Government intervention MICRO Flashcards
Policies to correct market failures from Negative Production externalities
- Government regulation
- Imposing a tax on output
- Imposing a tax per unit of pollutants
- Tradeable pollution permits
Policies to correct market failures from Negative Production externalities - Govt. regulation
In the case of a polutting firm, regulations can forbid the dumping of certain toxic substances into the enviroment.
- They can limit the qauntity of output produced by the polluting firm.
- Limit the emission of pollutants by setting a maximum level of pollutants permitted.
- Require polluting firms to install technologies reducing emissions.
Policies to correct market failures from Negative Production externalities - Tax on output
This is intended to work by directly correcting the overallocation of resources, resulting in a socially optimal level of production.
- This tax is imposed on the producer, therefore there is a upwards shift in the marginal private cost curve, because the firm now faces higher CoP.
- The new after tax equilibrium is shown where the demand curve inersects MSC resulting in a lower optimal quanitity produced and higher price at Popt.
- The optimal size of the tax is the distance between the MPC and the MSC, this ensures firms pay the full external costs of production.
- The welfare loss, shown on the diagram is therefore eliminated.
Policies to correct market failures from Negative Production externalities - Tax on emissions
Following the imposition of the tax there is an upwards shift in S=MPC toward MSC because of the firms higher costs of production.
- Since there are other subsitute energy sources with lower carbon or no carbon emissions that arent taxed, firms will switch production to thisese. This is the subsitution effect.
- As a result the MSC curve moves downwards to MSC2 as firms can now produce the same level of output while generating external costs and avoiding tax.
Policies to correct market failures from Negative Production externalities - Cap and trade schemes
The government can grant particular firms permits to produce a particular levels of pollutants over a given time period. These permits can be brought and sold between firms.
- The supply of the permits is fixed at a particular level by the government.
- The demand for permits curve is determined by the firms level of emissions.
Policies to correct market failures from negative consumption externalities
Government regulation -
- banning
- Remove smoking/drinking in public places
- Age restrictions
Advertising -
- Cover cigarettes
- Negative advertsiment on packets
Policies to correct market failures from Negative Consumption externalities - Indirect tax
The imposition of an indirect tax is charged initially to the producer of the good, this causes the MPC curve to shift inwards from S=MPC to MPC + tax because of the increase in CoP. Assuming the tax equals the external cost, the MPC curve will now intersect the MPB curve at Qopt. The equilabrium price paid by the consumer rises from Pm to Pm + tax and quanitity consumed falls to Qopt.
- An indirect tax internalises the cost of the externality, the consumer pays a higher market price for the external costs generated from consuming the good.
Advantages of tradable permits
- Since the government caps the number of permits, it is guaranteed that pollution will fall to the targets set by the government. This will maximise social welfare.
- The government can raise revenue by selling permits and by fining firms who exceed their pollution limit.
- This encourages companies to use and invest in green technology.
Disadvantages of tradable permits
This can be expensive to monitor and police , but it will only work if it is monitored well. The government needs to impose fines that are large enough to ensure firms follow the regulation.
- It will raise costs for businesses, and it is likely that these higher costs will be passed onto consumers
- It may be difficult to know how many permits the government should allow.
Why are taxes on emissions better than taxes on output?
Taxes on emissions incentivises firms to diversify and moce production to renewables or energy sources that dont emitted carbon.
Disadvantages to tax on negative production externalities
- Difficult to quantify the external costs and find the right tax to equal the value of the external costs of pollution.
- There is a risk that even if taxes are imposed some polluting firms may not lower their pollution levels, continuing to pollute even if they have to pay tax, pariculary prominant amonst larger firms that can bare the extra costs.
- Allocation of permits to polluting firms is difficult, working out what different firms deserve, issues of political favouritism may come into play, as governments gover preferntial treatment to some over others.
Advantages of regulation on negative production externalities
- They have the advantage that they are simple compared to market-based solutions and can be implemented more easily.
- They force polluting firms to comply and reduce pollution levels, which taxes may not always do.
Diadvantages of regulation on negative production externalities
- They do not allow the externality to be inernalised, regulations create no market-based incentive, this means…
- They are unable to make distinctions between firms that have higher or lower costs of reducing pollution.
- Unable to lower the size of the externality or incentives firms to use less polluting resources and therefore mean they diversify to less polluting methods.
- Issues with policing and costs that come with enforcement.
Evaluating policies to correct negative consumption externalities
- Difficult to measure the value of the external costs of consuming a good, so its not always easy therefore for governments to fully correct the externality.
- Inelastic demand, smoking for example is a addictive good which means its price inelastic, just because the price of a good rises does not mean that consumption will fall.
- Indirect taxation may cause consumption ton shift towards underground markets, regulation therefore may be more beneficial in this case.
- Regulation isnt price sensitive and therefore the elasticity of demand is irelavent.
- Administrative costs, whereas you gain reveue from tax.
Policies to correct market failures from positive consumption externalities
- Subsidies
- Direct provision
- Regulation
- Advertising or providing infomation
