GOV’T INTERVNTION AND FAILURE Flashcards
What is Government Failure?
When the costs of intervention outweigh the benefits; resulting in a worsening of the allocation of scarce resources and harming societal welfare
5 Types of Gov’t Failure
- Information Failure
- Administrative Costs
- Unintended Consequences
- Regulatory Capture
- Distortion of Price Mechanism (Min/Max Price)
Information Failure
- When Gov’t don’t have sufficient information to correctly value externalities due to Information Gaps or information being hard to quantify
- Can lead to poor judgment and Gov’t Policy being set wrong; Gov’t Failure
Administrative & Enforcement Costs
Policy itself may simply be too expensive to put in place and to enforce
Main examples:
- Regulation - Costs of policing certain policies may be too high
- Subsidies - Very expensive to give out; may not be used for correct purpose
Unintended Consequences
When something imposed by Gov’t to correct Market Failure ends up having its costs to society
Main Examples:
- Black Markets as result of Regulations, Min Price and Taxes on certain goods
- Over dependence on subsidies by firms; increased wastage
- Impacts on Poor of Regressive Taxes and Min Prices
- Impacts of strict regulation and taxes on firms; may increase so much that firms go out of business or let go off workers- Unemployment increases
Regulatory Capture
Occurs when CEOs and Managers influence regulators into loosening regulations on their monopoly; not helping society.
Distortion of the Price Mechanism (Max)
Max prices can create excess demand for goods/shortages whilst also decreasing the incentive for firms to produce these goods and maintain quality standards.
Distortion of the Price Mechanism (Min)
Minimum prices can create excess supply/surpluses in markets as many consumers no longer wish to buy goods at prices above equilibrium. This will lead to wastage and dumping of spare goods worsening the environment and can deplete natural resources and affecting future production.
What is an Indirect Tax?
A tax levied on the sales of goods and services
Explain the consumer burden of indirect tax
- The area of the price increase; the top one of the two
- This is the increase in price consumers now have to pay as a result of the tax
Explain the producer burden of tax
- Area below price; bottom one of the two
- This is the loss of revenue as a result of units that are no longer bought and inability to pass burden of tax over to consumers
PED Effect on Burdens and Tax Rev for Gov’t - Elastic
Tax Rev - Decreases
Consumer burden - Decreases
Producer Burden - Increases
- Producer not really able to pass burden over to consumers due to significant falls in quantity demanded in response to change in price
- Not as much quantity being taxed so lower revenue for gov’t
PED Effect on Burden and Tax Revenue - Inelastic
Tax Rev - Increases
Consumer Burden - Increases
Producer Burden - Decreases
- Producer able to pass more of burden over to consumers due to lower fall in quantity demanded in response to change in price
- High quantity still being taxed so high revenue for gov’t
Explanation of Indirect Tax
- Tax increases Costs of Production for goods they’re imposed on; typically demerit goods
- Internalises the externality as ‘Polluter pays’ for the externality
- Solves overconsumption/production
Evaluation of Indirect Tax
- PED - If demand is Price inelastic, tax wont decrease quantity enough to solve market failure
- Tax may not be set at right level due to imperfect information (Overtax - May cause businesses to shut down; unemployment - Also may lead to Black Markets)
(Undertax - Wont correct Market Failure) - Regressive nature of tax as it will have a greater impact on lower income families; Inequality
- Black Markets may emerge which would be even worse due to unsafe goods potentially being sold
