Government Intervention and Failure Flashcards
Gov failure
When the gov intervene to correct one or more market failures leads to a greater net social welfare loss. When the costs of government intervention to correct market failure exceed the benefits. Gov failure can happen if a policy decision fails to create enough of an incentive to change behaviour of agents to meet the aims of policy
Main causes of gov failure
Impact on inequality, unintended consequences, conflict with other micro/macro objectives, information failure before a policy is introduced, cost of compliance and implementation, policy may be ineffective
Ad Valorem (Indirect) Taxes
VAT. Effect is to cause a pivotal shift in the supply curve, because the tax is a percentage of the unit cost of supplying the product so a good that could be supplied for a cost of £50 will now cost £60 with 20% VAT.
Subsidy
money granted by the government to help an industry or business keep the price of a product or service low to help consumers.
Nationalism
When a government takes over a private sector company so that the business is now wholly or majority state-owned and controlled
Privatisation
The sale of state-owned companies to the private sector, normally through a stock market listing, opposite of nationalism.
Core arguments for privatisation
Power of markets and price mechanism
Private companies have a profit incentive and raise labour productivity
Gov gains significant revenue from sale of assets
Help create a shareholder democracy
Private sector firms more likely to be innovative and increase investment
Core arguments against privatisation
Social objectives are given less importance when a business wants private profits
Some are best state ran with a natural monopoly, like water supply
Government lose out on any future profit
Public sector assets often sold too cheaply
State-owned firms can be dynamically efficient
Regulation
Rule/Law by the government that must be followed by economic agents to encourage a change in behaviour
Benefits to regulations
Control, incentive to change behaviour, solves issues in free markets, allocative efficiency and welfare gain
Possible market failure causes from regulation
Cost, setting the right regulation, black markets, unintended consequences, equity
Pro-free market economists
See a market economy as a calm and orderly place in which the market mechanism achieves a better or more optimal outcome than can be obtained through government intervention
Interventionist economists
Believe that all too often, markets are uncompetitively characterised by monopoly power and prone to other forms of market failure and that by intervening, the government ‘knows better’ than unregulated market forces
Correcting market failure
To one extreme the gov can abolish the market, financed from general taxation and at the other extreme the gov can try influence market behaviour by providing info and by ‘nudging’ firms and consumers to behave a certain way. Between these extremes, govs impose regulations to limit people’s freedom of action in the market place.
Gov provision of public and merit goods
Gov could change prices of merit goods and other goods that yield external benefits, subsidies can also be used to encourage production and consumption. On the other hand, they can force consumers to consume merit goods, for example setting a vaccination as a requirement or a regulation to wear seatbelts in cars. They can also impose regulations that force firms or consumers to generate positive externalities, like ordering landowners to plant trees. In this case, it is illegal to not provide external benefits for others
Taxes
Taxes can be set upon good to disincentivise the use for it, this can be very helpful in reducing the consumption of demerit goods, while also bringing more general revenue towards the government, which allows them more resources
Negative of a Price ceiling
If set below the free-market equilibrium price, in a free market the market forces would raise the price to eliminate excess demand, however this is illegal, therefore there is no mechanism to remove excess demand. Rather than rationing by price, households are rationed by quantity, so queues and waiting lists occur and possibly bribery and corruption due to the struggles of obtaining a good as only favoured consumers can buy the good. Ceilings prevent prices from rising to attract new firms therefore secondary markets may emerge like black markets. Lower profits lowers capital investments long run which hurts consumers. Incorrect price ceiling can cause a massive gov failure
Negative of price floors
In order to affect the market it must be set above the free-market price. In a labour market a national minimum wage above the competitive market wage creates an excess in supply of labour, causing unemployment. May also cause rogue employers to break the law and pay poverty wages to vulnerable employees like illegal immigrants. Price floors also intervene with price functions as falling prices cause inefficient or high-cost firms to leave the market but a price floor prevents this, allowing inefficiency in a market
Evaluation of state versus private debate
Ownership of a business is less important than the extent to which an industry is genuinely contestable
Quality of regulation is also important- a regulator can act as a surrogate consumer
Avoid making ‘lazy assumptions’ such that the private sector is always more efficient
Macroeconomic context is important, a monopoly may face competition overseas
When may a subsidy be justifiable
Helping to correct market failures, protecting jobs during economic recession, improving export performance, reducing income and consumption inequality, funding innovation and growth, changing patterns of spending. Good example:
Improved nutrition can lift labour productivity and reduce long-term burden on health services
Disadvantages of a subsidy
Producers can become “subsidy dependent”, can lead to excess production, environmental risks from excessive production, distort resource allocation, can be very expensive and tax-payers bare the costs
Costs of black markets
Lost tax revenue, enables consumption of de-merit goods, low health and safety standards, takes businesses from law abiding citizens, poor info for gov which can cause more incorrect policies
Benefits of a black market
Provides more jobs, can provide legal necessities in short supply, people can afford healthcare, help countries survive economic crashes through survival in market which reduces strain on gov
Aims of competition policy
Prevent excessive pricing, promote competition, ensure quality standards and choice, regulate natural monopolies or effective privatisation of natural monopolies, promote technological innovation. All to protect consumers
CMA
The regulatory bodies of each market sector such as ORR-railway, CAA-aircraft, OFCOM- communications, OFWAT- water, OFGEM- gas and electricity
Positives of a price ceiling
Prevent excessive profits at expense of consumers, increase in consumer surplus meaning higher real living standards in long run, help stimulate improvements in productive efficiency, can be used as a tool for controlling consumer price inflation
