Ch-2 Government Interventions To Correct Market Failure Flashcards
Q1) write a short note on government intervention to minimise market power ? Or how does the government intervene to minimise market power ?
🔷 governments intervene by establishing rules and regulation design to promote competition and prohibit actions that are likely to restrain competition. These legislations differ from country to country. For example, in India we have the competition (amendment) act , 2007 to promote and sustain competition in market . The the antitrust laws in the US and the competition act 1998 of UK . search legislations generally am at prohibiting contracts , combinations and collusion among producers or traders which are in restraint of trade and other anticompetitive actions such as Predatory pricing.
🔷 Policy options for limiting market power also include price regulation in the form of setting maximum prices that firms can change. price regulation is most often used for natural monopoly that can produce the entire output of the market at a cost that is lower then what it would be if there were several firms . Examples of such natural monopoly are electricity , gas and water supplies .
🔷 In some cases, the governments regulatory agency determines an acceptable price, so as to ensure a competitive or fair rate of return. This practice is called rate of return regulation.
🔷 Another approach to regulation is setting price caps based on the firm’s variable costs , past prices , and possible inflation and productivity growth.
Q2) write a short note on government intervention to correct externalities ?
🔷 government initiatives toward negative externalities may be classified as:
i) direct controls
ii) market based policies
Q3) write a short note on direct controls measures ?
🔷 direct controls prohibit specific activities that required that the negative externality be limited to a certain level, for instance limiting emissions . Production , use and sale of many commodities and services are prohibited in our country.
🔷 Smoking is completely banned in many public places.
🔷 Stringent rules are in place in respect of tobacco advertising , packaging and labelling etc .
🔷 Governments may pass laws to alleviate the effects of negative externalities. for example India has enacted the environment ( protection ) act ,1986 .
🔷 The government may , through legislation, fix emissions standard which is a legal limit on how much pollutant a firm can emit . the set standard ensures that the firm produces efficiently . If the firm exceeds the limit, it can invite monetary penalties or / and criminal liabilities.
🔷 Another method is to charge an emissions fee which is levied on each unit of firms emissions . The firms can minimize costs and enhance their profitability by reducing emissions.
🔷 Governments may also form special bodies / boards to specifically address the problem: for instance the ministry of environment and forest , the pollution control board of India and the the state pollution control boards.
Q4) write a short note on market- based policies ?
🔷 the market based approaches focus on generation of a market price for pollution. This is achieved by :
i) setting the price directly through a pollution tax.
ii) setting the price ine directly through the establishment of a cap- and -Trade system .
Q5) what is pollution tax?
🔷 pollution taxes is a method of ensuring internalization of negative externalities.
🔷 The size of the tax depends on the amount of pollution a firm produces.
🔷 These taxes are named pigouvian taxes after A.C Pigou who argued that an externality cannot be alleviated (minimised) by contractual negotiation between the affected parties and therefore taxation should be resorted to.
🔷 These taxes, by making the polluter pay, seek to internalize external costs into the price of a product or activity.
🔷 More precisely , the tax is placed on the externality itself rather than on output.
🔷 For each unit of pollution, the polluter must choose either to pay the tax or to reduce pollution through any means at its disposal.
🔷tax increases the private cost of production or consumption as the case may be, and would decrease the quantity demanded and therefore the output of the good will be reduced which creates negative externality.
🔷 The proceeds from the tax can be specifically earmarked for projects that protect or enhance environment.
Q6) what are the problems faced in administering an efficient pollution tax?
🔷 pollution taxes are difficult to determine and administer because it is difficult to discover the right level of taxation that would ensure that the private cost plus Taxes will exactly equate with the social cost. If the demand for the good is inelastic the tax May only have an insignificant effect in reducing demand.
🔷 The method of taxing the polluters has many limitations because it involves the use of complex and costly administrative procedures for monitoring the polluters.
🔷 This method does not provide any genuine solutions to the problem. It only establishes an incentive system for use of methods which are less polluting.
🔷 In the case of goods which have inelastic demand, producers will be able to easily shift the tax burden in the form of higher product prices. This will have an inflationary effect and may reduce consumer welfare.
🔷 Pollution taxes also have potential negative consequences on employment and investments because high pollution taxes in one country may encourage producers to shift there production facilities to those countries with lower taxes.
Q7) what is cap-and-Trade system?
🔷 these are marketable licences to emit limited quantities of pollutants and can be bought and sold by polluters.
🔷 Under this method, each firm has permits specifying the number of units of emissions that the firm is allowed to generate.
🔷 A firm that generates emissions above what is allowed by the permit is penalized with substantial monetary sanctions .
🔷 These permits a transferable.
🔷 The high polluters have to buy more permits, which increases their costs , and makes them less competitive and less profitable.
🔷 The low polluters receive extra revenue from selling their surplus permits, which makes them more competitive and more profitable.
🔷 India is experimenting with cap-and-trade in the form of perform, achieve & trade (PAT) scheme and carbon tax in the form of a cess on coal.
Q8) what is the advantages claimed for tradable permits ? (Cap-and-trade system)
🔷The system allows flexibility and reward efficiency.
🔷It is administratively cheap and simple to implement and ensures that pollution is minimised in the most cost-effective way.
🔷It also provides strong incentives for innovation.
🔷Consumers may benefit if the extra profits made by low pollution firms are passed on to them in the form of lower prices.
