Government Intervention

Question 1

Why might a Government intervene in a Market?

Answer 1

• To address Market Failures
• Raise revenue; for political or social reasons
• Prevent externalities

Question 2

List the 7 ways a Government can intervene with Markets?

Answer 2

1. Indirect Tax’s
2. Subsidies
3. Max + Min. Pricing
4. Tradable Pollution Permits
5. State provisions of Public Goods
6. Provisions of Information
7. Regulation

Question 3

Define Indirect Taxation

Answer 3

• Tax’s on expenditure
  Two types; Ad valorem (%) and specific (unit)

Question 4

Effect + Aim of Indirect Taxation (Government Intervention)

Answer 4

• Causes ↑Cost of Supply –> Supply Curve Shift Left
• Aim is to internalise the negative externality cause by product –> Decrease output + Production + Consumption
• Tax cause Left Shift in S Curve –> If tax judged correctly consumption + output will fall to Socially Optimum Level

Question 5

Advantages of Indirect Taxes (Government intervention)

Answer 5

• Incentive to reduce externality e.g. pollution –> Polluting firms pay more than least polluting firms
  (only if price elastic - if inelastic ↑P will not cause same ↓D)
• Source of revenue for Government - Can be used to compensate those effected by externality
• Few administrative costs involved

Question 6

Disadvantages of Indirect Tax (Government Intervention)

Answer 6

• Producers can pass tax onto Consumers - IF PED Inelastic will have little effect on consumption
• Difficult to set appropriate tax (hard to quantify externality)

Question 7

Subsidy definition + When is it used (Government Intervention)

Answer 7

• Government grant given to business to reduce production costs, cause Rightward shift in S Curve.
• Reduce CoP, Reduce P, Increase D
  –> used for positive externalities to increase output to Socially optimum level

Question 8

Advantages of Subsidy (Government Intervention)

Answer 8

• Reduction in Cost of Production enables suppliers to ↓P
• Incentive for consumers to ↑Consumption
• May reduce inequality

Question 9

Disadvantages of Subsidies (Government Intervention)

Answer 9

• Cost to taxpayer of providing subsidy
• Ineffective increasing Consumption if PED inelastic
• Difficult to set appropriate subsidy (difficult to quantify externality)

Question 10

Maximum Price Definition

Answer 10

set by Gov making it illegal for firms to charge more than a certain price for a production
–> (a maximum price you can charge)
e.g. Rented accommodation or Rugby Union / League

Question 11

Draw + Explain Diagram for Maximum Prices

Answer 11

• Normal S + D Curve
• Pe at normal equilibrium
• Pmax = line at maximum price ( below Pe)
• gap between Q supplied and Q demanded = Shortage

–> Shortage can result in black market with prices higher than max price

Question 12

Advantages of Maximum Prices (3)

Answer 12

Ad
- Enable consumers on low incomes to afford products
- Help prevent / increase rate of inflation
- Prevent exploitation of Consumer by Monopolies

Question 13

Disadvantages of Maximum Prices (2)

Answer 13

• Shortages can mean some consumers don’t get product
• Producers may exit the market to use resources on more profitable Good
  –> If Gov subsidies producers to keep them in market will be cost to taxpayer

Question 14

Minimum Prices definition

Answer 14

Set by Gov, Price Guaranteed to producers

Question 15

3 ways Minimum Prices are used (Government Intervention)

Answer 15

• Commodities –> Gov sets Minimum Guaranteed Price (MGP) to ensure certainty and act as incentive to producers to supply commodity e.g. farmers
• Consumer Goods –> To deter consumption e.g. Scotland introduced min. Price for alcohol
• Labour Market –> Countries have National Minimum wage

Question 16

Draw + Explain Minimum Price Guarantee (Government Intervention)

Answer 16

D + S Curve same
Pe = Normal Equalibrium

MGP (Min. Guaranteed Price) at price set above Pe
- Surplus is difference between Q supplied and Q Demanded
–> Gov often buys this and stores it incase of shortage

Question 17

Advantages + Disadvantages to Minimum Price

Answer 17

Ad.
- Producer certainty on price they will receive
–> Enable producers to plan investment + output
- Prevent exploitation of producers by wholesalers who have significant buying power

Dis.
- If Min. Price too high, will be constant surplus
- Schemes involve high storage costs, to taxpayers
- Encourage over-production, may result in inefficient allocation of resources

Question 18

What are Tradable pollution permits?

Answer 18

• Government issues permits allowing firms to pollute up to certain limit
  –> permits are tradable between firms meaning ‘clean’ firms can sell permits to polluting firms

–> Method to reduce external costs

Question 19

Advantages of Tradable Pollution Permits

Answer 19

• Work through market mechanism
• Incentive for firms to reduce pollution
• Low cost of administering scheme
• Allows for planned reduction in pollution over time

Question 20

Disadvantages of Tradable Pollution Permits

Answer 20

• Pollution will continue, even if lower than before
• Large, efficient firms can buy permits and continue to produce
• Need to be internationally enforced
• May make countries good less internationally competitive

Question 21

Explain State Provisions of Public Goods (Gov. Intervention)

Answer 21

• Lack of provisions of public goods by free market (due to free rider problem)
  –> Gov often provides public goods, financed through taxation

However - Politicians determine resources allocated to goods without reference to consumers
–> alternative methods through agencies hired by Gov, charities or voluntary organisations

Question 22

Explain Provision of Information to address Market Failure (Gov. Intervention)

Answer 22

• Information Gaps closed by media, internet or advertisements designed to inform consumers about issues concerning goods
  e.g. adverts for vaccinations for children
  risks associated with smoking or junk food, apprenticeships or sources in higher education.

–> costs associated no guarantee will be effective

Question 23

Explain regulation as attempt to address market failure

Answer 23

• Regulations imposed on consumers and producers
  e.g.
• ban production of good –> drugs
• Regulations limiting production process or amount of pollution allowed
• Regulations relating to consumption of product e.g. prohibiting smoking in public places or age limit for cigs

–> requires enforcmenet to be effective

Question 24

Advantages + Disadvantages to regulation (Gov. intervention)

Answer 24

Ad.
- Limit the externalities e.g. no smoking in public or limit on pollution
- Act as incentive to develop new tech to reduce pollution
- Limit external costs without impact on Price

Dis.
- Cost of Enforcement of regulations e.g. inspectors
- Hard to quantify socially efficient level of pollution
- Limits consumer sovereignty

Question 25

What is Government Failure?

Answer 25

• result of gov. Intervention in market, causes welfare loss
  –> output and consumption to move away from socially efficient output.

Question 26

What are the causes of Gov failure?

Answer 26

Distortion of Price Signals
–> Gov intervention involves manipulation of Prices (e.g. max / min. Prices)
–> undermines key functions of price mechanism ( signalling, rationing, incentives)
–> mean resource not allocated efficiently

Unintended consequences
–> impact policy makers did not predicts
–> e.g. high tax on spirits (to ↑Gov revenue) resulted in ↓Revenue
–> cigarette smuggling

Excessive administrative cost
- e.g. cost of means-tested benefits

Information Gaps
- Unlikely Gov has all the information
- intervention could move output away from socially optimum level

Question 27

What would a possible Gov failure be if
- put high indirect taxes in place
- Min. Price for Agriculture
- Environmental subsidy for wind farms

Answer 27

High Tax.
- Smuggling to avoid taxation
- result in movement away from Socially optimum level of output

Min. Price
- Massive surplus
- Resources allocated inefficiently
–> e.g. land should be used for other things

Subsidy
- Energy produced from wind farms is expensive
- Create eye sores
- Can overwhelm electricity network