Government Intervention Flashcards
Is there government intervention in the uk
The UK is a mixed economy, which means both private enterprise and the government allocate resources to solve the economic problem of what, how and for whom to produce. Often the government intervenes where there is market failure and attempts to correct this so that resources are allocated more efficiently.
Give me examples of various measures a government could undertake to correct market failure
Indirect taxation, subsidies, maximum prices, minimum prices, trade pollution permits, regulation, provision of public goods and provision of market information.
The relative merits of each form of intervention are now considered in relation to different types of market failure. Note that the disadvantages of these measures point to the possibility of government failure.
What are indirect taxes
Indirect taxes are taxes levied on the expenditure of goods or services. The government often imposes taxes on goods which have significant external costs, such as petrol, tobacco, alcohol and electricity generated from burning fossil fuels.
What goods do the government often put indirect taxes on
The government often imposes taxes on goods which have significant external costs eg. Tobacco
What will an indirect tax do to a diagram /fix market failure
In a free market, the equilibrium is where MPC meets MPB=MSB, but the social optimum price is above where MSC meets MPC + tax, thus correcting market failure. The tax collected is shown by a rectangle enclosed by the y axis, to the new equilibrium and then a line drawn vertically down to the MPC curve and across to the y axis, the free market equilibrium shows how the tax area is split between consumers and producers. The consumer tax is above the producer tax.
Tell me the advantages of indirect taxes to correct market failure
In the case of pollution, indirect taxes are based on the principle that the polluters (both consumers and producer) pay, helping to internalise external costs.
They work with market forces so that choice still exists in terms of consumption and production, unlike the effects of some regulation.
The level of pollution should fall as output of the good or service is reduced and the price increased - the social optimum position of MSB = MSC Can be achieved.
Tax funds are raised for the government and these can be used to clean up the environment or to compensate tbf victims of pollution.
Indirect taxes are difficult to evade as they are often included in the market price. The sellers collect the tax revenue and send it to government.
Indirect taxes are convenient, since they tend to be paid in small amounts and regularly rather than in one lump sum.
Tell me the disadvantages of indirect taxes to correct market failure
It is difficult to quantify external costs and then place a monetary value on them. Consequently, the social optimum position might not be achieved.
Indirect taxes increase the costs of production for firms, making them less competitive than firms in other counties where such taxes are not applied.
Widespread use of indirect taxes may be inflationary
Firms may relocate to other countries with less stringent taxes on production.
The demand for the good or service may be price inelastic and so the overall reduction in pollution levels may be small
The tax revenue raised may not be used to compensate victims or clean up the environment
In the case of some goods, unintended consequences may occur such as the development of illegal markets: for examples, tobacco and alcohol smuggling to avoid high taxes.
The regressive nature of indirect taxes leads to further unintended consequences: for example, the burden of payment tends to fall on low income rather than high income groups.
Tell me an evaluation technique to do with indirect taxes
Consider the impact on different interest groups, eg how producers of an inelastic good, eg petrol can pass down tax to consumers mostly.
What is a subsidy
A subsidy is a grant provided by the government to encourage the production and consumption of a particular good or service. Subsidies are often applied on goods or services with significant external benefits, such as education and healthcare. They may also be given to alternative forms of economic activity which create less pollution, such as public transport and renewable energy.
Tell me about the subsidy diagram
When a unit subsidy is applied, Part of the subsidy passed on to consumers, part to producers.
The producer subsidy is above the consumer subsidy (unlike indirect taxes)
A subsidy increase the supply and shifts the supply curve to the right, lowers price and increases output. This can reduce demand for substitute goods eg. A reduction in price of wind power electricity may lead to a reduction in demand in electricity from coal and oil.
Tell me advantages of subsidies applied to renewable energy markets
Subsidies can reduce air pollution and other forms of external costs.
Subsidies on renewable energy generation promote sustained economic growth.
The rate of consumption of non renewable energy resources is reduced
Subsidies work with market forces. They help to internalise the external benefits from renewable forms of energy so that the social optimum level of output can be reached.
Tell me the disadvantages of subsidies applied to renewable energy markets
It is difficult to quantify external benefits and then place a monetary value on them. Consequently, the social optimum position might not be achieved
There is an opportunity cost to government subsidies. They may lead to higher taxes or cuts in government spending elsewhere. They may be a waste of money: for example, many subsidised bus services operate along routes with hardly any passengers.
