CH20 Government intervention in markets Flashcards
what are the 8 different ways in which govs attempt to correct market failure?
-indirect taxes
-subsidies
-maximum prices
-minimum prices
-trade pollution permits
-state provision of public goods
-provision of information
-regulation
when will total welfare be increased?
total welfare will be increased if any costs incurred in intervention are less than the benefits gained from intervention
using the example of firms emitting too many pollutants into the atmosphere, explain how governments can use indirect taxes to correct market failure? and how does the level of tax need to be set?
-the gov could impose a tax on production. Firms would respond by producing less because their costs of production have increased due to the tax.
-the level of tax needs to be set so that negative externalities are eliminated and the marginal social cost of production equals the marginal social benefit.
what are the 3 problems indirect taxes can have?
-They may be difficult to target. So the tax may be too large or too small to correct the market failure exactly. Partly, this may be due to information failure on the part of the gov: it doesn’t know the exact size of the market failure or it may now know the impact a tax will have on the market
-Governments may use indirect taxes to raise revenue as well as reduce market failure. The two objectives can then conflict when decisions are made about the size of the tax.
-Taxes are unpopular. In the 1990s, the UK gov was forced to abandon a plan to raise the rate of VAT on gas and electricity because of political opposition. It claimed it wanted to raise the rate of VAT partly to reduce greenhouse gas emissions.
using the example of positive externalities in consumption from historic buildings, explain how the gov can use subsidies.
-assume that there are positive externalities in consumption from historic buildings. The private benefit to the owner of the historic building is less than the benefit to society of the historic building.
-then a government could provide subsidies, for example for the upkeep of this historic building or for its repairs.
other than being used when there are positive externalities, when else can subsidies be used by governments?
they can also be used to correct information failure.
-the gov could subsidies the provision of information to those suffering from lack of information.
what are the 3 problems subsidies can have?
-they may be difficult to target. As with taxes, the subsidy may be too large or too small to correct the market failure exactly. Partly, this may be due to information failure on the part of the gov: it doesn’t know the exact size of the market failure or it may not know the impact a subsidy will have on the market.
-there can be conflict with other policy objectives. Someone must pay the subsidies. If it is government, this can conflict with objectives about low taxes or reducing government deficits. Subsidies can also be provided by firms. In the case of the UK electricity industry, gov regulations force electricity generators to buy certain percentages of their power from renewable sources. The prices paid are above the prices for conventional coal or gas generation. To make profit, electricity generators then charge their customers a higher price. So customers are subsidising renewable energy by paying higher prices than they would otherwise have done. This can increase inflation. It can also impact fuel poverty and the ability of low income households to heat their homes.
-subsidies can be difficult to remove. Those who receive the subsidies effectively receive an increase in their income. If the subsidy is lowered or removed, they can lobby government to delay or abandon plans to change the subsidy. Attempts to remove subsidies on basic foods or fuel in countries like Iran, Venezuela or India have caused major riots in the past. In some cases, govs have been toppled as a result.
what does imposing maximum prices do for certain goods?
it makes them more affordable.
what is one problem with the policy of maximum prices?
a problem is that if prices are forced down to make goods more affordable, then the quantity supplied falls.
what do maximum prices often lead to?
they often lead to black markets.
what happens to the market if the maximum price is set above the free market price?
there will be no effect on the market.
-the equilibrium price in the market will remain where the quantity demanded equals the quantity supplied and equilibrium output will remain the same.
when might a gov impose minimum prices?
-some goods such as alcohol and cigarettes, have significant negative externalities in consumption.
-so govs may attempt to correct the resulting market failure by raising their price to a level where marginal social cost and marginal social benefit are equal. And one of the ways to do this is to set a minimum price for the good.
what does imposing a minimum price above the free market price do?
it causes demand to fall, but also causes excess supply.
-excess supply becomes a problem if it finds its way back onto the market. In the cases of alcohol and cigarettes, minimum prices tend to create black markets where they are sold as less than the minimum price.
what happens if the minimum price is set below the free market price?
then there will be no effect on the market.
-the equilibrium price in the market will remain the same.
when could regulation by govs be used?
-it can be used to close information gaps.
-e.g. airlines could be forced to disclose all the charges for an airline ticket at the start of the booking process rather than the end. Banks are forced to tell their customers the rate of interest on a loan
-regulation is also used to control externalities. The gov could lay down maximum pollution levels or might even ban pollution-creating activities altogether.
