Alternative Methods Of Government Intervention

Question 1

Why governments intervene in a market mechanism

Answer 1

To correct market failure

Improve economic welfare

Question 2

Methods of government intervention

Answer 2

Indirect taxation
Subsidies
State provision 
Price controls
Buffer stock system
Regulation and legislation
Information provision

Question 3

Indirect taxation

Answer 3

Taxes of goods or services

Used for demerit goods or goods with negative externalities

Question 4

Why impose a tax

Answer 4

Finance government spending

Change the market price of a good

Question 5

Tax revenue

Answer 5

Income tax £182bn
VAT £138bn
National insurance £126bn

Question 6

Government spending

Answer 6

Social protection £240bn
Health £145bn
Education £102bn

Question 7

Types of indirect tax

Answer 7

Specific (fixed amount on purchases of commodities)
Ad valorem (charged as proportion of price)

Question 8

How tax works

Answer 8

Discourage production/consumption of demerit goods that produce negative externalities (reduce QD and QS by increased P)

Question 9

Indirect tax diagram

Answer 9

S + tax shift to the left of S
Increase price
Decrease quantity
Axis: cost/quantity

Question 10

Burden of tax if demand is inelastic

Answer 10

Burden on consumer

Question 11

Burden of tax is demand is elastic

Answer 11

Burden on producer

Question 12

Advantages of taxation

Answer 12

Internalise the negative externalities
Force payment on the polluter
Used to fund merit and public goods

Question 13

Disadvantages of taxation

Answer 13

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

Question 14

Conclusive points on taxation

Answer 14

Equitable?
Progressive of regressive?
PED?

Question 15

Subsidy

Answer 15

Payment usually from government to producers/consumers of goods and services
Reduce cost/price to encourage a higher level of production/consumption

Question 16

Subsidy diagram

Answer 16

S + subsidy to the right of S
Decrease in P
Increase in Q
Axis: P/Q

Question 17

Benefit of subsidy if demand is inelastic

Answer 17

More benefit to consumer (not as effective)

Large change in P = small change in Q

Question 18

Benefit of subsidy if demand is elastic

Answer 18

More benefit to producer (more effective)

Small change in P = large change in Q

Question 19

Advantages of a subsidy

Answer 19

Lower cost for producer 
Lower price for consumer 
Can bring positive spillover effects 
Create more tax revenue
(Child care subsidies) higher employment

Question 20

Disadvantages of a subsidy

Answer 20

Other incentives needed
Firms become dependent on financial assistance
Expensive extra burden on tax payers
Unintended undesired consequences

Question 21

State provision/government expenditure

Answer 21

Expenditure taxes used to fund government expenditure

Government supplying goods and services such as healthcare, education and housing

Question 22

State provision diagram

Answer 22

S + state provision way to the right of S
Decrease in P
Increase in Q
Axis: P/Q

Question 23

Alternative state provision diagram

Answer 23

MSB to the right of MPB
MC
Axis: benefit/Q

Question 24

Advantages of state provision

Answer 24

Corrects market failure

Question 25

Disadvantages of state provision

Answer 25

Difficult to calculate SB so how should it be provided Not enough people using the good, government failure may occur Opportunity cost

Question 26

Price controls

Answer 26

Minimum and maximum prices | When P doesn’t equal to MC

Question 27

Minimum price diagram

Answer 27

S and D Axis: P/Q Min price line above equilibrium price Excess supply

Question 28

Aim of minimum price

Answer 28

Protect workers on low pay (min wage) | Make markets equitable

Question 29

Maximum price diagram

Answer 29

S and S Axis: P/Q Max price below equilibrium price Excess demand

Question 30

Aim of maximum price

Answer 30

Enable those on low incomes to afford housing (max rent) | Make markets more equitable

Question 31

Advantage of maximum prices

Answer 31

Increase fairness | Prevent monopolies exploiting

Question 32

Disadvantages of maximum price

Answer 32

Demand higher than supply (people not able to buy) Gov may need to introduce a rationing scheme to allocate the goods Black market creation

Question 33

Advantages of minimum price

Answer 33

Producers have guaranteed minimum income (encourage investment) Stockpiles can be used for excess supply

Question 34

Disadvantages of minimum price

Answer 34

Consumers pay higher prices than market equilibrium Excess supply (inefficient allocation of resources) High opportunity cost Destroying excess is a waste of resources

Question 35

Buffer stock systems

Answer 35

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

Question 36

Why prices fluctuate

Answer 36

Changes in supply Changes in demand D and S are inelastic in agricultural markets

Question 37

Why price fluctuations are bad

Answer 37

High level of uncertainty for producers | Unlikely to invest in improving productivity

Question 38

Buffer stock system diagram

Answer 38

``` 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 ```

Question 39

Advantages of a buffer stock system

Answer 39

Farmers guaranteed income even in poor harvests

Question 40

Disadvantages of a buffer stock system

Answer 40

If price too high or low in respect to natural equilibrium the scheme would run into difficulties

Question 41

Regulation and legislation

Answer 41

Government intervene through legislation by influencing price or quantity Discourage use of demerit good producing negative externalities Limit monopoly power Prevent exploitation of labour

Question 42

Examples of regulation and legislation

Answer 42

Minimum age to buy alcohol Prevent emissions beyond a certain level Equal pay act

Question 43

Regulation and legislation diagram (demerit good)

Answer 43

``` MC MPB to right of MSB Axis: benefit/Q Decrease P Decrease Q ```

Question 44

Advantages of regulation and legislation

Answer 44

Easy to understand Legal ban sends clear signal it is wrong Fairer than taxes

Question 45

Disadvantages of regulation and legislation

Answer 45

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)

Question 46

Information provision

Answer 46

Ensure consumers and producers are well informed to reduce market failure

Question 47

Examples of information provision

Answer 47

Providing education on environment and health Promote widespread access to internet Legislation to prevent use of mis-selling/false information

Question 48

Problems with government intervention

Answer 48

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