument gains wait for areas in healthcare that are not classed as merit goods such as cosmetic surgery.
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How can information provision be sued to solve de-merit good market failure? Diagram
*see flashcard for diagram*
Information provision in the form of negative advertising such as TV campaigns can solve de-merit good market failure **where imperfecet information is the root casue of the problem**.
Individual consumers who are well informed will consume less -> shifting MPB curve left from MPB to MPB+neg advertising which now equals MSB.->market operates at social optimum level of output Q# with overconsumption and production issues solved and AE attained. Welfare has increased and market will remain at this equilibrium in the long term.
85
How can information provision solve merit good market failure? Diagram
*see flashcard for diagram*
Information provision in the form of positive advertising such as TV campaigns can solve merit good market failure where imperfecet information is the root casue of the problem.
Individual consumers who are well informed of full benefits of consumption will now consume more -> shifting MPB curve right from MPB to MPB+pos advertising which now equals MSB.->market operates at social optimum level of output Q# with underconsumption and production issues solved and AE attained. Welfare has increased and market will remain at this equilibrium in the long term.
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What are the cons/evaluation points of using information provision to solve market failure? (3)
1) Very costly
Because to be succesful, well targeted and spread to the masses then all forms of media outlets and public forums need to be used, increasing cost dramatically.
Opportuniy cost if surplus tax revenue does not exist -> USUAL ARGUMENT.
Can be argued that it is not the most effective use of tax payer moneyif advertising doestn have noticeable impact on consumer behaviour, using money to fund other market failure solving policies instead would be more efficient. To counter argument, if policy is used ALONGSIDE taxation, revenue from tax can be used to fund information provision providing a short term and long term solution
2) No garantuee will work as intended
Quantity of info OR advertising itself could be poor, unclear and not well targeted. If so, costs outweight benefits goverment failure, pre-existing market failures remain with a worsening of the misallocation of resources
**3) Long run policy, not effective in the short term.**
It will not change consumer behaviour immediately, takes time to educate public enough to alter consumption habits. Therefore using policy in isolation is unlikely to be succesful, better combined with subsidy or taxation.
87
How can the allocation of property rights be used to solve the tradgedy of the commons market failure?
Issuing property rights gives the holder owndership over a piec of land, part of the sea, air or river.
The idea is that with private owership there is a strong inscentive to maintain the resource otherwise it will be the priavte owner that will lose out from its depletion.
-If another prodcuer intrudes on the land, the holder is able to sue the trespasser, protecting the private propery that they own.
**-Any overproduction issues that previously existed leading to the tradgedy of the commons due to no private ownership of common access resources have been solved, resources alocated efficeintly at socially optimum level of output, benefiting current and future generations. Sustainable production results, dealing with root of problem.**
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What are the cons/evaluation points of using property rights to solve the tradgedy of the commons market failure?
1) Very difficult to implement and distribute property rights for the air or the sea. Policy is theoretically sound but has limits in its practical application.
2) It is costly.
Admin costs, distributing costs and strict enforcement is needed. Opportunity cost if surplus tax revenue does not exist. Can question if most effective use of tax payers money if an alternative policy could have been used that would be more effective at solving the market failure. THIS IS WEAK argument given scale of problem; benefits will substantially outweigh costs
89
What is the diagram for Minimum price to solve de-merit good market failure? Explain it
see flashcard
Min price used to discourage consumption of de-merit goods -> min price set above free market equilibrium from P1 to Pmin -> law of demand, discouraging consumption -> internalising NE -> reducing consumption from Q1 to Q# -> socially optimum level of output -> efficient allocation of resources, allocative efficiency
90
How can buffer stock schemes solve price volatility market failure? Diagram
Used by gov to keep commodity prices stable, protecting consumers from high prices and producers from low prices, given price volatility in the free market. The gov buys up excess stock when price is too low, and sells reserves of excess stock when price is too high.
*see flashcard for diagram*
prices are allowed to fluctuate between the bands but never permantely remain above or below them.
