Government intervention and types of intervention

Question 1

Reasons for government intervention

Answer 1

• Correct any market failure
• Achieve a fairer (or more equitable) distribution of income and wealth
• Achieve the government’s macroeconomic objective for the economy

Question 2

What is Indirect taxation?

Answer 2

Indirect taxes can alter the supply of certain goods or services , such as reducing the consumption of demerit goods(cigarettes) , this leads to the supply curve shifting left.

Question 3

What are the two different types of indirect taxation ?

Answer 3

• Specific/unit taxes: fixed amount put on a unit of a good/service. E.g per litre of alcohol
• Ad valorem taxes: involve adding a percentage of a good/service.E.g VAT at 20%

Question 4

What are the advantages of Indirect Taxation ?

Answer 4

• Indirect taxes are usually put on goods/services that have an inelastic demand curve, this means there is a high amount of tax revenue gained
• Tax helps internalise an external cost , to reflect more accurately the impact of a negative externality on price and quantity

Question 5

What are the disadvantages of Indirect Taxation ?

Answer 5

• Since supply curve is inelastic consumers do not respond much unless the tax is very large- can reduce the impact of the tax
• Extremely difficult to place an accurate monetary value on external costs - makes it near impossible to correctly ‘internalise’
• Regressive in nature - take a larger percentage of a poorer persons income, which is seen as unfair
• International competitiveness may be reduced - Cost of production is large relative to foreign competition

Question 6

What are subsidies ?

Answer 6

A payment made to producers to encourage increased production of a good/service, such as merit goods(Public goods), this leads to supply curve shifting right

Question 7

Advantages of Subsidies

Answer 7

• Can increase consumption of merit goods
• brings equilibrium closer to social optimum
• helps internalise the external benefits
• Reduce the price of a goods - reduces the effects of relative poverty.

Question 8

Disadvantages of Subsidies

Answer 8

• Hard to place a monetary value on the size of external benefits
• Carries an opportunity cost - money could be spent on new roads/hospitals
• Firms may become reliant on them - encourages productive inefficiency and laziness
• If placed on goods with inelastic demand - does not significantly increase consumption

Question 9

What are Minimum Prices ( benefits the suppliers )

Answer 9

• A Price floor placed above the free market equilibrium price for example, The setting of the National Minimum Wage

Question 10

What are the advantages of Minimum prices ?

Answer 10

• Give producers a guaranteed minimum price and income - helpful for farmers in LEDC
• Encourage production of essential products- Common Agriculture Policy (CAP)
• Excess supplies may be bought by the government and released in time of future shortage

Question 11

What are the disadvantages of Minimum prices ?

Answer 11

• Consumers pay higher- reduces their disposable income
• Encourages overproduction - may need to be put into storage which generates further costs
• Opportunity costs - When government purchases excess supplies
• May reduce international Competitiveness
• Unintended costs - may lead to undesired consequences

Question 12

What are Maximum Prices ( benefits the consumers )

Answer 12

A price ceiling above which prices are not permitted to rise for example rent controls in densely populated cities

Question 13

What are the advantages of Maximum prices ?

Answer 13

• Equity/ fairness - without maximum prices some would not be able to afford certain goods and services ( Prescription Medication)
• Reduces Exploitation - reduces ability of monopoly firms to charge higher prices

Question 14

What are the disadvantages of Maximum prices ?

Answer 14

• Creates excess demand - creates queues, shortages and waiting lists , this can have serious implications in places like healthcare
• Black markets - can lead to establishment of unofficial prices for things like music and event tickets

Question 15

What is Direct Provision ?

Answer 15

If a product is being provided in insufficient or excessive quantities (merit / demerit goods) or not at all (public goods). The government will organize provision with funds from their tax revenue.
The government will usually pay a private sector to pay for the production of the good e.g Government may pay a construction firm to build a new school.Generally these goods are free or nearly free , ‘at the point of consumption’.

Question 16

What are Regulations?

