Government intervention

Question 1

How may a government intervene to correct market failure?

Answer 1

• Indirect taxes
• Subsidies
• Maximum and minimum prices
• Regulation
• Trade pollution permits
• State provision of public goods
• Provision of information

Question 2

What are the disadvantages of indirect taxes?

Answer 2

• May be difficult to target
• Government may use indirect taxes to raise revenues as well as reduce market failure (two objectives conflict when deciding the size of the tax)
• Taxes are unpopular

Question 3

What are the disadvantages of subsidies?

Answer 3

• Difficult to target ; subsidy may be too large or small
• Conflict with other policy objectives
• Over reliance on subsidy

Question 4

What is a trade pollution permit?

Answer 4

A permission issued, usually by a government, to allow a fixed amount of pollution to be created ; this permit can be used by the owner or sold to another firm

Question 5

What is government failure?

Answer 5

When a government intervention leads to a net welfare loss compared to the free market solution

Question 6

What are the causes of government failure?

Answer 6

• Distortion of price signals
• Unintended consequences
• Excessive administrative costs
• Information gaps