91
Explain buffer stock schemes using diagram
*see flashcard for diagram*
price of commodity comes under falling pressure in figure 1 -> supply shifts right from S1 to S2 due to a massive harvest -> a price fall from P1 to P2 would not be allowed harming the livelihood of producers as it is below min.price -> Gov would buy up stock in the market, increasing demand, shifting from D1 to D2 -> pushing price back up to P1 ->withing the bands
Gov would store stock and release it onto market if price ever rose too high.
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What are the cons/evaluation points of a buffer stock scheme?
1) Very expensive
In theory, the gov selling stock when price is high and buying when stock is low will generate surplus income to fund the policy, however the storage of the stock is expensive, espeically if stock is perishable.
Opportunity cost -> cuts / taxes ->especially for developing countries
Money could have been spent in other areas more productively to promote development, **perhaps promoting divirsfication to tackle root cause of market failure.**
2) Difficult to maintain
Especially true if weather fluctuates yearly generating runs of good and bad harvests. The volumes needed to change a world commodity price are so large that a gov may simply not be able to. Scheme could collapse entirely if not enough stock available to sell / funds to buy
3) Not possible for some primary commodities
Some agricultural goods deteriorate too quickly
4) Difficult to set correct max and min price
An equitable price is a normative judgement and therefore easy to get wrong, whereby the scheme becomes too difficult to maintain.
Min price too high = Gov will have to buy huge volumes when price falls, not sustainable
Max price too low = Gov have to sell huge amounts of stored stocks, not feasbale given cost of storage
If Max price too high and/or min. price too low = policy intention will not be met with goverment failure as the result.
93
What policies can we use to solve negative externality in production market failure?
-Indirect taxation
-Regulation
-Tradable pollution permits
-Allocation of property rights
94
What policies can we use to solve negative externalities in consumption / de-merit good market failure?
-Indirect taxation
-Regulation
-Information provision, negative advertising
**-Min. price**
95
What policies can we use to solve positive externalities in consumption / merit good market failure?
-Subsidy
**-Regulation**
-State provision
-Inormation provision, positive advertising
96
What policies can we use to solve positive externality in production market failure?
-Subsidy
-Regulation
97
What policies can we use to solve missing market problem with public goods?
-State provision
98
What policies can we use to solve Price Volatility market failure?
**-Price controls; minimum price**
-Buffer stock schemes
99
What policies can we use to solve income inequality market failure?
-Maximum price
-State provision
100
What policies can we use to solve the tradegdy of the commons market failure?
-Property rights
101
What is government failure?
Gov failure occurs when the cost of intervention outweighs the social benefit resulting in a **worsening of the misallocation of resources in a market and a greater loss of social welfare.**
102
What are the 3 primary casues of Gov failure?
-When costs of policy are extremely high either directly (state provision, subsidy) OR indirectly (admin and enforcement costs)
-When there is imperfect information within the government.
Being unable to acuurately quantify the positive and negative externalities that exist
-When there are **unintended consequences**
Black markets, smuggling, firms cheating etc.
103
What are the evaluation points for government intervention in markets?
Why would a Gov not intervening maybe be the best idea?
1) Is there a market failure? Is there acc a significant misallocation of resources in the market
**2) Free markets could solve their own problems**
Through inscentive function of price mechanism whereny firms have profit motive to solve problems of fill new gaps in market, taking away need fot Gov intervention
3) If risk of GOv failure is high, rationale for NO INTERVENTION
even if there is a market failure, Gov failure could make these outcomes worse
**4) Leaving market free or not should depend on nature of good/service**
Competition can drive down costs and improve affordability with DE, whereas in some markets access to the good can be argued as a basic human right.
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What are the pros of a free market? (6)
1) Promote AE
Where society surplus is maxamised, the sum of both producer and consumer surplus. Given the basic economic problem, the price mechanism through its functions of signaling, incentivising and rationing is an effective and efficient way of allocating goods and services preventing shortages (excess demand) and surpluses (excess supply). Resources perfectly follow consumer demand as the socially optimum level of output is reached.
