Government Intervention

Question 1

What are the 5 ways governments can intervene in markets?

Answer 1

1) Subsidies.
2) Indirect taxation.
3) Regulation.
4) Setting price controls.
5) State provision of public goods.

Question 2

Why do governments intervene in markets?

Answer 2

To correct market failure.

Question 3

What are the 2 potential benefits of imposing an indirect tax?

Answer 3

1) A reduction in output, minimising the impact of a negative externality.
2) A raise in revenue to support a market, industry or future government spending/policies.

Question 4

What are the 4 potential drawbacks of imposing an indirect tax?

Answer 4

1) The tax may not work if the tax is too small or too large.
2) If PED is inelastic, a tax may not reduce demand to the socially optimum level.
3) Taxes are unpopular and disliked by both producers and consumers.
4) There may be potential conflict between reducing output and raising tax revenue.

Question 5

What are the 2 benefits of subsidies?

Answer 5

1) An increase in the consumption of goods that are of benefit to society.
2) Subsidies support local industries that are vulnerable to competition.

Question 6

What are the 2 questions that the government need to consider before allocating subsidies?

Answer 6

1) Questions over government policy objectives - how is the subsidy paid? What are the trade-offs?
2) Questions over targeting of the subsidy - what level of subsidy will correct market failure? Who will benefit from it?

Question 7

How can subsidies correct market failure?

Answer 7

They incentivise producers to increase supply of a certain good/service(s) (usually a merit good), reducing the price, boosting consumption.

Question 8

Why would governments set price controls?

Answer 8

Because the price mechanism can cause market failure, as it rations socially desirable goods and incentivises goods that are not.

Question 9

What controls can governments set on prices?

Answer 9

1) Maximum prices.
2) Minimum prices.

Question 10

What is a maximum price?

Answer 10

A legal limit imposed by the government on the price of a good or service, with the aim of reducing prices below the market equilibrium price.

Question 11

What is a minimum price?

Answer 11

A legal limit imposed by the government on the lowest price that a good or service can be sold for, with the aim of increasing prices above the market equilibrium price.

Question 12

Why do governments set maximum prices?

Answer 12

Some goods, e.g. food and housing, need to be affordable for the social welfare of the nation. By reducing prices below the market equilibrium price, more people can afford the given good.

Question 13

What is a drawback of setting a maximum price?

Answer 13

The creation of excess demand, as suppliers will be less incentivised to produce the given good.

Question 14

Why do governments set minimum prices?

Answer 14

To reduce consumption for goods with negative externalities, such as cigarettes or alcohol, through reducing demand by raising the price above the market equilibrium price.

Question 15

What is a drawback of setting a minimum price?

Answer 15

The creation of excess supply, as demand will be reduced through a higher price.

Question 16

What are the 5 types of market regulation?

Answer 16

1) Closing information gaps: e.g. forcing producers to disclose information on food labels.
2) Setting maximum pollution levels: e.g. the emission standard.
3) Grading the standard of service providers: e.g. Ofsted for education.
4) Creating trade pollution permits: a permit issued to firms up to the limit of the government’s cap on carbon emissions, e.g. the EU Emissions Trading Scheme.
5) Setting quality standards for manufacturing: e.g. the British Standards Institution (BSI).

Question 17

What is the main benefit of market regulation?

Answer 17

It is relatively cheap.

Question 18

What are 3 potential drawbacks of market regulation?

Answer 18

1) Regulations need to be enforced , which can be expensive if independent inspectors and regulators need to be set up.
2) If regulation is too tight, suppliers will leave the market.
3) If regulation is too loose, market failure will not be corrected.

Question 19

How can governments deal with the under provision of public goods?

Answer 19

Governments may decide to combat the under provision of public goods (caused by the free rider problem) by directly providing public goods, and paying for them through taxation.

Question 20

What is the main drawback of setting price controls?

Answer 20

The emergence of black markets - e.g. a minimum price on alcohol could result in cheap varieties being produced and sold illegally.