CH8: Government Regulation of markets Flashcards
What are the 3 types of economic systems?
- Market economy (aka free market) - price, products supplied and distribution of products are all decided by market forces
- Command economy -Price, products and distribution of product are dictated by the government
- 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
Definition: market failure
when market fails because supply and demand do not result in an outcome that satisfies both customers and suppliers
What are examples of market failures?
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
What are pros and cons of monopolies?
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
Definition: Cartel
Companies work together to keep prices high and/or restrict supply and ensure limited competition in the industry. Cartels can be official or unofficial.
What do governments use to ensure competition thrives?
Competition policy
What does competition policy cover?
- Abusing market power
- Monopolies
- M&A - if it results in competition which limits choice and inflates prices for consumer
Expand on Monopolies in term of competition policy
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.
Expand on Abusing market power in term of competition policy
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
Definition: Collusion
Two or more organisations privately agreeing to a pricing strategy
What is CAP (Common Agricultural Policy)?
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)
What is meant by when the equilibrium price is too low?
When supply/demand is left to market forces and the cost to produce the good is higher than the selling price
Why may governments subsidies farmers?
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
What are advantages to schemes like CAP?
- 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
What are disadvantages to schemes like CAP?
- Possibility of surplus products
- Misallocation of resources - putting effort/labour etc into producing unnecessary output
Definition: Maximum pricing
when prices for certain goods get too high the government caps them by imposing a max price
When is maximum pricing used?
- 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
What is essential for maximum pricing to be effective?
Maximum price MUST be set BELOW the equilibrium price
*note graphically demand is greater than supply in this case
What are problems which can arise with maximum pricing?
Associated with potential outcomes of extended shortages (*note graphically demand is greater than supply in this case):
- Creation of black marekts
- Reduced supply
- Reduction in quality of the goods as suppliers cut costs to increase their profit margin without increasing price
Definition: Externality (spill over effects)
The way anyone who is not the seller or consumer (ie.is a third party) is affected by a transaction between the seller/consumer.
What are negative externalities sometimes referred to as?
External costs
eg. passive smoking, which in turn increases public health costs to cover non-smokers
What are methods for dealing with negative externalities?
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
What are sources of negative externalities?
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
Definition: positive externality
an externality that has a positive effect on a third party
What are sources of positive externalities?
Education - increasing knowledge and skill in the economy
Treatment/vaccines
R&D
Infrastructure e.g new road
How do governments encourage positive externalities?
- Increase Supply - government may subsidise suppliers to reduce cost and increase supply
- 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 - Evaluation of the social benefit - finding the figure of the social benefit can help governments know how to best use resources
Definition: Merit goods
Goods which are considered suitably important and necessary so as to warrant being provided through public finances eg. education
What are features of merit goods?
- 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
Definition: Demerit goods
Products that potentially ham the consumer in some ways or is socially unacceptable
What are features of Demerit goods?
-People are unaware (or ignore) the costs of using the product
AND
-they harm the consumer or is socially unacceptable
How do governments discourage the use of demerit goods?
- Taxation
- Laws banning consumption or supply
- Regulations over advertising or packing - eg. restriction of cigarette advertising and packaging
Definition: Public goods
Goods which are not produced through the market but which are necessary and are therefore provided through government intervention
What are features of public goods?
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
What are Pros of state provision of public goods?
- 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
What are Cons of state provision of public goods?
- 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
How does the government tackle environmental concerns?
Tax companies responsible for pollution and use this money to clean affected areas
Regulate the accepted amount of pollution
In terms of the equilibrium price, where should a minimum wage be set at to be effective?
Above equilibrium price
