Government intervention Flashcards
Indirect taxation
taxes on expenditure of goods and services e.g. VAT (main indirect tax in UK), alcohol tax
Can be ad valorem (percentage tax by value) or specific (set tax per unit e.g. 58p per litre fuel duty)
How elasticity effects ad valorem tax
If inelastic (alcohol) consumers pay larger burden of tax discouraging consumption of demerit good reducing negative externalities
Government revenue is larger if inelastic as demand falls only slightly with the tax
How elasticity effects specific tax
The more inelastic the demand, the higher the tax burden for the consumer, and the lower the burden of tax for the producer
Indirect taxes could reduce the quantity of demerit goods consumed by
increasing the price of the good.
If the tax is equal to the external cost of each unit
then the supply curve becomes MSC rather than MPC so the free market equilbibrium becomes the socially optimum equilibrium thus internalising the externality
Define subsidy
a payment from the government to a producer to lower their costs of production and stimulate an increase in supply
Subsidies encourage the ______
consumption of merit goods - this includes the full social benefit in the market price of a good internalising the external benefit.
The government might subsidise recycling schemes so that
it is cheaper for consumers to recycle waste which will yield positive externalities for the environment
The vertical distance between supply curves shows the
Value of the subsidy per unit
When demand is price inelastic, consumers…. and producers…
consumers gain more form the subsidy whilst producers supply less than if it was elastic demand
The disadvantages of subsidies include
the opportunity cost to the government and potential higher taxes
the potential for firms to become inefficient if they rely on the subsidy and government failure if inefficient firms can carry on supplying because of subsidy ,
Triangles either side of consumer and producer tax burdens are
welfare loss
Maximum price
a regulated maximum price is a set price (below market equilbirium) that a good must be sold for less than so it doesn’t get too expensive and encouraging consumption or production good
Why maximum price is good
prevent monopolies exploiting consumers
leads to welfare gains for consumers as prices low and increase efficiency in firms due to incentive to keep costs low to maintain profit levels
Evaluation of maximum price
reduce firms profits less investment in long run so firms raise price of other goods so consumers have no net gain
could lead to government failure if misjudge where market price is
Minimum price
a regulated minimum price is a set price (above market equilbirium) that a good must be sold for more than so it doesn't get too cheap and discouraging consumption or production good e.g. national minimum wage reduce negative externalities but increase black market elasticity
Tradeable permits allow
regulated quantities of something to be bought or sold
Tradeable pollution permits help
limit negative externalities in the form of pollution - firms allowed to pollute up to a certain amount and any surplus on their permit can be traded
Advantages of tradeable pollution permits e.g. EU emission trading schame
benefit environment in long run by encouraging firms to use green production methods
raise government revenue as they can sell permits to firms which can be reinvested in green technology
internalises externality
incentive for firms to invest in greener methods
market created with fixed supply and greatest level of output for any given level of pollution as permits allocated efficiently
regulation part gives certainty over total level of pollution
Disadvantages of tradeable pollution permits e.g. EU emission trading schame
Firms relocating to where they can pollute without limits reducing their production costs
pass higher costs of production onto consumers
competition restricted if permits create a barrier to entry for potential firms
creates idea of firms battling pollution
pollution concentrated in hot spots
high administrative costs associated with monitoring pollution emissions
Money spent on firms, cost of production up, supply down, price up
If PED>1 then large fall in QD so drop in profits however if inelastic then small fall in QD
Why are tradeable permits better than regulation
permits end up with those who need it the most creating efficiency - greatest output per pollution
Why are tradeable permits better than taxation
- control quantity of pollution
- price of permit determined by market whereas tax levels are just an arbituary number with no economic value
Why are tradeable permits worse than regulation
- big firms can bypass permits as can buy more permits rather than cutting pollution and if create too many the price of permits is so low it doesn’t reduce pollution (30 billion permits)
Why are tradeable permits worse than taxation
- increases government revenue rather than firms getting revenue from selling permits
State provision of public goods
The government could provide public merit goods making them more accessible increasing their consumption and positive externalises but could be expensive incurring an opportunity cost on their revenue
Reason for market failure in industry
Monopolies (e.g. breaking up monopoloy of BAA airports), asymmetric information
Privatisation
When government firms are given to private sector giving a profit incentive increasing productivity e.g. British gas, telecoms, airways
Provision of information
Governments provide information to prevent information failure so consumers and firms make more informed economic decisions e.g. make it illegal for second hand car dealers not to reveal entire history of car or improve health care information
Regulation
use laws to ban consumption of a good e.g. minimum age of alcohol - reduce negative externality
Negatives of regulation
high administrative costs of policing, rise in black market sales, raise costs of firms who pass costs onto consumers
How to depict revenue for government (tax) or total cost to government (subsidy)
New equilibrium, vertically down, price axis
(box underneath is tax/subsidy revenue/cost for suppliers
