8) Government intervention Flashcards
Define a subsidy
a grant given by the government to producers to encourage production of a good or service
examples of subsidised goods
Wind power
solar power
farming
public transport
Why are goods subsidised??
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
How is a subsidy shown on the diagram and where is the size of the subsidy on the diagram??
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
Advantages and disadvantages of subsidies
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
How does a subsidy compare favourably and unfavourably to a tax??
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
Define state provision
is where the government decides which goods or services to provide and then spends money providing them.
Why does the state provide goods and how does it affect allocative efficiency??
- 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
common examples of state provided goods
- state education
- Healthcare/ NHS
- Police/fire services
How is state provision shown on a externality diagram and then a S+D diagram??
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
Advantages and disadvantages of state provision
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
Why state provision compares favourably and unfavourably to a subsidy??
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
Define a buffer stock
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
Examples of where buffer stocks are used
- commodities
- agriculture
- international cocoa organisation
- thai rice
Why and how are buffer stocks used??
- 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.
how are buffer stocks shown on a supply and demand diagram??
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
What are the advantages and disadvantages of buffer stocks??
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
Why a buffer stock compares favourably and unfavourably to a subsidy
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
What is regulation, legislation and prohibition?
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
Examples of legislation?
consumer rights act 2015- protects consumers against faulty or substandard goods
Environmental act 1990- limits damage to environment by regulation pollution an emissions
Why and how is regulation and legislation used??
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
How is prohibition shown on a S+D diagram??
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
Advantages and disadvantages of regulation/ prohibition??
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
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Why regulation compares favourably and unfavourably to a tax??
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
Define information provision
information provision is when the government educates the public to help consumers make better choices
Examples of information provision
- Standardised food labels eg coloured coordinated depending on ‘healthiness’
- cigarette warning
- anti drink driving campaigns
Why and how is information provision used for market failure?
- 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
How is information failure shown on an externality diagram??
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.
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Advantages and disadvantages of information provision
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
How does information provision compare favourably and unfavourably to legislation??
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
