4.1.8.9 - Government Intervention Flashcards
How do governments intervene in markets
- taxes
- subsidies
- minimum prices
- maximum prices
- information provision
- mandatory use/ direct provision
- regulation: limits/bans
What are indirect taxes
Taxes that affect the firms, they raise the costs of producing a good/service, meaning a rise in indirect tax will shift supply to the left as cost of production increases
What is ad valorem tax
Adding a percentage of the price of a good or service, eg: VAT being 20% on all items
What is specific or unit tax
Involves adding a fixed amount per unit (eg +£3 per unit) of a good or service
How is a unit tax displayed on a diagram
A parallel shift out of the supply curve occurs when a unit tax is applied
- unit tax adds a singular value to the price of all goods, so each price is increased by the same amount, despite the originals price of the good
- meaning the gradient is constant
A real life example of a unit tax
- the specific unit tax on a pack of 20 cigarettes is £4
- this is applies to all cigarettes no matter what brand or original price they are
How is an ad valorem tax shown on a diagram
- a shift out of supply leading to a curve of a steeper gradient
- this is because as the price of a good increases, a higher amount is payed in tax, leading to a steep gradient
What is the incidence of a tax
When the gov imposes a new indirect tax on firms, how much of that added tax the firms will be able to add onto consumers without losing profit is the incidence of the tax, it us usually determined by the PED of a good (inelastic good will have a higher incidence)
What is consumer and producer incidence
Consumer incidence is the amount of the tax that is passed onto the consumers
Producer incidence is the amount of the tax that the firms will pay themselves
- an in elastic product will have a higher consumer incidence as consumption isn’t very responsive to changes in price, firms will not lose business
Advantages of using indirect taxes
- when placed on goods with in elastic demand, a large amount of revenue is raised - this can be used by the gov to improve services such as healthcare and education
- it uses the price mechanism which means consumers are still able to use their own free will and make their own personal decisions about how they adjust their behaviour as a result to the changes in price
- consumers are forces to internalise the cost of the negative externalities, if the tax is applied effectively, consumers begin to realise the negative affects of the consumption of the goods and services
Disadvantages of using indirect taxes
- the quantity demanded is not likely to fall significantly as they are places on inelastic items unless the tax is very large, however is taxes are too large, the impacts are not as effective
- calculating the correct monetary value of tax is very difficult, which makes it almost impossible to force consumers to fully internalise the negative externalities
- indirect taxes are seen as unfair, if the price of goods increases poorer people are less able to purchase the goods whilst the richer are ineffective which arises the problem of inequality
What is a subsidy
A government grant payed to producers that owners their costs of production, with the aim to encourage firms to increase production of their goods/ services
How is a subsidy effect shown on a diagram
A parallel shift out of supply to the right
Why does subsidising items lead to a shift out of supply
- the costs of production is decreased
- the profitability therefore increases
- more firms are incentivised to produce the goods
- they increase their supply to maximise their profit
What are the advantages of using subsidies
- increase the consumption of the merit goods which brings the equilibrium closer to the socially optimum level of consumption, this enables people to begin to internalise the positive benefits of consuming the goods
- subsidies reduce the prices of goods meaning that they are more accessible for lower income households increasing equality
What are the disadvantages of using subsidies
- funding subsidies carries an opportunity cost, so if the scheme is not affective unnecessary sacrifices would have been made by the government
- firms receiving subsidies may become reliant on them which could lead to inefficiency and laziness, this could reduce the international competitiveness in the long run.