Unintended consequences may occur: for example, firms may become dependent on the subsidies and inefficient in production
Wind power and solar power may be less reliable sources of energy than traditional fossil fuels.
There are external costs associated with the provision of renewable energy sources: for example, noise and visual pollution from wind farms. They can also reduce property prices nearby.
What’s an evaluation point to do with subsidies about magnitude
Consider the magnitude of an event. For example, when assessing the effects of government subsidies in the renewable energy markets, this will depend upon how large the subsidies are as a proportion of total production costs for the firm.
What’s a maximum price scheme
In a maximum price scheme, the government may impose a limit on how much prices of certain goods and services can rise. Such schemes have been used in house rental markets to protect tenants from being exploited by their landlords.
Similarly, during the Second World War the government imposed maximum prices on basic food items to ensure fairer distribution.
Define a 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.
More recently, what goods were price caps / maximum prices put on
More recently, price caps were applied on various utilities such as gas and electricity. Currently there are price caps on selected rail fares and postal services. There have also been calls for the government to impose maximum wages on exceptionally high-paid public sector workers and bankers.
Where is a maximum price usually set
Usually a maximum price is set below the free market price, causing shortages or an excess demand. A maximum price set above the free market equilibrium price will have no effect.
Tell me about a maximum pricing diagram
There is a horizontal line drawn under the market equilibrium that is the maximum price. Draw vertical lines down from where p max touches supply and demand curves and a line from the free market equilibrium down. The whole area enclosed by the p max line is excess demand.
Tell me the advantages of maximum price
They can reduce exploitation of consumers, especially where a lack of competition exists. For example, the EU has capped the price of some mobile phone calls across member states.
They can reduce inequality, as in the case of a salary cap on highly paid public sector workers and bankers.
They can help people on low incomes to afford key products - for example, rental housing.
Tell me the disadvantages of maximum pricing
Unintended consequences may occur: for example, government intervention distorts the operation of the price mechanism, leading to an excess demand and inefficient allocation of resources.
In terms of the house rental market, it reduces the supply of rental property and makes the shortage worse in the long run.
Producer surplus falls and so landlords have less income with which to invest in and maintain their property.
Problems arise over how to allocate supply and meet the excess demand in the market, since price cannot increase. This may involve a first come, first served basis or sellers preference - both of which are deemed to be unfair.
It is difficult for the government to monitor and enforce maximum price controls in markets. There is a danger of shadow markets being created. Some people may be prepared to pay more for the good to ensure they obtain it. This is often seen with tickets at popular football matches and theatre shows.
What’s a minimum price scheme
In a minimum price scheme, the government may impose a limit on how much prices of certain goods and services can fall. Such schemes have been used in commodity markets to protect the income of farmers and also in labour markets to prevent the exploitation of workers (the national minimum wage),
More recently, there have been calls for a minimum price on goods which create high external costs, such as alcohol and fizzy drinks.
Tell me about farmers and getting a guaranteed minimum price
For example, EU farmers are guaranteed a minimum price for many commodities, including sugar, wheat and barley. Usually the minimum price is set above the free market price, causing agricultural surpluses or an excess supply. These are purchased by a government agency at the guaranteed minimum price.
Note that a minimum price set below the free market equilibrium price will have no effect.
Define minimum price
A floor price set by the government on a good or service, which below it cannot fall. It may be enforced through government intervention
Define guaranteed minimum price
Where the surplus output created is purchased by a government agency at the minimum price. The main aim of such a scheme is to protect producer incomes.
Tell me about the diagram for minimum pricing
A horizontal line is drawn about the free market equilibrium as price minimum (p min) then, where the line crosses the demand and supply curves, lines are draw vertically down to the x axis, this area is government expenditure on the surplus.
Total revenue for producers increase to where p min is equal to supply due to the guaranteed minimum price.
The excess supply is stockpiled by the government.
Tell me the advantages of minimum pricing
They can reduce the consumption of goods which are harmful to consumers and have high external costs, such as alcohol and sugar.
