1.4.1Government intervention Flashcards
maximum price
-Aims to increase consumption levels or prevent price rising so that it is affordable to consume- reduce relative poverty
-Prevent monopoly exploitation
-Set by government below equilibrium
-Demand increases but there is a shortage of supply
Explaining diagram
-Initial market equ at PeQe and the ceiling is at Pmax
-Low prices reduce incentive to supply - curve contracts
-Increased incentive to consume - demand extends
-Some consumers willing to pay P2 (consumer surplus) so the quantity requires rationing or auctioning
Evaluation maximum prices
Benefits:
-prevent exploitation of monopolies
-consumer welfare gains increase as prices are held down
-Incentives for firms to cut costs to maintain profits - innovation is encouraged
Disadvantages:
-Black market transactions- consumers are willing to pay more due to restricted supply
-Decline in quality to maintain profit - reduce quality to cut costs
-If profit is ultimately lowered then there will be less money for capital investment in the long run
-Firms can raise prices of other goods so consumers have no net gain
-shortages
-Long-term solutions like building more housing should be made however temporarily can be beneficial
Examples of maximum price
-Rent controls
-housing made more affordable especially for those on low incomes
-Prevented landlords exploiting high demand for properties due to shortage however creates even more of a shortage
Minimum price
-Set by gov above existing free market
-Help producers earn more
-Decrease consumption of demerit good
Diagram explanation
-High price increase incentives to supply and decrease incentive to consume
-Demand contracts
Evaluating minimum price
BENEFITS:
-consumption decreases so less negative externalities from consumption (strain on NHS)
-Producers receive higher price (agricultural industry)
DISADVANTAGES:
-costs the government to store/buy/export excess supply
-Producers may become overdependent
-Depends on elasticity of good- inelastic goods will not be affected
-Black market- police have to find and can cause serious health problems
-minimum wage may cause firms to lay off workers or increase prices due to increased COP- increased unemployment- excess labour supply
Examples of minimum price
-minimum wage
- protect workers from wage exploitation
-incentivises more workers to join labour market if a minimum pay is guaranteed
-incentivises productivity leading to overall greater local GDP
-Agriculture- income of producers increase as goods are inelastic
-Sugar tax
-reduce negative externalities like antisocial behaviour, less strain on criminal justice system, increase productivity at work and overall health
Indirect taxes
-taxes levied on the expenditure of goods and services
-initially paid by the producer, raising production costs
-specific tax: levied as a set amount per unit
-ad valorem tax: levied as a percentage of the selling price per unit
Example:
57.95p per litre
vat at 20%
Consumer and producer burden of indirect tax
-Producers can pass on some of the higher costs of production to the consumer by charging a higher price - liability of the tax
-the higher price is the consumer burden/ incidence
-Producers cannot pass on all of the tax so the remainder is paid by the producer having to accept a lower price which is the producer burden
-consumer above producer
Analysis and evaluation of indirect taxes
Benefits:
-Aim is to discourage consumption of certain goods often demerit which have negative externalities - internalise the externality and maximise societal welfare
-Also discourage production
-Raises gov revenue that can be used to further reduce negative externalities or provide other services/ better fund public goods - build wind farms to help reduce air pollution
-Provides incentives to become more socially desirable - increased road tax and fuel tax have led cars to become more fuel efficient
-The burden paid by the consumer is very high so the firm does not lose out on too much profit
Disadvantages:
-May not be effective at reducing consumption if the good is price inelastic- if addictive good
-Regressive- low income groups are paying a higher proportion of income in tax increasing inequality
-Encourage tax evasion, less effective at gaining government revenue- people use the black market and find a way of buying the same good, imports from abroad increase
-Additional tax paid by firms might harm employment and profitability of those industries if they cannot pass liability of the tax
-Difficult to determine who is to blame - it is not necessarily the fault of fast food restaurants that people eat unhealthily
Subsidies
-Grant given by government to firms or individuals to encourage production and consumption of a good
-Lowers production costs so shifts supply curve to the left
-P3 paid by consumers, p1 received by producers
-Producers pass on falling cost of production to the consumers in form of lower price
Example:
