Government Intervention

Question 1

Government intervention

Answer 1

Governments intervene in markets to try and overcome market failure. The government may also seek to improve the distribution of resources (greater equality).

Question 2

The aims of government intervention in markets

Answer 2

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

Question 3

Forms of government intervention in markets

Answer 3

Minimum prices
Maximum prices
Minimum wages
Nudges/Behavioural unit

Question 4

Minimum Prices

Answer 4

This involves the government setting a lower limit for prices, e.g. the price of potatoes could not fall below 13p.

Question 5

How a minimum price works

Answer 5

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.

Question 6

Problems of minimum prices

Answer 6

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.

Question 7

Maximum Price

Answer 7

This involves putting a limit on any increase in price

Question 8

Maximum prices may be appropriate in markets where

Answer 8

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.

Question 9

Eval of max prices

Answer 9

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.

Question 10

Buffer Stocks

Answer 10

A buffer stock involve a combination of minimum and maximum prices. The idea is to keep prices within a target price band.

Question 11

Agriculture suffers from various problems. These include:

Answer 11

Fluctuating Prices
Uncertainty leads to lack of income
Low-Income elasticity of demand
Positive Externalities of Farming

Question 12

Nudges

Answer 12

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.

Question 13

Tax

Answer 13

Tax is a method to discourage consumption of certain goods.

Question 14

Problems of tax

Answer 14

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

Question 15

Subsidy

Answer 15

The government may subsidise goods with positive externalities (for example, public transport or education).

Question 16

Problems of subsidies

Answer 16

Cost to government

Subsidies may encourage firms to be inefficient because they can rely on government aid.

Question 17

Buffer Stock Scheme

Answer 17

A buffer stock scheme is a government plan to stabilise prices in volatile markets. This requires intervention in buying and selling.

Question 18

Prices for agricultural products are often volatile because:

Answer 18

Supply can vary due to the weather.
Demand is inelastic
Supply is fixed in the short term

Question 19

Buffer stock schemes aim to:

Answer 19

Stabilise prices
Ensure the supply of food
Prevent farmers/producers going out of business because of a drop in prices.

Question 20

Advantages of buffer stocks

Answer 20

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.

Question 21

Problems of buffer stocks

Answer 21

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

Question 22

Reasons for Government intervention: Equality

Answer 22

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.

Question 23

Public goods.

Answer 23

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.

Question 24

Education

Answer 24

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.

Question 25

Shift consumer behaviour

Answer 25

The consumption of demerit goods like alcohol, tobacco and opiates can cause personal costs and significant social costs (e.g. crime). If the government identifies damaging goods, they can slowly change consumer behaviour – such as using higher tax, advertising campaigns and behavioural economics, e.g. making cigarettes difficult to buy with unappealing packets. Long-term government campaigns to reduce smoking in the UK and US have been effective in reducing smoking rates – something that has helped to increase life-expectancy.

Question 26

Environment

Answer 26

The environment is an area with a significant need of government intervention. The free market ignores external costs of business on the environment. It also fails to consider long-term considerations. For example, market forces may lead to the burning of fossil fuels, which cause increasing environmental problems around the world – which will get worse in the future. Given the potential costs to future generations, there needs to be government action to shift behaviour to renewable energy which doesn’t cause these environmental costs. Also, the environment involves many issues where private ownership does not apply. If pollution causes a worsening air quality, then this affects everyone on the planet, but market mechanisms do not provide an opportunity to deal with the issue.

Question 27

Monopoly power

Answer 27

In a free market, firms can gain monopoly power to charge high prices to consumers and monopsony power to pay lower wages to workers. This increases inequality and deadweight welfare loss. Government intervention to limit mergers and monopoly power can lead to increased economic welfare.
Strategic planning on

Question 28

Strategic planning on infrastructure

Answer 28

Another limitation of the free market is to underinvest in quasi-public goods like roads and railways. This can lead to transport bottlenecks. Governments can plan for future transport trends and invest in the roads and railways which are needed for the future.

Question 29

Disadvantages of government intervention: Government failure

Answer 29

Government failure is a term to describe how government intervention can cause its own problems. For example, the government may take decisions for short-term political consideration which lead to an inefficient outcome. For example, government tariffs to protect domestic industry spark off a trade war, where the economy contracts.

Question 30

Lack of incentives

Answer 30

In the free market, individuals have a profit incentive to innovate and cut costs, but in the public sector, this incentive is not there. Therefore, it can lead to inefficient production. For example, state-owned industries have frequently been inefficient, overstaffed and produce goods not demanded by consumers.

Question 31

Political pressure groups

Answer 31

Milton Friedman once quipped ‘There is nothing as permanent as a temporary government bailout.’ He was referring to farming subsidies. Introduced in the 1930s during the Great Depression to alleviate a farming recession. After the Second World War, no government dared to remove subsidies because farmers were a powerful pressure group who wanted to keep the subsidies.

Question 32

Less choice

Answer 32

Often government intervention in the economy (e.g. nationalisation of industries) has been associated with less choice. Government produced services have a monopoly. Command economies, often had very little choice as government decided what to produce. Choice is an important element of economic freedom and being able to maximise individual welfare.

Question 33

Impact of personal freedom

Answer 33

An increasing aspect of government intervention is through efforts to shift consumer behaviour – e.g. reduce congestion, improve health through reducing smoking rates and a healthier lifestyle. This includes taxes, behavioural influences and regulations. Sometimes people can feel this is overbearing on their individual choice.