Government intervention in markets

Question 1

In a free market, how are scarce resources allocated?

Answer 1

Through the price mechanism

Question 2

Why might a government decide to intervene?

Answer 2

To correct market failure

Question 3

What are the forms of government intervention? (4) (LPFI)

Answer 3

Legislation and regulation
Provision of goods and services
Financial intervention
Information provision

Question 4

What is an indirect tax?

Answer 4

A tax on spending

Question 5

What will a government impose an indirect tax on? Why?

Answer 5

A demerit good

Increases the price of the good, consumers may be unable/unwilling to but

Question 6

What is a subsidy?

Answer 6

A sum of money granted by the government to lower the cost of production

Question 7

What will a government grant a subsidy for? Why?

Answer 7

A merit good

Increases production and lowers the cost

Question 8

How will a government solve market failure associated with public goods?

Answer 8

They will provide these goods, through the use of taxation

Question 9

How will a government solve market failure associated with negative externalities? (3)

Answer 9

Regulation
Pollution permits
Taxes

Question 10

How does regulation fix market failure?

Answer 10

If a firm breaks the law, they will be fined, creating an incentive for them to change their behavior

Question 11

What is a pollution permit?

Answer 11

A permit sold to firms by the government, allowing them to pollute up to a certain limit

Question 12

How does pollution permits solve market failure?

Answer 12

Creates an incentive for them to pollute less

Question 13

How does taxed solve market failure?

Answer 13

Increase the cost of production, leading to a socially optimal level of output
Internalizes the externality

Question 14

How will a government solve market failure associated with a positive externality?

Answer 14

Subsidies

Question 15

How do subsidies solve market failure?

Answer 15

Increases production, lowers the cost, leading t a more socially optimal level of output

Question 16

How does information provision correct market failure?

Answer 16

Influences demand by making the consumer more aware of the potential benefits and costs

Question 17

What does a maximum price do?

Answer 17

Prevents the price from rising above a certain level

Question 18

Where must a maximum price be set for it to be effective? Why?

Answer 18

Below the equilibrium price

Creates excess demand

Question 19

When will a maximum price be used? (2)

Answer 19

Monopolies

Merit good

Question 20

What does a minimum price do?

Answer 20

Prevents the prices falling below a certain level

Question 21

Where must a minimum price be set for it to be effective? Why?

Answer 21

Above the equilibrium level

Creates excess supply

Question 22

When will a minimum price be used? (2)

Answer 22

Demerit good

Improve income of farmers

Question 23

What are buffer stocks?

Answer 23

Governments manipulate the free market price to stablilise price

Question 24

What markets often use buffer stocks?

Answer 24

Agricultural

Question 25

In a buffer stock if supply shifts to the right, what will the government do?

Answer 25

Buy up the excess supply

Question 26

In a buffer stock, if the supply shifts to the left, what will the government do?

Answer 26

Sell some of the buffer stock back to the farmers

Question 27

How can a government solve market failure associated with a monopoly? (3)

Answer 27

Maximum price
Regulation - nationalisation
Make the market more competitive

Question 28

How can a government solve market failure associated with redistribution of income?

Answer 28

Offer more benefits to the poor

Tax a higher % of the rich

Question 29

What is government failure?

Answer 29

Government intervention to correct a market failure creates leads to a misallocation of scarce resources

Question 30

What are the causes of government failure? (3)

Answer 30

Political self interest
Policy myopia - short term fixes
Regulatory capture

Question 31

What is regulatory capture?

Answer 31

When industries under the control of a regulatory body appear to operate in favour of the interest of the producers rather than consumers