Alternative Methods Of Government Intervention Flashcards
Why governments intervene in a market mechanism
To correct market failure
Improve economic welfare
Methods of government intervention
Indirect taxation Subsidies State provision Price controls Buffer stock system Regulation and legislation Information provision
Indirect taxation
Taxes of goods or services
Used for demerit goods or goods with negative externalities
Why impose a tax
Finance government spending
Change the market price of a good
Tax revenue
Income tax £182bn
VAT £138bn
National insurance £126bn
Government spending
Social protection £240bn
Health £145bn
Education £102bn
Types of indirect tax
Specific (fixed amount on purchases of commodities) Ad valorem (charged as proportion of price)
How tax works
Discourage production/consumption of demerit goods that produce negative externalities (reduce QD and QS by increased P)
Indirect tax diagram
S + tax shift to the left of S
Increase price
Decrease quantity
Axis: cost/quantity
Burden of tax if demand is inelastic
Burden on consumer
Burden of tax is demand is elastic
Burden on producer
Advantages of taxation
Internalise the negative externalities
Force payment on the polluter
Used to fund merit and public goods
Disadvantages of taxation
Difficult to determine amount to tax
PED of many demerit goods is inelastic so burden on consumer (may not have intended effect)
Equitable?
If it’s too progressive it will discourage work or production creating unemployment
Cost of enforcement
Non compliance
Conclusive points on taxation
Equitable?
Progressive of regressive?
PED?
Subsidy
Payment usually from government to producers/consumers of goods and services
Reduce cost/price to encourage a higher level of production/consumption
Subsidy diagram
S + subsidy to the right of S
Decrease in P
Increase in Q
Axis: P/Q
Benefit of subsidy if demand is inelastic
More benefit to consumer (not as effective)
Large change in P = small change in Q
Benefit of subsidy if demand is elastic
More benefit to producer (more effective)
Small change in P = large change in Q
Advantages of a subsidy
Lower cost for producer Lower price for consumer Can bring positive spillover effects Create more tax revenue (Child care subsidies) higher employment
Disadvantages of a subsidy
Other incentives needed
Firms become dependent on financial assistance
Expensive extra burden on tax payers
Unintended undesired consequences
State provision/government expenditure
Expenditure taxes used to fund government expenditure
Government supplying goods and services such as healthcare, education and housing
State provision diagram
S + state provision way to the right of S
Decrease in P
Increase in Q
Axis: P/Q
Alternative state provision diagram
MSB to the right of MPB
MC
Axis: benefit/Q
Advantages of state provision
Corrects market failure
Disadvantages of state provision
Difficult to calculate SB so how should it be provided
Not enough people using the good, government failure may occur
Opportunity cost
Price controls
Minimum and maximum prices
When P doesn’t equal to MC
Minimum price diagram
S and D
Axis: P/Q
Min price line above equilibrium price
Excess supply
Aim of minimum price
Protect workers on low pay (min wage)
Make markets equitable
Maximum price diagram
S and S
Axis: P/Q
Max price below equilibrium price
Excess demand
Aim of maximum price
Enable those on low incomes to afford housing (max rent)
Make markets more equitable
Advantage of maximum prices
Increase fairness
Prevent monopolies exploiting
Disadvantages of maximum price
Demand higher than supply (people not able to buy)
Gov may need to introduce a rationing scheme to allocate the goods
Black market creation
Advantages of minimum price
Producers have guaranteed minimum income (encourage investment)
Stockpiles can be used for excess supply
Disadvantages of minimum price
Consumers pay higher prices than market equilibrium
Excess supply (inefficient allocation of resources)
High opportunity cost
Destroying excess is a waste of resources
Buffer stock systems
For commodity markets where prices are volatile and fluctuate
Scheme to stabilise price of a commodity by buying excess supply in periods where S is high and selling when S is low
Why prices fluctuate
Changes in supply
Changes in demand
D and S are inelastic in agricultural markets
Why price fluctuations are bad
High level of uncertainty for producers
Unlikely to invest in improving productivity
Buffer stock system diagram
S glut way to right of S poor Axis: P/Q Target price in middle of S poor eq and S glut eq S poor = excess demand S glut = excess supply
Advantages of a buffer stock system
Farmers guaranteed income even in poor harvests
Disadvantages of a buffer stock system
If price too high or low in respect to natural equilibrium the scheme would run into difficulties
Regulation and legislation
Government intervene through legislation by influencing price or quantity
Discourage use of demerit good producing negative externalities
Limit monopoly power
Prevent exploitation of labour
Examples of regulation and legislation
Minimum age to buy alcohol
Prevent emissions beyond a certain level
Equal pay act
Regulation and legislation diagram (demerit good)
MC MPB to right of MSB Axis: benefit/Q Decrease P Decrease Q
Advantages of regulation and legislation
Easy to understand
Legal ban sends clear signal it is wrong
Fairer than taxes
Disadvantages of regulation and legislation
Little incentive for a firm to develop more efficiency mechanisms
Socially inefficient to ban everything
May encourage people to break the law
Taxes may be better for gov to collect money to spend on alternatives
Create underground economy (drugs)
Information provision
Ensure consumers and producers are well informed to reduce market failure
Examples of information provision
Providing education on environment and health
Promote widespread access to internet
Legislation to prevent use of mis-selling/false information
Problems with government intervention
Gov must have full knowledge of MC and MB
Difficult to measure costs/benefits
Size of tax/subsidy/legislation must reflect size of externality
Administrative costs
Opportunity cost
