Government Intervention And Failure Flashcards
Why do governments intervene in markets
To correct market failure, to address inequality
What are the types of government intervention
Indirect tax (specific and ad valorem)
Producer subsidies
Price controls (max and min prices)
State intervention
Regulation
Legislation
Which kind of good will governments get more tax revenue from with indirect tax
Inelastic (price change has minimal effect on quantity)
How can you show an indirect tax or subsidy diagramatically
It’s basically a shifted supply curve. Government revenue = area of the box from new equilibrium to original price of the good at that quantity to the y axis
What does indirect taxation result in
Welfare loss, as consumer and producer surplus decreasea
Why indirect tax
Revenue
Discourage demerit good consumption
Improve allocative efficiency when there are externalities
Redistribute income by taxing luxury goods
Why subsidy
Support sunrise firms
Encourage merit good production (renewable energy)
Disadvantages of subsidy
Expensive
Can be a poor incentive to firms
Unfair on foreign businesses who don’t have government support, so angers trade partners
Evaluation of government intervention
Causes welfare losses
Disrupts market mechanism (particularly min prices)
Creates distortion in markets
Why price floors
Agricultural support (common in developing countries) - price volatile market
Minimum wages
Demerit goods can be discouraged
When does min price have an effect
When it is above equilibrium price
Negative impacts of min prices (alcohol price)
Low income consumers are priced out, meaning it disproportionately affects low income groups
Incentivises black market production
Producers can make more profit for making demerit goods because PS up.
Why price cap (ie energy)
Consumer protection
Discourage profiteering (making “excess” profits on goods which are necessity)
Political factors - may be public pressure
When does market failure occur
When free markets fail to deliver efficient allocation of resources
Causes of market failure
Externalities lead to non socially optimal market equilibrium
Public, merit and demerit goods (public goods result in free rider problem, where people benefit without paying)
Imperfect information/information asymmetry
Absence of property rights
Price volatility
