Gov. Intervention in Markets Flashcards
6 Ways of correcting Market Failure
Indirect Taxes
Subsidies
Regulation
Provision of public goods
Tradable permits
Price regulation
Indirect Taxes dealing w market failure Pros & Cons 4 + Example
Pros - Reduce deadweight social welfare loss, increase gov. revenue
Cons - Regressive tax, meaning the burden of the tax falls on those with a lower income, this can serve ti increase poverty
If Demand is inelastic then burden is placed on consumers
Black markets can result. e.g. huge black markets for cigarettes (£2bn a year) and alcohol due to high indirect taxes
Assumes gov. has perfect information to set perfect rate of tax
Political reasons could cause government reluctance as tax raises are often unpopular with voters
Subsidies dealing w market failure + Example
3 Cons
Used to correct failure in goods w positive externalities e.g. higher education
Cons -
Opportunity Cost
Assumes gov. has perfect information to set perfect subsidy level, undersubsidise = doesn’t reach social optimum equilibrium, over = huge cost and gov. failure
Can lead to firms becoming overreliant, thus X-Inefficiency
easy to introduce but very hard to dismantle, as those who benefit will protest - e.g. subsidies for Uni fees were removed, meaning consumers bare more of the cost. Thus, research suggests students are more likely to vote Labour, who have promised to remove / reduce tuition fees
Hard to evaluate the extent of the positive externality - too large a subsidy could cause overproduction & vice versa
Regulation dealing w market failure 4 Cons & def. + Example
A rule or law enacted by gov. that must be followed by economic agents to change behaviour
Can be used to address information problems, e.g. schools must publish OFSTED results
Cons -
Hard to enforce when there’s a lot of producers and consumers who need t be monitored i.e. why fly tippings so common
Regulatory Capture - When benefits for society are overlooked for those of COs and Managers. When working closely with these people regulators may be influenced to reduce the extent of regulation e.g. Self-regulation on alcohol prices and marketing
Assumes perfect info, overregulation can cause firms shutting down (gov. failure)
Can reduce international competitiveness e.g. Minimum carbon price could damage UK Competitiveness
Doesn’t give an incentive for firms to go lower than what regulation requires e.g. car manufacturers have no incentive to reduce emissions more than the law requires. This is unlike market-based methods such as taxes
State Provision of public goods Pro Con + Example
Providing public goods through taxation
Cons -
High opportunity cost e.g. NHS severe underfunding
X-Inefficiency as no incentive to cut costs due to no profit incentive
State Provision of Public Goods (Nationalisation) Diagram
S is perfectly inelastic (VERTICAL), annotate this as Q*
Normal demand curve with it TOUCHING THE BOTTOM
P1 = 0 (Must write this in annotation, not just P1) as the good is state provided the price is paid through tax
Highlight Excess Demand in the triangle
Tradable Permits 1 Con + Example
market based solution allowing for a limited amount of negative externalities e.g. EU Emissions Trading Scheme, gives each member nation a percentage of the cap based on GDp & population. These countries can then sell permits for a certain amount of emissions to firms. Has caused a 21% decrease in greenhouse gases emmisions
Pros -
Efficient solution for firms. Doesn’t hinder firms too much like regulation does, costs of production wont skyrocket as can buy permits if needed
Con - Like regulation, monitoring can be an issue. Thus, works best when involves a small number of large firms as easier to monitor. For markets w many small firms, like agriculture, taxes may work better e.g. taxes on pesticides to discourage their use in farming
Fines may not be harsh enough, if so firms may just continue overpolluting and take the fine
Price Regulation cons + Example
Max price - Often when good has positive externalities e.g. Higher education capped at around £9000 per year. Min price - Often when good has negative externalities e.g. Scottish government puts min price of 50p per unit of alcohol the drink contains
Cons -
Black market (less tax rev.., dangerous for consumers)
Min price is regressive and hits poor harder
Regulatory Capture e.g. Self-regulation on alcohol prices & advertising
Enforcement for max price. e.g. Berlin big issue with enforcing rent price max
Unintended consequences e.g. In Venezuela there is a max price for many necessities like food and paper towels. This has caused many firms to stopselling them as they cannot make a profit, thus loss of social welfare
Price Cap Diagram
Subsidies Diagram
MUST DRAW 3 Equilibriums, including price up from new equilibrium showing price gov pay
S + Subsidy, not S1
