CH8: Government Regulation of markets

Question 1

What are the 3 types of economic systems?

Answer 1

1. Market economy (aka free market) - price, products supplied and distribution of products are all decided by market forces
2. Command economy -Price, products and distribution of product are dictated by the government
3. Mixed economy - Price, products and distribution of products are decided by a mixture of market forces and government. ie. the government tends to intervene where there are MARKET FAILURES

Question 2

Definition: market failure

Answer 2

when market fails because supply and demand do not result in an outcome that satisfies both customers and suppliers

Question 3

What are examples of market failures?

Answer 3

Monopolies - there is a sole supplier of a good or service in a market

Demerit goods -people choose to buy goods that do not benefit society eg. cigarettes

Inappropriate pricing - costs are too high to enter the market/barrier to entry hence there is little competition/choice for consumers which can lead to higher prices

Question 4

What are pros and cons of monopolies?

Answer 4

PROS: some industries - such as UTILITIES - are served more efficiently by a monopoly

large companies can have a positive impact in industries where R&D costs are high

CONS: set excessively high prices
Companies in industries with only a few large companies may decide to for a CARTEL

Question 5

Definition: Cartel

Answer 5

Companies work together to keep prices high and/or restrict supply and ensure limited competition in the industry. Cartels can be official or unofficial.

Question 6

What do governments use to ensure competition thrives?

Answer 6

Competition policy

Question 7

What does competition policy cover?

Answer 7

• Abusing market power
• Monopolies
• M&A - if it results in competition which limits choice and inflates prices for consumer

Question 8

Expand on Monopolies in term of competition policy

Answer 8

In general govs will try and prevent monopolies but some industries are more efficiently run by monopolies e.g. Utilities so these industries may be Nationalised (state owned).

Alternatively gov may choose to Privatise these industries but set up am industry regulator to ensure prices are appropriate due to lack of competition.

Question 9

Expand on Abusing market power in term of competition policy

Answer 9

Collusion (between suppliers)- reduces competition and ultimately leads to inflated prices for the consumer

Creating barriers to entry - larger companies can reduce some of their prices below the average total cost, making it non-viable for any company to set-up as a competitor

Exclusive disti/retailer/supplier agreements - preventing new entrants to the market

Imposing switching costs - customers find it financially punitive to switch providers

Question 10

Definition: Collusion

Answer 10

Two or more organisations privately agreeing to a pricing strategy

Question 11

What is CAP (Common Agricultural Policy)?

Answer 11

an EU agricultural policy to provide various programmes and subsidies to farmers.

Started off with guaranteed prices (created issues with over supply), then set-aside schemes, then quotes, then subsidies, and finally single farm payments (gov assistance is unrelated to production/avoids over supply issues)

Question 12

What is meant by when the equilibrium price is too low?

Answer 12

When supply/demand is left to market forces and the cost to produce the good is higher than the selling price

Question 13

Why may governments subsidies farmers?

Answer 13

Farmers operate in a unique economic climate:

1-Weather/disease can severely restrict supply even if the demand is high

2-Power of large retailers- they often buy products from the farmers and due to their market share they can strongly influence product prices which may not be profitable enough for the farmers to continue to supply their goods

3-New technologies/products can change level of supply and therefore prices

4-Secure food supply is key for many governments

Question 14

What are advantages to schemes like CAP?

Answer 14

• Farmers/producers are guaranteed a STABLE INCOME
• stable income can be invested in to R&D
• Customers get a stable supply at affordable prices
• Other issues can be addressed - eg. environmental/green issues

Question 15

What are disadvantages to schemes like CAP?

Answer 15

• Possibility of surplus products

- Misallocation of resources - putting effort/labour etc into producing unnecessary output

Question 16

Definition: Maximum pricing

Answer 16

when prices for certain goods get too high the government caps them by imposing a max price

Question 17

When is maximum pricing used?

Answer 17

• customers are being exploited by a monopoly situation
• there is an unexpected shortage in a product - hence threat from price increases
• ensure that the product is affordable for all sectors of society
• reduce inflationary pressures

Question 18

What is essential for maximum pricing to be effective?

