Government intervention Flashcards
What does it mean if the UK is a mixed economy
- Both private enterprise and the government allocate resources
- To solve the economic problem of what, how and for whom to produce
When is there government intervention in a market
When there is a market failure
What do governments attempt when intervening
They try to correct market failure so that resources are allocated more efficiently
What measures could a government undertake to correct market failure
- Indirect taxation
- Subsidies
- Maximum prices
- Minimum prices
- Trade pollution permits
- Regulation
- Provision of public goods
- Provision of market information
What are indirect taxes
Taxes levied on the expenditure of goods and services
What type of goods do the government impose taxes on
Goods which have significant external costs (tobacco, alcohol)
Indirect tax on a good diagram
(real card 37)
What does the diagram show
The MPC(marginal private cost) and the MSC (marginal social cost curve)
What is the equilibrium price and quantity in a free market
OPe and OQe
What is the social optimum price and quantity
OP1 and OQ1 where MSC=MSB for the last unit produced
What does the vertical distance ZY represent
The external cost for each unit consumed
How can the government successful internalise an external cost
By placing a tax equal to the external cost of ZY per unit
What is shown by the area P1YZW
The total tax collected
Who pays the total tax
Producers and consumers depending on the relative elasticities of demand and supply
What is the consumer tax area
YP1PeT
What is the producer tax area
PeTZW
Advantages of indirect taxes to correct market failure
(LIE WIT)
Level of pollution
- Level of pollution should fall as output of the good or service is reduced and price is increased
- Therefore social optimum position of MSB=MSC can be achieved
Advantages of indirect taxes to correct market failure
(LIE WIT)
Internalisation of indirect tax
- Internalisation of indirect taxes:
- Indirect taxes force polluters (both producer and consumer) to pay for the external costs
- This internalises the external costs in the case of pollution
Advantages of indirect taxes to correct market failure
(LIE WIT)
Evasion is Difficult
- Evasion is Difficult:
- It is difficult to evade indirect taxes
- They are often included in the market price
- Sellers collect tax revenue and send it to government
Advantages of indirect taxes to correct market failure
(LIE WIT)
Works with market forces
- Works with market forces
- So that choice still exists in terms of consumption and production
- Unlike some regulation effects
Advantages of indirect taxes to correct market failure
(LIE WIT)
Indirect taxes are convenient
- Indirect taxes are convenient
* They tend to be paid in small amounts in a regular manner
Advantages of indirect taxes to correct market failure
(LIE WIT)
Tax funds raised for the government
- Tax funds raised for the government
- This can be used to clean environment
- This can be used to compensate pollution victims
Disadvantages of indirect taxes to correct market failure
- Difficult to quantify external costs and place a monetary value on them
- So the social optimum position may not be achieved
Disadvantages of indirect taxes to correct market failure
- Increased costs of production for firms due to indirect taxes
- This makes firms less competitive internationally
- Compared to countries where these taxes are not applied
Disadvantages of indirect taxes to correct market failure
•Widespread use of indirect taxes may be inflationary
Disadvantages of indirect taxes to correct market failure
•Firms may relocate to other countries with less restrictive taxes on production
Disadvantages of indirect taxes to correct market failure
•Price inelastic demand for a good or service will mean the reduction in pollution levels may be small
Disadvantages of indirect taxes to correct market failure
•Tax revenue raised may not be used to compensate victims or clean the environment
Disadvantages of indirect taxes to correct market failure
- Unintended consequences may occur in the case of some goods
- E.g development of illegal markets or smuggling of tobacco to avoid high taxes
Disadvantages of indirect taxes to correct market failure
- Regressive nature of indirect taxes lead to further unintended consequences
- E.g burden of payment falls on low-income groups rather than high-income groups
What is a subsidy
A grant provided by the government to encourage the production and consumption of a good or service
Where are subsidies often applied on
- Goods or services with significant external benefits
- E.g education and healthcare
- E.g renewable energy to create less pollution
Application of subsidy on market for renewable energies
(real card 38)
What is the effect of the subsidy for the renewable energy good
To lower the price of each unit from Pe to P1 and to increase quantity from Qe to Q1
What is the subsidy per unit
AB
What is the total subsidy area
ABCP1
How is the subsidy passed on to consumers
In the form of lower price elasticity equal to the area AGPeP1
What is the other portion of the subsidy
GBCPe
What does this portion of the subsidy remain with
The producer
What will the lower price of the renewable energy sources help decrease
The demand for non-renewable sources from D to D1
Impact of the subsidy on renewable energy sources to the non-renewable energy market
(real card 39)
Advantages of subsidies applied to renewable energy markets
(RISE) Reduced external costs
•Reduce air pollution and other external costs
