AL Unit 8: Government Microeconomic Intervention Flashcards
Specific and ad valorem indirect taxes
Indirect taxes can be used to achieve the efficient allocation of resources and correct market failure
Specific taxes are where a specific amount of tax is required to be paid
Ad valorem taxes are where the tax to be paid is a percentage of selling price
Subsidies
Can be used to achieve efficient resource allocation and correct market failure
Maximum price controls
If equilibrium price is too high for many people, a maximum price can be established by the government to prevent it rising above a level
Minimum price controls
If equilibrium price is too low (encouraging overconsumption), a minimum price can be established by the government to prevent it falling below a level
Production quota
A government could set a limit on the quantity that may be produced in a time. Often used as an import control but can also be used domestically. May be the case in relation to the existence of negative externalities
Prohibitions
A ban on certain products being supplied. Would be made illegal and consumption banned. May be a time lag before put into effect
Licences
Where suppliers are given government permission to produce. Gives the government some degree of control because it can limit numbers issued
Regulation
A law or rule to reduce the extent of market failure. If a firm has too much monopoly power it is a commission. Effective in investigating if the monopoly is acting against public interest. Proposed mergers may also be referred to such as a regulation if it is thought they might be against public interest in limiting choice. Regulations could cover the description of a product sold to ensure consumers are informed. A regulatory body ensures this. Regulatory bodies are given the power to fine those responsible for pollution, enhancing effectiveness
Deregulation
Involves a reduction in the number of regulations i an economy to:
Allow a greater degree of competition to exist in a market
Increase the level of efficiency as a result of the greater competition
Reduce the extent of market failure
The direct provision of goods and services
A government could provide goods and services itself alongside the private sector. This is the case with certain merit goods. It is likely to be effective as a government can use the funds from taxation
Pollution permits
An example of a licence that can be issued by a government. The permit allows a firm to pollute in some way but only up to a certain level which will be less than when the permit was first issued. The aim is that over time a number of permits will be issued allowing a lower level of pollution than the previous. It may not be possible to eliminate pollution entirely but pollution permits should bring down the level over time
Property rights
The right of an owner of an economic good to decide how such a good is to be used. Market failure can occur due to the absence of clear property rights. A government could decide to extend property rights through the encouragement of a voluntary agreement
Nationalisation
A government could decide to provide a good itself by providing it through a state owned or nationalised industry. Nationalisation refers to the process by which a government takes a firm or industry into the public sector. Often done if it is thought that such action would be in public interest. A nationalised industry may not be as effective as one in the private sector because it involves the creation of a monopoly. Monopoly power is a market imperfection because equilibrium price will be higher and quantity lower than in perfect competition. Supernormal profits are not competed away in the long run due to the barriers to entry making it hard for new firms to enter. The firms average cost curve may not be at its minimum since the lack of competition reduces efficiency so unit costs are not minimised. This is inefficiency. A deadweight loss occurs when there is a monopoly leading to a higher price and lower quantity than in perfect competition so a consumer is worse off
Privatisation
A government may decide to privatise an industry by transforming ownership from the public to private sector. Deregulation refers to the process of reducing regulations, laws and rules in an industry. When removed it allows for greater competition which should lead to greater efficiency. Contracting out is where a service that was provided in the public sector is now provided by a firm in the private sector. Anything that leads to the promotion of competition can be supply side measures
Advantages of privatisation
Improvement in efficiency
Greater competition
Reduction in political interference
Disadvantages of privatisation
Creation of a private monopoly
Focus on profits
Fragmentation of an industry
Provision of information
Market failure can be caused by inadequate information. A government could aim to increase availability of appropriate information to influence consumers economic behaviour. It is assumed consumers always aim to maximise utility but they can only do this if they have the necessary information. if this is not available they are unlikely to be able to make rational decisions. A government needs to improve the accuracy and availability of information to make sure scarce resources are allocated as efficiently as possible
Behavioural and nudge theory
Consumers do not always act in a rational manner. Nudge theory is based on the idea that the behaviour of consumers can be nudged in a way to encourage or discourage the consumption of certain goods
Government failure
A situation where government intervention to correct market failure does not improve the level of economic efficiency. Occurs when government intervention causes an inefficient allocation of resources and a decline in economic welfare. Often arises from attempts to solve market failure but can lead to distortions or market imperfections
Lack of incentives (government failure)
The profit motive is usually lacking in the public sector and workers are paid less than the private sector
Poor information (government failure)
Government policy is only effective if it has all the information
Time lags (government failure)
May be a time lag between a decision to introduce a policy and when it comes into effect so conditions in economy may change
Political interference (government failure)
A government decision may be for short term political gain rather than for the long term economy
Moral hazard (government failure)
A government could encourage risk taking
Regulatory capture (government failure)
A government could be too friendly with those it regulates
Unintended consequences (government failure)
A policy to reduce poverty through benefits could lead to welfare dependency
Taxation (consequences of government failure)
May use a progressive income tax to redistribute income but if the top rate is high, there may be a disincentive for the higher paid to work as much. Some may choose to seek jobs elsewhere
Employment (consequences of government failure)
Governments may be reluctant to take decisions that make people redundant since it increases the level of unemployment
Net welfare loss (consequences of government failure)
When consequences of government intervention are contrasted with the original problem that needed the intervention so the overall effect may be a net welfare loss to society
Distortion of price signals (consequences of government failure)
A free market gives out price signals that lead to efficiency but government intervention could distroty these leading to inefficiency
Equity
Can be seen in terms of government policies aimed at bringing about a fairer and more equitable distribution of income and wealth
Equality
A situation where everyone is at the same level. There is the same status, rights and responsibilities for all members
Equity vs efficiency