Answer 18

Maximum price MUST be set BELOW the equilibrium price

*note graphically demand is greater than supply in this case

Question 19

What are problems which can arise with maximum pricing?

Answer 19

Associated with potential outcomes of extended shortages (*note graphically demand is greater than supply in this case):

1. Creation of black marekts
2. Reduced supply
3. Reduction in quality of the goods as suppliers cut costs to increase their profit margin without increasing price

Question 20

Definition: Externality (spill over effects)

Answer 20

The way anyone who is not the seller or consumer (ie.is a third party) is affected by a transaction between the seller/consumer.

Question 21

What are negative externalities sometimes referred to as?

Answer 21

External costs

eg. passive smoking, which in turn increases public health costs to cover non-smokers

Question 22

What are methods for dealing with negative externalities?

Answer 22

Taxation - taxes can be sued to pay for negative externalities e.g. cigarette tax

Evaluation of the social cost - finding the figure of the social cost can help governments know how to best use resources

Regulation - a level of accepted usage (e.g. pollution) is agreed by the gov and imposed on users

Increased info for consumers - educating consumers to stop using the product e.g. smoking education

Compensation schemes - compensation is given to the affected third parties

Question 23

What are sources of negative externalities?

Answer 23

Production processes - waste and emission affecting local communities

Congestion - pollution, accidents, delays, reduced output due to impact on working hours

Noise pollution - e.g. nightclub impacts local residents

Smoking

Excessive alcohol consumption - costs associated with damaged caused by people whist drunk. Also increased healthcare costs for tax payers

Question 24

Definition: positive externality

Answer 24

an externality that has a positive effect on a third party

Question 25

What are sources of positive externalities?

Answer 25

Education - increasing knowledge and skill in the economy

Treatment/vaccines

R&D

Infrastructure e.g new road

Question 26

How do governments encourage positive externalities?

Answer 26

1. Increase Supply - government may subsidise suppliers to reduce cost and increase supply
2. Increase Demand via:
   - prices for consumes are subsidised - lower price leads to increased demand
   - Consumption is made compulsory
   - Increased info on the benefits of certain goods
3. Evaluation of the social benefit - finding the figure of the social benefit can help governments know how to best use resources

Question 27

Definition: Merit goods

Answer 27

Goods which are considered suitably important and necessary so as to warrant being provided through public finances eg. education

Question 28

What are features of merit goods?

Answer 28

• Everyone should have access regardless of income
  BUT
  -Customers are unaware of benefits eg. healthcare

*Merit goods are often provided by the state to avoid under-consumption

Question 29

Definition: Demerit goods

Answer 29

Products that potentially ham the consumer in some ways or is socially unacceptable

Question 30

What are features of Demerit goods?

Answer 30

-People are unaware (or ignore) the costs of using the product

AND

-they harm the consumer or is socially unacceptable

Question 31

How do governments discourage the use of demerit goods?

Answer 31

1. Taxation
2. Laws banning consumption or supply
3. Regulations over advertising or packing - eg. restriction of cigarette advertising and packaging

Question 32

Definition: Public goods

Answer 32

Goods which are not produced through the market but which are necessary and are therefore provided through government intervention

Question 33

What are features of public goods?

Answer 33

1-Non-availability - you can’t stop anyone from consuming it even if they are not contributing in some way (the “free-rider” problem)

AND

2-Non-rivalrous - one person’s consumption doesn’t reduce another’s

Question 34

What are Pros of state provision of public goods?

Answer 34

• Goods and services that would never be produced, despite the public benefits, are made available
• State provision on a large scale benefits from economies of scale hence lower overall cost
• The cost to each individual is kept low

Question 35

What are Cons of state provision of public goods?

Answer 35

• No one can opt out - as collection of costs are via taxation
• No allocative efficiency as production levels are dictated by the government and not market forces hence can lead to oversupply
• allocative efficiency - where the level of output/production is consistent with consumer demand

Question 36

How does the government tackle environmental concerns?

Answer 36

Tax companies responsible for pollution and use this money to clean affected areas

Regulate the accepted amount of pollution

Question 37

In terms of the equilibrium price, where should a minimum wage be set at to be effective?

Answer 37

Above equilibrium price