explain and analyse the different methods of market modification required to correct market failure, including direct and indirect taxation, subsidies

Question 1

Pigouvian Tax

Answer 1

• a tax placed on any good which creates negative externalities
• makes the $ of the good = SMC –> creates more socially efficient allocation of resources
• tobacco tax

Question 2

Pigouvian Subsidy

Answer 2

• a tax placed on a good causing positive externalities

- makes the $ of the good = MEB

Question 3

Subsidy

Answer 3

• a direct/indirect payment to individuals/firms –> form of a cash payment from government or a targeted tax cut
• encourages consumers of a product to change behaviour that currently causes negative externalities
• paying cash incentives to households installing solar panels –> reduces negative externalities –> pollution from fossil fuels

Question 4

Indirect Taxes

Answer 4

• taxes imposed by the government on the transaction of a g/s
• discourages consumption of harmful products which cause externalities
• Pigouvian tax

Question 5

Direct Taxes

Answer 5

• taxes paid for by an individual to the government

- income tax/property tax

Question 6

How Taxes are a Remedy

Answer 6

• by placing a tax on products which have an impact on a third party, it discourages their consumption and reduces their harmful effects on unrelated third parties

Question 7

How Subsidies are a Remedy

Answer 7

• by providing a payment to an individual/firm for the use of a product, it encourages them to consume goods which benefit society –> reduces the external impacts –> market failure is fixed