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H2 Economics > Government intervention for market failure > Flashcards

Government intervention for market failure Flashcards

1
Q

Taxation

A

Tax: Compulsory payments made to the government on goods, influencing market prices
Effect: internalise external costs in their consumption/production–>Taxes will make them pay for the cost imposed on third parties. This will make external cost become part of their private cost. In this way, the MPC will increase to MPCt.
E.g: Landfill tax. sugar tax, alcohol tax, cigarette tax

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2
Q

Explain Taxation

A

DRAW GRAPH //
1. MPC=MPB ==> consumers only aim to maximise their own welfare
2. Tax=MEC, the amount of tax (tax = EsB) imposed is equal to the marginal
external cost incurred at socially optimum output Qs.
3. Effect==> increase the COP, MPC–>MPCt. Producers pass on higher costs onto consumer by raising prices from Pm to Ps, causing quantity demanded for good to fall from Qm to Qs.
4. MPCt=MSB (After tax, new market equilibrium) ==> decrease in the free market equilibrium output level to socially optimal output from Qm to Qs.
5. Over-allocation corrected, DWL eliminated

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3
Q

Taxation targets?

A
  1. negative externalities
  2. Demerit Goods
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4
Q

Strengths of Taxation

A
  1. Tax revenue to finance other projects, infrastructure, fiscal policy
  2. Low cost of enforcement: the government can simply allow market forces to operate to achieve the social efficient outcome without much enforcement.
    3.Financial incentive for behavioural changes if tax is levied on pollution rather than the product e.g. Spur firms to adopt new technologies to reduce negative externalities
  3. Reduces the demand for the good and level production if -ve externality is internalised
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5
Q

Limitation of taxation

A
  1. Difficult to accurately value external costs:
    imperfect information->may still be allocatively inefficient after tax
  2. Effectiveness restricted by PED:
    For price inelastic goods, higher tax required to achieve desired reduction in output-> may not be a politically viable option. Penalises firms in countries with such a system ⇒ Less competitive in the global market (esp for pollution, carbon tax)–>increases cost of living
  3. ↑ Taxes ⇒↑COP ⇒↑P of G&S ⇒ Inflation + ↓ Export competitiveness
  4. Firms may choose to relocate and sell their goods abroad to avoid the indirect taxation. This would remove their contributions to the economy, such as the payment of tax and the provision of employment, contraction to economy

Transition statement: Does not address root cause of imperfect information –>public education

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6
Q

Subsidies

A

Subsidy: given to producer-> lower COP by government absorbing cost->encourage higher level of production

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7
Q

Explain subsidies

A
  1. MPC=MPB ==> consumers only aim to maximise their own welfare
  2. Subsidy=MEB, the amount of subsidy (subsidy = EsA) imposed is equal to the marginal
    external benefit at socially optimum output Qs.
  3. Effect==> decrease the COP, MPC–>MPCt. Producers pass on higher costs onto consumer by raising prices from Pm to Ps, causing quantity demanded for good to fall from Qm to Qs.
  4. MPCt=MSB (After tax, new market equilibrium) ==> decrease in the free market equilibrium output level to socially optimal output from Qm to Qs.
  5. Over-allocation corrected, DWL eliminated
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8
Q

Subsidies targets?

A
  1. positive externality
  2. merit goods
  3. income inequality
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9
Q

Strengths of subsidies

A
  1. Reach specific target beneficiaries directly and reduce inequity:
    Those who cannot afford e,g education and healthcare–> equal opportunities and access to goods –>reduce price , more affordable, increase demand
  2. Easily implemented:
    Allows market forces to operate and flexibility to adjust subsidies, less government monitoring
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10
Q

Limitations of subsidies

A
  1. Difficult to accurately value external benefit:
    imperfect information->may still be allocatively inefficient after tax
  2. Effectiveness restricted by PED:
    For price inelastic goods, a larger subsidy is required to achieve desired increase in output and lower price to socially optimal level.
  3. High cost of financing and opportunity cost incurred. increase in taxes. This can discourage investments or cause a reduction of spending in other important public projects. Thus, a high opportunity cost in the form of other public projects may be forgone
  4. over reliance + wastage of resources
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11
Q

Direct Government Provision

A

Government supplies all of the good/service for free funded through taxes as the free market does not provide public goods

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12
Q

Direct Government provision targets?

A

Public goods

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13
Q

Advantages of DGP

A

Solves missing market problem

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14
Q

Disadvantages of DGP

A
  1. Lack of profit motive ⇒ May be X-inefficient
  2. Difficult to measure the social benefits and social costs since it displaces the price mechanism → no signalling function
  3. Need to estimate value of the good to consumers via cost-benefit analysis in order to decide how much of the good to produce
    Estimate through surveys/votes → However, not very accurate as consumers do not have to pay for it ⇒ May over declare the benefit to them
  4. Needs to be financed through tax revenue ⇒ Opportunity costs
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15
Q

Nationalisation

A

Nationalisation is the process whereby the government take over the ownership of the firms in the industry and have direct control on the operation of the firms.

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16
Q

Target? Explain Nationalism

A
  1. Market dominance
  2. The government will be able to provide the fund needed to cover the subnormal profit and allow the firms to continue production of the good ==>prevent the retrenchment of workers.
    - In addition, the nationalised firms can be merged and they will be able to reap more EOS, the cost-saving allows the firms to price their goods at a competitive price level so as to better compete with foreign good producers and re-capture some of the global demand==>which will increase their revenue==> reducing the sub-normal profit in the LR.

OR
the objective to profit maximise, the government takes over the production of the good and produce at the socially optimum level where P=MC, hence results in greater allocative efficiency as compared to profit motivated free market.