Advantages of subsidies applied to renewable energy markets
(RISE) Internalising external benefits
- Internalises external benefits from renewable forms of energy by working with market forces
- So social optimum level of output can be reached
Advantages of subsidies applied to renewable energy markets
(RISE)Subsidies on renewable energies
•Subsidies on renewable energy generation promote sustained economic growth
Advantages of subsidies applied to renewable energy markets
(RISE)Reduction of non-renewable energy
•Reduction of consumption of non-renewable energy resources
Disadvantages of subsidies
(DUO WE)Difficult to quantify external benefits
- Difficult to quantify external benefits and place a monetary value on them
- The social optimum position might not be achieved
Disadvantages of subsidies
(DUO WE)Unintended consequences
- Unintended consequences may occur
- E.g firms may become dependent on subsidies
- This may make them inefficient in production without subsidies
Disadvantages of subsidies
(DUO WE)Opportunity cost
- Opportunity cost to government subsidies
- May lead to higher taxes or cuts in government spending
- They may be a waste of money
- E.g many subsidised bus services operate with hardly any passengers
Disadvantages of subsidies
(DUO WE)Wind power and solar power
- Wind power and solar power may be less reliable sources of energy
- Compared to traditional fossil fuels
Disadvantages of subsidies
(DUO WE)External costs
- External costs associated with provision of renewable energy sources
- E.g noise and visual pollution from wind farms
- They can also reduce property prices nearby
evaluation of indirect taxes
- depends on impact on different interest groups
- e.g an increase in petrol may have a bigger impact on consumers than on petrol producers
- since demand is price inelastic petrol firms can pass on most of the tax to consumers
- the government is also likely to benefit from increased tax revenue
evaluation of subsidies
- depends on magnitude of the event
- e.g government subsidies in the renewable energy market
- this will depend on how large the subsidies are as a proportion of total production costs for firms
Define maximum price
- A ceiling price set by the government on a good or service above which it cannot rise
- It may be enforced through government legislation
Examples of maximum price schemes
- These schemes have been used in house rental markets
- This was to protect residents fro being exploited by landlords
- In WW2 the government imposed maximum prices on basic food items
- E.g milk eggs and meat
- This ensured a fairer distribution
Examples of recent price caps
- Price caps were applied on various utilities
- E.g gas and electricity
- Currently there are price caps on selected rail fares and postal services
- There have been calls for the government to impose maximum wages on highly paid public sector workers
Where is the maximum price usually set
- Below the free market price
* This causes shortages or excess demand
Maximum price diagram
(real card 40)
What does a maximum price of P1 cause
- Demand extends from Qe to Q2
- Supply contracts from Qe to Q1
- Leads to an excess demand of Q1Q2
What does the shortage of private rental housing lead to
- Housing may be allocated on a first-come, first-served basis or by the sellers’ preference
- Both forms of allocation have undesirable consequences
How may the government intervene in the housing markets
- The government may impose regulations on the type of consumers to who private landlords can rent
- E.g vulnerable people or young mothers
- However it is more likely that this type of legislation will be used for public sector housing
Advantages of maximum prices
- Reduce exploitation of consumers especially where a lack of competition exists
- E.g the EU has capped the price of mobile phone calls across member states
- Reduce inequality as in the case of a salary cap on highly paid public sector workers
- Help people on low incomes to afford key products
- E.g rental housing
Disadvantages of maximum prices
(DURPP)
Difficult for the government to monitor and enforce maximum price controls in markets
- Difficult for the government to monitor and enforce maximum price controls in markets
- Danger of shadow markets being created
- Some may be prepared to pay more for the good to ensure they obtain it
- E.g tickets at popular football matches
Disadvantages of maximum prices
(DURPP)
Unintended consequences may occur
- Unintended consequences may occur
- E.g government intervention distorts operation of price mechanism
- This leads to an excess demand
- This also leads to an inefficient allocation of resources
Disadvantages of maximum prices
(DURPP)
Reduced supply of rental property in terms of the house rental market
- Reduced supply of rental property in terms of the house rental market
- This worsens the shortage in the long run
Disadvantages of maximum prices
(DURPP)
Producer surplus falls
- Producer surplus falls
* Landlords would have less income with which to invest in and maintain their property
Disadvantages of maximum prices
(DURPP)
Problems arise over how to allocate supply
- Problems arise over how to allocate supply
- In order to meet the excess demand in the market as price cannot increase
- This may involve a first-come, first-served basis or sellers’ preference
- Both options are deemed to be unfair
Evaluation of maximum prices
- Depends on the difference between short-run and long-run effects of an event
- E.g a maximum rent control may have few short term effects
- In the long run it is likely to lead to a serious deterioration in the quality of properties