They encourage producers to switch to making ‘healthier’ drinks and foods containing less alcohol and sugar
They can reduce fluctuations in food prices and so make it easier for consumers to budget their income. They also ensure food supplies even in times of poor harvest, due to the availability of surplus stockpiles.
A guaranteed minimum price can stabilise and increase producer incomes, leading to greater investment and employment - for example, in agriculture.
Food surpluses can be used as a form of international aid to developing countries.
A national minimum wage can reduce exploitation of labour while increasing incentives to work.
Tell me the disadvantages of minimum prices
Unintended consequences may occur, for example, government intervention distorts the operation of the price mechanism, leading to an excess supply and inefficient allocation of resources
The price of some food and drinks will increase, which could lead to hardship for consumers on low incomes. A minimum price also reduces consumer surplus.
Minimum prices may be less effective in reducing consumption of alcohol and sugary drinks when demand is price inelastic.
A guaranteed minimum price scheme leads to the government buying up (agricultural) surpluses, which involves an opportunity cost. It may have to raise taxes or cut government spending elsewhere.
There are increased storage and security costs for the food surpluses. Alternatively, the food surpluses may have to be destroyed due to their perishability.
The food surpluses may be sold in overseas markets at very low prices. This could damage farmers in developing countries, who are unable to compete against imports of cheap food.
Farmers are guaranteed an income, which might cause them to become less efficient over time. There is less incentive for farmers to improve the quality of the food or to keep production costs down.
A national minimum wage may cause unemployment among workers in low skilled labour markets.
It is difficult for the government to monitor and enforce a minimum wage policy.
What are tradable pollution permits
They are how much firms are allowed to emit in carbon emissions for the year. The pollution permits are tradable, which means that firms can buy and sell the allowances between firms.
The emissions trading system (ETS) allocates permits to EU country’s every year for national governments to allocate amongst firms
Define 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.
Tell me the advantages of trade pollution permits
A market is created for buying and selling carbon permits, just like other goods and services. In effect, the price mechanism is used to internalise the external costs associated with carbon emissions.
Pollution permits can be reduced over time as part of a coordinated plan. For example, in 2008 the European Commission cut carbon allocations by 5%.
National governments can raise funds by selling their reserve pollution permits to industry. The revenue could then be used to clean up the environment or compensate victims.
Firms have an incentive to invest in clean technology
Production costs will increase for firms that exceed their pollution allowances, since they have to purchase additional permits, and this provides a source of revenue for cleaner firms that can sell their excess pollution permits.
The emissions trading system (ETS) may act as a foundation for global wide scheme. It has attracted interest from developed outside the EU. New schemes can be set up, benefiting the environment.
Firms are able to bank their excess pollution permits for use in future years.
Tell me the disadvantages of trade pollution permits
An information gap might cause the European Commission to issue too many carbon permits, so there is little incentive for firms to reduce pollution. Or issue too few permits, so that production costs for EU firms increase rapidly, reducing their international competitiveness. Some firms may relocate outside outside the EU to reduce production costs.
Disputes have arisen over the allocation of carbon permits for firms. Some companies believe they should receive larger allowances and have taken legal proceedings against the European Commission.
Firms may pass the cost of purchasing pollution permits on to their customers, leading to higher prices of goods eg electricity, steel, glass and paper. This is more likely to happen if demand is price inelastic.
Unintended consequences may occur: eg there is less pressure on major firms to clean up their act if it is possible to buy extra permits from elsewhere.
The price of pollution permits has fluctuated considerably since their inception in 2005. This has created uncertainty among firms about whether to invest heavily in carbon reducing technology. Firms need clear guidance on what carbon prices will be for the next decade in order to determine their investment levels.
There is a cost to the government of monitoring pollution emissions from the many companies within the scheme.
It won’t make a difference to the world if other countries continue polluting how they want.
The valuation of pollution permits is an inexact science. Perhaps it is too important to leave to the market. Much disagreement exists over the costs of greenhouse gas emissions. Some environmental groups believe too little is being done to reduce carbon emissions. Carbon trading is simply leading to false sense of security.
Why is there state provision of public goods
Public goods would not be provided/under provided in a free market economy due to the free rider problem. Once the good is provided, people are able to consume it without paying, and so private enterprise has no incentive to supply it, since making a profit would be difficult.
Consequently, the government or state tends to provide public goods in order to correct market failure.
