8) Government intervention

Question 1

Define a subsidy

Answer 1

a grant given by the government to producers to encourage production of a good or service

Question 2

examples of subsidised goods

Answer 2

Wind power
solar power
farming
public transport

Question 3

Why are goods subsidised??

Answer 3

Goods that are subsidised tend to have positive externalities of consumption ie wind power which reduces pollution. Therefore they are merit goods and are therefore produced and consumer more when subsidised because the price is lower

Question 4

How is a subsidy shown on the diagram and where is the size of the subsidy on the diagram??

Answer 4

A subside shifts supply from S1 to S2, lowering the price from p0 to p1 and increasing quantity from Q0 to Q1 as there is an extension in demand. The size of the subsidy is P2-p1 x the quantity of units sold, where p2 is the price producers would want to charge at this new level of quantity, but this is paid for by the government. (p2 higher than P0 and P1 lower than P0

Question 5

Advantages and disadvantages of subsidies

Answer 5

ADV- market better solution that better aligns the incentives of producers and consumers to consume at a an allocatively efficient level
-if PED is elastic, small subsidy leads to bigger increase in demand

Disadvantages

• opportunity cost of implementing subsidy, money could be spent elsewhere
• effectiveness depends on elasticity of supply and competition, low competition means less incentive to lower prices, could just mean more profit for firms

Question 6

How does a subsidy compare favourably and unfavourably to a tax??

Answer 6

Favourably- easier to encourage consumption of merit goods than discourage consumption of demerit goods
- tax and subsidy used together may be effective and tac revenue can Pay for subisdy

unfavourably- tax raises Revenue whereas subsidy has opportunity cost
-may undermine government objectives like austerity

Question 7

Define state provision

Answer 7

is where the government decides which goods or services to provide and then spends money providing them.

Question 8

Why does the state provide goods and how does it affect allocative efficiency??

Answer 8

• Public goods are non-profit goods and are provided for free or heavily subsidised by the state because there is no incentive for private firms to provide them due to their lack of profit
• Lower prices act as an incentive for consumers to increase consumption; these are usually merit goods deemed important by the govt, and so they have social benefits higher than the private benefits eg healthcare
• Society will be better off from increased consumption due to the positive externalities, improving allocative efficiency

Question 9

common examples of state provided goods

Answer 9

• state education
• Healthcare/ NHS
• Police/fire services

Question 10

How is state provision shown on a externality diagram and then a S+D diagram??

Answer 10

Externality:
Supply line = MPC= MSC
Demand lines have MPB to the right of MSB, because the MSB is greater than MPB because of its positive externalities

S+D: Supply shifts massively to the right to a point where the price is just above 0, the size of the subsidy is the quantity demanded multiplied by the difference between the new very small price and the price producers would charge on the old supply curve at this quantity

Question 11

Advantages and disadvantages of state provision

Answer 11

Adv- increases allocative efficiency as more resources directed towards an under-consumed good
-reduces inequality- everyone has access to a standard level of goods eg healthcare or education

DisAdv- Costs lots for the government to provide the goods, increases spending on current (paying public sector wages) and capital spending (building hospitals, schools etc)

• No market competition to discipline producers so costs may be higher than necessary
• Lack of competition gives no incentive to improve products and increase efficiency
• Increased state dependence

Question 12

Why state provision compares favourably and unfavourably to a subsidy??

Answer 12

Favourable- provides goods that would be otherwise under consumed because of the lack of business incentive to produce it; subsidies can’t provide public goods
-Reduces inequality more than subsidies

unfavourable- More expensive and higher opportunity cost for state provision than subsidies
-non-market based solution doesn’t incentivise reducing costs or innovation whereas subsidy does

Question 13

Define a buffer stock

Answer 13

a scheme intended to stabilise the price of a commodity by buying excess supply in periods when supply is high, and selling when supply is low

Question 14

Examples of where buffer stocks are used

Answer 14

• commodities
• agriculture
• international cocoa organisation
• thai rice

Question 15

Why and how are buffer stocks used??

Answer 15

• The price of commodities can be very volatile depending on the production in a given year. Production can depend on war, weather, flooding and other external factors, which in turn can determine a shortage or surplus
• in surplus (glut) years, the government buys the commodities to raise the price above a minimum price to help suppliers
• in shortage years, government sells their stocks to ensure there is adequate supply and lower the price
• Their main objective is to stop uncertainty and price fluctuations.

Question 16

how are buffer stocks shown on a supply and demand diagram??