- This is because landlords lack the funds to maintain them properly
What is a minimum price
- A floor price set by the government on a good or service below which it cannot fall
- May be enforced through government legislation
Where have minimum price schemes been used
•In commodity markets to protect incomes of farmers
•In labour markets to prevent market exploitation
(e.g national minimum wage)
Where have there been calls for minimum prices
- On goods which create high external costs
* E.g alcohol and sugar
Minimum price effect on agriculture
- EU farmers are guaranteed a minimum price for many commodities
- E.g sugar and wheat
Where is the minimum price usually set
Above the free market price, causing excess supply or surpluses
How does a government agency respond to excess supply
They purchase the excess supply at the guaranteed minimum price
What will happen if a minimum price is set below the free market equilibrium price
There will be no effect
Define guaranteed minimum price
- Where the surplus output created is purchased by a government agency at the minimum price
- The main aim is to protect producer incomes
Minimum price scheme diagram
(real card 41)
How will a minimum price of P2 affect demand
Demand will contract from Qe to Q1
How will a minimum price of P2 affect supply
Supply will extend to Qe to Q2 leading to an excess supply of Q1Q2
What is the government expenditure area on the diagram
The area Q1Q2YW
What would happen to the total producer revenue on the diagram
The revenue would increase from OPeXQe to OP2YQ2
Advantages of minimum prices
(NEGR(O) FC)
1.National minimum wage
A national minimum wage can reduce labour exploitation while increasing incentives to work
Advantages of minimum prices
(NEGR(O) FC)
2.Encourages producers to switch
Encourages producers to avoid producing goods containing alcohol and sugar
Advantages of minimum prices
(NEGR(O) FC)
3.Guaranteed minimum price
- Guaranteed minimum price can stabilise and increase producer incomes
- This would lead to greater investment and employment
- E.g in agriculture
Advantages of minimum prices
(NEGR(O) FC)
4.Reduced fluctuations in food prices
- Reduced fluctuations in prices would be caused
- So it is easier for consumers to budget their income
- Ensures food supplies even in times of poor harvest:
- Due to availability of surplus stockpiles
Advantages of minimum prices
(NEGR(O) FC)
5.Food surpluses
Food surpluses can be used as a form of international aid to developing countries
Advantages of minimum prices
(NEGR(O) FC)
6.Consumption of harmful goods reduced
- Consumption of goods which are harmful to consumers are reduced
- E.g goods which have high external costs such as alcohol and sugar
Disadvantages of minimum price(RUM GIF END)
RUM
- Reduced consumer surplus
* Price of some goods will increase leading to hardship for consumers on low incomes
Disadvantages of minimum prices(RUM GIF END)
RUM
- Unintended consequences may occur
- E.g government intervention distorts price mechanism operation
- This leads to an inefficient allocation of resources and excess supply
Disadvantages of minimum prices(RUM GIF END)
RUM
- Minimum prices may be less effective in reducing consumption of inelastic goods with high external costs
- E.g alcohol
Disadvantages of minimum prices(RUM GIF END)
GIF
- Guaranteed minimum price schemes lead to government buying surpluses
- This involves an opportunity cost or raising taxes or cutting government spending elsewhere
Disadvantages of minimum prices(RUM GIF END)
GIF
- Increased storage and security costs for food surpluses
* Food surpluses may have to be destroyed due to their perishability
Disadvantages of minimum prices(RUM GIF END)
GIF
- Food surpluses may be sold in overseas markets at low prices
- This could damage farmers in developing countries who struggle to compete against cheap imports
Disadvantages of minimum prices(RUM GIF END)
END
- Efficiency of farmers on guaranteed incomes may decline
* Due to less incentive for farmers to improve the quality of food or keep production costs down
Disadvantages of minimum prices(RUM GIF END)
END
National minimum wage may cause unemployment among workers in low-skilled labour markets
Disadvantages of minimum prices(RUM GIF END)
END
Difficult for the government to monitor and enforce a minimum wage policy
What are tradable pollution permits
- Pollution permits that can be bought and sold in a market
* They are an attempt to solve the problem of pollution by creating a market for it
Why did the European Commission(EC) set up the ETS (emissions trading system)
To limit greenhouse gas emissions from heavy industry
What is the ETS
- A cap and trade scheme
- An amount of carbon dioxide permits to national governments is set each year
- Governments divide up allowances among firms covered by the scheme
Why are pollution permits tradable
- So firms can buy and sell the allowances between themselves
- Any surplus on their permit can be traded
How were tradable pollution permits given before the scheme
- The permits were given free to the industry
* They were allocated on the basis of the amount of pollution created
How much of carbon permits are retained by national governments
•They are able to retain up to 10% of carbon permits
They can offer them for sale depending on the level of scarcity
How does the ETS reduce carbon emissions
- They give incentives to firms to invest in clean technology
- This reduces carbon emissions in the long run
Why are carbon permits reserved
- To enable new firms to enter the industries within the trading scheme
