Government Intervention Flashcards
Government intervention
Governments intervene in markets to try and overcome market failure. The government may also seek to improve the distribution of resources (greater equality).
The aims of government intervention in markets
Stabilise prices
Provide producers/farmers with a minimum income
To avoid excessive prices for goods with important social welfare
Discourage demerit goods/encourage merit good
Forms of government intervention in markets
Minimum prices
Maximum prices
Minimum wages
Nudges/Behavioural unit
Minimum Prices
This involves the government setting a lower limit for prices, e.g. the price of potatoes could not fall below 13p.
How a minimum price works
A minimum price will lead to a surplus (Q3 – Q1). Therefore the government will need to buy the surplus and store it. Alternatively, it may impose quotas on farmers to decrease the quantity of the good put onto the market.
Problems of minimum prices
It could be costly for the government to buy the surplus
A minimum price guarantee acts as an incentive for farmers to try and increase supply. As an unintended consequence, the minimum price encourages more supply than expected and the cost for the government rises.
To ensure minimum prices, the government may have to put tariffs on cheap imports – which damages the welfare of farmers in other countries.
Maximum Price
This involves putting a limit on any increase in price
Maximum prices may be appropriate in markets where
Suppliers have monopoly power and are able to generate substantial economic rent by charging high prices
The good is socially important – e.g. good quality housing is important to labour productivity and a nations’ health.
Demand is price inelastic because the good is necessary for maintaining minimum standards of living.
Eval of max prices
If supply and demand are very inelastic, then a maximum price may have little adverse impact on creating shortages. For example, if supply housing for rent is very profitable, then a maximum price will not stop landlords putting the house on the market.
Buffer Stocks
A buffer stock involve a combination of minimum and maximum prices. The idea is to keep prices within a target price band.
Agriculture suffers from various problems. These include:
Fluctuating Prices
Uncertainty leads to lack of income
Low-Income elasticity of demand
Positive Externalities of Farming
Nudges
It is a government policy to influence demand indirectly. For example, putting cigarettes behind closed covers – makes it harder or less enticing for people to buy.
Tax
Tax is a method to discourage consumption of certain goods.
Problems of tax
Demand may be inelastic
Hard for the government to know external cost and how much to tax
May encourage tax evasion – e.g. rubbish tax can encourage fly-tipping
Subsidy
The government may subsidise goods with positive externalities (for example, public transport or education).
Problems of subsidies
Cost to government
Subsidies may encourage firms to be inefficient because they can rely on government aid.
Buffer Stock Scheme
A buffer stock scheme is a government plan to stabilise prices in volatile markets. This requires intervention in buying and selling.
Prices for agricultural products are often volatile because:
Supply can vary due to the weather.
Demand is inelastic
Supply is fixed in the short term
Buffer stock schemes aim to:
Stabilise prices
Ensure the supply of food
Prevent farmers/producers going out of business because of a drop in prices.
Advantages of buffer stocks
Stable prices help maintain farmers incomes. A rapid drop in prices can make farmers go out of business, which leads to structural unemployment.
Price stability encourages more investment in agriculture.
Farming can have positive externalities e.g. helps rural communities. A drop in price could cause a negative multiplier effect within rural areas.
Target prices help prevent excess prices for consumers and help reduce food inflation. This might be important for households living in poverty, who may struggle to pay high prices during years of shortage.
It helps to maintain food supplies and avoid shortages.
It is possible the government could make a profit from a buffer stock scheme. If it buys during a glut and sells during a shortage, it can make a profit.
Problems of buffer stocks
Cost of buying excess supply could become quite high for the government and may require higher taxes.
Minimum prices and buffer stocks could encourage oversupply as farmers know any surplus will be bought. It could even encourage excess use of chemicals to maximise yields because farmers know any excess supply can be sold – even if the market doesn’t want it.
Government subsidy to farmers may encourage inefficiency amongst farmers. There may be less incentive to cut costs and respond to market pressures.
Some goods cannot be stored in buffer stocks, e.g. fresh milk, meat e.t.c.
Government agencies may have poor information e.g. what price to set, how much to buy? is there really a surplus? In practice, it can be difficult to know whether there is a surplus until later in the year.
Administration costs of the scheme.
Minimum prices for foodstuffs may require tariffs on imports.
Globalised markets. Agriculture is a globalised market. If some countries form a buffer stock scheme and buy excess supply, they may find that other countries ‘free-ride’ on their efforts to keep prices high and undercut them.
Are buffer stocks designed to help producers or consumers? Often agricultural buffer stocks are aimed at providing minimum prices and minimum incomes for farmers
Reasons for Government intervention: Equality
In a free market, there is likely to be significant inequality and poverty. This is not due to a meritocracy, but it could be due to unfair advantages of circumstances (inherited wealth, superior education). Governments can intervene to provide a basic security net – unemployment benefit, minimum income for those who are sick and disabled. This increases net economic welfare and enables individuals to escape the worst poverty. This government intervention can also prevent social unrest from extremes of inequality.
Public goods.
Public goods tend not to be provided in a free market because there is no financial incentive for firms to provide goods that people can enjoy for free. Governments can provide national defence, law and order and pay for it out of general taxation. Looking after the environment is also a public good, there are an increasing number of areas, where a government is needed to deal with issues such as forest fires, rising sea levels and pressure on water supplies.
Education
Merit goods are under-consumed in free-market because people underestimate the personal benefits and/or ignore the external benefits. This leads to an underprovision of health care and education. Government intervention to provide free education can lead to a significant improvement in the quality of life for people who are educated. There are also many positive externalities to the rest of society. A well-educated society can improve labour productivity and economic growth.