2)Encourage competition, entrepreneurship and innovation
through the profit motive, signalling and incentivising firms to enter the market if large profits are being made, repsonding to consumer tastes and need. Competition -> higher quality -> innovation -> lower costs of production -> lower prices and higher quantity -> raising CS
3) DE given the profit motive
usual DE benefits
4) Competitive markets create economic growth and boost employment in the economy.
Becasue Q is maximised at socially optimum level, increasing real GDP and with many competing firms the derived demand for labour is high. Employment allows greater opportunities for individuals to work and improve living standards
5) No Gov intervention to distort market outcomes
Certain Gov internvention could reduce societal welfare and create shortages/surpluses. Indivduals make decisions without paternalism
6) No risk of goverment failure through intervention
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What are the cons of a free market? (5)
1) Markets can fail in efficiently allocating scarce resources
-Variety of ways; existence of externalities, public goods, monopoly power and imperfect information.
Gov failure may be more beneficial to society than allowing free market to continue, intervention can solve failure, allocate resources efficiently and improve societal welfare
2) Can exclude individuals on low incomes
Becasue functions of price mechanism only work in allocating scarce resources by taking aqay shortages and surpluses rayjer than considering affordability or necessity of the goods. -> inequity ->individuals unable to access most basic life sustaining G/S -> risk of black market for food/drugs
**3) Profit seeking inscentives may lead to reduced quality by cutting costs**
For example the market for blood, where quality may fall or be tainted as suppliers look to maximise profits -> individuals will be harmed with poor product safety -> goverment regulation could combat this
**4) Creative destruction**
Where new competing firms enter a market and destroy existing firms due to innovation and superior efficiency -> unemployment
Whilst consumer benefit from efficiency gains and price reductions over time, firms shutting down will worsen unemployment and worsen living standards. WEAK ARGUMENT
**5) Volatile prices cause problems in some markets**
when left free from Gov intervention. Example market for primary commodities where demand and supply are affected by changes in economic cycle and weather conditions, as demand and supply are price inelastic the resulting price differentiation is significant -> destroys inscentives to invest as price changes are unpredictable -> harms individual producers who lose a source of stable income -> sudden price decreases can lead to decline of industries and structural issues particularly when factor mobility is limited
106
In an essay about monopoly regulation, what do we talk about?
What it is -> when/why competition authorities intervene -> the aims of intervention ->
-Price regulation
-**Quality control / performance targets**
-Profit control
-Windfall taxes
107
What is monopoly regulation for? Why do it?
Monopoly regulation / competition policy is implemented to promote competition, make markets work better and to imrove the efficiency and competitiveness of the economy.
108
When do competition authorities intervene in a market? EXAMPLES
When public interest is being harmed due to monopoly or oligopoly abuses;
-Highly concentrated, with dominance from one or few firms; monopoly, oligopoly, **monopsony**
-Collusive oligopoly with cartel agreements
-**Merger activity** that could result in outcomes against public interest
-Anti competitive strategies such as predatory pricing
**-In natural monopoly markets that are unregualted, not producing at socially optimum levels of output**
109
What are the aims of interventionin regards to regulating monopolies? (4)
1) Prevent excess pricing - where consumers are being exploited, charging prices in excess of marginal cost, reducing CS, burdening those on low incoems in particular
2) Keep quantity and quality of provision high - Monops can restric output and produce at an output below socailly optimum level, restricting consumer choice. Also without competitive drve, the quality of product may not satisfy consumers.
3) Promote technological advancement - To ensure supoernormal profits are being reinvested back into the business; benefits of DE
4) Promote competition by liberalising concentrated markets
110
What policies can we use to regulate a monopoly?
-Price regulation
-Quality control / performance targets
-Profit control
-Windfall taxes
111
What is price regualtion to regulate a monopoly?
