4.1.8 Market failures, policies and regulations Flashcards
What is an indirect tax?
An expenditure tax that increases a firm’s cost of production but can be transferred to consumers via higher prices
Why do governments levy taxes? (5)
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
What is the impact of indirect taxation on a diagram?
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
How does an indirect tax affect the consumer?
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
What are the evaluation points of how an indirect tax affects the poor? (3)
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
How are producers and workers affected by an indirect tax?
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
What is the evaluation for and indirect tax affecting producers and workers?
Argument strong if demand for good is price elastic, however if inelastic producer can transfer price rise onto consumer
How does an indirect tax affect the government?
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
What is the evaluation of the affect of an indirecg tax on the government?
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)
What is a subsidy?
A money grant given to firms to reduce costs of production and to encourage an increase in output
Why do Gov issue a subsidy? (3)
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
What is the impact of a subsidy on a diagram?
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
What is the impact of a subsidy on consumers?
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
What are the evaluations points for the affect of a subsidy on consumers? (4)
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
What are the affects of a subsidy on producers and workers?
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
What are the affects of subsidies on the government?
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
What are the evaluation points of the affects of a subisidy on the gov? (2)
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.
What is a minimum price?
A price floor, normally set above the equilibrium market price
Why do governments impose minimum prices? (3)
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
Explain the affects of a minimum price using a diagram.
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
What is the affect of a minim price on consumers?
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
What are the evaluation points of the affects of minimum prices on consumers?
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
What are the affects of a minimum price on producers?
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
What are the evaluation points for the affects of a minimum price on producers? (2)
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.
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
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
What is a maximum price? (Price ceiling)
A price ceiling normally set below the equilibrium market price
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
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
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
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
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.
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.
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.
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
What is market failure?
When the free market fails to allocate scarce resources at the socially optimum level of output
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.
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
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
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.
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.
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
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
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.
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.
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.
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
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.
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.
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.
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
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.
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.
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.