Answer 16

Supply lines- 2 perfectly inelastic supply lines at high quantity and low quantity
-minimum and maximum price levels, with a demand line that crosses the supply lines above and below the minimum price lines

Question 17

What are the advantages and disadvantages of buffer stocks??

Answer 17

ADV

• May be self funding, profits earned in shortage years can be used to buy in glut year
• market based solution incentivises producers to continue producers
• DISADV
• Limited deployability; only works for commodities that have long shelf life/ are non-perishable
• Unpredictable- glut and shortage years can be unpredictable which can affect costs

Question 18

Why a buffer stock compares favourably and unfavourably to a subsidy

Answer 18

favourably- incentivises continued production

• buffer stocks may be self funding
• when prices fluctuating, suppliers are disciplined by competition rather than subsidies

Unfavourable- subsidies can be applied to a wider range of industries whereas bufferstocks have limited deployability
-In a surplus year, buffer stocks increase the price for consumers instead of decreasing them like a subsidy

Question 19

What is regulation, legislation and prohibition?

Answer 19

Regulation- rules created by the government to control activity of economic agents
Legislation- rules created to enforce regulation
Prohibition-an attempt to prevent the consumption of a demerit good by declaring it illegal

Question 20

Examples of legislation?

Answer 20

consumer rights act 2015- protects consumers against faulty or substandard goods
Environmental act 1990- limits damage to environment by regulation pollution an emissions

Question 21

Why and how is regulation and legislation used??

Answer 21

A government threat to consumer and producers to limit the supply and consumption of demerit goods. Threats could be fines or prison depending on the severity of the breaking of the legislation. They are non market based solutions to correct negative externalities arising from the consumption of demerit goods

Question 22

How is prohibition shown on a S+D diagram??

Answer 22

demand line= normal
supply lines= a shift of the supply line all the way to the left. consumption doesn’t fall to completely 0 because some people continue consumption illegally ie black markets

Question 23

Advantages and disadvantages of regulation/ prohibition??

Answer 23

ADV- cheap to create
-regulations can be self funding from the fine revenue they collect

DisADV-
-Difficult to know how harsh to set fines/ regulations
-increase business costs/ businesses relocate to avoid it
-difficult/ expensive to enforce- expensive legal action to prove they’ve been broken
-

Question 24

Why regulation compares favourably and unfavourably to a tax??

Answer 24

Favourably- prohibition can almost completely discourage consumption whereas tax cannot (if optimum level is 0, its better)
-if the behaviour that the government wants to reduce does not have a price on it ie wearing a seat belt, it can’t be taxed but it can be legislated against

Unfavourably- taxes can be better self funding than legislation as fines may be hard to impose or collect
(costs of enforcing regulation much higher)
-costs imposed to businesses as a tax are easier to predict and collect whereas regulation imposes a cost that can need expert advice

Question 25

Define information provision

Answer 25

information provision is when the government educates the public to help consumers make better choices

Question 26

Examples of information provision

Answer 26

• Standardised food labels eg coloured coordinated depending on ‘healthiness’
• cigarette warning
• anti drink driving campaigns

Question 27

Why and how is information provision used for market failure?

Answer 27

• Market failure can arise from information failure, especially asymmetric information where people consume without knowing all the risks and benefits.
• the government can step in and force suppliers through legislation to provide all information, or provide it on their government website themselves free of charge
• Due to overestimation of benefits of their actions, consumption is higher than the socially optimum level

Question 28

How is information failure shown on an externality diagram??

Answer 28

Supply= marginal social cost= marginal private cost
Demand= marginal private benefit higher than marginal social benefit. The externality is negative, so the social benefit is lower than the private benefit. Clear overconsumption and welfare loss.
-

Question 29

Advantages and disadvantages of information provision

Answer 29

ADV- can encourage people to make better informed decisions to maximise their utility as they’re more aware of costs and benefits, in a way that taxing can’t do

• cheap to provide by the government
• effective when targeting businesses, so their consumers can’t avoid seeing the info

Dis Adv- if people are acting irrationally, then they may not maximise utility and overconsumption continues

• Limited impact, may need to be used alongside other methods eg taxes on cigarettes
• loopholes, whilst adhering to the letters of the law, manufactures may find ways around the spirit of the law

Question 30

How does information provision compare favourably and unfavourably to legislation??

Answer 30

Favourably- can be imposed faster and at a lower opportunity cost, as well as threatening legislation in the future if firms ignore regulations

Unfavourably- The size of the externality that information provision can correct is much smaller than legislation because legislation is much stricter. May need legislation in combination to correct big failures