Prices are not allowed to increase the year beyond a certain figure relating to RPI. (if youre a firm and your costs rice due to RPI, it is fair to increase prices)
There are three different approaches:
**RPI**
Prices can only rise perfectly in line with RPI, allowing firms to cover costs and inscentivises efficiency to generate profits
RPI - X
Restrict increase level below RPI where X = %
Idea is to promote efficiency 'if youre efficient you can cut costs, dont need a full RPI'
RPI +/- K
K = %, idea is that K allows for enough profits for capital investment. If + then there is not enough profit in RPI, if negative there is.
112
Show price regulation on a diagram
*see flashcard for diagram*
113
What are the evaluation points for price regulation on a monopoly? 1 positive, 4 negative
Positive:
1) It encourages firms to find efficiency savings, to cut costs as much as possible in hopes to charge prices at regulated price but still make a profit as costs have been cut more than price
Negatives:
1) How is K/X generated?
-Regulatory bodies do not have perfect information for costs and revenues for firms
-It is in interest of firms to conceal information to soften the regulation
-X too high = cripple firms/ shut down / emigrate
- X too low = No competitive outcomes
- K too high = No competitive outcomes
- K too low = Inefficient level of profits -> consequences
**2) Costs to regulatory bodies**
- Time consuming + costly investigation
- Tax payer bare costs
- Big opportunity cost, especially if X/K is set wrong
3) Regulatory bodies inscentivised to keep reducing X/K
-If a firm is succesful in adapting to the regulation, finding efficiency savings greater than X/K allowing supernormal profits to be made, regulators may continue to reduce X/K further
4) Risk of regulatory capture
- Best regulators will be those who have previuosly worked in industry...meaning possible bias with friends.
-Reduces extent of regulation, maybe not doing job and therefore not promoting competitive outcomes
114
What are quality control / performance targets when it comes to regulating a monopoly? Give examples
-Fining monopoly train providers for having more than a certain number of delays a day
-forcing gas and electric providers not to cancel winter supply if pensioner fails to pay bill
-imposing time targets for ambulance services
Targets that force a monopolist to meet needs and wants of society, providing services at minimum requirements and increasing Q of services provided.
115
What are the 2 evaluation points/consequences of quality control/performance targets on a monopolist?
1) Unintended consequences
strict performance targets, such as GP having to see certain number of patients a day, can mean shortcuts are taken that are harmful to society
2) Gaming the system
Firms find ways around the regulation, for example train companies may lengthen jounrey times to avoid 'delays'. Heightened regulation will promote such behaviour
116
What is profit control/ profit regulation to regulate a monopolist?
Where regulators impose a maximum amount of profit a firm can make, equal to what a competitive firm would make given the same costs and revenues. They then give companies a % return on capital invested, inscentivising DE and promoting innovation = more capital invested, more allowed profit.
117
What are the cons/evaluation points for profit control/profit regulation? (3)
1) **Asymmetric Information (cheating)**
-Monopolist can over report their 'capital employed' to make sure level of regulator profit is higher
**2) Inscentive for costs to increase**
They know that their costs will always be covered by the profit control equation, allowing for x inefficiency in production
3) Inscentive to over-employ capital
Because each machine will increase level of return equation, allowing for more profits to be made, even if capital is uneccesary and not a worthwhile investment for firm. Inefficient poduction decision, X inefficiency
118
What are windfall taxes on profits in terms of regulating a monopoly?
Where taxes are applied to monopoly profits to inscentivise the firm to reduce prices and lower the amount of overall profit made. **The tax collected can be used to enforce other forms of monopoly regulation / maintain the existence of regulatory bodies OR used to fund essential public services in economy**
119
What are the problems / evaluation points of windfall taxes on monopoly profits?
1) **Taxing revenue will increase AC and MC, resulting in even higher prices and lower Q at profit maximisng level** -> worsening outcomes for consumers, greater misallocation of resources, opposite intentions of policy
**2) Promotes tax evasion / avoidance**
Firms find loopholes or under report profits, meaning monopoly pricing and large SN profits remain with little benefits from tax revenue
3) taxing profit can reduce DE gains -> usual DIE argument
120
What is merger policy in the context of regulating monopolies?