Farmers- food security, steady income even with market fluctuations, farmers can remain competitive
-However, limited resources and only for certain farmers, overproduction
Local theatre group:
-protect declining industry
-builds community benefiting health and happiness
-Profit can be used to expand
-Other indutries more imprtant, education
-dependant
Consumer and producer gain of a subsidy
-producer above consumer
-Subsidy could cause large fall in price benefiting the consumer
-Or producers might not pass on subsidy in form of lower price - could absorb the subsidy themselves increasing profits
-More inelastic- greater fall in price for consumers
-More elastic- benefits falls more on producer
Analysis and evaluation of a subsidy
Benefits:
-Solves positive externality problem - promotes merit goods
-Lower production costs which boosts profitability- increased profits may be reinvested into new technology increasing output in the long run - incentive for firms to produce socially efficient goods as they receive a reward
-Used to protect declining industries
-prevents increasing (structural) unemployment within certain industries
-Lower market price - producer passes on savings to consumer - solve underproduction - encourage consumption
Disadvantages:
-Opportunity cost- money better spent elsewhere - taxes may need to rise
-Reduce incentives to cut costs- dependent on subsidies - moral hazard
-Benefit large firms who have the money to persuade the government to subsidise them - lobbying
-Depends on price elasticity of demand
-Difficult to measure size of externality
-Firms may absorb the subsidy - unlikely if the market is competitive
Judgement for use of a green tax
-The tax incentivises firms to switch to cheaper, less polluting energy sources with a lower tax or no tax at all
-These greener methods lower the marginal social cost of producing energy
-Tax revenue can subsidise green tech - more cost effective to switch over - depends on gov priorities
-The ultimate success is determined by whether there are effective green substitutes
-Oil is inelastic in demand so firms may just pass on liability of the tax rendering the policy ineffective
Tradable pollution permits
-Cap and trade system
-Gov gives firms an allowance to produce a certain quantity of CO2
-Unused permits can be sold
advantages and disadvantages of TPP
Benefits:
-Internalise the externality
-Incentivises firms to cut pollution as they can earn money by selling their left over permits - efficiency
-Guaranteed that pollution will fall to the target set by gov as supply is fixed
-Encourage a switch to green technology
-EU emissions trading scheme represents a 21% reduction in greenhouse gas
Disadvantages:
-Cost of administration - difficult to monitor - fines need to be imposed large enough to ensure firms follow the regulation
-Higher costs may reduce consumer surplus
-Firms may relocate
-Rich countries may exploit the system - they can buy more permits than developing countries - need a joint global effort
State provision of public goods
e.g. NHS, army, police force
Advantages:
-Redistributes income and wealth - tax money from rich people is used to pay for a good that poorer people may be unable to afford - everyone can now have access to
-Increases consumption of merit goods to correct market failure
-There will be benefits of the goods themselves - healthcare ensures a healthy workforce to aid economic growth
Disadvantages:
-Expensive and represents a high opportunity cost of administration
-May produce wrong combination of goods - there are no price signals/ market forces - democracy aims to solve this issue as consumers can vote for specific political parties - gov may suffer from corruption and conflicting objectives
-Gov production may be inefficient as they have no incentives to cut costs - no threat of going out of business
-Reduces independence of consumer - attract unwanted behaviour - overuse of NHS - take advantage
Provision of information
-Allow people to make informed decisions when there is asymmetric info
Advantages:
-Consumer can act rationally - market works properly
-Works best if used alongside other policies - demand can become more elastic in long run - used alongside indirect taxes to become more effective at reducing output
Disadvantages:
-Expensive for gov - opp cost
-Gov may not have complete information
-Irrational behaviour means consumers may not listen to the info provided
Regulation
-Rules enforced by gov that must be followed - legal action taken if the rules are broken - disincentivise bad behaviour
-e.g. - banning, limiting sales, price caps - environmental protection act
Advantages:
-Ensure consideration of externalities, prevent exploitation, keep consumers informed - overcome market failure and maximise social welfare
Disadvantages:
-Cost of administration of laws/ monitoring - opportunity cost
-Regulatory capture
-Firms may pass on costs - reducing consumer surplus
-Excessive regulation in a market may reduce competition by reducing room for innovation and increasing bureaucracy
