Government intervention 1.4 Flashcards
What are the advantages of an increase indirect tax?
-It internalises the externality the market now produces at social equilibrium position and social welfare is maximised.
-It raises government revenue, which could be used to solve the externality in other ways such as through education. This may help goods become for elastic in the long run.
However, this depends on what the government does with the revenue they raise.
What are the disadvantages of indirect tax?
(TT)
-It is difficult to know the size of the externality and so it is difficult to target the tax; the effect depends on where the tax is set. The government suffers from imperfect information when setting the tax.
What are the disadvantages of indirect tax?
(In)
If the demand for the good is inelastic, then the tax will be ineffective at reducing output.
What are the disadvantages of indirect tax?
(R)
-Indirect taxes are regressive, meaning the poor spend a larger proportion of their income on indirect taxes than the rich do.
What are the advantages of subsidy?
-Society reaches the social optimum output and welfare is maximised.
-They can encourage the growth of small businesses, bringing about and encouraging exports.
What are the disadvantages of subsidy?
-The government has to spend a large amount of money, which will have a high opportunity cost.
-It is difficult to know the exact size of the externality so it is difficult to target the subsidy. The government suffers from imperfect information.
What is a maximum price?
A maximum price is a legally imposed price for a good that suppliers cannot charge above. They are set on goods with positive externalties. For example, they are set on food as lack of food will have a negative impact on the NHS. They can prevent monopolies from exploiting customers.
Using a diagram, explain the effect of a minimum price.
Price has increased from P1 to P2.
There has been a contraction of demand from Q1 to QD.
There has been an expansion in supply Q1 to QS. This is because suppliers are responding to the incentive of higher price by producing a greater output.
However, there is a distortion of price signals so QS is > QD, creating an excess supply of QS - QD.
This creates a burden for producers as invested in their FOPs to produce at QS, but can only sell at QD. This may significantly reduce their profit margins.
If intervention buying occurs (QdQsbc), producer rev. will be P2cQs0. Without intervention buying (e.g. for developing countries) producer revenue will only be at P2bQd0.
DWL: abd.
What is the effect of a minimum price on consumers?
There is a -ve effect on consumers as they are paying higher prices. This effect has an increased burden on low income households as affordability is much lower as minimum prices take greater proportion of the income of the poor compared to the rich. Therefore, the effect a minimum price is regressive.
Consumers may suffer from increased taxes IF intervention buying occurs.
How can you evaluate the effect of minimum prices on consumers?
Consumers might like that fact that the industry survives as producers continue to produce an output in the market. However, overall the net effect on consumers is very -ve.
What is the effect of a minimum price on producers?
IF intervention buying occurs…
producers will benefit from a large increase in revenue and an increase in producer surplus.
Producers will survive in the market; if there is price volatility, producers will be protected by the minimum price.
(VERY DEPENDENT of intervention buying)
What is the effect of a minimum price on the government?
The government may solve key market failures.
However, governments will be concerned will the regressive effect min. price have on consumers.
Intervention buying acts as an opportunity cost.
What is the purpose of a price maximum?
To increase affordability of necessity goods.
Using a diagram, explain the effect of a price maximum?
The price decreases from P1 to P2.
There is now an extension is demand from Q1 to QD.
There is a contraction in supply from Q1 to QS.
Therefore, there is a distortion of price signals so there is an excess demand (QD-QS) as producers are unable to produce an output that satisfies the quantity demanded.
Producer revenue decreases from P1 x Q1 to P2 x Qs. This may lead to reduced profit margins.
What is the effect of a price maximum on consumers?
Consumers are benefiting from a decrease in price as they have access to the market (buy a supply from 0 to Qs). However, consumers between between Qs and Qd can’t access goods. This may force consumers to use alternative supply method (e.g. smuggling groceries or using the black market for rented accommodation).
What is the effect of a price maximum on producers?
There is a contraction of supply, so there is a fall in producer revenue and surplus. This may lead to producers leaving the market to provide goods elsewhere, so there is reduction in the quality and quantity of goods for consumers.
What are the advantages of pollution permits?
-Since pollution permits are strictly enforced, it is guaranteed that pollution will fall to the targets set by the government. This means that pollution will come down to a socially optimum level, so allocative efficiency will be achieved, thereby maximising social welfare.
-The policy promotes a long a run incentive for firms to invest in green technology. If firms invest in green technology, they will never be burdened when permit prices rise (Supply shifts inwards when gov. reduces the number of permits in circulation, S1 to S2 leads to P1 to P2).