If a merger between two companies can result in market share greater than 25% , competition authorities can intervene if merger is likely to harm public interest. Can be banned OR allowed with forced selling of stores tp rivals tp encourage competition and reduce marekt share
121
What are the 5 general eval points we can make when taking about monopoly regulation? JUDEGEMENT
Problems with regulation AND benefits of monopoly
**1) Assumption of regulators having perfect information is flawed**
Too strict reg = firms shutting down / emigrating
Too laxed = no AE outcomes
**2) Regulation is costly**
maintaining regulatory authorities, admin and enforcement. Tax payers burden, in hope of benefits through lower prices and better quality and higher quants BUT if not achieved then gov failure, worsening prior misallocation
3) Regulatory capture
Too soft reg can risk Gov failure
4) Monopoly has advanatges:
-DE
-EOS
-Cross subsidy
Regulation can negate these
5) Natural monopoly makes sense, by increasing comp in such market promotes wasteful duplication of resources and productive inefficiency
122
What is privitisation?
When a state run organisation is sold off to private sector.
Idea is that private sector will run organisation more efficiently than Gov because of profit motive. There will also be more competition in the market, reducing costs
123
What diagram do we use to show privitisation?
*see flashcard for diagram*
Evaluate as moving toward competitice outcomes, as a result CS gains
124
What are the 4 different types of privitisation?
1) Sale of state owned assets to private sector corporations or individuals.
2) Gov can contract out services to private sector where Gov controls and monitors output and quality but jobs themselves ae carried out by private firms I.E cleaning services in hospitals
3) A competitive tendering process; where private firms bid to build a project for the Gov. The winning bid will be the lowest cost and highest quality, mathcing requirements of Gov
4) A Public Private Partnership (PPP)
Where gov works alongside private sector firms to complete an infrastructure project.
A **PFI**, private finance initiative, is where private firms cover construction costs of project (i.e hospital) then lease it out to the Gov with annual payments with interest over time. Allowing gov to pursue key infrastructure projects even if finance is not currently available
125
What are the advantages of privitisation?
1) Increase in AE
More comp, firms strive to produce high quality goods and maximise consumer satisfaction
2) Reduction in X inefficiency
- Reduction in waste as firms need to drive down costs to remain competitive
3) Profit motive increases DE
Motive to innovate, create more competitive products
126
What are the disadvantages privitisation? 3
1) Could lose previous EOS benefits
Important to evaluate whether privitisation will lead to EOS benefits or losses. With one dominant state company, EOS being exploited benefit consumers, howeever if this is broken into lots of smaller firms then it is possible thet due to a lack of EOS then consumers end up paying a higher price despite efficiency gains
2) Firms dont want to run loss making services
-There has to be scope for profit
-Even if good benefits society
3) Loss of natural monopoly
- By opening up market to more comp, natural monopoly may lose EOS creating PIE.
-Anti comp poricing can lead to AIE of new firms shutting down
127
What are the eval points for privitisation?
1) Impact of privitisation depends on how many firms actually enter industry, If **barriers to entry** are high or new firms create their own barriers, new entrywill be restricted, possibly resulting in monopoploies/oligopolies
2) Form of privitisation used will determine whether it generates revenue or costs to Gov.
PFI may lead to higher costs to Gov in long run due to interest payments, opportunity cost
3) Important role for regulation post privitisation.
Important to prevent monopoly or oligopoly power with comp policy. OR if market fails in private hands due to negative externalities in production, policy might be needed to bring production to social optimum
4) **Assuming interest in industry**
-Privitisation will only be succesful if it can attract more firms to enter industry but thos may not occur -> limited comp = PIE and AIE as firms have no need to reduce costs
128
What is deregulation?
