AL Unit 8: Government Microeconomic Intervention

Question 1

Specific and ad valorem indirect taxes

Answer 1

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

Question 2

Subsidies

Answer 2

Can be used to achieve efficient resource allocation and correct market failure

Question 3

Maximum price controls

Answer 3

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

Question 4

Minimum price controls

Answer 4

If equilibrium price is too low (encouraging overconsumption), a minimum price can be established by the government to prevent it falling below a level

Question 5

Production quota

Answer 5

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

Question 6

Prohibitions

Answer 6

A ban on certain products being supplied. Would be made illegal and consumption banned. May be a time lag before put into effect

Question 7

Licences

Answer 7

Where suppliers are given government permission to produce. Gives the government some degree of control because it can limit numbers issued

Question 8

Regulation

Answer 8

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

Question 9

Deregulation

Answer 9

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

Question 10

The direct provision of goods and services

Answer 10

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

Question 11

Pollution permits

Answer 11

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

Question 12

Property rights

Answer 12

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

Question 13

Nationalisation

Answer 13

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

Question 14

Privatisation

Answer 14

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

Question 15

Advantages of privatisation

Answer 15

Improvement in efficiency
Greater competition
Reduction in political interference

Question 16

Disadvantages of privatisation

Answer 16

Creation of a private monopoly
Focus on profits
Fragmentation of an industry

Question 17

Provision of information

Answer 17

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

Question 18

Behavioural and nudge theory

Answer 18

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

Question 19

Government failure

Answer 19

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

Question 20

Lack of incentives (government failure)

Answer 20

The profit motive is usually lacking in the public sector and workers are paid less than the private sector

Question 21

Poor information (government failure)

Answer 21

Government policy is only effective if it has all the information

Question 22

Time lags (government failure)

Answer 22

May be a time lag between a decision to introduce a policy and when it comes into effect so conditions in economy may change

Question 23

Political interference (government failure)

Answer 23

A government decision may be for short term political gain rather than for the long term economy

Question 24

Moral hazard (government failure)

Answer 24

A government could encourage risk taking

Question 25

Regulatory capture (government failure)

Answer 25

A government could be too friendly with those it regulates

Question 26

Unintended consequences (government failure)

Answer 26

A policy to reduce poverty through benefits could lead to welfare dependency

Question 27

Taxation (consequences of government failure)

Answer 27

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

Question 28

Employment (consequences of government failure)

Answer 28

Governments may be reluctant to take decisions that make people redundant since it increases the level of unemployment

Question 29

Net welfare loss (consequences of government failure)

Answer 29

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

Question 30

Distortion of price signals (consequences of government failure)

Answer 30

A free market gives out price signals that lead to efficiency but government intervention could distroty these leading to inefficiency