Economics Chapter 15

Question 1

MIXED ECONOMY

Answer 1

Has a combination of a planned and a free market economic system. Some firms are privately owned while others are owned by the government. Both private sector and public sector co-exist. Some prices are determined by the market forces of demand and supply while others are set by the government.

Question 2

GOVERMENT INTERVENTION

Answer 2

When a market fails to allocate resources efficiently (either by over-allocating or under-allocating) it is up to the government to intervene and correct the market failure by removing or at least reducing the externality.

5 Methods of Government Intervention:

1. Taxation
2. Regulation/Legislation
3. Advertising/Persuasion
4. Subsidies
5. Direct Government Provision

Question 3

BENEFITS OF STATE INTERVENTION

Answer 3

Government can:

• Analyze social costs and benefits of all major decisions
• Encourage consumption of goods and services which are considered beneficial using subsidies legislations and provision of information
• Discourage the use of harmful products using taxes, legislations and provision of information
• Finance public goods
• Check price fixing
• Ensure fair resource allocation and employment
• Ensure adequate investment in capital goods
• Help vulnerable groups

Question 4

MAXIMUM PRICE

Answer 4

Price ceiling: Government may set a maximum price to enable the economically weaker sections to be able to afford basic necessities. The maximum price has to be set below the equilibrium price. It creates a shortage. To prevent development of an illegal market, some allocation methods have to be introduced such as rationing and lottery.

Rationing: a limit on the amount that can be consumed

Lottery: the drawing of tickets to decide who will get the products

Question 5

MINIMUM PRICE

Answer 5

Price floor (sometimes called price support): The government may set a minimum price to encourage the production of a product. This is the lowest price producers are allowed to charge. This creates a surplus. To prevent prices from falling the surplus will have to be bought up by government or an official body.

Question 6

SUBSIDIES

Answer 6

Subsidy: is a fixed payment per unit made to producers by the government to help them reduce their costs of production. As a result, producers will tend to increase supply at every given price. As supply increases, the market price will tend to fall. This benefits consumers as they are able to consume a larger quantity of goods. Subsidies are commonly granted to farmers to encourage them to produce more crops.

Question 7

TAX

Answer 7

Taxes are involuntary fees levied on individuals or corporations and enforced by a government entity.

A tax can be used to raise the market price of a product, either directly to reduce consumer demand for that product or making production more expensive so producer reduce market supply.

Question 8

INDIRECT TAXES

Answer 8

Taxes levied on goods and services are called indirect taxes. Indirect taxes include sales taxes (e.g. VAT), ad valorem taxes, and tariff and excise duties added to the price of goods and services. An indirect tax will normally be imposed on producers but they will pass them on as much of the burden of the tax as possible to consumers through higher prices.

If demand for a product is inelastic - tax will have a greater impact on price but the quantity demanded will not change much. Result- increased government revenue.

If demand for a product is elastic - a tax imposed will have a greater impact on the quantity demanded. Result- Government revenue may not increase as there will be a fall in quantity demanded.

Question 9

REGULATIONS

Answer 9

Regulations include rules and laws which place restrictions on activities of firms. Some examples are:

• Setting of age limits for consumption of demerit goods
• Setting emission standards
• Statutory warnings on cigarette packs
• Traffic restrictions

Advantage:

• A relatively easier method to bring about a change.

Disadvantage:

• May be difficult to enforce
• May be expensive to plan and enforce
• May restrict markets
• May create barriers to entry of firms

Competition Policy:

• It seeks to prevent firms from abusing their market power by encouraging competition

Environmental Policy:

• Include policies designed to improve environmental conditions. For example placing restrictions on pollutants emitted by firms into the sea or air by issuing tradable permits

Question 10

NATIONALISM & PRIVATIZATION

Answer 10

Nationalization: is the moving of the ownership and control of a firm from the private sector to the government

Privatization: refers to transferring the ownership of a state owned enterprise to the private sector