When Gov reduces legal barriers to entry in given industries, inscentivising more firms to enter market.
Idea is to increase comp and promote efficient outcomes
129
What is the diagram for deregulation?
*see flashcard for diagram*
same as privitisation, monopoly diagram moving toward compeitive outcomes, increasing CS
130
What are the pros of deregulation?
1) More consumer choice
-More firms, more choice
-Striving for competitive pricing therefore AE
-Inscentive for firms to produce where P=MC to satisy consumers
2)Improved PE and XE
Inscentivised to minimise costs, no waste
-Produce at min point on AC curve
**3) Increased DE**
Greater scope for profits, leading to DE, usual DE shit
131
What are the cons of deregulation? 2
**1) Loss of natural monopoly **
-New firms, comp breeds PIE and AIE
-Wasteful duplication of resources
2)-Possible formation of monopolies/oligopolies which could abuse power and lead to AIE and PIE (EXAMPLE Uk bus market)
No garantuee of new comp
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What are the evaluation points for deregulation?
1) Impact depends on how many firms enter industry
-If non-legal barriers to entry are high or new firms create their own barriers then entry to market will be restricted -> greater chance of monopolies / oligopolies
2) Important role for regulation post deregulation
To prevent abuse of oligopoly / monopoly power
3) **Consumer inertia** may stop consumers from switching suppliers
May no even be aware that new firms have entered, there is no garantuee of deregulation working. Comp authorities can help by assiting consumers in switching suppliers
133
What is nationalisation?
The process of taking an industry into public ownership.
134
What are the pros of nationlisation? 4
1) Greater EOS potential
-Leading to PE gains, lower AC and potential for lower prices, gains in CS
2) More focus on service provision
-We assume that gov looks to maximise social welfare and there will be AE benefits, maximising consumer surplus and meeting societies wants and needs
3) Less likely for market failures to arise from externalities
-Gov intends to maximise social welfare and consider full social cost + benefit when producing, not just private costs and benefits
-Production should be closer to social optimum
4) **Vehivle for macro economic control**
-Gov can manipulate wages to control infaltion
- Gov can control employment levels, increasing employment in recesion to keep unemployment low
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What are the cons of nationlisation?
1) Risk of diseconomies of scale
-State run monopoply, could be so huge -> DES -> increased AC -> loss of efficiency gains -> increases in prices
2) Lack of inscentive to minimise costs
- no profit motive
3) Risk of complacency and waste
-Due to lack of inscentive
-Higher costs of production, higher prices
4) **Lack of supernormal profits**
-Due to no profit motive
-lack of DE
5) Cost burden on tax payer
Very expensive to buy and maintain, usual cost argument
6) **Higher prices due to lack of competition**
-Possible monopoly outcomes
-AIE
7)**Greater risk of moral hazard**
Where individuals take risks and do not bare costs, they are born by thrid party, in this case tax payer
8) **Political priorities may overide commercial issues**
Politicians decide not to invest in state run comp[any to improve it despite investment being necesary I.E nect year there is elceltion therefore would rather not take risk.
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What are the evaluation points for nationalsation?
**1) Does delivery of key public services provide more benefits than costs? If so, despite expensive cost of nationaliation, society gains outweigh them ESPECIALLY if good would be underproduced in private markets due to lack of profit motive. Delivery of such services by Gov can create LR ecnomic growth, reduce income inequality**
2) Size of nationlised vs privatised firm
Important to make sure nationanilastion will result in greater EOS than if privatised.
3) If there is already strong regulation / competition in privatised industry, then nationalisation may breed inefficiencies.
4) Public private partnerships may be a better option to maximise social welfare where resources are allocated at social optimum level of output with lowmp[rices due to Gov control. DE benefits due to profit motive of privatised elements
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HI OLI!
Your doing great old goose LOVE YOU LOTS AND LOTS
- love very much so from ur FAVOURITE best friend ever (me) 😁😁😁😁😁😁😁😁❤️❤️❤️❤️❤️
