Goverment Intervention -T1

Question 1

Advantages of indirect taxes to correct market failure

Answer 1

Work with market forces so that choice still exists
Tax funds are raised for the government and these can be used to help compensate for the externality
Polluters pay helping to internalise the external cost
Indirect taxes are difficult to avoid
Indirect taxes are convenient, since they are paid in small amounts regularly

Question 2

Disadvantages of indirect taxes to correct market failure

Answer 2

Difficult to quantify external costs, social optimum may be missed
Indirect taxes will increase production costs reducing competitiveness against firms in countries where taxes are not applied
Widespread use may be inflationary
Firms may relocate to other countries
Demand for good may be inelastic so price change will not effect
Tax revenue may not be used to compensate
Illegal markets

Question 3

Why are indirect taxes applied

Answer 3

Imposed on goods with significant external costs

To push supply curve , MPC, to the MSC equilibrium point

Question 4

Why are subsidies applied

Answer 4

Applied to good with significant external benefits

Moves supply curve out

Question 5

Advantages of subsides applied to renewable energy markets

Answer 5

Reduce air pollution and other forms of external cost
Promote sustainable economic growth
Rate of consumption of non renewable energy is reduced
Work with market forces so maintain choice

Question 6

Disadvantages of subsides applied to renewable energy markets

Answer 6

Difficult to quantify external benefits, social optimum may not be achieved
Opportunity cost to government subsidies
Firms may become dependant on subsidy or become inefficient
External costs associated with renewable energy, e.g noise

Question 7

Advantages of maximum prices

Answer 7

They can reduce exploitation of costumers especially when there is a lack of competition
Reduce inequality, in the case of high paid public sector workers and bankers
Can help people on low incomes to afford key products

Question 8

Disadvantages of maximum pricing

Answer 8

Distorts the price mechanism leading to excess demand, and inefficient allocation of resources
Reduces supply of rental property
Problems arise over how to allocate supply to meet the excess demand in the market: first come first serve or sellers preference are both unfair
Difficult for government to monitor
Decline in revenue for producer

Question 9

Why is maximum pricing introduced

Answer 9

To impose a limit of how much the cost of certain goods can rise
Ww2 - Basic food items
Rental housing market- protect tenants
Maximum wages can be imposed on highly paid public sector workers and bankers

Question 10

Why are minimum price schemes introduced

Answer 10

Limit on how much price level can fall
Prevent exploitation of workers
Minimum price on goods with high external cost e,g sugar and alcohol

Question 11

Advantages of minimum price

Answer 11

• Reduce consumption of goods that are harmful to consumers and have high external cost
• encourages producers to switch to making better less harmful products
• reduce fluctuations in food prices, making it easier for consumers to budget their income
• stabilise producer incomes leading to higher investment
• food surpluses can be used to aid foreign countries
• minimum wage, increases incentive to work

Question 12

Disadvantages of minimum price

Answer 12

Distorts price mechanism, excess supply
Reduces consumer surplus, price will increase which will disproportionately effect those on low incomes
Ineffective if demand is price inelastic
Difficult to enforce
Opportunity cost as government has to buy out food excess supply
Food will be sold at very low price internationally damaging local farmers
Farmers become less efficient as they are guaranteed an income

Question 13

Objective of trade pollution permits

Answer 13

They have a costs meaning it incentivises companies to invest in cleaner technology

Question 14

Advantages of trade pollution permits

Answer 14

Market is created for buying and selling, so price mechanism is used to internalise the external costs of pollution
Reduces pollution
Governments can raise funds by selling pollution permits
Firms have incentive to invest in clean technology
May stimulate a global scheme
No matter what we reduce the level of pollution to the socially optimum level
Long run incentive

Question 15

Disadvantages of trade pollution permits

Answer 15

Number of firms issued as government may quantify the externality incorrectly. Too many/little
Allocation of permits ( who gets them)
Firms may pass the costs of buying permits onto consumers, this is likely to happen if demand is inelastic
Less pressure on major firms as they can afford lots of permits
EU is only one part of the world
Companies may ship production overseas
Value of pollution permits is not exact
Cost to monitor and hard to enforce
Price of pollution permits varies

Question 16

Reason for state provision of information

Answer 16

• encourage production and consumption of healthy goods, as they are under provided in the market
• discourage production and consumption of unhealthy goods as they are over provided
• protection e.g smoking, seatbelts, vaccination

Question 17

What is regulation

Answer 17

Government rules in markets to influence the behaviour of consumers and producers

Question 18

Advantages of regulation

Answer 18

Simple to understand
Imposed to protect costumers
Possible to fine or close down companies for breaking regulations
Money from fines can be used
Could reduce the problem of asymmetric info, smoking
Fines act as a deterrent for both producer and consumer

Question 19

Disadvantages of regulation

Answer 19

Expensive to monitor
May be set at wrong level
Increase production cost making them less competitive
May prevent the operation of the price mechanism

Question 20

Government failure, and types

Answer 20

When government intervention leads to inefficient allocation of resources and net welfare loss
Distortion of price signals, unintended consequences, excessive administration costs and information gaps, regulatory capture

Question 21

Distortion of price signals

Answer 21

Maximum price leads to excess demand

Minimum price leads to excess supply

Question 22

Unintended consequences

Answer 22

Indirect taxes may lead to illegal markets
Subsides may lead to firms relying on them and becoming inefficient
Maximum price may lead to a shortage of goods and services, highly skilled workers that want higher wages
Minimum price, could lead in unemployment or excess supply
Trade pollution, firms that produce lots of carbon may find it easier to spend on permits than invest in clean technology - lack of competition
Regulations may act in interest of the firm instead of consumer

Question 23

Excessive administration costs - government failure

Answer 23

administration costs - cost which arise in the formulation, monitoring and enforcing of government measures
Tax collection
Welfare benefits
Constant monitoring. E.g fishing boats

Question 24

Information gaps, government

Answer 24

Fish catches per boat too high
EU government fail to understand how the rest of the world would react to the inclusion of air travel in emissions trading scheme
Government set very high rate of income tax for top earners encouraging tax evasion reducing tax revenue