Q9) what is the main argument in opposition to the employment of tradable emission permits (cap and Trade system) ?
🔷The main argument in opposition to the employment of tradable emission permits is that they do not in reality stop firms from polluting the environment .
🔷 Moreover, if firms have monopoly power of some degree along with a relatively inelastic demand for its product, the extra cost incurred for procuring additional permits so as to further pollute the atmosphere, could easily be compensated by charging higher prices to consumers.
Q10 ) write a short note on merit goods?
🔷Merit goods are goods which are deemed to be socially desirable and therefore the government deems that its consumption should be encouraged.
🔷Examples of merit goods include education, health care, welfare services, housing, fire protection, waste management, public libraries, museum and public parks.
🔷In contrast to pure public goods, merit goods are rival, excludable, limited in supply, rejectable by those unwilling to pay, and involve positive marginal cost for supplying to extra users.
Q11) what is the reasons for government provision of merit goods?
🔷 in the absence of government intervention in case of merit goods, there will be welfare loss to the society due to under production and under consumption.
🔷Information failure is widely prevalent with merit goods and therefore individuals may not act in their best interest because of imperfect information.
🔷Equity considerations demand that merit goods such as health and education should be provided free on the basis of need rather than on the basis of individual’s ability to pay.
🔷There is a lot of uncertainty as to the need for merit goods E.g. health care.Due to uncertainty about the nature and timing of healthcare required in future, individuals may be unable to plan their expenditure and save for their future medical requirements. The market is unlikely to provide the optimal quantity of health care when consumers actually need it, because they may be short of the necessary finances to pay the market price.
Q12) what is the action taken by government in case of merit goods?
🔷 the possible government responses are are regulation, subsidies, direct government provision and combination of government provision and market provision.
🔷Regulation determines how a private activity may be conducted. For example, the way in which education is to be imparted is government regulated.
🔷Governments can prohibit some type of goods and activities, set standards and issue mandates making others oblige. For example, government may make it compulsory to avail insurance protection. Compulsory immunization may be insisted upon as it helps not only the individual but also the society at large.
🔷 Government could also use legislation to enforce the consumption of a good which generates positive externalities. E.g. use of helmets, seat belts etc. The Right of Children to Free and Compulsory Education Act, 2009 which mandates free and compulsory education for every child of the age of six to fourteen years is another example.
🔷A variety of regulatory mechanisms may also be set up by government to enhance consumption of merit goods and to ensure their quality.
Q13) what is demerit goods? Or why should government should therefore intervene in the marketplace to discourage their production and consumption of demerit goods ?
🔷Demerit goods are goods which are believed to be socially undesirable.
🔷Examples of demerit goods are cigarettes, alcohol, intoxicating drugs etc.
🔷The consumption of demerit goods imposes significant negative externalities on the society as a whole and therefore the private costs incurred by individual consumers are less than the social costs experienced by the society.
🔷The production and consumption of demerit goods are likely to be more than optimal under free markets.
🔷The price that consumers pay for a packet of cigarettes is market determined and does not account for the social costs that arise due to externalities.
🔷In other words, the marginal social cost will exceed the market price and overproduction and over consumption will occur, causing misallocation of society’s scarce resources.
🔷The generally held argument is that consumers overvalue demerit goods because of imperfect information and they are not the best judges of welfare with respect to such goods.
🔷The government should therefore intervene in the marketplace to discourage their production and consumption.
Q14) How do governments correct market failure resulting from demerit goods?
🔷At the extreme, government may enforce complete ban on a demerit good. e.g. Intoxicating drugs. In such cases, the possession, trading or consumption of the good is made illegal.
🔷Through persuasion which is mainly intended to be achieved by negative advertising campaigns which emphasize the dangers associated with consumption of demerit goods.
🔷Through legislations that prohibit the advertising or promotion of demerit goods in whatsoever manner.
🔷Strict regulations of the market for the good may be put in place so as to limit access to the good, especially by vulnerable groups such as children and adolescents.
🔷Regulatory controls in the form of spatial restrictions e.g. smoking in public places, sale of tobacco to be away from schools, and time restrictions under which sale at particular times during the day is banned.
🔷Imposing unusually high taxes on production or purchasing the goods making them very costly and unaffordable to many is perhaps the most commonly used method for reducing the consumption of a demerit good. For example, the GST Council has bracketed four items namely, high end cars, pan masala, aerated drinks and tobacco products into demerit goods category and therefore these would be taxed (with a cess being added on to the basic tax) at much higher rates than the top GST slab of 28 per cent.
🔷 The government can fix a minimum price below which the demerit good should not be exchanged.
Q15) what are various limitations for government intervention in case of demerit goods?
🔷There are many practical difficulties in imposing taxes. In order to impose a tax which is equivalent to the marginal external cost, the government need to know the exact value of the marginal external cost and then put accurate monetary value to those negative externalities. In practice, this is extremely difficult to do.
🔷The demand for demerit goods such as, cigarettes and alcohol is often highly inelastic, so that any increase in price resulting from additional taxation causes a less than proportionate decrease in demand. Also, sellers can always shift the taxes to consumers without losing customers.
🔷The effect of stringent regulation such as total ban is seldom realized in the form of complete elimination of the demerit good; conversely such goods are secretly driven underground and traded in a hidden market.