Answer 16

Rules and/laws to control/restrict the actions of economic agents in order to reduce market failure.Example of regulations:
- Banning smoking in public places
- Minimum legal age to drink alcohol
- Max emissions levels on new cars
If consumers do not adhere to the rules and they may be punished

Question 17

What is Information Failure ?

Answer 17

• Occurs when people have an inaccurate or incomplete data and so make potentially ‘wrong’ choices/decisions
• In competitive markets, it is assumed that producers and suppliers both have perfect information

Question 18

What are the causes of Information Failure ?

Answer 18

• Long term consequences: info gaps about long term benefits.
• Complexity: Info failure when product is too complicated
• Unbalanced information : when buyer/seller know more information than the other
• Price information : Consumers are unable to quickly find sufficient information

Question 19

What are example of information Failure ?

Answer 19

• Addiction to painkillers and other drugs
• Complexity of pension schemes
• Uncertain quality of second hand products

Question 20

What is Asymmetric information ?

Answer 20

Asymmetric information in markets is when there is an imbalance in information between buyer and seller which can distort choices

Question 21

What are the two types of asymmetric information?

Answer 21

• Moral Hazard

- Adverse Selection

Question 22

What is Moral Hazard ?

Answer 22

• Occurs when insured customers are more likely to take greater risks
• If your bike is not insured you will take great care to avoid it getting stolen. You will lock it carefully. - - However, if it becomes insured for its full value then if it gets stolen you do not really lose out. Therefore, you have less incentive to protect against theft. This becomes a situation of asymmetric information.
• The insurance company may assume you will look after your bike, but you may know that you won’t.

Question 23

What is Adverse Selection ?

Answer 23

• Adverse selection occurs when buyers have better information than sellers and so the highest cost consumers end up buying a particular product.
• For example health insurance companies know those who buy health insurance are more likely to need to use it so they raise the price because if they don’t they will suffer a loss

Question 24

What is Government Failure ?

Answer 24

When government intervention in a market reduces overall economic welfare
-Government failure is said to occur when resources are misallocated

Question 25

What are the reasons for government failure?

Answer 25

• Unintended consequences
• Inadequate information
• Market distortions
• Administrative costs
• Regulatory Capture
• Policy myopia
• Political self interest

Question 26

What is Inadequate information ?

Answer 26

• Governments often have to act with imperfect information.
  It is very difficult to put a monetary value on benefits and external costs.
  - For this reason, subsidies and indirect taxes used to deal with this issues
  is unlikely to be effectively internalise and lead to social optimum and
  maximum output

Question 27

What is Unintended consequences

Answer 27

• For example, imposing a minimum price per unit for alcohol may lead to:
  - Greater consumption of hard drugs and consequently causes more pressure on health services and policing
  - Reduced alcohol consumption of alcohol may increase unemployment in the alcohol industry
• These consequences are considered to be unforeseen by the government and thus be unintended

Question 28

What is Market distortions

Answer 28

• Government intervention for market failure may lead to inefficiencies such as surpluses and shortages
• A maximum price on aspects of health care can lead to an excess demand
• Minimum wage can lead to an excess supply in some low paid occupations

Question 29

What is Administrative costs

Answer 29

• Possible that costs of researching and implementing intervention might outweigh the possible benefits which could lead to an even worse allocation
• For example , the costs of recruiting and paying inspectors to ensure certain regulations are being adhered to may exceed the external costs

Question 30

What is Regulatory Capture

Answer 30

• When regulatory bodies such as OFGEM (Gas & Suppliers) that oversee the behaviour of privatised monopolies eventually are influenced by the firms they have been set up to monitor
• This is mainly because of the fact that the regulators depend on the existence of dominant firms

Question 31

What is Policy myopia

Answer 31

• When politicians provide short-term fixes to a problem rather than taking long considerations and analysing the full problem
• The risk is that myopic decision-making will only provide short term relief to particular problems but does little to address structural economic problems.

Question 32

What is Political self interest

Answer 32

Pursuit of self interest among politicians can lead to misallocation of resources