Equity is discussed in relation to fairness. Efficiency is another objective of government microeconomic policy. This involves the achievement of productive and allocative efficiency. This would ensure resources were allocated in the best optimal way
Absolute poverty
Occurs when the resources required for minimum physical health are lacking with limited access to food, clothing and shelter. The World Bank has the poverty line at $1.90 per day
Relative poverty
Means low income relative to others in a country
The poverty trap
A potential problem of means-tested benefits given by a government to reduce poverty is that as people receive money as benefits they may not be entitled to as much support as before. This gives rise to the poverty trap
Negative income tax
Income tax is a way of redistributing income because it is likely to be progressive. It not only takes ore from a person as their income rises, but a higher proportion of that income. Negative income tax involves people on low incomes receiving money from a government instead of paying income tax to it
Universal benefits
A government can provide universal benefits t people that do not take into account their income
Means tested benefits
A government can provide benefits to those less well off through means tested benefits. This can be a tax credit which are given to those who have children or a job that pays a very low wage. Takes into account income and therefore need for benefits
Universal basic income
A government guarantee that each person receives a minimum income. It will provide enough money to cover basic costs of living
Transfer payments
Revenue received from taxation is used to give financial support to people like pensions. These are worthwhile since they involve money being received by those who are less well off
Inheritance and capital taxes
A government can bring about a more equitable distribution of wealth as well as income with inheritance and capital gains tax
Demand for labour as derived demand
Labour is not demanded for its own sake but for what it can contribute to the production process
Factors affecting demand for labour
The price of labour and the other factors of production
The productivity of labour and the other factors of production
The demand for labour is closely linked to the marginal physical product of labour which is the additional output produced if a firm increases the labour input by one unit
Causes of movement along the demand curve for labour
The demand curve for labour is a function of the wage paid. The higher the wage rate, the lower the demand for labour so the demand curve for labour slopes down from left to right. Other factors are assumed to be constant. If wage rates change there will be movement along the demand curve
Causes of shifts in the demand curve for labour
A shift occurs when there is a change in a determinant of demand for labour other than the wage rate:
Changes in labour productivity
Changes in labour skills
Changes in prices of products produced
Changes in demand for the products
Changes in prices of substitutes and complements of the products
Demand for labour will shift inwards during a recession and outwards during a boom when product demand and therefore labour demand rises
Marginal revenue product theory
Firms are interested not only in the extra output produced by employing one more unit of labour but also in the revenue from selling the additional output produced. The marginal revenue product of labour is obtained by the marginal physical product of labour multiplied by marginal revenue received
Derivation of a firms demand for labour
It is assumed that a firm is in a perfectly competitive market for labour and so cannot influence the price of labour. The firm therefore regards labour supply as perfectly elastic
The supply of labour for industries
For the industry, the supply curve will be upward sloping from left to right because more people want to work when wages are increased
The supply of labour for individuals
For an individual, a rise in wages may persuade them to work fewer hours giving rise to a backward bending supply curve for an individual. The backward bending supply curve reflect the importance of the pecuniary advantages of work to that employee which is the advantages of employment in the form of financial benefits (wage factors)
Non-wage (non-pecuniary) factors why people work
Working conditions
Promotion prospects and career opportunities
Hours of work
Pension provision
Availability of fringe benefits
Facilities available at work
Strength of vocation or job satisfaction
Training and professional development provided
Net advantages
The balance between the pecuniary and non-pecuniary advantages of employment
Labour supply
Labour supply is the number of workers willing and able to work multiplied by the number of hours they are willing to work. The higher the wage rate the more labour is supplied. The supply curve therefore slopes up from left to right. Other factors affecting supply are assumed to be constant. If wage rate changes there can be movement along the supply curve
Shift in supply of labour
Occurs when there is a change in determinant of supply other than wages
Size of working population of a country
Tax and benefit levels
Net migration
Preferences for work
Net advantages
Equilibrium wage rate and employment in a labour market
Equilibrium is when demand equals supply
Wage determination in imperfect markets
Workers may be members of a trade union so determines wages. A government may intervene through a minimum wage. May be a single employer of labour (monopsony employer)
The influence of trade unions on wage determination and employment in a labour market
Workers may belong to a trade union which is involved in collective bargaining with employers on behalf of workers. May insist on the existence of a closed shop to increase bargaining power. A trade union can reduce the supply of labour by pressuring the government or employers into making employment entry harder which affects wages. A trade union could also try to increase demand for labour through a productivity agreement
The influence of government on wage determination and employment in a labour market using a national minimum wage
In a free market there is no government intervention but can in labour markets. May decide to introduce a minimum wage. Those employed will gain a higher wage but fewer will be employed
The influence of monopsony employers on wage determination and employment in a labour market
It could be the case that there is just one firm in the market to employ a factor of production which is a monopsony. In a competitive market each firm must accept the prevailing market wage
The determination of wage differentials by labour market forces
If labour markets are competitive with identical workers and perfect mobility wages will move the the same equilibrium. Wage differentials can occur by
Variation in human capital by differences in education and training
Differences in productivity from skill variation
Discrimination
Compensation for risk taking, unsocial hours or poor conditions
These influence elasticity of supply and demand of workers. Wages are higher the more inelastic supply and demand
Transfer earnings and economic rent
Transfer earnings are the earnings that are the minimum to keep a factors
Economic rent is the additional payment a worker receives from transfer earnings
Factors affecting transfer earnings and economic rent in an occupation
Elasticity of demand and supply will determine the sizes
The amount of economic rent a worker can obtain is limited by the fact that there is generally low mobility of labour
There can be differences in wages in an industry across a country because there might be an agreed wage rate but specific demand and supply circumstances may mean actual earnings in different areas are higher (wage drift)
