Government Intervention in markets - Taxes and Subsidies Flashcards
What is market failure?
Free market fails to allocate scarce resources at the socially optimum level of output
How do negative and positive externalities cause market failure?
Won’t be accounted for in the free market mechanism
Firms want to maximise profit (private costs)
Consumers want to maximise utility (private benefits)
External costs and benefits ignored
How do merit and demerit goods cause market failure
Imperfect information leads to irrational decisions by consumers
How do public goods cause market failure
Free rider problem and profit-motivated firms
How does monopoly power cause market failure
One dominated seller and high barriers to entry
Consumers exploited with higher than socially optimum prices and lower than socially optimum quantities
What are the two types of indirect tax
Specific tax
Ad Valorem tax
What is a specific tax
A fixed amount of tax per unit of good
What is ad Valorem tax
Chared as a proportion of the price
Why are subsidies given
Because there is underconsumption or underproduction of a merit good.
What happens if the government undertakes
Quantity won’t fall to socially optimum
Not internalising externality perfectly
What happens if the government over tax
Very regressive
Firms may shut down
Leads to black markets
What is bad about black markets if there is over taxing
Government lose tax revenue
Quality of good is unknown
Eval for taxation
Assumption government will tax at the right level
Price inelastic demand - tax produced is a hypothecated tax used to further reduce negative externalities
What happens if the government over subsidise
High costs
government failure
Encourages subsidy dependency - inefficient
What happens if the government under subsidise
Market failure has not been solved