- Firms can invest in schemes that reduce carbon emissions outside the EU
Disdvantages of tradable pollution permits(FUC DIE)
FUC
- Firms may pass costs of purchasing pollution permits to consumers
- This leads to higher prices of commodities
- E.g electricity
- This is likely if demand is price inelastic
Disadvantages of tradable pollution permits(FUC DIE)
FUC
- Unintended consequences may occur
- E.g less pressure on major polluting firms to clean up their act if they can buy extra permits elsewhere
- Firms may relocate outside of the EU to reduce production costs
Disadvantages of tradable pollution permits(FUC DIE)
FUC
Cost to government of monitoring pollution emissions from many companies within the scheme
Disadvantages of tradable pollution permits(FUC DIE)
DIE
- Disputes have arisen over allocation of carbon permits to firms
- Some companies believe they should receive larger allowances
- Some companies have taken legal action against the EC
Disadvantages of tradable pollution permits(FUC DIE)
DIE
- Information gaps may cause the EC to issue too many carbon permits
- This means there is little incentive for firms to reduce pollution
- Information gaps may also cause the EC to issue to little carbon permits
- This means production costs for EU firms rise rapidly
- This reduces their international competitiveness
Disadvantages of tradable pollution permits(FUC DIE)
DIE
- EU is just one part of the world
* Unless all countries engage in a similar scheme global emissions will continue to increase
Advantages of tradable pollution permits(PEN FAP)
PEN
- Pollution permits can be reduced over time as a part of a coordinated plan
- E.g in 2008 EC cut carbon allocations by 5%
Advantages of tradable pollution permits(PEN FAP)
PEN
- ETS may act as a foundation for a global-wide scheme
* It has attracted interest from developed countries outside of the EU
Advantages of tradable pollution permits(PEN FAP)
PEN
- National governments can raise funds by selling their reserve permits to the industry
- The revenue could be used to clean up the environment or compensate victims
Advantages of tradable pollution permits(PEN FAP)
FAP
- Firms have an incentive to invest in clean technology
* Firms are able to bank their excess pollution permits for use in future years
Advantages of tradable pollution permits(PEN FAP)
FAP
- A market is created for buying and selling carbon permits
* In effect the price mechanism can internalise the external costs associated with carbon emissions
Advantages of tradable pollution permits(PEN FAP)
FAP
- Production costs will increase for firms that exceed their pollution allowances
- This is because they have to purchase additional permits
- This provides a source of revenue for cleaner firms that can sell their excess pollution permits
What is the purpose of state provision of information
RED
- Reminds and notifies people of laws for their own protection
- E.g seatbelts in motor vehicles
- E.g not consuming alcohol while driving
What is the purpose of state provision of information
RED
- Encourages production/consumption of underprovided goods and services that have benefits
- E.g pensions that yield long-term benefits
- E.g healthy goods such as fruit
What is the purpose of state provision of information
RED
- Discourages production/consumption of overprovided goods and services that have costs
- E.g unhealthy goods such as alcohol
Define regulation
- Government rules in markets to influence behaviour of consumers and producers
- E.g Environmental Protection Act
What is the Environmental Protection Act
- Minimum environmental standards for emissions were set
- For over 3500 factories involved in waste incineration and oil refining
- These firms are monitored by government pollution inspectors who can impose fines and close down factories
Advantages of regulations
FLAIRS
- Firms can deter consumers and producers to not break the law
- Revenue collected from fines can compensate victims
Advantages of regulations
FLAIRS
- Limits can be imposed on operation of firms to protect consumers
- E.g limit on number of night air flights from Heathrow airport
Advantages of regulations
FLAIRS
- Asymmetric information problem can be reduced
- E.g restrictions on sale of tobacco will cause difficulty for young people to start smoking
- If they do not understand the consequences
Advantages of regulations
FLAIRS
- It is possible to fine or close down companies that abused regulations
- E.g for emitting dangerous levels of toxic waste
Advantages of regulations
FLAIRS
- Regulations require firms to restore and clean up the site after production
- E.g in mining and quarrying operations
Advantages of regulations
FLAIRS
- Simple to understand
* E.g legal restrictions on the age at which people can buy alcohol
Disadvantages of regulations
WISE U
- Wrong level may be set for regulations to correct market failure
- E.g difficult to attach a monetary value to pollution emissions
- So social optimum position may not be reached
Disadvantages of regulations
WISE U
- Increased production costs of firms may be caused
- This reduces competitiveness among global markets
- Especially against firms with few restrictions
Disadvantages of regulations
WISE U
- Stopping of operation of price mechanism may occur
* Regulations may overrule the mechanism than work with it
Disadvantages of regulations
WISE U
- Expensive to monitor and enforce and administration costs can be high
- E.g in the case of pollution levels imposed on firms
Disadvantages of regulations
WISE U
•Unintended consequences may occur
