Government Intervention and Failure

Question 1

Gov failure

Answer 1

When gov intervention 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

Question 2

Main causes of gov failure

Answer 2

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

Question 3

Ad Valorem (Indirect) Taxes

Answer 3

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.

Question 4

Subsidy

Answer 4

money granted by the government to help an industry or business keep the price of a product or service low to help consumers.

Question 5

Nationalism

Answer 5

When a government takes over a private sector company so that the business is now wholly or majority state-owned and controlled

Question 6

Privatisation

Answer 6

The sale of state-owned companies to the private sector, normally through a stock market listing, opposite of nationalism.

Question 7

Core arguments for privatisation

Answer 7

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

Question 8

Core arguments against privatisation

Answer 8

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

Question 9

Regulation

Answer 9

Rule/Law by the government that must be followed by economic agents to encourage a change in behaviour

Question 10

Benefits to regulations

Answer 10

Control, incentive to change behaviour, solves issues in free markets, allocative efficiency and welfare gain

Question 11

Possible market failure causes from regulation

Answer 11

Cost, setting the right regulation, black markets, unintended consequences, equity

Question 12

Pro-free market economists

Answer 12

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

Question 13

Interventionist economists

Answer 13

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

Question 14

Correcting market failure

Answer 14

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.

Question 15

Gov provision of public and merit goods

Answer 15

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

Question 16

Taxes

Answer 16

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

Question 17

Negative of a Price ceiling

Answer 17

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

Question 18

Negative of price floors

Answer 18

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

Question 19

Evaluation of state versus private debate

Answer 19

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

Question 20

When may a subsidy be justifiable

Answer 20

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

Question 21

Disadvantages of a subsidy

Answer 21

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

Question 22

Costs of black markets

Answer 22

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

Question 23

Benefits of a black market

Answer 23

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

Question 24

Aims of competition policy

Answer 24

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

Question 25

CMA

Answer 25

The regulatory bodies of each market sector such as ORR-railway, CAA-aircraft, OFCOM- communications, OFWAT- water, OFGEM- gas and electricity

Question 26

Positives of a price ceiling

Answer 26

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