Government Intervention in Markets Flashcards
Direct Provision
Provision of goods and services by the government. Where government can choose to produce the good or fully finance the production of a good but produced by private firms.
Advantages:
Assuming the Govt has total control over the supply of goods, it can directly provide the good up to the socially optimum quantity.
Direct provision may also fulfil other objectives the govt has.
Limitations:
Production by government may be inefficient or of lower quality as they lack the profit motive and may be less experienced in the production of the good. Problem of red tape, such as formalities and routines may lead to slower decision making and waste of scarce resources.
Provision of goods by the government may cause a strain on the government’s budget. In view of the need to meet many competing wants of the society, the government may under-produce the good.
Joint Provision
Government partners with private firms to provide certain goods and services. Sharing of risks and responsibilities to provide quality services to the public whilst maintaining affordability.
Advantages:
Joint provision allows for some risk-sharing between the govt and firm, a well-designed public private partnership will allocate risk to a partner with the greatest incentive and ability to manage it at least costs. Ensuring production of goods and services at the lowest costs to society.
Profit objective of firms is likely to encourage greater efficiency than the public sector. Competitive pressures in private sector encourages cost-efficiency and thus lower prices for consumers.
Disadvantages:
Given the complex nature of PPPs, there are difficulties in negotiating the complicated details and specifications. Thus the project may take a long time to be implemented, given the need to weigh costs to benefits thoroughly.
Given the long duration of contracts, and the difficulty in anticipating all contingencies, some aspects of the PPP may need to be renegotiated at some stage. The Govt therefore will have to bear the costs of contract renegotiation, performance monitoring and enforcement to ensure the private firm delivers a socially optimal outcome.
Taxes /subsidies
The government can impose a tax to correct market failure caused by goods that generate negative externalities.
If the govt imposes a tax per unit output equal to the marginal external cost at Qs, producers will be induced to produce less of the good because of higher MPC. It forces producers to internalise the externality, shifting the MPC upwards, cost of production rises leads to a fall in supply. Resulting in a shortage which causes Qe to fall to Qs.
Advantages:
Given MEC is possible to calculate accurately, the tax rate can be adjusted to changing MEC and hence more accurate in attaining the socially efficient level of output.
The tax revenue collected can be used to fund other projects or interventions which can help to reduce the negative externalities created in the long run, thereby addressing the root cause of the problem.
Firms will be more motivated to find better methods of production to reduce the cost of production and maximise profits. Hence, a tax encourages firms to be more efficient, leading to improved social welfare overtime.
Limitations:
There is difficulty in assessing the monetary value of the external costs. This can lead to over-taxation, which will reduced consumption/production to a quantity lower than Qs, leading to an even greater deadweight loss.
Common tax rates may not be efficient as external costs may differ for different stakeholders. It would be very difficult and costly to administer a different tax rate on each firm or consumer.
If demand for the good is price inelastic, a large tax will be required in order to reduce Qe to Qs. Imposing a large tax may be politically unfavourable and thus taxation may not be the best.
Quotas
A legal restriction on the quantity of goods and services that can be produced in a particular time period.
To prevent over-consumption/production of goods, a government can impose a production quota equal to the socially optimal quantity. This directly solves the market failure as producers are not allowed to produce beyond Qs.
Advantages:
Quota limits the number of good and controls the quantity at the source. It is not subjected to consumers and producers’ responsiveness to price changes, so the outcome of the policy is more certain.
Limitations:
Quota usually means that a shortage will occur in the market. This will result in an upward pressure on prices. While Qs is met, this may create problems of equity as only the richer segments of society can consume the good.
Tradable Permits (in pollution contexts)
A tradable permit gives a firm the right to emit a specific quantity of pollution to the environment. Ideally, the number of permits corresponds to the level of pollution that is admissible at Qs.
Permits are sold to highest bidders, price determined by DD and SS. Firms that are able to reduce their level of emissions below the stipulated amount can sell their remaining unused permits for cash. Firms that pollute more will be required to buy more permits to sustain their higher emission level.
Advantages:
The government can simply set the total amount of permitted emissions to the Qs level, without requiring additional information about specific costs or benefits.
The information and incentives generated by the market exchange of permits automatically leads to a desirable solutions where firms most responsible for polluting will undertake most of the costs.
All firms will have an incentive to develop and install the pollution control equipment. Those firms which are able to reduce the level of their emissions below the stipulated amount could sell their remaining unused permits.
Limitations:
Larger firms may simply purchase permits to pollute without actively reducing their emissions, leading to a concentrated pollution in certain areas. Compromising the well-being of residents in the area.
Government will need to invest in equipment to measure the emission of each firm, so as to ensure that they do not emit beyond the amount allowed by the tradable permits. This adds strain to govt budget.
Rules and Regulations
The use of legal intervention (such as a total ban) to force consumers and producers to behave in certain ways, and produce a more desirable economic outcome than that achieved by free market.
Advantages:
R&R are simple and clear to understand and are often straightforward to administer. For laws to be more effective, penalties for breaking them can be made sufficiently harsh and inspections made more frequent.
When negative impacts are significant, it might be much safer to ban the good altogether rather than relying on other measures.
Limitations:
R&R may be difficult to change when the MEC or MEB changes over time. Such changes requires legislative approval, which can take a long time due to political disagreements.
For R&R to be effective, enforcement measures must be adequate. However, enforcement measures, especially in large countries, can be costly and this can lead to a greater deadweight loss.
Provision of Information and Public Education
Government can provide information to help consumers and producers value the actual cost and benefit of a good or service.
Advantages:
Provision of information addresses the root cause of the problem. By correct the source of the problem, it can prevent the problem from persisting in the future, and the provision of information then serves as a longer-term solution.
Provision of information merely provides market participants with better information but does not artificially distort the workings of the free market.
Limitations:
Outcome of information campaigns is uncertain. This is because mindsets can be difficult to change, and thus campaigns may take a long time, if ever, to be effective.
Information campaigns which are usually prolonged uses scarce resources which could have been put to better use elsewhere.
Government Failure (need to know)
A situation where government intervention leads to greater market inefficiencies than would otherwise occur without it.
Problems of Information
A lack of information about the true value of the external cost makes it very difficult for a government to impose the correct value of a tax that attempts to reduce production to the Qs level. Time lag may also render the information inaccurate and outdated, leading to an inaccurate level of tax.
A lack of information about level of consumer demand may lead to a government engaging in directly providing too much or too little, resulting in inefficiency.
Costs of Government intervention
All forms of intervention uses scarce resources and hence there are costs to society carrying out these measures. Costs of administering the law, may fail to correct the market failure efficiently due to bureaucracy and red tape. Which leads to slower decision making and waste of scarce resources. Hence, Government failure arises.
Lack of Market Incentives
Government intervention may lead to a fall in market incentive. An inappropriate amount of subsidy may actually allow inefficient firms to survive or welfare payments may discourage work effort. Resulting in an even greater deadweight loss to society in the long run.
Political Objective of the Government
The government may interfere in the market despite the lack of any real need to do so because of political objectives to achieve.
This results in inefficiency and runs counter to the optimal level that could have been attained by market forces.
