Government Intervention Flashcards
Why are price fluctuations bad? (3)
- Causes revenue/profits of producers to fluctuate
- Reduces their living standards in the and years
- May force them into bankruptcy/cash flow problems if price falls below costs of production - Discourages investment, due to uncertainty, producers save extra profit rather than investing it
- Impact on customers. If they are other firms, their profits also fluctuate, as they don’t know their costs of production
What’s a way to reduce the uncertainty caused by fluctuating prices?
Diversification - producing of a range of products
Explain a Buffer Stock Scheme
- Government estimates LR market price
- Government sets a max & min price, either side of the LR market price
- In a good year, P goes below minP so government buys to keep P=minP
- In a bad year, P goes above maxP so government sells to keep P=maxP
Will a buffer stock scheme work? (7)
- It involves a cost to the government. There is an initial cost and a cost of storage
- Is the product perishable?
- What if a bad year occurs first? The government might be temped to set the price range quite high to buy more often and sell less often. But this makes issues worse and means consumers pay more
- Asymmetric information - producers know more about the LR than the government so they may push the government to set a higher target price range
- The model assumes D does not change, if it does the price range is wrong
- Requires all producers to be part of the scheme
- How often the government has to intervene depends on the PED
Define Market Failure
Market Failure is when the price mechanism does not allocate resources efficiently. In theory the market should produce the ‘correct amount’ of each good, but this does not always happen - sometimes the market will ‘under-produce’ and sometimes it will ‘over-produce’
What are the main causes of market failure: (4)
- Nature of the good/ “public good”
- External costs & benefits
- Asymmetric information
- Factor immobility
What is a Public Good?
A Public Good is one where there is:
- non-rivalry: one person consuming the food does not mean there is less available for other customers
- non-excludability: once a good is provided then it is impossible to prevent non-payers from using the good
- the free rider problem: a person can receive the benefits of a good without paying for it, so the ‘logical’ thing to do is not to pay, but if everyone thinks like this then no one pays and so no firm would be prepared to make the good, so no one would get it. This is called a missing market
All public goods are provided by the government and we all pay via taxation. However not all government provided goods (public sector) are public goods
Explain the concept of Externalities
In theory markets are efficient because the market equilibrium (S=D) is where the marginal (extra) cost = marginal (extra) benefit. However these are the costs/benefits to those people involved in the trade (buyer/seller) but there may be costs to 3rd parties (people not involved in the trade). The efficient Q (or allocation of resources) ought to take these 3rd party costs/benefits into account, but the price mechanism does not.
The Costs/Benefits to those involved in the trade = Marginal Private Costs/Benefits
The Costs/Benefits to 3rd parties = External Costs/Benefits
All Costs/Benefits = MPC/B + External C/B = Marginal Social Costs/Benefits
When Qm does not equal Qse there is market failure
Qm > Qse - the market overproduces
Qm
Describe issues with externalities: (4)
- Measuring externalities - even if we can agree that an external cost/benefit exists, it is almost impossible to put a monetary value on an externality
- SR vs LR - many products cause an external cost in SR but an external benefit in LR
- May be both external costs & benefits - these may counter act each other, ie. polluting factory creating jobs
- Size of Qse-Qm (market failure) depends on elasticity of curves (more inelastic = less difference)
Explain Asymmetric Information
For a market to work efficiently both buyer and seller should have access to the same information (about the quality, benefits, alternatives…). Where this does not occur we have market failure caused by asymmetric information
Examples:
- Seller knows more: cars, housing, foods, drugs, education
- Buyer knows more: health insurance
Explain mobility of labour
Mobility of labour refers to how willing/able workers are to move jobs. There are 2 types of immobility:
- Occupational immobility: where the workers don’t have the skills/qualifications to change profession. Often this includes an unwillingness/mobility to retrain
- Geographical immobility: where workers can’t travel to/don’t live in areas where jobs are. One reason why they are unwilling to move is house prices, another - family/friends
What are the possible solutions to immobility of labour: (4)
- Subsidising training schemes/paying people on training
- Rent control (maximum price for rent)
- Building of new, affordable housing
- Improving transport links (easier/cheaper to travel to work)
What are the 2 categories of government intervention?
- Replacing the market
- Internalising the externality: polluter pays, the firm is responsible
Explain and evaluate State Provision
State provision - state producing the product at Qse. However how does the state know how much to provide? Also it is an opportunity cost as the state produces many other things.
Explain and evaluate Regulation
Regulation - introducing laws: asymmetric information - calories on packaging, banning children from buying certain products, introducing limits or quotas on the amount of pollution a firm can produce.
Advantages:
- Easy to understand and easy to enforce
Disadvantages:
- Can be expensive to monitor firms
- May increase costs for firms
- Ignores price mechanism (government regulation does not account for changes of Qse)