4.1.8 Market failures, policies and regulations Flashcards
What is an indirect tax?
An expenditure tax that increases a firmβs 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 poorβs 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.