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

Question 31

Equity

Answer 31

Can be seen in terms of government policies aimed at bringing about a fairer and more equitable distribution of income and wealth

Question 32

Equality

Answer 32

A situation where everyone is at the same level. There is the same status, rights and responsibilities for all members

Question 33

Equity vs efficiency

Answer 33

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

Question 34

Absolute poverty

Answer 34

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

Question 35

Relative poverty

Answer 35

Means low income relative to others in a country

Question 36

The poverty trap

Answer 36

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

Question 37

Negative income tax

Answer 37

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

Question 38

Universal benefits

Answer 38

A government can provide universal benefits t people that do not take into account their income

Question 39

Means tested benefits

Answer 39

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

Question 40

Universal basic income

Answer 40

A government guarantee that each person receives a minimum income. It will provide enough money to cover basic costs of living

Question 41

Transfer payments

Answer 41

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

Question 42

Inheritance and capital taxes

Answer 42

A government can bring about a more equitable distribution of wealth as well as income with inheritance and capital gains tax

Question 43

Demand for labour as derived demand

Answer 43

Labour is not demanded for its own sake but for what it can contribute to the production process

Question 44

Factors affecting demand for labour

Answer 44

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

Question 45

Causes of movement along the demand curve for labour

Answer 45

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

Question 46

Causes of shifts in the demand curve for labour

Answer 46

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

Question 47

Marginal revenue product theory

Answer 47

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

Question 48

Derivation of a firms demand for labour

Answer 48

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

Question 49

The supply of labour for industries

Answer 49

For the industry, the supply curve will be upward sloping from left to right because more people want to work when wages are increased

Question 50

The supply of labour for individuals

Answer 50

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)

Question 51

Non-wage (non-pecuniary) factors why people work

Answer 51

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

Question 52

Net advantages

Answer 52

The balance between the pecuniary and non-pecuniary advantages of employment

Question 53

Labour supply

Answer 53

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

Question 54

Shift in supply of labour

Answer 54

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

Question 55

Equilibrium wage rate and employment in a labour market

Answer 55

Equilibrium is when demand equals supply

Question 56

Wage determination in imperfect markets

Answer 56

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)

Question 57

The influence of trade unions on wage determination and employment in a labour market

Answer 57

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

Question 58

The influence of government on wage determination and employment in a labour market using a national minimum wage

Answer 58

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

Question 59

The influence of monopsony employers on wage determination and employment in a labour market

Answer 59

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

Question 60

The determination of wage differentials by labour market forces

Answer 60

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

Question 61

Transfer earnings and economic rent

Answer 61

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

Question 62

Factors affecting transfer earnings and economic rent in an occupation

Answer 62

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)