Government intervention in markets Flashcards
In a free market, how are scarce resources allocated?
Through the price mechanism
Why might a government decide to intervene?
To correct market failure
What are the forms of government intervention? (4) (LPFI)
Legislation and regulation
Provision of goods and services
Financial intervention
Information provision
What is an indirect tax?
A tax on spending
What will a government impose an indirect tax on? Why?
A demerit good
Increases the price of the good, consumers may be unable/unwilling to but
What is a subsidy?
A sum of money granted by the government to lower the cost of production
What will a government grant a subsidy for? Why?
A merit good
Increases production and lowers the cost
How will a government solve market failure associated with public goods?
They will provide these goods, through the use of taxation
How will a government solve market failure associated with negative externalities? (3)
Regulation
Pollution permits
Taxes
How does regulation fix market failure?
If a firm breaks the law, they will be fined, creating an incentive for them to change their behavior
What is a pollution permit?
A permit sold to firms by the government, allowing them to pollute up to a certain limit
How does pollution permits solve market failure?
Creates an incentive for them to pollute less
How does taxed solve market failure?
Increase the cost of production, leading to a socially optimal level of output
Internalizes the externality
How will a government solve market failure associated with a positive externality?
Subsidies
How do subsidies solve market failure?
Increases production, lowers the cost, leading t a more socially optimal level of output
How does information provision correct market failure?
Influences demand by making the consumer more aware of the potential benefits and costs
What does a maximum price do?
Prevents the price from rising above a certain level
Where must a maximum price be set for it to be effective? Why?
Below the equilibrium price
Creates excess demand
When will a maximum price be used? (2)
Monopolies
Merit good
What does a minimum price do?
Prevents the prices falling below a certain level
Where must a minimum price be set for it to be effective? Why?
Above the equilibrium level
Creates excess supply
When will a minimum price be used? (2)
Demerit good
Improve income of farmers
What are buffer stocks?
Governments manipulate the free market price to stablilise price
What markets often use buffer stocks?
Agricultural
In a buffer stock if supply shifts to the right, what will the government do?
Buy up the excess supply
In a buffer stock, if the supply shifts to the left, what will the government do?
Sell some of the buffer stock back to the farmers
How can a government solve market failure associated with a monopoly? (3)
Maximum price
Regulation - nationalisation
Make the market more competitive
How can a government solve market failure associated with redistribution of income?
Offer more benefits to the poor
Tax a higher % of the rich
What is government failure?
Government intervention to correct a market failure creates leads to a misallocation of scarce resources
What are the causes of government failure? (3)
Political self interest
Policy myopia - short term fixes
Regulatory capture
What is regulatory capture?
When industries under the control of a regulatory body appear to operate in favour of the interest of the producers rather than consumers
