8.9 Government Intervention In Markets

Question 1

Why do governments intervene in markets?

Answer 1

• to correct market failure.
• for example, they might provide healthcare and education, which the free market would underprovide.

Question 2

What are indirect taxes?

Answer 2

• taxes on expenditure.
• they increase the cost of production for firms, so producers supply less.
• this increases market price and demand contracts.
• They could be used to discourage the production or consumption of a
  demerit good or service. For example, the government could impose a £1 tax per
  packet of cigarettes

Question 3

What are the two types of indirect taxes?

Answer 3

• Ad valorem
• Specific taxes

Question 4

What are Ad valorem taxes?
Draw a diagram to show an ad valorem tax

Answer 4

• Ad valorem taxes are percentages, such as VAT, which adds 20% of the unit
  price.
• This is the main indirect tax in the UK
• The incidence of tax might fall differently on consumers and producers.
• Producers could make consumers pay the whole tax or if they feel this would lower sales and lose them revenue, they could choose to pay part of the tax.

The supply curve shifts upwards

Question 5

What does the incidence of tax depend on for ad valorem taxes?

Answer 5

• on the price elasticity of demand of the good.
• For cigarettes, since the demand is fairly price inelastic, consumers might have the larger burden of tax.
• This should, in theory, discourage consumption of the demerit good and
  reduce negative externalities.

Question 6

How is government revenue affected with ad valorem taxes?

Answer 6

• Government revenue from ad valorem taxes is larger if demand is price
  inelastic.
• This is because demand falls only slightly with the tax.

Question 7

What are specific taxes?

Answer 7

• Specific taxes are a set tax per unit, such as the 58p per litre fuel duty on
  unleaded petrol.
• The more inelastic the demand, the higher the tax burden for the consumer,
  and the lower the burden of tax for the producer.

Question 8

How can indirect taxes help reduce the quantity of demerit goods consumed?

Answer 8

• By increasing the price of the good.
• If the tax is equal to the external cost of each unit, then the supply curve becomes MSC rather than MPC, so the free market equilibrium becomes the socially optimum equilibrium.
• This internalises the externality. In other words, the polluter pays for the damage.

Question 9

What are subsidies?

Answer 9

• A subsidy is a payment from the government to a producer to lower their costs of production and encourage them to produce more

Question 10

What is the importance of a subsidy?
Draw a diagram of a subsidy and explain

Answer 10

• Subsidies encourage the consumption of merit goods.
• This includes the full social benefit in the market price of the good.
• Therefore, the external benefit is internalised.
• For example, the government might subsidise recycling schemes so it is cheaper for consumers to recycle waste, which will yield positive externalities for the
  environment.
• The supply curve shifts to the left.
• More of the merit good is produced and the price falls
• The vertical distance between the supply curves shows the value of the subsidy per unit.

Question 11

How does elasticity affect the subsidy given to consumers and producers?

Answer 11

• Consumers gain more from the subsidy when demand is price inelastic
• Producers supply more when demand is price elastic.

Question 12

What are some disadvantages of subsidies?

Oh Please Take Gifts

Answer 12

• opportunity cost to the government
• potential higher taxes
• the potential for firms to become inefficient if they rely on the subsidy.
• government failure, if they subsidise less efficient industries.

Question 13

What is a maximum price, why might it be impose?
Draw a diagram to show maximum price

Answer 13

• The government might set a maximum price where the consumption or production of a good is to be encouraged.
• This is so the good does not become too expensive to produce or consume.
• Maximum prices have to be set BELOW the equilibrium, otherwise they would be ineffective

Question 14

What are some benefits of imposing a maximum price?

Answer 14

• They prevent monopolies exploiting consumers.
• For example, in the EU, price caps on roaming charges are in place to make sure it is not too expensive for consumers to use their mobile phones abroad.
• Maximum prices control the market price, BUT this could lead to government failure if they misjudge where the optimum market price should be.
• they could lead to welfare gains for consumers by keeping prices low
• they could increase efficiency in firms, since they have an incentive to keep their costs low to maintain their profit level.

Question 15

What are some costs of imposing a maximum price?

Answer 15

• it could reduce a firm’s profits, which could lead to less investment in the long run.
• firms might raise the prices of other goods, so consumers might have no net gain
• emergence of black markets

Question 16

What is a minimum price, why might it be imposed?

Answer 16

• The government might set a minimum price where the consumption or production of a good is to be discouraged.
• This ensures the good never falls below a certain price.
• For example, the government might impose a minimum price on alcohol, so it is less affordable to buy it.
• The National Minimum Wage is an example of a minimum price.
• Minimum prices have to be set ABOVE the free market price, otherwise they would be ineffective.

Question 17

What are some benefits of imposing a minimum price?

Answer 17

• They would reduce the negative externalities from consuming a demerit good, such as alcohol.

Question 18

What are some costs of imposing a minimum price?

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Answer 18

• Leads to imbalance in the market
• Emergence of black markets
• Depends on elasticity?
• Wont affect the rich too much

Question 19

What are tradeable pollution permits?

Answer 19

• These could limit the amount of negative externalities, in the form of pollution,
  created in industries.
• Firms will be allowed to pollute up to a certain amount, and any surplus on their permit can be traded.
• This means firms can buy and sell allowances between themselves.
• For example, there could be a limit on the quantity of carbon dioxide emissions
  released from the steel industry

Question 20

What are some advantages of tradeable pollution permits?

Answer 20

• Should benefit the environment in the long run, by encouraging firms to use green production methods.
• The government could raise revenue from the permits, because they can sell them to firms.
• This revenue could then be reinvested in green technology.
• If firms exceed their permit, they will have to purchase more permits from firms
  which did not use their whole permit.
• This raises revenue for greener firms, who might then invest in green production methods

Question 21

What are some disadvantages of tradeable pollution permits?

Answer 21

• It could lead to some firms relocating to where they can pollute without limits, which will reduce their production costs.
• Firms might pass the higher costs of production onto the consumer in the form of higher prices
• Competition could be restricted in the market, if the permits create a barrier to entry for potential firms.
• It could be expensive for governments to monitor emissions.

Question 22

What is the state provision of public goods?

Answer 22

• The government could provide public goods which are underprovided in the free market, such as education and healthcare.
• These have external benefits.

Question 23

What are some advantages of state provision of public goods?

Answer 23

• This makes merit goods more accessible, which might increase their consumption and yield positive externalities.

Question 24

What are some disadvantages of state provision of public goods?

Answer 24

• It could be expensive for governments to provide education, and the government will incur an opportunity cost of spending their revenue.

Question 25

What is the provision of information?

Answer 25

• By providing information, governments can ensure there is no information failure, so consumers and firms can make informed economic decisions.
• This could be expensive to police.

Question 26

What is regulation?

Answer 26

• The government could use laws to ban consumers from consuming a good.
• They could also make it illegal not to do something.
• For example, the minimum school leaving age means young people have to be in school until the age of 16, and education or training until they turn 18.

Question 27

What are some advantages of regulation?

Answer 27

• This has positive externalities in the form of a higher skilled workforce
• Firms which fail to follow regulations could face heavy fines, which acts as a
  disincentive to break the rule

Question 28

What are some disadvantages of regulation?

Answer 28

• If there was a compulsory recycling scheme, it would be difficult to police and there could be high administrative costs.
• Bans could be enforced for harmful goods, although they can still be consumed on the black market.
• It could raise costs of firms, who might pass on the higher costs to consumers.