17
Q

Advantages of nationalism

A

1.Control over supply of goods (can produce at allocatively efficient output)
2. Control over quantity, quality and affordability
3. Where there are high barriers to entry due to high startup costs ⇒ Private firms unable to undertake such production during initial years of heavy losses
4. Due to social/political reasons e.g. production of notes, weapons, nuclear fuels which are of strategic importance

18
Q

Disadvantages of nationalism

A
  1. Lack of profit motive ⇒ May be X-inefficient, remove the incentive for the firms to R&D or to seek for more cost-efficient method of production
  2. Needs to be financed ⇒ Opportunity costs
19
Q

Government regulation

A
  1. Quota
  2. Banning
  3. Tradable permits
  4. Quality standards
    AIM: correcting behaviour
20
Q

Quota

A

Quotas are a fixed quantity of a particular good which can be
produced under official regulations.

21
Q

Explain Quota

A
  1. Impose limit on quantity produced at socially optimal output level, OQs where MSB=MSC
  2. Lowers output level from free market equilibrium output level to socially optimal output level
  3. Eliminates deadweight welfare loss
  4. draw graph\I: When demand increases from DD1 to DD2, the price of the good will
    also increase accordingly from P1 to P2 due to the operation of market forces.
  5. e.g In the context of Singapore, government determines the number of
    COEs to be issued and car owners are expected to bid and buy a
    COE in order to own a car.
22
Q

Quotas targets?

A

Goods with negative externality

23
Q

Advantages of Quota

A
  1. immediacy of effect
  2. predictability of outcome -> clear and easy to follow, greater certainty than taxes
24
Q

Disadvantages of quota

A
  1. Displaces price mechanism ⇒ Price no longer performs signalling function
  2. Government needs to predict socially optimal output level
  3. However, Imperfect info → Difficult to determine socially optimal level ⇒ May still be allocatively inefficient if quota greater/lower than socially optimal output level
  4. No market-based incentives to reduce below quota
  5. Difficult to enforce + High costs for enforcement
  6. Politically unpopularPenalties must be sufficiently harsh
25
Q

Bans

A

Define: legal prohibition of good. Reduces output of the good/service to 0
E.g e-cigarette, shisha-smoking and selling of chewing gum are completely banned in Singapore

26
Q

Explain ban

A

no external cost will incur on third party since smoking shisha generates extremely high external cost==>addresses market failure due to over-smoking of shisha by reducing consumption to 0=Qs
DRAW GRAPH

27
Q

Ban targets?

A
  1. negative externalities
  2. demerit goods
28
Q

Advantages of ban

A
  1. Easy to implementGreater certainty
  2. Allocatively efficient if MSC is so high/MSB is so low that MSB=MSCat output of 0
29
Q

Limitations of a ban

A
  1. High costs for enforcement
  2. Possible for rules to be side stepped
  3. Displaces price mechanism ⇒ May lead to formation of black marketMay be allocatively inefficient as unable to reap marginal social benefits
30
Q

Tradable permits

A
  1. Impose quota on total permits in the market at socially optimal output level of pollutants
  2. Lowers output level from free market equilibrium output level to socially optimal output level
  3. Eliminates deadweight welfare loss
  4. Permits can be traded among firms
  5. Extra permits sold by firms to firms that require more permits
  6. Penalises buyer and rewards the seller
  7. Price of permits determined by market DD and SS (set by no. of permits⇒ perfectly price inelastic supply)
31
Q

tradable permits targets?

A

Negative externalities (pollutants)

32
Q

Advantages of tradable permits

A
  1. Flexibility in progressively changing number of permits issued ⇒ No needf or accurate valuation of external costs
  2. Firms with lower abatement cost can sell their permits to firms with higher abatement cost ⇒ Lower costs incurred by society
  3. Abatement cost = Cost of reducing pollution
  4. Greater certainty than taxes
  5. Incentive for firms to reduce pollution further through R&D
33
Q

Disadvantages of tradable permits

A
  1. External costs may be underestimated ⇒ No. of permits too high⇒ Permits underpriced ⇒ Little incentive to reduce output
  2. Makes market less competitive → Favours bigger firms which have the ability to pay for permits + Availability of funds to invest in environmentally friendly production technology
  3. Imperfect info → Difficult to determine socially optimal level
  4. Difficult to distribute in a fair way
  5. Difficult to enforce + High costs for enforcement
  6. Politically unpopular
  7. Penalises firms in countries with such a system ⇒ Less competitive in the global market==> Penalties must be sufficiently harsh
34
Q

Public education

A

-For imperfect info: Raise awareness of true costs/benefits to individual
-For externalities: Knowledge of externalities does not affect consumers’ choices as they still only pursue self interest
-Change mindset of individual to care more about social outcomes
-Appeal to firm’s/individual’s sense of social responsibility
-Change consumers’ taste and preferences to/away from good/service
-Encourages/discourages demand for the good/service towards DD under perfect info
-Corrects under/overconsumption of the good
-Reduces deadweight loss

35
Q

Public education targets?

A
  1. Goods with externalities
  2. Merit/Demerit goods (imperfect info)
36
Q

Advantages of Public education

A
  1. Long term solution(For imperfect info)
  2. Targets the root of the problem that is imperfect info and changes the behaviour of the individuals themselves
37
Q

Disadvantages of Public education

A

-Difficult to change mindset of some individuals (esp for externalities)
-Expensive
-Requires long time
-Difficulty in collecting and disseminating all necessary info
-Should be used in conjunction with other punitive measures in the short term e.g.Taxes

37
Q

Disadvantages of Public education

A

-Difficult to change mindset of some individuals (esp for externalities)
-Expensive
-Requires long time
-Difficulty in collecting and disseminating all necessary info
-Should be used in conjunction with other punitive measures in the short term e.g.Taxes

H2 Economics (2 decks)

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