- if subsidies are placed on goods with an inelastic demand, the price may be reduced however there may not be a significant rise in the level of consumption
What are minimum prices
Price floors that are places above the free market equilibrium price in order to be effective it is likely that the gov will have to buy excess supply to prevent market failure
What are the advantages of using min prices
- helps to give producers a guaranteed income which helps them to generate as reasonable standard of living through a minimum wage
- it can be used to encourage the production of essential farming produce
What are the disadvantages of using minimum prices
- consumers must pay a higher price which may lower their disposable income
- they encourage over-production due to the price incentive to producers which is an inefficient use of resources
- if the gov have to purchase the excess supply in order for the intervention to be effective, an opportunity cost must be faced
- high prices may encourage the creation of illegal markets for products
What are maximum prices
A price ceiling or upper limit that is set below the equilibrium price that cannot be exceeded
What are the advantages of max prices
- goods and services are made more affordable and therefore fairness and equity is implemented
- they can reduce a firms ability to exploit consumers is they have monopoly power by charging an excessive amount for specific goods and services
What are the disadvantages of max prices
- firms are less incentivised to produce the goods and services as their profit is reduced, this could lead to product shortages and excess demand
- black markets may be created for goods and services where people will often over charge for certain goods (eg: concert tickets resell)
What is information provision
- When governments intervene in free markets to correct information failures about certain goods, this helps to reduce the market failure of merit and demerit goods
- several methods are used by governments in an attempt to move the quantity demanded closer to the socially optimum level, these methods include:
- compulsory labelling on foods (eg: traffic lighting sugars fats salt on packaging)
- health warnings though images (graphic images on packs of cigarettes)
- TV adverts and campaigns
What are the advantages of information provision
- brings the quantity demanded closer to the socially optimal equilibrium meaning that in the long term negative externalities are reduces and positive externalities are increased
- helps consumers to act rationally as they have the ability to make fully informed decisions
- the markets for goods can be made more elastic in the long run meaning that when used alongside indirect taxation, gov intervention will be very effective
What are the disadvantages of info provision
- can be very expensive for the government meaning that an opportunity cost will be faced
- the government do not always have access to all of the information they need in order to fully inform consumers correctly
- consumers can act irrationally meaning that they will not always listen and respond to the information being given to them
What is direct provision (mandatory use)
When the government enforce the use of goods and services to bring their consumption towards the socially optimum level
The government make the goods accessible by funding the production and then enforce the use of the goods with provision
Advantages of direct provision
- works well wit extreme cases of market failure where the socially optimal level of consumption is100%
- the intervention id easy for consumers to understand
- is quick to implement and for the effects to be seen
Disadvantages of direct provision
- can be difficult to accurately calculate the exact levels of socially optimum consumption
- it dictated peoples behaviour so can be classed as a violation of peoples free will
- enforcement costs can be time consuming and expensive
- it may lead to the creation of black markets
What is regulation using limits and bans
When the government implement rules or laws used to restrict the actions of economic agents in order to bring consumption closer to the socially optimum level:
- banning smoking in public places
- maximum emission levels
- establishing green belt land around major cities
- minimum age to drink alcohol
What are the advantages of using regulation
- works well with extreme cases of market failure where the socially optimal level of consumption is 0%
- can be quick to implement
- easy to understand
What are the disadvantages of regulation
- can be considered a violation of free will
- compliance may increase business costs meaning the competitiveness of markets decrease
- hard to calculate the specific socially optimum level of consumption
- can lead to black markets
What is the criteria used to evaluate gov intervention
- speedy impact
- deals with long lasting attitudes
- raises revenues/ is cheap
- works via the price mechanism
- flexible policy
- certain impact
What is environmental market failure
- negative externalities lead to some form of environmental damage, it arises from the over-exploitation of environmental resources
- major environmental market failures that are likely to affect the world for example through climate change or global warming
How to a lack of property rights lead to markets failure
- a lack of property rights related to environmental resources can be a reason for environmental market failure
- property rights are the legal rights of ownership or use of economic resources, if a good doesn’t have property rights they become common goods
- economic agents suffer no consequences from polluting the atmosphere due to the pollutants such as plastic being common goods,
How does the tragedy of the commons lead to market failure
- the over use or exploitation of resources such as the forests or the atmosphere occurs as these resources are commonly owned
- individuals gain full benefit of these commonly owned resources however only receive a fraction of the costs pf their actions
- eventually complete market failure will occur if the resources are entirely destroyed or permanently damaged
What is resource depletion
When we use up a stock of natural resources faster than they can be replenished
What is resource degradation
When economic agents over-consume a resource and make it less productive than it was before the initial consumption
What are pollutant permits
- the government issue a limited number of permits which allow a fixed volume of pollutants to be produced
- a market for pollutant is created as firms must buy permits in order to pollute the atmosphere
- the price of the pollutant permits incentivises firms to produce less pollution as they can sell these permits to make profit
- the high price of the permits internalises the negative externality of production and the private costs of production are made more severe
- permits make the environment an excludable good so it cannot be subject to the tragedy of the commons os it is no longer a public good
Advantages of pollutant permits
- uses the market mechanism son powerful incentives are produced meaning people are still able to use their free will to make the decision to lower their pollution
- the revenue raised from selling these permits can be used by the gov to invest in green technology or to create environmental schemes as a way to protect the environment
Disadvantages of pollutant permits
- the gov will suffer from imperfect information as measuring the level of pollution produces is almost impossible
- it is very expensive to enforce the regulation or fine for non compliance
- it is difficult to accurately estimate the socially optimal level of pollution
- they are only effective when solving environmental market failures that are caused by a lack of property rights
